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Associated Banc-Corp (NASDAQ:ASBC)

Q4 2012 Earnings Call

January 17, 2013 5:00 pm ET

Executives

Philip B. Flynn – President, Chief Executive Officer & Director

Christopher J. Del Moral-Niles – Chief Financial Officer & Executive Vice President of the company and bank

Scott S. Hickey – Executive Vice President, Chief Credit Officer of the company and bank

Analyst

Scott R. Siefers – Sandler O’Neill & Partners, LP.

Christopher McGratty – Keefe, Bruyette & Woods

Emien Harmon – Jefferies & Co.

Dave Rochester – Deutsche Bank Securities

Ken Zerbe – Morgan Stanley

Jon Arfstrom – RBC Capital Markets

Matthew Clark – Credit Suisse

Terry Mcevoy – Oppenheimer & Co.

Steve [Sigerello] – UBS

Peyton Green – Stern, Agee & Leach

Mac Hodgson – SunTrust Robinson Humphrey

Welcome to the Associated Banc-Corp’s fourth quarter 2012 earnings conference call. At this time all participants are in 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.AssociatedBanc.com. As a reminder, this conference call is being recorded.

During the course of the discussion today, Associated’s 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. Addition 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 10K and on any subsequent SEC filings. These factors are incorporated herein by reference.

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.

Philip B. Flynn

Welcome to our fourth quarter earnings conference call. Joining me today are Chris Niles, our Chief Financial Officer and Scott Hickey, our Chief Credit Officer. Highlights for the fourth quarter are outlined on Slide Number Two. This quarter’s solid results were driven by strength across all of our businesses. In spite of the many uncertainties during the quarter our bankers remained focused on serving our customers and growing the franchise.

For the quarter we reported net income to common shareholders of $45 million or $0.26 a share and that compares to net income of $40 million or $0.23 a share a year ago. Return on tier one common equity for the quarter was 9.6% up from 9% a year ago. Loan balances increased by 3% during the quarter with the majority of growth coming from the commercial portfolios. Average deposits increased by 7% from the third quarter to $16.7 billion with period end non-interest bearing deposits growing by 10%.

Net interest income increased by $6 million compared to the last quarter and the increase included approximately $2 million of non-recurring interest income received during the quarter related to an income tax refund. Our net interest margin for the quarter was 332 basis points. Credit quality indicators continued to improve and we recorded a $3million provision for loan losses during the quarter, entirely driven by loan growth.

We increased the quarterly dividend 60% to $0.08 per share and we repurchased $30 million of common stock, or about two million shares at an average price of $12.70. Even after completing these capital actions, our tier one common equity ratio remains very strong at 11.58%.

For the full year on Slide Three we reported net income to common shareholders of $174 million or $1 per share, a significant increase from $0.66 per share in 2011. Return on tier one common equity for the full year was 9.5%, up from 6.7% last year. Total loan balances increased by $1.4 billion during 2012 representing 10% year-over-year loan growth. Net interest margin for 2012 increased to 330 basis points from 326 last year as we reduced our deposit and funding costs.

Credit quality indicators improved significantly with non-accrual loans 29% lower than a year ago. We’re proud of the progress the company has made on capital management as we redeemed all outstanding trust preferred securities, increased the dividend twice, and repurchased a total of $60 million of stock during 2012. We will continue to remain focused on effectively managing and deploying our capital in order to drive long term value for our shareholders.

Turning to Slide Four, over the past three years we’ve cleaned up the credit book, addressed regulatory matters, and embarked on a strategy to grow Associated in the markets we serve. We’ve made significant investments in people and systems in order to position the company for the future. This past year we saw some of the results from our investments and hard work as loan balances continued to grow at the top end of peers, credit continued to improve, we defended the margin in a low rate environment and we deployed capital through various actions in order to build value for our shareholders.

Looking to 2013, we believe that associated is very well positioned to focus on growth opportunities and to capitalize on market disruptions and win business from clients across our footprint. Given the current low rate environment, we’ll have to be very focused on defending the margin throughout the year and we’ll continue to look for and drive efficiencies in order to effectively manage expenses. We will also continue to look for ways to deploy capital in accretive value added transactions.

Let me share some detail on the main performance drivers during the quarter. Loan growth is highlighted on Slide Five. Loan balances continued to grow during the quarter with net growth of $445 million. This represents a 3% quarter-over-quarter growth rate and a 10% increase year-over-year. Growth during the fourth quarter was well balanced with increases to most major portfolios.

