Associated Banc-Corp (ASB) Q3 2007 Earnings Report, Transcript and Summary

Good afternoon. My name is Sophia [ph] and I will be your conference operator today. At this time, I would like to welcome everyone to the Associated Banc-Corp. Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remark there will be a question-and-answer period. [Operator Instructions] Thank you. It is now my pleasure to turn the floor over to your host Mr. Paul Beideman, Chairman and CEO of Associate Banc-Corp. Sir, you may begin your conference.

Thank you very much. And thank you all for participating in our call today. Lisa Binder and Joseph Selner are also here on the phone, and as you saw we announced our earnings at $0.56 per share in third quarter. And as normal all time, I will make a few brief comments about some key components of it and then we’ll be happy to answer any questions that you have. Why don’t I start with the margins, and we’re really very happy with the fact that the margins and net interest income improved really measurably in the third quarter, up to 3.62 and net interest income up over $5 million over the second quarter. In essence, everything that was weak about the second quarter returned to normal levels and in the third quarter as it relates to levels of prepayment fees and non-accruals which you’ll recall we were identifying as a weakness in second quarter and those things got back to normal levels. But I think most importantly, and as simply stated, loan yields improved while deposits costs stabilized, and that takes a lot of work but if what we have seen in the numbers. Our home equity growth was really quite solid in the third quarter and that’s something that we have been emphasizing and focusing on and we’ve talked about that possibility of occurring in the second half of the year, and I am really glad to see the lift that we are generating there and that is our highest yielding asset. But really, with market movements that are beginning to occur here pricing I think really becomes the biggest variable and we are seeing our loans spreads are beginning to improve through September and frankly, continuing to October and we believe that as interest rates move here, there is an opportunity to, and as credit markets stabilize we believe that, that increased spreads are real opportunity for us. One aspect that was somewhat unique to the third quarter was the dislocation around Libor rates as a result of the market conditions that existed in August and September, and that had a positive effect in the third quarter, which obviously won’t really continue, going forward. On the liabilities side, we believe that we continue to be fairly disciplined in terms of our money market and our CD pricing, and we’ve talked about this before, we try to take a portfolio approach to managing costs on the deposit side of the equation, and we don’t take the lead, but we can have pieces of our money market and certificate portfolios out there with very competitive rates, while we are working to manage margins for the portfolio. Also average DDA balances were higher in the third quarter which is a contributor. But when you put it all together, assets yield are up 6 basis points while our liability costs were down 4, and that’s probably the single biggest factor in terms of driving the margin improvement. Much of the effect of the interest rate changes really wasn’t felt in the third quarter since those changes occurred late in September and that we, when you put all this together we anticipate that the overall level of net interest income will be essentially the same in the fourth quarter as it was in the third quarter. We will continue to see strong home equity growth, we will see DDA seasonality as a positive, as well as, some core momentum in DDA growth that we have been focusing on and we would like to begin to see some improved level of commercial loan growth as well. And we put it all together. The one-time effect basically of the Libor, positive effect of Libor dislocation in the quarter in the third quarter can be more than offset by the core variables around spread on commercial loans, growth and home equity loans and positive flows on the deposit side of the equation. So we believe that the overall performance in terms of margins will be stable going forward and opportunity as these margins can be maintained and pricing can improve their performance and core growth can improve that slightly. In terms of credit, and see where our charge-offs were in our provision, the charge-offs in the third quarter included $6 million loss basically from one credit that we have been talking about, frankly, from the earnings announcements from last quarter and we have said that it's a possibility and that did occur. We became aware of the risk associated with this credit, really right on top of our earnings announcements last year, or last quarter and have been talking about it was as much clarity as we can ever since, but as a result of that really the credit was not a non-performing loan at the end of the second quarter. So, it's something that we have been carrying with us and working through this quarter. The CNI credit and there it is, it's something that we view really as an isolated incident due to the nature of it. If you put this credit aside we really feel quite good about the overall direction of our credit metrics in this very, very challenging environment. We are really beginning to see coming to fruition, some of the efforts that we have been putting forth to really attack the level of commercial non-performing loans and certainly that’s paid off for us this quarter. Commercial non-performers are down over 20% or about $29 million. And while it's harder for you to see, our sub standard loans are also down about $50 million and we are going to focus aggressively on reducing these loans, to choke off the flow of loans into the non-performing categories. There is no doubt that this put some pressure on our volume objects but there is also no doubt that it has a positive impact on