Associated Banc-Corp (NYSE:ASB) Q2 2023 Earnings Call Transcript

Associated Banc-Corp (NYSE:ASB) Q2 2023 Earnings Call Transcript July 20, 2023

Associated Banc-Corp misses on earnings expectations. Reported EPS is $0.56 EPS, expectations were $0.59.

Operator: Good afternoon, everyone, and welcome to Associated Banc-Corp’s Second Quarter 2023 Earnings Conference Call. My name is Alicia, and I’ll 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 is being recorded. As outlined on Slide 1, during the course of the discussion, management may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. Associated’s actual results may differ materially from the results anticipated or projected in 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 and the Risk Factors section of Associated’s most recent Form 10-K and subsequent SEC filings.

These factors are incorporated herein by reference. The reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to Pages 24 and 25 of the slide presentation to Page 10 of the press release financial tables. Following today’s presentation, instructions will be given for the question-and-answer session. At this time, I would like to turn the conference over to Andy Harmening, President and CEO, for opening remarks. Please go ahead, sir.

Andrew Harmening: Thank you, Alicia, and good afternoon, everyone. Welcome to our second quarter earnings call. I’m Andy Harmening. I am joined once again by Derek Meyer, our Chief Financial Officer; and Pat Ahern, our Chief Credit Officer. I’ll start by sharing some highlights for the quarter, and from there, Derek will provide update on margin, income trends and capital. And then Pat will share an update on credit. So midway through the year, we’ve started to see some renewed stability through the banking system, and that’s especially true here in the Midwest. Unemployment rates in most of our states remain below the national average. The consumer remains healthy, and our business customers continue to seek ways to expand and optimize their operations where it makes sense.

And with that stability as our backdrop, we’ve continued to make progress with our plan to attract, deepen and retain customer relationships, optimize our balance sheet and enhance our profitability profile over time. You can see that in our loan portfolios, where we’ve continued to add significant volumes of high-quality consumer and commercial loans to our books. You can see it on the deposit side, where we’re deepening relationships with our mass affluent strategy and acquiring new relationships with a brand-new brand campaign and multiple product and service enhancements. And you can see it in digital, where we’ve already made several upgrades to the new platform we launched less than a year ago, leading to an increased customer satisfaction score and a decreased customer attrition rate.

We have become a company that has developed an ability to execute even amid a volatile quarter in banking. But importantly, we’ve reached these milestones without sacrificing our foundational discipline on credit quality and expense management. We look forward to carrying the momentum into the back half of this year. So with that, I’d like to highlight key results for the second quarter on Slide 2. Our second quarter results reflected the continued expansion of our balance sheet, stable credit trends and progress against our initiatives. We added loan balances in all three major segments, again in the second quarter led by C&I and auto finance. However, as we discussed a quarter ago, lending activity as a whole has slowed from the strong pace we saw in 2022.

To fund our growth and enhance our liquidity profile, we tap the wholesale markets to increase deposits by $1.7 billion during the quarter. This reliance on wholesale funding sources is expected to dissipate over time as we begin to realize the full impacts of our customer acquisition and relationship deepening initiatives. With increased funding costs impacting the entire industry, our net interest margin came in at 2.8%, which is down from our fourth quarter peak, but it’s still a 9 basis points above the same period a year ago. As a partial offset to margin pressures, we saw noninterest income increased by $3 million from the prior quarter, helping us deliver PTPP income of $133 million for the quarter, a $23 million increase from the same period a year ago.

We are continuing to monitor asset quality closely, but our credit trends remained relatively stable during the second quarter. We saw 15 basis points of net charge-offs during the quarter and added 1 basis point of ACLL. We added $22 million in provision for the quarter, but still matched our net income available to common equity from the same period a year ago. Now staying on the topic of credit. I’d like to take a moment to reiterate a few important points about who we are as a company on Slide 3. We take an active, disciplined and conservative approach to credit. This includes an ongoing and deep review of the existing portfolios. And in addition, our efforts to de-risk our balance sheet over the past 14 years have put us in a relative position of strength.

