Associated Banc-Corp (ASB) 2012 Q2 法說會逐字稿

Good afternoon everyone, and welcome to the Associated Banc-Corp second quarter 2012 earnings conference call. My name is Jamie, 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 towards the end of today's conference. Copies of the slides that will be referenced during today's call are available at the Company's website at Investor. Associatedbanc.com. As a reminder today's conference call is being recorded.

During the course of the discussion today associated management, may make statements that constitute projections, expectations, beliefs, or similar forward-looking statements. Associated's actual results could differ materially from those 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 FCC website in the Risk Factors sections of Associated's most recent Form 10-K, and any subsequent Form 10-Q. These factors are incorporated herein by reference. Following today's presentation instructions will be given for the question and answer session.

At this time I would like to turn the conference call over to Philip Flynn, President and CEO, for opening remarks, please go ahead sir.

Thanks, good afternoon. Welcome to our second quarter conference call. Joining me today are Chris Niles, our Chief Financial Officer, and Scott Hickey, our Chief Credit Officer. Highlights from the quarter are outlined on slide two. In general this quarter's performance was in line with our expectations and was marked by improving fundamental trends. We continue to be focused on building upon the strength of our franchise, and capitalizing on opportunities to grow our business.

We reported net income available to common shareholders of $42 million in the second quarter, or $0.24 per share, and that compares to net income of $26 million, or $0.15 a share a year ago. Return on Tier 1 common equity for the quarter was 9.26%, and that's up from a little over 6% a year ago. Loan balances grew by $445 million, or 3% during the quarter with all of the net growth coming from our commercial portfolios. Total loans have grown by $1.6 billion, or 12% from a year ago.

Net interest income was essentially flat compared to last quarter and year end. Despite the continuing record low rate environment, net interest margin was down just 1 basis point compared to the first quarter. We continue to see steady improvement in credit quality metrics and recorded zero provision for loan losses this quarter as the portfolio continues to improve. And during the quarter we repurchased $30 million worth of common stock, and we redeemed $25 million of trust preferred securities, as we remain focused on deploying our capital in a disciplined manner. Even after these two transactions, our Tier 1 common equity ratio remains strong at 12.04%.

On slide three the loan portfolio grew $445 million during the quarter, representing a 3% quarter-over-quarter, and 12% year-over-year growth rate. Second quarter loan growth was driven by continued momentum in the commercial portfolios, as commercial real estate lending grew by $193 million in the first quarter, and commercial and business lending increased by $401 million. The commercial real estate business continues to provide us with opportunities for growth, and we are seeing solid results from across the footprint including opportunities in the newer loan production offices.

Within commercial and business lending, general commercial loans which includes middle market activity grew by $139 million, our mortgage warehouse lending unit grew by $122 million, oil and gas loans by $79 million, power and utility loans by $61 million. The combined retail and residential mortgage portfolio shrank by $149 million during the quarter. Residential mortgage loans were down by a net $50 million, due in part to the sale of $109 million of loans from the portfolio during the quarter. The loan portfolio sale facilitated funding the deposit transfers related to the three branches we sold during the quarter. The retail loan portfolio which includes home equity loans was down $99 million from the first quarter. Home equity balances continue to experience runoff as consumers continue to refinance equity loans into new mortgages The mortgage business continued to perform strongly with mortgage loans originated for sale during the quarter of $738 million,which was up 31% from the first quarter. We have been pleased by the continued strength of our mortgage originations, and while we expect the current trends to moderate, the third quarter will also likely be an active mortgage banking period.

On slide four, average deposits of $15.1 billion were up slightly from the first quarter, and have grown by $1 billion, or 7% from a year ago. Period end checking and savings account balances were up more than 18% from a year ago. However period end deposits were down from first quarter levels, and flat compared to year-end 2011 partly due to the sale of $114 million of deposits in connection with the sale of the branches in rural western Illinois. Deposit volumes were negatively impacted during the quarter, as we continued to allow brokered collateralized public funds, and other high-cost time deposits to run off, consistent with our disciplined deposit pricing strategy. We continue to be focused on gathering commercial deposits through our enhanced Treasury management offerings, and while we are beginning to see signs of improving volumes in our analyzed checking accounts, we still see significant growth opportunities for expanding these services within our existing footprint and commercial customer base.

