Associated Banc-Corp (ASB) 2012 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to the Associated Banc-Corp's fourth quarter 2012 earnings conference call. My name is Laura and I will be your operator today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session at the end of this conference. Copies of the slides that will be referenced during today's call are available on the Company's website, at investor.AssociatedBank.com. As a reminder, this 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 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 Factor section of Associated's most recent Form 10-K, and on any subsequent SEC filings. 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 over to Philip Flynn, President and CEO, for opening remarks. Please go ahead, sir.

Thank you, Laura, and welcome to our fourth quarter earnings conference call. Joining me today are Chris Niles, our Chief Financial Officer, and Scott Hickey, our Chief Credit Officer.

Highlights for the fourth quarter are outlined on slide number 2. This quarter's solid results were driven by strength across all of our businesses. In spite of the many uncertainties during the quarter, our bankers remained focused on serving our customers and growing the franchise. For the quarter, we reported net income to common shareholders of $45 million, or $0.26 a share. That compares to net income of $40 million, or $0.23 a share, a year ago. Return on Tier 1 common equity for the quarter was 9.6%, up from 9% a year ago. Loan balances increased by 3% during the quarter, with the majority of growth coming from the commercial portfolios. Average deposits increased by 7% from the third quarter to $16.7 billion, with period end non- interest bearing deposits growing by 10%.

Net interest income increased by $6 million compared to the last quarter, and the increase included approximately $2 million of nonrecurring interest income received during the quarter related to an income tax refund. Our net interest margin for the quarter was 332 basis points. Credit quality indicators continued to improve, and we recorded a $3 million provision for loan losses during the quarter, entirely driven by loan growth. We increased the quarterly dividend 60% to $0.08 per share, and we repurchased $30 million of common stock, or about 2 million shares, at an average price of $12.70. And even after completing these capital actions, our Tier 1 common equity ratio remains very strong, at 11.58%.

For the full year, on slide 3, we reported net income to common shareholders of $174 million, or $1.00 per share, a significant increase from $0.66 per share in 2011. Return on Tier 1 common equity for the full year was 9.5%, up from 6.7% last year. Total loan balances increased by $1.4 billion during 2012, representing 10% year-over-year loan growth. Net interest margin for 2012 increased to 330 basis points from 326 basis points last year, as we reduced our deposit and funding costs. Credit quality indicators improved significantly, with non-accrual loans 29% lower than a year ago. We're proud of the progress the Company has made on capital management, as we redeemed all outstanding trust preferred securities, increased the dividend twice, and repurchased a total of $60 million of stock during 2012. We will continue to remain focused on effectively managing and deploying our capital in order to derive long-term value for our shareholders.

Turning to slide 4, over the past three years, we've cleaned up the credit book, addressed regulatory matters, and embarked on a strategy to grow Associated in the markets we serve. We've made significant investments in people and systems in order to position the Company for the future. This past year, we saw some of the results from our investments and hard work, as loan balances continued to grow at the top end of peers, credit continued to improve, we defended the margin in a low rate environment, and we deployed capital through various actions in order to build value for our shareholders.

Looking to 2013, we believe that Associated is very well-positioned to focus on growth opportunities and to capitalize on market disruptions and win business from clients across our footprint. Given the current low rate environment, we will have to be very focused on defending the margin throughout the year, and will continue to look for and drive efficiencies in order to effectively manage expenses. We will also continue to look for ways to deploy capital in accretive, value-added transactions.

Let me share some detail on the main performance drivers during the fourth quarter. Loan growth is highlighted on slide 5. Loan balances continued to grow during the quarter, with net growth of $445 million. This represents a 3% quarter-over-quarter growth rate and a 10% increase year-over-year. Growth during the fourth quarter was well balanced, with increases to most major portfolios. Commercial and business lending balances increased by $262 million during the quarter and were driven primarily by growth of $174 million in general commercial loans, which include middle-market C&I activity. Part of this quarter's growth in general commercial loans was driven by year-end related customer activity. We would expect that middle-market commercial loans in the first quarter will be flat with the fourth quarter level, given seasonality and the strong activity at year-end.