Commercial and business lending balances increased by $262 million during the quarter and were driven primarily by growth of $174 million in general commercial loans which include middle market C&I activity. Part of this quarter’s growth in general commercial loans was driven by year end related customer activity. We would expect that middle market commercial loans in the first quarter will be flat with the fourth quarter level given seasonality and the strong activity at year end.

We experienced continued but slower growth in our specialized lending portfolios during the quarter including a $50 million increase in mortgage warehouse lending. Growth of $77 million in power and utility loans was partially offset by a decline in oil and gas lending from the third quarter of $39 million. Oil and gas and power and utilities loans collectively represent 4% of the total loan portfolio, about the same as the third quarter.

Commercial real estate loans grew by $164 million during the quarter and was comprised of $120 million of income producing loans and $44 million of construction loans. The growth in investor commercial real estate loans was driven by about $60 million of multifamily and $30 million of office building secured loans and in the construction space growth was the result of increase in multifamily and retail projects.

Residential mortgage loans grew by $172 million or 5% during the quarter. Approximately 20% of this quarter’s residential mortgage growth came from hybrid ARM products with the remainder comprised of 15 year and under fixed rate product. We continue to be disciplined and have seen pricing hold up near the 3% level on mortgages we hold on the balance sheet. We’re continuing to sell 30% year production to the agencies through our mortgage banking operations.

The retail loan portfolio which includes mostly home equity loans continues to experience pay downs and declined $153 million from the prior quarter. We expect to continue to see run off in these portfolios into 2013 as consumers deleverage and refinance into lower priced first lien mortgages. The composition of the home equity book remains stable from the prior quarter with first lien home equity loans accounting for about 55% of the total portfolio.

Regarding the recently published qualified mortgage guidance, while we’re still reviewing the materials, Associated’s long standing lending practices already include many of the rules suggested. We believe that we’re currently operating largely in line with the proposed guidelines and we don’t expect material changes to our underwriting and origination procedures.

Turning to Slide Six, average deposits of $16.7 billion were up 7% from the third quarter and have grown by $1.8 billion or 12% from a year ago. Period end non-interest bearing account balances are up $439 million from the third quarter and have grown by 21% from a year ago. Although some of this quarter’s non-interest bearing deposit growth was the result of customer’s seasonal year end account activities, we’re pleased with the continued strength in deposit in flows. During the quarter, we also saw increased deposit flows from municipalities and bankruptcy trustees. Investments in our commercial deposit and treasury management platform as well as investments into the retail network are continuing to bear fruit.

Although it’s still early after TAG expiration, we’re encouraged by the strength of our deposit relationships and believe that a well capitalized and highly rated institution such as Associated, will be a net beneficiary of the expiration of the program. Total CDs declined by $103 million during the quarter consistent with our disciplined deposit pricing. Together higher cost CDs and customer repo agreements have declined by over $1.4 billion from a year ago.

Net interest income grew by $6 million or 4% quarter-over-quarter and the net interest margin for the fourth quarter was 332 basis points. Excluding the $2 million of non-recurring interest income related to the tax refund, net interest income would have grown 2% quarter-over-quarter and the net interest margin would have been closer to 3.29%.

Liability management drove most of the benefit to the NIM this quarter as we grew lower cost deposits and we redeemed our trust preferred securities. Over the past year yields on earning assets have compressed by 11 basis points while we’ve managed down interest bearing liability costs by 27 basis points enabling us to defend the margin at a fairly tight band around the full year 2012 level of 3.3%.

Our expectation for 2013 is that earning asset yields will continue to compress over the course of the year while our ability to manage deposit costs lower becomes more challenging. We do see some continuing benefit from repricing of the CD book over 2013 and of our approximately $500 million of higher rate federal home loan bank advances maturing during the first half of 2013 that will provide some level of support to the margin. Additionally, we do have about $25 million of 9.25% subordinated debt outstanding that becomes callable in October and we would expect to redeem that.

Total non-interest income for the quarter was $78 million, down $3 million from the third quarter. Net mortgage banking income declined by $2 million primarily due to the establishment of a $3 million repurchase reserve against previously sold mortgage loans. Although we have seen only a limited number of repurchase claims over prior quarters, similar to other banks, this activity has steadily increased during 2012 and particularly during the fourth quarter resulting in our decision to establish the reserve.

In other non-interest categories, we saw increases in card based fees and capital markets fees that were offset by declines in insurance commissions and service charges on deposits during the quarter. Although service charges on deposits declined slightly, we believe these revenues will continue to improve as we grow our customer base. We also recognized lower net asset losses compared to the third quarter that was offset by lower realized gains from the sale of investment securities.

