Associated Banc-Corp (ASB) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Associated Banc-Corp first quarter 2014 earnings conference call. My name is Nicole and I'll be your operator today.

(Operator Instructions)

Copies of the slides that will be referenced during today's conference are available on the company's website at associatedbanc.com/investor. As a reminder, this conference call is being recorded.

During the course of today's discussion 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 and the risk factors section of Associated's most recent Form 10K and subsequent SEC filings. These factors are incorporated herein, by reference.

For reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference, please see pages 2 and 3 of the press release financial tables. 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, welcome to our first quarter end conference call. Joining me are Chris Niles, our Chief Financial Officer, and Scott Hickey, our Chief Credit Officer.

Highlights for our first quarter are outlined on slide 2. These solid results were highlighted by robust loan growth and reduced expenses. As a result, we delivered net income to common shareholders of $44 million or $0.27 per share.

We had a great quarter for loan growth as average balances increased 3% from the fourth quarter to $16.2 billion. Commercial loans drove most of the overall growth with a record quarter, while mortgage loans also contributed to this increase.

Net interest income, excluding interest recoveries, increased $1 million from the fourth quarter. We continue to defend the net interest margin, which at 312 basis points has only compressed 5 basis points from last year's first quarter.

Core fee-based revenues were essentially flat and total non-interest income of $74 million was down only $2 million from the fourth quarter due to less gains on sales of assets and loans. However, we more than made up for the lost revenues with reduced non-interest expense, which declined $12 million from the fourth quarter. We maintained the quarterly dividend at $0.09 per share, and we repurchased $39 million of common stock, or approximately 2.3 million shares and our Tier 1 common equity ratio remains very strong at 11.2%.

Now let me share some detail on the main divers of our first quarter earnings. Loans are highlighted on slide 3.

Average loans grew $416 million, or 3% from the fourth quarter to $16.2 billion. Growth during the first quarter was driven by record results in our commercial businesses, and commercial real estate, which were up $420 million combined.

For our retail business, growth in mortgage balances were offset by continued runoff in the home equity and installment loan portfolios. Average commercial real estate loans grew by $171 million during the quarter to $3.9 billion. Multi-family loans provided most of the growth and continue to make up the largest segment of this portfolio.

In addition, we also saw an increase in retail loan activity. From a geography standpoint, most of the CRE growth was in Chicago, St. Louis, and Ohio.

Commercial and business lending average portfolios grew by $249 million, or 4% during the quarter. Within this group, general commercial loans grew by $157 million, or 3%, our C&I loan growth continues to be driven by lending to manufacturing companies in our upper Midwest footprint.

Oil and gas and power and utilities average balances both grew during the quarter by a combined $132 million. And as mortgage refinance activity continued to slow, our mortgage warehouse portfolio declined $40 million from the fourth quarter.

Average residential mortgage loans grew by 2% in the first quarter, driven by increased ARM production. First quarter loan production mix was 60% variable rate, up from 45% the prior quarter.

In addition, with the refinance boom ending in the middle of last year, our production mix has shifted from 70% refinance earlier in 2013, to about 40% now. However, since mortgage rates still remain relatively low, we expect consumers to continue deleveraging into lower priced first lien mortgages.

We continue to sell substantially all of our 15- and 30-year production. And during the first quarter, our mortgage banking units sold $204 million of loans to the GSEs compared to $327 million in the prior quarter. The gain on sales of these loans was 2.11%, compared to 172 basis points last quarter. Home equity installment loans continue to decline although at a slower pace, compared to prior quarters.

If you turn to slide 4, in addition to increased line commitments, our commercial clients also increased utilization of their lines in the first quarter. This contributed to our commercial loan growth, although we note that this increase is partially seasonal.

Commercial real estate line utilization of 64% has steadily increased each quarter as construction projects fund. Given current funding activity, we expect this to continue into the year.

Line utilization for our specialized lending areas also increased as our oil and gas segment booked a significant amount of fully funded deals compared to the prior quarter. This was partly offset by mortgage warehouse line utilization dropping from 29% in the fourth quarter to 24% this quarter.