performance going forward. And helps us manage risk in this challenging environment. I don’t think that we'll see the same level of reduction in the fourth quarter that we have seen in the third quarter, although we'd certainly like to see those levels of non-performance at least stable and hopefully with even some additional reduction going forward. I think it is also important to note that through the nine months this year our consumer charge-offs remained stable to ’06 levels and our consumer foreclosures remained stable to ’06 levels as well, and I believe that that‘s really a function of how we have been focusing on managing our core mortgage business but also how we have been changing the variables associated with how we are managing the risks associated around mortgage and home equity credit. Our provision in the quarter was $8.7 million leaving us with a reserve percentage of 1.32% of total loans, and this is well within our ranges to determine adequacy. And so we feel that that was the right action to take into the quarter. Fees, core fees are continuing really to show quite strong growth year-over-year, and frankly quarter-over-quarter and I said before my previous comparison is year-over-year for these first group the efforts of the organizations, our trust fees are up 16%, deposit fees are up 14%, commissions are up 8%, even though the insurance business is sort of been flat, but our brokerage business has really been a very strong performer in that category as well. And our card based fees are up 19%, so we feel very, very strong, very, very good about that growth and we believe that we have the momentum in our businesses to continue to generate that kind of growth. The mortgage business was down slightly, the biggest effect there really was a valuation change from the second quarter of about $4 million in regards to the MSR asset and there is a reduction in one-time fee gains of about $4 million. Expenses are up about $1.5 million, that’s entirely a result of having such an expense for three months instead of one and you can see that on our staff expenses are virtually flat, so we feel that we’ve really done a pretty good job of integrating the company but also getting the sales out of it that we had anticipated. Just briefly about the fourth quarter, and just some facts there. Really I think, maybe the clearest way to think about it is what's repeatable? Given the fact that there are some really substantive changes I think in terms of very important aspects of our performance here in the third quarter. Margin and net interest income in the third quarter were very, very strong and up very noticeably from the second quarter. We believe that much of this momentum will continue and as a result of all the variables, they can affect this complex equation, we believe that the overall level of net interest income in the fourth quarter will be at roughly the same levels in the third quarter. And as… if there were any one time things in the third quarter they are going to be replaced by the core variables and the core movements around pricing and volume in the fourth quarter. In term of fees, we believe that the core fees will remain strong and that mortgage banking will be relatively stable. So, the growth that we’re seeing in core fees is sustainable and hopefully the 4% or the $4 million deterioration in them, it's our evaluation isn’t repeatable, but the level of performance in the mortgage business we think is. In terms of credit, we have stated, in the quite here, and in the news release, we believe that our losses will settle as historic levels from the company. So, that is basically thing that we believe that a level of provision that we’ve taken in the third quarter perhaps even better than that, based upon what we’re looking at within a range is repeatable again in the fourth quarter as are the level of expenses. So, in a nutshell, that’s the quarter. We feel very, very good about the progress that we’re making around the variables that we control and that’s really what we‘re thinking about in terms of how we're managing the business in this environment. It is an incredibly challenging environment and as the economy goes, so do we and rest of the financial institutions in it, but we’re fighting very hard to manage the variables that we control to maximize performance around net interest income creation and managing the risk associated with credit in this environment. And we’d liked to think for the progress that we made here in the third quarter is going to be sustainable. So those were my comment. And I’ll be happy to open things up to questions. I’m sorry, one other quick thing. In relation to the fourth quarter, there probably is going to be some noise created as a result of these branch sales that we’ve been talking about. We had a small amount less than $2 million in terms of a financial gain in the third quarter, but in the fourth quarter we’re going to see between $12 million and $ 15 million of premium from the sale of branches and deposits will be impact, they were adversely impacted by about $50 million in the third quarter maybe be a little less. And it will be impacted by about $118 million in the fourth quarter. So there will be the noise there. But we also, our intention is to not just pass this $12 million to $15 million worth of gain to the bottom-line but to investigate some actions that we maybe able to take in the fourth quarter to quit that money to use to enhance our performance going forward. So, as we clarify our plans in that arena and its appropriate to do so, we can provide more detail, but that income is very likely going to come into third, into fourth quarter and we will take a series of actions perhaps creating severance accruals or doing some restructuring to put that money to good cause, so, that so that it's not just going to pass to the bottom-line. So, now we open up things up for questions. Question and Answer

Thank you. [Operator Instructions]. Your first question is coming from Andrea Jao with Lehman. Please go ahead.