Non-interest expense for the quarter increased by $7 million or 4% and for the full year total non-interest expense of $681 million increased by 5% compared to the full year 2011. The fourth quarter increases in personnel and occupancy expense accounted for $6 million of the $7 million total increase in non-interest expense of which four was directly attributable to severance and lease breakage costs related to our recently announced branch consolidation plans and other efficiency initiatives.

Legal and professional fees remained elevated during the quarter driven by continued cost related to ongoing BSA enhancements. The majority of expense related to BSA has been incurred and totals approximately $17 million, $10 million of which was expensed in 2012. We would expect lower legal and professional fees in 2013.

On Slide Seven, credit continued to improve over the course of 2012. Net charge offs of $21 million for the quarter were impacted by two notable items. First, we implemented a change in our practices for non-affirmed home equity and mortgage loans discharged in bankruptcy proceedings which resulted in $5 million in charge offs during the quarter. Second, during the quarter we completed a note sale of 185 small commercial loans with an unpaid principle balance of $10 million that resulted in $4 million of charge offs. In the future, we expect to continue to review opportunities such as this note sale to efficiently remedy small non-performing loans.

For the full year, net charge offs declined by 44% to $84 million and we expect lower net charge offs in 2013. Potential problem loans declined to $361 million from $404 million last quarter and from $566 million a year ago. The level of non-accrual loans to total loans continued to improve to 1.6% from 1.9% at the end of the third quarter and have improved for 11 consecutive quarters. Total non-accrual loans of $253 million were down from $278 million at the end of the third quarter and down $357 million from a year ago.

The allowance for loan losses now equals 1.93% of loans, covers 117% of period end non-accruals. The provision for loan losses for the quarter was $3 million. We expect provision expense to increase with new loan growth in 2013.

On Slide Eight our capital ratios continue to remain very strong with a tier one common equity ratio of 11.58%. We are well capitalized and well in excess of the proposed Basel III expectations on a fully faced in basis. These strong capital levels have allowed us to complete the series of capital actions in the fourth quarter and throughout the past year.

Our priority for capital deployment continues to focus on organic growth. We look to grow the dividend over time in line with earnings growth and will continue to evaluate other opportunities to optimize our capital structure over the coming year.

Our full year 2013 outlook is outlined on Slide Nine. We expect loan growth in 2013 in the high single digit range from year end to year end. This outlook is in line with performance from the second half of 2012. We expect the first quarter’s loan growth to be seasonally low. We’ll remain focused on disciplined deposit pricing and we’ll look to continue to grow core retail deposits and commercial deposits through our enhanced treasury management offerings.

We expect modest net interest margin compression over the course of the year driven by continued pressure on earning asset yields. We expect to defend margin compression through liability repricing and refinancing actions to partially offset asset yield compression. We expect total non-interest expense for 2013 to be flat on a year-over-year basis compared to the 2012 reported level. Benefits from reduced regulatory costs are expected to be offset by continued investments in the franchise. Credit trends are expected to continue to improve with provision expense increasing with new loan growth. Capital deployment was a priority in 2012 and will continue to be a priority in order to drive long term shareholder value.

With that, we’ll open it up for your questions.

Question-and-Answer Session

Operator

(Operator instructions) your first question comes from Scott R. Siefers – Sandler O’Neill & Partners, LP.

Scott R. Siefers – Sandler O’Neill & Partners, LP.

My first question was just on the reserve build for mortgage repurchase issues. I guess that could be one or two things, just sort of general elevated levels of repurchase requests or a new thing that a lot of the big banks learned about back in December was the increased look back period from ’04 to ’06. I guess, what dynamics were at play in the need to build that up please?

Christopher J. Del Moral-Niles

It’s not an increased look back period. What we have seen is we’ve seen very moderate and practically immaterial volume in this area in 2009 and ’10. We saw a modest amount of increase but was still relatively immaterial in ’11 and into the first part of ’12 and we saw increasing volumes of requests coming through in 2012. So we thought it was prudent and appropriate given the new OCC guidance that was out there and what we saw others doing to establish a reasonable and prudent reserve. The bulk of the activity was related to ’06, ’07, ’08 lending and we think it’s a reserve that’s in line with peer levels and appropriate for the level of our foreclosure activity.

Scott R. Siefers – Sandler O’Neill & Partners, LP.

Does that kind of cover you for both Fannie and Freddie or just one of them?

Christopher J. Del Moral-Niles

No, it’s for all agency activity.

