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Associated Banc-Corp
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Good afternoon, everyone, and welcome to Associated Banc-Corp's Third Quarter 2019 Earnings Conference Call. My name is Omar [ph], and I will be your operator today. At this time all participants on a listen-only mode. We will be conducting a question and answer session at the end of this conference. Copies of the slides that will be referenced during today's call are available on the company's website at investor.associatedbank.com. As a reminder, this conference call is being recorded.
As outlined on Slide two, during the course of the discussion today, management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements.
Associated's actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional detailed information concerning the important factors that could cause Associated's actual results to differ materially from the information discussed today is readily available on the SEC website, in the Risk Factors section of Associated's most recent Form 10-K and subsequent SEC filings. These factors are incorporated herein by reference.
For reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to Page 15 of the slide presentation and to Page 10 of the press release financial tables. Following today's presentation, instructions will be given for the question-and-answer session.
At this time, I would like to turn the conference over to Philip Flynn, President and CEO, for opening remarks. Please go ahead, sir.
Thanks and welcome to our third quarter earnings call. Joining me as usual today are Chris Niles, our Chief Financial Officer; and John Hankerd, our Chief Credit Officer.
As in the slide we understand that there is some problems with the SECs at your website. So, you can find our third quarter materials on our own company website.
Our third quarter GAAP earnings on slide three were $0.49 per share driven by strong credit quality and higher non-interest income. Excluding acquisition related costs our earning were $0.50 a share.
Our credit quality metrics continue to improve in the third quarter driving a $6 million decrease in provision for credit losses and decreases in potential problem loans and nonaccrual loans. We will continue to selectively pursue additional opportunities for credit risk mitigation in the oil and gas portfolio, but our plan to de-risking action have been largely executed.
We significantly improved our funding mix this quarter, using deposits acquired in the Huntington branch transaction coupled with proceeds from reducing our investment securities portfolio, we paid down network transaction deposits and other higher costs funding.
We continue to optimize our capital as we prepaid for CECL adoption in the first quarter of next year, and we repurchased $60 million of common stock in the third quarter leaving $82 million of our current authorization available.
Turning to slide four, several factors continue to drive EPS growth in the first nine months of 2019. Total loans have grown at a compound annual growth rate of 6% since 2017 and deposits have grown at a compound annual growth rate of 7%.
Loan growth was driven by solid commercial and business lending, while the Huntington branch acquisition completed in June contributed to our deposit growth. As we recently announced we received OCC approval for the First Staunton purchase and we anticipate First Staunton will further enhance our loan portfolio and our deposit franchise.
Our 2019 year-to-date efficiency metrics have improved over the same period in 2017 as a result of increased scale and focus expense management. Our capital priorities remain to support organic growth of the book, pay a competitive dividend, support external investments and opportunistic in market efficiency driven acquisition and to repurchase shares.
In 2019 we build upon our strong capital position in preparation for CECL adoption while taking actions in line with our priorities including paying higher dividends, acquiring the Huntington branches and repurchasing $130 million worth of common shares year to-date.
Loan details for the third quarter are shown on slide five. Total loan balances were down from the prior quarter as modest increases in our commercial real estate and home equity portfolios were offset by decreases in commercial and business lending and our residential mortgage book.
CRE lending increased in the quarter as construction loan funding outpaced the pay down. We note that pay downs remain elevated driven by lower rates that have encouraged customers to take the project to the permanent market.
While we had strong residential mortgage originations our overall residential portfolio was down due to higher pay off, the sale of approximately $240 million of prepayment sensitive mortgages and the sale of $32 million of non-accruing and restructured residential and home-equity loans.
The higher payoffs were driven by lower long-term rate which have incented borrowers to refinance. Further, homeowners are increasingly refinancing adjustable rate mortgages typically held in our portfolio into fixed-rate mortgages typically sold in the secondary market.
The sales of the $240 million of mortgages is part of our delevering strategy and enabled us to pay down higher cost funding. It also reduced interest rate risk by lowering our asset sensitivity and it freed up capital in advance to CECL adoption.