We experienced continued but slower growth in our specialized lending portfolios during the quarter, including a $50 million increase in mortgage warehouse lending. Growth of $77 million in power and utility loans was partially offset by a decline in oil and gas lending from the third quarter of $39 million. Oil and gas and power and utilities loans collectively represent 4% of the total loan portfolio, about the same as the third quarter.

Commercial real estate loans grew by $164 million during the quarter, and was compromised of $120 million of income producing loans and $44 million of construction loans. The growth in investor commercial real estate loans was driven by about $60 million of multi-family and $30 million of office building secured loans. And in the construction space, growth was the result of increases in multi-family and retail projects.

Residential mortgage loans grew by $172 million, or 5% during the quarter. Approximately 20% of this quarter's residential mortgage growth came from hybrid ARM products, with the remainder comprised of 15-year and under fixed rate product. We continue to be disciplined and have seen pricing hold up near the 3% level for mortgages we hold on the balance sheet. We're continuing to sell 30-year production to the agencies through our mortgage banking operations.

The retail loan portfolio, which includes mostly home equity loans, continues to experience pay downs and declined $153 million from the prior quarter. We expect to continue to see run-off in these portfolios into 2013, as consumers deleverage and refinance into lower priced first lien mortgages. The composition of the home equity book remained stable from the prior quarter, with first lien home equity loans accounting for about 55% of the total portfolio.

Regarding the recently published qualified mortgage guidance, while we're still reviewing the materials, Associated's long-standing lending practices already include many of the rules suggested. We believe that we are currently operating largely in line with the proposed guidelines. We don't expect material changes to our underwriting and origination procedures.

Turning to slide 6, average deposits of $16.7 billion were up 7% from the third quarter and have grown by $1.8 billion, or 12%, from a year ago. Period end non-interest bearing account balances are up $439 million for the third quarter, and have grown by 21% from a year ago. Although some of this quarter's non- interest-bearing deposit growth was the result of customers' seasonal year-end account activities, we're pleased with the continued strength in deposit inflows. And during the quarter, we also saw increased deposit flows from municipalities and bankruptcy trustees. Investments in our commercial deposit and Treasury management platform, as well as investments into the retail network, are continuing to bear fruit. Although it's still early after [TAG] expiration, we're encouraged by the strength of our depositor relationships and believe that a well-capitalized and highly rated institution, such as Associated, will be a net beneficiary of the expiration of the program.

Total CDs declined by $103 million during the quarter, consistent with our disciplined deposit pricing. Together, higher cost CDs and customer repo agreements have declined by over $1.4 billion from a year ago. Net interest income grew by $6 million, or 4% quarter-over-quarter, and the net interest margin for the fourth quarter was 332 basis points. Excluding the $2 million of non-recurring interest income related to the tax refund, net interest income would've grown 2% quarter-over-quarter and net margin -- net interest margin would've been closer to 3.29%. Liability management drove most of the benefit to the NIM this quarter, as we grew lower cost deposits and we redeemed our trust preferred securities.

Over the past year, yields on earning assets have compressed by 11 basis points, while we've managed down interest-bearing liability costs by 27 basis points, enabling us to defend the margin at a fairly tight band around the full year 2012 level of 3.3%. Our expectation for 2013 is that earning asset yields will continue to compress over the course of the year, while our ability to manage deposit costs lower becomes more challenging. We do see some continuing benefit from repricing of the CD book over 2013, and of approximately $500 million of higher rate Federal Home Loan Bank advances maturing during the first half of 2013 that will provide some level of support to the margin. Additionally, we do have about $25 million of 9.25% subordinated debt outstanding that becomes callable in October, and we would expect to redeem that.

Total non-interest income for the quarter was $78 million, down $3 million from the third quarter. Net mortgage banking income declined by $2 million, primarily due to the establishment of a $3 million repurchase reserve against previously sold mortgage loans. Although we have seen only a limited number of repurchase claims over prior quarters, similar to other banks, this activity has steadily increased during 2012, and particularly during the fourth quarter, resulting in our decision to establish the reserve. In other non-interest income categories, we saw increases in card-based fees and capital markets fees that were offset by declines in insurance commissions and service charges on deposits during the quarter. Although service charges on deposits declined slightly, we believe these revenues will continue to improve as we grow our customer base. We also recognize lower net asset losses compared to third quarter that was offset by lower realized gains from the sale of investment securities.

