Associated Banc-Corp (ASB) 2011 Q3 法說會逐字稿

Good afternoon and welcome to Associated Banc-Corp's third quarter 2011 earnings conference call. My name is John and I will be your operator today. At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session at the end of this conference.

As a reminder, this conference call is being recorded. During the course of the discussion today, Associated management may make statements that may constitute projections, expectations, beliefs or similar forward-looking statements.

Associated's actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional detailed information concerning the important factors that could cause Associated's actual results to differ materially from the information discussed today is readily available on the SEC website in the risk factors section of the Associated's most recent Form 10-K and any subsequent Form 10-Q.

Following today's presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded Thursday, October 20, 2011. At this time I would like to turn the conference over to Philip Flynn, President and CEO, for opening remarks. Please go ahead, Sir.

Thank you, John. Welcome to our Third Quarter conference call. Joining me today are Joe Selner, our CFO; Scott Hickey, our Chief Credit Officer, and our recently appointed deputy CFO, Chris Niles. This afternoon I'll begin by reviewing our results for the Quarter and then update you on what is going on with our businesses. I will begin by pointing out a few highlights from our Third Quarter results on Slide 2.

We reported net income to common shareholders of $34 million or $0.20 a share. This compares to net income of $26 million or $0.15 a share for the Second Quarter, a 33% increase. Our loan portfolio grew 3% to $13.5 billion during the Quarter, with solid growth from each of our major segments, including commercial, commercial real estate and residential mortgage. We continue to see the results from the investments we are making in these areas.

Consistent with our strategy to fund loan growth through runoff of the securities portfolio, net interest from income grew quarter-over-quarter while securities income continued to contract. The net interest margin for the Quarter was 323 basis points, down 6 basis points from last Quarter. This was driven by a compression of yields on earning assets, partially offset by a decline in costs of non-brokered deposits and partially reflecting the effect of our TARP refinancing.

We're pleased with the ongoing improvement in our credit quality indicators including a 14% decline in non-accrual loans during this Quarter. Non-accrual loans of $403 million are at the lowest level in 7 quarters and represent 3% of total loans down from 3.6% last Quarter.

We recorded a provision for loan losses of $4 million, less the net charge-offs of $30 million. The lower provision and reserve release were driven by the continued ongoing improvement in the credit quality of the loan portfolio. Despite this lower level of provision, we note that our overall allowance for loan losses now covers essentially 100% of period-to-end non-accrual loans.

Our capital ratios remain very strong, even after our repayment of TARP, with Tier 1 common ratio of 12.44% and a total capital ratio of 15.81% at September 30. As you know, we completed repayment of our remaining TARP funds in September through a secondary senior note offering and a preferred stock offering. This action was in line with our prior commitment to exit TARP in a shareholder-friendly manner.

If you go to Slide 3 you will see some information on our loan portfolio. As mentioned, the Company's portfolio grew to $13.5 billion at September 30. This was up $414 million from June 30, representing a 3% quarter-over-quarter growth rate and a 9% year-over-year growth rate. The total commercial lending portfolio grew by a net $306 million, while our retail and residential mortgage portfolio grew by a net $108 million.

For the Quarter, we increased commercial and business loan balances by a net $198 million and commercial real estate loans by a net $108 million. Within the $4.5 billion commercial and business lending portfolio, our specialized group accounted for the majority of the growth, including about $70 million of mortgage warehouse financing, which was driven by the current levels of mortgage refinancing activity.

The commercial real estate lending portfolio grew by $108 million to $3 billion. We're working with strong regional developers and continue to see opportunities for growth and expansion in CRE lending. We're seeing positive results from the new CRE offices in Indianapolis and Cincinnati. Additionally, this past Quarter we've added commercial bankers to the team in Indianapolis in order to provide full relationship banking.

The retail and residential mortgage portfolio grew by $108 million, or 2%, to $6 billion at the end of the Quarter driven by production volume due to historic low rate environments. We continue to be the leading mortgage originator in the state of Wisconsin, but we anticipate a slower pace of net growth for the fourth quarter of the year.

Competitive pressures continue to be seen throughout the footprint contributing to the decline in our average yield for loans. But, as we stated, we will continue to be competitive where we see an opportunity to expand the client relationship through the offering of other products and services. Our investments in key hires in our treasury management segment is 1 example of our commitment to supporting full relationship banking at Associated.

Our long-term risk appetite calls for the portfolio to be roughly balanced in thirds. Today it remains somewhat overweighted on consumer assets and somewhat underweighted on the commercial real estate side, primarily due to the significantly reduced levels of construction lending. We're pleased with our lending activity this Quarter, and continue to expect a moderate pace of loan growth in the range of 2% to 3% for the coming Quarter.

