Jan 19, 2012
Executives
Philip Flynn - President and CEO Joseph Selner - EVP and CFO Scott Hickey - EVP, Chief Credit Officer Christopher Del Moral-Niles - EVP, Deputy Chief Financial Officer Tim Sedabres - Vice President, Finance
Analysts
Anthony Davis - Stifel Nicolaus & Co. Jon Arfstrom - RBC Capital Markets Dave Rochester - Deutsche Bank Securities Ken Zerbe - Morgan Stanley R.
Scott Siefers - Sandler O'Neill & Partners LP Chris McGratty - Keefe, Bruyette & Woods Terry McEvoy - Oppenheimer & Co. Erika Penala - Bank of America Merrill Lynch Emlen Harmon – Jefferies & Company, Inc.
Maclovio Pina – Morningstar Equity Tom Alonso - Macquarie Mac Hodgson - SunTrust Robinson Humphrey
Operator
Good day ladies and gentlemen and welcome to the Associated Bank’s fourth quarter earnings release analyst call. At this time, all participants are in a listen-only mode.
Later we will conduct a question-and-answer session and instructions on how to participate will be given at that time. (Operator Instructions).
And as a reminder, today’s conference call is being recorded. Now I would like to turn the conference over to Tim Sedabres for some forward looking language.
Tim Sedabres
During the course of the discussion today, Associated management may make statements that constitute projections, expectations, beliefs, or similar forward-looking statement. Associated’s actual results could differ materially from the results anticipated or projected in any such forward-looking statement.
Additional detailed information concerning the important factors that could cause Associated’s actual results to differ materially from the information discussed today is readily available on the SEC website in the risk factors section of Associated’s most recent Form 10-K and any subsequent Form 10-Q. 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 Phil Flynn, president and CEO for Associated for opening remarks.
Philip Flynn
Thanks Tim and thank you everybody and welcome to our fourth quarter conference call. So joining me today are Joe Selner, our CFO, Chris Niles, our Deputy CFO and Scott Hickey, our chief credit officer.
Today I will begin by reviewing our results for the quarter and full year and provide you with an update on the key drivers of our business and finally share our outlook for 2012. Fourth quarter highlights are outlined on slide 2.
We reported net income available to common shareholders of $40 million or $0.23 per share. This compares to net income of $34 million or $0.20 per share for the third quarter, a 17% increase.
We delivered another quarter of consistent loan growth with our loan portfolio growing 4% to $14 billion during the quarter. We continued to see solid growth from each of our major portfolios, which include commercial, commercial real estate and residential mortgage.
Net interest income from loans grew quarter over quarter while securities income continued to contract as we continued to fund loan growth through the run-off of the securities portfolio. Net interest margin for the quarter was 321 basis points, down just two basis points from the last quarter as compressing asset yields were largely mitigated by aggressive liability repricing.
We see continuing improvement in our credit metrics, including a 12% decline in nonaccrual loans this quarter. Nonaccrual loans of $357 million are at the lowest level in two years and now represent 2.5% of loans, down from 3% last quarter.
We recorded a provision for loan losses of just $1 million. And despite this reduced provision, our overall allowance for loan losses now covers more than 100% of our period end nonaccrual loans.
And of course, our capital ratios remained very strong with a tier 1 common ratio of 12.24% and a total capital ratio of 15.53% at year end. If you go to slide 3, you will see highlights from 2011.
2011 as we said was a year of transition for Associated as we continued to execute on our strategic plan to position the company for the future. And we accomplished many key milestones during the year.
In September, for example, we were pleased to have our MOU with the OCC terminated and fully repaid TARP without raising additional common equity. We consistently grew our loan book throughout the year with total loans growing 11% year over year and commercial and business loans growing 17% year over year.
In spite of the low interest rate environment, we increased the margin year over year. Credit quality improved considerably with nonaccruals down 38% and net charge-offs down 69% from a year ago.
Finally, we were pleased to deliver full year net earnings to our common shareholders of $115 million. Turning to slide 4, you can see that over the past year, we’ve made considerable progress in increasing net income to shareholders on a quarterly basis with improvements of over $5 million per quarter in each period as we continue to remix our balance sheet and invest in our franchise.
On slides 5 and 6, you will see detail on our loan portfolio. The portfolio grew to $14 billion at December 31.