Non-interest expense for the quarter increased by $7 million, or 4%. And for the full-year, total non-interest expense of $681 million increased by 5% compared to the full year 2011. The fourth quarter increases in personnel and occupancy expenses accounted for $6 million of the $7 million total increase in non-interest expense, of which $4 million was directly attributable to severance and lease breakage costs related to our recently announced branch consolidation plans and other efficiency initiatives. Legal and professional fees remain elevated during the quarter, driven by continued costs related to ongoing BSA enhancements. The majority of expense related to BSA has been incurred and totals approximately $17 million, $10 million of which was expensed in 2012. We would expect lower legal and professional fees in 2013.

On slide 7, credit continued to improve over the course of 2012. Net charge-offs of $21 million for the quarter were impacted by two notable items. First, we implemented a change in our practices for non-affirmed home equity and mortgage loans discharged in bankruptcy proceedings, which resulted in $5 million of charge-offs during the quarter. Second, during the quarter, we completed a note sale of 185 small commercial loans with an unpaid principal balance of $10 million that resulted in $4 million of charge-offs. In the future, we expect to continue to review opportunities such as this note sale to efficiently remedy small non-performing loans.

For the full year, net charge-offs declined by 44%, to $84 million, and we expect lower net charge-offs in 2013. Potential problem loans declined to $361 million, from $404 million last quarter and from $566 million a year ago. The level of non-accrual loans to total loans continued to improve, to 1.6% from 1.9% at the end of the third quarter, and have improved for 11 consecutive quarters. Total non-accrual loans of $253 million were down from $278 million at the end of the third quarter and down $357 million from a year ago. The allowance for loan losses now equals 1.93% of loans, covers 117% of period end non-accruals. The provision for loan losses for the quarter was $3 million. We expect provision expense to increase with new loan growth in 2013.

On slide 8, our capital ratios continue to remain very strong, with a Tier 1 common equity ratio of 11.58%. We are well capitalized and well in excess of the proposed Basel III expectations on a fully phased in basis. These strong capital levels have allowed us to complete the series of capital actions in the fourth quarter and throughout the past year. Our priority for capital deployment continues to focus on organic growth. We'll look to grow the dividend over time, in line with earnings growth, and will continue to evaluate other opportunities to optimize our capital structure over the coming year.

Our full year 2013 outlook is outlined on slide 9. We expect loan growth in 2013 in the high single digit range from year-end to year-end. This outlook is in line with performance from the second half of 2012. We expect the first quarter's loan growth to be seasonally low. We'll remain focused on disciplined deposit pricing, and we'll look to continue to grow core retail deposits and commercial deposits through our enhanced Treasury management offerings. We expect modest net interest margin compression over the course of the year, driven by continued pressure on earning asset yields. We expect to defend margin compression through liability repricing and refinancing actions to partially offset asset yield compression.

We expect total non-interest expense for 2013 to be flat on a year-over-year basis compared to the 2012 reported level. Benefits from reduced regulatory costs are expected to be offset by continued investments in the franchise. Credit trends are expected to continue to improve, with provision expense increasing with new loan growth. Capital deployment was a priority in 2012 and will continue to be a priority in order to drive long-term shareholder value.

So, thanks. And with that, we'll open it up for your questions.

(Operator Instructions)

Scott Siefers, Sandler O'Neill.

Good afternoon, guys.

Good afternoon.

Let's see. I guess my first question was just on the reserve build for mortgage repurchase issues. So that could be one of two things, general elevated levels of repurchase requests or then the newer thing that a lot of the big banks got -- or learned about, I should say, back in December was the increased look-back period from '04 to '06. What dynamics were at play in the need to build that up, please?

It's not an increased look-back period. So what we've seen is, we've seen -- we had very moderate and practically immaterial volume in this area in 2009/'10. We saw a modest amount of increase, but was still relatively immaterial '11 and into the first part of '12. And we saw increasing volumes and requests coming through in 2012. And so we thought it was prudent and appropriate, given the new OCC guidance that was out there, and what we saw others doing to establish a reasonable and prudent reserve. The bulk of the activity was related to '06, '07, '08 lending, and we think it's a reserve that's in line with peer levels, and appropriate for the level of our foreclosure activity.

Great. That's helpful. And then, does that cover you for both Fannie and Freddie, or just one of them?