Turning to deposits and funding, during last quarter's earnings call, we discussed our funding initiative to reduce collateralized municipal deposits, networked transaction deposits, brokered CDs, and institutional funds. And you'll recall that near the end of the fourth quarter, we replaced funding sources with lower cost, longer term financing in the form of 5 year putable, variable rate federal home loan bank advances.

As a result of that initiative, average deposit balances of $17 billion declined $891 million during the fourth quarter. Although period end deposit balances of $17.5 billion actually increased $243 million from the end of the fourth quarter.

Turning to slide 5, net interest income declined $2 million from the fourth quarter. However, if you net out the interest recoveries that we had in the fourth quarter, it was up $1 million. In addition, the first quarter had $2 million less interest earned due to the day count difference that always exists in the first quarter.

Net interest margin for the first quarter was 312 basis points, down 11 basis points from the prior quarter, but that was in line with what we had expected. Fourth quarter net interest margin of 323 basis points was inflated, as you will recall, by approximately 8 basis points, due to $4 million in interest recoveries. So year-over-year, the NIM is down only 5 basis points, which we believe speaks to our diligent management of the margin.

Total asset yields declined 14 basis points from the fourth quarter and are being driven primarily by continued compression of commercial loan yields. Compression has actually slowed in our residential mortgage and investment portfolios.

Our aggressive liability management on the funding side continues to drive costs down each quarter. However, with overall deposit costs of just 19 basis points, and interest bearing liability costs of 31 basis points, our ability to reduce these costs is becoming even more constrained.

Non-interest income is highlighted on slide 6. Total non-interest income for the quarter was $74 million, down $2 million from the fourth quarter, and down $8 million from the first quarter of 2013. These declines are driven by lower mortgage related income, as refinance activity has slowed.

As expected, mortgage banking income of $6 million declined $2 million from the fourth quarter and is down $11 million on a year-over-year basis. Core fee based income, which includes service charges on deposit, card based income, insurance revenue, brokerage commissions and trust fees was essentially flat from the fourth quarter.

Asset gains decreased $2 million, as less net gains on real estate were realized in the first quarter. As we continue to evaluate consolidation opportunities and rationalize the footprint, we expect to see more real estate transactions flowing through this account.

Turning to slide 7, total non-interest expenses declined $12 million from the fourth quarter to $168 million. Quarter-over-quarter personnel expense decreased $4 million as our FTEs continued to decline, and are now at their lowest levels since mid-2010. In addition, the fourth quarter had over $2 million in severance costs.

Business development and advertising expense declined $3 million, mainly related to less media advertising in the first quarter. Legal and professional fees were down $2 million from the prior quarter, primarily related to declining consultant costs. Losses other than loans declined $1 million as we had more favorable than expected resolutions of a few litigation matters.

Turning to slide 8, we had another quarter of improving credit quality as net charge-offs, non-accruals, past dues, and potential problem loans all declined. Net charge-offs of only $5 million were in line with the prior two quarters. Potential problem loans declined 7% to $220 million this quarter and are down 36% from a year ago.

The level of non-accrual loans to total loans continued to above to 1.08% from 1.17% at the end of the fourth quarter. Total non-accrual loans of $178 million were down 4% from the fourth quarter. Our total allowance for loan losses equals 1.63% of total loans and covers over 150% of period end non-accrual loans.

For 2014, we are reporting a new roll-up called provision for credit losses in our consolidated financial statement. This roll-up includes provision for loan losses and unfunded commitments. The provision for credit losses was $5 million for the quarter, and was primary driven by loan growth.

Turning to slide 9, our capital ratios continue to remain very strong with a Tier 1 common equity ratio of 11.2%. We're well capitalized and we're in excess of the Basel III expectations on a fully phased-in basis. Our priority for capital deployment continues to focus on organic growth, will insure that our dividend stays in line with earnings growth, and we will be disciplined in other opportunities to optimize our capital structure over the coming year.

On slide 10, we want to discuss our outlook for the remainder of 2014. We're slightly increasing our guidance on average loan growth to 6% to 8%. We expect average deposits and other funding to 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 the decline in mortgage banking income will be partially offset by other fee growth, and as we said before, non-interest expense is expected to be flat to last year. Finally, our provision for credit losses will grow based on loan growth.