This was up $528 million from September 30, representing a 4% quarter-over-quarter growth rate and an 11% year-over-year growth rate. Fourth quarter loan growth was driven by net growth in commercial and business lending of $386 million, net growth in commercial real estate lending of $112 million.
The retail and residential mortgage portfolios grew by a net $29 million during the quarter. A little more detail on the loans.
Our commercial and business lending portfolio benefitted from growth in all categories, including C&I lending, owner occupied commercial real estate lending and lease financing. General commercial loans, which include middle market activity, grew by a net $127 million and represented about 24% of the total loan growth.
Power and utilities lending increased by about $90 million during the quarter while oil and gas lending increased by about $70 million. These two portfolios showed strong growth but are coming off of a small base.
Mortgage warehouse financing added approximately $95 million of net growth in outstandings. Our commercial real estate lending portfolio grew by $112 million to $3.1 billion.
We continue to see opportunities for growth and expansion in CRE lending because of the retrenchment of other competitors and other sources of capital. Our residential mortgage portfolio continued to show strong momentum growing by a net $111 million during the quarter despite the sale of $94 million of previously portfolio-ed assets.
This growth was partially offset by run-off in the home equity book of about $67 million as consumers continued to favour first lien residential mortgages as they pay down and delever in this period of low rates. Mortgage loans originated for sale during the quarter were $844 million, up 79% from the third quarter.
We are pleased with our lending activity throughout 2011 and expect continued loan growth of approximately 3% quarterly for the coming year, although the first quarter may be a little less due to seasonal factors. Moving to deposits on slide 7, total deposits of $15.1 billion were up 2% from the end of the third quarter.
Net deposit growth was primarily driven by a $217 million or 6% increase in demand deposits and a $226 million or 11% increase in interest-bearing demand deposits. Quarter over quarter, we saw a continued growth in average NOW accounts and money market balances that were partially offset by declines in average brokered CD balances.
Our focus continues to be on growing core customer deposits. On slide 8, we highlight the impact of the remixing of our balance sheet during the quarter.
As projected, we’ve continued to fund our loan growth largely with the run-off from the securities book. We expect that to continue over the first half of 2012.
Using securities run-off to fund loan growth should help us to defend the net interest margin in early 2012. Core deposit growth during the quarter also largely allowed for the reduction of short and long term funding balances as we worked to reduce our average cost of liabilities.
We expect to see further run-off of high cost and brokered CDs during the first half of 2012 which we expect to replace with lower cost customer funding. Fourth quarter net interest income was $152 million.
The fourth quarter net interest margin was 321 basis points, down two basis points from the prior period. While yields on earning assets compressed by 7 basis points quarter over quarter, cost of interest-bearing liabilities was managed down by 5.
From the year ago quarter, we note that both NII and NIM improved as growth in interest income on loans and reduced deposit costs more than offset the impact of reduced securities income. While we believe the margin will continue to be pressured by the current low rate environment, we remain optimistic that we will be able to report a relatively stable margin throughout 2012.
Non-interest income for the quarter was $74 million, up $2 million from the third quarter. Card-based and other nondeposit revenues declined by $4 million from the prior quarter, primarily due to the expected impact of the Durbin amendment.
Mortgage banking income increased by $5 million from the third quarter, driven by increased mortgage production, lower valuation expense on mortgage servicing rights, and a $3 million gain on the sale of $94 million of portfolio mortgages previously mentioned. Personnel and occupancy expenses remained relatively flat from the prior quarter.
However, total noninterest expense for the quarter was $175 million, up $13 million from the third quarter, primarily due to a $10 million change in losses other than loans. The largest contributor to this category of losses other than loans related to the additional litigation reserves we established for the Harris matter.
Other drivers of the increase in noninterest expense include increased data processing expenses and increased business development and advertising expenses. However, we note that the bottom line impact of the losses other than loans would offset by a reversal of certain prior year’s tax reserves due to the expiration of the statute of limitations.
In December, we announced plans to consolidate 21 retail branches during the first and second quarters of 2012 as part of our footprint enhancement strategy. All of the impacted branches are within close proximity to other Associated locations, in most cases within two miles, and we remain committed to continuing to invest in the retail footprint.
We expect the consolidations will increase deposits per branch at the remaining locations and allow us to service the impacted markets more efficiently. Over the course of 2012, we expect non-interest expenses to grow in the low single digits on a year-over-year basis as we continue to invest in the company for the long term.
