Apr 19, 2008
Executives
Paul Beideman - Chairman and Chief Executive Officer Lisa Binder - President and Chief Operating Officer Joseph Selner - Executive Vice President and Chief Financial Officer
Analysts
Andrea Jao - Lehman Brothers Terry Mcevoy - Oppenheimer Ben Crabtree - Stifel Nicolaus Scott Siefers - Sandler O'Neill Peyton Green - FTN Midwest Securities Tom Doheney - [Decade Capital] Kenneth James
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the Associated Banc-Corp First Quarter 2008s Earnings Conference.
During today's presentation, all parties will be in a listen-only mode. Following the presentation the conference will be open for questions.
[Operator Instructions]. This conference is being recorded April 17, 2008.
I would now like to turn the conference over to Mr. Paul Beideman, Chairman and CEO of Associate Banc-Corp.
Please go ahead, sir.
Paul Beideman - Chairman and Chief Executive Officer
Thanks Nicole and Lisa Binder and Joe Selner are on the phone call as well and I want to thank you all for joining the call. As you can see from our press release, we earned $0.52 per share in the first quarter and we are pleased with our revenue dynamics specifically with how net interest income continues to improve.
We are seeing sustained loan growth in the target categories that we have been talking about and also we are seeing improving deposit flows, which are contribution to net interest income growth. Our credit metrics are largely as we have forecasted them to be with increasing NPAs, but losses remaining stable to what we have seen in the fourth quarter.
There are several one time items that occurred in the quarter that largely offset each other. We have a $5 million gain from our interest in the Visa public offering reversal of tax reserves for about 4 million.
Fair value accounting changes that impact our business by about $1.5 million. We booked an expense for $2 million to reserve certain funding commitments.
We had a $3 million charge for other than temporary impairment which relates to our Freddie Mac preferred stock and we took a provision for in excess of losses of about $7 million. So there is some noise in the quarter.
Let me go right to discussion about credit you know, I will make a few comments and we will take certainly all your questions later. In our recent presentation and discussion that we have had with investors we have been articulating that losses will be arranged similar to what we have been seeing recently that non-performers would continue to increase and that we maybe providing at levels that are higher in charges and losses were 16 versus 15.5 in the fourth quarter, NPAs did increase by 25% and the provision was $7 million higher moving the ratio of allowance to total loans from 1.29% to 1.32%.
The NPAs are reflecting really the deterioration of four credits in our corporate banking business. And certainly there is a lot of movement that occurs in and out of all of this category that the net effect other than these four credits is relative stability.
And we spent a lot of time talking about our portfolios that maybe a different way to look at it to put some perspective on this, think about it from the line of business point of view. In our consumer businesses we are seeing and continue to see really relative stability in terms of the overall performance of our mortgage and our home equity portfolios.
The regional banking businesses CNI lending and CRE as it relates to the regional banking commercial business is also reflecting stability. Our program that we have been working on for several quarters to identify deteriorating credits and then exit those credits really has been quite successful in this segment.
And even in this challenging economic environment we are not seeing increases to non-performing loans I think as a result of those efforts. And we are all really very pleased with how our managers and bankers have embraced this program and have executed it and the results that its showing.
Our corporate banking operation which six months ago had virtually no non-performing loans has seen some deterioration and that deterioration is occurring in businesses and credits, so we linked our equity to the challenging housing environment. And that really is the single largest contributing factor to the increase in NPA.
Losses have remained stable and as we have stated, we did tightened our underwriting standards really across our consumer businesses sometime ago and have been focusing on de-emphasizing real estate to the extent that we can. And that while these NPAs are elevated, we believe that we will continue to see a similar relationship between non-performing loans and charge-offs as we have seen over the last 18 months.
I am sure, there will be a lot of questions around credit and we can go into those issues in more detail during that phase. Net interest income was up over the fourth quarter and significantly up over the last year and we are really very happy with the dynamics around net interest income and the improvement that we are seeing both in terms of loan growth and overall deposit levels.
The growth metrics that we have been articulating in our strategic discussions really are beginning to take hold in the business. And deposit levels although certainly impacted us, they always are by first quarter seasonal factors are measurably improved from prior first quarter periods.
Over the last several years, deposit outflows have been significantly higher in DDA and in other core categories and we have seen here in the first quarter this year. And we are very very happy with that.