Second quarter net interest income was flat compared to both the prior quarter and the year ago. The stability is a result of the flat level of earning assets driven by the continued funding of loan growth with runoff from the securities portfolio. While we continue to run down the securities book we expect loan growth should drive an increase in earnings assets in the third quarter. Net interest margin for the quarter was 3.30%, down just 1 basis point. Yields on earning assets have compressed by 20 basis points over the past year, while we have effectively repriced deposits and other liabilities down by 26 basis point, which has enabled us to defend the margin at near the level from full year 2011.

We continue to be very disciplined in our deposit pricing strategies and we expect to be further pricing compression in the CD book, and expect to manage other liability costs lower over the balance of the year. Non-interest income for the quarter was $76 million, down $2 million from the first quarter. On a core basis we saw increases in insurance, card base, trust and brokerage fees, however these improvements offset declines in deposit service charges, capital markets and mortgage banking income.

On a nonrecurring basis we incurred two notable charges during the period. A $6 million noncash impairment on software placed into production during the quarter related to our small business lending unit, and a $3 million net impairment on certain limited partnership investments. We also recorded an one-time gain of $6 million on the sale of the three outlying branches in rural western Illinois that did not fit within our footprint strategy. Total non-interest expense for the quarter was down $4 million. Personal occupancy expenses were down $2 million, while data processing expense increased by $2 million, driven by increased software and systems costs during the quarter. Other expenses were down by $4 million as we received $4 million from our insurance carrier as reimbursement for costs previously incurred, relating to the proposed settlement of an ongoing legal matter.

On slide five, credit metrics continued to improve during the quarter. Net charge offs are down 47% from a year ago. On a quarter-over-quarter basis the majority of the increase of C&I charge offs was related to one loan, without this one item net charge offs who have been considerably lower for the quarter. Some lumpiness can be expected as charge offs trend towards relatively low levels. Potential problem loans continued to decline to $410 million, down from $480 million in the prior quarter, and down from $699 million a year ago. The level of nonaccrual loans to total loans continued to improve to 2.2% from 2.3% at the end of the first quarter, while total nonaccrued loans were down to $318 million from $468 million a year ago. The allowance for loan losses now equals 2.26% of loans, and covers 104% of period end nonaccrual loans. Provision for loan losses for the quarter was zero, with the continuing steady improvement in the portfolio.

On slide six, our capital ratios continue to remain very strong, with Tier 1 common at 12.04% even after completing the $30 million share repurchase, and $25 million trust redemption during the quarter. Our current capital levels are also well in excess of the proposed Basel III expectations on a fully phased-in basis. These strong capital levels will allow us to continue to deploy capital in a disciplined manner. Our priority for capital deployment continues to focus on organic growth. We will revisit the dividend police at year end, and will be evaluating other opportunities to optimize our capital structure over the balance of the year. We continue to be focused on building long-term value for our shareholders by increasing our profitability over time.

On slide seven, our outlook for the second half of the year is summarized. We reaffirm loan growth expectations of approximately 3% per quarter, we will remain focused on disciplined deposit pricing. The margin will continue to be pressured by the current low-rate environment, however we continue to believe that we will be able to defend our relatively stable margin for full-year 2012 compared to full-year 2011. Core fee-based revenues will likely improve modestly while the strength in mortgage banking experienced in the first half of the year is unlikely to be sustained.

We remain committed to low single-digit quarterly expense growth including the costs of continuing BSA enhancements and footprint upgrades, We are in the process of consolidating our Green Bay corporate offices and staff from multiple facilities to one facility in downtown Green Bay. Credit is expected to continue to improve at a steady pace, and capital deployment will continue to be a focus and we will remain disciplined in deploying over time to drive value for our shareholders.

With that we will open it up for your questions.

