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Associated Banc-Corp (ASB 2.09%)
Q1Â 2019 Earnings Call
April 25, 2019, 5:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good afternoon, everyone, and welcome to Associated Banc-Corp's First Quarter 2019 Earnings Conference Call. My name is Tim, and I will be your operator today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session at the end of this conference. Copies of the slides that will be referenced during today's call are available on the Company's website at investor.associatedbank.com. As a reminder, this conference call is being recorded.
As outlined on Slide 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 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 reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to pages 13 and 14 of the slide presentation and to Page 8 of the press release financial table. 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.
Philip B. Flynn -- President and Chief Executive Officer
Thanks. Welcome to our first quarter earnings call. Joining me today, as usual, are Chris Niles, our Chief Financial Officer; and John Hankerd, our Chief Credit Officer.
Turning to Slide 3, our first quarter earnings were $0.50 cents per share, driven by growing commercial and business lending along with improving expense trends. We had growth of over 5% in our general commercial lending business and saw increases across most of our specialty verticals. This loan growth contributed to a $6 million increase in net interest income on a year-over-year basis. Our non-interest expenses decreased 1% from last quarter, due in part to the elimination of the FDIC surcharge. We experienced our typical seasonal deposit flows and we repurchased $30 million of common stock in the quarter, leaving $181 million on our current authorization available.
Loan details for the first quarter is shown on Slide 4. Total loan balances increased more than 1% from the prior quarter due to growth in commercial and business lending, which was up over 4% from the fourth quarter of '18 and up 15% year-over-year. The increase from the prior quarter was led by growth in our general commercial lending business. We also saw gains in our specialty verticals, particularly in power and utilities. Our C&I loan pipeline remains solid and we expect balances to increase through the remainder of the year.
As anticipated, our commercial real estate loans declined in the quarter due to continued elevated pay down activity. However, we believe we are nearing the inflection point and we expect that this portfolio will begin to show positive growth in the second half of the year as we begin funding our construction lending commitments. We currently have over $1 billion in unused commitments and expect that we will fund $500 million of those over the remainder of 2019.
Our residential mortgage portfolio was up slightly in the first quarter. Growth in this business has been restrained by generally weak sales volume in the housing industry and modest refinance activity.
Turning to Slide 5, average deposits were up $300 million from the fourth quarter. Our deposit mix shifted slightly in the first quarter as we managed our seasonal DDA outflows and funded our loan growth by increasing our interest bearing deposits. We saw the usual deposit outflows from our municipal customers as they continue to draw on government funding they received in the third quarter. Additionally, we saw reduced non-interest bearing balances from consumers and commercial customers as often occurs in the first quarter. We expect these balances will return in coming months. We offset these outflows in part by temporarily increasing our network transaction deposits which were less expensive than alternative funding sources such as FHLB advances.
Despite the increase this quarter, our long-term strategy to reduce these index deposits remains on track. On a year-over-year basis, our network deposit balances decreased nearly $200 million from the first quarter of 2018, continuing the downward trend of network deposit mix as shown in the upper right chart. As announced, we expect to receive approximately $850 million of core deposits in the Huntington branch transaction in June, which will benefit our efforts to further reduce network deposits. Our loan-to-deposit ratio was 91% at the end of the quarter. At the low end of the range, we typically experienced at this time of the year.
Turning to Slide 6, we discuss our net interest income. Net interest income increased $6 million from the first quarter of 2018 but was down from the previous quarter due to lower levels of prepayments and acquisition related accretion. Looking at the graph on the left, the dark green bar depicts our net interest income excluding prepayments, acquisition related accretion and day count effects. Removing these effects, our core net interest income trend has been positive over the last year. We had a $2 million increase in core net interest income in the first quarter of 2019 compared to the previous quarter, driven by higher loan volume. On a year-over-year basis, first quarter net -- core net interest income increased $10 million.
Lower prepayments and accretion drove the significant reduction in our commercial real estate portfolio yield from the previous quarter, which is shown in the graph on the right. These factors have created noise in the commercial real estate portfolio yields over the last year, but we expect that the yields will remain near current levels for the remainder of 2019 barring any Fed rate actions. While our total interest bearing liabilities cost increase driven in part by our deposit mix shift, the rate of increase this quarter slowed slightly compared with the increases seen in 2018.