Yes. No, it's for all agency activity.

Okay. Terrific. That's very helpful. I appreciate it. And then, just want to make sure I understand the provision guidance for next year. Still an excellent and still improving credit profile overall. And I want to make sure, it sounds like the provisioning for next year is probably going to look a lot like what we saw in the third quarter, where some nominal provision for loan growth, but not necessarily to cover whatever charge-offs might come through.

Well, let's be clear. The third quarter was $0. The fourth quarter was $3 million, and that's largely to accommodate growth. And we will continue to provide to accommodate growth, provided that credit trends continue to improve.

Okay. Got it.

So Scott, just a little more -- this is Phil -- on that. We've seen continued meaningful improvement in our credit quality now for three years. We've also seen significant loan growth over the last two years. So the benefit of improvement in the credit portfolio has offset the need to provide for loan growth over the last two years in a meaningful way. But that benefit is coming to an end now, with the credit portfolio having improved to the point it has. And with continued robust loan growth, we expect the need to cover some of that with provisioning.

Okay. Great. But it doesn't sound like the provision is going to be anywhere near what an anticipated level of charge-offs would be in the coming year.

Likely not.

Okay. Perfect. All right. That's very helpful. I appreciate it.

Chris McGratty, KBW.

Good afternoon, guys. Phil, the expenses -- just so I am clear, the run rate for '13 is off the report at 682, right?

Correct.

Okay. Can you talk maybe about capital deployment through acquisitions? I think, during the past quarter, you talked more openly about completing possibly a bank deal. Can you talk about what markets, what size? And then, do you think, in reality, you'll announce a deal this year?

So, what we've been talking about is a desire to deploy capital in an accretive way. We think the best way to do that is to look at opportunities in our markets where we have scale, so that if we were to acquire part of an institution or an entire institution, there would be very significant and highly likely cost take-out's to drive the economics of the transaction. I think it's reasonably likely we'll do something this year along those lines.

Great. And then, last one and I'll jump in the queue. The tax benefit of $5 million, there was also the $2 million through spread income. Those are two separate adjustments that we should be making? Am I interpreting that correctly?

That's correct. Those are two separate transactions.

Okay. Thank you.

Emlen Harmon, Jefferies.

Good evening.

Good evening.

Let me kick it off just talking about your loan growth guidance, and you guys pointed us as to high single digits. Could you give us a sense of the mix of loan growth and which areas of the loan book you think are going to be supporting that?

Sure. When you look at what we just did in the fourth quarter, we had essentially completely balanced loan growth between commercial banking activities, commercial real estate activities, and our residential mortgage business, somewhat offset by the continued decline in the home equity loan book. We expect balanced growth like that next year.

Okay.

So in other words, all of our major businesses are doing quite well, in regards to loan growth.

And if I think about that -- if I think about the commercial loan book, specifically you guys have obviously been beneficiaries of picking up some market share in your home market. Do you expect that to continue, as well, or is the mix within the commercial book maybe going to change a little bit, as well?

No. We expect to grow our basic commercial banking business in our footprint, as well as grow the specialty businesses that are in the commercial areas, as well.

Got you. Okay. Thanks. And then, I did notice the commercial -- specifically, the C&I loan yields were up quarter-over-quarter, and I'd be interested in terms of the business mix that's actually driving you to see expansion there, where some of your peers are seeing those yields -- the majority of your peers, I should say, are seeing those yields compress?

We did benefit from a few interest recoveries that accrued to us during the quarter that particularly had an impact on the improvement in the C&I book. So the overall trend continues to be more of a defensive trend, not an increasing trend, without the benefit of those recoveries.

Got you. Okay. Thanks.

Dave Rochester, Deutsche Bank.

Good afternoon, guys.

Good afternoon, Dave.

Could you just update us on loan pricing trends on the commercial side. I know you mentioned resi was around 3%, which sounded pretty stable with last quarter. Are you seeing that kind of stability on the commercial side, as well?