Turning to the commercial portfolio, the decline in commercial and business lending was primarily related to oil and gas portfolio. As we previously discussed, we have purposely produced our oil and gas loan, its changing dynamics in the industry, specifically more capital-intensive drilling and volatile production rate have let us to reassess and ultimately lessen our exposure to our more highly leveraged borrowers.
On slide six, you can see in the middle graph that we've reduced the oil and gas book by about $170 million since the end of the first quarter, while we've largely executed our de-risking plan balances in this portfolio may decline slightly in the fourth quarter as we selectively pursue additional credit risk mitigation opportunities.
Our commercial real estate pipeline remains strong as shown in the right-hand graph. Unfunded commitments have increased almost $400 million since the third quarter 2018, while construction funding may slow in the fourth quarter as weather becomes less favorable we believe our commercial real estate portfolio is well-positioned to grow in 2020.
Looking ahead, we now anticipate full year 2019 loan growth to come in below our previous guidance of 3%, our reduced expectation is due in part the factors we just mentioned, $240 million sale, our residential mortgages and the downsizing of oil and gas portfolio.
Additionally, we're forecasting residential mortgage prepayment to accelerate in October/ November and we expect that portfolio is down some rather than flat. Turning to seven, average deposits were up a $100 million from the second quarter.
In addition to overall deposits growth we achieved a beneficial mixture as we increase lower cost deposit and decrease higher costs funding. Our lower cost funding which includes demand and savings deposits increased by $1 billion in the third quarter driven by the Huntington branch acquisition in June.
Using funds from investment securities sales and runoff and funds from sale $240 million of prepayment sensitive mortgages, we reduce higher costs money market and time deposit, Federal home loan Bank advances and network transaction deposit by $1.3 billion.
The reduction in network transaction deposit in the quarter continues our strategy to decrease these higher cost sources of funds as shown on slide eight. Improved deposit mix to achieve during the third quarter is detailed in the right hand graph, low-cost checking and savings deposits now comprise 55% of our deposit mix, up from 49% at the end of the first quarter.
Our loan to deposit ratio was 93%, well within our historical range which gives us flexibility to continue pursuing the strategy of reducing our cost funding sources while keeping that ratio below a 100%.
For the fourth quarter, we expect to further improve our funding mix with cash flows from our securities portfolio. We anticipate that mix improvement along with the relatively low loan to deposit ratio will help drive funding cost lower and dampen downward margin compression.
Turning to slide nine, we continued the reduction of the investment securities portfolio to $6 billion in the third quarter as we use securities as a source of funds to pay down higher cost institutional funding and reposition our portfolio for a stable to declining rate environment.
We reduced our lower yielding taxable securities by about $490 million and our tax-exempt security portfolio we held balances essentially flat in increased yield by replacing short duration security with higher-yielding longer duration municipal securities.
The next several months we'll continue to use the cash runoff from our taxable portfolio to pay down higher cost funding. We're targeting an overall securities portfolio level of about 17% to 18% of total assets, and we anticipate we'll reach that level in early 2020.
Turning to slide 10, net interest income was $206 million decrease of $7 million from the previous quarter and our net interest margin was 2.81% down six basis points from the second quarter.
Lower net interest income was caused by several factors. On the asset side averaged one month LIBOR and the third quarter decreased over 25 basis points from second quarter negatively impacting commercial real state and commercial and business lending yield.
Long term interest rates were also decreased resulting in elevated refinancing in our residential mortgage portfolio and pay off of higher coupon loan. Additionally this increased prepayment rate drove accelerated recognition of deferred origination costs further reducing our mortgage.
Looking ahead we expect that the asset yields will continue to be pressured by persisting LIBOR compression and lower mortgage rates. On the liability side our total interest-bearing deposit cost decreased 12 basis points driven by our improved deposit mix and lower rates in most deposit category.
We anticipate that deposit cost will further decrease in the fourth quarter given there our loan to deposit ratio remained relatively low, enabling us to grow the loan book without paying up funding and that our securities portfolio will remain a source of funds for the fourth quarter allowing us to further reduce higher cost funding.