Going forward, we expect that upward pressure on liabilities costs will be mitigated by several factors. First, the Fed has meaningfully changed its tone regarding rate increases and we now expect that there will be no additional Fed action in 2019. This should stabilize the cost of our index based funding.
Second, we expect that core deposit balances will increase from the Huntington transaction in June and from seasonal deposit inflows in the third quarter, enabling us to reduce higher cost funding.
Third, we anticipate our relatively low loan-to-deposit ratio to enable us to fund anticipated loan growth without having to pay up for funding. Given our anticipated loan growth and reduced upward pressure on funding costs, we expect that our core net interest income will continue its upward trend for the remainder of the year.
Turning to Slide 7, we show the margin impacts of lower prepayments and accretion. We've also detailed the quarter-to-quarter impacts of day count and the Fed Funds LIBOR spread. Prepayments and accretion negatively impacted our first quarter net interest margin by 12 basis points compared to the previous quarter. The dark green bar in the graph on the left side of Slide 7 shows our core margin without the prepayments, accretion and date count effects. Excluding those effects, we grew our core margin over the last two quarters and by five basis points year-over-year. The right side of Slide 7 shows a walk down between the third quarter of '18 and fourth quarter of '18 on the top graph and between the fourth quarter of '18 and the first quarter '19 on the bottom graph. We've also broken out the negative impact of the compressed Fed Funds LIBOR spread.
As you can see, our loan and funding composition has had a positive impact on our margins in each of the last two quarters. While much of this quarter's lower net interest margin is explained by the factors I've mentioned, we also recognized that the interest rate environment was meaningfully shifted since the end of 2018. The yield curve is flatter and rates on the long end are significantly lower. These lower long-term rates have reduced our expectation for our mortgage portfolio yields and to a lesser extent our securities portfolio yields.
Additionally, compression in the Fed Funds LIBOR spread has persisted, further decreasing our NIM estimates. Consequently, we now expect our 2019 net interest margin to be stable or slightly lower than it was in 2018, assuming no additional Fed action.
Turning to Slide 8. First quarter non-interest income of $91 million was up $7 million from last quarter and up $1 million year-over-year. The increase from last quarter was primarily driven by our insurance business, as we realized seasonally higher income from property and casualty contingency fees. Additionally, our mortgage business was up this quarter, due to increased gain on loan sales and we had asset losses in the prior quarter that did not occur in the first quarter. These gains were offset somewhat by lower service charges and deposit account fees, as our customers typically incur lower non-sufficient funds fees in the first quarter than they do in the fourth quarter. Our capital markets fees were also down due in part to lower interest rate swap income.
Moving to Slide 9. Non-interest expense of $192 million was down a $1 million from the fourth quarter and well below the run rate of $800 million full year guidance that we provided. The decrease was driven by the discontinuation of the FDICs surcharge, resulting in a $2 million reduction to Associated's FDIC assessment. Certain pension and miscellaneous employee expenses were also down this quarter. The benefit of these decreases was partially offset by higher stock compensation expense adjustments. We also had higher occupancy expense due to elevated snow removal costs which we sincerely hope will not recur in the second quarter.
Looking ahead to the remainder of 2019, we expect to incur one-time charges related to the Huntington transaction of approximately $7 million with the majority occurring in the second quarter and the rest in the third quarter. We also expect our expense run rate to increase in the second half of the year as a result of the 14 net additional branches and additional customer activity. We anticipated these Huntington related expenses when we previously provided our non-interest expense guidance and we continue to target $800 million of expenses for the full year. Our adjusted efficiency ratio was 61.6% in the quarter. We remain confident that we will achieve our guidance of 100 basis point improvement in our full year adjusted efficiency ratio.
On Slide 10, we detail our quarterly credit quality metrics. Potential problem loans decreased by $9 million in the quarter. Non-accrual loans increased to $156 million. While this is an increase over the fourth quarter, non-accrual loans are flat compared to the third quarter and down from the first quarter of 2018. Net charge offs were $7 million in the quarter, up from the previous quarter but down from levels seen in the first three quarters of 2018. The aggregate allowance for loan losses was 1.02% of total loans, essentially unchanged from the previous two quarters. And our provision for credit losses was $6 million, up from a $1 million last quarter, but still relatively small in relation to our $23 billion loan portfolio. Our credit environment remains benign.
