Associated Banc-Corp (NYSE:ASB) Q3 2023 Earnings Call Transcript

Associated Banc-Corp (NYSE:ASB) Q3 2023 Earnings Call Transcript October 19, 2023

Associated Banc-Corp reports earnings inline with expectations. Reported EPS is $0.53 EPS, expectations were $0.53.

Operator: Good afternoon, everyone, and welcome to Associate Banc-Corp’s Third Quarter 2023 Earnings Conference Call. My name is Alicia, and I’ll be your operator today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session at the end of this conference. Copies of the slides that will be referenced during today’s call are available on the company’s website at investors.associatedbank.com. As a reminder, this conference is being recorded. As outlined on Slide 1, 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 the Associated’s actual results to differ materially from the information discussed today is readily available on the SEC website in the risk factor sections of Associated’s most recent Form 10-K and 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 the conference call, please refer to pages 23 and 24 of the slide presentation and 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.

Andy Harmening: Well, good afternoon, and welcome to our third 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 will start today by sharing some highlights for the quarter. From there, Derek will provide an update on margin, income, capital trends, and then Pat will share an update on credit. Now I mentioned back in July that we were starting to see renewed stability after a volatile spring, and what we saw here at Associated in the third quarter was a definitive continuation of those stabilizing trends. Employment trends remain very strong in our footprint with most Midwestern states seeing unemployment below the national average, and Wisconsin coming in below 3%.

Our prime and super prime retail customers remain resilient in the face of macro uncertainty. What this means for us is that we’ve been able to focus squarely on execution of our initiatives as we look to track and deepen customer relationships, optimize our balance sheet and improve our profitability profile. These initiatives have clearly taken hold in the face of challenging operating environments. On the asset side, we’ve steadily added high quality consumer and commercial loan balances that enable us to rely less heavily on lower yielding non-relationship balances. On the funding side, the customer acquisition and attrition trends we shared for Q2 look even stronger in Q3. Initiatives such as our new Mass affluent strategy, product enhancements, and brand campaign are clearly having an impact, and that led to $527 million in core customer deposit growth during the third quarter.

This not only helps us fund our loan growth, but it enables us to decrease our reliance on wholesale and network funding sources now and in the future. And finally, on the digital side, we’ve regularly upgraded our online and mobile experiences since we launched our new platform a year ago. These changes have contributed significantly to higher customer satisfaction scores and decreased customer attrition. And while we’ve continued to get traction since launching Phase 1 of our strategic plan a little bit over two years ago, we haven’t lost sight of what got us here in the first place, our foundational discipline on credit quality and expense management. As the banking environment continues to evolve in the coming quarters, that discipline is going to remain front and center for us.

It’s also important that we’re thoughtful about what comes next for Associated Bank as we look to set the bank up for long-term success. That’s why our team is working hard putting the finishing touches on Phase 2 of our strategic plan, which we look forward to sharing in more detail later this quarter. With that, I’d like to highlight our results for the third quarter on Slide 2. Our third quarter results reflected the steady growth of our balance sheet and continued progress against our initiatives. As mentioned in the past, our stated goal is to fund the majority of our growth with core customer deposits. We grew these deposits meaningfully in 2022. And after a period of industry-wide volatility in the first half of this year, core customer deposits grew by over $500 million here in Q3, as we continue to realize the impacts of our customer acquisition and relationship deepening initiatives.

This enabled us to pay down high-cost non-customer funding sources like brokered CDs during the quarter. On the loan side, all three of our major consumer and commercial loan segments once again saw net balance growth during the quarter, led by growth in our auto finance business. With that said, it’s clear that lending activity has slowed in most categories as compared to 2022. Shifting to the income statement, funding costs continue to be a pressure point for the entire industry in this rate environment. Here at Associated, however, the pace of downward pressure on margin has slowed. In Q3, our NIM decreased by 9 basis points to 2.71%. For the third quarter, we saw a slight increase in our non-interest income. Our third quarter non-interest income grew by 2% versus the prior quarter, partially offsetting the ongoing pressure on NII.

