Q4 2019 Earnings Call
Good afternoon, everyone and welcome to associated Bancorp's fourth quarter and for your 2019 earnings Conference call.
My name is Hector and that will be operated today.
At this time all participants on the listen only mode. We will be conducting a question and answer session. At the end of this call for copies of the sites that will be reference during today's call are available on the company's website at investor Dod associated Bank Dot com.
My name just conference call this being recorded.
As outlined on slide so during the course of the discussion today management may make statements that constitute projections expectations beliefs or some other forward looking statements associateds actual results could differ materially from the results anticipated or projected and any such forward looking statement.
Additional detailed information concerning the important factors that could cause associateds actual results to differ materially from the information discussed today is readily available on the FCC website and the respective sex and all the Socit. Its most recent Form 10-K and any subsequent SCC following.
These factors are incorporated herein by reference.
Well a reconciliation of the non-GAAP financial measures to GAAP financial measures mentioned in this conference call. Please refer to slide presentation. That's a 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 or Chris Niles our CFO .
Had a hurt our deputy Chief Credit Officer Cat is succeeding current Chief credit Officer, John anchor.
I'd like to begin by extending our gratitude to John for its 15 years of service at associated and wish him well earned retirement after almost 40 years in banking will compare that to his new responsibilities and know that his 30 years of banking experience, including nine at associated well served think well.
Turning to slide three 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 2080.
Going into the year, our expectation was for two rate increases however, as we all know the fed cut rates three 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 up 2018 to 1.3 billion at the end of 19, and we sold a billion dollars up lower yielding 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 non interest expense by $28 million year over year, even while we added 14 that branches from Huntington and Jim.
We continued to benefit from positive credit trends and our overall credit metrics have remained stable as we further de risks our oil and gas portfolio.
We remain committed to disciplined underwriting standards.
We built capital ahead of the Cecil 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 four 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 utilities vertical.
First one 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 in wholesale trade sector.
Our commercial real estate portfolio faced significant headwinds in late 2018, and early 19 from higher than expected paydown activity.
However, we returned to growth in the second quarter 2019 and are optimistic that this positive trend will continue throughout 20.
Commercial real estate comprises about a quarter of our total loans and growing the C.R.E. balances as a share of total loans is a focus of our management team this year.
The CRM portfolio is well diversified by geography property type and borrower with about one third of our sea ray loans in multifamily properties or exposure to retailers remains very modest and our construction exposure remain near 6% at the ended 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.
[noise] fourth quarter loan trends are highlighted on slide five our commercial and business portfolio had a challenging quarter with declines in general commercial lending.
Right and the oil and gas, but however, power and utilities had another strong quarter at several credits booked late in the quarter. We expect continued growth in this vertical in 20.
Siri continued its rebound with modest growth in the fourth <unk> 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 remain Wisconsin's most active mortgage lender in 2019 and grew originations in the fourth quarter, giving us positive momentum as we head into 20.
[noise] turning to slide six as shown in the left graph, our oil and gas balances decreased by nearly 100 million from the end of Q3 D. into Q4 after wrapping up the fall borrowing base Redetermination period, we benefited from more credit resolution some payoffs than we previously anticipated looking ahead.
Should we expect balances in this portfolio will stabilize as we near the completion of the plan de risking.
In the middle graph power utility balances have grown by 300 million over the last five 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 2018 and have risen for four consecutive quarters.
Looking forward, we expect to grow our average total loans by 2% to 4% in 2020.
[noise] turning to slide seven we highlight or annual deposit trends.
Average deposits grew 3% or approximately 660 million from a year ago, driven primarily by the Huntington branch acquisition.
We met our Huntington deposit retention goals and expect the same success with first on.
The graphs on the right side of the slide highlight progress we've made in improving our deposit mix, while growing overall deposit balances.
At the end to 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 and lower cost deposits. We saw 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 at these higher costs buttons fell 41% from 2018 and now just represents 6% of our total deposits.
Three mixing of our deposits contributed to the 37 basis point reduction in interest bearing deposit costs over the past two quarters of 29 team.
[noise] fourth quarter deposit details the rod slide eight.
Fourth quarter average deposits were down 1.1 billion 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.
Well interest bearing demand average balances were also down about 300 million. This was due to seasonal outflows as municipal customers drew on 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.
Well, we anticipate these balances may increase in the first quarter 20, as we experienced additional seasonal deposit outflows and we fund anticipated draws on commercial loans. We expect the addition of first start in deposits will mitigate the overall level of non core deposits and further reduce our cost of funding.
While our loan to deposit ratio will remain somewhat 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 nine our investment portfolio declined to 5.6 billion as we sold securities and let balances run off to pay down higher costs funding.
We decreased lower yielding taxable securities by approximately 400 million, while we increased our tax exempt out slightly.
Our portfolio yield increased as we retain less short duration securities and added add is higher yielding longer duration muni bonds.
We expect our securities book to trough in the first quarter.
