Associated Banc-Corp (ASB) 2014 Q3 法說會逐字稿

Good afternoon, everyone. Welcome to the Associated Banc-Corp's third-quarter 2014 earnings conference call. My name is Shay, and I will be your Operator today.

At this time all participants will be in a listen only mode. We will be conducting a question and answer session at the end of the conference. Copies of the slides that will be referenced during today's call are available on the Company's website at associatedbank.com/investor. As a reminder, this conference 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.

For a reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this call, please see 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 call over to Philip Flynn, President and CEO for opening remarks. Please go ahead sir.

Thank you. Welcome to our third-quarter earnings conference call. Joining me today are Chris Niles, our Chief Financial Officer and Scott Hickey, our Chief Credit Officer.

Turning to slide 2. Our strong results this quarter reflect growing net interest income trends and improving credit dynamics. Average loan balances increased 3% from the second quarter to $17.1 billion, with equal contributions from our commercial and mortgage businesses.

Net interest income grew $4 million, up 2% from the second quarter with two basis points of NIM compression. Credit trends were positive with declines in potential problem loans and low net charge-offs driving provision expense of only $1 million for the quarter.

Non-interest fee revenue grew $3 million, up 4% from the second quarter. Expenses increased modestly during the third quarter, primarily driven by our Fall marketing campaign costs. We also repurchased 5 million shares of common stock during the quarter. We delivered net income to common shareholders of $49 million or $0.31 per share and a return on Tier 1 common equity of 10.4%.

Now let me share some details on our third-quarter results. Loans are highlighted on slide 3.

Average loans grew $495 million from the second quarter to $17.1 billion. This represents a 3% quarter-over-quarter growth rate and a 9% increase year over year. Mortgage lending accounted for the majority of growth this quarter.

Commercial and business lending average portfolios grew by $184 million or 3%. Within this group, mortgage warehouse line utilization remained elevated and, in fact, increased $115 million from the second quarter. Toward the end of the third quarter, we started to see these lines pay down and we expect this trend to continue into the fourth quarter as the traditional home buying season ends.

General commercial loans were relatively flat from the second quarter. We saw several significant pay-offs and line pay-downs during the third quarter. In addition, competition has picked up even more as all banks seem to be seeking asset growth.

We continue to see aggressive structures and pricing that does not equate with the risk. From a risk adjusted return on capital perspective, certain transactions do not make sense for us and we've therefore been selective. Average commercial real estate loans grew by $51 million during the quarter, multi-family loans continue to make up the largest segment of that portfolio.

Average residential mortgage loans grew by $231 million or 6% in the third quarter driven by continued strong adjustable rate mortgage production. Our mix has changed from 45% variable in late 2013 to 59% in the third quarter.

In addition, mix has shifted to 69% purchase and new construction from 30% earlier in 2013. We continue to sell substantially all of our 15-year and 30-year productions.

During the third quarter our mortgage banking unit originated $298 million of loans for sale to the GSEs, compared to $276 million in the prior quarter. Installment loans grew by $75 million or 19% during the third quarter driven by the purchase of a 45% participation in our Associated Bank branded credit card portfolio, which we announced on June 30.

Slide 4 reflects the trends that we've seen in our commercial line utilization. Commercial and business lending utilization grew 170 basis points driven predominantly by increased mortgage warehouse line usage. Commercial real estate line usage of 58% has fallen, as many projects we funded in prior quarters have been completed and have paid off.

In addition, new construction loans were booked in the third quarter with minimal funding thus lowering our overall utilization. Average deposits increased by $701 million from the second quarter to $17.9 billion. Checking balances grew $369 million or 5% during the third quarter and were up 4% from last year.

We also saw growth in average money-market balances and continue to see modest declines in time deposit balances. So at the end of the third quarter, our loan to deposit ratio was 94%.

Turning to slide 5, net interest income continued to grow and was up $4 million from the second quarter and up $12 million from a year ago. Net interest margin for the third quarter was 3.06%, down two basis points from the prior quarter.

Notably both loan yields and funding costs were flat, so all of this quarters margin compression is attributable to the investment portfolio. Essentially, this quarters loan growth was all funded with deposits and without further compression of the loan books margin.

We continue to aggressively manage our liability funding costs lower and have kept interest bearing deposit costs below 20 basis points, while growing deposits over the last two quarters.

We also benefit from having nearly $8 billion in money-market balances funded at 16 basis points. Nonetheless, in this rate environment, our expectation is for continued modest NIM compression each quarter. Year over year, NIM is down seven basis points.