And as always, we’re continuing to monitor asset quality closely. Our net charge-off ratio came in at 25 basis points for the quarter as we added another $22 million in provision and held our ACLL ratio flat at 1.26%. While several key credit metrics have ticked up slightly compared to the prior quarter, we consider the data to be consistent with a gradual normalization to pre-COVID performance levels. We have not seen anything to suggest trouble on the horizon for a specific industry or geography. On Slide 3, we highlight our deposit trends for the third quarter. As you know, industry-wide volatility in the spring combined with an ongoing battle for deposits to create significant funding headwinds for the first half of the year. While much of the volatility cleared up by June, short-term funding and liquidity pressures combined with a mixed shift in customer accounts had a lingering impact on Q2 balance flows.

We continue to see some impact from mix shift during the quarter but the situation is largely stabilized, providing a clearer view of the impacts from our deposit gathering initiatives that started to take hold in 2022. During the quarter, we saw net growth in both consumer and commercial balances, and core customer deposits as a whole grew by $527 million or 2%. This growth enabled us to decrease our reliance on higher cost network and broker deposits, which decreased by $418 million or 8% during the quarter. As a reminder, our strategy is to fund our loan growth primarily with customer deposits. We expect to hold wholesale network funding levels in check as we move through the remainder of the year and into 2024. And we remain confident in our ability to fund our growth at a reasonable cost going forward based on our initiatives.

Based on year-to-date trends and current market conditions, we’re affirming our guidance and continue to expect total core customer deposits to decrease by 3% for 2023, but increase by 2% in the back half of the year. On Slide 4, you can see that the deposit growth hasn’t come by accident. As we’ve discussed previously, our team has been hard at work to enhance our offerings with an eye towards attracting new relationships, deepening existing relationships, and increasing retention. It’s clear at this point our initiative has taken hold. Since 2022, we’ve focused on upgrading product and surface offerings, and have promoted these new offerings with a customer-centric brand strategy. As of the third quarter, our consumer household acquisition rate was up 20% versus the same period a year ago, and our attrition rate was down 17%.

Digital has also been instrumental to our success. And through the open architecture of our new platform, we’ve been able to move more quickly to deploy upgrades and enhancements to make our customers’ lives easier. In a little more than a year since the platform launched, we’ve had 99.9% uptime and have already made 11 customer-facing upgrades, leading to a multi-year high in customer satisfaction scores. And finally, since launching a new mass affluent strategy to deepen relationships with high potential customers, we’ve already added over $550 million in net new deposits, nearly doubling our full-year goal by September 30. This growth represents a roughly 12% increase in our pre-launch baseline. So as we’ve said, our plan is to fund our loan growth with core customer relationships, deposit relationships.

And we steadily continue to execute this plan in the face of a challenging funding environment. As a result, we’re bringing in new dollars and deepening relationships with a customer base that is more satisfied. Shifting to Slide 5, we’ve steadily added high quality loan balances to our portfolio with another $344 million added here in the third quarter. This marks the six consecutive quarters in which all three of our major loan segments have reported net growth. While growth has continued throughout the year, the pace of growth has slowed. And it’s clear that pipelines have also slowed as customers make a more cautious approach in what appears to be a higher for longer rate environment. During the third quarter, we again saw moderate growth in our auto finance portfolio where we continue to focus squarely on prime and super prime clientele.

As a reminder, we do not intend to become disproportionately reliant on auto loans, but the portfolio continues to provide us a high quality, yield-friendly option to diversify our consumer loan book away from lower yielding non-relationship assets such as third party originated mortgage. On the commercial side, our mortgage warehouse business led the way during Q3, but that’s not something we would expect to become a theme. Looking forward, it’s clear that the lending environment has begun to slow for the industry, but we continue to seek selective growth that emphasizes relationships, quality, and diversification while delivering accretive returns. This enables us to de-emphasize lower yielding non-relationship asset classes over time. Given the slowdown in lending environment, we now expect total loan growth of between 5% and 6% for 2023.