Scott R. Siefers – Sandler O’Neill & Partners, LP.

I just want to make sure I understand the provision guidance for next year. It’s still an excellent and still improving credit profile overall and I just want to make sure, it sounds like the provisioning for next year is probably going to look a lot like what we saw in the third quarter where kind of some nominal provision just for loan growth but not necessarily to cover whatever charge offs might come through.

Christopher J. Del Moral-Niles

Let’s be clear, the third quarter was zero. The fourth quarter was $3 million and that’s largely to accommodate growth and we’ll continue to provide to accommodate growth provided the credit trends continue to improve.

Philip B. Flynn

Just a little more on that, we’ve seen continued meaningful improvement in our credit quality now for three years. We’ve also seen significant loan growth over the last two years so the benefit of improvement in the credit portfolio has offset the need to provide for loan growth over the last two years in a meaningful way but that benefit is coming to an end now with the credit portfolio having improved to the point it has and with continued robust loan growth, we expect the need to cover some of that with provisioning.

Scott R. Siefers – Sandler O’Neill & Partners, LP.

But, it doesn’t sound like the provision is going to be anywhere near what an anticipated level of charge offs would be in the coming year?

Philip B. Flynn

Likely not.

Operator

Your next question comes from Christopher McGratty – Keefe, Bruyette & Woods.

Christopher McGratty – Keefe, Bruyette & Woods

On the expenses, just so I’m clear, the run rate for ’13 is off the reported $682, right?

Philip B. Flynn

Correct.

Christopher McGratty – Keefe, Bruyette & Woods

Can you talk about capital deployment through acquisitions? I think during the past quarter you talked more openly about completing possibly a bank deal. Can you talk about maybe what markets, what size and then do you think in reality you’ll announce a deal this year?

Philip B. Flynn

What we’ve been talking about is a desire to deploy capital in an accretive way. We think the best way to do that is to look at opportunities in our markets where we have scale so that if we were to acquire part of an institution or an entire institution there would be very significant and highly likely costs take outs to drive the economics of the transaction. I think it’s reasonably likely we’ll do something this year along those lines.

Christopher McGratty – Keefe, Bruyette & Woods

Then this last one and I’ll just back in the queue, the tax benefit of $5 million there was also the $2 million to spread income, those are two separate adjustments we should be making? Am I interpreting that correctly?

Christopher J. Del Moral-Niles

That’s correct, those are two separate transactions.

Operator

Your next question comes from Emien Harmon – Jefferies & Co.

Emien Harmon – Jefferies & Co.

Can you talk about your loan growth guidance? You guys pointed as a kind of high single digit, can you give us a sense of the mix of loan growth and just kind of which areas of the loan book you think are going to be supporting that?

Philip B. Flynn

When you look at what we just did in the fourth quarter, we had essentially completely balanced loan growth between commercial banking activities, commercial real estate activities, and our residential mortgage business somewhat offset by the continued decline in the home equity loan book. We expect balance growth like that next year. In other words, all of our major businesses are doing quite well in regards to loan growth.

Emien Harmon – Jefferies & Co.

If I think about maybe the commercial loan book specifically, you guys have obviously been beneficiaries of picking up some market share kind of in your home market. Do you expect that to continue as well or is the mix within the commercial book maybe going to change a little bit as well?

Philip B. Flynn

No, we expect to grow our basic commercial banking business in our footprint as well as grow the specialty businesses that are in the commercial areas as well.

Emien Harmon – Jefferies & Co.

I did notice the commercial or specifically the C&I loan yields were up quarter-over-quarter and I’d just be kind of interested in terms of the business mix that’s actually driving you to see expansion there where the majority of your peers are seeing those yields compress.

Christopher J. Del Moral-Niles

We did benefit from a few interest recoveries that accrued to us during the quarter that particularly had an impact on the improvement in the C&I book. The overall trend continues to be more of a defensive trend not a increasing trend without the benefit of those recoveries.

Operator

Your next question comes from Dave Rochester – Deutsche Bank Securities.

Dave Rochester – Deutsche Bank Securities

Could you just update us on loan pricing trends on the commercial side? I know you mentioned resi was around 3% which sounded pretty stable with last quarter. Are you seeing that kind of stability on the commercial side as well?

Philip B. Flynn

It’s stable to the extent that we’re picking and choosing what type of credit we’re putting on. In some markets, particularly in some of the leveraged or sponsored business I think pricing is becoming quite competitive to the point where you have to ask yourself whether you’re getting an appropriate return for the risk so we’re being selective there. I guess the word to take is that we’re being disciplined about not just the residential mortgages that we’re putting on but we’re making sure we’re getting paid for the commercial real estate, the specialized book as well as the basic commercial banking business.