Year to-date our net interest margin is 2.86% while lower rates will continue to weigh on asset yield, we believe the actions we've taken to delever the balance sheet by reducing lower yield assets and higher cost funding will enable us to meet the low-end of our full year and interest margin guidance were about 2.84%.
That outlook assumes a single 25 basis point fed rate cut in the fourth quarter. Turning to slide 11, third quarter non-interest income of $101 million was up $5 million from last quarter and up $13 million year-over-year.
The increase over last quarter was primarily due to gains on investment sales that we realized just part of delevering and funding mix improvement strategy. Additionally higher mortgage loan sales including the sale of $240 million of prepayment sensitive mortgages from the portfolio drove increase mortgage banking income in the quarter.
These gains were partially offset by seasonally lower insurance commission.
Moving to slide 12, non-interest expense of $201 million was up 3 million in the second quarter. The increase was partially due to a full quarter of occupancy expense from the acquired Huntington branches, while our occupancy cost grew, we were able to hold personnel expense flat despite staffing the additional branches.
Advertising expense was also higher in the third quarter due to plant TV and digital campaign. Looking ahead to the fourth quarter we're taking action to offset the negative impact of the challenging interest rate environment.
We expect to incur approximately $3 million in restructuring charges in Q4 which will enable us to maintain flat, modestly lower non-interest expenses in 2020. That includes First Staunton cost, both integration and ongoing operating cost.
We dissipate these restructuring charges will put our full year 2019 non-interest expenses in the range of $790 million to $795 million. Turning to slide 13, the banks credit quality remains strong and our credit metrics improved from the second quarter excluding charge-off of oil and gas loan.
Potential problem loans decreased $33 million in the quarter to $133 million driven by reductions in commercial real estate potential problem loans. Non-accrual loans decreased $38 million primarily reflecting the smaller oil and gas portfolio and the sales of non-accrual loans from the resi mortgage and home equity portfolios.
Net charge-offs were $20 million in quarter with the majority coming from the oil and gas book. We expect charge-offs will returned to more typical level in the fourth quarter. Our provision for credit losses was $2 million, down from $8 million last quarter.
As we previously discussed we'd already provided for and reserve against the risk, we saw in the oil and gas portfolio. As such we believe future oil and gas loan losses will be manageable and within our historical patterns of normal provisioning.
The aggregate allowance for loan losses was 0.94% of total loans down from previous quarter. As we previously disclosed we continue to expect that CECL will increase our overall allowance for credit losses by about 30% to 40%.
And with that, we'll be happy to take your questions.
At this time we'll be conducting a question answer session. [Operator Instructions] Our first question is from Scott Siefers, Sandler O'Neill and Partners. Please proceed with your question.
Afternoon guys, how are you?
Afternoon, Scott.
Chris, maybe question for you, so obviously lot of balance sheet action in the recent past here. I guess, just as we look forward what would be your best guess as to exactly how the tank will ultimately be positioned when they think their R&D fully completed? And maybe ideally, if possible as measured by how much margin would be address for each 25 basis point cut when everything is all said and done?
Sure. I think if you look at the guidance we're given we're at $286 margin today and our exposure for the full year will be to take it down for $284 at the end of the year assuming another rate cut. So that's consistent with the guidance in the past which is sort of three-ish basis points for 25 basis points rate action and its in that same general range and we're trying to further minimize that through the actions we've taken. So that would be a rough indication of the actions we're taking.
We're still going to be asset sensitive, because we still got preponderance of our loans over $13.6 billion and predominantly commercial LIBOR related asset. While we're doing all sort of thing we can in the back end make sure the funding cost are being adjusted downwardly as quickly as possible thereafter.
Okay. All right. Perfect. Thank you. And then maybe, Phil you had talked about the loan growth portfolio coming in will be below the loans that guide, because I'm just curious – I'll hoping it just no more than really just a very modest change from month or so ago, but given the most of actions have been disclosed that the Barkley's conference, what the change versus three -- versus the 3% previously and below that now other things…
We think the prepayment activity in the mortgage business is going to continue probably more prolong than we would have thought. And this interesting remix of people paying off their adjustable rate mortgages which we hold in portfolio, refined those into 30-year to fix rate stuff that we're still originating, but selling on are going to dampen that portfolio to probably instead of what we assume flat, it will be down a bit this quarter.
