Associated Banc-Corp (ASB) 2014 Q4 法說會逐字稿

Welcome to Associated Banc-Corp's fourth-quarter 2014 earnings conference call. My name is Roya 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 associatedbank.com/investor.

As 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 really 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 conference 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 turn the call to Philip Flynn, President and CEO for opening remarks. Please go ahead sir.

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

On slide 2, I want to talk about our 2014 highlights. The year was another successful one for Associated. We were able to grow the balance sheet and net interest income while slightly reducing expenses. Average loans of $16.8 billion were up 7.5% from 2013. Commercial and residential mortgage loans drove the growth, with each category of double-digits.

Our fourth quarter average loans of $17.4 billion were a new high for Associated. Average deposits of $17.6 billion were up slightly from 2013 and we continue to position ourselves toward the most optimal funding mix possible.

Net interest margin of 308 basis points compressed 9 basis points from 2013. Despite this we grew net interest income $35 million, due to solid earning asset growth. Non-interest income declined $23 million from 2013 and was fully attributable to the $28 million decline in mortgage banking income.

We delivered on our commitment of flat expenses for the three straight years, we were actually down $1 million from 2013. Net income to common shareholders was $186 million or $1.16 per share with a return on Tier 1 common equity of 9.9%. We continue to return capital to our shareholders through dividends and share repurchases.

We increased our dividend on common shares for the third straight year. And during 2014 we repurchased $259 million or 14.3 million shares of common stock. In the fourth quarter, we executed two separate accelerated share repurchase programs, which totaled $100 million.

Now let me share some detail on our results. Loan details are highlighted on slide 3. Average loans grew $1.2 billion or 7.5% from year ago to $16.8 billion. Mortgage lending showed strong growth in 2014 and was up $488 million or 13%.

We remain primarily an ARM lender with 3/1, 5/1 and 7/1 arms accounting for approximately two-thirds of our residential mortgage portfolio. We continue to be the leading mortgage originator in Wisconsin and our mortgage servicing portfolio is approximately $8 billion.

Average commercial real estate loans grew $285 million during the year. Multi family loans continue to make up the largest segment of that portfolio. Commercial and business lending average portfolios grew by $686 million or 12% from 2013. Within this group, general commercial loans grew $258 million or 5% during the year.

Manufacturing continues to be our largest contributor to C&I growth. We expect another good year of commercial loan growth in 2015. We continue to diversify our commercial loan portfolio in 2014 with growth of $259 million in Oil & Gas and $163 million in Power & Utilities.

We expect continued growth in these businesses next year, although as they mature and in light of the decline in oil prices this growth rate will slow. During 2014 our home equity and installment portfolios continued to runoff, though at a slower rate than the previous years. Average balances declined $283 million in these portfolios combined and we expect to continued, but slowing, runoff in home equity and student loans during 2015.

Loan details for the fourth quarter are highlighted on slide 4. Average loans for $246 million from the third quarter to $17.4 billion. This represents growth of 1% quarter over quarter and 10% year-over-year. Mortgage lending accounted for over 70% of growth this past quarter.

Commercial Real Estate, General Commercial Loans, Oil & Gas and Power & Utilities were all up slightly from the third quarter. As expected, mortgage warehouse average balances were down $51 million, or 13% from the third quarter.

On slide 5 we'd like to describe our Oil & Gas business in a little more detail. We're focused on the upstream sector and all credits are secured by oil and gas reserves.

The loans are typically working capital revolvers and the availability of funds is determined by a borrowing base, which is subject to semiannual determinations. These are generally syndicated deals with several banks participating.

Oil and gas of course are commodities and as such can experience price volatility. This is not something new. There are many ways to mitigate this commodity risk. First, our borrowers typically reduce this pricing risk by entering into multi-year hedges. In addition, the pricing environment is continuously monitored and factored into redeterminations of the borrowing base.

We established our Oil & Gas business in 2011 and have grown the book to 48 clients with more than $1 billion in commitments. At December 31, 2014 the outstanding balance of the portfolio presented about 4% of Associated's total loan out standings.