Good afternoon everyone.

Hi, Andrea.

Just want to clarify what ex-acquisition, balance sheet loan growth, deposit growth was and the contribution of acquisition to the margin this quarter?

Hudson?

Yes.

Well, it's really quite small, I mean the entire asset size was things under, in terms of the loan was under $300 million. So, it really is very small in terms of its impact. It had some small effect on average balances, but it's really pretty small. In terms of net deposit levels the sales of the branches and reducing by $50 million probably had a bigger effect than Hudson did.

Okay. Just checking and on the margin similarly modest?

Yes. Well, on the $20 billion things $300 million of assets spread across the category equally isn't much of an impact.

Okay. In your press release you stated real-estate construction loans added to loan growth, isn’t that a bit surprising at this point. Wouldn’t growth in construction be a bit surprising at this point?

Well, we’ve been… no I don’t think so. There’s a couple of things going on. One is that the conduit activity really isn’t anywhere near where it used to be. And so the payoffs which were affecting all of our real-estate portfolio is at a much lower level, in fact almost non existent in the third quarter. And the construction lending that we continue to do is focused on our large customers driven by our corporate real estate area within which we have really significant confidence, on financial terms of which we’re comfortable, and we’ve been spending really a lot of time focusing on the segments, where you can play. And in retail construction and in apartment building type construction, those are areas where we’re still seeing good growth and a condominiums no. But almost as a counterbalance to the housing market and the condominiums type of real estate development apartments actually are strengthening their position because customers are moving towards that as an alternative. And we have seen in… especially in the metro markets that type of construction with well established customers who we know, who have diversified risk is pretty stable.

Okay, great. Thank you.

Thank you. Your next question is coming from Scott Siefers with Sandler O'Neill, please go ahead.

Good morning guys.

Hi Scott.

I guess, I just had a couple of separate questions. Paul, is there something you could kind of drill down into the pricing environment a little more on the loan side, you made some of those comments in your margins discussion, but I guess, I’m wondering where that improvement is coming from, if it's customers willing to tolerate higher rates or you guys are drawing the line in the sand, et cetera?

Well, we've pretty much had the line in the sand for sometime. The difference is maybe the world is rationalizing a little bit. And the folks, the companies that have been more aggressive in the past or being more circumspect, the fact that there at least has been the development of somewhat of a curve allows for that. When interest rates come down historically credit spreads improve. And if you go back historically and look at it, we’ve seen it and if we can be disciplined enough, we can capture it. And so far we’ve been pretty successful at it. Also, the growth in home equity is, if that’s sustainable which we believe it is, even in this environment, if we’re doing it to our credit standards with our customers that’s a yielding asset that is on a relative basis that creates stronger earnings, stable assets on our books, so all these things together struck the balance. And then if you can control pricing on the deposit side and be disciplined as the rates are coming down. And you’re really locking that in, so it’s working both sides of the equation. But the bankers on their system have to realize, what the opportunity is when rates change and focus very precisely transaction-by-transaction on how they are going to capture it, so it’s really a meat and potatoes approach to selling and knowing what at least you are trying to do before you talk to the customer.

Okay.

Because it’s a different environment now than it was two months to three months ago in terms of that opportunity.

Okay. And then on the home equity, I wanted to kind of follow-up on that as well, that’s all just your own customer base, right? You are not doing funds through correspondent or brokerage stuff?

Virtually all, I mean the company our size little bit of everything in there, but it’s virtually our customer bases, it's the function of better marketing and better selling.

Okay. And then if I could jump over to credit for a second, I want to follow-up on, I thought there were a couple of credits that you guys had specified on the second quarter call. And one of them obviously talking about, was that other one that I guess could have been involved in the charge-off was that… has that been removed now?

It's hard to remember three months ago, that I was thinking about, but I believe… yes I would say.

Okay. Sounds good. And I guess, I think you have inserted all the other kind of credit ones in your comment, so. Good. I appreciate it.