Non-interest income is highlighted on slide 6. Total non-interest income for the quarter was $75 million, up $3 million from the second quarter and up $4 million from a year ago. We continued to rationalize our real estate holdings. During the quarter, we completed two separate transactions where we recognized total gains of $4 million.

In Green Bay, we consolidated two branches and sold the excess property. In St. Paul, we were able to sell one of our largest branch buildings and surrounding land and build a smaller, more cost effective branch, one block away.

Mortgage banking income of almost $7 million was up $1 million from the second quarter and up $3 million year over year. Insurance commissions were down $6 million from the second quarter and down $3 million from last year. The decrease was primarily related to the establishment of reserves for remediation costs on legacy debt protection products.

Turning to slide 7. Total expenses were up $4 million from the last quarter. Advertising expenses increased $2 million related to our fall marketing campaign, and FDIC expenses were up $2 million as growth in loans outstanding contributed to higher FDIC charges.

In this environment, expense management remains a key focus and Management is committed to keeping our full year expenses flat versus 2013, while still investing in technology solutions to drive operational efficiency.

Turning to page 8, credit quality continues to improve. This quarters net charge-offs benefited from one $7 million recovery on a commercial real estate loan with net charge-offs of just six basis points for the second consecutive quarter. It is difficult to imagine credit quality getting any better.

Potential problem loans declined $68 million this quarter, and at $220 million, this balance is 21% lower than a year ago. With these continuing positive credit trends, our provision for credit losses of $1 million was driven by an increase in our provision for unfunded commitments. Total allowance for loan losses equals 155% of total loans and covers 145% of period end non-accrual loans.

With that, we'd be happy to take your questions.

Thank you.

(Operator Instructions) Our first question comes from Emlen Harmon from Jefferies.

Hey, good evening.

Hi.

Just -- you talked to the average loan growth in your prepared remarks, speaking to the end of period growth specifically, was fairly flat quarter-over-quarter. I know that loan growth does tend to slow some in the third quarter. With that as a back drop, could you just talk about any changes that you're seeing in the pipeline and whether or not we should view this as, in fact, a seasonal trend?

Yes, Emlen, we've always encouraged everyone not to get too terribly hung up on quarterly information. We thought that we would get about 8% average loan growth this year versus last year and we think we're about on track to do that this year.

The pipelines are okay. The one thing I would say, as I mentioned in my remarks, is that we are being selective on transactions where we just don't think it makes sense from a risk and return point of view.

Got you, okay thanks. And then on the remediation of the legacy debt protection products and within the insurance business. Not much of an insurance background for me, but could you explain that business for us a little bit?

Just what that product entails and how we should think about the size of that business as you are involved in it?

Yes, well our Associated Financial Group is an insurance brokerage, so that's a business we've been in for a long time. It's one of the larger bank-owned employee benefits brokers in the country.

This specific issue has to do with a review that the regulators ask us and all banks to do going back now a couple of years, to look at add-on products where third parties were selling products to our customers. And so over this last couple years we've continued to look back in history at lots of our add-on products and have been working with the regulators on remediation and refunds to customers in events where we don't think that the customers got the full benefit for what they were signing up for.

And this is a common industry theme you've been reading about this. So we have in the past paid out a significant amount of money to our customers. We established this reserve because we're now taking a look at not just current customers, but former customers, as well. And that's why we established the reserve. It happens to hit our insurance line, but it's not specifically part of the AFG business.

Got you. So as we think about the products that have been looked at, do you have a sense of just how far through that review process you've actually gone with the regulators?

That's a hard question to answer. I think we're pretty far along.

Got it. Thanks for taking the questions.

Thank you. Our next question comes from Scott Siefers from Sandler O'Neill.

Afternoon. First question, Phil I was hoping you could maybe expand upon those comments you made about the competitive pressure on the lending side, particularly C&I. Is that coming from larger banks or smaller banks or is it simply broad-based, what are your thoughts there?

It's broad based. You're starting to see more and more loosening structures. Obviously pricing is quite competitive, as I think I've said many times.

We're always willing to be competitive on price for the right transactions, but when the transactions are getting to be quite liberal as far as structure terms, et cetera, you get to the point where you really need to take a step back and think about the long term.

Okay, I agree, but appreciate the color. And then maybe a couple questions for Chris.

One, is there any just given what's happened with the longer end of the curve, just any update on how you're thinking about securities, the securities portfolio and just what you do with cash flows as they come along?