It's stable to the extent that we are picking and choosing what type of credit we are putting on. So in some markets, particularly in some of the leveraged or sponsored business, I think pricing is becoming quite competitive, to the point where you have to ask yourself whether you're getting an appropriate return for the risk. So we are being selective there. I guess the word take is that we are being disciplined about not just the residential mortgages that we're putting on, but we're making sure we're getting paid for the commercial real estate, for the specialized book, as well as the basic commercial banking business. We have fully implemented a risk adjusted return on capital model throughout all of our business lines. Our incentives are paid off of that, as well as earnings throughout all of our business lines. And so people are quite focused on making sure that they are being paid for risk and getting an appropriate return on capital.

Okay. That sounds good. Switching gears to the balance sheet. I noticed that securities grew, along with short-term borrowings, so I was just wondering what the driver was for that and if we should expect to see more of that in 2013?

No. We pre-funded some purchases at the end of the year, in anticipation of volumes and activities going into the first of the year. So we purchased securities that largely settled late in December. We borrowed short-term, knowing we would get deposit inflows right at the end of the year that would carry that into the first quarter. So it's just a pre-funding of first quarter activity.

You guys are just buying more of the same stuff?

Yes. No material changes in our overall investment philosophy, structure or composition.

And you certainly shouldn't expect to see the securities book grow by $500 million a quarter.

No. Got you. Okay. And just one last one on the expense side. Heading into next quarter, I know year-over-year, we should be flat. Should we start to see the step down in 1Q, despite any seasonal bump up you might get? Are the expense cuts going to cut into that and actually drive that number down in 1Q?

I would expect that 1Q would probably be down, yes. But we are trying to think about yearly numbers and drivers, because any quarter can move around a little bit. But clearly, the BSA expenses are all -- not all, but very largely behind us. We had some unusual expenses in the fourth quarter related to efficiency moves, which won't be repeated. So I would think you'll start to see it moderate.

The fourth quarter is typically our highest net expense quarter, so you will see it moderate.

Got it. All right. Thanks, guys.

Ken Zerbe, Morgan Stanley.

Thanks. Just a couple quick ones. In terms of FHOB advances, you said they come due in the first half. Do you have more specific timing on that? Is that lump sum, or is that several tranches over the two quarters?

There are $500 million tranches, $200 million in the first quarter and $300 million in the second.

Okay. And then the other thing -- can you explain a little bit, the $2 million benefit, I think it was interest on a tax refund in the NII line. Was that related to the $5 million of refund, or is that -- because it seems like a rather large amount of interest, I guess.

Actually, the refund was actually $50 million, and it's related to the way we had accounted for, essentially, our loan losses. We were able to go back and recharacterize our loan losses for tax purposes, and amend our return and claim back $50 million that we had not previously claimed. And the interest is related to those, which was returns filed for '09 and '10. And the interest, therefore, related to that was almost $1 million, as we received it in the fourth quarter of 2012.

But the $50 million --

Is pure cash. A cash refund of $50 million, and we got earnings on that cash of $2 million.

Perfect. Okay. Great. Thank you very much.

Jon Arfstrom, RBC Capital Markets.

Thanks. Good afternoon.

Good afternoon.

A couple of follow-up questions. Phil, on the loan growth, slide 5, you made some comments that you thought a lot of it had to do it had to do with some year-end activity. But it was a pretty big jump compared to the type of growth you saw in Q3, and I'm just curious if you think there's anything else going on, if you are seeing any increased borrower confidence or do you attribute most of it to year-end?

Well, so if you've got slide 5 open, you can see that commercial, resi, commercial real estate, all grew about the same amount net. Our power business grew, mortgage warehouse grew, with all the activity that's going on. Oil and gas had some pay downs. That's not to say -- that will come right back up, as we go into this year. So I wouldn't put much concern about that. And home equity has continued to pay down consistently. The area where there was some year-end activity was in that general commercial loan space, where we had some year-end activity from our customers, including some syndicated loan volume where we've underwritten some loans and then those loans will be sold to other institutions, in fact, have already been sold to other institutions this year. So that drove a little bit of the growth.

But generally, all of our business units are out doing a good job now, and have been for a while, of gaining market share and gaining wallet. So I would expect, as I said earlier, continued growth in all of the business units in a well-balanced way, but probably at more of the pace that you saw in the combination of the third and fourth quarter, not just the fourth quarter. If you annualized the fourth quarter, you would be in double-digit loan growth. We've had double-digit loan growth for the last two years. And at some point that needs to moderate to more of the high single-digit area, and that's what we expect.