Moving on to slide 9, we continue to see improvement in our key credit metrics. Potential problem loans continued to decline to $566 million, down from $660 million at the third quarter and down from $964 million a year ago.
The level of nonaccrual loans to total loans continued to improve to 2.5% from 3% at the end of the third quarter. Nonaccrual loans were down 12% to $357 million from $404 million last quarter and down 38% from $574 million a year ago.
Our overall allowance for loan losses now covers over 105% of our period end nonaccruals. The provision for loan losses for the quarter was $1 million.
Net charge-offs of $23 million were down 25% from $30 million in the third quarter. We expect continuing improvement in credit trends throughout 2012 with a very modest outlook for provision expense.
Our capital ratios are on slide 10 and continue to remain very strong and remain well in excess of regulatory benchmarks and what will be expected under Basel III. On slide 11, we highlight some of our expectations going into 2012.
Again, we expect continued loan and deposit growth, a relatively stable margin, a modest improvement in fee income and further improvement in credit trends. This positive revenue outlook will require modest expense growth as we continue to invest in the franchise.
As we said publicly, we are reviewing our dividend policy and have submitted a capital plan to the Fed that includes increased dividends in 2012. So thank you.
And with that, we’d be happy to take your questions.
Operator
(Operator Instructions) Our first question comes to us from Tony Davis of Stifel Nicolaus. Your line is open.
Anthony Davis - Stifel Nicolaus & Co.
Just I guess a follow up here on the credit dynamics, you say very modest. I mean, given the dramatic improvement in early state indicators, I just wonder how you are thinking about with the reserve as a percent of criticized credits, or reserve adequacy.
Given the – I guess given the dynamic rate at which you are growing loans, how should we think about the way you are thinking on reserves?
Philip Flynn
Yeah, Tony, thank you. We believe that as you point out, we are getting good loan growth which, of course, is requiring a certain level of reserves to be held against the new loans although they don’t take up a lot of reserves since these are high quality loans we are putting on.
On the other hand, the portfolio is improving as you point out quite rapidly both in the potential problem area as well as nonaccruals. So that’s providing an offset to the need for additional reserves for growth.
So our outlook right now is that our loan loss provisioning will be very close to zero, frankly, for the year. It could go negative early and could get go modestly positive later in the year.
But as you know, it depends on how things turn out from quarter to quarter. We are still carrying a fairly robust level of overall loan loss reserves of 270 basis points.
So the pressure is probably more on the downside of reserves than what we might have to provide in provisions. I think you’ve heard us say before we are not huge fans of doing negative provisioning but accounting rules may drive us to that.
Anthony Davis - Stifel Nicolaus & Co.
Got you. Fair enough.
Joe, one for you. I just wanted if you could update us on the funding repositioning opportunities.
The last I recall you had about $2.5 billion of CDs, I think the embedded was like 1.5% rate and something like $5 billion in money market. Can you just walk through that?
Joseph Selner
I’ll let Chris do that. He is closer to it.
Anthony Davis - Stifel Nicolaus & Co.
Okay. Chris?
Christopher Del Moral-Niles
No problem. So I think if we look at the last page of the press release tables, you will find a breakdown of all the different categories of both current funding as well as a period end composition of funding.
I would highlight for you top of the last page. Time deposits of $2.5 billion on average for the quarter at a weighted average rate of 1.44%.
And you will see there again, money market deposits of little over $5.3 billion on average at a weighted average rate of 27 basis points. Total deposit levels at an average cost of 51 basis points for the period which we think compares relatively favourably with peers and others.
Anthony Davis - Stifel Nicolaus & Co.
And finally, Phil, one question, I guess, on the branch consolidation. And in this rate environment we are in, the post Durbin, wanted if you could just comment on the percentage of the 270 branches or so that you have right now that are profitable on fully load basis.
This 21 branch consolidation you have announced, and is that about it, or do you see more consolidation and efficiency opportunities out there?
Philip Flynn
For the foreseeable future, that’s it. I would remind everybody that over these last several years, we’ve closed on average about 10 branches a year.
We took a hard look at our expense run rates as you would expect in this environment at the end of last year and took the opportunity to consolidate these 21 branches in two locations that are within on average two miles. I think the farthest one is only three and a half.
