Associated Banc-Corp (ASB) 2018 Q2 法說會逐字稿

Good afternoon, everyone, and welcome to Associated Banc-Corp's Second Quarter 2018 Earnings Conference Call. My name is Hector, 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 investor.associatedbank.com. As a reminder, this conference call is being recorded.

As outlined on Slide 2, during the course of today's discussion, 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 can 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 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 refer to the slide presentation and to 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.

Thank you, and welcome to our second quarter earnings call. Joining me today are Chris Niles, our Chief Financial Officer; and John Hankerd, our Chief Credit Officer.

Turning to Slide 3. We had earnings of $0.53 per share excluding acquisition-related costs. Please note that the second quarter marked the first full quarter of Bank Mutual contributions to our financial statements. As a reminder, the acquisition closed on February 1, and the first quarter of 2018 only included 2 months of Bank Mutual results.

The transfer of Bank Mutual accounts to Associated systems was completed over the weekend of June 23 and 24. I'd like to take a moment to recognize our team for their tremendous dedication and thousands of hours of diligent work.

Average loans in the quarter were up over $900 million from the first quarter, driven in part by an additional month of Bank Mutual balances and solid loan growth in the commercial and business lending segment. Average deposits were essentially unchanged from the first quarter and reflected our usual seasonal pattern of outflows during the second quarter. We benefited from higher fee revenue with both insurance commissions and card-based fees showing growth during the quarter. We recorded $7 million of Bank Mutual-related acquisition costs, bringing our total merger-related costs to $28 million. While our second quarter expenses were elevated as a result of running 2 branch networks, our expense control efforts continue to be effective. And excluding acquisition-related costs, our efficiency ratio continued to improve. We repurchased nearly $7 million of stock this quarter at an average price of $26.52, and we paid a dividend of $0.15 per share. Our return on average tangible common equity was 15%.

Loan details for the second quarter are highlighted on Slide 4. Average loans grew by 4% from last quarter while we managed our overall loan book toward achieving a more equal balance between our commercial and business lending, commercial real estate and residential mortgage portfolios. Specifically, we continue to reduce our exposure to multifamily commercial real estate, and we held our residential mortgage portfolio balance steady. In the second quarter, our commercial and business lending segment experienced solid growth with strength across many different lines of business.

Notably, our general commercial activity, which includes core manufacturing loans, was the leading contributor to C&I growth this quarter. Growth came from commitments to new customers as well as increases to existing clients driven by improved market demand. Higher oil prices induced customers in our oil and gas business to draw on lines of credit to continue the development of their assets. Our mortgage warehouse business also rebounded this quarter with seasonally higher utilization despite headwinds caused by tight housing inventory and rising mortgage rates. Power and utility segment also saw an increased deal flow as we booked several new credit facilities. Looking forward, our C&I loan pipeline is solid, and we expect continued growth in the third quarter.

In our commercial real estate business, we're seeing an elevated level of loan payoffs and increased competition in term loan funding rates and structures. However, we remain optimistic as our construction loan commitments have grown 16% year-to-date versus the same period last year. We anticipate the future funding of these construction loans will drive future CRE portfolio growth. In particular, we saw solid results from our loan production offices in Indiana, Michigan and Texas in the quarter.

On Slide 5, we show how we've been managing our loan portfolio exposures. As we've discussed previously, we have a goal of maintaining approximately 30% to 40% in each of our 3 major loan categories. The addition of Bank Mutual caused our portfolio exposures to move away from our internal targets, particularly the multifamily residential mortgage books. As such, we've been moderating our multifamily exposure by allowing maturing loans to run off. Over the next year, we will selectively finance projects to maintain the portfolio. We've also been managing our residential mortgage exposure by reducing the amount of loans we keep in portfolio versus those we originate and sell in the secondary market. Our sales in the quarter increased by $200 million versus last year as we reduced the proportion of originated loans kept in portfolio to match runoff.