On Slide 11, we updated our outlook for the rest of 2019. We continue to anticipate 3% to 6% average loan growth for the year. We expect continued solid and commercial industrial growth and our commercial real estate portfolio will begin to ramp up in the second half of the year. Given the Fed's more dovish outlook in the flatter yield curve, we now expect our full year net interest margin will be in the mid to 90s range based on no additional Fed rate action. We continue to expect our fee based revenues will improve year-over-year. We're comfortable that we'll be able to meet the $800 million non-interest expense guidance.
Our capital priorities have not changed as we look to fund organic growth, pay a competitive dividend, pursue non-organic growth opportunities and repurchase shares. We remain disciplined in our approach to acquisitions and share repurchases as we look to optimize capital and build shareholder value.
And with those comments, I'll open it up for your questions.
Questions and Answers:
Operator
Thank you. At this time, we will be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Scott Siefers of Sandler O'Neill. Please proceed with your question.
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Good afternoon guys. Thank you for taking the question. I guess, I was hoping to just delve a little into the lower prepayments for the quarter. I guess, just as you look at things that's something that's going to prove transient, in other words, would be -- would we expect that to go up to somewhere between, call it 5 and 10 basis points a quarter of benefit to the reported margin or is this lower kind of 2 basis points level sort of the new run rate, and I guess, if so why or why not?
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
Sure. So Scott, you'll recall, we closed on the Bank Mutual acquisition. And if I draw your attention to Page 7 or Slide, we noted we had not planned for the accretion when we closed on the transaction, and the way it came in was probably a little lumpier than we had anticipated. So you'll notice the dark orange bars on a chart sort of bounce around between 7 and 13 basis points over the last four quarters. We think we've run through most of the big box essentially that would have come through that. I trust that there won't be more, but it's very hard to predict. But at this point in time, we think the larger part of the accretion, if you sort of look at our press release tables, you'll see we started off with $34 million of net unaccretive discount. We're down to $16 million now. So it's very clear to say, more than half of it is run through. So to -- you threw out 5 basis points that seems in the high end, because the numbers from last year would be at, probably cut in half just by definition, because half of balances are gone and what's left is likely to pay off on a more steady basis. So I would say, it's going to be hopefully a little more than 2 basis points, but probably not more than 5 basis points. But again, it's lumpy and if it comes to us in lumpy terms, it's hard to predict.
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Yeah. Okay. Now that's helpful color. I appreciate it. So it sounds like maybe this new level is sort of a better base to go off.
Philip B. Flynn -- President and Chief Executive Officer
No. And we try to make that point Scott along the way and went to some trouble to present the slides so that you can really see what the core NIM is in that dark green bars, which is (multiple speakers) right.
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Yeah, exactly. And that is a perfect segue into what I was going to ask. That's sort of a follow up. As we look at sort of the flat to down slightly guide for the reported March for the full year, are we sort of saying that the core margin may actually keep increasing a bit while those...
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
That is our expectation. We've -- because of what we're seeing on the commercial long road side on the one hand and because of the anticipated flow back in of our normal seasonal deposits and the addition of the lower than market costs coming from deposits, we think we'll have positive tailwinds for ourselves on the margin over the next several quarters on the core margin.
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Yeah, perfect. Thank you very much. And if I could slip one -- separate one in here. I appreciate the -- telling us about the roughly $7 million of one-time costs related to the Huntington transaction? I know the sort of steady state or ongoing costs of that transaction are already embedded in to your guidance for the full year expense number of about $800 million, but are you able to share roughly what the ongoing costs from those branches are expected to be?
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
We haven't detailed that in general, but the costs of running the branch kind of tend to be several hundred thousands, $400,000-ish per branch is what we will assume and there'll be some operation on back office, customer service costs on top of that for processing transactions.
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Yeah, OK. All right. That's perfect. Thank you guys very much. I appreciate it.