Moving on to deposits on Slide 4, net customer deposits and funding of $15.7 billion at the end of the Quarter were up 5% from $15 billion at the end of the second quarter. We continue to focus on growing core customer funding and reducing brokered CDs and network deposits.

Net deposit growth was primarily driven by a $493 million, or 15%, increase in demand deposits and a $223 million, or 5%, increase in money market deposits during the Quarter. About half of the run-up in DDA reflects end-of-quarter rebalancing activity by our commercial and trust customers, and while we expect a significant portion of that liquidity to flow out in the Fourth Quarter, we're nonetheless encouraged by the continuing positive trends.

Through our focus on growing core customer funding, we have decreased our costs of money market deposits by 22 basis points, or 44% year-over-year, by reducing our reliance on higher cost brokered network deposits.

Third Quarter net interest income was $153 million, declining by $1 million from the prior quarter. Consistent with the Company's strategy of funding loan growth primarily through securities runoff, net interest income from loans grew quarter-over-quarter while securities income continued to contract.

The Third Quarter net interest margin was 323 basis points, down 6 basis points from the prior period. Yields on earning assets compressed by 12 basis points quarter-over-quarter, while the cost of interest-bearing deposits, excluding brokered CDs, declined by 6 basis points. This contributed to the net 6 basis point reduction in overall net interest margins.

For the balance of the year, we believe margin will be impacted by the current rate environment but, we expect to sustain the current margin at about these levels. Non-interest income for the quarter was $72 million, up $7 million, or 11%, from the second quarter.

The improvement was primarily driven by increases in mortgage banking income, which benefited from a $5 million increase in income, as a result of higher mortgage production, as well as $2 million from lower valuation expense on mortgage servicing rights. Non-interest income was also impacted by reduced counter-party allowances on our customer derivatives positions, although this was largely offset by lower valuations on other investments.

Service charges on deposit accounts at $20 million were also relatively flat. However, regulatory changes coupled with changes in checking related product fees and customer behavior will continue to have a impact on fee-based revenue during the Fourth Quarter. During the Fourth Quarter the impact of the Durbin amendment will be about $4 million, and we anticipate the annualized gross revenue impact from the final decision will be $17 million to $19 million.

We're exploring various strategies to simplify and rebalance our fee structures in light of the regulatory changes, and will be rolling those out in the Fourth Quarter. Our outlook assumes we will continue to see refi activity continuing into the Fourth Quarter and that increased mortgage banking revenues will also partially mitigate the pressure on fee revenues.

Total non-interest expense for the Quarter was $162 million, up $3 million or 2% from the Second Quarter, primarily attributable to the increases in personnel and occupancy. Personnel expense increased $1 million as investment in key hires continued and occupancy expense was up $2 million from the second quarter. Our increased occupancy costs partially reflect the effects of our footprint enhancement strategy.

To date, we have deployed new signage to most of our branches and have completed work on 8 branches to conform to our new specifications. Additionally, we have constructed or relocate 4 additional branches. By year end, we expect to complete over a dozen additional remodels and we remain confident that these investments will enhance our returns in these communities for years to come.

We would also note that our foreclosure and OREO expenses decreased during the quarter. However, this benefit was offset by net increases in our unfunded commitments expense. We expect personnel expense will be relatively flat in the Fourth Quarter, while other non-interest expense will increase modestly as we continue to invest in our brand and our footprint.

Moving on to credit on Slides 5 and 6, you will see the continued improvement in your key metrics. Potential problem loans declined to $660 million, down 6% from $699 million for the Second Quarter, and down 42% from $1.1 billion a year ago.

The level of non-accrual loans to total loans continue to improve to 299 basis points from 357 at the end of the Second Quarter. Non-accrual loans were down 14% to $403 million from $468 last quarter, and down 45%, from $728 million a year ago. Non-accruals now stand at the lowest level we've seen in 7 quarters.

The provision for loan losses for the quarter was $4 million, down significantly from $16 million at the prior quarter, and down from $64 million a year ago. The key drivers of the provision expense were net charge-offs of $30 million, down 32% from $45 million from the prior quarter.

The accruing TDR allocation decreased $3 million, due to lower impairment on the retail portfolio. We released $22 million of FAS-114 reserves on non-accrual loans and an additional $1 million in reserves related to a slight decrease in the FAS-5 allocation, due to the positive asset quality migration within the portfolio.

We expect provisioning to trend lower and net charge-offs to remain at around these levels throughout the remainder of the year. We continue to be encouraged by the overall improvement of credit, which we believe is an indication that things continued to improve for our customers.