We'd also like to note that we continue to manage our retail property exposures downward as well given the evolving challenges for retailers. However, with the strength and growth we're seeing in the underlying economy, we continue to expect 1% to 2% quarterly growth in our overall loan portfolio for the remainder of 2018.

On Slide 6, we highlight our quarterly deposit trends. Average deposits were essentially unchanged from the first quarter. We expect the deposits will continue to follow their typical seasonal pattern and build during the second half of the year. Our loan-to-deposit ratio was 96% for the quarter. This ratio typically peaks during the second quarter as deposit outflows are generated by municipalities and school districts working down their state funding. We anticipate that ratio will decrease in the third and fourth quarters as it has in previous years. During the quarter, we continue to optimize our funding mix. We developed a new product for our correspondent banking customers and forged new relationships with large municipal customers. We continue to decrease our rate-sensitive network transaction deposits, and we lowered our effective spread on the remaining network deposits.

Turning to Slide 7, we discuss our loan and deposits yields, net interest income and margin. Our commercial loan portfolio yield increased nicely, benefiting from the full effect of the March rate hike and the elevated level of LIBOR throughout the quarter. Our residential loan portfolio yield also ticked up by 3 basis points. We continue to see competitive pricing pressure in the deposit marketplace, particularly for time deposits. However, we've been able to maintain pricing discipline, and our interest-bearing deposit cost increased just 10 basis points during the quarter.

Net interest income of $226 million was up $43 million from the second quarter of '17 and up $16 million from last quarter. The majority of the $16 million quarter-over-quarter increase is due to loan portfolio growth and improving margins. We also recognized $3 million more of purchase loan accounting items this quarter, including scheduled purchase loan accretion and prepayments related to acquired Bank Mutual loans. It's not uncommon to have prepayments, and we anticipate there may be additional such events in 2018. But they are difficult to predict.

Our securities portfolio also contributed almost $3 million more in the current quarter as we continue to reposition the Bank Mutual portfolio, primarily into municipal securities. The net interest margin was 3.02% in the second quarter, up 10 basis points from the first quarter and up 19 basis points from the prior year.

Turning to Slide 8, we have a breakdown of the specific factors that contributed to the 10 basis point increase in net interest margin versus last quarter. 6 basis points of the increase was due to net loan growth and funding composition. Bank Mutual purchase loan-related items, including an additional month of purchase loan accretion and prepayments, contributed 2 basis points. Other net changes, including the remixing of the securities portfolio, also contributed about 2 basis points.

The graph on the right side of Slide 8 shows that over the last 2 quarters, we've seen our net interest margin expand even when excluding the effects of accretion and prepayments. In aggregate, prepayments contributed 9 basis points to this quarter's margin. Excluding prepayments, our margin was approximately 2.93%. Going forward, our balance sheet remains modestly asset-sensitive, and we're poised to further benefit from rising rates. Consequently, we expect that our net interest margin, excluding accretion and prepayments, will continue to expand. We also expect lower accretion although prepayments will remain unpredictable.

Factoring in all of the above and expected Fed action in September and December, we believe our reported margin will be around 3% for the remainder of the year.

Turning to Slide 9, I'd like to provide you some highlights on the Bank Mutual conversion. As I mentioned, in June, we converted all Bank Mutual accounts to Associated Bank systems. As a result of the many, many hours of hard work and diligent planning by hundreds of our colleagues, we welcomed about 89,000 new retail customers to Associated. Additionally, over the last few months, we've been fostering relationships with over 3,000 Bank Mutual commercial and business customers. We've also issued approximately 36,000 new debit cards. We continue to target 45% of cost savings and expect our fourth quarter efficiency ratio will improve by over 200 basis points year-over-year. While customer retention rates have been good so far, we understand that the most challenging work to retain customers began at conversion as that event marked the first real change for Bank Mutual customers. We laid the groundwork for successful retention with our communication efforts prior to conversion, and we're focused on assisting with any concerns our new customers may bring.