Since 2009, we’ve taken steps to exit high-risk portfolios, replace those balances with lower risk asset classes and implement processes and procedures to identify and eliminate risk. And today, we’re squarely focused on prime, super prime consumers, core commercial lending and a diversified balance sheet. This broad focus has protected us from overextending ourselves in any one particular area and limited our exposure in at-risk subcategories such as CRE office. We also benefit from operating primarily in stable, conservative Midwestern markets that don’t see the big swings you might see in other parts of the country. As mentioned previously, this long-held disciplined approach on credit has also given us the flexibility to continue to execute on our strategic initiatives in the face of a dynamic operating environment.

With that, I’d like to provide some details on our loan trends on Slide 4. During the second quarter, we continue to add high-quality loans to the balance sheet in areas such as C&I and auto finance. We’ve now reported growth in each major segment for five consecutive quarters. And while we continue to book loans, the pace of new deals coming into the pipeline has slowed as our customers take a more cautious approach in the uncertain macro environment. Within our portfolio, we continue to emphasize selective growth in high-quality loan categories that help us diversify our portfolio while delivering an enhanced profitability profile. Over the last seven quarters, the expansion of our C&I business and growth in our new equipment finance and asset-based lending verticals, has helped us expand our offerings and sharpen our focus on high-quality relationship-based lending.

This enables us to deemphasize lower-yielding non-relationship asset classes such as third-party originated mortgage. As we announced back in Q1, we’ve chosen to exit this low-margin business with relatively low relationship value. We originated approximately $1 billion of these loans in 2022 and we now expect to originate just $60 million in ’23 as we wind down this business to focus on other areas that enable us to optimize our returns over time. So in summary, we remain confident in our ability to drive high-quality accretive growth on our balance sheet. And as such, we continue to expect loan growth of between 6% and 8% in 2023. On Slide 5, we highlight our funding trends for the second quarter. During the quarter, we tapped the wholesale and broker deposit markets to help enhance our liquidity profile, fund our loan growth and replace higher cost FHLB advances.

These actions were temporary in nature and not intended to be part of our long-term strategy. Within our core customer deposit base, we did see some short-term volatility from a subset of uninsured business deposits and public funds in March and April. But that volatility largely dissipated by the end of the quarter. And in the face of this challenging environment, we actually saw modest growth in our consumer deposit base during the quarter. This stabilization reflects the granularity of our deposit base and our recent efforts to attract and deepen customer relationships with digital tools and product enhancements. We expect to hold wholesale network funding levels in check as we move through the back half of the year, and we remain confident in our ability to fund our growth at a reasonable cost going forward based on our initiatives.

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With that said, based on current market conditions, we now expect total core customer deposits to decrease by 3% for the year. However, we expect to drive growth of 2% in the back half of the year as we continue to execute on our initiatives. On Slide 6, we’re sharing additional details on our initiatives designed to acquire deep and retain customer relationships. We’ve continued to see promising signs of progress with these efforts. We’ve actually seen momentum pick up as we move through the year. As I mentioned previously, we’re up and running with a variety of initiatives across the bank, and we’ve seen several leading indicators that give us confidence we are on track. First, in one of the most challenging environments for regional banks in years, we actually grew net consumer and business households during all three months of the second quarter.

Secondly, we’ve implemented several enhancements to our product and service offerings and launched a new brand campaign, which resulted in an 11% increase in consumer household acquisition rates and a 13% decrease in attrition year-over-year. Third, I want to remind you that the new digital platform we launched last fall was built with open architecture, enabling us to quickly respond to customer feedback and deliver more and more frequent upgrades. Since launching the platform 10 months ago, we’ve already successfully released 9 upgrades. As a result, we’ve seen a strong positive trend in our top box completely satisfied customer satisfaction scores. And most recently, during the second quarter, our satisfaction scores hit a three year high in mobile banking.

Finally, since launching a new mass affluent strategy to deepen relationships with high potential customers, we’ve already added over $300 million in net new deposits that surpassed our full year goal. This growth represents a roughly 8% increase from our prelaunch baseline. As you can see, we’re bringing in new dollars and deepening relationships with a customer base that is more satisfied. While we’re pleased with the initial results of these efforts, we’ve yet to realize the full impact of the initiatives, and we’re working on additional enhancements as we speak. What’s not going to change though is our commitment to the foundational strength of our company, which is maintaining discipline with regards to credit risk, expense management and operational risk management.