We recently performed a stress test on this portfolio at a price of $50 per barrel for the next five years, and $55 per barrel thereafter without changing any other variables, such as volume or cost. Valuation of oil and gas reserves is based on the present value of production over the life of the reserves. Current prices do not necessarily drive long-term valuations.

Our stress test identified eight credits with potential loss content. As of the end of the year we had quantitative and qualitative loan reserves specifically described below with us portfolio in excess of 135% of those identified potential losses.

The stress test did not involve the modeling of the risk rating migration within the portfolio, just the potential losses. Upon the semiannual borrowing base redetermination, it's likely we will see some level of negative migration in ratings if the current pricing environment continues. This could mean some volatility and provisioning during 2015 as we adjust market price into the portfolio. More information on our Oil & Gas business is available on our investor relations site where we posted a presentation on this topic in December.

Slide 6 reflects the trends that we've seen on our commercial line utilization. Commercial & Business lending utilization declined 60 basis points from the third quarter. Fourth quarter utilization is up about 6% compared to last year. Recent declines in mortgage rates have spurred refinance activity and have driven the mortgage warehouse utilization rate to 52% compared to 29% at the end of 2013.

Commercial Real Estate line usage of about 58% was down slightly from the prior quarter, as we saw higher payoffs driven by completed conception projects, which refinanced at year end. In the fourth quarter we added more loans in our REIT business, which typically have lower utilization rates than our existing Commercial Real Estate book.

Moving to deposits and funding. Average deposits of $17.6 billion for 2014 were up 1% from last year. Money market, checking, and savings products grew by $471 million or 3% from 2013, accounting for the majority of our funding and averaged $11.8 billion for 2014 with a weighted average cost of just 15 basis points.

Prime deposits, our most expensive source of deposit funding, continued to decline during 2014 to an average balance of only $1.6 billion. During the fourth quarter we issued to $250 million of 2.75% 5-year senior notes and $250 million of 4.25 10-year subordinated notes. This transaction decreased total net interest margin by about five basis points in the quarter. And going forward to carrying cost will be around 10 basis points.

With this new funding in place we expect to call our $430 million 5 1/8% Senior notes in February of 2016. In 2015 we expect to grow deposits in relation to loan growth and maintain a loan to deposit ratio under 100%. At the end of the fourth quarter that ratio was 94%.

Turning to slide 7, net interest income continued to grow and was up $2 million from the third quarter and $8 million from a year ago. 2014 total net interest income of $681 million was up $35 million or 5%. Net interest margins for the fourth quarter was 3.04%, down two basis points from the prior quarter.

The average yield on Commercial & Business lending loans increased 22 basis points from the third quarter to 3.5%. However, this increase was impacted by interest recoveries and prepayment fees of nearly $5 million in the fourth quarter. The interest recoveries and prepayment fees added eight basis points to the net interest margin.

On the liability side we continued to manage interest expense with flat year-over-year interest-bearing liability costs. In the fourth quarter, the cost of interest-bearing liabilities increased six basis points and was primarily driven by the carrying cost of the debt we issued in November. We've kept interest-bearing deposit costs around 20 basis points during 2014 while growing deposits over the last three quarters. For 2015 we expect to grow net interest income while NIM continues to modestly compress.

Turning to slide 8, talking about non-interest income. In 2014 we had $290 million, which was down $23 million from the prior-year. Driving the decline was the $28 million reduction in net mortgage banking income from last year.

2013 mortgage banking income benefited from 1.2 billion more loans originated for sale, higher gains on sale, and almost $15 million in MSR recoveries. Core fee-based income was up slightly in 2014 as increases in trust, insurance, and retail brokerage fees more than offset declines in service charges and card income. We expect the Ahmann & Martin acquisition to add approximately $25 million to non-interest income in 2015, which would equate to mid to upper single-digit growth overall.