Turning to Slide 10. Second quarter noninterest income of $93 million was up $2 million from the first quarter and up $10 million from the second quarter of '17. Our insurance business was up over $1 million from the first quarter. And our recent acquisitions, including Anderson Insurance, are an important part of this growth. We also benefited from seasonally higher employee benefit fees in this space. Our card-based and loan fee segments also grew by about $1 million from the first quarter.

On Slide 11, noninterest expense of $211 million was down $2 million from the first quarter. As a reminder, Bank Mutual was essentially a stand-alone company for almost the entirety of the second quarter. The closure of 36 net branches and conversion happened on June 24, and the corresponding reduction in full-time employees mostly occurred on July 1, so minimal net savings were realized in the quarter. Further, we had elevated expenses in the second quarter related to the Bank Mutual conversion. These costs were driven by temporary call center help, contractors facilitating the mapping of Bank Mutual accounts to Associated systems and utilization of our testing resources. With that said, we have a solid track record of expense discipline, and the improving trend of our efficiency ratio demonstrates our ongoing commitment to controlling costs. Going forward, we expect to realize Bank Mutual synergies in the third and fourth quarters and to continue to improve our efficiency.

On Slide 12, we discuss Bank Mutual acquisition-related costs. We recorded $7 million in acquisition-related costs in the second quarter, bringing the year-to-date total to $28 million. We now expect that our total acquisition-related costs will come in between $29 million and $31 million, down from the $40 million guidance we laid out at the beginning of the year. The reduction in acquisition costs resulted from lower severance and advisor-related expenses and was partially offset by the higher branch and back office operating expenses we incurred as we worked through the conversion. We expect to book the remaining acquisition-related costs in Q3, and we expect the elevated personnel expenses and operating wind-down costs to moderate during the third quarter. We're still targeting $825 million of total expenses for 2018. Including anticipated Bank Mutual synergies and the impact of Anderson Insurance, which was acquired in June 1, our implied noninterest expense run rate is approximately $196 million. We've updated our fourth quarter 2018 noninterest expense run rate guidance to a range of $194 million to $198 million.

On Slide 13, we detail our quarterly credit quality trends. Potential problem loans decreased by $41 million in the quarter as our credit environment remains benign. Nonaccrual loans decreased slightly to $204 million. Net charge-offs were only $8 million in the quarter, including $7 million from the oil and gas portfolio, and they continue to moderate. The aggregate allowance for loan losses decreased to 1.1% of total loans from 1.13% in the first quarter.

I'd like to highlight that the increase in OREO is entirely attributable to the closed Bank Mutual branches. We've already contracted to sell most of the branches and anticipate closing on those sales in the third and fourth quarters. With the benign credit environment, our provision for credit losses was $4 million, up from 0 in the first quarter, and it was primarily driven by loan growth.

On Slide 14, we update our outlook for 2018. We anticipate 1% to 2% quarterly loan growth for the remainder of the year. Our commercial loan and CRE pipelines remain solid, and conversations with our customers have been positive. Employment levels are still very high in our footprint, and we remain optimistic that the tax cuts enacted at the end of 2017 will continue to drive loan growth in 2018. We're tightening the range on our noninterest income guidance and now expect it to be between $365 million and $370 million. We're maintaining our full year noninterest expense guidance of $825 million, which includes $29 million to $31 million of acquisition-related charges. We expect our tax rate to be approximately 22% for the second half of 2018, giving a full year effective tax rate of about 20%. Our effective tax rate was lower in the second quarter as we implemented onetime tax planning strategies to maximize the positive impact of the Tax Cuts and Jobs Creation Act. Our capital priorities have not changed as we look to fund organic growth, pay a competitive dividend, pursue nonorganic growth opportunities that increase shareholder value and repurchase shares.

With those comments, I'll open the call for questions.

