© 2024 Alpha Spread Limited. All Rights Reserved.
www.alphaspread.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on www.alphaspread.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on www.alphaspread.com, or relating to the use of, or inability to use, www.alphaspread.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance.
You don't have any saved screeners yet
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, everyone, and welcome to Associated Banc-Corp's Third Quarter 2018 Earnings Conference Call. My name is Dana, and I will be your operator today. [Operator Instructions]. Copies of the slides that will be referenced during today's call are available on the company's website at investor.associatedbank.com.
As a reminder, this conference call is being recorded. As outlined on Slide 2, during the course of 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 and the Risk Factors section of Associated's most recent Form 10-K and any subsequent SEC filings. These factors are incorporated herein by reference.
For a reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to the slide presentation and to Page 10 of the press release financial tables.
Following today's presentation, instructions will be given for the question-and-answer session.
At this time, I would like to turn the conference over to Philip Flynn, President and CEO, for opening remarks. Please go ahead, sir.
Thanks, and welcome to our third quarter earnings call. Joining me today, as usual, are Chris Niles, our CFO; and John Hankerd, our Chief Credit Officer. Turning to Slide 3, we had earnings of $0.49 a share, excluding acquisition-related costs. This quarter was marked by deposit inflows, decreasing expenses and strong credit results. Average deposits were up about $1 billion from the second quarter, reflecting our typical seasonal pattern of inflows and some CD funding initiatives we undertook during the third quarter. We continue to grow our noninterest-bearing deposits while further reducing our network funds.
We wound down Bank Mutual operations during the quarter and expect our run rate expenses to trend lower in the fourth quarter. We don't expect any further significant acquisition-related costs. We continue to benefit from the benign credit environment with nonaccrual loans continuing to decrease, allowing for a net reserve release in the quarter. We've taken several actions to optimize our capital, including repurchasing approximately 4 million shares of stock during the third quarter and repurchasing an additional 2 million shares during accelerated stock repurchase program in Q4.
At the end of the quarter, we had a common equity Tier 1 capital ratio of 10.4%. Loan details for the third quarter are shown on Slide 4. I'll highlight some trends we saw in each of our 3 primary asset classes. Growth in the commercial and business lending segment was up 3% versus last quarter, with particularly good results in our power and utilities and oil and gas segments. Average balances increased in all of our specialty lines of business and in our general commercial portfolio. And our C&I pipeline remains solid.
Our commercial real estate balances were down as both the commercial real estate investor and construction segments declined during the quarter, which we'll discuss on the next slide. Our residential mortgage portfolio was up slightly in the third quarter. Growth in this portfolio has been restrained by the lack of refinancing activity. We continue to sell essentially all of our fixed rate production and retain substantially all of our adjustable-rate mortgages.
On Slide 5, we provide more color on trends in our commercial real estate portfolio. There were 2 factors that challenged our CRE business this quarter. First, debt funds and non-bank entities have become more competitive, impacting both new production and contributing to higher-than-expected loan payoffs. We experienced this trend with both term loans and in our construction lending book, where fewer completed loans rolled over on our balance sheet as permanent financing and more flowed out to these alternative investors. The second factor resulting in lower CRE growth is a recent shift in our commitment mix toward more construction lending, which has lower initial average funding levels. Consequently, while our total CRE commitments are growing, the higher level of construction loans in the mix has led to a lower percentage of funded commitments and lower net balances. We anticipate that funding levels for our more recent construction commitments will increase in 2019.
Looking forward, we expect lower net CRE outstanding loans through the winter. While this will be partially offset by anticipated commercial and residential lending activity, our overall average loan balance is expected to be modestly lower in Q4 as growth in other lines of business will likely not offset the CRE trend.
