Associated Banc-Corp (ASB) 2016 Q3 法說會逐字稿

Good afternoon everyone and welcome to Associated Banc-Corp's third quarter 2016 earnings conference call. My name is Matt and I will be your operator today. At this time all participants are in a listen-only mode.

(Operator Instructions)

The slide presentation and accompanying press release financial tables that will be referenced during today's call are available on the company's website at investor.associatedbank.com. As a reminder, this conference call is being recorded.

During the course of the discussion today, 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 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 page 10 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.

Thanks and welcome to our third-quarter earnings call. Joining me today are Chris Niles, Chief Financial Officer; Scott Hickey, our Chief Credit Officer; and Jim Simmons our Deputy Chief Credit Officer. Our third-quarter results reflect our growing and diverse franchise. We reached record deposit levels and recorded one of our highest revenue quarters in a while, driven by mortgage banking and capital markets activity. We delivered solid performance across our businesses with measured loan growth, strong deposit and revenue trends, and stable expenses. Our progress against our 2016 priorities is summarized on slide 2.

We are committed to delivering solutions that benefit our customers. During the quarter we completed the rollout of Wi-Fi across our branch network to increase customer adoption of digital solutions. We are pleased to report our active mobile base is growing. In September, we had 33% more mobile customer sign-ons than a year ago. In addition, we rolled out instant-issue EMV chip card capability, allowing bankers to give our customers an activated, permanent card upon account opening and before they leave our branch. We also opened two new branches in Chicago.

Average loans grew $411 million in the third quarter, net of portfolio loan sales. Average loans have grown by 9% year over year. Year-to-date growth has been balanced across our major loan categories and remains on track to meet our 2016 guidance.

Average deposits grew $1.1 billion in the third quarter to a record $21.4 billion, fueled by seasonal inflows and organic year-over-year growth. Noninterest income was up significantly in the third quarter in large part due to strong mortgage banking volumes and gains. We also reported higher revenues in several other fee categories.

Expenses came in at $175 million, and we remain on pace for our fifth straight year of improved efficiency. We posted double-digit returns on capital and we paid out 32% of third quarter's net income through dividends. Bottom line, we delivered $52 million of net income available in common equity, or $0.34 per common share in the quarter.

Loan details for the third quarter are highlighted on slide 3. Average loans were up 2% from the second quarter. On the horizontal bar chart we highlight the quarter's average growth by loan type. In orange, average commercial real estate loans were up $202 million or 4% from the second quarter, driven by growth from our teams in Chicago and Ohio. On a year-over-year basis CRE lending is up 14%, and retail and multi-family project loans have accounted for the largest portion of this growth. CRE line utilization was unchanged and remains in the high 50%s in the third quarter.

In green, residential lending was up $125 million or 2%. Absent the $239 million of portfolio loan sales, residential lending would have been the largest contributor to growth this quarter. Purchase and new construction activity continued to account for about 60% of production. We did see a significant shift towards fixed-rate loan production during the quarter, which has continued into this month.

In blue, average commercial and business loans were up $103 million or 1% from the second quarter. The increase was driven by continued growth in our mortgage warehouse, power and utilities, and REIT lending businesses. Overall our specialty commercial businesses saw lower utilization, with an aggregate level in the low to mid-60%s. Corporate bank line utilization was down from the second quarter and remains in the mid-40%s. Together, corporate and general commercial lending balances were down $58 million on average.

In summary, we saw growth across our asset classes. Our loan mix did not materially change, and we remain on track to meet our 2016 loan guidance of high single-digit average growth.

On slide 4 we highlight our deposit trends. Average deposits were up $21.4 billion, 5% from the second quarter. We reached record deposit levels and were particularly pleased with double-digit year-over-year growth in non interest-bearing demand deposits. Our loan to deposit ratio returned to the low 90%s in keeping with our seasonal deposit inflows.

I'd like to spend some time explaining the pronounced seasonality we see between the second and third quarters in regards to deposits. Some of our customers have very seasonal inflows, especially municipalities. Their deposits tend to peak in the third quarter when many have fiscal year ends and then move lower over the next 12 months. We are pretty comfortable with the seasonal pattern, and we manage the ins and outs well.