Sure.

[Operator Instructions]. Your next question is coming from Terry Mcevoy with Oppenheimer. Please go ahead.

Hi, Terry. Terry Mcevoy – Oppenheimer: Hi. Good afternoon. How much of the $27 million reduction in NPAs came from the sale of non-performers in the quarter, and could you just may be comment on that market please?

Yes. None, well, it depends what do you mean by sales, I guess it not complex definition, but some companies package non-performers together go to a third party, sell them at a loss or disposing them off to another company. There is none of that in there. These credits have been worked out. I mentioned at the end of the second quarter that there were couples of credits that we were… I think, I probably used the term selling, but it’s almost it's being paid off in essence, as opposed to selling it to another provider of credit at par. So there is really… and that’s us working, that’s our efforts going out there and finding someone to take the credit away. So the payoffs, the non-performers reduction are a result of being paid-off, working the credit out or having it go some place else. We haven’t packaged any loans to sell. And that market right now is much tougher than it was, I think, for obvious reasons a couple of quarters ago. We look at it all the time, in my time here we’ve never done it, but we’ve continued to look at it as an alternative if it's financially viable we would considerate, but we’ve been able to reduce some and the sub-standard credits as well by and it just didn’t happen in this quarter. We’ve been working at this for some time and there’s lot of flow in and out of these categories. We’ve been able to catch up and pass it by, if you will, so that we have gotten more worked out than were coming in. And, but it’s a function of our credit organization and our bankers in the filed are focusing on it more and more aggressively and having it stick. Terry Mcevoy – Oppenheimer: Charge-offs, about $6 million ahead of the provision, is that the $6 million credit that you’ve been talking about or were the loans charge-offs that previously reserve has been set aside?

Now, it basically reflects that, correct. Terry Mcevoy – Oppenheimer: Okay. And then just a last question on capital, it's kind of, up in the, up from the second quarter with the acquisition couple of quarters behind you now. Could you just talk about comfort levels for capital and potential uses of excess capital in the remainder of the year?

Well, our approach to that really is unchanged. We’ll continue to balance all the different uses, and we’re not hesitant to buy stock back. We, if you remember we had a buyback very, very late in the second quarter with Hudson in that quarter as well. You could almost think of that buyback late, late, late in the second quarter as the third quarter event. But it just happened to occur in the second quarter. But we’ll continue to look at that as a viable option in terms of the use of capital but we'll also look at acquisitions and at the dividend level each year. So I mean, our approach to it, really hasn’t changed very much, but in the calendar third quarter we didn’t buy back any stock.

Your next question is coming from Michael Cohen with Sunova Capital. Please go ahead.

Hi. Couple of quick questions. Can you talk about your appetite for ongoing acquisition? And as well, you had mentioned a potential kind of, restructuring charge in the forth quarter to potentially sort of improve efficiency, where do you think you could potentially take your efficiency ratio to over time, given all the improvement you had in other areas over the past three years?

Well, it stays in a low 50s right now and we are pretty comfortable with the efficiency ratio in that area. Having said that, we continue to look at our expenses all the time and also look at investments. So we’re, I am not suggesting that we want to take our expense level down significantly but when we keep thinking about how we are going to reposition ourselves and strengthen our ability to grow, that implies maybe to some, in some ways disinvesting in business A, B, or C and investing in another one and that’s, and those kinds of charges would be necessary to do that. In terms of our acquisitions, we, in this environment things again have changed pretty dramatically I think and it may constrain acquisition alternatives, at least for a time here with buyers and sellers stock as being somewhat depressed. We will continue to look at market really is the primary driver and will the acquisition generate a greater part probability of growing incremental revenue and value as a result of it, so is it an attractive place to be and can… does the company have the right culture and can we bring a business mix to it that can generate more revenue then it was generating for itself. And so that’s how we continue to think about it. We look all the time, we get opportunities on a regular basis. So if we would find opportunities at the right price that would meet those criteria, we would continue to look to do bank acquisition.

Okay. Do you generally kind of look at intangible book value earn back period? Is that one of the metrics you use or how do you think about it?