We assume that we will hang on to approximately 90% or more of the customers based upon our past history when we have done this and will save somewhere in the neighbourhood of give or take $300,000 per average branch. So this was a move to become more efficient, continue to serve our customers in a convenient manner but recognizing the realities that we have to take a hard look at our delivery channels in this low rate environment.
Operator
Thank you. Our next question comes from Jon Arfstrom of RBC Capital Markets.
Your line is open.
Jon Arfstrom - RBC Capital Markets
A question, just to follow up on Tony’s first question. I know this is a volatile category but the 30-day, 90-day past due number just really dropped materially.
Is there any story there?
Scott Hickey
This is Scott, Jon. We talked about it at the last meeting we got together.
We had kind of a handful of large credits that were in various stages of negotiation or documentation that subsequently all got cleared up this quarter. I think the numbers you are seeing there today are probably closer to what we’d be expecting going forward.
But none of those went into non-performing status at the end of -- from last quarter.
Jon Arfstrom - RBC Capital Markets
That’s a great trend. A couple of questions on the guidance, Phil, on the expenses, the low single digit year-over-year growth.
What do you plan to spend the money? Is it hiring, is it incentives, is it occupancy?
Given us an idea of your plan.
Philip Flynn
That’s three of them.
Jon Arfstrom - RBC Capital Markets
Can you weigh them for me?
Philip Flynn
There is an awful lot of moving pieces. As you know, we’ve been making substantial investments in this franchise and those continue.
So the cost of branch renovations and relocations and remodels that we have been doing is now slowly becoming embedded in our run rates. We’ve done a lot of hiring over these last, call it, 18 months.
A lot of that is done. We don’t really expect a lot of growth in our head count.
We expect that as our performance continues to improve, our incentives will rise, although that will be proportionate to the revenue and profitability that we are generating. We are expecting to see positive operating leverage this year which we haven’t had for quite a while.
So we continue to make the investments that we have to make in the franchise. We will continue to pay for the investments that we have already made but a lot of the rehiring and such that we have done over the last 18 months is slowing quite dramatically now.
Jon Arfstrom - RBC Capital Markets
And then just one quick question if I may on fee income. You are, I know, in modest improvement and I think we all understand the headwinds, what are you thinking on the drivers of that improvement?
Philip Flynn
The drivers are varied. We expect the mortgage business continue to be successful.
We are growing our wealth management business and getting good results there. Frankly, we are coming off of such a low point now on deposit related fees that they are likely to slowly start to increase now from the very bottom based upon growth in our customer base, taking the opportunity as we see it to make sure we are getting paid fairly for the services we provide.
There is a number of areas. We’ve also made, as you know, significant investments in our treasury management offerings, both product offerings and the online systems.
That all is coming live in February, so we expect to get lift from that as well.
Operator
Thank you. The next question in queue is from Dave Rochester of Deutsche Bank.
Your line is open.
Dave Rochester - Deutsche Bank Securities
Nice quarter. It seemed like loan growth was a bit stronger than you expected.
Last quarter, was there any change at all in the competitive landscape? I know you have been benefitting from the retrenchment of some competitors.
And I was just wondering if that’s actually improved at all over the last quarter, if this is sort of a function of the platform buildout over the last 18 months that you mentioned?
Philip Flynn
I would attribute to the latter. We’ve done a lot of building out of our commercial bank, our commercial real estate area.
We’ve got in the specialty groups that are up and going. And the mortgage business has been very strong.
So I think that all the work we’ve done is starting to click. I mean, the economy certainly isn’t robust, it’s not terrible in the upper Midwest, it continues to swing up.
But I think generally what you are seeing is the effect of all the work that we have done over the last 18 months or so to get this place going again.
Dave Rochester - Deutsche Bank Securities
Thanks. And on capital, you talked about dividends going higher and publicly, you have also talked about your thoughts on share repurchases.
I was just wondering if you’d changed that at all in the last few months. And a related topic on a capital deployment would be M&A if you’ve changed your thoughts there.
Philip Flynn
Yeah, so we have, as many banks have done, submitted capital plans to the Fed and are in discussions about our plans for the coming year. And so you will need to stay tuned on that.
Share buybacks, you’ve heard me say in the past that they were my least favourite use of capital. On the other hand, when you are trading at such absolute low values although we’ve picked up about 11% year to date, you do have to take a look at that at least in some modest way.