And that drives your comments, with seasonally low Q1 is more of the fourth quarter?

Q1 is usually low, and then we're going to have some pay downs as we syndicates some loans. So that's going to drive a fairly low first quarter, which we expect to pick up from there.

Okay. So this is maybe more of the new -- quote, new Associated loan mix, and it's what we'll likely see in the future, this kind of activity at year-end?

Well, it all depends on transactions. Remember, we had an unusual year end, with potential changes in tax laws. So we had some privately owned companies doing transactions to get in front of whatever might've happened with capital gains. As it turned out, not a whole lot happened with capital gains, but we didn't know that a month or six weeks ago.

Okay. A couple more. You made the comment, market disruptions as opportunities. Is that still primarily Milwaukee, or is there anything else happening?

It mostly relates to our very deliberate calling effort around changes, particularly in the Milwaukee area, but in other parts of the footprint, too.

Okay. And then, last question, a small one on mortgage banking. My sense is that it's lower than typical banks. But what percentage of those revenues are refinanced revenue?

Oh, a lot.

Substantially, most of it.

Most of it? Okay.

Yes. Just like everybody else. I mean, the boom in mortgage banking that we've seen all of 2012, and which, frankly, is still continuing as we speak, is driven by refi.

So when you talk about higher fees but potentially lower mortgage, that's what you are talking about is the refinance piece of it?

The fee comment is higher fees from all of our lines of business, private banking, insurance, foreign exchange, capital markets, swap activity, but we expect lower mortgage banking year-over-year, as each of the quarters in 2012 was individually more than the full year 2011, and we don't see that pace continuing.

It may well continue as we get early into this year, but our assumption is it tails off as we get later into the year.

Okay. That make sense. Thanks.

Matthew Clark, Credit Suisse.

Good evening, guys.

Good evening.

On the loan growth front, can you give us a sense for your underlying assumptions there, on the outlook on the economy? Are you assuming really no pickup, or much of a pickup, given that you're looking for high single-digit and you guys have been doing 10-plus? And also, whether or not there is any incremental change in your expectation for an increase in utilization, as well?

Yes. So the assumptions around our loan growth are that utilization is flat. It's been flat at high 40s, 48%, 49% now for about three quarters. We're not assuming any big pick-up there. We're not assuming any big pick-up from economic activity. In general, as we've talked about numerous times, the upper Midwest has done relatively well compared to other parts of the country. Manufacturing continues to do pretty well. There continues to be change and disruption, like we were just talking about, with some of our competitors. And we expect to be the beneficiary of all that, but we're not expecting anything heroic out of the economy to help us along here.

Okay. And then, in terms of the latest growth, the 445 you guys put up this quarter, can you break that down by market in terms of some of your LPO's, the contribution there, and some of your other major markets?

Sure. Well, you see in our slide deck by category where the growth came from. By markets, we had, as you would expect, significant balance changes in our footprint. So Illinois, frankly, led the pack, with a significant amount of the growth. Wisconsin, about one third of what we saw in Illinois. Now this is the combination across business units. So it's commercial and commercial real estate. So a lot of activity in Illinois and those areas, about one third of that in Wisconsin, Minnesota about double Wisconsin. And then in our specialty businesses, say in oil and gas, a lot of activity, as you would expect, is in the oil patch. So it's quite diverse across our geographies. In the LPO's, we had good solid growth, commercial real estate driven, in Indianapolis and Cincinnati. Michigan is newer, but it's starting to put on some business, as well.

Okay. And then, as you continue to retool the banking model, can you give us a better sense for what's left to do and how significant that might be?

Sure. We continue to invest into the retail branch network. This past year, we touched 50 branches and we expect to touch another 50 branches in 2013. That will start to come to an end, as we get toward -- into early 2014. We'll largely be completed. We've made significant investments already into enhancing mobile banking, changing out many of the ATM's to be image-enabled. A lot of that is already done. We always have continued upgrades and enhancements to our offerings. So we'll have a major upgrade of our online offering later this year, although from a cost point of view, it's not terribly significant. The BSA AML issue, as we've talked about, is largely behind us from an expense point of view. We've upgraded significantly our internal financial systems, and that's done. We are in the process of upgrading our commercial loan booking system. That's a project that's kicking off right now. But again, most of these are not big dollar amounts. The big dollar amounts here were really driven by the need to invest into the physical retail footprint, and we are now more than halfway through that project.