Turning to slide 9, fourth quarter non-interest income was down $5 million from the last quarter. Mortgage banking income declined $4 million from the third quarter and this decline was related to the 35-basis-point drop in the 10-year Treasury note from September 30, 2014 to December 31, 2014. This rate drop resulted in a lower gain on sale as margins tightened and also impacted the MSR valuation reserve to a lesser extent compared to the prior quarter.

Annual non-interest expense is highlighted on slide 10. We delivered on our commitment to keep expenses flat in 2014. They actually declined slightly to $679 million. We are able to do this while making significant investments in technology and facilities.

Technology spend of $80 million increased $5 million from 2013, but this increase was entirely offset by a $7 million reduction in personnel expense. This highlights our strategic focus on implementing technologies solutions to replace labor-intensive processes. FTEs have declined almost 12% since 2011.

FDIC expenses were up $4 million in 2014 as growth in loans outstanding contributed to the higher FDIC charges. With our credit metrics continuing to improve foreclosure and REO expenses declined by a third from 2013 to about $7 million.

Business development and advertising expense is were up $3 million in 2014 as we began our new Challenge Your Bank advertising campaign. In this rate environment we remain focused on efficiently managing our personnel costs, continuing our technology investments, and reducing other costs across the organization. Absent the Ahmann Martin acquisition we expect 2015 expenses to be down slightly. Factoring in the acquisition we expect expenses to be under $700 million for the year.

Slide 11 shows that non-interest expense for the fourth quarter was flat to the prior quarter and down $7 million from last year. Personnel expenses of $97 million in the fourth quarter was down $4 million from last year, as FTE reductions have begun to translate into cost savings.

The Company's 2014 tax expense increased by $6 million, as income grew and the effective tax rate remains largely unchanged at approximately 1%. Going forward we expect marginal tax rates to climb into the low 30% as earnings continue to improve.

On slide 12, credit quality continues to be a positive story. Net charge-offs of only $4 million were up $2 million compared to last quarter. For our C&I book, charge-offs have fallen to nine basis points compared to 38 basis points a year ago.

Potential problem loans declined $30 million this past quarter. At $190 million this balance 19% lower than a year ago. The level of nonaccrual loans to total loans also continues to improve, and is just over 1% down from 1.07%. Fourth quarter nonaccrual loans of $177 million are down 4% from last year.

Our total allowance of loan losses equals 151% of total loans and covers 150% of period end nonaccrual loans. The provision for credit losses was $5 million in the fourth quarter, $16 million for the full-year. We expect provisioning to increase in 2015 along with loan growth and potential changes in credit quality.

I'd like to provide more detail on slide 13 on the acquisition that we announced last week. We've known the management team at Ahmann Martin for several years, which helped in negotiating this transaction. We view this deal as a way to add more scale to our insurance business and balance our fee categories by adding more commercial property and casualty expertise.

We also believe this will provide more cross sell opportunities with our corporate and commercial banking customers. This is a stock transaction valued at approximately $48 million, with contingent considerations of approximately $8 million. We expect the deal to close in February. This transaction is not expected to have a material impact on our earnings in 2015 or 2016, but is expected to become accretive in 2017.

On slide 14 we'd like to recap our 2015 outlook. We're expecting high single-digit average loan growth similar to what we had in 2014. Average deposits and other funding should grow with assets while we maintain a loan to deposit ratio under 100%. We expect 2015 first quarter net interest margin to be approximately 2.95%. And thereafter NIM will compress modestly throughout the year.

As discussed earlier the Ahmann Martin acquisition will increase non-interest income and expense in 2015. We expect total non-interest income to increase to the mid-to upper single digits. Non-interest expense is expected to be in the low single digits. We expect to continue to deploy capital through our previously-stated priorities. And finally our loan loss provision is expected to grow based on loan growth, changes in risk rates, or other indications of credit quality.

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

(Operator Instructions)

Scott Siefers, Sandler O'Neill & Partners.

So I was hoping you could walk through the loan guidance for the year. To get to upper single digits, which would be similar to this year, I guess it implies a little bit of reacceleration from what you saw in the fourth quarter. Maybe not to the level of the first three quarters of last year but still maybe a little reacceleration.