Return on cash investment, we think it’s an important variable. Certainly, return on equity is a critically important variable but a disciplined risk reward analysis around what the possibility of gaining and losing revenue stream are going to be as a result of the mix of the company in a type of business that it does. You can… and we’ve seen it a 100 of times, not with us, but where revenue expectations are grossly overstated in terms of what can happen in an acquisition and you've got to really be able to understand what the risks associated with it are too. So I mean if you damage the revenue stream, your assumptions don’t matter. It's got to be an objective evaluation of what kind of prospect the thing's going to create. And cash return really I think helps to clarify that kind of thinking, you know accretion and non-accretion is a theoretical discussion to a large extent.

Sure. Great. Thank you very much, Paul.

[Operator Instructions]. Your next question is coming from Ben Crabtree with Stifel Nicolaus. Please go ahead.

Hi, Ben.

Hi, I just need a little help in understanding the kind of the dynamics in the credit quality side. If I understand correctly, well first of all the $6 million charge-off, is there more remaining on that loan in the books?

No

Okay. So that’s gone. Now, but that was not included in non-performing loans at the end of the second quarter?

Correct.

So in other words, the drop from 180 to 150 round terms, it happened completely irrespective of this loan?

Correct.

Okay. I just needed to understand that. And I guess that’s basically my question. Okay, thank you.

Sure

Your next question is coming from Kenneth James with Robert W. Baird. Please go ahead.

Hi. Good afternoon.

Good afternoon.

I just want to ask you a question about some of your commercial lending initiatives. I know that you put a lot of emphasis there.

Yes.

And staking all of your expectations for better performance on really generating CNI at a minimum, getting corresponding DDA accounts. Didn’t seem like there had been a lot of momentum there in the third quarter. Just wonder if you could touch on what transpired there and how if any, that might change here over the coming quarters.

We continue to work at it, but we are working at it in a challenging environment partially. Demand is an issue to consider, our own constraints around credit quality and pricing and the like sometimes are constrained. But we are continuing to work through those issues internally and to get our commercial business positioned well to start to generate that growth on our terms in a very challenging environment. We, to some extent, are in our own way, as we attack these sub-standard and non-performing loans, I mean I can sit here and say that our origination volumes have been improving and that sort of thing and to some extent that’s true, not quite to the level we would like to see them but part of the pay downs of these non-performing loans and sub-substandard loans are substantive and up to weigh that down. At the end of the day, that’s a good trade, and we are happy with it. And the optics of it aren’t as positive as we would like to see them in terms of the strategy in our commercial business but it’s the right thing over the long run for the performance of the company, especially in this environment. So I am not as happy as I could be in terms of where that thing is going and how it has been moving, but I feel good about our prospects, going forward when I look and see what the managers of the business are doing. Our corporate business is really starting to grab hold. The conduits are to a large extent out of the way. So there has been a tremendous amount of noise in our real estate business around what we are doing versus what we were unwilling to match in terms of low ROE kinds of permanent financing and that’s changing the dynamics little bit, to Andrea’s question before. And we are seeing good solid growth in our home equity portfolio. So I get confidence that management in the organization, Lisa and her new team and the things that they are doing can get the growth, the left is [ph] for us to continue to work on this commercial segment to get it to the level that we would like it to be.

Okay. Thanks. I just want to get a clarification on comments in your commentary on net interest income and margin, it sounds like, in the way you were alluding to what happened is the volume, the margin might be down a few bps and funding asset volumes would be a little bit better to keep net interest income number flat. Is that a good assumption?

That’s pretty much what I was trying to say.

Okay.

There are still many moving parts you know, you tell me if next week what it is going to do, there’s so many things that can affect us. But when we look at what’s going on that was really… and the last is DDA, in fact it is the most important piece in terms of dollar for dollar, how both the margin and the net interest income number move, but your summary was probably better than mine.

Okay. And if we get another 25 basis point reduction this month does that change your thinking at all?

In terms of our asset liability management, we try to position ourselves to be neutral but when rates move like that, you get the opportunity to manage your spread differently, demands, changes in the minds of the customers and it’s how well you execute against those things that really will then begin to move to net interest income. The spread opportunities when rates come down, if a curve comes into place are real and you got to know that, and you got to be able to figure out how to position your business to capture it. And so why are we growing our home equity loan right now in an environment where demand is down? Well all things aren’t equal, we are improving our selling and our marketing, and it’s bringing that business to the table and we’re able to grow it, so that’s a good thing.