Of course we're picking up gain on sale, whatever that turns out to be on the other side of that. The pipeline in the commercial business continues to look good. The pipeline in commercial real rate and the unfunded commitments looks good. So there isn't any big seismic shifts going on here We think for demand is more driven by this interest rate environment that everybody is suggesting too.
Okay. Perfect. And then I guess along the lines of the mortgage sale, $240 million sales portfolio loans in the third quarter. Can you able to quantify what the gain related specifically to those sales loan?
Sure. The growth gain was approximately $5 million. However we would note, we did hold some current period production. So it's not that it was $5 million of access, we sold 5 million of old instead of selling to gain $3 or $3.5 million of new. So incrementally it was probably worth about a $1.5 million or $2 million.
Perfect. Okay. Good. Thank you, guys. Appreciate it.
Our next question is from Chris McGratty, KBW. Please proceed with your questions.
Great. Thanks. Phil or Chris, the expense, just want to make sure I got the expense guide rate for 2020. You're seeing this year 790, 795 including the one-timers. Are the one-timers for next year related to the acquisition? Or is this simple exercise is putting $790 to $795 in for next year? And then maybe some [Indiscernible].
Yes. So to restate what I just said. This year we'll come in at $790, $795 total. Next year we will close the First Stauton deal in the first quarter. That will obviously have integration costs associated with it. And then there'll be additional operating expenses that we will bear throughout the year. Including all of that we anticipate that our expenses with the actions that we're taking right now will be lower flat to moderately lower than where we come in this year.
Okay. Give any idea what the one-time charges are for that transaction, will back that up?
The one-time charges would be mid single digit millions number.
Yes. Probably under five.
But this year remember we had onetime charges related to Huntington that were similar.
Got it. Okay.
And then you know, then in that $790 to $795 for this year also includes a $3 million restructuring charge that we anticipate this quarter in order to set up next year in the way that I just described.
Yes, understood. And then maybe just a couple of housekeeping…
From another words its pretty harsh expense management going on around here right now as you would expect.
Yes. It sounds like it. Just a couple of housekeeping then I'll step back. The FDIC benefit, a lot of your peers have been getting. Was there a benefit this quarter that resulted in lower expenses?
As I think if you look at the trend in ours, it was -- ours was realized earlier in the year for different reasons. But yes, it's not a significant trend to our knowledge this quarter.
Okay.
I mean, it's trended lower but it started a while ago.
Got it. And then the tax benefits it was -- can you quantify that. I think in the release you said that there was a charitable [ph] donation?
That was last quarter.
Got it. Okay. Thank you.
Incremental in this quarter.
Our next question is from John Armstrong, RBC Capital Markets. Please proceed with your questions.
Thanks. Good afternoon guys.
Hey, good afternoon John.
Question on the restructuring charge, I know it's small, but just give us an idea of what you're doing and what's driving that?
Yes. So..
I mean, I want to talk about it, but I'm curious?
Yes. We haven't fully disclosed everything yet. We've got some filing to do. So I'd rather leave it at that for now John.
Okay. All right. In terms of the fee businesses just had a question on the insurance and wealth kind of flattish year-over-year. I mean not terrible you're holding your own, but give us give us an idea of the outlook there and what you're planning there and is there a way to accelerate that growth?
Sure. I think there's a number of business initiatives underway, John to accelerate the insurance business. Clearly, we've been digesting a couple acquisitions over the last couple years. There's a seasonal pattern here through the course of the year. But to your observation year-over-year it probably hasn't grown as much as we would have hoped. In fact we expected to be a positive value and it's kind going to trending flat. With regard to the wealth management business, I think fee competition continues to be a factor there. assets under management can continue to grow, but decompression is a real force at play and we're actively -- obviously responding to market conditions. But continue to grow clients and continue to grow our presence in the market. So we're encouraged by that.