(Operator Instructions)

Our first question comes from the line of Scott Siefers with Sandler O'Neill.

First question is just on the margin, just want to clarify and make sure I understand the nuances. So it sounds like for the third quarter and the fourth quarter each you're expecting about a 3% reported margin. And the nuance behind that is simply rising core margin offset by moderating PAs. Is that the right way to look at it?

It is, and the wildcard, of course, is prepayments that will probably come along and drive it up a little bit higher.

Okay. Perfect. And then I think you began to or at least touch on it a little in your comments, Phil, but just the expense guide. I know you reiterated the full year $825 million reported base. But just as you look at the 4Q core guide, in particular, just up a little, I was wondering if you could just chat a little about what drives that change versus 90 days ago.

I don't think it changed. I think we were always targeting around $195 million in the fourth quarter.

I think we had a range of $191 million to $197 million, and now we've got a range of $194 million to $198 million, so it's fine tuning the range.

Okay. So that's just a function of 90 days more experience, sort of have a better idea of what's going to go on or what -- why the need for that?

Yes, we know exactly which people we kept through the conversion. We know exactly which contracts we've terminated and which ones are going to keep rolling, etc. So we've had a little finer tune on it. We moved the upper end of the range up by about $1 million, and the average moved by less than $1 million.

Yes, I agree. Midpoint, not much of a change, but nonetheless, the delta, so I just wanted to make sure I knew the fine-tuning of it.

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

So you had some great C&I loan growth this quarter, and it sounds like your pipeline is pointing to more strong growth next quarter. Are you guys thinking that 1% to 2% you mentioned is just primarily going to be driven by that C&I and you'll continue to have some runoff in the CRE, maybe construction stabilizes based on what you're talking about with the commitments?

We feel really good about the C&I growth. CRE has a very strong pipeline, has a lot of unfunded construction loans, and they've booked more than $1 billion of new commitments to date this year. The little bit of wildcard with CRE is how much prepayment we get out of the Bank Mutual book, particularly in the multifamily space, which frankly is okay with us. As you know, we've been very focused on our overall exposure to multifamily. We did the Bank Mutual deal knowing that, that was going to add a significant amount. We'd just as soon get that in balance, but we're assuming there'll be a certain amount of continued unscheduled runoff on the multifamily. But even with that, we should be comfortable in that 1% to 2% range. We also can turn the dial on the residential mortgage book if we feel like it. I think we talked before about the fact that with slack commercial loan growth in the back half of last year and the first quarter, we ended up somewhat, in our view, overweighted on the residential mortgage side, and that's why we chose to rebalance that this quarter by essentially selling the production that we put on.

And so how would you expect that portfolio to turn going forward? Would that grow at all? Or are you still looking to kind of keep that stable here?

It will grow. It can grow whenever we feel like it. If we get the floating rate loan production from commercial and commercial real estate that we're expecting, then we'll probably portfolio some of the residential mortgage production.

Got it. And then on, I guess, the securities book, the direction of that will just depend on the magnitude of deposit growth from the back half. Is that fair?

Yes, that's sort of the plug at the end.

Yes. Got it. And just switching to capital real quick if I could, the pace of the buyback had slowed a little bit this quarter, but you guys are definitely sitting well above the capital target range you talked about previously. Maybe if you could just update us on that target and how you're thinking about that differential and how to use it going forward.

I think you can expect us to continue to look for opportunities a la the Bank Mutual transaction. And we want to be in good shape capitalized as we look around the landscape out there. But we will also continue to be opportunistic if those things present themselves regarding buybacks. When the stock dipped, you could see we jumped in and bought some.

Yes. Great. And then just one last one on the NIM. After the June hike, have you guys seen any broad-based deposit pricing adjustments in the market or just the pickup in CD competition you guys talked about?

We've seen it on the time deposit side, not too much elsewhere.