Our capital ratios are on Slide 7. They remain very strong, even after our recent repayments of the remaining TARP funds. Capital levels continue to remain well in excess of regulatory benchmarks and what will be expected under Basel 3.

Finally, we just celebrated the 150th anniversary of Associated at the downtown Neenah, Wisconsin branch. This branch is the oldest location in our Company's family tree, dating back to 1861 as the first National Bank of Neenah.

First National Bank of Neenah was 1 of the 3 founding banks in northeast Wisconsin that formed Associated in 1970. We're proud to celebrate this milestone as we look forward to the future of Associated. Thank you, and now we'll open it up for your questions.

(Operator Instructions) And we'll take our first question coming from Terry McEvoy from Oppenheimer. Please go ahead, Terry.

Thanks, good afternoon. I wonder if you could talk about the opportunities in Wisconsin and Milwaukee for just hiring any employees that are maybe looking for a new home given some consolidation in that marketplace. Is that window still open? I know you provided some numbers on the last call in terms of hiring. Any updates there would be appreciated.

Sure, Terry. Yes, we continue to always look for high quality people who can help us grow the Company, and the window that you referred to in Milwaukee remains open. We've hired, as I think I've said before, at this point more than 100 people, most of those in customer-facing rolls from M & I Bank. And we continue to believe that over the coming quarters the potential disruption that we'll see from the integration of that bank will give us opportunities both on the hiring front but most importantly an opportunity for us to grow our own business.

And then, just a second question. Is it too early to think about buy backs, increases in dividends? I know the third quarter you took care of TARP. Is there another window there or is there a gap that needs to happen before you kind of have those types of conversations with the appropriate people?

Yes, we have said publicly we will be reviewing our dividend policy and so we'll be taking a look at that prior to the end of the year.

Great. Thanks, Phil.

Sure.

Thank you, sir, we'll take our next question from Chris McGratty from KBW. Chris, please go ahead.

Good morning, guys -- or good afternoon, I should say. In terms of Durbin, you gave the revenue numbers, how much you are going to be able to mitigate. I know it's a little early, but as you get in to 2012, what percentage ballpark do you think that you guys could offset?

Yes, Chris, we're still in the process of deciding how we're going to respond to this. So I'm just not prepared right now to hazard a guess as to what we might be able to mitigate. We're committed with whatever we do to ensure that we deliver a valuable service to our customers and that we get paid a fair and reasonable price for that. So we are looking at all of the different ways that we price our services to customers, and certainly we're mindful of the fact that a significant amount of revenue that we used to receive from interchange fees has gone away because of Durbin and we need to do what we can to be sure that we're receiving a fair amount of revenues for what we're providing, but we'll roll out more detail on exactly what we plan to do in this coming quarter.

Okay. Great. In light of the -- in the revenue pressures of the industry, you guys are investing quite a bit of the branch, refurbishment initiative, how much of the expenses are kind of in the numbers versus a step-up rate kind of going forward?

Yes, we'll provide more guidance as we get into January and talk about 2012, but we're in the first year of a 4-year project, so certainly the expense of what we're planning to do, particularly with our branch refurbishment, is not yet completely reflected in our numbers.

Okay. That is helpful. Lastly on the provision you guided at least the lower dollar amount going forward, is there a chance it goes negative?

There is a chance it goes negative, yes.

Okay.

I've said before I'm not a huge fan of that, but the reality is accounting rules and the rapid improvement in the portfolio could result in that.

Okay. And then last, the growth number you gave, that was an unannualized number, the 2%?

Yes, that is 2%, that is quarter over quarter. We've grown about 9% year over year. We've grown -- we grew about 4% I recall first the second quarter, about 3% second to third quarter. We're anticipating 2% to 3% fourth quarter.

Helps a lot. Thanks a lot.

Sure.

Okay. Thank you. And we'll take our next question from Emlen Harmon from Jefferies. Please go ahead with your question.

Thanks, good evening. Just maybe a follow-up to the question on expenses and understanding the ramp there. You guys talk of just kind of the -- on the branch side, investment side of things there. Could you talk too about specialty lending where you are on the hiring front there and how we think about expenses ramping up in that part of the business as well?

Sure. A component of the growth that you saw in our commercial and business lending segment came out of our specialized lending area, in fact about $140 million of that growth; $70 million of that was out of the mortgage warehouse, so that's not long-lived outstandings, it is driven by refi activity out there in the broker world. We have hired the vast majority of the people that we need in our specialized lending group, so there isn't a whole lot more hiring we have to do there. A part of our specialized lending group, however, is the commercial deposit and treasury management area. We hired a new head of that. We hired a number of new people there, but there is some more hiring to do in treasury management. Overall, we're up to just over $0.5 billion of outstandings in the specialty lending areas. As I said, a pretty good chunk of that is mortgage warehouse, about $240 million actually, so we're getting steady but not unreasonably rapid growth there, which is what we planned for.

