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Edited Transcript of ASB earnings conference call or presentation 25-Apr-19 9:00pm GMT

Q1 2019 Associated Banc-Corp Earnings Call

Green Bay Apr 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Associated Banc-Corp earnings conference call or presentation Thursday, April 25, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Del Moral-Niles

Associated Banc-Corp - Executive VP & CFO

* Philip B. Flynn

Associated Banc-Corp - President, CEO & Director

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Conference Call Participants

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* Christopher Edward McGratty

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Jon Glenn Arfstrom

RBC Capital Markets, LLC, Research Division - Analyst

* Michael Masters Young

SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst

* Robert Scott Siefers

Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research

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Presentation

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Operator [1]

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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. (Operator Instructions) Copies of the slides that will be referenced during today's call are available on the company's website at investor.associatedbank.com. As a reminder, this conference call is being recorded.

As outlined on Slide 2, during the course of the discussion today, management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Associated's actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional detailed information concerning the important factors that could cause Associated's actual results to differ materially from the information discussed today is readily available on the SEC website, in the Risk Factors section of Associated's most recent Form 10-K and any subsequent SEC filings. These factors are incorporated herein by reference.

For 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 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.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [2]

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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 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 noninterest 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'll 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 noninterest-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 indexed 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 experience 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, while it 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 increased 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 cost will be mitigated by several factors. First, the Fed has meaningfully changed its tone regarding rate increases, and we now expect 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 will enable us to fund the 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 day count effects. Excluding those effects, we grew our core margin over the last 2 quarters and by 5 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 of '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 2 quarters.

While much of this quarter's lower net interest margin is explained by the factors I've mentioned, we also recognize that the interest rate environment has 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 to slightly lower than it was in 2018, assuming no additional Fed action.

Turning to Slide 8. First quarter noninterest 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 recur 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. Noninterest expense of $192 million was down $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 FDIC 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 onetime 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 noninterest 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 a 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. Nonaccrual loans increased to $156 million. While this is an increase over the fourth quarter, nonaccrual 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 3 quarters of 2018. The aggregate allowance for loan losses was 1.02% of total loans, essentially unchanged from the previous 2 quarters. And our provision for credit losses was $6 million, up from $1 million last quarter but still relatively small in relation to our $23 billion loan portfolio. Our credit environment remains benign.

So on Slide 11, we update our outlook for the rest of 2019. We continue to anticipate 3% to 6% average loan growth for the year. We expect continued solid commercial and industrial growth, and our commercial real estate portfolio will begin the ramp-up in the second half of the year.

Given the Fed's more dovish outlook and the flatter yield curve, we now expect our full year net interest margin will be in the mid 2.90s 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 noninterest expense guidance.

Our capital priorities have not changed as we look to fund organic growth, pay a competitive dividend, pursue nonorganic 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.

With those comments, I'll open it up for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Scott Siefers of Sandler O'Neill.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [2]

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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, is that something that's going prove transient? In other words, 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?

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [3]

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Sure. So Scott, you'll recall we closed on the Bank Mutual acquisition. If I draw your attention to Page 7 in our slides, we noted we had not planned for the accretion when we closed on that transaction. And the way it came in was probably a little lumpier than we had anticipated. And so you'll notice the dark orange bars on the chart sort of bounce around between 7 and 13 basis points over the last 4 quarters. We think we've run through most of the big box. Essentially, that would have come through that. That's not to say there won't be more, but it's very hard to predict. But at this point in time, we think a 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 unaccreted discounts. We're down to $16 million now. So it's very clear to say more than half of it has run through. So to -- you threw out 5 basis points. I think it's in the high end because these numbers from last year would be probably cut in half just by definition because half the 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. But again, it's lumpy, and if it comes to us in lumpy terms, it's hard to predict.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [4]

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Yes. Okay. No, that's helpful color, so I appreciate it. So it sounds like maybe this newer level is sort of a better base to go off of. So I appreciate that color.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [5]

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Well, we tried 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 has been rising.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [6]

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Yes, exactly. And that's a perfect segue into what I was going to ask as sort of the follow-up. As we look at sort of the flat to down slightly guide for the reported margin for the full year, are we sort of saying that the core margin may actually keep increasing a bit while those...