So finally, on Slide 6, our team once again paired solid revenues with diligent expense management during the third quarter. Given the funding pressures facing the industry, our PTPP income dipped to $125 million or $8 million lower than the second quarter. But despite these funding pressures, our year-to-date PTPP income is $68 million higher in 2023 than it was in 2022, a 20% increase. With that, I’ll hand it over to Derek Meyer, our Chief Financial Officer, to provide further detail on our margin, income statement, and capital trends for the quarter. Derek?

A close-up of a loan officer offering a helping hand and sharing a smile with a customer.

Derek Meyer: Thanks, Andy. I’ll start by highlighting our asset and liability rate trends through the third quarter on Slide 7. Our total asset yields have continued to rise due to rising rates and the repricing nature of a large segment of our loan book. Since the start of the rate cycle, total earning asset yields have increased by 277 basis points, or roughly 53% of the increase of Fed funds target rate over the same period. Commercial and CRE yields have grown the most as we continue to add new loans and categories such as asset-based lending and equipment finance, while our floating rate back book continues to reprice higher. On the liability side, rising rates, liquidity pressures, and a mix shift in customer deposits, they converged to create significant funding cost pressure for the whole industry.

While these pressures have stabilized meaningfully in Q3, they continue to pose a challenge for profitability in the near term. Here at Associated, interest bearing liability costs have now increased by 309 basis points since the fourth quarter of 2021. Specific to deposit betas, the S curve we were planning to see in the rising rate environment has largely played out as expected. But the shape of the curve has steepened meaningfully in 2023 amid the funding cost pressures described previously. As such, our interest-bearing deposit beta has now climbed to roughly 56% since the start of the rate cycle. Moving to Slide 8, the funding cost pressures facing the industry combined to drive a 9 basis point compression in our NIM in Q3. While pressures remain, we view this trend as a clear sign of stabilization compared to margin trends in the first half of the year.

This stabilization was also demonstrated by our [dollar] (ph) net interest income, which decreased by just $4 million after significant pressure in Q1 and Q2. As we mentioned previously, however, we’re not relying solely on the rate environment to dictate our earnings going forward. We benefited from a natural asset sensitivity over the past couple of years as rates have risen, but we’ve also taken actions on both sides of the balance sheet to decrease that sensitivity and drive more durable interest income in future quarters. Whether it’s adding high-quality customer loans, core customer deposits, or layering in interest rate hedges, these actions have been designed to provide our company with additional flexibility to maintain our performance through the cycle.

As a reminder, we do not intend to call the peak on the interest rate environment in the near term, but we will continue to take reasonable steps over time to manage our asset sensitivity and downside rate risk. As you can see on the right-hand side of this slide, these efforts have gradually decreased our asset sensitivity over the past several quarters. We expect to continue benefiting in a rising rate or higher for longer scenario, but we’re also better positioned for an eventual decrease in rates over time. The macro outlook remains uncertain, but based on our current expectations for balance sheet growth, deposit betas, and Fed action, we now expect net interest income growth of between 8% and 10% in 2023. On Slide 9, we continue to manage our securities book in the third quarter to remain within our 18% to 20% target.

Since the third quarter of 2022, the yield on our securities book has risen by 74 basis points, but [indiscernible] to reduce our longer-term rate risk. After adjusting our CET1 capital ratio to include the impacts of the AOCI, this impact would have represented 101 basis point hit to CET1 in the third quarter. This impact is up slightly from the prior quarter, primarily driven by the rebound in rates. As a percentage of total assets, our investment, security, and cash positions were maintained at roughly 20% for the second straight quarter. We continue to target investments to total assets of between 18% and 20% in 2023. On Slide 10, we highlight our non-interest income trends. Despite the downward pressure for market-driven headwinds and adjustments to our fee structure, non-interest income grew modestly for the third straight quarter and landed at $67 million.