We have fully implemented a risk adjusted return on capital model throughout all of our business lines. Our incentives are paid off of that as well as earnings throughout all of our business lines and so people are quite focused on making sure that they are being paid for risk and getting an appropriate return on capital.

Dave Rochester – Deutsche Bank Securities

Just switching gears to the balance sheet, I noticed that securities grew along with short term borrowings. I was just wondering what the driver was for that and if we should expect to see more of that in 2013?

Christopher J. Del Moral-Niles

We prefunded some purchases at the end of the year in anticipation of volumes and activities going into the first of the year. So we purchased securities that largely settled late December. We borrowed short term knowing we would get deposit inflows right at the end of the year that would carry that into the first quarter so it’s just a prefunding of first quarter activity.

Dave Rochester – Deutsche Bank Securities

You guys are just buying more of the same stuff?

Christopher J. Del Moral-Niles

Yeah, no material changes in our overall investment philosophy, structure, or composition.

Philip B. Flynn

You certainly shouldn’t expect to see the securities book grow by $0.5 billion a quarter.

Dave Rochester – Deutsche Bank Securities

Just one last one on the expense side, heading into next quarter I know year-over-year we should be flat. Should we start to see the step down in 1Q despite any kind of seasonal bump up you might get? I mean, are the expense cuts going to cut into that and actually drive that number down in 1Q?

Philip B. Flynn

I would expect that 1Q would probably be down, yes. We’re trying to think about yearly numbers and drivers because any quarter can move around a bit. But clearly, the BSA expenses are very largely behind us. We had some unusual expenses in the fourth quarter related to efficiency moves which won’t be repeated. So yes, I would think you would start to see it moderate.

Christopher J. Del Moral-Niles

The fourth quarter is typically our highest net expense quarter so you’ll see it moderate.

Operator

Your next question comes from Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

Just a couple of quick ones, in terms of FHOB advances, you said they come due in the first half, do you have more specific timing on that? Is that lump sum or is that several tranches over the two quarters?

Christopher J. Del Moral-Niles

There are $500 million tranches, $200 million in the first quarter and $300 million in the second.

Ken Zerbe – Morgan Stanley

The other thing, can you just explain a little bit the $200 million benefit, I think it was interest on a tax refund in [NII] line, was that related to the $5 million of refund because it seems like a rather large amount of interest?

Christopher J. Del Moral-Niles

Actually, the refund was actually $50 million and it’s related to the way we had accounted for essentially our loan losses and we were able to go back in and recharacterize our loan losses for tax purposes and amend our return and claim back $50 million that we had not previously claimed and the interest was related to those which was in turn filed for ’09 and ’10 and the interest therefore related to that was almost $1 million as we received it in the fourth quarter of 2012.

Ken Zerbe – Morgan Stanley

But the $50 million?

Christopher J. Del Moral-Niles

Is pure cash.

Philip B. Flynn

We got a cash refund of $50 million and we had earnings on that cash of $2 million.

Operator

Your next question comes from Jon Arfstrom – RBC Capital Markets.

Jon Arfstrom – RBC Capital Markets

A couple of follow up questions, on the loan growth at Slide Five you made some comments that you thought a lot of it had to do with some year end activity but it was a pretty big jump compared to the type of growth you saw on Q3 and I’m just curious if you think there is anything else going on? If you’re seeing some increased borrower confidence or do you attribute most of it to year end?

Philip B. Flynn

If you’ve got Slide Five open you can see that commercial, resi, commercial real estate, all grew about the same amount net. Our power business grew, mortgage warehouse grew with all the activity that is going on. Oil and gas had some pay downs that will come right back up as we go into this year so I wouldn’t put much concern about that and home equity has continued to pay down consistently.

The area where there was some year end activity was in that general commercial loan space where we had some year end activity from our customers including some syndicated loan volume where we’ve underwritten some loans and then those loans will be sold to other institutions. In fact, have already been sold to other institutions this year, so that drove a little bit of the growth.

But generally, all of our business units are out doing a good job now, and have been for a while, of gaining market share and gaining wallet. I would expect, as I said earlier, continued growth in all the business units in a well balanced way but probably at more of the pace that you saw in the combination of the third and fourth quarter not just the fourth quarter. If you annualize the fourth quarter you’d be in double digit loan growth. We’ve had double digital loan growth for the last two years and at some point that needs to moderate to more of the high single digit area and that’s what we expect.