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

(Operator Instructions)

Chris McGratty of KBW.

Chris, on your margin guidance, I was wondering if you could help frame the degree of compression going forward. I'm interested in both in when you think the margin may be troughing. Is it around 3%, kind of when and where, any guidance would be great. Thanks.

It's hard to call the long term. As you're aware, Chris, many loans that come on today come on at spreads that are frankly below our absolute margin today. So effectively, new loans are inherently dilutive, assuming rates and LIBOR rates remain where they are for the time of year.

So we've not put a floor out there, although I'd like to think that the very incremental dilution you're seeing to the margin will be the case so long as we stay at these levels. So, as long as we are growing reasonably, I don't expect significant margin movement quarter to quarter, but it will be a continual slow grind as long as we stay at low rates.

Just remember, if you take, if you put aside the fourth quarter where we had the interest recoveries, the third quarter net interest margin was 1 basis point higher than what we reported for the first quarter. And if you go all the way back to the first quarter of 2013, it was 5 basis points higher. So absent the noise of interest recoveries, this thing has been declining 1 or 2 basis points on average for the last year or so.

Any perspective, Chris, on what the new kind of blended origination yields were in the quarter versus what was on the books already?

LIBOR plus 250 to 300 is a reasonable range for many of the credits that we originate. Unfortunately, those are both below our, certainly, right at or below our margin. Much of what we originate is on a one-month LIBOR basis.

And how much of the growth, Chris, was credits in the quarter.

It was a portion of the growth within the commercial but again, we had broad based growth, we do very little [SNICK] activity within our CRE portfolios, and obviously our residential portfolio is all home grown.

Okay. Just the last housekeeping, the BOLI income ticked up in the quarter, is this the run rate that we should be using going forward?

No, BOLI is idiosyncratic based on, unfortunately events, so we don't project it per se. It's just a background number.

Okay. Thanks a lot.

Ken Zerbe of Morgan Stanley.

First question I had, just in terms of capital deployment, I saw right on the press release you put in a comment that you're looking for opportunities to deploy capital. Let's assume that's probably M&A, I would say.

Could you just address your comments, are you seeing more activity in M&A versus where you were last quarter? Was there a reason why this is now popping up in the press release? Just trying to get a sense of your views on how M&A potentially is changing over the last couple of months.

Sure Ken, so a couple things, we've said all along that our priorities for capital use are to fund organic growth in the Company, to pay a competitive dividend, to look for other opportunities, to deploy capital through acquisitions, and finally share buy-backs. For the past year and a half, we've been steady buyers of our shares, and we well will continue being steady buyers of our shares.

With the resolution of our BSA/AML matter, we are in a better position now than we were to be able to execute on a potential transaction. So that's why we mentioned that, and it's something we've been mentioning all along.

As far as activity, we are both actively out talking to potential banks and other institutions, as well as getting more inbound calls. I think it's not a secret that we have capital to deploy, and that, again, with the resolution of the regulatory matter, we're in a position to execute.

Got it, okay.

Next question I had, just in terms of the loan growth guidance, it seems like the guidance is going up a little bit more than what this quarter alone would suggest. Has the outlook materially changed? I mean, obviously I saw the line utilization rates picking up a little bit. Is there something meaningfully different in the environment, or are you going on just the activity that we've seen this quarter and extrapolating that going forward?

You might want to look at -- we report our loan growth on averages, which we think is the best way to do it, but you might want to look at the point-to-point growth. So we had point-to-point growth of $545 million, which, frankly, is more than what we had expected three months ago.

So if you look at that -- where we ended the first quarter, versus where we started, we've had very robust loan growth in this first quarter. On a non-annualized basis, certainly, very robust. We don't it to continue at that clip, but this was a much stronger first quarter than what we had originally thought, and that certainly affects our outlook for what the average loan growth for the whole year will be.

Got it. Meaning the second, third and fourth quarters might actually be consistent with what you thought before? Okay. That totally makes sense.

Okay, and then just final question, advertising down this quarter? You're actually not the first bank to have lower advertising. Can you just remind us, is there something unusual about fourth quarter where banks generally advertise a lot more and less in first quarter? I was just curious about the seasonality there.