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [7]

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That is our expectation. We believe -- because of what we're seeing on the commercial loan growth side, on the one hand, and because of the anticipated flowback in of our normal seasonal deposits and the addition of the lower-than-market cost Huntington deposits, we think we'll have positive tailwind for ourselves on the margin over the next several quarters on the core margin.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [8]

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Okay. Yes. Perfect. And if I could slip one separate one in here. I appreciate the -- telling us about the roughly $7 million of onetime costs related to the Huntington transaction. I know the sort of steady-state of ongoing costs from that transaction are already embedded into your guidance for the full year expense number of about $800 million. Are you able to share roughly what the ongoing costs from those branches are expected to be?

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [9]

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We haven't detailed that in general, but sort of the cost of running a branch kind of tend to be several hundred thousands, $400,000-ish per branch is what we'll assume. And there'll be some operational and back-office, customer service costs on top of that for processing transactions.

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Operator [10]

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Our next question comes from the line of Chris McGratty of KBW.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [11]

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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 of interest-bearing deposits in the quarter, do you have a spot rate as of March 31?

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [12]

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I don't have the spot rate as of March 31. We don't generally look at that on a daily count basis. But to the broader point, if I look at Page 6, we detailed sort of the yields by class. We're not doing anything with savings account rates. They're going to stay low. We have the press release tables, sorry. Interest-bearing demand rates don't seem to have a lot of upward pressure on them nor do money markets 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 6 to 9 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 have taken a look at those longer-dated CD specials and are starting to back them off. I think the FDIC data came out this week, and of the 22 categories tracked, 6 of them 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 here also.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [13]

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And here.

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [14]

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And here.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [15]

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Great. Maybe one more on the securities. You mentioned in your opening remarks kind of more challenging reinvestment rates. Are you -- 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 new -- where is kind of new money put on today?

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [16]

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Yes. 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.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [17]

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Okay. Okay, great. And then the $800 million...

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [18]

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We'd rather make more loans.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [19]

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Totally got it. The $800 million -- does the $800 million -- can you remind me, does that include those charges from Huntington, the one-timers? Or is that excluded? I can't remember.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [20]

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They're all included.

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Operator [21]

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(Operator Instructions) Our next question is from the line of Jon Arfstrom of RBC Capital Markets.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [22]

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A 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 quarter and you are pretty optimistic. But give us an idea of kind of the puts and takes to the higher end or lower end of the range.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [23]

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Yes. I mean, we had a good quarter after having watched loan balances basically shrink 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 turn 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 lower 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 towards the higher end of that range at this point as we look out.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [24]

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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?

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [25]

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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 the overall portfolio from a credit quality point of view still looks unbelievably good. 10 years in the recovery cycle, but we're still there.

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Operator [26]

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Our next question comes from the line of Michael Young of SunTrust Robinson Humphrey.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [27]

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I just wanted to -- I wanted to ask just on the kind of loan mix. Historically, you guys have always targeted 1/3-1/3-1/3. 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 outsized pace relative to that. So just trying to think about, going forward, how you're thinking about kind of the balance of the loan book.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [28]

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Yes. So good question. We've never tried to dial it into exactly 33% for each of the 3 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. Yes, 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 saying 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 late cycle. So we're very diligent about concentrations on geographies and product types and all that kind of stuff.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [29]

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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, 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.

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Christopher J. Del Moral-Niles, Associated Banc-Corp - Executive VP & CFO [30]

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Sure. So the good news is assuming rates don't go higher, the expected beta on that stuff will be 0 for the foreseeable future. And the one upside, perhaps, to network deposits is they also have a beta of 1 on the way down. So essentially, there's a hedge there against the Fed lowering rates unexpectedly on us, which has consequences. But nonetheless, we'd look to continue to sort of manage that book down, as we continue to grow core deposits. So ideally, the best answer here is we'll continue to add and grow core deposits over the balance of the year and through acquisitions and, as a result, mitigate our need to have that market-based funding there.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [31]

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Yes. Putting $850 million of core deposits on from Huntington is going to be a big help there.

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Operator [32]

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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.

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Philip B. Flynn, Associated Banc-Corp - President, CEO & Director [33]

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Okay. Well, thanks for joining us today. We're really pleased with this quarter's loan growth and lower expense trends. We're optimistic, as I mentioned, for continued loan 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. And as always, thanks for your interest in Associated.

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Operator [34]

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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.