So finally, on Slide 7. Our team once again paired strong revenues with diligent expense management during the second quarter. And despite the challenges facing the industry during the quarter, our company delivered PTPP income of $133 million, which represented a 21% increase as compared to the same period a year ago. We remain committed to delivering positive operating leverage during 2023. So with that, I’m going to hand it over to Derek Meyer, our Chief Financial Officer, to provide a little more detail on our margin, income statement, cap and capital trends for the quarter.

Derek Meyer: Thanks, Andy. Starting on Slide 8, I’ll begin by highlighting our asset and liability rate trends through the second quarter. Our total asset yields have continued to rise due to rising rates and the floating rate nature of our large segment of our loan book. Since the start of the rate cycle, total earning asset yields have increased by 259 basis points or roughly 53% of the increase in Fed funds target rate over the same period. Our commercial and CRE portfolios, largely comprised of floating rate loans have seen the largest increase. On the liability side, rising rates and the volatility impacting the industry this spring is combined to put additional pressure on funding costs across the industry. Here at Associated interest-bearing liability costs have now increased by 279 basis points since the fourth quarter of 2021 or roughly 50% of the move in Fed funds target.

While the general S-curve effect we expected to see on deposit betas has played out largely as we expected, our beta accelerated following the volatility we saw in the spring, our short-term build and wholesale network funding and the ongoing mix shift away from noninterest-bearing deposits. Accordingly, our interest-bearing deposit beta has now climbed to roughly 52% since the start of the rate cycle. Moving to Slide 9. Mix shift and other funding cost pressures combined to drive a 27 basis point compression in our NIM for the second quarter. Nonetheless, our NIM still represented a 9 basis point increase from the same period a year ago. On a dollar NII basis, we saw similar impacts during the quarter, yet still delivered dollar NII that reflected a 19% increase from the same period a year ago.

And as Andy discussed, we continue to take significant actions on both sides of the balance sheet to drive more durable margin over time. One example is that we’ve gradually layered in swaps over the past several quarters to decrease our asset sensitivity and enhance the durability of our margin. Given the ongoing uncertainty around the macroeconomic picture and the likelihood of a higher for longer scenario, we did not add additional swaps during the second quarter. Nonetheless, we’ve continued to see our estimated NII sensitivity come down gradually by design. The macro outlook remains uncertain. Our current expectations assume one additional 25 basis point Fed funds increase in September with no rate cuts in 2023. Based on our current expectations for balance sheet growth, deposit betas and Fed action, we now expect net interest income growth of between 10% and 12% in 2023.

As a reminder, we do not intend to call the peak on interest rate environment in ’23 but we do – but we will continue to take reasonable steps over time to dampen our asset sensitivity and manage our downside risk. On Slide 10, we’ve continued to manage our securities book in the second quarter to align with our 18% to 20% target. Throughout the past year, the yield on our investments has steadily risen with the rate environment but we’ve reined in durations to reduce our longer-term rate risk. After adjusting our CET1 capital ratio to include the impacts of AOCI, this impact would have represented an 88 basis point hit to CET1 in the second quarter. This impact is up slightly from the prior quarter, primarily driven by the rebound in rates from the decrease at the end of March.

As a percentage of total assets, our investment security and cash positions were maintained at roughly 20% during the quarter. We continue to target investments to total assets of between 18% to 20% in 2023. Shifting to Slide 11. Noninterest income grew by $3 million in the second quarter despite the ongoing pressure from market-driven headwinds and customer-friendly fee adjustments that we faced in the past several quarters. The largest contributing factor for the increase was the moderate growth in mortgage banking income driven by higher MSR values. We also saw modest growth in card-based wealth management and other fee-based revenues. These increases were partially offset by decreases in service charges, BOLI income and asset gains. Despite the quarterly increase in noninterest income, we continue to expect total 2023 noninterest income to track between 8% and 10% versus 2022.