All banks at this time really are experiencing the same challenging credit environment and its certainly been impacting Associate’s performance. And the future course of the economy remains unclear.
I think interest rate coming down is taking some of the pressure off of the resets of mortgages and the like and taking some pressure off of that business. But certainly, all factors around the economy still remained uncertain.
So it's really difficult to predict with precision where you are going to be. But at this point, there seems to be more and more clear differentiation along financial institutions and their risk dynamics.
And from our perspective the companies that are going to succeed in this environment are going to have low absolute losses and also create positive revenue momentum, so that when the credit environment does stabilize, that the stabilization will occur faster and that the positive revenue dynamics will begin then to start to translate into real earnings momentum. And that’s really the approach that we are trying to take in terms of the risk management, but then also the business management around revenue creation within our businesses.
And we have been talking about that for sometime and we think that we have begun to show some real progress there. We believe that we understand really where we are now in terms of the credit metrics of our portfolios and credit metrics of our business is much more clearly now than we have really at any time in our past.
And that’s helps build some confidence around these things as well. The uncertainties obviously around the depth and level of how economic conditions improve or deteriorate.
But on a metrics basis, we believe we have a pretty good handle of understanding regarding how these portfolios are performing. Just quickly, the expenses and you can see and read from the tables, the expenses seemed well controlled in the first quarter, staff expenses down and overall expenses down from the fourth quarter.
And fee income, which is certainly affected by seasonal conditions in the first quarter from the fourth quarter, the core fees compared I think stayed really through the first quarter of last year with some stress perhaps on asset management largely from deterioration that we have seen in market valuation. So in summary that’s really how we see things in the first quarter.
And I will be happy to open things up for questions.
Operator
Thank you. (Operator Instruction).
Our first question comes from the line of Andrea Jao with the Lehman Brothers. Please go ahead.
Paul Beideman
Hi,
Andrea Jao
Good afternoon everyone.
Paul Beideman
Hi, again.
Andrea Jao
I mean, good afternoon.
Paul Beideman
Yes.
Andrea Jao
How should we think about the mortgage banking line going forward. Is a fair value adjustment just this quarter?
Paul Beideman
Yes. Since this is the first quarter where the accounting standards have changed that should have been, but the entry that defines the difference if you will, this quarter.
So we have highlighted it as a one time item. It will have an effect going forward based on a whole series of variable that can impact it certainly, but it’s a change to what occurred in this quarter and we felt it should be highlighted.
Joseph Selner
Andrea this is Joe.
Andrea Jao
Hi Joe.
Joseph Selner
Again the accounting rules allow you now in terms of the fair value measurement, allows you to count for servicing asset in the fair value management and that is now a permanent change. So each quarters we have commitments and we have close loans, we will be able to count that value.
So this is just a change in how we are recognizing it in and it will be permanent now. So you should think about it as, part of our evaluation every quarter.
Paul Beideman
So I guess I mean it’s recurring in the sense that will happen, but this is the first quarter we are changed.
Andrea Jao
Okay. I guess, it makes the question, how should we think of a run rate?
Joseph Selner
It is very difficult, because the essence of change is creating volatility.
Andrea Jao
Okay.
Joseph Selner
And so it’s very very challenging to predict, with markets volume based its execution in market space in terms of sale of mortgage in the secondary market. All those variables.
It is best predictable at the MSR.
Andrea Jao
Okay.
Paul Beideman
I would suggest to you that the way we try to think about it, is we try to think about at the activity. And the activity in the mortgage banking business has been strong in the first quarter and we are seeing that continue.
Now we will do marks at the end of the quarter, be the same direction, the same magnitude that’s difficult to tell, because it is the point time mark. But I think the fundamental business is doing okay.
Joseph Selner
The fundamental business is quite strong right now as the interest rates have come down. And Paul has just commented on that, this is the first time, really in the last 5 years, we are starting to see an environment where mortgage demand is strengthening in any real way.
And I am very happy to see how the repositioning of our business that we took a few years ago you know, shaking it from the branches, encouraging its dedicated forces is beyond with it, in terms of successes that the volume that they are generating.
Paul Beideman
And I guess Andrea the easiest way for me to demonstrate that views on our table as we put mortgage loan originate for sale during the period. We have a table and it was 248 million the first quarter last year and this quarter was over 500 million.