We believe an important measure of a successful bank is its ability to gather, retain and grow deposits. Deposits are the most cost-effective and dependable form of funding, and play an important role in our continued growth. We're focused on offering a well-located branch network with competitive products and solutions that help us retain and track customers. We are pleased report we grew deposits 12% year over year in Illinois -- a recent focus of ours -- per recently released FDIC data.

On slide 5 we summarize the credit quality trends of our loan book. We continued to see low levels of stress and historically low levels of loss in our non energy-related loans. Potential problem loans decreased $16 million from the prior quarter. Nonaccrual loans were up modestly to 1.46% of total loans, up 3 basis points from last quarter. Total net charge-offs were down $2 million for the quarter.

Outside of energy we saw a net recovery of $4 million related to the general commercial book. Our non-energy portfolio is performing remarkably well, and we've seen very low charge-offs over the past several quarters. Substantially all the net charge-offs in the third quarter were related to our oil and gas book. The total allowance for loan losses increased to 1.36% of total loans, and this was slightly higher than the prior quarter as our provision more than covered net charge-offs. Outside of energy, we are pleased with the credit resiliency of our customers and businesses.

On slide 6 we provide more detail on our energy book which accounts for less than 4% of our loans. The Shared National Credit exam is complete and fully reflected in our third quarter results. We are also nearly 25% percent through the fall borrowing base redeterminations, and we expect to be completed by December.

Prior-end oil and gas loans were just under $700 million and decreased $60 million from the prior quarter as new fundings were offset by repayments and charge-offs. Since the fourth quarter of 2015 we have funded 12 new credits with $253 million of commitments and $148 million of outstanding. Utilization levels have been stable over the past several quarters. The end of the third quarter utilization remained in the low 70%s.

We built up our oil and gas reserves late last year and into the spring in light of the volatility and stress in the market. Since then we managed through a handful stress credits and like others we realized some losses. Three loans have caused all of our losses to date. We don't believe we have remaining loans in the portfolio with similar loss content.

Our oil and gas reserve of $38 million or 5.5% of outstandings is down from its peak in the first quarter, reflecting the charge-offs we've taken, but it is still higher than a year ago. The mark on the book remains consistently in the low 90s. We are adequately reserved for what we know now. Prices have improved, and we believe the industry is operating on steadier ground today. Needless to say, oil prices above $50 per barrel bode well for us and the industry. Importantly, new credits generally have less leverage, more equity and lower assumed future and oil gas prices.

Turning to slide 7, net interest income was up $2 million from the second quarter and up $8 million from a year ago. Year-to-date net interest margin was 2.8% as expected. Our third quarter margin was slightly lower at 2.77%. Lower yields on investment securities accounted for most of the margin compression in the quarter. The yield on loans was flat at 3.35% as total commercial, residential and consumer yields were essentially unchanged quarter over quarter.

The cost of total interest-bearing deposits increased 1 basis point; however, higher levels of non interest-bearing deposits provided a 1 basis point improvement in net free funds. Overall deposit funding costs were essentially flat quarter over quarter. On a year-over-year basis, total funding costs have only increased by 1 basis point.

I'd like to spend a moment on the recent increase to the one- and three-month LIBOR rates. Our floating commercial book is predominantly one-month LIBOR, and we saw little to no benefit from the recent rise in the three-month LIBOR rate. The modest improvement to the one-month rate was offset by continuing competitive pressure on new and renewed loans across our markets. We don't expect any material benefit in 2016, per possible Fed rate action this year, and we expect near-term LIBOR gains to be offset by modest NIM contraction.

Turning to slide 8, noninterest income was $95 million, up $13 million from the prior quarter. Mortgage banking income increased $14 million to $18 million on higher gains. Loans originated for sale were $466 million, up about 45% from the second quarter. We also recorded a $2 million benefit on the fair value of our mortgage pipeline at quarter end. In addition, portfolio loan sales generated another $9 million of gross gains during the quarter.

Insurance commissions were down $3 million for the quarter. As you know we generate higher revenues in the first half the year, and we expect insurance revenue to be lower in the second half. Year over year, insurance commissions are up 11%. All other fee-based revenue was higher in the third quarter, including service charges, trust service fees, card-based fees and brokerage annuity commissions.