Okay. Do you sense that there might be some additional severance-related charges going forward, maybe in the first half?

Not planning on any right now. We have closed and consolidated 10% of our branch network in the past, call it, 13 months. So I think we've done most of what we need to do there, if not all. We'll continue to evaluate that. We're in an industry that has over capacity, and we're in an industry where consumers' behavior is continuing to change so that they are not coming into branches to do their routine transactions, and we've been investing to make sure that they have alternative methods to transact with us. So as that continues to change, we'll continue to evaluate our physical distribution network. But we've taken a pretty good swing at it, compared to most institutions, already.

Okay. Great, guys. Thanks.

Terry McEvoy, Oppenheimer.

Thanks. Good afternoon.

Good afternoon, Terry.

Just a question on the capital deployment. If I annualize your dividend versus consensus for this year, you're pretty close to, let's call it, a 30% payout. As I look out to '13, or as you look out to '13, and looking at capital deployment, do you see a heavier emphasis on buyback, given where your dividend is today versus at least estimated earnings?

Well, you'll recall that we announced an authorization for $125 million of buybacks, of which we executed $30 million in the fourth quarter. And you can certainly expect that we will continue to look at share buybacks through the course of this year. And you are correct, using consensus numbers, at $0.32, we're probably in that 30% range or so. So, a lot of our dollars will be going toward, most likely, share buybacks. And then we will also be looking, as I said, to do an in-market acquisition, if we can find something that makes sense for our shareholders.

And then on the expense management side, have you shared any specific targets -- cost-saving targets -- and how do you look at reinvesting within the business, and specifically what areas are you reinvesting in?

Sure. I kind of covered that a moment ago. But what we continue to make investments into the physical footprint. Most of those costs are capitalized. So what we've done to date is starting to roll through our income statement in the form of capital expenses, and those will continue and will build for a while. And then there's some continued systems work, but that's not nearly as significant. So we've got a headwind from continued need to invest in the franchise to make up for past under investment. We've got the benefit of the BSA AML remediation costs rolling away. We're being quite disciplined about adding staff. In fact, the headcount has shrunk. And so when you net all of that out, we believe that as we've guided flat expenses year-over-year, it is quite achievable.

Great. Thanks a lot.

Sure.

Steve Scinicariello, UBS.

Good afternoon, everyone.

Good afternoon, Steve.

I just want to follow-up on a question from my good friend Jon Arfstrom on loan mix. If I look at the pie chart on page 5, just curious, as you look out and think strategically over the next three years or so, where do you want that mix to be, and what are some of the components, as you look ahead, in terms of that future loan mix?

Sure. So if you look at that pie chart, residential mortgage will continue to grow, but it will certainly be likely offset by shrinkage in home equity as people refi into low-cost permanent loans or into hybrid ARMs out of their home equity loans. So we expect the mix of resi, home equity and installment to be somewhere ultimately in around the, call it 35%, 40% range, maybe down toward 35%. Personal and business lending, which includes commercial banking, small business lending as well as our specialty businesses, has grown and will probably continue to grow; but depending on our growth in commercial real estate, it will probably settle in a 40% range and commercial real estate would take up the rest. So we're somewhat under invested still in commercial real estate compared to the roughly 30% or so of the portfolio that we think we want to grow that to.

Makes sense. And then within that commercial and business lending mix, how big do you think some of those specialty segments might get to be?

Well, if you look at our mortgage warehouse business as we got to year end, the outstandings there were about $500 million. And then the combination of our oil and gas business and power and utilities business was about $500 million between the two of them. We expect the mortgage warehouse business probably from an outstandings point of view to decline somewhat as we go through the year, because it's so tied to refi activity. And we expect power and utilities and oil and gas to continue to grow. So the combination of all three of those specialty businesses, which are the dominant ones, is about $1 billion and probably stays around that range, probably goes up a couple hundred, $300 million, maybe, by the time you get to the end of this year. So it's becoming more meaningful, but certainly in the context of a $15 billion portfolio which will be growing, certainly isn't a dominant part of the portfolio.