So again that’s the point mortgage is doing pretty good.
Andrea Jao
Okay. Great.
So I was just hoping to get a bit more detail on your outlook on loans. Can commercial and home equity continue?
Paul Beideman
We believe that it can. The momentum that we are generating is coming from a whole series of initiatives around improving our selling and marketing effectiveness and it’s coming from business sources.
I will say this way, we are able to get this business on our terms. We are underwriting it and originating it based upon the standards that we put into place, that’s not changed in fact if anything is tighter.
What's changed is the capacity to execute. And for example, in the first quarter our regional CNI business had it’s best production quarter of the last 8 quarter.
And the home equity business, I mean part of it that interest rates have come down and some of it is first linked, which frankly we are very happy with. But just to give you a some color, the LTV on the first linked is about 58% with average FICO scores of around 760.
So there is an opportunity and first linked position is a more attractive position at about 70% of it in the first quarter was first linked. So I mean we feel good about that and I believe that this is the time that you can begin to be opportunistic if you maintain those standards.
Andrea Jao
Okay. It looks likes you guys are in a good place.
Okay. Thank you very much.
Paul Beideman
Thanks
Operator
Thank you. Our next question comes from the line of Terry Mcevoy with Oppenheimer.
Please go ahead.
Terry Mcevoy
Good afternoon.
Paul Beideman
Hi Terry.
Terry Mcevoy
Is it strange for Associated Bank to have four credits of that size about $50 million and move into non-performing status. Was there a specific review of a portfolio done in the first quarter I think Paul you had mentioned it was.
Paul Beideman
Yeah.
Terry Mcevoy
I think related to housing market, just seemed a little strange?
Paul Beideman
Well I have been here for five years in these corporate portfolio has been pristine for all five. But it is comprised of larger size CNI loans and commercial real state loans that we've sliced and diced for the folks in our recent presentation.
And its clearly function of those few credits that are linked to -- well the deterioration is linked thankfully to a few credits not a portfolio, but a few credits that have deteriorated that are linked to the real estate construction, the home construction specifically component of business. We have gone through both in our regional portfolios and in commercial portfolios and aggressive systematic review of all the loans in it.
And the non-performers that we are seeing here are a reflection of that and obliviously the deterioration of the credit. I believed and we've talked about this at some of the Q&A sessions that we had with investors over the last couple of months that the non-performers could increase a little bit more and in the second quarter from that review.
But again it is going to be a couple of credits, its not going be a portfolio kind of an issue. And face the problem what we see today in the economic environment we are operating in today, we would like to think that after that we are going see things feel little more stable.
Now, why we feel that way? If you think back, we are not and I guess this is a good think about being a $22 [trillion] bank.
There is 400 customers in this entire portfolio. So can we get our hands around it?
The answer is yes, you can. We are looking at 400 relationships in total in entire corporate banks.
So if economic conditions change you know good or bad its going to reflect, its going to affect the portfolio one way the other. But before looking at it today and making some assumptions about how we see it, we feel much more confident as a result of going through this review process that we understand what these dynamics are.
Terry Mcevoy
And then the in 10-K, I think it was mention that you are going through systems conversion of our core banking platform in mid '08 any additional expenses and why you specifically see that happening?
Paul Beideman
We anticipate it happening in May. And that’s still up for some discussion, but that’s the plan at this point in time.
The run rate expenses right now reflect three conversion types of expenses. Overtime we believed that the conversion is going to increase our effectiveness first of all, because we are up grading our system substantively and can be more efficient as we grow and as we manage and build our systems going forward.
So we actually see it as a potential and to dust clears to have a small -- it’s not a massive effect on overall cost, but a slight reduction.
Terry Mcevoy
Great. Thanks Paul.
Operator
Thank you. (Operators Instructions).
Our Next question is from the line of Ben Crabtree with Stifel Nicolaus. Please go ahead.
Ben Crabtree
Thank you. Good afternoon.
Paul Beideman
Hi Ben.
Ben Crabtree
The salary line, it got me by a surprise little bit it. Seasonally that’s a number you know, one would want to get salary increases and go back on (inaudible) you normally get the sequentially increase and you didn’t.
Is that part of the cost containment program, is there anything unusual in there and is this a good base to work from going forward?