(Operator Instructions). Our first question comes from Scott Siefers from Sandler O'Neill, please go ahead with your question.

Good afternoon, guys. First I guess just on the margin gains, I guess it still kind of strikes me as kind of conservative. I think you did a 326 margin last year meaning you would have to average like a 320 for the remainder of the year. You noted thoughts about potential pressure, but do you see anything that would lead you to believe that in the second half of the year there's going to be really significant pressure, or should we just kind of think about that as ongoing conservatism, as it relates to the margin outlook?

We still have assets repricing downwards at a steady clip, and we have done a lot to reduce our liability costs. We will continue to focus on that. But a lot of the higher priced CDs have now priced down. We have a couple other things that we are looking at doing. So we are comfortable that we will be comparable to next year. Maybe a little bit higher, but it's a very tough environment out there with assets repricing as rapidly as they are.

Okay. That is helpful. And then I guess probably most appropriate for Chris, just kind of housekeeping questions. So we have got the three items in noninterest expenses, the software write-down, then the gain on the retail branches, and then the $3 million impairment charge. Are any of those in the asset gains and losses line item?

Yes. Yes, they are.

Okay. All of them or --

Yes. The $6 million, yes, all three are there in the other gains and losses item.

Okay. Perfect. So basically no need to adjust anything except for that $4.984 million in asset losses for the quarter?

You will adjust it as you see fit, but that is where those three items are.

Okay. That is perfect. I appreciate it. Thanks, guys.

Our next question comes from Dave Rochester from Deutsche Bank.

Just back on the margin, I was just hoping we could drill down the loan yields, I was just wondering what production yields are looking like for C&I, and then on commercial real estate for this quarter?

Sure. We continue to see a competitive landscape for core basic middle market C&I lending. And that's an area of continuing compression. Again in our market space, if we are getting to a 3-plus% net yield on a floating rate instrument, that is coming out great. But as you can see from the tables and the numbers in the back, those are loans that have historically yielded well in excess of 4, where we had many times floors in excess of 4, and they continue to ratchet down. We have had better yield sustenance on the commercial real estate side, that is a market where it has seemingly been a little easier to find the right balance of yield and credit. And that has been able to stay at a little bit higher elevated level.

I guess securities yields were up a little bit, about 12 bips this quarter, which helped offset some of that loan yield pressure. I was just wondering what the driver was for that, and if that were premium amortization related do you happen to know the dollar amount of that of this quarter versus last quarter?

I don't have the total amount of premium amortization of this quarter handy here. We can follow back on you with Dave, but we have seen that number moderate, clearly.

Okay. And as you are stabilizing the securities book going forward, I was just curious what you guys are buying to offset any of the runoff you are seeing?

The traditional purchases have all been bank eligible standard Fannie/Freddie paper, the focus has been recently on hybrid ARMs, and that has been in current purchase activity.

Great. Thanks, guys.

Our next question comes from Jon Arfstrom from RBC Capital Markets.

Good afternoon, guys. Just a follow-up on pricing. Are you seeing that same type of pricing pressure in the national businesses, or is that more niche related and a little less susceptible to that?

It depends on which business. The oil and gas business with the type of companies we target are getting reasonable yields. Utility lending, of course is very high quality, therefore thinner yields. The project stuff we do, pretty reasonable yields, although those are high quality credits as well. The mortgage warehouse business,the yields are okay, but we are doing an awful lot of treasury management work with those companies too which is helpful, so it varies in each of the units.

Okay. On the commercial real estate growth, you touched on some of this, but can you give us a little bit more detail in terms of size, geography, type, and any change in where you are seeing in some of the opportunities?

Sure. We are really pleased with the progress we have made in commercial real estate. We have hired an awful lot of very experienced people in our upper Midwestern offices, and the growth we are seeing particularly this quarter was really well balanced. Just as an example in our Cincinnati LPO, we did about $60 million, up in Indianapolis we did a little over $50 million, in Wisconsin about $40 million, in Indianapolis about $20 million. Down in St. Louis about $10 million, so it is nicely balanced through the geography, and we are real happy with that.