Jon Arfstrom – RBC Capital Markets

That drives your comments with seasonally low Q1.

Philip B. Flynn

Yes, Q1 is usually low and then we’re going to have some pay downs as we syndicate some loans so that’s going to drive a fairly low first quarter which we expect to pick up from there.

Jon Arfstrom – RBC Capital Markets

So this is maybe the more quote new Associated loan mix and it’s what we’ll likely see in the future, this kind of activity at year end?

Philip B. Flynn

Well, it all depends on transactions. Remember, we had an unusual year end with potential changes in tax laws so we had some privately owned companies doing transactions to get in front of whatever might happen with capital gains. As it turned out, not a whole lot happened with capital gains but we didn’t know that a month or six weeks ago.

Jon Arfstrom – RBC Capital Markets

A couple more, you made the comment market disruption opportunities, is that still primarily Milwaukee or is there anything else happening?

Philip B. Flynn

It mostly relates to our very deliberate calling effort around changes, particularly in the Milwaukee area, but in other parts of the footprint too.

Jon Arfstrom – RBC Capital Markets

Then just last question, a small one on mortgage banking, but my sense is that it is lower than typical banks, but what percentage of those revenues are refinance driven?

Philip B. Flynn

A lot, most of it. Just like everybody else, the boom in mortgage banking that we’ve seen all in 2012 and which frankly is still continuing as we speak, is driven by refi.

Jon Arfstrom – RBC Capital Markets

So when you talk about higher fees but potentially lower mortgage, that’s what you’re talking about is the refinance piece of it?

Christopher J. Del Moral-Niles

The fee comment is higher fees from all of our lines of business private banking, insurance, foreign exchange, capital market swap activity. But, we expect lower mortgage banking year-over-year as each of the quarters in 2012 was individually more than the full year 2011 and we don’t see that pace continuing.

Philip B. Flynn

It may well continue as we get early into this year but our assumption is that it tails off as we get later into the year.

Operator

Your next question comes from Matthew Clark – Credit Suisse.

Matthew Clark – Credit Suisse

Maybe on the loan growth front, can you give us a sense for your underlying assumptions there may be on the outlook on the economy? Are you assuming really no pick up or much of pick up given that you’re looking for a high single digit and you guys have been doing 10 plus? Also, whether or not there’s any incremental change in your expectation for an increase in utilization as well?

Philip B. Flynn

The assumptions around our loan growth is that utilization is flat. It has been flat at high 40s, 48% to 49% now for three quarters. We’re not assuming any big pick up there. We’re not assuming any big pick up from economic activity. In general, as we’ve talked about numerous times, the upper Midwest has done relatively well compared to other parts of the country. Manufacturing continues to do pretty well, there continues to be change and disruption like we were just talking about with some of our competitors and we expect to be the beneficiary of all that but we’re not expecting anything heroic out of the economy to help us along here.

Matthew Clark – Credit Suisse

Then in terms of the latest growth of $445 you guys put up this quarter, can you break that down by market in terms of maybe some of your LPOs, the contribution there and some of your other major markets?

Philip B. Flynn

You see in our Slide deck by category where the growth came from. By markets we had, as you would expect, significant balance changes in our footprint. Illinois frankly, led the pack with a significant amount of the growth. Wisconsin about maybe a third of what we saw in Illinois. Now, this is the combination across business units so it’s commercial and commercial real estate. There’s a lot of activity in Illinois in those areas. About a third of that in Wisconsin, Minnesota about double Wisconsin and then in our specialty business, say in oil and gas, a lot of that activity as you would expect is in the oil patch. So, it’s quite diverse across our geographies. In the LPOs we had good solid growth commercial real estate driven in Indianapolis and Cincinnati. Michigan is newer but is starting to put on some business as well.

Matthew Clark – Credit Suisse

As you continue to retool the banking model can you give us a better sense of what’s left to do and how significant that might be?

Philip B. Flynn

We continue to invest into the retail branch network. This past year we touched 50 branches and we expect to touch another 50 branches in 2013. That will start to come to an end as we get into early 2014, we’ll largely be completed. We’ve made significant investments already into enhancing mobile banking, changing out many of the ATMs to being imaged enabled. A lot of that is already done.

We’ll always have continued upgrades and enhancements to our offering so we’ll have a major upgrade of our online offering later this year. Although, from a cost point of view it’s not terribly significant. The BSA AML issue, as we talked about, is largely behind us from an expense point of view. We’ve upgraded significantly our internal financial systems and that’s done. We are in the process of upgrading our commercial loan booking system, that’s a project that is kicking off right now.