So we are reviewing all of our capital planning right now, discussing all that with the regulators in a very cognizant that investors want to see capital return. And we are working on that.
Operator
Thank you. The next question is from Ken Zerbe with Morgan Stanley.
Your line is open.
Ken Zerbe - Morgan Stanley
Just a comment on your NIM guidance for NIM being relatively stable in 2012. I think so the common view among most mid-cap banks is that you are going to have NIM compression.
But it seems that the reason for that is because you have such strong – or the industry would have strong deposit inflows goes into securities, irrespective of the impact on NII, I am kind of wondering if you have loan growth of 3%, you have stable NIM. Like how is it that you are able to keep NIM stable?
Because my initial impression is that, that would imply actually weaker deposit inflows on a net basis and hence you have to run -- continue to run off in the securities portfolio. Am I thinking about that in the right way?
Christopher Del Moral-Niles
I think the way we would think about – this is Chris Niles – is the current excess liquidity afforded to us by the investment portfolio will allow us to reposition those cash flows into loans. That will result in a pick up from the change in mix.
However, new loans in today’s competitive low rate environment are not yielding a lot more than our securities were when we bought them a year ago. And so the NII pickup is essentially close to a flat trade.
When we initiated the strategy a little over year ago, our hope had been that rates would stay elevated and we would trade from securities into loans and actually expand margins as we reinflated the loan book. Given the overall low rate environment, we’ve not been able to expand the margin the way we had hoped but we are able to defend the margin very adequately as the securities continue to run off and we are able to roll them.
Philip Flynn
Yeah, so if you recall that slide that I referred to earlier where you saw that we basically funded our loans with securities run off this past quarter, that dynamic will continue. Additional deposits that we are growing, we have an opportunity and we still have an opportunity for some period of time to pay off other liabilities that carry a higher rate and so maybe that’s the piece that you are looking for.
We do have the opportunity to continue to see higher cost brokered CDs in such rolling off, replaced with much lower cost core deposits.
Ken Zerbe - Morgan Stanley
Yeah, I think the deposit mix is probably what I was looking for. Now that helps.
And then in terms of the capital plans that you said you submitted with the Fed. Obviously your assets are little less than $50 billion.
So when we think about kind of the capital plan that you guys have to submit versus some of the larger banks, I mean, is it the same level of rigor, the same amount of stress they put in a portfolio or is there something you guys you have to do more or less of versus what the larger banks may do?
Christopher Del Moral-Niles
This is Chris Niles. There are multiple stress test scenarios that we provide as part of our capital planning and we provide them as well a range of scenarios for expected base case budgets and outlooks, consistent with our growth and expectations and the overall business environment.
Very similar to the high level core (ph) plans, although probably a little less total detail given the size of the institution.
Operator
Thank you. The next question in queue comes from Scott Siefers with Sandler O'Neill.
Your line is open.
R. Scott Siefers - Sandler O'Neill & Partners LP
Assuming first if you could talk a little, Phil, about just pricing on overall commercial loans, Chris alluded to it earlier a second ago. But then also if you could just chat about what you are seeing on overall line utilization rates.
Most of your growth is come from, I think, a combination of market share and some of the new teams you’ve hired. But if you could touch on maybe both of those aspects please.
Philip Flynn
Sure. So first of all, utilization rates -- I’ve got it, the total utilization is hanging around in the high 40s – 48% across the whole place.
And that hasn’t really changed much from last quarter, it came up some as we trended through last year. But we are still at pretty low utilization rates.
As far as the competitive dynamics that are going on out there, it depends on the product type. We are getting what we feel is very fair and good pricing in the commercial real estate business.
The capital markets aren’t there like they used to be for refined commercial real estate and a lot of our competitors have exited that space. In some of our specialty groups we are getting what we think is pretty good pricing.
Commercial area, depending on where you are at, say, if you are down in Chicago, it’s quite competitive to the point where if you are not doing a good job of cross-selling other products and services which we are doing a better job at but not yet to the level that we need to get to, these loans are awfully competitively priced. But our belief is as we continue to roll out our new commercial deposit, treasury management products, we will do a better and better job of capturing more and more of the share of wallet from these customers.
And it will make up for the competitive nature of how we are pricing things.
R. Scott Siefers - Sandler O'Neill & Partners LP
Okay. That’s helpful.