As far as product type, it is mixed between, multifamily is the most active sector of commercial real estate for us, and across the country right now. But we did about $40 million of multifamily, about $30 million of office, and the rest was scattered amongst other stuff. We have got the construction activity is mostly weighted in the multifamily as well.

Okay. Okay and then can you give us any update in terms of Milwaukee, how it is going in Milwaukee, you have hired a lot of people there, and maybe just a market share update of what you are seeing in the commercial portfolio?

We are doing well in Milwaukee. Milwaukee is obviously a critically important market for us. We have been very active in calling on prospects. I have personally been doing a lot of that this last year. We are getting some nice traction with moving some accounts from competitors, so we are pleased with that. We have a lot more to do there.

Our next question comes from Terry McEvoy from Oppenheimer.

Good afternoon. Before you came to Associated, the bank had built up a pretty large [SNC] book. Was there an exam this last quarter, any impact at all, and was that responsible for that C&I charge off that you mentioned in your prepared remarks?

Everybody goes through the Shared National Credit Review, which has now been a long time ago. It will be coming back around here shortly, but the charge we took had nothing to do any Shared National Credit review, it was an unusual one-off situation related to a retail oriented company.

Understood. And then I am obviously no expert in the utility industry. You guys have built up that book, and just looking at the news this quarter, some coal companies have filed bankruptcy. Patriot and one other one I can't remember. Could you just talk about the diversity in that portfolio, whether you had exposure to coal, and how can we monitor some of the growth components, and the credit risk going forward?

Sure. What you need to do when you are thinking about energy producers whether they are independent power producers or utilities, whether they are burning coal or natural gas, or whatever it is. Ultimately all of that is passed through to rate payers, and it is in rate bases. So what is happening right now to coal companies, which we don't lend to, is the utilities have the ability to switch fuels, and so to the extent they can turn off a coal plant and turn on a gas-fired unit, that is what they are doing. And so there is a longer-term issue there with very plentiful natural gas starting to displace as base load fuel for utility companies what has traditionally been the major fuel which was coal. On top of that, you have got lots of impending clean air act issues around burning coal, and a lot of expense to retrofit older coal plants. For the utilities, this is not an issue because it ends up in rates, for coal producers, yes, big issue.

To reiterate.

We don't lend to coal companies. Right.

Thanks a lot.

Our next question comes from Emlen Harmon from Jefferies.

Good evening.

Good evening.

Kind of a lot of the discussion about the margin earlier, I would be interested to hear your thoughts on the interest income trajectory as well?You guys had talked about earning assets being up next quarter, just wanted to see if you had a sense if you could hold the line, increase interest income, and what your sense was there?

I mean as the balance sheet starts to expand now, we will get increasing interest income. It's something we have been talking about for quite a while now. If you roll the clock back 18 months, our plan, if you will, or our forecast was as securities ran down and loans came up, we would be picking up margin, as things have turned out, given the absolute low rates that we've been working through, we've been kind of trading like yielding securities for like yielding loans. But as the volumes now of loans build, and we maintain the securities book, we will start to pick up net interest income. For the next couple of quarters as we were talking about,we do believe we can defend a reasonable margin. We will give you further guidance as we get at the end of the year to what we think about next year, but we and all banks are really challenged in this low-rate environment.

Okay. Thanks. And then just on the BSA compliance costs, it looked like we did see kind of a drop-off in the legal fees this quarter. Was that kind of a function of the BSA and is that coming off a little bit quicker than you had anticipated originally?

No. You should attribute that a little bit to timing. We had anticipated that BSA costs would be higher in the first half and then start to tail in the second half. We have some costs that have slipped from the second to the third quarter, so I don't want you to draw the conclusion you are coming to. We still have some significant BSA costs specifically for the look back that we have to do, coming up here in the third quarter.

We also note that we had attributed part of the received from our insurance carrier to offset legal fees that we had previously expensed. So they are partially reflected as a reduction in that line item. That was about $2.5 million.

That said, even with the timing issue on BSA, we will still hold the expense growth to the low single digits.