Paul Beideman
There is only moving parts in those thing. In the forth quarter you remember there was a severance charge in there.
Our raise is -- that’s vast majority of our raises take effect in March. So the first quarter although it has sub security and also com back in a new [pending] benefits charges and all that the effective salary increase is really won't be seen more until the second quarter.
The offsets are that we are always working on being efficient. If you look at our head counts and none of the numbers are in front of me, but recollection tells me that headcount is absolutely flat from January of last year to January of this year and we happen to buy a bank in the middle of the year.
So, we in essence through a whole series of actions kept that headcount flat even though we bought Hudson, which wasn't large, but certainly had positions associated with broadening the organization. So we've been working down the headcount and continue to focus on that all along.
And so, it’s a constant investment in business in certain areas and a revaluation of expenses and others and the net of that is the headcount basically is flat year-over-year. So, I would assume that there will be some small increase to staff expense going forward just because those raises start to come into effect more in the second quarter, but then we're going to continue to work on ways to be to be more efficient as well.
So I guess in a nutshell, it’s a decent place.
Ben Crabtree
Okay, great. The tax rate, obviously you got the special benefit here but looking for a little bit of guidance, I have been using 32 going forward, is that a reasonable number?
Paul Beideman
Yes.
Ben Crabtree
Then maybe a question or two, following on relative to the large credits. Maybe I reason too much into that, but it seems like some of your recent hires have been more oriented towards the large corporate business.
And I'm just wondering Paul, if by moving into that space if you're kind of building more volatility into your numbers with higher average loan size and things like that, whether or not you kind of lose the small variability factor that’s been true for Associated, most of its history?
Paul Beideman
Yeah, I don't think the nature of the company changes. We've been in the corporate banking business for a decent amount of time before even I got here.
So it's long before five years ago. The hires that we are making are part of the strategy to get us better positioned in the stronger market from one point of view.
So that’s an investment in capacity to grow. But it's also an investment in the capacity to diversify the revenue streams from this business segment.
We're bringing in people into to organization that have expertise in cash management and fee-related aspects of this business that can allow us to broaden those relationships out. So it's less a lending focus, lending driven business and more of a value relationship oriented business.
So you can do the lending, but then we can maximize the return on equity and the value that can be obtained from the other ancillary businesses that the loan can support. And the other point I would like to make is that we are seeing some credit deterioration and I think the reasons for it are obvious.
From my five years, I'd say this portfolio has been just pristine and it's been managed well as it's been built and I think that’s evidence of it. In this review process that we've gone through, we've gone back and looked at these loans very very closely and there's really very few of them that I would suggest that we would regret having made.
It's good high quality customers that have been in existence for quite sometime that for the reasons that again that are obvious. Their prospects have deteriorated.
But if we've underwritten them well, if the land is at 65% loan to value and we've applied conservative general standards to it, okay, it’s a non-performing loan, but we are not going to take a 40, 50% charge-off on the thing. We are going to -- if there is a charge-off in at all, it's going to be relatively small and in many cases it's our hope that it just doesn't exist.
The optics of non-performing are affected by it because of the nature of a real estate transaction it takes longer to work out of it. Could we sell them?
Probably at some point we could some of them. But in this environment right now, the losses you are taking is exaggerated because of just the nature of the markets and the demand.
And when we see our collateral position, it's much enhanced over what those levels of alternatives would be.
Ben Crabtree
And these four loans, have they been on the books for a while or are they relatively young for you?
Paul Beideman
Well, they have been on the books for some time and there have been relationships that we've had for some time.
Ben Crabtree
And then if I could shift gears for one last question. Paul, going back to I guess when we talked in Chicago a few months ago, you were seeing a little more rationale in loan pricing beginning to enter the market, just was looking for an update on that.
Has it held and are you still feeling fairly good about that issue?
Paul Beideman
A little more. I believe that -- well from my perception, banks are still being way too aggressive given what the credit spread can be and it's my expectation in our organization that we are going to maintain that discipline and that we are going to continue to work to improve the relative, the absolute credit spread that we are getting and that's part of the discipline in this environment and bank should be able to get it.
The competitive factors and some of your rationality drives, I will call it overaggressive behavior relative to all other credit alternatives that are out there. Banks in today's environment should be capturing higher credit spreads.