Okay. All right. Thank you for that. And then, one more back on loan growth, just the general, commercial outlook like we all understand some of the pressure some oil and gas and resi and refinance, but just any thoughts on the general commercial outlook, any changes in attitude of the borrowers at all?
No. I think we talked about this in the last call. I think that the general sentiment is one of uncertainty. What's going on going forward you've got election issues. You've got all the drama in Washington, continued worries about trade war. So I think people are anxious about that. And perhaps delaying some of their capital initiatives, but not to a great extent. I mean the pipeline is still looks fine and we have a number of transactions. We know that we'll be funding up in the fourth quarter. So I wouldn't dramatically change your outlook, but just the sentiment is continuing to trend in the wrong direction.
Okay. All right. Thanks guys appreciate it.
[Operator Instructions] Our next question is from Jared Shaw, Wells Fargo Securities. Please proceed with your questions.
Hi, good evening. Just I guess couple of detailed Russian on the securities portfolio. What's the yield roll off that you're seeing if those cash flow come in and what should we looking at is that increment cost of the higher cost deposits that you're going to be paying off?
Yes. So the yield roll off those payments across the entire $4 billion of taxable with certain average deals of 2033, so the allies grow up bit higher than that, but not much. And so its been the source to fund that as we pay down things. So today, you'll notice our Federal home loan bank advanced rate. It's an average of 232. So we'll be looking to manage as the margin downward that we make the most of it.
And we call that $250 million note off that which we were paying on that till three quarters.
Two points during three quarters?
Yes. So that's gone.
Okay, great.
So we're basically take – we're picking up and that's benefit there.
Okay. Got it. And then on the incremental oil and gas derisking that you're talking about is that really just going to be more cash flow and refinancing that portfolio? Or do you expect to take a couple of charge offs in that next quarter?
We anticipate that there'll be some more charges but not at the level that we just thought take in the third quarter. And you're right after finishing up a couple of distress credits here we've worked through almost all those at this point. The portfolio will shrink down as borrowing bases is redetermined lower or as we exit credits in that in that mean. So it'll -- the pace of the decline of that book is going to slow. But we feel like we've dealt with over this for first three quarters of this year, some of the more highly leveraged stuff that we were concerned about.
And you had said that you feel that the -- that you provided what you need to in there, so even if we see charge offs that may not necessarily flow through the provision?
That's correct.
Okay. And then what's the allowance on the oil and gas portfolio at the end of the quarter?
About four million bucks right now.
4%, I'm sorry 4%.
Great. Thanks very much.
Our next question is from Terry McEvoy, Stephens Inc. Please proceed with your questions.
Hi. Thanks. Good afternoon. Question for Chris. I'm just trying to think about the fourth quarter average earning assets. Maybe if you could just talk about the reduction in the securities portfolio. I think Phil said ultimately down to 17 or 18. I'm just curious how much of that will occur in the fourth quarter?
Yes. I think we said, Phil comment for the next several months through the first quarter, so perhaps its phased -- I think that is phased out over the next few quarters. And keep in mind we'll be getting some new balances in from First Staunton likely at the end of the first quarter. So we'll start rebuilding from there.
And then question, the deposits, any deposit attrition since June coming from the HBAB [ph] branches deposits that you acquired? I can remember as part of that transaction. Had you planned on consolidating any of those branch locations?
Yes. We consolidated a lot of them. That's all done. All the consolidations were done. We did assume at the time of the acquisition about 10% attrition to the best of my knowledge we're running inside of those numbers. And aside from the CD books which obviously repriced lower, the core checking, savings, money market related to the accounts are all being retained at 9% or better levels.
And the reason as I was trying to think about the restructuring that you just announced earlier on this call, if it was connected at all to those branches, but that's largely been completed?
Correct.
That's it. Thank you.
We have reached the end of the question and answer session and I will now turn the call back over to Philip Flynn for closing remarks.
Okay. Thanks for joining us everybody today. We are pleased with the bottom line results this quarter and the improving credit quality and funding mix that we've been working so hard on. So we look forward to talking to you again in January and to welcoming First Staunton colleagues and customers to Associated it in February. If you have any questions, as always give us the call. And thanks for your interest in Associated.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.