Thanks. And then just wanted to ask a separate question just on capital management.
So I know the OCC MOU was terminated last year but unless I am mistaken, I think the one with the Fed is still around, it would obviously be difficult to argue that you guys do not have adequate capital and risk at this point. But is there any update on that – do they have any significant bearing on what your capital management activities could be at this point?
Philip Flynn
Sure. The Fed MOU is still outstanding and it absolutely has a lot to do with what we can do.
Recognizing in this world whether you have an MOU or not, the regulators, and in particular, the Fed, have an awful lot to say what big banks do and banks our size do as far as dividends and share buybacks. So it is a new world.
But in our particular circumstance, we still have Fed MOU, we still have to work with them on our capital planning and we are right in the midst of doing that.
Operator
Thank you. The next question in queue comes from Chris McGratty with KBW.
Your line is open.
Chris McGratty - Keefe, Bruyette & Woods
Just a question, more of a technical question on the one-time items. It seems like they ran through the expense line.
What was the dollar amount of litigation charge and the tax reversal? I know you said they’re largely upside but what were the dollars?
Joseph Selner
The litigation reserve was about $8 million in the quarter. And the tax reserve release was about $6 million.
Chris McGratty - Keefe, Bruyette & Woods
Okay. Was there an MSR write-down in the quarter as well?
Joseph Selner
No, there was actually recovery of $1.5 million.
Chris McGratty - Keefe, Bruyette & Woods
And then just on the expense, the guidance going forward, maybe you could just give me a little clarification. What’s the starting – I guess, what’s the starting point of expenses?
Is it 100 – is it this quarter’s $175 million is kind of low single digit growth off of this or is it full year?
Joseph Selner
Well, the way I would encourage you to think about expenses is as we’ve given you some guidance for the year, expenses tend to be lower in the first half of the year and ramp up in the second half or start to ramp up in the second half. I think you should think about it kind of an average, lower in first half, higher in the second half because we will be – there will be expenses that grow with the size of the institution, grow with the profitability of the institution, all of that will be relevant as we think about it.
So I think you just try to think about it in the overall annual look.
Christopher Del Moral-Niles
$175 would be too high of a starting point.
Joseph Selner
Yeah, I am sorry.
Christopher Del Moral-Niles
Substantially too high.
Chris McGratty - Keefe, Bruyette & Woods
Any kind of guidance you can kind of leave me to in terms of what’s the better starting point?
Joseph Selner
It was $162 million in the third quarter and $175 million, so we’re probably going from $162 million into the fourth quarter. So again, I don’t think we want to give you an exact number.
But you can probably get to that.
Chris McGratty - Keefe, Bruyette & Woods
I can figure it out. Thanks a lot.
And then as a tax rate, what should we be using for ’12?
Joseph Selner
Again, we think as we grow more – get more earnings, we’re going to put more taxes on at the marginal rate. We’ve been saying it’s in the low 30s.
I think that’s a fair – it’s a fair way for you to think about it.
Operator
Thank you. Next question in queue comes from Terry McEvoy with Oppenheimer.
Your line is open.
Terry McEvoy - Oppenheimer & Co.
Thanks. Phil, since you have a history in some of the specialized businesses, power, oil, gas et cetera, though it’s relatively new for Associated, could you just talk about maybe the credit performance through the cycle in the specialty businesses and compare that to, just call it the legacy Associated C&I portfolio, and whether you see any differences between the two?
Philip Flynn
Well, yeah, I see some differences. The power and utilities generally speaking are high quality credits, often times investment grade, or near investment grade credit.
So as compared to a general basket of middle market loans or commercial real estate loans, through the cycle they will have much, much, much lower loss rates. Likewise in the oil and gas business, as long as you stick to conforming reserve secured loans which is what we are doing, through the cycles of prices and we are now seeing natural gas prices to decline.
Through those cycles, if you are prudent with the way you forecast future cash flows and build the cushions in, losses on reserves secured loans are extremely low. I’ve lived through many cycles in that business.
One of the reasons why we’ve chosen these two businesses as well as a few specialty businesses is that in our view through the cycles, they will have significantly lower losses than your typical middle market commercial or middle market commercial real estate loans. But as you rightly point out, these are new businesses for Associated Bank.
Terry McEvoy - Oppenheimer & Co.