Got you. So it sounded like at least from a salaries perspective you're getting closer to a run rate at least and then is there a variable component to just comp on that side of the business, and as you see that grow more does that come into play at all?

Well, there is a variable comp component to almost all of our customer facing relationship managers, so, sure.

Okay. And then just--

We accrue for that along the way. So whatever incentives we plan on paying for this year's performance in January have been accrued. They're in the numbers.

Got you. Okay. And, again, just touching on the dividend, you said you were going to take a look at your policy in the fourth quarter. Does the outstanding fed (inaudible) effect your approach there at all or is that not much of a concern?

We're in constant contact with the fed and so whatever plans we would have around any capital activities, including the dividend repayment, we would run by them as a matter of course. So I'm not real concerned about that right now.

Okay. Great. Thanks for taking my questions.

Sure.

Okay. Thank you. And we'll take our next question from Jon Arfstrom from RBC Capital. Jon, please go ahead. Your phone may be muted. We opened up Jon Arfstrom's line.

Can you hear me?

Yes.

All right. Good afternoon. Question on loan growth. Phil, you talked about how a lot of the growth had come from the national businesses and you said that $70 million was increase in warehouse. Where else did it come from, maybe geographically or type other than the warehouse growth?

Sure, so let me run through where the loan growth came from, if you want. First of all on the commercial and business lending side, we had to call it $200 million of growth there. So about $138 million of that came out of the specialized groups of which $70 million was from the mortgage warehouse business, about $30 million each from oil and gas and power and utilities, and then the rest from other odds and ends. And then out of our general commercial business we had about $60 million of growth and that was spread out across the three-state footprint. In the commercial real estate area we had $108 million of growth, about $50 out million of Wisconsin, about $30 million out of Illinois, the rest of it in Minnesota, generally speaking in the multi-family area which we have been focussed on. And then our residential mortgage business grew by about $113 million and much of that came out of Chicago, Milwaukee, and then the rest was scattered in other places.

Do you expect the mix to be similar in Q4, meaning will it be as warehouse-heavy or do you expect other drivers in Q4?

Yes, we think the warehouse outstandings will start to tail off. We're already seeing our own origination pipeline slowing quite a bit this past couple weeks. I'm sure that's the case with our broker customers. So I think by the time we get to the end of this quarter you'll see the warehouse outstandings come down. But that aside, we would expect to get good solid growth in each of the 3 areas. We continue to have a very strong pipeline in the commercial real estate business and the combination of the specialty as well as of course the general commercial lending and small business area will continue to grow, too.

Okay. Good. Just a question on the securities portfolio size, where would you like that to be in terms of overall size?

We continue to allow the securities portfolio to serve as a source of liquidity and funding for our ongoing loan growth and we would expect to see that portfolio to continue to shrink for the next couple of quarters.

That will be the source of funds for lending?

We are presently surprised by some of the inflows we're seeing on the DDA and other fronts as customers are seeking liquidity, but as we look forward we will be looking to continue to look to optimize the cost of our liabilities and expect that we will continue to see the investment portfolio shrink for the next couple of quarters.

Okay. And then, Phil, just one last question for you, I don't know if you want to take a stab at it or not, but in your summary slide, slide 8, you talk about focussing on levers on earning expansion. I think I know some of the answers, are there maybe top 2 or 3 priorities that we should focus on for 2012 and beyond?

Yes, I don't want to get deeply into talking about 2012, but since I kind of opened up the question with the slide, I think you're going to continue to see loan growth. That's very important. If you recall the past at Associated we had about a $16 billion loan portfolio which shrank by $4 billion and is now climbing back to about $12.5 billion. So you should continue to see probably the most important earnings driver being loan growth and, as Chris was just saying, over the coming quarters we'll get to a point where the securities portfolio will probably stick.

Okay.

And then you'll see some ballot sheet expansion driven by loan growth. That's the most important area. Additionally, we'll expect to see pickup in our retail business reflecting the significant investment we're making in refurbishing the branch system out there. Probably later in the year, although we are starting to see pretty encouraging deposit growth, which is, of course, critically important. On the fee side, we've had a lot of headwinds in fees of course, and as we know from Reg E and coming Durbin. So certainly year over year there will be a lot of pressure there. But as I was saying before, we need to figure out appropriate way to get paid for the services we're providing and we will do that.