Operator
Our next question comes from the line of Chris McGratty of KBW. Please proceed with your question.
Chris McGratty -- KBW -- Analyst
Great. Thanks. Chris, maybe another question for you on the deposit costs. Many of your competitors, and I think you're sending the same message, have talked about less promotional activity in your markets. So I'm interested in some comments there and also relative to the 1.3% average cost interest bearing deposits in the quarter. do you have spot rate as of March 31st?
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
I don't have the spot rate as of March 31st. We don't generally look at that on a daily count basis. But to the broader point, if I look at Page 6 was detailed sort of the yields by class. We're not doing anything with savings account rates. They're going to stay low, and we have the press release table, sorry, interest-bearing demand rates don't seem to have a lot of upward pressure on them nor do money market at this point in time. And network deposits are market based funding. We're going to look to reduce those as we reduce balances over time.
And CDs is where all the promotional activity had been focused on for the last six to nine months, and that's probably one of the larger drivers of our yield on interest-bearing liabilities going up, and that's where we've seen -- we would echo some of the sentiments from our regional bank peers. People are taking a look at those longer dated CD specials and it's starting to back them off. I think the FDIC data came out this week, and of the 22 categories tracked, six of them have showed declines. And so my expectation is, we'll continue to see longer-dated CDs priced north of Fed funds continue to come off the table at many of our competitors. And we're (Multiple Speakers)
Chris McGratty -- KBW -- Analyst
Great. And maybe one more on the securities. You mentioned in your opening remarks kind of more challenging reinvestment rates. Are you -- what -- I guess, what's the plan to either grow or shrink or hold balances flat in the bond book and then also kind of where are you putting on new -- where is kind of new money put on today?
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
Yeah. So as you can see, we really haven't moved the balances there much on a quarter-to-quarter or year-over-year basis. So you can surmise that we're looking to the securities book as a source of funds, not a place to put new funds. And that's in part because, new yields are on taxable stuff in the low 3s and it just doesn't make sense to us to put on stuff in the low 3s.
Chris McGratty -- KBW -- Analyst
Okay. And then (Multiple Speakers)
Philip B. Flynn -- President and Chief Executive Officer
We'd rather make more loans.
Chris McGratty -- KBW -- Analyst
Okay. I got it. Thanks. The $800 million -- does the $800 million, can you remind me does that include those charges from Huntington the one-timers or is that exclusive? I can't remember.
Philip B. Flynn -- President and Chief Executive Officer
It's all included.
Chris McGratty -- KBW -- Analyst
Okay. Thank you.
Operator
(Operator Instructions) Our next question is from the line of Jon Arfstrom of RBC Capital Markets. Please proceed with your question.
Jon Arfstrom -- RBC Capital Markets Corp -- Analyst
Thanks. Good afternoon.
Philip B. Flynn -- President and Chief Executive Officer
Good afternoon, Jon.
Jon Arfstrom -- RBC Capital Markets Corp -- Analyst
Question on the loan growth guidance, more bigger picture, Phil. But, where's your head at today in terms of the range. I mean, it seems like you had a pretty good loan growth, causing you to be pretty optimistic, but give us an idea of kind of the puts and takes to the higher end or lower end of the range?
Philip B. Flynn -- President and Chief Executive Officer
Yeah, I mean, we had a good quarter after having watched loan balances basically shrink over a good piece last year. So our commercial backlog is strong. Our specialty units look good. As I mentioned, we've done a lot of work around our commercial real estate book to try to estimate when we're going to get that term, because we've been making a lot of new loans and new commitments. So in the not too distant future, those lines will cross and we'll start to see growth there. And resi mortgage will continue to bump along, but at a much slower pace than we've seen in some years. But all in all, we feel very comfortable with that range and I think it would be fair to say that it's probably moving toward the higher end of that range at this point as we look out.
Jon Arfstrom -- RBC Capital Markets Corp -- Analyst
Okay, good. That's helpful. And then, I guess, the other unasked question here is just on the provision in terms of how you guys think we should think about the provision. I mean, obviously you had a little bit this quarter, it was nothing a year ago, but what's the message in terms of adjusting the risk rate and indications of credit quality and loan volume? How should we be thinking about it?