Our next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Just sticking on the deposit topic. I know you talked about how you get a little bit more flow back into the bank this quarter, and that's more seasonal. But where are you more optimistic or most optimistic in terms of gathering core deposits?

In our core markets. I mean, I think the core base of the seasonal flows and -- inflows and outflows are in our core Wisconsin, Illinois marketplaces, and that's where those larger noninterest-bearing DDA relationships have resided, and that's where we see the volatility. So that's where we'll see the inflows we expect. And that said, it's fair like almost every bank to say that it's difficult to gather new retail deposits. The competition from the big 3 national retail players is the real thing.

Okay. And is the plan, do you feel like you have the ability to continue to run down those network deposits?

Yes. I mean, that is certainly on our mind since the data on those is quite high. So we're looking for other opportunities to replace that funding.

Okay. On loans, we talked about this last quarter and you kind of hinted at it, but can you talk a little bit about, call it, the core C&I mood of your borrowers? It sounds like it's better. I'm just curious if you feel like it's better than it was last quarter.

Yes. I actually think it's the optimism that we're hearing in our conversations with our commercial customers has picked up, which is interesting. We would've thought that would happen a while ago. I didn't necessarily explain why it took so long, and that's even in the face of the potential trade issues that were out there, which over the long haul could have a real impact in this part of the country and in how it all plays out.

Okay. Good. And then just last follow-up here on M&A. How active is the marketplace? Would you say it's becoming more active, and you're seeing more opportunities or not much of a change?

I think post the Crapo Bill, it's become more active. I mean, you've seen several transactions announced of decent size, and there's conversations going on.

Okay. And you remain very interested in that, I would assume.

If we can find more transactions like Bank Mutual, we are really interested.

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

Chris or Phil, on loan pricing, I'm interested now 6 months removed, 6, 8 months removed from the tax bill, have you seen any narrowing of credit spreads or loan pricing either by yourself or competitors based on competition?

Yes. So far the banks have not traded away their good fortune that I can tell. We'll see how that plays out over the long haul, but you can see by our own results, we're not experiencing any loan yield pressure at least at this point. I mean, we're very disciplined about what we put on our books, too. So I think I made a comment earlier that we are seeing in some of the commercial real estate space some pricing instruction that we don't like but we simply pass on that. So there is a little bit of that.

Okay. And if I could, following up on Jon's question on M&A, you mentioned I think twice in your remarks, if you could find the Bank Mutual type of deal you'd be game. What about larger deals given Crapo? What's the appetite for either something transformational?

Look, we are very focused on creating shareholder value here. If we think that a larger transaction makes sense, we would pursue that. However, when you look at the multiple we pay for Bank Mutual versus some of the multiples of recently announced transactions, it may behoove us to look at smaller deals that aren't going to be subject to a wild bidding frenzy, which we've seen lately as far as I'm concerned. So I think it's very difficult to overpay for a bank and ever recover from that.

Our next question comes from the line of Nathan Race with Piper Jaffray.

A lot of my questions have been asked and answered, but I guess I had one question on your REIT exposure. Growth was kind of flat this quarter, and we've seen a decent amount of M&A and capital raising in that space specifically, so just curious if you can update us on kind of the underlying health of some of your customers within that space.

I don't have any real comment on that. We haven't seen any credit deterioration to speak of in the REIT book. So I'm sorry. I don't really have any color on it.

And perhaps in terms of underlying growth opportunities, is it more or less or just kind of steady-state within that asset class specifically?

In the REIT book?

Yes.

We've built the book over the last, call it, 4-ish years. We're very focused actually with our REIT customers in expanding to other types of business with them. So a large REIT, like any large corporate, the price of entry is typically participation in a not terribly well-priced credit facility, line of credit. And then we look for opportunities to do project financing, gain cash management depository business. And our REIT team has done a very job nice job of harvesting, if you will, those opportunities that we gain by participating in the first place. So I would say a lot of their focus is on that versus simply growing the overall level of REIT commitments.