But again, most of these are not big dollar amounts. The big dollar amounts here were really driven by the need to invest into the physical retail footprint and we are now more than half way through that project.

Matthew Clark – Credit Suisse

Do you sense that there might be some additional severance related charges going forward in the first half?

Philip B. Flynn

We’re not planning on any right now. We have closed and consolidated 10% of our branch network in the past, call it 13 months. So, I think we’ve done most of what we need to do there, if not all. We’ll continue to evaluate that. We’re in an industry that has over capacity and we’re in an industry where consumers’ behavior is continuing to change so that they’re not coming into branches to do their routine transactions and we’ve been investing to make sure that they have alternative methods to transact with us. As that continues to change we’ll continue to evaluate our physical distribution network but we’ve taken a pretty good swing at it compared to most institutions already.

Operator

Your next question comes from Terry Mcevoy – Oppenheimer & Co.

Terry Mcevoy – Oppenheimer & Co.

Just a question on the capital deployment, if I just annualize your dividend versus consensus for this year you’re pretty close to a 30% payout. As I look out to ’13 or as you look out to ’13 in looking at capital deployment do you see a heavier emphasis on buyback just given where you’re dividend is today versus at least estimated earnings?

Philip B. Flynn

Well, you’ll recall that we announced an authorization for $125 million of buybacks on which we executed $30 in the fourth quarter. You can certainly expect that we will continue to look at share buybacks through the course of this year. You’re correct, using consensus numbers at $0.32 we’re probably in that 30% range or so and so a lot of our dollars will be going towards most likely share buybacks. Then we’ll also be looking, as I said, to do an in market acquisition if we can find something that makes sense for our shareholders.

Terry Mcevoy – Oppenheimer & Co.

Then on the expense management side, have you shared any specific targets, cost saving targets and how do you look at reinvesting within the business and specifically what areas are you reinvesting in?

Philip B. Flynn

I kind of covered that a moment ago but what we continue to make investments is into the physical footprint. Most of those costs, of course, are capitalized so what we’ve done to date is starting to roll through our income statement in the form of capital expenses and those will continue and will build for a while. Then there’s some continued systems work but that’s not nearly as significant.

So we’ve got a headwind from continuing to need to invest in the franchise to make up for past under investment. We’ve got the benefit of the BSA AML remediation costs rolling away. We’re being quite disciplined about adding staff. In fact, the headcount has shrunk. When you net all of that out we believe that as we’ve guided, flat expenses year-over-year is quite achievable.

Operator

Your next question comes from Steve [Sigerello] – UBS.

Steve [Sigerello] – UBS

I just want to follow up on a question on loan mix. If I look at the pie chart on page five, I’m just kind of curious as you look out and kind of think strategically over the next three years or so, where do you want that mix to be and what are some of the components as you look ahead in terms of that future loan mix?

Philip B. Flynn

If you look at that pie chart, residential mortgage will continue to grow but it will certainly be likely offset by shrinkage in home equity as people refi into low costs permanent loans or into hybrid loans out of their home equity loans. We expect the mix of resi, home equity and installment to be somewhere ultimately around 35% to 40%, maybe down towards 35%. First lien business lending which includes commercial banking, small business lending as well as our specialty businesses has grown and will probably continue to grow. But depending on our growth in commercial real estate it will probably settle in a 40% range and commercial real estate would take up the rest. We’re somewhat under invested still in commercial real estate compared to the roughly 30% or so of the portfolio that we think we want to grow that to.

Steve [Sigerello] – UBS

Then within commercial and business lending mix, how big do you think some of those specialty segments might get to be?

Philip B. Flynn

Well, if you look at our mortgage warehouse business, as we got to year end the outstandings, they were about $0.5 billion and then the combination of our oil and gas business and power and utilities business was about $0.5 billion between the two of them. We expect the mortgage warehouse business probably from an outstandings point of view to decline somewhat as we go through the year because it’s so tied to refi activity. Then, we expect power and utilities and oil and gas to continue to grow.

The combination of all three of those specialty businesses which are the dominate ones, is about $1 billion and probably stay around that range. It probably goes up a couple hundred, $300 million maybe by the time you get to the end of this year. So, it is becoming more meaningful but certainly in the context of a $15 billion portfolio which will be growing, certainly isn’t a dominate part of the portfolio.