Okay. Thank you.

Okay. Thank you. I did want to remind anyone on how to queue up for any questions. (Operator Instructions) We'll take the next question from Scott Siefers from Sandler O'Neill. Scott, please go ahead.

Good afternoon, guys. I think most of my questions have been answered, but I guess, number one, so on NII, it looks like we're hopefully reaching that inflection point. Do you think given the ongoing securities portfolio reduction, can we kind of stabilize it in the fourth quarter, is that going to be something we see maybe early next year? How are you thinking about that? You gave good color on the next couple of quarters of securities portfolio decline and on the margins as well but how are you thinking about reaching that inflection point?

Well, I think we're close. Arguably we're there, but within the next quarter or 2 it will be clearly -- clearly we will reach that inflection point. The issue that we have been facing is the plan for funding loans has worked out very well. We expected to be reducing the securities portfolio in order to fund reasonably robust loan growth and that is what we have been doing. What hasn't worked out so well is that we're trading a yield on securities for essentially about the same yield on loans while we expected loan yields to be higher but interest rates have come down so dramatically over the course of the year that it is sort of a wash right now as we trade out of a security and make a loan. So until we get to the point where we're done funding loan growth and start to see some balance sheet expansion it's kind of a struggle to get a lot of NII growth right now.

Okay. I appreciate that. And then I wanted to ask basically the same question on the fee side. You've given a lot of good color on whether it's Reg E or Durbin, but I guess probably the biggest dollar delta over call it the last several quarters has been in the mortgage business. I know a good chunk of that is, for example, provisions of portfolio loans, do you think once we get beyond the fourth quarter and the impact of Durbin should we ultimately be on a steady state on the fee income side are you thinking?

Just for clarity, the portfolio of loans actually reduced our fee income.

Yes, that's what I meant.

So we dampened that fee income trend.

Yes.

Which in part why we alluded to the fact that we expect in the current rate environment where we're not portfolio in any of the fixed rate product despite the slow down, we'll see some lifts in to the fourth quarter from those fees as well. One day we would like to see a steady state, but it's very volatile as you know.

Yes. Okay. I think that is about it. All right. Thank you.

Okay. Thank you. And we'll take our final question at the moment coming from [Erica Pinelli] from Bank of America. Erica, please go ahead with your question.

Hi. Good afternoon. This is Russell Gunther on for Erica. Most of my questions have been asked and answered, but I just have one. Within your early stage delinquency bucket it looks like commercial real estate increased a bit, also a little pick up in the restructured accruing loans in this bucket as well. Can you give us a sense for what for what was going on in this quarter and just how the commercial real estate is performing in general?

Sure. So there are two questions. First of all, the accruing TDR, a little bit of pick up was really a result of the new guidance on how we account for that. There was not any big news in there, Scott, right?

No. On the accruing really it's just -- the accruing loans restructured. It went up slightly primarily as we -- we had looked back 3 quarters to January 1. As we looked back there were about 14 million of loans that we reclassified in to restructuring relatively minor so that was kind of the look back for 3 quarters.

On the 30 to 89 day pick up we've now seen that for 2 quarters. We've done some digging there because we were a little bit concerned about that trend. It turns out that of the, call if $100 million that's in that bucket today, that about (inaudible) is 4 loans, 2 of those have since paid current since the end of September. Another one that was going to be paid off is now being retained and rebooked and will be current. So, as we sit today, I'm not really concerned about that 30 to 89 day bucket. If it continued to trend up for some reason we would certainly be concerned and we will talk about it more in the next call, but I think we're okay there. Overall, the commercial real estate portfolio continues to improve.

Thank you for that. That's very helpful. Just one clarifying question, please. On the loan growth at 2% to 3%, is that end of period or averages?

That's end of period.

End of period loan growth. Okay. Great.

Although the averages have been about that too. We're not getting real spiky stuff at the end. This has been pretty steady throughout the quarters.

Great. All right. Thanks for the help, guys.

Okay. Thank you and I'm showing no further questions in the queue. I'd like to turn the call back to Philip Flynn for closing comments.

Thanks. Thanks for joining us today on our call. We're very pleased with the results from this quarter and despite a soft economy, we continue to see opportunities in our markets to grow our business. We are proud to have delivered on our commitment to our shareholders to repay TARP in a shareholder friendly manner. So we look forward to talking to you again next quarter, and if you have any questions, as always, in the meantime give us a call. Thanks again for your interest in Associated.

Ladies and gentlemen, this concludes the Associated Bank-Corp third quarter 2011 conference call. You may now disconnect.