Our next question comes from the line of Terry McAvoy with Stephens Inc.

The dairy industry is struggling for a couple of different reasons. Could you just talk about your exposure and whether that presents a risk at all to the overall Wisconsin economy?

Yes. We have essentially very little, if any, exposure directly to dairies. We do finance food processors, cheese manufacturers and such. It is a threat to some degree to particularly, look, the actual dairy producers. For us, we're not directly exposed to that, and the processors are doing fine. Go ahead, John.

I would just add that as it relates to the impact from trade, tariff issues, that we're taking a close look, evaluating the portfolio or in the process of looking at the portfolio in its entirety to see what type of impact our clients are going to be experiencing potentially and focusing at analysis on risk rating of the client and our portfolio -- or our exposure, client exposure, and that's something in process. And that, obviously, will include our exposure to cheese manufacturers and processors.

And then just as a follow-up, I had my notes last quarter. The commercial deposit platform was going to be converted over in the fourth quarter. Is that still the case? And then, I guess, another question is will any of the cost saves be pushed out into the first quarter of '19?

Yes, we're still on track to make that conversion, and this is not a cost save play. This is improving the functionality, features, getting a mobile app for commercial deposit customers, et cetera. So this is not an efficiency play. This is table stakes.

(Operator Instructions) Our next question comes from the line of Michael Young with SunTrust Robinson Humphrey.

I wanted to start just with the loan growth this quarter. Obviously, the commercial being pretty strong. Could you give us a sense of maybe how much of that was shared national credits or participations versus kind of direct originations?

Do you have that information handy?

No. I mean, the growth in the portfolio has been pretty spread out, in general. And we've seen growth in various areas of the commercial portfolio. Our specialized industries grew. Our power generation grew. Our asset-based lending and our conventional commercial all have shown strong growth. I would say that as it relates to shared national credit growth that really the focus has been otherwise. There really hasn't -- the growth hasn't been stimulated by that particular area much at all.

All right. Great. As then just as we look forward with some of the commercial real estate, I guess multifamily and retail in particular maybe moderating a little bit, what are the yields on those kind of books of business versus maybe just core commercial that will continue to grow? And what impact will that have on overall commercial asset yields?

It's not going to impact it very much at all because we're not ceasing to make multifamily loans. We're going to allow some runoff to occur, and then we'll selectively backfill. So the portfolio will come down modestly. But in the context of a $23 billion loan portfolio, it's not going to move the overall yields around.

Okay. And maybe one last one just on the residential side. I think I asked last quarter, but any plans maybe in the future to kind of securitize or move a larger piece of that book off just given where the network deposit pricing is moving, et cetera?

No, we don't have any plans to do that.

Our next question comes from the line of Jared Shaw with Wells Fargo Securities.

This is actually Timur Braziler filling in for Jared. Most of my questions have also been asked and answered. Just one more. Can you identify the tax benefit dollar amount that was booked this quarter?

Sure. If you think about the normalized tax rate for the full year, that's closer to 20 -- then the number should've been closer to $20 million in taxes rather than $14 million or $15 million. So you can say, so the delta was that $5 million or $6 million, in aggregate, relative to where it could've been. And again, it's a variety of tax strategies related to making sure that we took full advantage of the Tax Cuts and Jobs Act.

Okay. So it's using a base of 20% not the 22% that we should expect in the back end of the year?

Well, if you use the $22 million, that gets you closer to $7 million, $8 million, right? So -- but the 20% will be the full year number.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

All right. Well, thank you for joining us today. We are very pleased with the quarter's expanded bottom line, the completion of the Bank Mutual conversion and the continued favorable credit environment so we look forward to talking to you again in October. If you have any questions in the meantime, please give us a call, and thank you again for your interest in Associated.

This concludes today's conference, you may disconnect your lines at this time. Thank you for your participation.