Let me correct. It was $1.5 million that was recorded in this period.

Got you. Thanks. Appreciate the answers.

Our next question comes from Erika Penala from Bank of America.

It is Russell Gunther on for Erika, how are you?

Good to hear you Russell.

Thanks for taking my question. First one is on the provision with respect to you guys continue to have solid loan growth, credit continues to move in the right direction. You mentioned the lumpiness of net charge offs, and then thinking about that in the context of continued solid loan growth and a healthy reserve. I know you left your credit guidance unchanged, so is it fair to interpret modest provision to be of the magnitude, or lack thereof the last couple quarters, or given expectations are we at a point yet where we might see a positive provision to provide for that?

I think you can still count on like modest provisions for the balance of the year.

Okay. And then last one from me is just with regard to share buybacks. You've been active this quarter, could you remind us what your current authorization is, and would you expect to be active in the market at current levels?

We would remind folks that over the course of the last 12 months we've retired a significant amount of our Tier 1 capital, well in excess of the 10% of total capital, including the TARP that we redeemed and the common stock. And that we will be revisiting our dividend policy at the end of the year, and we will be looking to optimize our capital structure over the balance of this year.

As we sit currently we do not have an open allocation to buy back stock.

Okay. Thanks for that. And then sorry, one more just on the C&I charge off that you mentioned this quarter, could you provide some color about geographic location and type of credit?

I don't want to say too much about it, but it's a company that operated in a national footprint inside of some major retailers, which had a very poor season and it's very seasonally dependent, so when the numbers came out, we took a conservative review of the credit, which will give us flexibility on working it out or perhaps selling it out.

Russell, this is Scott Hickey. Just from context geographically although it's a national company the headquarters of the Company is in a market in which we operate.

Okay, guys. Thanks so much, I appreciate the help.

Our next question comes from Chris McGratty from KBW.

Good afternoon guys. One of your peers kind of spooked the market this afternoon with the Basel III adjustment, obviously you guys have plenty of capital, but have you done the Basel III computation for your 12%? Is that a 12% Basel 1 or a Basel III?

The reported number that we're showing today is a Basel I, I think it's important to note that on a Tier 1 capital basis, at least according to our read, there are no material deductions. The MSR deductions,The DTA deductions are not material to us. We would note that trust preferreds aren't part of the Tier 1 number, as year 1 common equity context, but the potential for AOCI is a plus to that, and our AOCI is in excess of $160 million. So it would actually be a net plus to our Tier 1 common number.

On the risk weighted asset side we believe the adjustments are probably somewhere on the order of magnitude of about a 5% I think need a little more digging to make sure we understand all of the parameters in our home equity and other loans, but I feel pretty confident in the range of 5% to 7% on the risk weighted assets, so we believe that the net impact to our capital ratios will be modest, and well in excess of the expected fully phased-in levels, and with the AOCI's fully phased in it is actually almost a push.

That's great. Phil could you talk about your desire to do a special dividend?

What desire is that?

Well, you have plenty of kettle what is your appetite for considering a special dividend versus a buyback?

We haven't considered a special dividend. Do you think we should?

Well, I mean you've seen some of your peers do it, and I think there are mixed reactions both positive and negative from some banks.

We'll think it through, I am being flippant, as we get toward the end of the year, but we'd have to be convinced that it was going to be conducive to long-term growth of shareholder value.

That is fair. Chris, just one for you on the liabilities how you talked about nearing the end of the CD repricing, and you called the trumps this quarter, can you just help us get our arms around what's left that you could potentially redeem or restructure, maybe on the nondeposit side of the liability structure?

On the non-deposit side, I think we have federal home loan bank borrowings, and the federal home loan bank borrowing that we had that were term are continuing to come due in the ordinary course, and we're renewing them at considerably lower rates. So that's a net plus. Further down the balance sheet side, we did redeem $25 million of trust preferreds this quarter, however we would noted that all $180 million of the principal amount outstanding is all callable, and we will be looking very carefully to optimize the capital over the balance of the year.

Do you happen to have the weighted average cost of those $180 million in front of you?