Got you. It makes sense. And so as I think out, it seems like as some of those other components grow on the CRE side, as well, sounds like you might have some yield pick-up opportunities as you look ahead. Is that a fair way to think about it?

I like your thinking. We're in a low interest rate world where the portfolio continues to mature and be in churn, so a lot of our -- on the resi side, you continue to refi. We refi a lot of our own stuff, so that's slowly grinding down. The commercial real estate business is becoming more competitive, but the pricing is still reasonable for the risks involved. Our specialty businesses tend to get pretty decent pricing. But when you look at the whole portfolio, the expectation is asset yields continue a slow grind down in this low rate environment.

Got it. Well, thanks so much.

Peyton Green, Sterne Agee.

Good afternoon. A couple questions. First, to what degree would you expect the loan growth to actually drive earning asset growth? I know in the past, really, couple years, the loan growth has really absorbed securities cash flow.

Correct. So we no longer expect to have net run-off in the securities book, period to period. So while you won't see the growth you saw in the fourth quarter, order of magnitude, you will see ongoing stabilization and growth in the securities portfolio, which means it will be driven -- the balance sheet growth will be driven by loan growth.

You'll see the balance sheet expanding as we go through the year.

Okay. And then separately, what is your expectation of securities cash flow and what is the roll-off yield, and where are you reinvesting these days?

Unfortunately, the reinvestment yields continue to be grinding lower and lower, just as they are in the loan books. So unfortunately, they are down in the one handle area on the marginal reinvestment; and reinvestments are, unfortunately, still cash flowing back at $100 million-plus per month.

So, Peyton, I think we've talked about this before, but we are not -- and maybe we're going to be proven wrong one day -- but we are not going out the yield curve in that search for yield in the securities book or in our resi book. We're not booking 30-year resi's. We're not booking long dated securities. We're clearly giving up yield there in the short run, but we really don't want to own really long dated securities and 30-year mortgages when and if rates turn.

Okay. And I know you've done a great job to reposition the borrowings and the wholesale nature of the deposit base from a few years back. But is there any -- in that vein, is it time to go a little longer on the liability side?

It's a great question. And the answer is, not yet. And we hope we start pricing up CDs at just the right moment. But at this point, as you saw, the growth we had in our deposits this past quarter and the fact that we are bringing on a lot of deposits at very low cost, it's not time yet for us to extend out there.

Okay. All right. Great. Thank you very much.

Appreciate it.

Mac Hodgson, SunTrust.

Good evening.

Good evening.

Phil, on M&A, and market M&A, can you remind us of the asset size of an institution you'd be looking to target?

It's hard to say. It depends what the opportunities are. I think it's highly likely, since this institution hasn't done a sizable acquisition for six-plus years, that we would do something pretty bite-sized before we ran, before we did a little walking. We've worked really hard to put Associated in a good, sound financial position. We're growing across our businesses. We're doing well. We are not going to jeopardize the franchise by doing something large that our shareholders end up paying for.

Okay. Got you. And you touched on this in your prepared remarks, but could you elaborate on any deposit activity you saw in the fourth quarter or you expect to see in the first quarter related to TAG? I'm just curious what sort of trends you're seeing.

Too early to tell, really. But we had a significant inflow in front TAG expiration. Some of that was from larger depositors, don't know exactly where those deposits came from. But when you look at our profile, with the capital we have, with the ratings we have, we're really not anticipating any issues at this institution. If anything, we expect to be a beneficiary of people getting cold feet without TAG protection and perhaps smaller or weaker institutions.

Okay. Great. Thanks.

(Operator Instructions)

Showing no further questions, this will conclude the question-and-answer session. I would like to turn the conference back over to Phil Flynn for any closing remarks.

Thanks, Laura. Thank you all for joining us today. The quarter's strong performance was highlighted by loan and deposit growth, as well as higher net interest income. As we've been talking about, we are going to remain focused on deploying capital and value-added transactions which will build shareholder value, and we're optimistic on our ability to continue to grow the franchise this year. So we look forward to talking you again in three months, and if you have any questions, please give us a call. And as always, thanks for your interest in Associated Bank.

Ladies and gentlemen, this concludes the Associated Banc-Corp fourth quarter 2012 conference call. Thank you for attending today's presentation. You may now disconnect.