The primary factors for the quarter-over-quarter increase were a $1 million increase in asset gains and modest increases in service charges and deposit account fees and wealth management fees. With that said, we continue to expect total 2023 non-interest income to contract by between 8% and 10% versus 2022. As a reminder, this anticipated compression is driven by current market dynamics and moderation in deposit account fee income due to OD NSF changes we made in the back half of 2022. Moving to Slide 11, our third quarter expenses increased by 3% versus the prior quarter, but were flat with the same period a year ago. We continue to make targeted investments in people and technology to support our initiatives. Our FTE efficiency ratio rose to 58.5% during the quarter, but it remains 29 basis points lower than the same period a year ago.

Additionally, our non-interest expense bases remained below 2% as a percentage of average assets and is now down 18 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 expect total non-interest expense growth in between 3% and 4% in 2023, but would note that this number excludes the impact of any non-recurring items incurred in the fourth quarter, such as FDIC’s special assessment. Shifting to Slide 12, we continue to prioritize paying a competitive dividend and funding organic growth while managing capital levels towards the target ranges.

Here in the third quarter, our capital ratios grew versus the prior quarter and versus 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 at the 6.75% to 7.25% range by year-end. We’ve increased the upper end of our CET1 target range and are now targeting a range of 9% to 9.75%. I’ll now hand it over to our Chief Credit Officer, Pat Ahern, to provide an update on credit quality.

Pat Ahern: Thanks, Derek. I’d like to start on Slide 13 with an update on our allowance trends. We utilized the Moody’s August 2023 baseline forecast for our CECL forward-looking assumptions. The Moody’s baseline forecast remains consistent with a resilient economy despite the high interest rate environment. The baseline forecast contains no additional rate hikes, slower but positive GDP growth rates, a cooling labor market, and a continued deceleration of inflation. Our ACLL increased by $4 million during the quarter to $381 million. Our allowance continues to be driven by a combination of portfolio loan growth, nominal credit movement, and general macroeconomic trends that reflect the stability of our Midwest footprint. Accordingly, our reserves to loans ratio remain flat to the prior quarter and 6 basis points higher than the same period a year ago at 1.26%.

Moving to Slide 14, our quarterly credit trends remained relatively stable across the portfolio during the third quarter, with migration reflecting a broad-based normalization in portfolio performance. We did see moderate increases in non-accrual loans, delinquencies, and charge-offs during the third quarter, but as previously discussed, we anticipated these shifts as a sign of normalization back to pre-pandemic levels, as opposed to an indication of broader issues in the portfolio. As Andy mentioned, we have not seen anything to suggest a pattern of credit stress in a specific industry or geography. We added another $22 million in provision during the third quarter, which matches our second quarter provision build and is consistent with the past four quarters.

As mentioned, this provision build was largely a function of loan growth, limited credit movement, and macro trends. We remain focused on monitoring the uncertainty of the macro economy to ensure current underwriting reflects elevated inflation, supply chain disruption, and 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 ongoing interest rate sensitivity analysis bank wide. Going forward, we expect any provision adjustments to continue to reflect changes to risk rates, economic conditions, loan volumes, and other indications of credit quality. On Slide 15, I’ll remind you that our conservative approach to credit has been optimized over the course of the past several years as we’ve built a diverse portfolio of high-quality commercial loans and a focus on prime and super-prime consumer portfolio.

While CRE has been cited as an area of risk in the media over the past several quarters, we feel well positioned given 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 portfolio is based in the Midwest, with an emphasis on multi-family and industrial properties. Office loans represent just 3.4% of our total loans as a bank, and within that portfolio, we are weighted towards suburban Class A properties. While we feel well-positioned given our business model approach and the markets we operate in, we continue to monitor this and all of our portfolios closely. With that, I will now hand it back to Andy to share some closing thoughts.