Great. And then just the commercial real estate growth in the fourth quarter, was that in market upper Midwest credits?
Philip Flynn
It was almost all in the upper Midwest. If there was anything outside of the upper Midwest, it was with a upper Midwest based developer customer who might have a particular product specialty in some other place.
But what we are doing is footprint or the rare occasion outside the footprint with a developer who is a customer in the footprint.
Operator
Thank you.
Philip Flynn
Matt, do we have any other questions?
Operator
Yes, sorry. One moment please for our next question.
And thank you. Our next question comes from Erika Penala with Bank of America Merrill Lynch.
Erika Penala - Bank of America Merrill Lynch
My first question is a follow up on Scott’s question with regard to commercial loan yield competition. I noticed that the average rate on C&I came down just 5 basis points quarter over quarter.
Given the color that you’ve provided – do you think this pressure widens in 2012 or could you keep it in this range?
Philip Flynn
I think there will be slow downward pressure throughout the course of the year. But remember that you have a fair sized portfolio that’s been added to on the margin.
So even with a lot of competitive pricing, it’s not going to move the needle on the whole portfolio very dramatically.
Erika Penala - Bank of America Merrill Lynch
Got it. And again, I just want to make sure I understood what Chris was saying in response to Ken’s question, in that you are really looking at 2012 in terms of a flat balance sheet growth and sort of remixing your liabilities and assets will give you some margin support.
But in terms of how that translates to NII, that would be a flattish NII for 2012?
Christopher Del Moral-Niles
Well, no, we will continue to grow NII as loan interest income continues to come on to the balance sheet and lower yielding securities continue to run off. But the loans that will be coming on at the margin are going to come on at tighter and tighter spreads we anticipate given the continuing low rate environment.
We will have modest growth in NII as the balance sheet continues to expand and grow. As earning assets in total mix towards loans, we will have expanding NII.
Erika Penala - Bank of America Merrill Lynch
Got it. Okay.
And just my last follow up question. Phil, you mentioned that the loss content in specialized lending has typically been fairly low.
Is the implication here that as you add these new specialties for Associated that the inherent loss content of this portfolio in a “normal cycle” is lower than it was when you compared to the legacy and loss content?
Philip Flynn
Absolutely. And it’s not just because of the specialty mix in, it’s because we are building a portfolio in a much more disciplined way than we did in the past.
I mean, as we talked about before, one time this bank allowed real estate construction loans to grow to 11% of the total loan portfolio, you will not ever see that again here at Associated Bank, at least not while Scott and I are here.
Operator
Thank you. Our next question in queue comes from Emlen Harmon of Jefferies.
Your line is open.
Emlen Harmon – Jefferies & Company, Inc.
Another follow up on loan growth and specialty lending, when you guys had initially started that business talked about that being maybe $500 million to $600 million portfolio over time. Could you give us a sense of just where that stands today and how you think that could grow as the balance sheet grows over time?
Philip Flynn
So as of the end of December, I think the segments that you are probably interested in, oil and gas, we had approximately $170 million of outstanding loans and power and utilities we had about $130 million. And then we have other much smaller specialty some of which are legacies of Associated Bank, insurance and public funds and a little bit of financial institutions.
The biggest piece of the specialized industry book at the end of the year was the mortgage warehouse at $340 million but as we talked about in the past that’s a fairly volatile loan class. It moves up and down pretty rapidly in response to what’s going on in mortgage refinancing.
So we are growing this book. It still remains a pretty modest piece of the business but we are quite comfortable continuing the growth path that we have been on for this past year.
But we are also very mindful of making sure that it’s proportionate to the other things that we do. And we will continue to report on this as the quarters go by.
Emlen Harmon – Jefferies & Company, Inc.
Okay. Got you.
Thanks. And then one kind of a – it’s little bit ticky tacky, so I apologize.
But I saw the service charges line go down a couple of million bucks in the quarter, anything underlying that?
Scott Hickey
Not that we don’t ask that but we don’t – we can’t give you a good explanation because I think it’s customers having more money and not over drawing their accounts. We just can’t come up with a real good explanation.
Emlen Harmon – Jefferies & Company, Inc.
As far as overdraft and this is again related to that line – as far as overdraft fees are concerned, are you guys high to low sale, or have you gone to low to high, or is there a potential hit from reordering on that over time?