On Slide 6, we highlight our quarterly deposit trends. Average deposits were up a little over $1 billion from the second quarter as we experienced our usual seasonal inflows and we proactively sought to build our CD book. We expect the deposits will continue to build during the fourth quarter. The strong inflows included an increase in noninterest-bearing deposits of $179 million, which enabled us to further reduce our network deposits. Average network deposits were down over $150 million from last quarter and over $1.1 billion from the previous year. Our loan-to-deposit ratio was 92% for the quarter, down from the second quarter, in the middle of the range we've seen over the last several years.
Turning to Slide 7, we discuss our loan to deposit yields and net interest income. Our commercial and business lending yield benefited from a strong move in 1 month LIBOR early in the second quarter. However, during the third quarter, a more subdued LIBOR increase occurred later in the period and consequently did not provide the lift to our yield that we had with prior rate hikes. However, we anticipate the loan repricing benefits from the most recent LIBOR increase will largely flow through in the fourth quarter.
In our CRE portfolio, yield declined as we experienced lower levels of prepayment-related accretion, which we'll discuss further in a moment. Our overall liabilities cost was up from the second quarter as we purposely positioned ourselves for expected future Fed rate hikes. We took two notable actions in the quarter and increased our near-term liability costs but lowered our expected betas in future periods. First, we extended the term on $1.8 billion of Federal Home Loan Bank advances to between 1 and 3 years. Second, we added $500 million of higher-cost CD funding, principally from municipal customers. While both of these actions increased third quarter interest expense, they position us to benefit from a locked-in cost of funds over the next several quarters.
Our higher liabilities cost this quarter was also due to increased money market fund exception pricing, mostly with public funds customers. However, we've been successful at defending our market share and used these incremental funds to further reduce our network deposit funding.
Despite the third quarter's 20 basis point increase in deposit costs, our three year cycle-to-date total deposit beta and interest-bearing deposit beta remain at 0.3 and 0.4, respectively, which are in line with our expectations, given where we are in the rate cycle. While we anticipate fourth quarter deposit costs will be somewhat higher, we expect the increase to be less than the uptick we had in the third quarter.
Looking at the right side of Slide 7, net interest income of $219 million was up $29 million from the third quarter of 2017 but down a bit from last quarter. The majority of the decrease from Q2 is due to lower remaining scheduled purchase loan accretion and prepayments related to acquired Bank Mutual loans. We anticipate the scheduled accretion to gradually decrease. And while there may be additional prepayments, it's difficult to predict their timing.
Turning to Slide 8, we have a breakdown of the specific factors that contributed to our net interest margin. Lower Bank Mutual loan prepayments resulted in a 5 basis point decrease in our margin, and lower scheduled accretion contributed an additional 1 basis point to the decline. The narrowing of the LIBOR Fed fund spread to more normalized levels resulted in a 2 basis point decrease, and higher funding costs also contributed to our lower net interest margin this quarter.
The graph on the right side of Slide 8 shows that we've grown our net interest margin in the third quarter year-to-date time frame over the last 3 years, even when excluding the effects of accretion and prepayments. Our core net interest margin depicted by the dark green part of the column has grown in each of the last 2 year-to-date periods.
Going forward, our balance sheet remains modest -- moderately asset sensitive, and we expect to benefit from future Fed rate actions. We continue to anticipate our reported margin will be approximately 2.95% for the full year 2018. Turning to Slide 9, third quarter noninterest income of $88 million was down $5 million from last quarter but up $2 million year-over-year. The decrease from last quarter was driven by seasonality in our insurance businesses. Insurance income is higher in the first and second quarters due to contingency and override fees we received based on the previous year's activity in that business. The decrease is also partially due to lower mortgage banking income resulting from reduced gains on sales and lower refinancing activity in the housing market.
The year-over-year increase in noninterest income primarily reflects the incremental benefit of our recent acquisitions of Whitnell, Diversified Insurance Solutions and Anderson Insurance, which continue to provide higher wealth management and insurance revenues.
Moving to Slide 10. Noninterest expense of $204 million was down $7 million from the second quarter. The decrease was primarily driven by lower acquisition-related expenses and the continuing improvement in run rate costs as we wound down Bank Mutual's operations. Our technology expense was down about $2 million, and our legal and professional expense was down about $1 million. These reductions were partially offset by an increased investment in business development and advertising activities in the quarter as we on-boarded and marketed heavily to our newest customers.
Slide 11, we continue our expense discussion with a tally of Bank Mutual acquisition-related costs. We recorded $3 million in acquisition-related costs in the third quarter, bringing the total to $32 million. We've completed most of the cost reductions from the acquisition and don't expect any significant additional costs. We are pleased to have come in well under the $40 million guidance we laid out at the beginning of the year.
Looking ahead, we expect our noninterest expense to be in the range of $196 million to $198 million in the fourth quarter. Beyond the acquisition-related and severance cost savings, we expect the further reductions will primarily come from lower personnel, advertising and other expenses.
Finally, on Slide 12, we detail our quarterly credit quality metrics. Our potential problem loans decreased by $5 million in the quarter as our credit environment remains benign. Nonaccrual loans decreased by $50 million from the second quarter to $154 million. The large decrease was primarily driven by credit upgrades and payoffs. Net charge-offs were $12 million in the quarter, including $9 million from an oil and gas -- from the oil and gas portfolio. The aggregate allowance for loan losses decreased to 1.03% of total loans from 1.1% in the second quarter. And with the benign credit environment, our provision for credit losses was negative $5 million, down $9 million from the second quarter.
So with those comments, I'll open it up for your questions.
[Operator Instructions]. Our first question comes from the line of Dave Rochester from Deutsche Bank.
Just a question on the loan side. It doesn't sound like the pressure on CRE from the nonbanks is abating at all. And I was just curious, if that persists, not only through this quarter but into next year, are you thinking it will still be difficult to grow loans in 2019? Or do you think with C&I strength and maybe a tick up in resi, if you get some seasonal tick up on the purchase side that, that can help offset and drive some growth?
Yes, we actually think, as we get through the fourth quarter, that we'll start to see commercial real estate net growth again. We've been actively putting out new commitments on Slide 5. You saw that our unfunded commitments have ticked up to a relatively larger level than normal. Those loans will start to fund up. It's very hard to say what kind of payoffs are coming. We've been talking to our customers, obviously we're close to them. We still think there's some to come in the fourth quarter, but we're optimistic that we'll resume growth in this particular portfolio starting next year. On top of that, the C&I loan pipeline looks very good. And so we're optimistic about that as well.
Okay, great. And then just switching to the buyback. I know you mentioned you've done about 2 million shares so far this quarter. Is it fair to say that with your loan growth guide for this quarter, the fourth quarter, and just given where the stock is trading, that you guys aren't done yet and that you'll be continuing to be active in the buyback this quarter?
Dave, I think we've been pretty clear about articulating our capital priorities. And we'll continue to sort of abide by those. But we don't give guidance about share buybacks. And the 2 million, Dave, we should say, is in an ASR. So you know how those things work.
Yes, yes, yes, exactly. Good. And then I guess just switching to the NIM, just given your commentary that you're expecting a smaller increase in interest-bearing deposits in 4Q and just based on your reiteration of the 2.95% for the year, it sounds like you are expecting to see that core NIM, ex accretion, expand a little bit in 4Q?
Yes.
Yes. And that trend, with further rate hikes, is expected to continue into next year, I would guess.
Yes.
Great. And then just one last one on deposits. Just given the loan growth guide, and it sounds like you're expecting further deposit growth, I was just wondering about your priorities for excess deposit growth. Is the thought to just continue to pay down the network deposits? Or do you split that between paying those down as well as borrowings? How do you guys think about that? And then plans for the securities book. I know that came down a little bit on an end-of-period basis this quarter. It doesn't seem like you're thinking about growing that at all.
Yes. So if you look at the first page of the press release, Dave, you'll note that we took down the Federal Home Loan Bank advances in aggregate by $1.4 million. So we'll continue to optimize between our highest cost sources of liabilities. And with that wholesale funding or the network deposits or others, we'll continue to sort of manage that to an optimal cost. Obviously, there's no value in keeping excess funding levels. The securities book today doesn't look like a source of value in the current environment, but we'll continue to evaluate the overall balances as we move through the course of 2019.
Our next question comes from the line of Scott Siefers from Sandler O'Neill + Partners.
Can you guys talk just a little more about -- it's sort of just the same. I appreciate the color you've given so far, but just given that the noninterest-bearing inflows were largely seasonal, what is ultimately the sustainability of those deposits? Like how long will they stay with us? Where do they end up going, et cetera?
Sure. So part of the funding of the quarter was public fund CDs, and those will stick to the balance sheet for a slightly longer period of time. In fact, as you'll recall, we've historically talked about seasonal outflows as we start off the year. And because we lock some of these up, we're anticipating those seasonal outflows will be slightly less in the first half of next year, and that we've locked in that funding for a longer term. So it was purposeful with that specifically in mind.
Okay. Perfect. And then can you talk about how much more leverage there is on the provision? It's a little bit of a no-brainer when you had the enormous energy reserve. Now that energy reserve looks a lot more reasonable or like it's sort of hitting a bottom, and you're seeing albeit extraordinarily modest non-energy charge-offs. But as you look at your overall reserving levels, what's the thinking there?
Well, it's hard to say. But if you think about this quarter with essentially no loan growth and an improving portfolio with nonaccruals, for example, coming down 25% and other -- all the other indicators getting better, you can see why we ended up with a negative provision. We're not forecasting net loan growth in the fourth quarter, as we've just said, and we don't see the credit portfolio starting to turn for the worst. So there's probably not a whole lot of pressure on provisioning, to be honest, in the fourth quarter as we sit here today. Things can change, but we don't see that. As we get into next year, hopefully, we're going to be growing loans like gangbusters, and we'll be providing it again.
Yes, okay. And I guess final question, just going back to the margin. So glad to hear that we'll get a little relief in the fourth quarter, sort of estimating like a 2.83% core level in the third quarter, so that should expand. And then as you think out into next year, and I know, Phil, you suggested that core would continue to expand in out quarters, but you've got the PAA sort of ratably declining. So is your feeling that if we -- let's say, we have a full year margin of 2.95% this year, can the reported net interest margin still expand in 2019?
Yes. The reported margin has a lot of noise in it because of the purchase accounting treatment on the Bank Mutual portfolio. Clearly, as time goes on, with the prepayments we've seen and with the scheduled accretion starting to roll down and accelerate a little more than we originally thought because of the prepayments, that noise will start to abate a bit. Whether or not they're reported from one quarter to the next quarter as going to be up or down is hard to predict. But our core net interest margin is on a steady upward climb.
Our next question comes from the line of Ebrahim Poonawala from Bank of America.
Just if you could talk to -- from an expense standpoint, so relative to the $196 million, $197 million run rate for fourth quarter, how should we think about expenses going into 2019? Are there any additional savings tied to Bank Mutual or will that be fully reflected in that run rate in -- just in terms of what's the core inflation that you expect on expenses from thereon?
Yes. So what we have said throughout the last few quarters is, by the time we get to the fourth quarter, we expected a clean expense run rate. So I think you should expect, when we give full year guidance in a month -- in 3 months, that our expenses should be mirroring that fourth quarter core run rate.
Understood. But can you just, without giving any specific guidance, Phil, talk to around what you're seeing in terms of just inflation around employee or comp expenses, technology investments, network? Just put organic inflation on expense growth next year.
Yes. So I would take you back to our history. And prior to the series of acquisitions that we did, you saw that we essentially held our expenses flat despite other demands for, obviously, salary increases and such for some years. Our expectation is to continue to run this place in that kind of disciplined manner, where we become more efficient as the quarters and years tick by, which allow us to continue to reward our colleagues appropriately as time goes on. So absent acquisitions, we have a history of running a flat expense base, an efficiency ratio that's gotten better year after year after year after year for years, positive operating leverage, and we expect to be in that same mode.
Our next question comes from the line of Chris McGratty from KBW.
Chris, just a clarification on the buyback. Number one, can you remind us after the 2 million ASR that you did in Q4, what's the dollar amount of buyback left? And the rules beyond the ASRs? Is there any time that you're effectively out of the market until those settle?
So we are out of the market while the ASR is active. The ASR has not yet closed. At the conclusion of the ASR, we will have $141 million left on our authorization that was recently updated by our board.
Okay. And then kind of a broader question, Phil. I think last quarter, you talked about potentially looking at acquisitions, and historically, you've been pretty consistent in the market, Phil. I have a broader question to the Midwest market that you're in. Are there any markets that would be theoretically off-limits within the Midwest if the right strategic option came about?
So I would never say, in the upper Midwest, that nothing would be possible, but we have expressed and demonstrated a strong desire to look for efficiency-driven acquisitions, which by necessity drive us to look for things that are within our footprint where there is significant overlap. We are well aware of the way -- how the market seems to feel about large acquisitions and particularly acquisitions that extend a franchise. That hasn't so far been terribly successful for the acquirers, at least as far as the market seems to be concerned.
Our next question comes line of Jon Arfstrom from RBC Capital Markets.
Just on the loan growth slide, Phil, can you talk a little bit about Power and Utilities and Oil and Gas and what you're seeing in those 2 categories, kind of the drivers there?
Sure. I mean, our Power business has been a steady performer since we started it up some years ago, and they continue to drive nice results. It's an active market, and we're an active player in it. Oil and Gas, there's -- with higher prices and the focus that we have, there's continued opportunity to grow there. Both of those, however, operate within comfort levels that we have as far as not being overextended to any particular industry. So there's room in both of them to grow, but there's not unlimited room either.
Great. Okay. And then the next slide, Slide 5 -- I'm a Vikings fan, so you're going to have to explain this to me, Phil. What are you saying here? You're saying that within a quarter or 2, some of these challenges in commercial real estate abate or fade away? Is that what you're saying with this slide?
That's our belief. We've seen this tick-up in nontraditional lenders over the last quarter or two, and other banks have been talking about that in their calls of late. I'm not sure that's going to go away for any particularly reason until one of them stumbles and does something stupid. But absent that, we have been originating a significant amount of construction loans, which, by their terms, will fund up. So our best estimate is that taking or making reasonable assumptions about payoffs and outflows, we will outrun that dynamic sometime as we get into, hopefully, early 2019, and we'll start to see net growth off of both stuff that's in the pipeline that hasn't closed yet and stuff that's already closed that's, by its terms, funding up.
Okay. So generally optimistic, I guess more broad based. When you add all this up, you'd say you're generally more optimistic? Okay.
Yes. We have a really strong commercial real estate team in the upper Midwest who are very active. And I have full confidence that they're out looking for and finding quality transactions for us.
Okay. Good. And then just one small item you've highlighted in the press release. But the comment about deposit growth in Illinois, can you just touch on that? I'm assuming you highlighted that for a reason.
Well, yes. It was 14%. We had some success there. That's about $600 million to $700 million. So we have about $6 billion of deposits, give or take, in Illinois. So we called that out as a successful endeavor by our folks who are in that state.
Okay. And is there any theme there?
No. The theme is true across our footprint that we are successfully continuing to grow our deposit base. In Wisconsin, we've retained our third market share and picked up share on the market leader, which is U.S. Bank.
[Operator Instructions]. Our next question is a follow-up question from Scott Siefers from Sandler O'Neill.
I wanted to switch in to the fee base for a second. So mortgage came in, in the third quarter maybe a little weaker than I would have thought. I mean, I definitely understand all the environmental issues, whether it's gain on sale margins, refi waning, et cetera, but still, it was a pretty substantial decline. So I guess, first, is there anything unusual in there, like evaluation adjustment, hedging loss, anything like that? And then two, I guess, we -- you sort of get into even weaker origination seasons, would you say the third quarter is a low watermark? Or does that revenue number get pressured further from here?
So Scott, there were no special notable items in the third quarter that would cause you to move that needle a lot. So the number is indicative of a real trend. And in general, we have less production in Q4, so the gain on sale will likely come down a little bit into Q4.
Our next question comes from the line of Terry McEvoy from Stephens.
Just one last question on my list here. How much of the 20 basis point increase in your interest-bearing deposits do you think came from that $0.5 billion of CD growth in the quarter? Any way to separate one from the other?
Yes. Actually, Terry, if you look at Page 7 of the press release table, we allocate out sort of by category, and you can see the comparisons between the September period and the June period. So the total cost of time deposits went up by, call it, $3.5 million, as you can see there, on the $400-plus million net change of balances. So you can do a little math, and that's the answer.
Okay. And then earlier, did you talk about where you expect just cost of interest-bearing deposits to trend in the fourth quarter? Was it a similar increase, or do you expect that growth rate to slow down?
We expect the incremental growth rate to slow down because we've pre-funded some things during the quarter, and we essentially took some rate a little bit higher during the third quarter, which we don't anticipate we'll have to further chase funding in Q4, given we already have some and given that the loan growth pressure will be less.
Our last question comes line of Jared Shaw from Wells Fargo Securities.
This is actually Timur filling in for Jared. Chris, maybe my first question is for you, and I'm sorry I missed this. But when you were talking about some of the actions taken on the liability side to expensive durations, like cost -- I caught the FHLB component, that $1.8 billion. What was the amount of CDs that we're the added? And what was the duration on those CDs?
It was $0.5 billion, and it was generally between 90 days and 12 months, so it's a kind of a blend. But generally speaking, over a quarter or 2, most of it will come up, but that will extend us into the early part of '19.
Okay. And was the cost provided on either the FHLB duration extension or the incremental $0.5 billion of secure --- or of time deposits?
We didn't specifically call it out. But again, if you look at the tables on Page 7, you can see that the cost of time deposits went up by a little over -- a little more than $3 million in the balance change there, and relatedly, the Federal Home Loan Bank advances, the weighted average cost went from 1.77% to 2.08%, which is the implied cost of the extension.
Okay, understood. And maybe just looking more broadly at how the liability side of the equation is currently comprised. Understand that deposit cost is likely to go higher again on the fourth quarter, although at decelerating levels. As we look out further, though, what type of deposit beta -- or if you have funding beta, are you guys looking at it internally as we start thinking about potential rate hikes in 2019 and beyond?
I think our cycle-to-date betas are 0.3 on total deposits and 0.4 on just the interest-bearing components. And those are generally in line with what we have modeled, and that's consistent with our expectations at this point in time in the cycle.
Okay, so fairly stable to what you've experienced so far?
In aggregate, over the entire cycle, correct, which obviously is the acceleration from the third quarter.
Right. Okay, and then just lastly, for me, I'm wondering what, if any, reserves are released from the reclassifications of nonperformers?
Well, I don't know off the top of my head. Nonperformers have specific reserves against them, but that would have been a certain amount of them, for sure. I don't know off the top of my head.
But -- okay, I guess another way of putting that. Assuming that we start getting some stability in the nonperforming loan base, is it then safe to say that the allowance is going to be a little bit more stable at current levels? Or is there still incremental room to maybe release some of the allowance, whether it's on the energy book or other components?
Yes. Like I said earlier, in an environment where credit quality is very strong and doesn't show any signs of weakening, and as we've already said, we don't see a lot of growth in the fourth quarter, there's probably not a lot of pressure there. As we get into next year, we'll see how it plays out.
Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Phil Flynn for closing remarks.
Well, thanks, everybody, for joining us. Again, we are pleased with this quarter's strong deposit inflows, the Bank Mutual cost takeouts we've achieved, and the continued very benign and very favorable credit environment. So we look forward to talking to you in January. And if you have any questions in the meantime, give us a call. And as always, thank you for your interest in Associated.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.