Andy Harmening: Thank you. I’d like to close out by reiterating a couple key points from our presentation on Slide 16. First, we’ve set ourselves up to drive quality, relationship-focused loan growth that decreases our reliance on lower-yielding non-relationship balances and enhances our profitability profile. However, given the recent slowdown in the lending environment, we now expect total loan growth of between 5% and 6% in 2023. Second, the deposit environment is clearly stabilized following a volatile first half of the year. The stabilized environment, combined with our deposit initiatives, drove strong core customer deposit growth in the third quarter. With that said, we’re leaving our guidance unchanged for the full year, given the seasonality we typically see in balance flows as we approach year-end.

Shifting to revenue, we’ve adjusted our most recent forecast for balance sheet growth, deposit betas, and rate environments. We now expect to deliver net interest income growth between 8% and 10% in 2023. And lastly, our disciplined approach to expenses remains a foundational focus for our company. As such, we are maintaining our non-interest expense guidance for the year, but would note that this guidance excludes non-recurring items incurred in Q4, such as the FDIC special assessment. With that, let’s open up for questions.

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Daniel Tamayo with Raymond James. Please proceed with your question.

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Q&A Session

Daniel Tamayo: Hi, good afternoon everybody. Maybe first just on the non-accruals, the increase in C&I, I know you mentioned there was not really a pattern to that increase, but if it’s just a normalization of credit costs, just curious how you’re thinking about what we should, or how we should be thinking about what normalization of net charge-offs or even provision could look like? Thanks.

Andy Harmening: I would say in terms of net charge-offs, we saw a little bit of a spike this quarter, but I think last quarter was probably a little more normal than what we saw this quarter. I think these are just a handful of things. I think non-accruals could be, going forward, we’re going to watch as credits normalize back, where they settle at, it’s hard to say right now. And for provision, we’re probably pretty consistent over the last couple quarters and I would expect similar pattern.

Daniel Tamayo: Okay, great. And then looking at the loan growth, I’m just curious what the thought is in terms of future loan growth, where that might come from. And then, if you could touch on where new loan yields are for those categories, that’d be helpful.

Derek Meyer: Yeah, this is Derek. So obviously, the auto has been pretty steady, and we expect that to continue. We haven’t moved the credit box. It’s getting bigger, so you would normally expect the rate of growth to drop, but we also expanded into our footprint states. And so the dollar increases are steady. I think this quarter, like most quarters, we expected balanced growth. So you would have — we would have, in our prior guidance that we just took down, expected similar growth in C&I. And while we continue to have more new names this year and grow that year-over-year because of the RM hires, we saw the back of our pipeline not replenish and pull through into additional fundings at the pace we saw earlier in the year. So that has pulled through in our guidance.

And then we’ll think about how we position that for next year when we give 2024 guidance. We really haven’t been sharing our new production yields, so I won’t go there, but that’s how things have been materializing.

Andy Harmening: But I’ll say — Daniel, this is Andy. With regards to portfolio growth, it’s important to know where you’re growing and where you’re not. And where we’re not growing is on the third party originated mortgages and that by far has been the lowest yielding portfolio that we have. So when we stopped origination of that portfolio, which in its peak, I believe in 2020, was just around $1.5 billion in production, then a billion — and then we shut it down. So basically you’ll see a runoff on the balance sheet or decrease in that category, which means that our residential real estate most likely won’t grow at the pace of the market. We believe that over time we’ll be able to replace that with quality C&I business. Today clearly CRE is a very stable low to no growth category, although paydowns have been a little bit slow.

So I think over time you’ll see that in the C&I. With regards to fourth quarter numbers, we just took a hard look at our pipeline, and we also took a hard look at relationships that may not have be full relationships. And so we won’t extend or be aggressive in those that are lower yielding and those that are not full relationships. And usually those are tied together. So that’s a little bit for the reason that we’ve adjusted the year-end forecast on full growth.

Daniel Tamayo: Okay, that’s helpful. And then just lastly, a high-level question. You touched on third-party origination mortgages, but I guess just for that asset class overall, have you thought about or is there a way that it might make sense to sell perhaps some of those loans to kind of reset the margin to a certain extent or is there a breakeven point or a place where rates could get to where that could be more attractive?