Philip B. Flynn -- President and Chief Executive Officer
Sure, so keep in mind that last year we really didn't have a lot of loan growth. So that weighed on the fact that we didn't have any provisioning. We had loan growth this quarter. So that's a piece of it. So if we continue to have the really decent loan growth that we expect, we'll be providing along the way, of course. But you know the overall portfolio from a credit quality point of view still looks unbelievably good. 10 years into a credit recovery cycle, but we're still there.
Jon Arfstrom -- RBC Capital Markets Corp -- Analyst
Okay. All right. That helps. Thank you.
Operator
Our next question comes from the line of Michael Young of SunTrust Robinson Humphrey. Please proceed with your question.
Michael Young -- SunTrust Robinson Humphrey -- Analyst
Hey, good evening. Just wanted to -- I wanted to ask just on the kind of loan mix. Historically you guys have always targeted a third, a third, a third, and commercial real estate has come down to be a pretty small percentage of the balance sheet now. And the other commercial categories are growing maybe at an outsize pace relative to that. So just trying to think about it going forward how you're thinking about kind of the balance of the loan book?
Philip B. Flynn -- President and Chief Executive Officer
Yeah. So good question. You know we've never tried to dial it into exactly 33% for each of the three major food groups. They operate in a range. Certainly commercial real estate has fallen down to what probably about 25%-ish percent right now, maybe a little more than that, but somewhere around there. Yeah, we expect as we get further into the year that we'll have commercial real estate growth. But we, in particular, want to continue to grow our commercial -- general commercial loan book, because obviously it's diverse, it covers lots of different industries. We are and have been very deliberate about growing commercial real estate over these last few years just because we are so late in the cycle as I was referencing a moment ago. It's not to say that we're not comfortable with what we're putting on. We're very comfortable with it. But it's cycle. So we're very diligent about concentrations on geographies and product types and all that kind of stuff.
Michael Young -- SunTrust Robinson Humphrey -- Analyst
Okay. And one last one just on the deposit side if I could go there. Just on the network deposits, if we're not going to see any more rate hikes going forward, I mean, is there an interest in going ahead and terming some of that out and really reducing it. I know in the past you wanted to hold it at a certain level to have that lever available, but maybe just any updated thoughts, big picture on network deposits there?
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
Sure. So I mean I guess the good news is, assuming rates don't go higher, the expected beta on that stuff will be zero for the foreseeable future. And the one upside, perhaps, to network deposits is, they also have a beta of one on the way down. So essentially there -- there's a hedge there again, a Fed lowering rates, unexpectedly honest, which has some of the consequences. But nonetheless, we'd look to -- continue to sort of manage that book down, as you can see in real core deposit. So ideally, the best answer here is, we'll continue to add and grow core deposits over the balance of the year and through the acquisitions, and as a result, mitigate our need to have that market based funding there.
Philip B. Flynn -- President and Chief Executive Officer
And putting $850 million of core deposits on from Huntington is going to be a big help there.
Michael Young -- SunTrust Robinson Humphrey -- Analyst
Okay. Thanks.
Operator
At this time, there are no further questions over the audio portion of the conference. I would like to turn the conference back over to management for closing remarks.
Philip B. Flynn -- President and Chief Executive Officer
Okay. Well thanks for joining us today. I'm really pleased with this quarter's loan growth and lower expense trends. We're optimistic, as I mentioned for continued long growth and we expect to maintain our effective cost controls for the rest of the year. We look forward to welcoming Huntington's Wisconsin branch customers to Associated in June and to talking to all of you again in July. So if you have any questions in the meantime, give us a call. As always, thanks for your interest in Associated.
Operator
This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.
Duration: 28 minutes
Call participants:
Philip B. Flynn -- President and Chief Executive Officer
Christopher J. Del Moral-Niles -- Executive Vice President, Chief Financial Officer
Scott Siefers -- Sandler O'Neill & Partners -- Analyst
Chris McGratty -- KBW -- Analyst
Jon Arfstrom -- RBC Capital Markets Corp -- Analyst
Michael Young -- SunTrust Robinson Humphrey -- Analyst
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