And then related to that -- it's obviously anybody's guess now what happens with the curve and overall rates as we look into next year. But if we got a situation where the Feds started to raise the short end but the long end stayed low such that we got kind of a flattening of the curve qualitatively, what are your thoughts on how Associated would deal with that kind of a situation?

Couple of questions in there. I'll try and unpack a few of them.

I would broadly remind you that going back a few years, we had spent a fair amount of time structure and portfolio that was relatively short-dated and had significant cash flows. Over the time, we invested a substantial portion of those cash flows into loans and that has continued.

And the effect has been a modest but increasing extension of the duration over the course of the last year and a half. And so they sit here today at the end of September -- as we sat at the end of September, our duration was up to just over four, up from three is where it had sat for most of prior periods.

So as it turns out, the subsequent drop in rates will actually benefit us on a mark-to-market basis and our portfolio values will be up higher. All of that extension really has come from our investment in Ginnie Mae project loans because we've added about $1 billion dollars of Ginnie Maes and that tends to perform fairly closely or closer than other asset classes with moves in Treasury. So we think we're well positioned.

And it also happened to be 0% risk-weighted, fully backed by the US government, and highly complimentary to improving LCR profiles. So, from a overall investment portfolio what have we been doing, and how has that worked, and how will that change? It's worked out pretty well. I don't see it changing a lot.

But as we've lengthened the amount of incremental cash flows have actually come down and therefore our need to reinvest has come down. And in fact if you look at the balance sheet page, you'll notice that during this quarter our overall investments were actually net negative. So, we actually had net reductions in the investment portfolio in the third quarter and I don't have a compelling scenario for how that's going to change per se as I look forward absent any change in our business or activities.

So with regard to how do I see this sort of the broader theme playing out with regard to the rates and the curve, I would note that we believe we are fundamentally asset sensitive and we're particularly asset sensitive to the short end of the curve. And so to the extent that the curve were to flatten out by the short end going that would be very positive for us. We don't have a lot of assets on our balance sheet that are particularly tied to the long end of the curve.

We tend to sell all of our 15-year and 30-year product and so we're not reliant upon that coming back in again. And we do most of our commercial lending inside of 5 years and even that lending that we do that has a term on it. I'll remind you that 83% of our loans reprice or reset within a year. So we are really going to be holding to the short end of the curve not the long end. And the good news is the short end can't go down a lot, so I'll pause there.

All right that's perfect. I appreciate just kind of the qualitative thoughts. So thank you and that's all I have.

Thank you. Our next question comes from David Rochester from Deutsche Bank.

Hi, good afternoon.

Good afternoon.

I had a question on capital. You returned a lot this quarter and I was just wondering about how you think about the pace of repurchases going forward? And then with a TCE ratio now about 7.5%, what's your comfort level taking that down to 7% or below with repurchases?

So, Dave, on a broad basis, I think you've seen in our prior presentations we have laid out that we believe our Tier 1 common equity ratio has some room to move down. We've laid out a long term perspective that we think that can come down into the nines and we will look at that as a long term outlook.

Obviously that's a long term in concert with our thoughts around other strategic opportunities to grow the balance sheets. That includes both on balance sheet growth directly, organic growth, acquisition funded growth, and other strategies. And if we can't find the right way to get there organically or through acquisitions, we look to repurchase as sort of a way to get there over time.

And so would you anticipate the pace of repurchase activity slowing going forward or do you think it remains more elevated as we saw this quarter?

I think we'll continue to look to fund loan growth first and foremost, and as those opportunities present themselves that'll be our first use. We'll look to do M&A as our second lever. And to the extent we're able to pull on that lever that would probably cause us to diminish share repurchase activity.

And to the extent that we don't find the right opportunities to either grow the organic book or growth through M&A, we'll have to continue to look to share repurchases as the way to get to the right answer.

I mean we're in a position where we have significant Tier 1 capital, obviously, and to the extent we're not using it for M&A, we don't really want to just stockpile it. We don't need to stockpile it.

Okay, and then just switching to expenses. It kind of sounds like the higher FDIC expenses may be a good run rate going forward, but will you get relief with that Fall marketing campaign dropping out of the run rate as we go forward?

So, the FDIC, yes, is tied to risk-weighted assets and should be a run rate adjustment. The Fall marketing campaign really carries into the fourth quarter. So for us, the campaign starts in the third quarter and carries through the fourth. So you should see that somewhat elevated in Q4, as well.

So that'll dropout in the first quarter I guess?

Yes. But we'd remind you we're still committed to keeping expenses flat to last year. So basically rounding the numbers we're at $168 million in the first quarter, $168 million in the second, $172 million this quarter and we need to be at $680 million for the year give or take a little bit.