As we’ve discussed, this anticipated compression is driven by current market dynamics and moderation in deposit account fee income due to customer-friendly overdraft NSF changes made in the back half of 2022. These proactive changes gave us additional confidence in our ability to strengthen our low-cost deposit base, enhance our broader profitability profile in 2023 and beyond. Moving to Slide 12. Our second quarter expenses increased by 2% versus the prior quarter amid ongoing investments to support our initiatives. Our FTE efficiency ratio rose to 57% during the quarter but it remained 284 basis points below the same period a year ago. Additionally, our noninterest expense base continues to decrease as a percent of average assets and is now down 15 basis points from the same period last year.

While we continue to invest in strategies to support our growth aspirations in 2023, we are committed to keeping expense growth below revenue growth over the long term. On an ongoing basis, we will continue to pursue opportunities to optimize our expense base where possible. With that in mind, we now expect total noninterest expense growth of between 3% and 4% in 2023. Shifting to Slide 13. We continue to prioritize paying a competitive dividend and funding organic growth while managing capital levels towards our target ranges. During the second quarter, our regulatory capital ratios grew versus the prior quarter and versus prior year-end 2022. We remain comfortable with our capital levels as we look out over the remainder of the year. Given current market conditions and the expectation for short-term rates to remain elevated in the near term, we continue to expect TCE to land between 6.75% and 7.25% by year-end and CET1 to land between 9% and 9.5%.

I will now hand it over to our Chief Credit Officer, Pat Ahern, to provide an update on credit quality.

Patrick Ahern: Thanks, Derek. I’d like to start on Slide 14 with an update on our allowance trends. We utilized the Moody’s May 2023 baseline forecast for our CECL forward-looking assumptions. The Moody’s baseline forecast remains consistent with recent observed trends and assumes an additional near-term rate hike, GDP growth rates similar to the first half of 2023, a cooling labor market and a deceleration of inflation. At the end of the second quarter, our ACLL landed at $377 million. This figure represents an $11 million increase from the prior quarter as allowance continues to be driven by a combination of portfolio loan growth, nominal credit movement and reflects general macroeconomic trends benefiting from stability in the Midwest.

Accordingly, our reserve to loan ratio increased 1 basis point from 1.25% to 1.26% during the quarter. Moving to Slide 15. Our quarterly credit trends remained stable across the portfolio during the second quarter. We did see nonperforming assets, nonaccrual loans, delinquencies and charge-offs increased slightly during the quarter, but we view these increases as a sign of both normalization back to pre-pandemic levels as well as some one-off situations as opposed to an indication of a broader issue in the portfolio. We added another $22 million in provision during the second quarter, which is consistent with the past three quarters. As mentioned, this provision build was largely a function of loan growth, limited credit movement and some macro trends.

Given recent volatility in the industry, I’d like to take the opportunity to reiterate that the recent growth in our loan portfolios continues to focus on our core business, growth of key relationships and expanding our engagement with familiar customer segments. Our experienced team continues to adhere to a disciplined underwriting culture and a proactive approach to portfolio management that we have solidified over the past 10-plus years when the bank worked to derisk the portfolio. We remain focused on monitoring the uncertainty in the macro economy to ensure current underwriting reflects elevated inflation, supply chain disruption, labor costs to name just a few economic concerns. In addition, we continue to maintain specific attention to the effects of elevated interest rates on the portfolio, including the ongoing interest rate sensitivity analysis bank-wide.

Going forward, we expect any provision adjustments to reflect changes to risk grades economic conditions, loan volumes and other indications of credit quality. Finally, on Slide 16, Andy discussed previously that our conservative approach to credit has been optimized over the course of the past several years and as we’ve built a diverse portfolio of high-quality commercial loans across the bank and a focus on prime and super prime consumer portfolio. While CRE has frequently been cited as an area of risk in the media, our approach to CRE lending reflects the conservative approach we’ve applied across the bank. In building our CRE portfolio, we focused on partnering with well-known developers in stable Midwest markets. Over two-thirds of our CRE portfolio is based in the Midwest with an emphasis on multifamily and industrial properties.

Office loans represent just 3.5% of our total loans as a bank. And within that portfolio, we are weighted towards suburban Class A properties. While we continue to monitor this portfolio closely, we feel well positioned given our business model approach and the markets we operate in. With that, I will now hand it back to Andy to share some closing thoughts.