What in your mind are the major puts and takes? Is that a function of maybe less drag from some of these portfolios that have been declining? Or is there an increased tolerance to grow some of the portfolios you moderated a bit last quarter? How are you thinking about the countervailing dynamics?

First of all the shape of our loan growth in the fourth quarter, although on an average basis it was somewhat lower than we'd seen, actually came on quite strong at the end of the quarter. We enter the first quarter of 2015 with something of a tailwind. Because of the shape of the way the loans came on.

We've had really balanced growth across our various businesses and we expect to continue that. Commercial Real Estate, which has been a maturing business through 2014 and it has started to see payoffs, is refilling their pipeline so we expect strong growth in that area. The General Commercial lending business, we expect good growth from.

Residential mortgage right now is actually booming is probably the right word. With the decline in rates there's a lot of activity there now. A lot of that will be sold on but our adjustable rate mortgage portfolio business we expect to continue to grow at a nice clip. The rate of pay down in the home equity business has slowed and will continue we think to slow.

We'll probably have less growth in the Oil & Gas business until transactions begin to occur in that business as buyers and sellers adjust to new price expectations. But given the growth in the other businesses we still feel pretty comfortable that we're going to achieve loan growth that was similar to what we just saw.

That's helpful color. I appreciate it. Maybe a second question is for Chris. I guess fee income came in a little light of what I had been looking for. Is there anything unusual that hurt any of the line items, like in mortgage banking or anything -- in other words, anything you would consider one time in there?

We had lower gain on sale and lower income in the mortgage banking line as a whole, that was the largest shortfall for the quarter. We also saw a small down tick in asset gains, which aren't recurring. But again on a period-to-period basis they were down. So I don't think there is a nonrecurring number to point to.

There was a small charge we took for our insurance business that was $1 million. That obviously was a one time charge; that'll come back But I think our guidance that we gave you for the full year reflects the fact that we expect business to stabilize, normalize, and grow at a reasonable pace into next year.

I think that's it for me. Thank you.

Dave Rochester, Deutsche Bank

Good afternoon, guys. Quickly on capital, TC ratio is now around 7%. How long -- or how low do you feel that you can take this ratio over the next year? You're obviously seeing continued decent growth in the loan portfolio and you'll be I would imagine repurchasing shares. What's maybe a lower bound for that ratio longer-term?

We've publicly put out there Dave as you'll recall a range of Tier 1 capital ratios from 8% to 9.5% or at 9.74% on Tier 1 common; still comfortably above that. And we continue to chop away at that as we move through the course of 2015.

That does not mean will be as concerted a share repurchaser, but we're going to follow our stated capital priorities; fund our growth. Obviously, that's the best used of our capital. Pay a competitive dividend, look for acquisitions and in the absence of acquisitions, we'll probably continue to do a modest amount of share repurchase.

Is there any kind of level that you're looking at for the TC ratio specifically? Or are you just more focused on the regulatory ratios?

We're all about regulatory ratios.

Got you. What kind of cost savings are you factoring into your expense growth guidance at this point? You mentioned expenses could be down ex the deal and I know you were working on technology solutions that could help reduce back-office headcount.

Will we see those efforts pan out this year? And I would imagine you'll be investing in growth as well, maybe if you could just talk about the ups and downs there.

Sure I'd refer you to slide 10 and 11 in the graph that shows our FTE count. I think as we've talked about on previous calls, there's been a lot of noise in our personal expense lines, a lot of it because of severance costs. But as you can see we've become more efficient through these technology investments and have been able to reduce some of the labor costs.

As that is coming to an end and the noise that flows through the expense line comes to an end the financial benefit of having less FTEs starts to come to the fore. We will see the pickup that you would expect with having from the peak of employment here to where we are today of a reduction of about 15%. You'll start to see that, so that's a big driver.

Got you. And just a little housekeeping item. The $5 million in prepayment penalty income and interest recoveries, what was the split of that this quarter and what was that total balance last quarter?