Philip Flynn
That’s all of these and that was the heart of the Harris legal matter that so many banks have wrapped up. We’ve now gone to time of presentment quite a while ago.
Operator
Thank you. The next question in queue is from Maclovio Pina with Morningstar Equity.
Your line is open.
Maclovio Pina – Morningstar Equity
Just one very quick question on loan growth, it’s a very sturdy cliff that you are projecting. And I am just wondering if there is any particular market where you expect to see the strongest growth, and also if you can give any details on sectors, if we are talking about C&I loans?
Philip Flynn
If you take a look at the slide presentation on the page where we’ve got some detail on loans, we’ve had a balanced loan growth for most of this year and certainly in the fourth quarter between commercial and all the various segments of commercial which we detailed out on that slide. Commercial real estate grew at a little more than $100 million this quarter across a number of different product types and across geographies and our footprint.
And our residential mortgage book of mortgages that we retain for our own balance sheet continues to grow. That’s been offset by continued softness in home equity portfolio where people are paying off their home equity loans and refi-ing into firsts.
The outlook is for continued balanced growth and I said roughly that 3% per quarter, maybe a little bit of softness in the first quarter because of seasonal factors across all three of the major components of the portfolio and well diversified both geographically and by product type within the commercial sector and the commercial real estate sector.
Operator
(Operator Instructions) Our next question comes from Tom Alonso with Macquarie. Your line is open.
Tom Alonso - Macquarie
I guess most of my questions have been answered. Just real quick, on the expense guidance, should we just think about, I am trying wrap my head around sort of the branch consolidations and give or take $6 million of savings, as I just think of that as basically money that’s been freed up to invest elsewhere.
Philip Flynn
I think that’s fair. We have quite a bit of investment we are doing in the branch system.
So by becoming more efficient this way, it allows us to improve the overall delivery.
Tom Alonso - Macquarie
And then just on the growth in the mortgage warehouse, that $95 million increase, is that basically just driven by the market or is that you guys expanding that line?
Philip Flynn
We’ve done both. So we’ve expanded our customer base nicely over the course of this year.
Our guys have done a very good job there and of course, with the mortgage refi boom that’s going on across the country, those customers are more active than they are for borrowing in our warehouse facilities.
Tom Alonso - Macquarie
And then just one, last one on the balance sheet, sort of your guidance for funding loan growth through the first half of the year with securities run off, so we should look for the balance sheet to remain relatively flat and then should start to grow in the second half of the year, is that fair?
Christopher Del Moral-Niles
Correct. The growth in the second half of the year will be funded with deposits which should allow for expanding NII going into the back half of the year.
Tom Alonso - Macquarie
Okay. Securities balances are likely to remain flattish in the back half but you will have loan growth?
Christopher Del Moral-Niles
Correct.
Operator
Thank you. The next question is from Mac Hodgson from SunTrust Robinson.
Your line is open.
Mac Hodgson - SunTrust Robinson Humphrey
Most of my questions have been answered. Just one to clarify, to be sure I understand.
The only non-core item in expenses this quarter was the additional $8 million of litigation. Is that right?
Joseph Selner
I think in any quarter there is things that you could identify as being unique but I think in terms of thinking about the quarter, that $10 million increase in other – losses other than loans is probably the thing that would be relatively a good way to think about it. I mean, there – for example, one of the things that we could point out is non-cores we had – we got part of the Visa escrow decision that was made by Visa and we had to book $700,000 in expense but we booked $700,000 in revenue.
Well, that doesn’t accrue every quarter but we have those things every quarter. So I think you are thinking about it as the way we expressed that it’s probably fair.
Mac Hodgson - SunTrust Robinson Humphrey
Great, it’s about $10 million. Okay.
That’s helpful.
Operator
And at this point, I would like to turn the program over to Phil Flynn for any closing comments.
Philip Flynn
All right. Well, thanks Matt.
Thanks everybody for joining us on the call today. We are happy with the results for this quarter and our progress that we made throughout 2011.
And we really do remain optimistic and are committed to building shareholder value through our long term strategy for growth here at Associated. So we look forward to talking to you again next quarter.
If you have any questions in the meantime, just give us a call. Thanks again for your interest in Associated Bank.
Operator
Ladies and gentlemen, thank you for joining today’s conference. This does conclude the program and you may now disconnect.