Andrew Harmening: Thanks, Pat. I’d like to reiterate a couple of points from the presentation on Slide 17. First, based on the resiliency of our markets and the ongoing momentum with our lending initiatives, we remain confident in our ability to drive high-quality loan growth throughout the year. As such, we continue to expect total period-end loan growth of between 6% and 8% in 2023. Secondly, while we see that our core deposits have stabilized, we now expect core customer deposits to shrink by 3% for the year. But with that said, we also remain confident in our initiatives on the deposit side based on several leading indicators that point to momentum in the back half of the year. With this in mind, we expect to see positive core customer deposit growth of 2% in the second half of the year.

Shifting to revenue. We’ve adjusted our most recent forecast for balance sheet growth, deposit betas and Fed action following unique events of the spring. We now expect to deliver net interest income growth of between 10% and 12% in 2023. And finally, we continue to invest strategically in both people and technology, but our disciplined approach to expenses remains foundational. We also remain committed to delivering positive operating leverage as a company. As a result, we’ve lowered our expense guidance to between 3% and 4% growth for the year. So with that, let’s open it up for questions.

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Q&A Session

Operator: [Operator Instructions] Thank you. Our first question comes from Daniel Tamayo with Raymond James. Please proceed with your question.

Daniel Tamayo: Good afternoon, guys. Thanks for taking my questions.

Andrew Harmening: Hi, Dan.

Daniel Tamayo: I guess, first, just on the funding side. I think I heard you say this, I think it was Andy that the wholesale and network transaction deposits are expected to be stable in the back half of the year? Just correct me if I’m wrong on that. But I was just hoping to get kind of a sense into that’s wrong expectation for how that – how those will fluctuate if it’s just – if there’s a loan-to-deposit target that you’re hoping to keep or if there’s levels that you don’t want to go above related to those funding sources? And then just kind of trends within the second quarter in terms of the core deposits that gave you confidence in being able to grow in the back half of the year.

Andrew Harmening: Yes. Maybe I’ll start that one out and then turn it over to Derek. One of our absolute imperatives in the second quarter is to ensure that we had a strong liquidity position, which we do. So we wanted to make sure that our day 1 liquidity position was in a good place for the bank in an uncertain time. Since that period of time, we’ve been able to see that our uninsured uncollateralized deposits are down to 21%. We’ve seen that we have day 1 coverage of well over 100%. And we have seen the stability of our deposit base emerge in the month by month as we’ve come through this whatever you want to call this four month period of time we just came through. With regards to loan-to-deposit ratio, because we know that we have a stability in our deposit base, right now we’ve stated that we wanted to be in the 90% to 95% range.

Because we took a bit of a conservative approach, in my opinion, an appropriate approach to liquidity we actually lowered our loan-to-deposit ratio in the second quarter. And so we’re well within the range. We don’t have to add to that on the high-cost deposit front in order to maintain it. And to me, there’s finally an emergence of a deposit trend that we think we have a much better view into as we head into the second half of the year. Derek, do you want to take any of the rest of that?

Derek Meyer: Yes, I think the only – the way to connect the dots on the guidance and what Andy just shared is if we got 6% to 8% loan growth for the year, and we’ve gotten – a little over 4% from that since December already. You could see us consuming that 2% customer deposit growth in the back half of the year to fund the low end of our range. I think if we had good quality lending relationships, we wouldn’t rule out adding to that funding with additional wholesale. I think the point we want to make, though, is that we’ve seen stability at the back half of the quarter and our core customer deposits, and we’re confident about being able to grow that. And that the impact that we’ve seen on our margin from the disruption is largely behind us.

Daniel Tamayo: Okay. I appreciate all that color. I guess as we think about the NII guidance that you gave, specifically kind of thinking about that from a margin perspective, and this relates to NII as well. But just curious to get your thoughts on maybe the cadence of the margin over the next few quarters. Just your thoughts on when that might bottom. And a clarification within that. I may have misheard you, but I thought you said you were assuming a rate hike in September. Was that supposed to be July? Or — so just those things with a quick clarification. Thanks.