It was de minimis last quarter. This quarter there were two related Power transactions, which paid off fixed-rate loans and took their debt to the bond market for refinancing. There was between $3.5 million to $4 million of gains on those two transactions alone. The interest prepayments in and of themselves were not as significant

Right around $1 million.

Thanks guys.

Emlen Harmon, Jefferies.

To start off, just a real quick one. What was the absolute level the MSR valuation charge and how much of a difference was that relative to the third quarter?

In the grand scheme of things you can to the overall valuation, I guess I'll draw your attention to page 4 of the tables. It didn't change that much. The impact of the charge was just over $2 million

Just over $2 million. Got you.

Let me restate that. I apologize. The valuation itself, you can see it was outlined, it didn't change much in basis points, but in dollar terms there was a change quarter over quarter. It was less than $1 million, apologize.

Got it. Thank you. And then just looking at the guide this year compared to last year, the provision guide this year indicates that the provision could be driven by changes in risk grade, whereas last year it was more a function of growth. Is that change specific to your earlier commentary on energy? Or are you seeing trends elsewhere in the portfolio that are causing you to be more cautious?

This is Scott. I think we don't see a lot in the portfolio of fundamental changes in risk rating. Given the volatility in the oil prices we may in the first half see some volatility in risk ratings, depending on the redeterminations. But the core portfolio has been pretty stable to improving.

Got it. And just one last one on the portfolio. How long does oil need to be below $55 before it starts to imply more meaningful potential losses on that reserve book?

I know that obviously you guys have different calculations on the life of the reserves for a number of those projects, but just be curious how time plays an effect in your provisioning thought process?

If you look at most of our customers, as you'd expect they're all well hedged through 2015 at fairly robust prices relative to the high $40s. We don't see a lot of stress from that perspective. In fact a number of them are hedged into 2016 as well. So short, short-term we don't see a lot of stress again some risk rating migration.

But we did our model holding oil at $50 for five years and we see some de minimis losses if they had stayed at that level for five years. And again we've got about 135% reserve against what that expected loss could be at that level.

Very helpful. Thank you.

Just -- this is Phil, just to add to that. What we see in our oil and gas reserves secured business, which again is entirely what we do, no service companies, no midstream, no refining. In that business as a secured lender we really think that the risk is some volatility in provisioning and little if any loss. That's our forecast as we set today.

Chris McGratty, KBW.

Phil, on M&A you didn't talk about M&A much but we're seeing it pop up in all sizes across the country. Obviously 2014 was a year of buybacks. Can you talk about how much time and effort M&A is in terms of priorities for you guys entering the year?

It's hard to -- I'd say in the last six months between Niles and I we've spent a decent amount of our weeks spending time visiting with folks. We're dedicating a meaningful amount of time to talking to potential merger partners, potential acquisition partners.

Is the -- are the conversations -- I think awhile back it was kind of the smaller banks across street for the cost savings. Have you changed at all the outlook in terms of whether you'd think about something larger in terms of getting some additional scale or particular markets that might be of interest? Thank you.

We haven't changed our priorities as to what we're looking for. We still believe that an efficiency driven acquisition is the safest and best for our shareholders. As that's what we continue to be focused on. We're looking for opportunities where we can expand in a local market and do it on an efficient basis.

Thank you. Jon Arfstrom, RBC Capital Markets.

Just a couple more energy questions. It sounds like you haven't pulled back on your appetite at all. Is that right?

We haven't pulled back on our appetite. Recognize the fact that everybody's pricing assumptions have changed. And this business is just basically built upon transactions occurring out there in the oil patch.

At this point buyers and sellers have not adjusted to the new realities of where oil prices are. I don't think buyers are willing to pay at old prices and sellers are not yet prepared to sell at new prices. So there's always a period of transition when prices like this change before you reach equilibrium in the market and people have a better sense of where they should at what prices they should transact business. That will clearly slowdown the financing opportunities across bank land for some period of time.

Okay. And you may have just answered this, but any way to gauge a change in the competitive environment? Or is it just there aren't any deals and we don't know yet.

