Associated Banc-Corp (ASB) 2013 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to the Associated Banc-Corp's fourth-quarter 2013 earnings conference call. My name is Kate, and I will be your operator today.

(Operator Instructions)

Copies of the slides that will be referenced during today's call are available on the Company's website at associatedbanc.com\investor. 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 Factors section of Associated's most recent Form 10-K and any subsequent SEC filings. These factors are incorporated herein by reference.

(Operator Instructions)

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

Thanks. Good afternoon. Welcome to our 2013 earnings conference call. Joining me today are Chris Niles, our Chief Financial Officer, and Scott Hickey, our Chief Credit Officer.

Highlights for 2013 are outlined on slide 2. The year was another successful one for the Bank. From a total revenue standpoint, we were up approximately $20 million from last year, while holding total expenses flat. As a result, we were able to deliver net income available to common shareholders of $184 million, or $1.10 per share, which represents a 10% improvement in EPS over 2012.

Average loans of $15.7 billion were up 6%. Commercial and residential mortgage loans both growth -- each category up12%.

Average deposits of $17.4 billion were up 12% from 2012. And we continue to drive strategies which will optimize our funding mix from a cost and a liquidity perspective.

Net interest margin for the year of 317 basis points compressed by 13 basis points, yet we grew net interest income $20 million, or about 3%. Gross fee income of $313 million was flat compared to 2012, as declines in mortgage banking income were offset by improving core fee-based revenues and favorable results on the impairment of non-core assets.

We delivered on our commitment to keep expenses flat. We were actually down $1 million, despite significant investments in personnel, technology and facilities during 2013.

We continue to return capital to our shareholders through an increased dividend and common stock repurchases, delivering a 100% combined payout for the year. Our Tier-1-common-equity ratio remains very strong, at 11.46%.

So, now let me share some detail on the main drivers of our 2013 earnings. Loans are highlighted on slide 3. Average loans grew $921 million, or 6% from a year ago, to $15.7 billion. As we've rebuilt and rebalanced our loan portfolio, we are approaching our historical loan balance peak of $16.1 billion reached in 2008.

2013 was another good year for residential mortgages, as we grew this portfolio $384 million, or 12%, to $3.7 billion. For the portfolio, we remain primarily an ARM lender, with over $2 billion of 5-1 and 7-1 ARMs. We continue to be the leading mortgage originator by units in Wisconsin, and sell substantially all of our 15- and 30-year production to the agencies. Our mortgage servicing portfolio's grown to over $8 billion.

Commercial real estate grew $355 million, or 11%, to $3.7 billion. Most of the growth in commercial real estate came in multi-family loans, which make up the largest segment of this portfolio.

Commercial and business lending average portfolios grew by $671 million, or 13%, from 2012. Within this group, general commercial loans accounted for the largest amount, growing by $304 million, or 7%. Manufacturing continues to be the largest contributor to C&I loan growth. Given a positive economic backdrop, we expect continued commercial loan growth during 2014. We note that commercial line utilization has declined to about 45% in the fourth quarter, from 48% earlier in the year.

We continue to diversify our commercial portfolio by building out our power and utilities, and oil and gas businesses. We purchased several power and utility portfolios during 2013, and continue to see our specialty portfolios as growth opportunities. While we continue to expand, we do expect the rate of growth to slow as the business matures.

A large portion of our 2013 loan growth was offset by the continued run-off of our home-equity and installment portfolios. Balances declined $489 million during 2013, as customers continued to deleverage and refinance into lower-priced first-lien mortgages. We expect to see continued run-off in HELOCs and student loans in 2014. 41% of our year-end home-equity loans are in a first-lien position.

In addition, we'd add that our mortgage warehouse utilization continued to decline with the slowdown in mortgage refinancing. We also increased our securities portfolio during the fourth quarter by 8%, to approximately $5.3 billion.

To recap, as we look forward to 2014, we expect to see continued growth in commercial, commercial real estate, and specialized lending, and modest net growth in overall consumer lending. So, in aggregate, we expect mid-single-digit loan growth in 2014.