And anticipate holding the balance said 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 2.686% 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 and acquisition related prepayments and purchase loan accretion in 2019 than we did an 18.
Second our deposits repriced higher in the first part of 19.
They continued to be affected by the rate hike cycle that ended in late 2018.
Lag effect is typical during rate cycles, and often persist 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 dates.
Turning to slide 11, we highlight fourth quarter net interest margin trends.
Net interest income was 200 billion down 6 million from the previous quarter as our repositioning efforts resulted in a smaller balance sheet.
However, our net interest margin increased.
Two basis points from the third quarter as the decrease in our funding costs outpaced asset yield reductions.
The net interest margin results were driven by dynamics on both sides of the balance sheet.
The asset side average one month LIBOR or 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 oversold, and we increase 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% Sumida stay.
Able 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 that 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.
As shown 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 years level.
Controlling costs as long 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 hunting and 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 and 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 for stands 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 four years. We expect this trend will continue.
So looking ahead to 2020, we expect total non interest expense to be between 790 million and 795 million, including the cost of converting and operating for Sutton.
On slide 14, we summarize the annual credit quality trends of the loan book during 2019, the credit environment remain 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 zero in 2018, but down from 26 million in 2017.
As we've previously noted we have already provided floor and reserved 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 in previous years.
As part of the implementation of Cecil 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 Cecil implementation, while we it is hard to our stated priorities to support organic growth pay a competitive dividend pursue end market efficiency, driven acquisitions and repurchase shares.
We increased our digital that 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.
We will restate, our 2020 outlook, which reflects our expectations of a stable economy and the closure of the first on 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 375 385 million.
Noninterest expense anticipated to be between 790 million and 795, including acquisition related costs in connection with the first Dutton transaction.
We expect to 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 continued 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.
Thank you at this time will be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question Q you May press star to if you'd like to remove your question from MCU for participants using speaker equipment and maybe not.
Sorry to pick up your handset before pressing the star Keith one moment, please while we poll for questions.
Your first question comes from line of Scott Siefers with Piper Sandler. Please proceed with your question.
Definitely guys. Thanks for taking my question.
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 on I guess, specifically, where I'd be most curious is in the margin guidance is there any additional purchase accounting adjustment baked into there or is that kind of.
A clean margin guide up to 80 to 85.
Yep.
Clean margin guide and all the first on 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 change in the rates and it was it was a million dollars.
Okay.
Two significant.
All right, though 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 you know 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.
Okay.
Alright, Thank you guys.
Your next question comes from line of Perry Mcevoy with Stephens. Please proceed with your question.
Good evening.
Good evening.
I was hoping you could discuss maybe your thoughts on insurance and mortgage banking in 2020 looks like the insurance.
Dipped a little bit in the fourth quarter. So within the context of that 375 to three to five you could just provide some commentary there. Please.
The insurance business.
Is inherently a slow growing business.
We did a number of acquisitions.
We didnt do any this past year, we'll see what happens in the coming year, but the 375 385 assumes a steady state for the insurance is.
And it assumes.
You know a lower run rate of mortgage banking income than what we enjoyed in the back half of the year given rate stabilization.
Okay and then.
Looking at your noninterest expenses I see the 1.3 million dollar acquisition related costs.
Did I Miss some severance severance expenses as well in the fourth quarter is that into the 203.6 million dollar number.
It is tear and if you look at page 10 of our press release tables, we break out the severance specifically.
Sounds the four for the quarters three in change it rounds up before it was five for the year and for the fourth quarter relative.
Okay. Thanks for pointing that out Chris Thanks, guys.
Yes.
Your next question comes from the line of Jon Arfstrom with RBC. Please proceed with your question.
Thanks, Good afternoon.
Good afternoon John .
Sure Chris I'm on slide five the decline in general commercial may have touched on a bit but can you go into detail a little bit more about what really drove about.
Yes. It was it was kind of across the board I think we feel it's.
Pretty anomalous, we're not really terribly concerned we anticipate 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.
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 on 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 do the simple math.
I think it suggests maybe it bottoms on our own five and a half billion in Q1 is that.
The right we're thinking about it.
Yes, I think that a bottom out at roughly 17% of assets during Q1, and we're basically bouncing around the bottom now and it will.
It will they won't grow other than portion to our balance sheet as they move through 2020.
You guys almost all but my earnings model, but I was just trying to get through an earning asset number.
Yep.
No plow expense $2 million Snowplows [laughter] Clark.
And it's snowing outside right now it's been great. This winter.
One last one Chris So I know you've done a lot of thinking about Cecil.
How should we think about the provision for 2020.
You get a little bit of an increase in the state of reserves, but what he wants to think about your provision.
Yes. So in general we think our provision should have less volatility under Cecil so it should essentially track growth in the portfolio.
Will be our baseline.
And.
We would anticipate we've got some nice both 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 clinically that's going to stop here at December 30, Onest. 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 provision going forward.