I think it's the latter. There really aren't a lot of transactions going on right now. As you would expect. And the one thing about this business which is interesting, the banks that are active in it, they all tend to look at transactions in very similar ways.

It's not like the leverage lending business or the general commercial business where people take different views and are willing to take a flyer on terms or tenor or pricing. The business tends to be somewhat homogenous across the banks that are active in it. So you don't really tend to get outliers who decide well, it might be 47 today, but I think it's going to 80, so I'm lending you money at 80. You're not going to see that.

Okay. Great. I appreciate the help on the stress testing you've done. I guess when you talk about the risk rate, this just formulaic, if something is downgraded you have to put the reserve even though you don't necessarily believe there's a loss content? That's what you're saying?

Well the accountants would be very angry if I said it that way. Whatever we provide is for losses that we think are there. But you're correct in that there is a mechanical way of calculating provisioning based on risk rates.

Touchy-feely question on energy for you, Phil. You get put on every list as having energy exposure, right or wrong.

We do, that's correct.

Is it fair or unfair? Do feel like you are unfairly lumped in with, say, Texas regional banks that have energy exposure?

I think it's certainly fair to say we have energy exposure. I mean it's very important to realize that at our bank at least it's 4% we're also not exposed any knock on effects from a slowdown in the energy business. We're not a real estate lender in Houston or in North Dakota. We're not going to get that type of impact if this stays this way for a prolonged period of time.

But we are a lender to the Oil & Gas business and I'd remind anyone who doesn't recall this that although Associate started in the business in 2011, myself and the people who run this business have been in it for up to 35 years. This is how I started this Bank. So I've seen a lot of price volatility in the last 35 years. I am personally not overly concerned about what we have today given the nature of our portfolio.

That's helpful. And Chris, maybe this is for you, but on the Ahmann & Martin deal, no real accretion in 2015 I believe you said? Is that just a function of the accounting and 2016 as well? It's just the heavy amortization early on?

Exactly. We did note there was up to additional $8 million in contingent payments. And assuming everything works out we'll be delighted to make those additional contingent payments in full, but if they do they will offset the accretion.

So a lot of it is just accounting?

Yes. On a cash basis this is a positive transaction all the way along. Revenue minus expenses. But there's accounting issues there.

Great, thanks for the help.

(Operator Instructions)

Stephen Geyen, D.A. Davidson.

Just curious about the asset yield compression. I think it was about five basis point this quarter. Anything in particular that drove that? Any large repricing that you don't expect to recur?

I think looking at the quarter over quarter trends on page 7 of the tables, I would note we had positive repricing, but was the 8 basis points of prepayment fees and recoveries that positively drove the Commercial & Business lending numbers. You dial that back and it would be about flat and that's probably about what we're assuming.

We think essentially and I think we said this last year, the portfolio has largely repriced at this point in time. There will be some modest compression as it moves through the course of the year, but it's essentially getting down to about what we think it will be, assuming rates don't move.

I was looking at asset compression ex the recoveries and prepayments and that's where I came up with the 5 basis points, but okay. And then maybe just a housekeeping item as far as the effective tax rate. Right around 31%? Is it likely to continue into 2015?

I think as we continue to grow our earnings that number will continue to marginally go up. So we encourage you to think about it moving higher.

Okay. And just one clarification. Ahmann, that's all fee income and nothing of it as far as earning assets?

Yes, it's an insurance brokerage.

Got it, thank you.

It appears we have no questions in queue at this time. I would like to turn the floor back over to Phil Flynn for closing remarks

Thanks and thank you everyone for joining us today. 2014's strong performance was highlighted by balance sheet growth as well as higher net interest income. We were able to modestly reduce expenses and grow the bottom line. We're optimistic in our ability to continue to grow our franchise this year and remain focused on deploying capital to build shareholder value.

So thanks again for being on the call, we look forward to talking to you again in three months. Thanks for your interest in Associated.

Ladies and gentleman, this concludes the Associated Banc-Corp fourth quarter 2014 conference call. You may disconnect your lines at this time and thank you for your participation.