I don't know about other banks, but for us, we initiated a significant launch of our brand campaign during the fourth quarter, so we spent more money on that, and our pattern has been, and will be, that we generally do spring and fall pushes on advertising, on brand advertising. So those would be the seasonal effect that you would see at Associated.

Got it. Okay, perfect, thank you.

Jon Arfstrom of RBC Capital Markets.

Just following up on Ken's question on C&I growth. It does seem like something has changed when you look at the last couple of quarters. And I know a lot of your book is upper Midwestern type credits. Is there anything specific in the C&I growth, or is this just broad-based?

The growth that we had this quarter and in the fourth quarter was broad-based. We're quite pleased to see it across all our business lines. So our general commercial lending has been strong, commercial real estate was strong and has been strong a while.

Our specialized units had very strong growth, particularly this past quarter. And the mortgage business, for adjusting or for originating adjustable rate mortgages that we can put on our balance sheet has also been good. It's been a very good six months for loan growth.

Absolutely. Okay. On your 2014 --

Didn't have any purchases in there, there was nothing unusual. This was organic growth that we generated.

Yes. Okay. And I guess the other thing you mentioned, fewer loan payoffs?

Yes, there was less loan payoffs here and there and line utilization as you saw in that chart is ticking up. It looks like there is some seasonality, particularly in the general commercial space for the first quarter, so we'll see how that plays out, but we don't expect that to materially impact us.

Okay. On the 2014 outlook slide, you give us, we can probably solve for this, but you give us the loan growth number, and the continued NIM compression. Is it safe to assume that you're assuming modestly higher net interest income that would track with loan growth?

We're assuming growing dollar NII over the course of the year.

Okay, good. That helps.

You want to definitely as you look at our first quarter compared to the fourth, back out $4 million of net, of interest recoveries that artificially popped up NII in the fourth quarter. We had a much lower amount in the first and there's a day count adjustment of a couple million, as well. So NII actually taking out the anomalies in the fourth quarter has got a nice trend.

Okay. And then just one for Scott, if I can.

Scott didn't think he was going to have to say anything today.

Yes, the credit guy is not center stage any longer. But Scott, anything you're seeing from a credit point of view out there that concerns you, things that you're maybe steering the bank away from?

Yes, sure. The leverage market's been rather frothy at the higher multiple levels, and we've stayed away from those high 5, 6 multiple type deals, so we've definitely been out of that market.

I think in the real estate side, you read a lot about multi-family, particularly on the construction side, we monitor that very closely. So those would be the two areas that I think there's a fair amount of activity where we're, have close monitoring within the Company as to how we're going to play in those markets.

Okay, all right. Thanks for the help, guys.

Sure.

Emlen Harmon of Jefferies.

To continue on the commercial growth theme, I mean, we did see the utilization rate balance this quarter. Anything you're seeing that would indicate that there's a C change in use of utilizations and maybe we start to see that heading the other way for a while?

Well, that would be nice. I think it's a little early to call that.

Certainly, if you look at slide 4, commercial real estate will continue to decline because we have something in the neighborhood of $0.5 billion of unfunded construction commitments which will be funding up. At some point that will start to top because you'll start to get churn in the portfolio as construction loans mature, and most likely get taken into the permanent loan markets.

On the specialized side, the oil and gas loans really vary. Sometimes when they come on, they fund very quickly. Other times they fund more slowly, depends on drilling activity. So it's hard to predict.

Commercial is the wild card. So we've had -- we've been hanging around in the mid-40s. We've ticked up here by a couple percent in the first quarter. It's very hard to predict whether that will continue. But overall, with what's going on with CRE, the overall utilization rate probably has a bias towards going up at this point.

Got it. Okay, thanks. And then just one quick housekeeping item, Chris. Have you guys decided what the effect of payroll taxes was on, just on the personnel line this quarter?

It was a couple million bucks.

Perfect, thanks, guys. Appreciate it.

Erika Najarian from Merrill Lynch.

This is Ebrahim, just a quick question on your expense guidance for being flat compared to 2013. When we look at the first Q run rate, which, as you pointed out, included some seasonal payroll impact, maybe weaker marketing spend. We're already at a level which is below 2013. Is the expectation of expenses that that line is going to bounce around? Or should we see expenses relative to the Q1 run rate trend lower from here?

We're not changing our guidance, which would be basically about $681 million, actually, to be exact. Which was what we had last year. We expect that this year.

So, yes, we're running at slightly below that pace if you were to analyze the first quarter. But I mean I would remind you that it's a fair size company. Expenses can move around from quarter to quarter. So that's why we tend to give guidance on an annual basis.

We will have a marketing campaign that will hit second quarter numbers. We will have a fall marketing plan of later numbers, et cetera.

Good, and I guess what I was trying to get to is, are we getting to a point where the investments you've been making, and you point this out on slide 7 on the technology spend, et cetera, are we getting to a point where that is sort of falling off, and we actually start seeing expense here falling to the bottom line?

I think looking at slide 7, you'll see the head count continues to come down as we've implemented these efficiency initiatives, and we would expect that to start running through the numbers over time as the investments start to fall off. But we continue to make investments. And we're continuing to buy and build new technology solutions. We're not speaking quite yet as to the timing, but the trends continue and they're moving in the right direction.

All right. Thank you very much.

(Operator Instructions)

Stephen Geyen of D.A. Davidson.

Just looking at the balance sheet, just curious what you consider an optimal balance sheet. I was looking at some of the liquidity ratios. What are you focused on?

Sure, so I think we feel comfortable that we have an LCR-compliant profile today. And we have securities positions that arguably has us well situation to address certainly our needs, but also potentially to the question earlier to absorb other that might not have the liquidity profile they need, or the liquidity profile is a larger institution.

I think we have potentially some excess liquidity that we would like to see deployed as we grow our balance sheet going forward. From a pure capital perspective, I think we'd say again that we feel we are very well capitalized and so there's room for that to move down, again, through acquisition or other action over time.

Okay. And maybe a followup question on the loan yields, just curious if the renewal rates on current loans, are you getting the same or better pricing on new loans?

We have a nice dynamic in our renewal book of business, which tends to be smaller-sized and concentrated in our regional, and to some extent more rural markets in Wisconsin, that has a slightly higher average yield, and those are still renewing at a reasonable rate, and we're pleased by that. That's what helps sustain the margin. Clearly, on new origination, it's at the margin, again, I mentioned earlier, a lot of that comes in at larger dollar size, and that ranges often between 250 and 300 over LIBOR.

Sure, okay. I guess last question, given the competitive pricing in loans, have you adjusted how you look at the risk adjusted return on capital as far as credit, that may be contribution from fee income now that you have made some improvements to the corporate services? I guess over the last couple of years.

We've been running the RAROC model here for the last two years, and we continue to refine that model over time. But I think it's helping us move the business in the right direction, and clearly, our bankers are taking that into consideration as they're pricing new loans.

Bankers here from the top of the house all the way through the relationship managers are paid essentially on a matrix on earnings and returns, and at the relationship manager level, it's net income and risk adjusted return on capital. So, they are highly incented, if they are going to do a lower priced higher quality transaction, to make sure that they sell other services in order to get a decent return.

Okay. Thank you.

(Operator Instructions)

Scott Siefers of Sandler O'Neill.

I guess, Chris, probably best for you, could you talk a little bit, or discuss in a little more detail the deposit strategy that you guys had talked about last quarter, and then that, Phil, you alluded to earlier on in the call? You guys have moved the loan to deposit ratio pretty quickly.

I know there's the end of period dynamic with deposits having come up, whereas averages were down. So, I'm just curious where are you in that strategy? How much of the quarter-to-quarter change in deposits was seasonality, and where do we go from here on that tactic?

There's a typical seasonal outflow January, February, in the first quarter on core DBA from businesses. We saw that, but in addition to that, I think as we mentioned at the end of, in December of last year, we put on the federal home loan bank advances, and we leave pricing, particularly institutional and large dollar size municipal deposits in a way that we thought would incent some of them to find another home, and that happened over the course of the quarter.