Average deposits of $17.4 billion were up 12% from 2012. Our low-cost money market, checking, and savings products grew by over $2 billion, or 17%. Non-interest-bearing checking grew by $300 million, or 8%, to $4.2 billion, on average.

Our interest-bearing deposits, including savings, money market, and interest-bearing checking, total $11.3 billion, and had a weighted average cost of just 17 basis points in 2013. Time deposits, our most expensive source of deposit funding, continued to decline during 2013, and at period end, totaled just $1.7 billion. Overall, the cost of interest-bearing deposits declined by more than $10 million, or 12 basis points year over year.

During the fourth quarter, we also took actions to reduce our collateralized municipal deposits, networked transaction deposits, brokered CDs, and institutional funds. We replaced these funding sources with lower-cost, longer-term financing in the form of five-year put-able, variable-rate Federal Home Loan Bank advances. The impact of these actions reduced total deposits in customer funding by over $1 billion.

We refinanced $400 million of higher-cost FHLB term advances in the first half of 2013, and redeemed $26 million of 9.25% subordinated debt in October. These actions contributed to the $19 million of realized funding-cost savings during the year. We've also recently called for the early redemption of $155 million of our 1 7/8% senior notes issued in 2012. These securities will be retired in February.

Looking to 2014, we continue to build out our commercial deposit and treasury management solutions. We are introducing a new lock-box solution in the first quarter; and combined with the treasury portal we rolled out early in 2013, we feel good about our product lineup. We expect to grow core deposits this year in the high-single digits year over year.

Turning to slide 4, our yield on earning assets increased in the fourth quarter; although for the full year, the yield on earning assets declined 20 basis points to 3.5%. While the average yield on commercial and business lending loans declined 6 basis points in the fourth quarter, the average yield on mortgages and retail loans continued to increase. CRE loans posted an average yield of over 4% for the quarter, but this included over $3 million of interest recoveries. However, even after adjusting for these interest recoveries, gross interest income on loans and securities improved quarter over quarter, and the NIM expanded.

Competition for asset generation, particularly C&I loans, is high, due to stronger bank balance sheets and lower economic growth. This is a stealing market share game. Pricing was tighter during the year, as there was a lot more bidding on term sheets; and in addition, loosening loan structures were more prevalent in some of the markets where we compete.

On the liability side, interest expense continued to decline. The cost of interest-bearing liabilities declined 16 basis points year over year and 3 basis points quarter over quarter. These savings are being driven by disciplined deposit pricing and aggressive liability management.

We continue to look at ways to further reduce our interest-bearing liability costs; however, with overall deposit costs of just 22 basis points and interest-bearing liability costs of 35 basis points, our ability to manage these costs lower is becoming constrained. Nonetheless, dollar net interest income is expected to grow, even as NIM continues to modestly compress in 2014.

Non-interest expense is highlighted on slide 5. Total non-interest expenses declined slightly from 2012 to $681 million. FTEs declined by 7%. Technology and equipment spend increased by $8 million, as we continue to focus on technology solutions for labor-intensive processes within the Bank. As our credit metrics have improved, foreclosure and OREO expenses declined by a third from 2012 to about $10 million, and are less than half of the levels a few years ago.

Legal and professional fees, which include consulting and our BSA/AML remediation-related expenses, have declined by about a third, or $11 million, from 2012. Occupancy expenses decreased more than $1 million from 2012, and we believe we can lower this expense further through some of the real estate initiatives implemented during the past year.

For the fourth quarter, total non-interest expense of $179 million was up $15 million from the third quarter. Personnel expenses increased $3 million, although it does include a $2 million of severance costs related to ongoing efficiency initiatives. Business development and advertising expense increased $2 million quarter over quarter, as we ramped up advertising related to our brand campaign. The $2-million increase in legal and professional fees from Q3 was almost entirely made up of what we expect will be one-time consulting expenses related to DFAST and compliance enhancements. Other expenses were up $3 million from the prior quarter, and included a $1-million increase in charitable contributions.

Overall, we remain focused on efficiently managing our personnel costs, continuing our technology investments, and reducing other costs across the Organization. And we expect flat expenses again this year, as we had last year and the year before.

Non-interest income of $313 million was flat compared to 2012. Our core fee categories increased $4 million, or 2%, led by strong trust fee growth of 12%. Trust assets under management of $7.4 billion grew 15% from last year, and are at an all-time high.

Mortgage banking income of $49 million in 2013 declined from record levels in 2012, as the refinance boom ended last Spring. While the first two quarters of 2013 continued to benefit from strong mortgage banking results, the second-half run rate is likely more typical of what we would expect in 2014. With this in mind, total non-interest income is expected to decline slightly in 2014.

The Company's 2013 tax expense increased by $4 million, as income grew and the effective tax rate remained largely unchanged at about 30%. While the Company's enjoyed annual tax rates of just under 30% over the last couple of years, going forward we expect marginal tax rates to climb into the low-30%s, as earnings continue to improve.

Turning to slide 6, credit quality continued to improve in the fourth quarter, as net charge-offs, non-accruals, past dues, and potential problem loans all declined. Net charge-offs of only $5 million were flat compared to last quarter, as we continue to experience higher recoveries. For our consumer book, charge-offs have fallen to 19 basis points, compared to 93 basis points a year ago. Potential problem loans declined 15% to $235 million this quarter, and are down 35% from a year ago.

The level of non-accrual loans to total loans has now improved for 15 consecutive quarters, and is at 117 basis points, down from 1.33%. Total non-accrual loans of $185 million are down 11% from the third quarter. The total allowance for loan losses equals 1.69% of total loans, and covers 145% of period-end non-accruals. The provision for loan losses was $2 million in the fourth quarter and $10 million for the full year.

On slide 7, our capital ratios continue to remain very strong, with a Tier-1-common-equity ratio of 11.46%. We are well capitalized, and are in excess of the Basel III expectations on a fully phased-in basis. Our net income available to common shareholders was $184 million. Our return on Tier 1 common was 9.8% for the year.

Our stated capital deployment priorities place an emphasis on organic growth and paying a competitive dividend; and total dividends per common share of $0.33 increased 43% from 2012. Other capital uses would include non-organic opportunities and share buybacks. And we repurchased about 7.7 million shares of common during 2013.

On slide 8, we'd like to recap our outlook for 2014. We are expecting mid-single-digit average loan growth, similar to 2013. Average deposit and other funding should grow in the high-single digits. Net interest margin will compress modestly throughout the year.

We expect non-interest income to be down slightly, as core fee growth will be offset by a decline in mortgage banking income. Non-interest expense is expected to be flat. And finally, our loan loss provision will grow based on loan growth.

And with that, we'll open it up to your questions.

(Operator Instructions)

And our first question comes from the line of Matthew Clark with Credit Suisse. Your line is open.

Good evening, guys.

Good evening.

Maybe just first on the muni deposits that you guys reduced and the $1 billion. Just curious what those cost, on average, and the cost of what you replaced them with on the FHLB side?

The average cost of the deposits we displaced was right around 20 basis points. And the weighted average cost of what we replaced them with, the Federal Home Loan Bank advances, was just south of 10 basis points.

Okay. And then, in terms of your expense guidance, looks encouraging relative to the run rate this quarter. It sounds like you had a couple million in severance, an uptick in charitable contribution. Can you just give us -- other than, I think, occupancy, can you give us a sense for what else is going to keep you flat for the year?

Again, we had a substantial run-up in advertising, along with our fourth-quarter brand push, and we won't be repeating that throughout the year. We also had a run-up in legal and professional, and consulting, costs to make sure we were on top of all the things that are changing as we move forward in the new regulatory environment. And we'd like to think that those costs are largely behind us, and those will moderate the expense trend going into 2014.

Okay. And then, was there an MSR write-up this quarter or not? Just curious.

It was nothing material.

Okay. Okay. I'll step back. Thanks.

Our next question comes from the line of Chris McGratty with KBW. Your line is open.

Good afternoon, guys. Phil, you guys paid out roughly 100% total payout in 2014. Given your outlook for growth and your strong capital position, is that kind of a fair assumption again? Is there any restrictions of you guys doing a combined 100% again?

No, there's no particular restrictions. If we were to do the same amount of share buybacks this year as we did last year, we would need to renew our Board authorization. But we still have plenty of room in front of us to get through most of this year.

And can you remind us what's left?

90-ish.

$90 million. Okay.

We intend to renew it We intend to renew it, and we have no reason to believe there would be any limitation on our ability to continue at the current pace.

Okay. And on M&A, Phil, can you update on what you might be seeing in the Midwest today? There's been a couple of transactions, not necessarily in your Wisconsin market, but maybe what you're seeing in terms of opportunities?

As we've talked about many times, I do believe that the industry is ripe for consolidation. It hasn't happened to any great degree. That doesn't mean I don't think it's going to. I think, as time goes on, particularly smaller banks will continue to struggle with this economic environment, interest rate environment, regulatory environment, et cetera.

And just anecdotally, there's been a noticeable pick-up of interest of people giving us a call. And I wouldn't be surprised to see more activity this year.

Great. And then, Chris, can you help us on the size of the securities book going forward?

Sure. I think we've been trying to keep the securities book in line with the overall growth. We took a look at where we were, balance-wise, in the fourth quarter, and decided to pre-invest some balances here at the end of the year. You'll recall we did something very similar at the end of last year. We sort of think of that as pre-investment for expected cash flows, in anticipation of the fact that oftentimes our first-quarter loan growth is a little softer than other periods during the year.

Great. Thanks.

Our next question comes from the line of Ken Zerbe with Morgan Stanley. Your line is open.

Thanks. Probably have some more questions on the same topics we've been talking about. If I look at, I guess page 1 -- the first exhibit page that you guys have -- your long-term funding went up by $2.5 billion, which is huge. I get that you're replacing the collateralized munis, and that's great. But the other $1.5 billion -- are you using long-term funding to increase your securities portfolio? I'm just trying to match up all the numbers there.

Let me be clear. We took advantage of what we saw as a very attractive program offered by the Federal Home Loan Bank of Chicago, called their Reduced Capitalization Advance Program, RCAP, which provided for us to take long-term, put-able advances. So, they are liquidity in cash to us for five years that we can repay without penalty, any point six months or later. And these are variable rate advances.

So, we have short-term effective funding available to us, but five-year guaranteed liquidity, which, from an LCR perspective, from a liquidity management perspective, is a great outcome. Because we've effectively converted what we previously had was collateralized municipal deposits that were tying up our most liquid assets, and replaced it with essentially funding from the Federal Home Loan Bank on a five-year committed basis that is being pledged with whole loans that were sitting on our balance sheet, otherwise not being used. And creating great liquidity out of our investment portfolio.

And to top it off, we did it for 10 basis points lower cost than what we had been funding previously.

And we can put this back six months out from when we borrow it. So, we can keep it for five; we can get rid of it after six months.

Got it. Okay. That helps out. Great explanation.

In terms -- just to be super clear, in terms of the expense guidance of flat, is there any items in 2013 that you're adjusting for? I think I have $681 million in my model, but is that the number that we're talking about?

We're committed to $681 million or less.

Got it. Perfect.

Okay, and then just last question -- on loan growth. I know your guidance is for the mid-single-digit growth. Been a little bit weaker last several quarters than that; I think close to zero. What gives you the confidence again? And maybe you addressed this, but what gives you the confidence that we're going to see the pick-up in loan growth, whereas we have not seen it in the last few quarters?

Sure. If you look into the fourth quarter, first of all, we went to a basis of reporting our loan outstandings on an average quarter basis, as opposed to point-to-point growth. But if you look at what actually happened in the fourth quarter, we had, point to point, $300 million to the loan growth in the fourth quarter. So, what that means is: As we come into the first quarter of this year, we are very well poised, from an average to an average point of view, of having probably 1.5% to 2% loan growth in the first quarter, average over average. So, when we talk about getting for the year to mid-single digits, we feel like we're in a very good position to have a good start on that.

Got it. Perfect. Thank you.

Our next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Your line is open.

Good afternoon, guys. Actually, I think most of mine have been answered. I guess just one clarification question. So, you've got a total of -- it looks like $5 million or so of one-time costs in the expense lines from the $2 million of severance, and then the other $3 million that aggregate. The $3 million -- did that include the charitable contribution, or was that just the DFAST and then the compliance, as well?

The severance, again, was $2.5 million-ish. We would note that advertising expenses were considerably higher, and they won't be necessarily recurring at that pace.

Legal and professional fees were considerably higher, and won't be recurring at that pace. And that the other expenses, which included the charitable contributions down there in the other category, but also we had the write-off costs on the sub debt. We had some expanded travel and training expenses at the end of year. All of that we don't think will necessarily repeat in quite the same way as we move into 2014.

Okay. All right. So, probably even -- sounds like even more than the $5 million that gets called out in the release. And then I guess the bottom line, though, is flat for 2014?

We very committed to absolute flat on dollar terms.

Okay. I think that does it, so I appreciate it.

Our next question comes from the line of Emlen Harmon with Jefferies. Your line is open.

Good evening, guys.

Good evening.

Within your guidance, you call for the provision to be contingent on loan growth. So, I understand there could be some provision put up for that. But also, you guys had a fair amount of recoveries this year; you're also releasing some reserves. Can you help me understand how that provision that you use for loan growth interplays with what's actually happening underneath from a credit perspective?

Sure. Recall that, for now, basically 3.5-plus years, we've had an improving credit quality. We've been getting the benefit for some period of time of reserve releases driven by improving credit metrics that were more than enough to offset the need to provide for loan growth. That dynamic pretty much went away, call it, six months ago or so -- a couple quarters ago.

Over this last couple of quarters, we've continued to have very significant unusual recoveries. We don't plan for that in the future. Apples to apples, taking out the recoveries, and also with charge-offs, particularly in the retail area, moderating, we think that provisions, at least for the coming year, are very much going to be tied to what happens with loans. We expect pretty modest provisioning during the course of the year, particularly if we have mid-single-digit loan growth. We're still not anywhere near getting to a, quote, normal part of the cycle. Loan provisions will grow for us, and I believe for most banks, over the coming years as we leg back into whenever the next cycle starts.

Got you. Okay. Thank you. That's helpful. I guess maybe think about -- a fair way to think about it would be to think about 2013 in total had $10 million in charge-offs. If you get good loan growth, maybe you'd trickle up a little bit from that; does that sound fair?

Well, with $10 million in provisions for the year.

I'm sorry. Yes.

Yes.

Okay. And then, how should we be thinking about the starting point for the NIM next quarter? Ex the interest recoveries, seems like you guys were up 4 or so basis points on the quarter. Just want to understand how we get to your guidance for the year, as we progress through the year.

Sure. Part of that -- in the pick-up, there was a little bit of premium amortization that helped, as well. But we would expect, nonetheless, if rates move up a little on the long end, we might see more of that lift.

What we have seen is continued competitive environment in lending. And so, while we're putting on mortgages now at an even or better rate, as things roll off and we replace them, much of the commercial activity is still very competitive. And we expect to see modest erosion to the effective commercial yields over the balance of the year. But it should be relatively modest.

So, it would be fair to say we were pleased to see what happened in the fourth quarter with the NIM, even backing out the interest recoveries. It's entirely possible that we might be seeing some stabilization. But it's really too early to call that yet. We think it's prudent to think that we'll have continued, very slow erosion in the NIM in the coming quarters. But that could change.

Got you. When we think about your guidance, that's more referring to what happens on a quarterly basis, as opposed to what's happening on an annual basis?

Right. The NIM can move around, as we all know, quarter to quarter, based upon other factors, particularly interest recoveries. But over the course of the year, we would expect some modest compression in the NIM. And the one thing we know is it won't be smooth.

Got it. Okay. Thanks a lot, guys.

Our next question comes from the line of Dave Rochester with Deutsche Bank. Your line is open.

Good evening, guys. You mentioned you're getting more inbounds on the M&A front, and expecting more activity, in general, in the market. In terms of your ability to do deals this year, have you formally gotten out from under the constraints that you may have had under the BSA issues?

If we were formally out of those constraints, you would absolutely know it. The answer is, no, not quite yet.

Okay.

We completed all the work, as we've said, quite a while ago. And we feel like we're in a good place, and we're awaiting regulatory confirmation.

Got it. And does your expense guidance assume that you're going to complete the branch refurbish program in 2014 still, or are you extending that a little bit into 2015?

We've actually -- that whole program has evolved over this last three years. We expect that we will continue that program into 2015 before it's complete. But recall we've actually consolidated a number of branches. So, overall, the program has gotten a little bit smaller, and we've gotten a lot better, as time has gone on, about being cost efficient.

The bulk of it, at least 80%, will be done by the end of this year. And then there'll be some remaining next year.

Got it. And just switching to the margin, I noticed the securities yield was up a little bit this quarter. You had mentioned securities premium am earlier. Was just wondering what the dollar amount of that was this quarter, and how much it may have supported the margin?

It was about $2 million, dollar-wise.

$2 million, in terms of a decline this quarter?

$2 million less premium amortization.

Got you. Okay. Great. In terms of the expense, for the quarter?

Correct. The premium amortization expense declined by $2 million. So, it helped.

Perfect. And on mortgage banking, I know you mentioned that should decline next year -- or this year. What's a more normalized level of income from that business, do you think? How much should it decline?

Our estimate is: If you look at the third and fourth quarter of 2013, that combined run rate is probably a reasonable forecast. It's subject to a lot of market forces, obviously. But that's what we're assuming.

All right. Thanks, guys. Appreciate it.

(Operator Instructions)

Our next question comes from the line of Peyton Green with Sterne, Agee. Your line is open.

Good afternoon. Thank you for taking my question. I was wondering, Phil, last year, sequentially, the loan growth was much stronger in the first half of the year. It was harder to come by in the second half. Would you think it would be a little bit different coming into 2014, maybe flipped, or what's your guidance? I know historically in the first quarter, it's been a tough quarter, historically, for Associated to book much loan growth.

Given the shape of what happened in the fourth quarter, we're going to have good average loan growth in the first quarter. One of the other things that's happened is: As the mortgage refi boom came to an end, we tended to have these spikes in usage by our mortgage warehouse borrowers. That's significantly abated. I wouldn't call that noise, but some of the noise of relatively large outstandings for short period of time is kind of out of the picture now. There's a little less volatility month to month, quarter to quarter, than what we were experiencing in the past.

As far as whether -- how we're going to get this single-digit average loan growth, I would hate to try to prognosticate whether it's first half or second half. This first quarter, like I said, looks pretty promising. But as opposed to a year ago, it's significantly more competitive in the various geographies and asset classes that we deal in. And not just from a pricing point of view, but also from a structure point of view, which precludes us from wanting to participate in some of that. We are continuing to run the shaping of our portfolio with an eye toward the next credit cycle.

Okay. And then, maybe if you could put an outlook in the context of what the pipeline looks like, maybe compared to what it looked like six months ago.

Pipeline is in pretty good shape. Commercial real estate looks very promising. Our specialty businesses continue to do quite well. Commercial continues to have a very competitive environment, particularly in the Chicago area. Our pipeline for the mortgage business is running in the $500 million to $600 million range, which is half or less from what it used to be. But overall, it's in decent shape.

Okay. All right. Great. And then, if you look at your guidance, would the bigger risk be on the loan guidance, and maybe the expenses come in better than you think in terms of flat, maybe they're down 1% or 2%, or -- ?

I think the guidance that we've offered is -- we stand behind all of it. We think we will achieve what we've said. I wouldn't weight one more than the other.

I did say that we were happy with what happened with the net interest margin. Maybe it turns out a little better. We'll just have to see. As we like to say: One quarter a trend does not make.

Sure. Okay. Great. Thank you very much for taking the questions.

I'm not showing any further questions at this time. I'd like to turn the call back over to Phil Flynn for closing remarks.

Okay. Thanks for joining us today, everybody. This past year's strong performance was highlighted by balance-sheet growth, as well as higher net interest income. We were able to modestly reduce our expenses and grow the bottom line; and we remain focused on deploying capital to build shareholder value. And we're optimistic in our ability to continue to grow the Franchise in 2014.

So, we'll look forward to talking with you again next quarter. If you have any questions in the meantime, as always, give us a call. And thanks for your interest in Associated.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a good day.