Okay, and then along those lines can you just update us on the branch refurbishment plan at this point? If that's still on track and you're wrapping that up, I guess, next year: is that the plan?

Yes, we've been moving through the branch upgrade consistently. We've got several projects essentially in flight as we sit here today. Phil mentioned two earlier where we had either consolidated or built something new over the course of the last quarter. And there's another half dozen similar projects in flight currently, and there's another half dozen on the drawing board.

But it all wraps up by the time we get to the third quarter of next year and those have already been identified. And I think you'll start to see the overall cost of occupancy come down year-over-year and we'd expect that to continue in subsequent periods, as we get through the investment hump.

Got you. And then just one last one regarding M&A. If you could just update us, there you mentioned M&A. I know it's been a part of the plan and strategy, but any updates or changes to your thoughts there? And if you could just comment on the volume of conversations, activity in the market, anything you're seeing?

We are actively meeting with people, talking with people, looking at opportunities. But I think as I've said publicly fairly recently, we believe that the risk around M&A has substantially increased from a approval point of view, from the expectations that whatever you buy you're now responsible for. And so we're being, we think, appropriately cautious and prudent. That said, we do believe that finding the right transaction would be a good thing for Associated and we're out looking.

All right, great thanks.

Thank you.

Our next question comes from Ken Zerbe from Morgan Stanley.

Great, thanks. Just had a quick question on the loan growth. I think you mentioned you're still looking at the 8% loan growth number for the year and I just wanted to clarify.

Is that based on full-year 2014 average over 2013 average? Because if so, it would actually imply a fairly decent amount of loan growth roughly 3% in fourth quarter. I'm just trying to square that with your comments that--

It's not that much. It is average to average and as we report all of our loan out standings on an average basis because we think it gets away from quarter end anomalies. But it doesn't require 3% growth to get to 8% average over average. It's a little less than that.

Got it, understood and but you're still comfortable with that given the comments about increased competition and challenging structures across the industry?

Yes.

Okay, thank you much. Appreciate it.

Thank you, Ken.

Our next question comes from Jon Arfstrom from RBC Capital.

Good afternoon.

Hi, Jon.

Most of my questions I've scratched off here. But Chris, you talked about the 6 branches to 12 branches on the drawing board. Is that for refurbishment or changing or making smaller? Is that like the St. Paul example, is that what you're talking about?

St. Paul was a home run. We won't get that many home runs. I mean St. Paul was an unusual situation where we had a very large building that was the headquarters of a bank the Company had bought many years ago, including seven acres of land on a very good corner in St. Paul.

So we essentially entered an arrangement with one of our real estate developer customers to redevelop all that. They built us a new building on one far end of that parcel and are redeveloping the whole thing into a mixed use property and we booked a substantial gain. That's unusual.

The other ones are more just, I think, we're moving away from what would have been $3 million city branches into $1.5 million glass boxes. And that continues to be the case, and those economics continue to be compelling, and we continue to move the orientation of our retail footprint in that direction. And it seems to be working positively for us.

Most of what's left is refurbishment of existing branches. There are a few relocations and where we would look to sell what we move out of, but we won't have the type of gains we just reported on a routine basis.

Got it. This probably goes hand in hand, but you have a quote in your release about investing in technology and for operational efficiencies. Where is the money going, the major categories, and what do you expect to get from that?

Sure, so we -- we're in the final throws of updating our website. In fact we just rolled out new functionality around people making loan applications online for mortgages. And in the coming couple of months we will have complete redo of the website, which will give people a lot more functionality. We think that drives costs.

We have, as we've talked about before, a major back stop initiative to get end-to-end processing into all of the commercial loan fulfillment. That's starting to wind up and will be finished early next year. And there's many other examples like that.

I mean if you look at slide 7, you can see just going back a year, we've significantly reduced the FTE. If you rolled it back even farther than that, you'd see a very significant reduction. And a lot has been driven by the combination of reducing the branch footprint, but a lot of it also has been driven by automating a lot of manual processes.

Got it. Okay and then just maybe one more for you or Scott. Just your oil and gas business, I know gas really hasn't moved, but oil price is down. Is there anything we need to think about or worry about there?

We're going to let Scott talk. Go ahead, Scott.

So Jon, when you look at that business, we've done a review of that, and most of our customers are certainly hedged well into 2015 and 2016. So, even with the price volatility we see they're well hedged.