That's a theory. The practice is intense competition takes some of that away.
We are going to keep driving at it, and yeah I do think it is getting better and I do think that on the deposit side of things some of the pressures beginning to be relieved but it's still -- it's not where it should be.
Ben Crabtree
Great. Thanks a lot.
Operator
Thank you. Our next question is from the line of Scott Siefers with Sandler O'Neill.
Please go ahead.
Scott Siefers
Good afternoon guys.
Paul Beideman
Hi Scott
Scott Siefers
I think most of my questions have been answered, but Paul, I was just hoping if you expand a little on something you said at the outset and then maybe you touched on a little in responding to the last question. But you made the comment about improving deposit flows, which I guess only sounded surprising and that this tends to be your weakest quarter.
So I guess I'm wondering what kind of things you guys are focusing on why you see -- why you think things are maybe a -- I guess I took it to mean that things are perhaps a little better than they usually are this time of year, just the overall dynamics on what drove you to make that comment if anything?
Paul Beideman
Sure. I think there is some external effect.
As rates come down that some pressure on commercial demand deposits does get alleviated. So on a portfolio basis, some of the pressure is relieved just because interest rates are coming down and I think that has some effect.
But we feel good about what's going on inside the company. Just a couple of facts: Our consumer checking weekly production sales are up over 17% over what they were last year, but our small business checking is up 60% over the last year and that's a function of what we would categorize as a big opportunity of where there has been some under-performance as part of what the company has done and many of the things that Lisa is doing and the management team is doing to focus on that business and we've talked about hiring in business development officers in prior calls.
We are starting to see the impact of that and there is 60% increase in small business checking production every time it's going to really contribute to that variable. So in terms of our marketing of our savings products, our money market products, and the core selling around the improved home equity and then linking checking products to that selling process, we are seeing services per household beginning to increase across the entire portfolio and the measures are starting to move in the right direction and over time that starts to build.
So we feel that although there is some market effect because rates have come down, we think a lot of it is a result of changing the growth dynamics and the sales dynamics in our retail and commercial business.
Scott Siefers
Perfect. Thank you.
Operator
Thank you. Our next question is from the line of Peyton Green with Ftn Midwest Securities.
Please go ahead.
Peyton Green
Good afternoon. I was just wondering if you could comment Paul on the opportunity to hire additional capacity at this point of the cycle.
Is it getting better or are people still chasing the same talent?
Paul Beideman
It's hard for me to gauge what's going on in the whole marketplace. It's hard for me to gauge what others are seeing and others are doing, but we have been very successful over the last 12, 15 months of hiring in a category of talent really across our businesses and across our support function from a whole variety of different companies that are enhancing the execution of those businesses and the quality of the support that they receive.
We feel very good about how we've been able to attract and bring talent in. It seems to me -- my subjected comment would be, it seems to me that because banks are also suffering to some extent here at some level, there is much less attacking of our people by others.
There is much less trying to take our group people, which has been an issue for us in some of our markets. Just because of that they are not hiring.
We are in certain areas and as I mentioned the question earlier before, we are keeping our headcount sort of net, but we are also -- we are hiring in certain key areas and I feel very good about the success that we have had.
Peyton Green
Okay. And then in terms of the positive certainly on the deposit side activities getting better, where are you still not as pleased with progress?
Paul Beideman
Around the core business, we are seeing -- it's still on the deposit side. I guess…
Peyton Green
Okay.
Paul Beideman
At the end of the day, it's still on the deposit side and it's still on the -- although we are seeing progress, the level, the potential of commercial deposit balances and commercial demand deposits still is something that we can improve at. So it was one area I would really just continue to highlight and probably the same I have been talking about for the last two years is improving our trajectory of growth of commercial demand deposits and other core deposits that are linked to those commercial relationships.
Peyton Green
Okay, great. And then with respect to the HELOC growth, how much of that -- you mentioned that a significant portion of it was first lien, how much of it was first lien versus more typical secondly?
Paul Beideman
Overall 60%. Between 60 and 65% was first lien and our portfolio have been around 35%, so it's a different mix.
There is more obviously more of a whole loan component to it than a line of credit component to it, which historically has been, where we have had greater emphasis.
Peyton Green
Okay. So you are saying they are amortizing?