Capital markets revenue was up $3 million to a record $7 million in the quarter driven by increased loan syndication fees and derivatives activity. There were no investment securities gains in the third quarter as we didn't further restructure our investment portfolio. Ginnie Mae securities currently represent about two-thirds of our securities.

Turning to slide 9, expenses came in at $175 million, up $1 million from the prior quarter. This included a $2 million lease termination charge and $1 million of severance. Adjusted for these, run rate expenses were essentially flat to a year ago. Personnel expense was up $2 million from the second quarter. The increase was related to severance, higher mortgage-related commissions, and a modest increase in risk and compliance colleagues.

Occupancy was up related to a $2 million termination charge on office space in Chicago. We continuously look for ways to better manage office space and will be centralizing our commercial and private bankers in downtown Chicago. Technology and equipment was slightly lower at $19 million. Outside of modest increases to FDIC and loan expense, all remaining expense categories were down in the third quarter.

The reality is that we operate in a banking environment where rates are expected to remain lower for longer and we need to remain to expense disciplined. We are constantly retooling our costs to make sure we are competitive, while driving the higher efficiency. Regards to taxes, our third quarter effective rate of 31% was up from 30% in both prior and year-ago quarters.

Before I open up to your questions I would like to address our Community Reinvestment Act rating of Needs to Improve, which we recently received from the OCC. This CRA rating covers the period between 2006 and 2010. The rating reflects issues that have since been resolved. In particular, we have significantly enhanced our services to low to moderate income and minority communities across our footprint, and we have discontinued legacy debt protection products offered by third parties.

The OCC has conducted a subsequent evaluation of the bank's CRA performance for the period between 2011 and 2014. We expect a new rating to be released in 2017. While there can be no assurance as to future CRA ratings, we anticipate an improved rating next year. With that, we'll turn it over to your questions.

(Operator Instructions)

Scott Siefers, Sandler O'Neill.

Good afternoon. Just looking for a little bit more color on the oil and gas portfolios. So I guess, you know, pretty heavy charge-off so it seems limited, and it's basically just a single credit. I'm curious, you talked about the refill of the nonaccrual bucket, and then I was a little surprised to see the non-performers, or non-accruals not go down more despite the sizeable charge-off. So, just what are your thoughts on those dynamics?

Sure Scott, this is Scott Hickey. Despite the fact that we have moved through and seen a number of charge-offs in the portfolio, we are still seeing a number of customers under stress and going into bankruptcy. So that in itself has not abated. So some of these customers moving into the bankruptcy role, although we still feel we are well secured we nevertheless do move those into nonaccrual.

Okay. What is it then, if they are moving into nonaccrual I think you suggested in the prepared remarks that you wouldn't expect to see credits with similar loss content as the few that have caused charge-offs -- charges so far. What is it that gives you confidence that despite these things moving into the nonaccrual bucket that they won't have the similar type of loss content?

This is still Scott. The two loans where we've taken most significant charges had unique characteristics. I don't want to get too technical, but there was a heavy reliance on non operated working interest collateral. In both of those cases we had relatively weak operators that went bankrupt. Both of those loans and the collateral backing them went through a liquidation process at very low prices. That generated a lot of losses. Needless to say, we've gone through the rest of the book. We don't have loans that have those exact same characteristics, nor of course are we making loans like that anymore.

Okay. I appreciate that. Thank you very much.

Jon Arfstrom, RBC Capital Markets.

Good afternoon. First of all good luck to the Pack tonight.

They are going to need it.

Curious if you're going to run the earnings call from Lambeau if you're still in the office, but it sounds like you're in the office.

Lambeau isn't too far away.

One foot out the door. You touched a little bit on the commercial real estate drivers, maybe give us a little bit more detail in terms of what you are seeing and where that is occurring, and maybe what the pipeline looks like there?

Sure. The pipeline for our commercial real estate has been quite robust for literally years. If you look at our year-to-date production, it's pretty well-balanced across our various offices around the Midwest, so our Illinois teams have generated probably about 45% of the loan production followed by Minnesota and Wisconsin. And then high single digits from Ohio, Missouri, Texas et cetera.