In addition, we take the NYMEX strip and take a discount off of that and then a further discount, so we think we're fine as we look in the short-term. Now a prolonged three-to-five-year decline in oil prices is different discussion, but in the near term we think we're in good shape.

Okay, thanks a lot.

Our next question comes from Terry McEvoy from Sterne, Agee.

Hi, thanks. Good afternoon. Just a follow-up on Jon's question, is most of the energy portfolio reserve-based lending? And I'm curious, if any of the portfolio was on the servicing side of the business.

Those are all reserve-secured lending.

Correct.

We're not in the service business. We're not in the midstream business. We're in the reserve secured lending business.

Okay that's easy. And then what were the yields on the arms that you added to the portfolio in the third quarter? And then where is that product today, and does it make sense to continue to add going forward if they're lower?

Sure. So I don't have the production yields for the third quarter but Jon, I'd point you to the tables on page 7. And the residential mortgage book is predominantly an ARM mortgage book a combination of 3/1s, mostly 5/1s and 7/1s. And you can see their yields for the quarter on average was 3.27%.

Current yields on what we're doing today, we tend to have pricing right around 3%, but as we go through the process, there are reasons why we sometimes have an adjustment. And so the effective yield tends to come in slightly above 3% even in today's rate environment. So a new loan on average booked today would probably be north of 3%. And at those levels we're happy to continue to book hybrid ARMs in our portfolio.

And then just one last question. Loan yields were flat, which was nice to see. CRE was up a bit. Are there any loan fees or anything lumpy in there to keep that flat quarter-over-quarter?

No, we didn't have any big anomalies this quarter.

That's great. Thanks.

It was encouraging. It's too early to call it, but we're hopeful of a little flattening.

That's perfect. Thanks again.

I'd still like to say one quarter does not make a trend.

We can hope.

(Operator Instructions) Our next question comes from Chris McGratty from KBW.

Good afternoon.

Good evening, Chris.

Phil or Chris, on loan deposit change in the quarter, is that arbitrage between reducing some borrowings and growing some core deposits? Or are you managing like you've seen some of your peers to a loan deposit ratio in the face of conventionally higher rates?

Well we've said that we want to maintain -- it's a fine line, the loan deposit ratio. We definitely don't want to be over 100%, but we also want to utilize our deposits. So this quarter's results were very good that way. We were pushing up against 100% in the second quarter and we moved it back down to 94% on good core deposit growth.

Okay, just the last one, on the buyback. So what's left in the authorization? And I guess absent anymore buybacks, what's the average fully diluted share count [we should see] in the fourth quarter given the timing of the ASR?

Sorry so there's $55 million remaining under the authorization and the last share repurchase we executed was in the third quarter. So we haven't executed anything in the fourth quarter.

Okay.

So the numbers on the press release table are the numbers we have.

Right but given was there anything unusual, I guess I can day count when you did the buyback the large 5 million shares in the quarter. But is that the way to look at it for a starting point for what's average fully diluted share count for Q4?

The actual shares outstanding are at the bottom of the income statement.

No I understand that. Okay, got it.

Thank you. Our next question comes from Ebrahim Poonawala from Merrill Lynch.

Good afternoon.

Good afternoon.

All of my questions have been asked, just one follow-up question in terms of buybacks. Given -- and you've talked about this publicly over the last month regarding the caution around M&A. Given that the stock is about 7% to 8% lower today than where you bought back in the third quarter why not be more aggressive given your view on near term M&A outlook?

And generally seasonally slower quarter with regards to loan growth and given expectation that you'd base capital anyway organically over the next couple quarters if you bought back some more in full forward activity,you can still sort of build back capital ratios?

Was there a question in there?

Yes, the question is why not be more aggressive with the stock 7% lower today than 3Q in terms of buying it back, given the caution on M&A?

We're not really in the mode of putting up big signals as to what we want to do on things like buybacks. We were quite aggressive in the third quarter and you're right the share price is lower today.

Got it. Thank you very much.

At this time we have no further questions. I'll turn the call back over to our speakers for closing comments.

Well thanks everybody for joining us today.

In closing, we were very happy with our third quarter results. Despite the rate environment we're able to grow net interest income in the bottom line. We really started to see the benefits of a larger loan portfolio this quarter with increasing NII, up substantially year-over-year and quarter-over-quarter, so that's encouraging.

To the speakers last point, or the questioner's last point, we'll continue to be opportunistic as we think about ways to deploy capital. And we'll look forward to talking again with our full year results in January and providing you guidance for next year at that time.

So thanks again for your interest in Associated and if you have any questions in the meantime, please feel free to give us a call.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation