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Good afternoon, everyone, and welcome to Associated Banc-Corp's Fourth Quarter and Full Year 2019 Earnings Conference Call. My name is Hector, 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 in 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.
Thank you, Hector, and welcome to our fourth quarter and full year 2019 earnings call. Joining me today are Chris Niles, our CFO; and Pat Ahern, our Deputy Chief Credit Officer. Pat is succeeding the current Chief Credit Officer, John Hankerd.
I'd like to begin by extending our gratitude to John for his 15 years of service at Associated and wish him a well-earned retirement after almost 40 years in banking. We welcome Pat to his new responsibilities and know that his 30 years of banking experience including 9 at Associated will serve the bank well.
Turning to Slide 3. In 2019, we faced an interest rate dynamic that was significantly different than the environment for which we had positioned the bank at the end of 2018. Going into the year, our expectation was for 2 rate increases. However, as we all know, the Fed cut rates 3 times, and we spent much of the year repositioning the balance sheet for a lower rate environment. We reduced our higher cost network transaction deposits from $2.3 billion at the end of 2018 to $1.3 billion at the end of '19, and we sold $1 billion of lower yield investment securities. Aided by the Huntington branch transaction, we increased our low-cost deposit mix from 51% to 56% at the end of the year.
Since we couldn't control market interest rates, we focused on controlling our costs. We reduced our absolute noninterest expense by $28 million year-over-year even while we added 14 net branches from Huntington in June. We continued to benefit from positive credit trends, and our overall credit metrics have remained stable as we further derisked our oil and gas portfolio. We remain committed to disciplined underwriting standards. We built capital ahead of the CECL implementation that occurred on the first of this year, while continuing to deploy capital in accordance with our stated priorities. We increased our dividend by 11%, and we repurchased $177 million of common stock.
Turning to Slide 4, we highlight our 2019 loan trends. Year-over-year, we had solid growth in our commercial and business loan portfolio, particularly in general commercial lending and in our power and utility vertical. Commercial and business lending balances were up 9% year-over-year despite shrinking in the fourth quarter. This portfolio represents 36% of our total loan book at year-end, and our largest single industry exposure remains the manufacturing and wholesale trade sector.
Our commercial real estate portfolio faced significant headwinds in late 2018 and early '19 from higher-than-expected pay down activity. However, we returned to growth in the second quarter of 2019 and are optimistic that this positive trend will continue throughout '20. Commercial real estate comprises about 1/4 of our total loans and growing the CRE balances as a share of total loans is a focus of our management team this year. The CRE portfolio is well diversified by geography, property type and borrower with about 1/3 of our CRE loans in multifamily properties. Our exposure to retailers remains very modest, and our construction exposure remained near 6% at the end of the year.
Our residential mortgage book was up slightly in 2019, represented about 36% of the total loan book at year-end. Portfolio growth in '19 was negatively impacted by the sale of $240 million in prepayment sensitive mortgages in the third quarter.
Fourth quarter loan trends are highlighted on Slide 5. Our commercial and business portfolio had a challenging quarter with declines in general commercial lending, REITs and the oil and gas book. However, power and utilities had another strong quarter, and with several credits booked late in the quarter, we expect continued growth in this vertical in '20.
CRE continued its rebound with modest growth in the fourth quarter despite seasonal headwinds. Average balances in the residential mortgage book decreased in the quarter as a result of the previously mentioned sale of mortgages late in the third quarter. However, we remained Wisconsin's most active mortgage lender in 2019 and grew originations in the fourth quarter, giving us positive momentum as we head into '20.
Turning to Slide 6. As shown in the left graph, our oil and gas balances decreased by nearly $100 million from the end of Q3 to the end of Q4. After wrapping up the fall borrowing base redetermination period, we benefited from more credit resolutions and payoffs than we previously anticipated. Looking ahead, we expect balances in this portfolio will stabilize as we've neared the completion of the planned de-risking.
In the middle graph, power and utility balances have grown by $300 million over the last 5 quarters. We anticipate that trend will continue into '20. Our commercial real estate pipeline remains strong as seen in the right-hand graph. Unfunded commitments have increased nearly $400 million to $2 billion since the third quarter of 2018 and have risen for 4 consecutive quarters. Looking forward, we expect to grow our average total loans by 2% to 4% in 2020.
Turning to Slide 7, we highlight our annual deposit trends. Average deposits grew 3% or approximately $660 million from a year ago, driven primarily by the Huntington branch acquisition. We've met our Huntington deposit retention goals and expect the same success with First Staunton. The graphs on the right side of the slide highlights the progress we've made in improving our deposit mix while growing overall deposit balances.
At the end of 2019, our mix of low-cost deposits was 56%, up from 51% at the end of '18. While our deposit mix had been trending positively over the last several years, the jump in lower cost deposits we saw in '19 is the result of our balance sheet repositioning efforts. These efforts also led to the continued reduction of our network transaction deposits. 2019 year-end balances of these higher cost funds fell 41% from 2018 and now just represents 6% of our total deposits. The remixing of our deposits contributed to the 37 basis point reduction in interest-bearing deposit costs over the past two quarters of 2019.
Fourth quarter deposit details are on Slide 8. Fourth quarter average deposits were down $1.1 million from the third quarter as our funding needs declined with the sale of lower-yielding securities and prepayment sensitive residential mortgages. These asset reductions enabled us to reprice certain high-cost deposit categories lower, including some of our noncore price-sensitive depositors to withdraw funds. Net outflows from time deposits and money market accounts totaled $700 million. Most of these outflows were public funds. While interest bearing demand average balances were also down about $300 million, this was due to seasonal outflows as municipal customers to run their operating accounts.
We also continued the reduction of our network deposit balances in the quarter, decreasing these high-cost deposits by over $300 million. While we anticipate these balances may increase in the first quarter of '20 as we experienced additional seasonal deposit outflows, and we fund anticipated draws on commercial loans, we expect the addition of First Staunton deposits will mitigate the overall level of noncore deposits and further reduce our cost of funding. While our loan-to-deposit ratio will remain seasonal, we anticipate maintaining this ratio under 100%, funding the majority of our loan growth with core deposits and a lower total cost of deposits, given no Fed rate increases.
Turning to Slide 9. Our investment portfolio declined to $5.6 billion as we sold securities and let balances runoff to pay down higher cost funding. We increased lower-yielding taxable securities by approximately $400 million, while we increased our tax-exempt balance slightly. Our portfolio yield increased as we retain less short duration securities and added higher-yielding, longer-duration muni bonds. We expect our securities book to trough in the first quarter and anticipate holding the balance at about 17% of total assets.
Turning to Slide 10. Our full year net interest income was $836 million, down $44 million from 2018, and our net interest margin was 2.86%, down 11 basis points from the previous year. The lower net interest income and margin were caused by several factors. First, we had $20 million less in acquisition-related prepayments and purchased loan accretion in 2019 than we did in '18.
Second, our deposits repriced higher in the first part of '19, as they continue to be affected by the rate hike cycle that ended in 2018. This lag effect is typical during rate cycles and often persists for some months after the final rate hike.
Third, our commercial loan yields were negatively impacted by Fed rate decreases in 2019. This effect was exacerbated by LIBOR to Fed funds compression as LIBOR rates decreased in anticipation of Fed action. This led to lower LIBOR-based asset yields while the rates on our Fed index funding held steady until the actual Fed action date.
Turning to Slide 11. We highlight fourth quarter net interest margin trends. Net interest income was $200 million, down $6 million from the previous quarter as our repositioning efforts resulted in a smaller balance sheet. However, our net interest margin increased 2 basis points from the third quarter as the decrease in our funding cost outpaced asset yield reduction. The net interest margin results were driven by dynamics on both sides of the balance sheet.
On the asset side, average 1-month LIBOR in the fourth quarter decreased 39 basis points from the third quarter, negatively impacting commercial loan yields. However, long-term rates were relatively steady, reducing refinancing activity and stabilizing residential mortgage yields. Our investment portfolio yield increased slightly, as lower-yielding securities ran off or were sold, and we increased the mix of higher-yielding municipal bonds.
On the liability side, our balance sheet repositioning strategy resulted in lower funding costs in the fourth quarter. Total interest-bearing deposits and total interest-bearing liabilities decreased 25 basis points and 21 basis points, respectively. Looking ahead, we expect our deposit cost to continue to decline in the first quarter, although at a slower pace than what we saw in the third and fourth quarters of '19. We anticipate our asset yields will stabilize, resulting in a full year '20 net interest margin between 2.8% and 2.85%, assuming a stable interest rate environment.
Turning to Slide 12, we highlight annual noninterest income. Total noninterest income for the year was $381 million, up $25 million from 2018. The increase from the previous year was driven by higher net mortgage banking income, which was up $12 million from 2018. Gains on investments also contributed to the year-over-year increase. We anticipate the mobile and digital loan application technology investments we made in 2019, including solutions for mortgages, consumer loans and business loan applications will help facilitate revenue growth in the coming year. For 2020, we expect total noninterest income to be between $375 million and $385 million, excluding investment gains and losses.
Slide 13, we show noninterest expense trends. Actual noninterest expense was $794 million, below our initial guidance for the year of $800 million and $28 million below the prior year's level. Controlling costs has long been a focus here at Associated, and 2019 was no different. Our noninterest expense was down year-over-year even with the exclusion of acquisition and restructuring-related costs which were elevated in 2018. The year-over-year decrease was achieved despite the additional operating expenses of the Huntington branches acquired in June of 2019.
We recently took actions to keep our costs in check for 2020 and beyond. While we incurred $3 million in restructuring-related charges in the fourth quarter, we anticipate the restructuring will enable us to maintain flat to modestly lower noninterest expenses in 2020, including the full absorption of First Staunton's costs. While we maintain our focus on controlling costs, we understand that we need to continue investing in technology that will further improve operational efficiency and enhance our digital presence and capabilities. We've increased our technology spending by more than 25% over the past 4 years, and we expect this trend will continue. Looking ahead to 2020, we expect total noninterest expense to be between $790 million and $795 million, including the cost of converting and operating First Staunton.
On Slide 14, we summarize the annual credit quality trends of the loan book. During 2019, the credit environment remained benign, and our credit metrics generally improved. Potential problem loans decreased $93 million from the end of 2018. Our provision for credit losses was $16 million, up from 0 in 2018, but down from $26 million in 2017. As we've previously noted, we have already provided for and reserve against the risks we currently see in the oil and gas portfolio. We anticipate future oil and gas loan losses are manageable and within our historical patterns of normal provisioning. The allowance for loan losses at the end of 2019 was 0.88%, down from the third quarter and previous years.
As part of the implementation of CECL this quarter, we expect to incur an after-tax equity adjustment of $70 million to $80 million, which will reduce our tangible common equity ratio by 21 to 24 basis points as expected.
On Slide 15, we highlight our strong capital position. In 2019, we maintained our disciplined approach to capital deployment. We built up capital in preparation for CECL implementation, while we adhered to our stated priorities to support organic growth, pay a competitive dividend, pursue in market efficiency-driven acquisitions and repurchase shares. We increased our dividend 11% in 2019 and have grown the dividend by 68% since 2015. We deployed capital through the Huntington branch acquisition, and we returned $177 million to shareholders through common stock repurchases.
To sum up. On Slide 16, our 2020 outlook which reflects our expectations of a stable economy and the closure of the First Staunton transaction in February. We expect 2% to 4% annual average loan growth and to maintain our loan-to-deposit ratio under 100%. We anticipate our full year 2020 net interest margin will be between 2.8% and 2.85%, assuming a stable interest rate environment. Noninterest income is expected to be between $375 million, $385 million. Noninterest expense anticipated to be between $790 million and $795 million, including acquisition-related costs in connection with the First Staunton transaction. We expect the 2020 effective tax rate between 19% and 21%. Our loan loss provision is anticipated to adjust with changes in risk grade, other indications of credit quality and loan volume. And finally, we expect to continue to deploy capital through our stated priorities, and we'll continue to operate with at least a 7% tangible common equity ratio.
With that, we'll open it up to your questions.
[Operator Instructions]. Your first question comes from the line of Scott Siefers with Piper Sandler.
A couple quick ones for you. Just in terms of the guidance, I know it's pretty small in the grand scheme of things. But does the guidance outside of expenses include or exclude First Staunton? And I guess, specifically, where I'd be most curious is in the margin guidance, is there any additional purchase accounting adjustments baked into there? Or is that kind of a clean margin guide 2.80% to 2.85%?
Yes. Clean guide and all the First Staunton stuff is included in all the guidance we gave you.
Okay. Perfect. And then are you able to say what -- in the press release, you noted some credit valuation adjustments in the fourth quarter. Are you guys able to detail the size of those?
It's a relatively small number. It's on our customer derivatives and it's just changing the rates, and it was $1 million.
Okay. So nothing too significant. All right. And then final question, just I think you also put in the release, there was an 18% sequential increase in potential problem loans. Anything in particular there? Or is that just kind of normal ebbs and flows?
No. We're dealing with such absolute low levels of potential problem loans, that -- year-over-year, they're down, they were up a little bit in the back half of the year, but it doesn't seem systemic, and we're not concerned about it.
Your next question comes from the line of Terry McEvoy with Stephens.
I was hoping you could discuss maybe your thoughts on insurance and mortgage banking in 2020. It looks like the insurance dipped a little bit in the fourth quarter. So within the context of that $375 million to $385 million, could you just provide some commentary there, please?
Yes. The insurance business is inherently a slow-growing business. We did a number of acquisitions. We didn't do any this past year. We'll see what happens in the coming year. But the $375 million to $385 million assumes a steady state for the insurance biz, and it assumes a lower run rate of mortgage banking income than what we enjoyed in the back half of the year given rate stabilization.
And then looking at your noninterest expenses, I see the $1.3 million acquisition-related cost. Did I miss some severance expenses as well in the fourth quarter? Is that in the $203.6 million number?
It is, Terry. And if you look at Page 10 of our press release tables, we break out the severance specifically. It rounds to $4 million for the quarter, it's $3 million and change, it rounds up to $4 million. It was $5 million for the year and $4 million for the fourth quarter, rounded.
Your next question comes from the line of Jon Arfstrom with RBC.
Phil or Chris, on Slide 5, that decline in general commercial, you may have touched on it a little bit, but can you go into detail a little bit more on that? What really drove that?
It was kind of across the board. I think we feel it's pretty anomalous. We're not really terribly concerned. We anticipate pretty robust loan growth this coming year. We expect the general commercial lines to grow. We certainly expect commercial real estate to grow. Commercial real estate is sitting on $2 billion of unfunded commitments. They had their best year for new production ever in 2019, more than $2.8 billion of new transactions. So that $2 billion, a significant amount of that will fund up in addition to the new work they're doing now. So the combination of reasonable expectations in commercial banking, strong expectations in commercial real estate, steady growth in resi mortgage makes us feel pretty confident that we're going to hit that 2% to 4%.
Okay. Good. That helps. And then the comment you made on the securities portfolio. I just did a simple math, and I think it suggests maybe it bottoms at around $5.5 billion in Q1. Is that the right way to think about it?
Yes. It's definitely going to bottom out at roughly 17% of assets during Q1, and we're basically bouncing around the bottom now, and it will -- it won't grow other than in proportion to our balance sheet as we move through 2020.
Okay. You guys almost filled out my earnings model, but I was just trying to get to an earning asset number.
$2 million is snow plow expense. And it's snowing outside right now.
It's been great this winter. Last one, Chris. I know you've done a lot of thinking about CECL. How should we think about the provision for 2020, maybe a little bit of an increase in the state of reserves, but how do you want us to think about your provision?
Yes. So in general, we think our provision should have less volatility under CECL, so it should essentially track growth in the portfolio would be our baseline. And we would anticipate -- again, we've got some nice growth anticipations, but -- and the overall nature of the portfolio environment. And we've been on a positive or benign credit environment, and there's no reason to believe that's going to stop here at December 31. So there's some positive general portfolio trends, which will be partially offset by the growth trend we see going forward, but generally less volatile provisioning going forward.
And it feels like most of your cleanup in energy is done as well.
Yes. We feel -- we've reduced that portfolio substantially, another $100 million in the fourth quarter. We don't see a whole lot of charge-offs left and for stuff that we're worried on about beyond that. The contribution we're making to CECL here in this quarter should cover our worries. So I feel pretty good about where we are on that.
Your next question comes from the line of Chris McGratty with KBW.
So in terms of capital, you talked about a 7% floor on the tangible ratio. Can you speak to inorganic growth opportunities? I think in the past, you said 1 to 2 small deals a year would be possible. And I think recently, you talked a little bit more openly about the potential merits of an MOE. Maybe some updated thoughts here?
Yes. So our stated goal is to continue to look for efficiency driven in footprint, relatively modest acquisitions, and we have discussions going on. What I've said about the possibility of MOE is there's a limited number of options, and we're always open to talking to anyone about what makes sense for our shareholders as well as potentially someone else's. So we're open to those discussions.
Your next question comes from the line of Jared Shaw with Wells Fargo.
Chris, actually hit one of my questions. But any thoughts on acquiring business lines or portfolios apart from your comments on potential whole bank deals?
Sure. You saw us do the Huntington branch transaction, which at the end of the day was almost all deposits and buy any portion of what Huntington has buying out there Wisconsin stuff. So we're always open to looking at nonwhole bank deals. We're particularly interested in looking at opportunities like we had with Huntington, where we can continue to grow low-cost core deposits. Those kind of opportunities are few and far between, of course. But to the extent something came up, we would certainly be interested in that. As far as looking at loan books and portfolios, we're open to that, but it's not as high a priority is continuing to build out the deposit base.
And of course, we continue to be interested in asset management-related opportunities should they present themselves and...
And insurance transactions as well, yes.
Okay. And then on your -- on the CRE portfolio, can you comment on what you're seeing in terms of payoff, pay down trends? And what your expectations are around that as you look going into 2020? Do you expect that to stay stable or potentially increase or decrease?
Yes. So we had a real rush of payoffs back end of 2018, leaking into 2019. That has abated somewhat, and we don't expect any elevated payoff activity. So the funding up of a couple billion dollars of commitments there on our books, coupled with new production minus reasonable level of payoffs, and there's always plenty of payoffs. I mean it's the nature of the commercial real estate business that it's somewhat of a hamster wheel of making new loans, having loans payoff. That's how it's supposed to work for banks. But we're going to be net ahead and should be healthily net ahead this year.
[Operator Instructions]. Your next question comes from the line of Michael Young with SunTrust Robinson Humphrey.
Just wanted to ask about the appetite for residential mortgage on balance sheet production in 2020. Is that impacted by CECL? And do you view that at all as an alternative to securities book growth? Just kind of get your high-level thoughts there.
Sure. So the securities book is going to remain at a lower level than we've historically held, as Chris said, around that 17% range. So to the extent the balance sheet expands with loans, that will creep up a bit. The residential mortgage stuff, it's a good point. Clearly, CECL causes more credit to be attracted to those loans. So we're going to be very deliberate about what goes on the balance sheet. We have a very active origination sale, retain service model here, and we'll continue to look at continuing that model. But I think it's fair to say that we have some reticence to put lower yielding residential mortgages that attract significantly more capital because of the accounting rules than they used to on the balance sheet.
Okay. And just a follow-up on the technology and equipment expense. Can you talk about where kind of new dollars are being put to work? Maybe how much of that is kind of customer experience driven versus efficiency efforts, et cetera?
Sure. It turns out that usually improving the digital customer experience also leads to more efficiency. So we're now up to about 80% of our mortgage applications are rolling through our Blend application that we rolled out earlier this year. That causes significant efficiency with the digitization of that application from the moment that someone starts typing on their computer or their phone or their tablet. Most of our efforts are customer-facing, so that we remain relevant and more than competitive with many of our competitors in our footprint, and that will continue. But we also have other significant technology projects that we completed.
We recently completed a complete revamping of our campaign -- marketing campaign management system, which automates a lot of our ability to digitally connect with customers and send out hundreds and thousands and millions of e-mails in an efficient manner. So that's both a customer-facing technology, but clearly drives efficiency and accuracy in the back shop. So I'd say it's both, but it's more heavily weighted toward the customer experience.
Your next question is a follow-up from Scott Siefers with Piper Sandler.
I was just curious on the overall credit portfolio. I guess if there -- if we're sort of nearing the end of energy-related charge-offs as you finished derisking that portfolio, where are your nonenergy charge-offs running these days, maybe in terms of basis points would be great?
I know they're very small, but I'm just trying to get a sense for what the expectation for total charge-offs would be if we're kind of sunsetting on the issues in the energy portfolio?
Yes. I mean that's always hard to prognosticate because any one charge-off can drive that. In this past quarter, we had $14 million of net charge-offs, a little less than $10 million were oil and gas-related, most of the rest of it was some mortgage and other consumer assets. So the vast bulk of our charge-offs this past year were oil and gas, and the remainder was next to nothing. I don't have the basis points in front of me, but it's probably a single digit.
Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Philip Flynn for closing remarks.
Well, thanks, everybody, for joining us today. We feel well positioned going into 2020. The efforts we made to reposition our balance sheet for the rate environment we're in, we believe, will pay dividends. We should have a stable net interest margin potentially rising a little bit. You saw the results in the fourth quarter of our NIM actually going up 2 basis points. We feel good about our loan growth. We will manage expenses as we always do, and we believe we're in a benign credit environment. So I think we're well positioned to perform well in 2020.
We look forward to welcoming our First Staunton customers and colleagues in February, and we look forward to talking to all of you in April. And as always, if you have any questions, give us a call, and thanks again for your interest in Associated.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.