Steve [Sigerello] – UBS

As I kind of think out it seems like as some of those other components grow on the CRE side as well it sounds like you might have some yield pick up opportunities as you look ahead. Is that a fair way to think about it?

Philip B. Flynn

I like your thinking. We’re in a low interest rate world where the portfolio continues to mature and be in churn so a lot of our, on the resi side you continue to refi. We refi a lot of our own stuff so that’s slowly grinding down. The commercial real estate business is becoming more competitive but the pricing is still reasonable for the risks involved. Our specialty business tends to get pretty decent pricing. But, when you look at the whole portfolio the expectation is that asset yields continue a slow grind down in this low rate environment.

Operator

Your next question comes from Peyton Green – Stern, Agee & Leach.

Peyton Green – Stern, Agee & Leach

A couple questions, first to what degree would you expect the loan growth expansion to actually drive earning asset growth? I know in the past couple years the loan growth has really absorbed securities cash flow?

Christopher J. Del Moral-Niles

Correct. So we no longer expect to have net run off in the securities book period-to-period so while you won’t see the growth you saw in the fourth quarter order of magnitude you will see ongoing stabilization and growth in the securities portfolio which means the balance sheet growth will be driven by loan growth.

Philip B. Flynn

You’ll see the balance sheet expanding as we go through the year.

Peyton Green – Stern, Agee & Leach

Then separately, what is your expectation of securities cash flow and what’s the role off yield and where are you reinvesting these days?

Christopher J. Del Moral-Niles

Unfortunately, the reinvestment yields continue to be grinding lower and lower just as they are in the loan book so unfortunately they’re down in the one handle area on the margin investment and reinvestment are unfortunately still cash flowing back at $100 million plus per month.

Philip B. Flynn

I think we’ve talked about this before, but we are not and maybe we’re going to be proven wrong one day, but we are not going out the yield curve in that search for yield in the securities book or in our resi book. We’re not booking 30 year resi, we’re not booking long dated securities. We’re clearly giving up yield there in the short run. But we really don’t want to own really long dated securities and 30 year mortgages when and if rates turn.

Peyton Green – Stern, Agee & Leach

I know you’ve done a great job to reposition the borrowings from the whole sale nature of the deposit base from a few years back but in that vein is it time to go a little longer on the liabilities side?

Philip B. Flynn

It’s a great question and the answer is not yet. We hope we start pricing up CDs at just the right moment. But at this point, as you saw, the growth that we had in our deposits this past quarter and the fact that we’re bringing on a lot of deposits at very low costs it’s not time yet for us to extend out there.

Operator

Your next question comes from Mac Hodgson – SunTrust Robinson Humphrey.

Mac Hodgson – SunTrust Robinson Humphrey

On M&A and market M&A can you remind of us the asset size of an institution you’d be looking to target?

Philip B. Flynn

It’s hard to say, it depends on what the opportunities are. I think it’s highly likely since this institution hasn’t done a sizeable acquisition for six plus years that we would do something pretty bite sized before we ran and do a little walking. We’ve worked really hard to put Associated in a good sound financial position. We’re growing across our businesses, we’re doing well, we are not going to jeopardize the franchise by doing something large that our shareholders end up paying for.

Mac Hodgson – SunTrust Robinson Humphrey

You touched on this in your prepared remarks, but could you elaborate on any sort of deposit activity you saw in the fourth quarter or you expect to see in the first quarter related to TAG? I’m just sort of curious what sort of trends you’re seeing.

Philip B. Flynn

It’s too early to tell really but we had a significant inflow in front of TAG expiration. Some of that was from larger depositors. We don’t know exactly where those deposits came from but when you look at our profile, with the capital we have, with the ratings we have, we’re really not anticipating any issues at this institution. If anything, we expect to be a beneficiary of people getting cold feet without TAG protection in perhaps smaller or weaker institutions.

Operator

(Operator instructions) Showing no further questions this will conclude the question and answer session. I would like to turn the conference back over to Phil Flynn for any closing remarks.

Philip B. Flynn

Thank you all for joining us today. The quarter’s strong performance was highlighted by loan and deposit growth as well as higher net interest income and as we’ve been talking about we’re going to remain focused on deploying capital in value added transactions which will build shareholder value and we’re optimistic on our ability to continue to growth the franchise this year. We look forward to talking to you again in three months and if you have any questions, please give us a call. As always, thanks for your interested in Associated Banc.

Operator

Ladies and gentlemen this concludes the Associated Banc-Corp fourth quarter 2012 conference call. Thank you for attending today’s presentation, you may now disconnect.

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