Actually multi-family has not dominated our new production this year. It is the second category, retail has actually led. But we have had good balance from retail, multi-family, industrial office, et cetera. So it's been well-balanced. As a number of banks are starting to bump up or get concerned about the OCC guidance on real estate concentrations, competition is starting to lessen a little bit. Pricing continues to firm. These structures are pretty attractive, we happen to have plenty of room as we sit here today to take advantage of those dynamics.

Okay. Good. I guess the flip side, the general commercial being down. Maybe touch on what is happening there. Is that a few isolated things or is there something deeper there?

No. We had good growth in the first half of the year and from what I can tell from reading industry information and seeing what some other banks are reporting, a number of banks are reporting slower general commercial loan activity in the third quarter. I don't know exactly what to attribute that to, but there is nothing that we know of that is a big concern.

Okay. That is what I had, thank you.

Chris McGratty, KBW.

Thanks for taking my question. Chris, I have one for you. How should we be thinking about the investment portfolio? Obviously you've seen some downward pressure in yield. Can you help me on what you're buying, anything changed? Any material delta in prepayment speeds, and kind of the overall size would be great. Thanks.

Yes we did see -- following Brexit, or right at the end of June we started to see an increase in the prepayments going through July, stepping up dramatically in August and further into September, and obviously that trend -- we know it because we already see the prepayment factors for what we're going to get hit with in October -- will continue to be an increasing prepayment. That combined with the fact that yields were lower during the quarter contributed to our lower net interest margin for the quarter.

And what we have been buying, as you are well aware, have been the Ginnie Mae plain vanilla and [BF] securities and the yields on that, despite the fact that they are a zero risk weight and have all the right dynamics, have also been attractive to others. So actually yields have not only fallen because the market felt soft, but because the entire market seems to be buying that product, and so we have seen the attractiveness of that investment portfolio option fall precipitously over the course of the quarter.

While that remains sort of our strategy that we had in place, we are sitting here frankly looking forward and saying: does that still makes sense as a platform? And we are reevaluating alternatives. I don't think that means we're going to do any of the stuff that we haven't done per se, in this investment portfolio, but it means we are thinking the allocation of the investment portfolio going forward.

Okay would that temporarily, given the mismatch in yield, would that temporarily keep you out of the market? Should we be thinking lower investment balances the next couple quarters or is it kind of stability?

Look, we've got an ongoing process where you're riding the markets as they go. Obviously if rates backed up again, or as a result of the Fed hike in December they started to pick up again, we probably would jump in with both feet. But as we sit here today, it's tough at these yields to put into portfolio stuff that we know is going to be both diluted to the margin and diluted for ability to earn -- have positive earnings over time.

Got it. Thanks for taking the question.

Terry McEvoy, Stephens.

Hello. Thanks. Good afternoon. Phil, you mentioned the 60-plus increase in the number of employees was risk and compliance-related. The number did catch my eye. Anything specific in the quarter to -- behind the increase in those employees?

No. They weren't all in risk and compliance by any means. I think we just call those out as maybe -- I'm guessing maybe there was a dozen of them or something. There were other people picked up here and there. We did not add 60 people in risk and compliance. We have plenty.

Good. Then, sticking with expenses of your efficiency ratio, 63% but it benefited from the gain in the mortgage area. As you think about 2017 and Phil you talked about the rate environment remaining low, what else are you looking at to improve the efficiency ratio, particularly on the expense side? Or is it really just a waiting game for the revenue picture to start to look better?

As we sit here today, it is the same grind that we've been on. So we have been slowly increasing revenues, and we been keeping expenses flat. And so we are slowly grinding the efficiency ratio to a better number. I like the 63% this quarter too, but don't fall in love with it.

Maybe just one quick last question. The capital markets was up $5 million quarter over quarter, I think it was $7 million. How's the pipeline for capital markets look as we get into the fourth quarter here?

Yes. There's a couple of drivers of that. There's the syndication business, which in our case is largely commercial real estate driven. And we have built a very good commercial real estate business, and we are very active underwriters and then sellers of commercial real estate loans. So that pipeline continues to look good. The other piece is the [derivatives] business. That is more dependent upon what our customers' rate outlook is and how much they want to lock in their interest rate exposures. So that one is a little harder to predict.