Sure most of your cleanup.
Did you have done as well.
Yeah, we we feel we produce that portfolio substantially.
Other hundred million in fourth quarter.
We don't see a whole lot of charge offs left.
And first stuff that we're worried down about beyond that.
The contribution we're making to Cecil here in this quarter.
Should cover our our worries so I.
I feel pretty good about where we are that.
Alright, thanks to help.
Your next question comes from line of Chris Mcgratty with KBW. Please proceed with your question.
Okay, great. Thanks for the question.
[noise] fill in terms of capital you talked about.
7% floor on the tangible ratio.
Can you speak to inorganic growth opportunities I think in the past you said, one or two small deals or a year, but would be possible and I think recently you talked a little bit more openly about potential merits of the Nemo aid maybe some updated thoughts here.
Yeah. So are you know 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 M. OE is.
Theres a limited number of.
Options.
And we're always open to talking.
Anyone about what make make sense for our shareholders as well as potentially someone else's. So we're open to those discussions.
Great. Thanks.
Your next question comes from line of Jared Shaw with Wells Fargo. Please proceed with your question.
Hi, good afternoon guys.
Chris actually a hit one of my questions, but any any thoughts on.
On acquiring business lines or portfolios apart from your comments on potential whole bank deals.
Sure.
You know you saw us.
Due to Huntington branch transaction, which at the end of the day was almost all deposits and buying a portion of what Huntington has by an out there, Wisconsin stuff. So we're always open to looking at.
Non whole bank deals were particularly interested in.
Looking at opportunities like we had with with Huntington, where we can continue to grow low cost core deposits.
Those kinds of opportunities or you know few and far between of course, but to the extent something 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 priority is continuing to build out the deposit base.
Of course, we can see you'd be interested in asset management related opportunities should they present themselves and insurance transactions as well yeah.
Okay and then.
On your.
On the see every portfolio can you comment on what you're seeing in terms of payoffs paydowns trends and what your expectations are around that as you look I'm 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 back end of 2018 leaking into 2019 that has.
Abated somewhat.
And we don't expect.
You know any elevated payoff activity. So the the funding up a couple billion dollars of.
Commitments that are on our books.
Coupled with new production.
Minus you know reasonable level of payoffs and there's always plenty of payoffs I mean, it's the nature of the commercial real estate business that is somewhat of a hamster wheel of making new loans, having loans pay off 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.
Great. Thank you.
As a reminder, if you'd like to ask a question. Please press star one on your telephone keypad.
As a reminder, if you'd like to ask your question. Please press star one on your telephone keypad one moment. Please while we pull from more question.
Your next question comes from line of Michael Young with Suntrust Robinson Humphrey. Please proceed with your question.
Hey, Thanks for taking the question just wanted to ask about the appetite for residential mortgage on balance sheet production. In 2020 is that impacted by Cecil and do you view that at all as an alternative to securities book growth.
Got it gets your high level thoughts there.
Sure so.
You know the Securities book is going to remain at a lower level than we've historically held as Chris said around that 70% range. So to the extent the balance sheet expands with loans that will creep up a bit.
On the residential mortgage stuff that's a good point clearly cecil causes more credit to be attracted to those loans.
So we're we're going to be very deliberate about what goes on the balance sheet, we have a very active.
Origination sale retained service model here and we'll continue to look it at continuing that model.
But I think it's fair to say that.
You know, we have some reticence to put lower yielding residential mortgages that attract.
Significantly more capital because of the accounting rules and 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 it's kind of customer experience driven versus efficiency efforts et cetera.
Sure.
It 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 tablet.
Most of our.
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've completed we recently completed a complete revamping of our our campaign Martin marketing campaign management system, which automates a lot of our ability to digitally connect with customers and send out hundreds and thousands or millions of emails in an efficient manner. So that's.
It'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.
Okay. Thanks.
Your next question as a follow up from Scott Siefers with Piper Sandler. Please proceed with your question.
Hi, guys. Thank you 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 de risking that portfolio where are your non energy charge offs running these days maybe in terms of basis points would be great. I know there. They are very small, but I'm just trying to.
To get a sense for what the expectation for total charge offs would be if we're going to.
Sunsetting.
On.
The issues in the energy portfolio.
Yeah, I mean, that's that's always hard to prognosticate, because anyone charge up can drive that in this past quarter, we had $14 million net charge offs.
A little less than 10 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 oil and gas and the remainder was was next to nothing I don't have that basis points in front of me, but it's probably a single digit.
Okay.
Alright, perfect. Thank you.
Yep.
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 today, we feel well position 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.
The results in the fourth quarter of our me I'm actually going up two basis points, we feel good about.
Our loan growth, we will manage expenses as we always do a Murray believe we're in a a benign credit environment. So I think we're well positioned to perform well in 2020.
We look forward to welcoming our for certain customers and colleagues in February .
And we look forward to talking all of you in April and as always if you have any questions get was called 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.
Okay.
Okay.