A little bit to our surprise, some of them came back in the end of the first quarter. And again, there's a little bit of uptick at the end of quarters typically, but we were surprised that despite our efforts to reprice and displace and replace funding, balances came back at the end of the quarter potentially where they ended the last quarter. So frankly, we thought we would have more of an impact on our absolute balances than we did. The averages were consistent with our expectation. The pop back up at the end of the quarter was a welcome surprise.

Okay, good, that's helpful. I guess that's a good problem to have, if nothing else.

Yes, and I think the FHLB borrowing program, just as a reminder, has an all-in weighted average cost today of less than 10 basis points, so it's worked out quite nicely from an overall liability cost. And we also took out our senior notes that we had during the quarter.

So, the combination of reduced volume costs, potentially the Federal Home Bank was all refinanced and repriced from what we had last year into the first quarter. We took out the debt, and we lowered deposit costs, all contributed to obviously helping us defend the margin.

Yes. Okay. Perfect. And then if I could jump little bit back to the line utilization rates.

Obviously, as we've discussed pretty big jump by across basically every category. I'm just curious what you guys consider sort of a typical line utilization rate? I'm concerned mostly with the commercial side, but if you want to go into the other portfolios as well, that would be helpful, too.

I think, it wasn't that long ago and I've been a banker for a long time, that you would have been looking at low 50%'s, right? 55%, 53%. In this economy that we've been in now for a while, everybody's utilization rates have ticked down meaningfully below 50%.

I would think in a more normal environment, you'd be north of 50% on the commercial side, and we've still got a ways to go even with the tick-up that we had. Particularly for a bank like us. We're not a big player in unfunded large corporate deals. That's not really what we do. So there's still a reticence on the part of many businesses to make significant investments.

You've also got the dynamic, which has been talked about many times, of lots of cash on corporate and middle market balance sheets to be deployed before borrowings pick up. And we still haven't seen much of that yet either.

Yes. Okay. That's perfect. I appreciate it.

Peyton Green of Sterne, Agee.

Phil, I was wondering maybe if you could add just a little color on the commercial loan growth. And I apologize if I missed this, but would you attribute, and certainly the line utilization information is very helpful, but would you attribute the success to the calling effort really getting more traction, and broadening out of customers, or were you getting more business from existing customers?

I think it's a combination of many things, Peyton. I think we had -- we have a calling officer base that is well established here now. We haven't been doing a lot of hiring, so it's not like we have a bunch of new people, so people are well established in their calling routines. I think that's paying off.

We've had very good results in our specialized businesses. Commercial real estate has been doing well now for a long time. And as those construction loans ramp up, we obviously get outstandings from those. It is quite broad-based.

What it really isn't is the economy generating a whole lot of loan activity for us or anybody, this is generally taking share from someone else. And we've had, for example, very good results in commercial banking up in the twin cities. We hired some very good people up there over the last couple of years, and they've been doing a very good job of taking some sizable accounts from some of our competitors up there. That's the --

Okay. And so really, no change in your ability to grab business from others? You still see a pretty good opportunity there? Is that fair?

We do. Although as Scott was saying earlier, we are very disciplined about what we're building here as far as the loan portfolios. So we are staying away from quite a bit of the frothy private equity driven, higher leverage deals. That's not where we're playing to any great extent today. So we're leaving some potential loan business on the table that perhaps others are picking up.

Okay. And then, maybe in your calling efforts, do you get any sense that this will be a better capital spend year by commercial customers, or do you still feel like they're somewhat under the desk, and not really coming out?

Well, if we see utilization continue into the second quarter, and past then, then perhaps we can start to say companies are getting a little more aggressive on capital spending. I still think it's a little early to declare victory on that.

Okay. Great. Thank you for taking my questions.

Of course.

Thank you. I am showing no further questions at this time. I'd like to hand the call back over to Mr. Phil Flynn for any closing remarks.

Okay, well, thank you Nicole, and thank everybody for joining us today. Just to close, we are really happy with the first quarter results, and we are quite optimistic about the rest of the year, we're off to a very good start, so we look forward to talking to you next quarter. And as always, if you have any questions in the meantime, give us a call, and thanks again for your interest in Associated.

Ladies and gentlemen, this concludes the Associated Banc-Corp first quarter 2014 conference call. You may all now disconnect. Have a great day, everyone.