And Terry, just for clarity it was $3 million quarter over quarter from the second quarter, $5 million year over year -- $4.8 million year over year.

Thanks Chris. Thanks Phil as well.

Jared Shaw, Wells Fargo

Good morning, or good afternoon. Looking at the $9 million gain on sale of portfolio loans, were those all residential mortgages? And what drove the decision to sell those versus continue to hold them?

Sure the answer is yes, they were all residential, and essentially it's two factors, I think that's still thought through the portfolio mix is generally where we want it to be, it hasn't changed much. Had we not sold we would've change the mix a little bit. Also we looked at Brexit, we were cognizant and expected prepayments to be a factor moving forward.

And we looked at our overall portfolio, and as you are aware most of our portfolio is in ARM products, principally the 5/1 ARM. Sort of looked at that mix and thought: how much fixed rate exposure do we want potentially in an environment where prepayments might accelerate? And we decided to take some chips off the table.

Just to confirm those came out of loans held for investment versus held for sale.

Correct.

When we look at the loans held for sale, is that -- what is the mix there between the commercial real estate loans you are originating for syndication versus residential?

There is a very small amount that usually might be there at quarter end. By and large the trades get done within the quarter, and they are closed out at quarter end on the commercial side. That pipeline essentially is all residential.

Then looking at the slide where you talk about the energy exposure, you talk about being new loans funded since fourth quarter of 2015. What was the amount funded this quarter?

I'm sorry Jared I just don't have that in front of me. It would be a few loans, I'm guessing maybe $50 million. Those are probably approximately right.

Okay. Finally, on the change in the margin guidance, or outlook being a little weaker, is that really all from the securities portfolio, or is there something else that is impacting the weaker margin?

Cost of funding looks pretty stable. Yield on loans was stable. Probably stable-ish, maybe a little downward pressure. Probably securities.

Obviously we're in competition for loans. But securities were the key drivers of margin compression and again I think as was asked earlier, if we continued our current investment strategy there would be more downward pressure because rates are absolutely lower and prepayments are accelerated.

I think as Chris intimated we are taking a hard look at that right now.

Thanks. Finally, is this a good tax rate to use going forward? We've been down in this 30.5% range for a little while now. Is this a new base or should we still assume a little bit higher for the future?

This is probably a decent assumption.

Okay. Thank you.

Scott Siefers, Sandler O'Neill.

I just wanted to follow up on margin. Chris, when you were going through your remarks you said in the fourth quarter if we get a Fed rate hike it probably wouldn't do anything to the fourth-quarter margin. I just want to see how you're thinking about things, say we got one in December, what that would do in the first quarter?

I recall in first quarter this year following last December's rate hike there really wasn't much impact, with I think the real [timing] factor being the network deposits which moved up immediately. Any change to what the phenomena would be this time around, or is what happened last year pretty much the same as what we're going to face this time around.

I would like to believe that we learned some things from what we did last year. So the outcome might slightly be more positive. That really had no impact at all in the fourth quarter, and the carry-over into the first quarter, we saw some lift on the gross yield and margin but we also do a lot of renewals in our book in the first quarter. And it appears that essentially the competitive dynamic traded away some of the lift we saw with new lower rates on the renewals. And what we ended up with was compression from the cost of funds.

I will tell you that I think that our cost of funds position as we finish the year here is looking relatively strong, and I think we have learned something about managing that a little better. But that will remain to be seen in the first quarter and how the renewal effects weigh against any yield uptick in the 1-Month LIBOR. At this point in time, don't expect it to have any impact for Q4. Might be a modest positive going into Q1.

Thank you. I appreciate it.

I would like to turn the floor back over to management for any closing comments.

Thanks. So, just in closing our loan deposits, fee and expense trends were all steady to positive for the quarter and our credit metrics outside of energy remain very strong. We look forward to talking with you again next quarter, and if you have any questions in the meantime, give us a call. Thanks again for your trust in Associated.

This concludes today's teleconference. You may disconnect your lines at this time.