Okay.

And on the commercial side you got to be able to recognize what the variables are and try and work with which you can control.

Okay. Just from the kind of I know better pricing spreads and some yield curves slope will come back, real good thing, but just from a kind of static DAP gap basis, it would seem like 75 basis points over a 90 to a 180 day period would be a lot to deal with on the loan side and I am just wondering if you could comment on what you are seeing already with the 50 basis points on the deposit side, on the stickiness of rates, are you seeing people kind of aggressively take advantage of that or are the deposit rates a little stickier than you would have thought?

Right. It’s all the math. The smaller banks are out there they are trying to bang away on the volume and price on both sides of the equation and I guess they always do that. Because that’s all they can do. But we look at it and we are going to work hard to be disciplined, and trying to figure out what the answer is and then manage the business toward getting that answer. You can still be competitive but you don’t lead. And that’s pretty much our philosophy. If that constrains growth a little bit, okay, so be it. But it isn't going to constrain to the extent possible, margins.

Okay. Thank you.

Your next question is coming from Andrea Jao with Lehman. Please go ahead.

Hello again.

Hi.

Just had a bunch of quick questions, hopefully what will be quick questions. Last July you mentioned that you had a letter of intent for $10 million in non-performing loans from a purchaser, and you expected that to close in August. Did that happen? And forgive how dense I may sound, but how did that impact the decrease on non-performers?

When Terry asked me about corporate sales loans, there are two different kinds of sales we’re seeing. Yes, that occurred and it’s really it’s a in my mind that’s not so much selling non-performing loans, it's having another provider of credit to your customer take the loan of your hands.

Okay.

But it's semantics, I guess. But yes, that did occur but that’s something we have been working for quite some time.

Okay. That’s helpful. Also the total $15 million in gain that you expect in the fourth quarter you mentioned that there would be some offsets, will these just be partial offsets? And what exactly do you mean by… what kind of restructuring were you referring to?

I really can’t answer either of those questions with any precision because we haven’t worked in the details of analyzing all of those alternatives yet.

Okay. Fair enough.

Okay. And that’s the honest answer.

Okay.

I am trying to give you some heads up that there is going to be noticeable numbers passing through this thing and other ones probably in other categories. I don’t know if, I can’t figure it and honestly say, none of it will come to the bottom line or all of it will. But we need to really look through a whole series of options in terms of what to do.

Okay. Fair enough, just had to ask. And then do you still have 3.9 million shares remaining under your repurchase authorization?

Yes

Okay, and the tangible ratio has bounced back to 661, are you comfortable already at that level. If not, can you remind us kind of what level you target or would you be comfortable with?

We were comfortable when it comes down towards 620 as a result of doing the share buybacks and the purchase of Hudson in the same quarter and we're comfortable, obviously we’re more comfortable at this level, it provides more flexibility. We like to be in the mid sixes and that we think that’s a good place to be.

Okay.

But we can put a band around it depending upon what we are doing and how we are going to deploy it.

Okay. Fair enough. Thank you. It’s very helpful.

Your next question is coming from Heather Wolf with Merrill Lynch. Please go ahead

Hi there.

Hi, Heather.

On the impact from Libor work this quarter, can you tell us exactly how much that was and how it impacted your net interest income?

Yes, it affected the margins in September by about 2 basis points.

Okay. And was this… it was on the, I assume just on the lending side, higher yield?

Yes. Frankly, it's a portion of the commercial loan portfolio that is Libor based.

Okay.

So it’s not a huge effect, but in September there was this dislocation and it was noticeable, however, it had a 2 basis point effect.

Okay. Great. And then just on the impact from the 50 basis points that we have seen already from the Fed, I assume you’re sort of neutral to slightly asset sensitive?

Yes. I would, yes, neutral I think is the precisely accurate term. When we run the whole thing through over an intermediate period of time, it comes out pretty much even. So the net effect to net interest income is how we can manage price and volume in the key categories that can affect it.

Okay. Great. Thanks very much.

Thank you. There appear to be no questions at this time. I would now like to turn the floor back to Mr. Paul Beideman for any closing remarks.

I have no closing remarks; thank you all for your attention. And if you have any further questions, please don’t hesitate to give Joe or I a call. Thanks.