$150 million of them are at 7.625%, and the other two are both floating rates, roughly around 3%.

Great. Thanks a lot.

Our next question comes from Stephen Geyen, Stifel Nicolaus.

Good afternoon. Just one question, you mentioned the sale of the resi, the $109 million, in relation to the branch sale. I'm just curious if maybe you're entertaining any thoughts about maybe a reallocation, additional sales in the future to I guess free up some deposits for potentially some loan growth in higher-yielding assets?

At this point in time I think we are focused on growing our earning asset base going forward. So I think we have done a fair amount of optimizing out of securities into loans, and we're fairly comfortable holding our loan positions that we've put on the balance sheet so far, and are looking to grow them into future quarters.

Okay so you're pretty comfortable with the current mix of the loan portfolio?

Yes. We're probably still a bit overweighted on the consumer side. Resi equity, and the little bit of retail we have in the student loans, we are seeking to get into as I've described before those rough buckets of a third. We're about right in the C&I although we continue to want to grow that, but we're still a little bit light still in CRE, but it is all moving nicely right in the right direction right now.

(Operator Instructions). Our next question comes from Mac Hodgson from SunTrust Robinson and Humphrey.

Chris, do you mind describing again the $4 million dollar reduction and expenses related to the insurance settlement? I didn't exactly followI think it was in response to Emlen's question you mentioned $1.5 million. I didn't exactly follow where the impact hit expenses?

Sure. We had a total recovery from our insurance carriers of $4 million, of which $1.5 million was reimbursement of previously expensed legal fees. And that amount was reported as a contraexpense for this quarter, reducing our run rate reflected in that line item by $1.5 million. The other portion was reported as a $2.5 million charge in the $2 million dollar offset of that,in the losses other loans area.

Got you. Okay great, and then on your expense guidance in the PowerPoint, I think last quarter it was low single digit year-over-year growth, and it's low single digit quarterly growth. Just want to be sure I understood that your guidance is kind of quarter to quarter, and not year-over-year?

I think in balance you'll see that works out to be about the same number. I think we just want to make sure you didn't take the run rate as given the current period. Given there was some noise in there. I think if you took last year's number and do single digits, or you take the current quarter and add it you will end up with very comparable numbers.

We weren't trying to change the measuring, the goalposts on that.

Got you. Was there anything that drove the decline from the first quarter in service charges? Anything unusual there?

In deposit service charges?

Yes, exactly.

I can't say there is anything in particular. In the course of the last 12 months, we have taken a very careful review of all of the service charges and fees that we charge our customers, and we have made a variety of changes that has had an impact on those fee revenues over the last 12 months. I think you are seeing that run rate sort of flow through, but there was nothing special or particular about the fees in this period.

Okay. And maybe lastly, Phil, if you don't mind discussing or just giving us an update on the level of M&A discussions going on in your marketplace, and the Company's appetite for M&A as you sit today?

Nothing has really changed as far as whole bank M&A. You are not seeing much activity anywhere in the country including around here. I think as the full impact of the Basel III capital rules are fleshed out, and potentially impact a lot of smaller banks coupled with the low-rate environment, I think ultimately you are going to see an awful lot of consolidation, but it hasn't happened yet, and there isn't a whole lot of material discussion going on right now.

Okay. Great. Thanks.

(Operator Instructions). And at this time I am showing no additional questions. I would like to turn conference call back over to Phil Flynn for any closing statement.

Thanks Jamie. Thanks everybody for joining us on the call. As we said we were pleased with this quarter's performance. We had really strong commercial loan growth, a reasonably stable margin higher core fees, stable core expenses, and we had multiple capital deployment transactions, so we remain optimistic and committed, as we have said, to building shareholder value through our long-term growth strategy for growth here at Associated. So we will look forward to talking to you again next quarter. If you have any questions in the meantime, as always give us a call. Thanks again for your interest in Associated.

Ladies and gentlemen, this concludes the Associated Banc-Corp second quarter 2012 conference call. We thank you for attending. You may now disconnect your telephone lines.