Paul Beideman
Yes.
Peyton Green
10, 15 year loans?
Paul Beideman
Yes. And because the opportunity is that the housing values have fallen significantly.
And if you can do it now at 78%, you are getting a loan at 78% loan to value. And with interest rates coming down, there is a legitimate market there for first lien positions for that's more affluent customers to refinance or to move from company A to Associated.
And this is sort of just -- it's not precise information, it's anecdotal. But we are seeing a lot of business, but we are hearing about a lot of business that we have been more countrywidish or brokerage-oriented, now coming back towards the traditional bank where I think the trust relationship is a little stronger.
Peyton Green
Okay. And so, I mean this is because the jumbo market has somewhat fallen apart, do you think you are seeing the home equity loans basically replacing jumbos?
Paul Beideman
That could be a piece of it. We are doing some jumbo business in its own rate.
Our mortgage portfolio is stabilizing to some extent to where it was running off, millions of dollars a month. And part of that is some jumbo business that's coming into the first mortgage channel also.
So Joe's numbers before don't talk about the HELOC or the home equity portfolio at all, so we are seeing double on the mortgage volume in the first quarter that isn't even in the seasonal peak period, not including the HELOC where the home equity growth that we have put on.
Peyton Green
Okay
Joseph Selner
I was talking about the secondary market, not the portfolio piece, all right.
Peyton Green
Okay, great. Thank you very much.
Operator
Thank you. Our next question is from the line of Tom Doheney with [Decade Capital].
Please go ahead.
Tom Doheney
Hi. Good afternoon guys.
Paul Beideman
Hi.
Tom Doheney
I was curious; do you sell any MSR this quarter?
Paul Beideman
No.
Joseph Selner
No.
Tom Doheney
Okay, great. And then, I want to make sure I have this right.
I may have missed this. So the four NPAs that came in this quarter, it's four loans of 50 million in aggregate?
Paul Beideman
Yes, 41.
Joseph Selner
49.
Paul Beideman
49, yeah, okay.
Tom Doheney
Is there any geographic area within your footprint where these are coming in particular or is it spread throughout the footprint?
Paul Beideman
To Chicago. There is no rhyme or reason to it, it just happens to be where the business is, but there is not a geographic concentration.
Tom Doheney
Okay. And then, you mentioned something about credits secured by land, are the NPAs that came in secured by land?
Paul Beideman
Well, it's unfortunate but I'm not sure. But basically because they are in the residential, construction residential marketplace there is land involved, yes.
Joseph Selner
Or some stage of development?
Tom Doheney
Right.
Paul Beideman
It could be raw land or projects that have been built or are in a stage of building that where the demand for purchase has…
Joseph Selner
And because of the size, many of these borrowers have multiple projects and they all have different characteristics, but some are in earlier stages, some are later stages.
Tom Doheney
So are these local builders regional builders.
Paul Beideman
In our footprint. They are in our market, these customers are here.
Do some of them have products, I mean, projects that go a little further than the three states? I can't answer that explicitly, but generally they are Midwestern customers.
Tom Doheney
Okay.
Operator
Thank you. Our next question is from the line of Kenneth James.
Please go ahead.
Kenneth James
Hi, good afternoon. A question on the margin, I was wondering I can get your outlook there.
It seems like given the way the trends are going, you could optimistically probably hold this level and if not see some modest expansion as we go through the year, would you concur with that?
Paul Beideman
Yeah. The level with which interest rates fell in the first quarter created some volatility there certainly.
But the margin itself, we believe, it's going to be stable around -- I mean, I would call it 4 basis point decline from 362 to 358 stable. In my mind that's not a massive deterioration especially with some of the volume.
And then you got the seasonal effect of demand deposits that come back in the second half of the year. So when you balance all that out, I would suggest that it's going to remain in that mid 50s kind of an area.
Kenneth James
Okay. Thank you.
Operator
Thank you. (Operator Instructions).
Okay. Mr.
Beideman, I think we have no questions.
Paul Beideman
All right. Thank you all for participating and for your attention and questions.
And, as always if -- feel free to call Joe and myself with any other questions you may have. Thank you.
Operator
Ladies and gentlemen, this concludes today's Associated Banc-Corp first quarter 2008 earnings conference. Thank you for your participation and you may now disconnect.