Associated Banc-Corp (ASB) Earnings Call Transcript & Summary

Good morning. I am Matt Kesselhaut, and I work with Jason Goldberg covering the U.S. bank stocks here at Barclays. On behalf of the entire Barclays financial service equity research team worldwide, welcome to our 18th Annual Global Financial Service Conference. While we are virtual this year, we aim to provide you with as close to the same experience as prior years with all presentations and meetings conducted via video. Thank you for joining us and what we will share with you for the next 3 days. To kick off the conference, I'd like to welcome Associated Banc-Corp. From ASB, we have Philip Flynn, President and CEO; Christopher Del Moral-Niles, CFO; and David Stein, Head of the Consumer and Business Bank. On the left-hand side, you should see our first automatic audience response question, which we are asking each bank at the conference. The first question is what is your current position in shares at ASB. Overweight? Market weight? Underweight? Not involved? [Voting]

While the audience answers the question, I'm going to hand it off to ASB to start their presentation. Thank you.

Thanks, Matt. Good morning. This is Phil Flynn. I'm glad to be talking to you and thanks for your interest. This morning with the deck that we filed that you have in front of you, we have a number of important announcements to make regarding efficiency efforts as well as some improvements that will occur in our net interest income going forward for the next couple-plus years. But to start on Slide 2, our franchise, as you all know, is a $36 billion bank headquartered in Wisconsin with branches in the Great Lakes area in Minnesota, Wisconsin and Illinois; $25 billion of loans; $27 billion of deposits. We are the largest bank headquartered in the state of Wisconsin. We have about 4,300 employees as of September 11. That's post the sale of our insurance brokerage company. We service more than 1 million customers out of 8 states. We have loan production offices and additional 5 besides the 3 states I mentioned. Over 120 communities served. We're the #1 mortgage lender in the state of Wisconsin. You can see on the slide that more than 70% of our deposits are sourced in Wisconsin and that we have a balanced loan portfolio. Moving over to the next slide. The region that we operate in, although it's, of course, like everywhere, been impacted by the pandemic and the impact on the economy. In fact, generally, our states have done somewhat better than the country as a whole. 7 of the 8 footprint states have lower unemployment rates than the national average, and all have had improving month-over-month trends. You can see the national average versus where our footprint is. We're seeing good reaction, good trends in our customers. So first of all, of course, like everybody, we are awash in liquidity, up 42% since December. But of a particular note, our customers are becoming much more active. So debit and credit card purchases have moved up 25% from April through July, and our consumer loan portfolio deferrals really went to almost 0 these last few months. And as time is going on, and we're starting to contact these customers, most of them are starting to pay. Most of them are not asking for any additional deferrals. So that all seems positive. Turning to customer branch activity. All of the trends that we've seen for these years of customers more and more embracing online and mobile banking have all been pulled forward because of the impact of the pandemic. So in our branches, teller transactions are down 20% year-over-year. Teller transactions are now occurring about 65% through the drive-thrus and about 35%, give or take, in the lobbies, and that's flipped on its head from what it used to be. It used to be about 2/3 in the lobbies, 1/3 in the drive-thrus. So even though our lobbies have now been open for some months, people are embracing online and mobile banking and in particular, using our electronic scheduling. So if they do want to come into the branch, they can make an appointment and not spend any additional time. You could see our active mobile users have climbed quite dramatically, up 16% since January, and that continues a trend that we've seen for some years. So customer activity, the way that customers want to access their bank, continues to change and has been accelerated. Now turning to the next page. I want to summarize the optimization initiatives that we're announcing this morning and then go into a little bit more detail in further slides. So first of all, we're announcing the consolidation and/or sale of 21 of our branches. That's about 8% of the network and impacts about 100 of our colleagues. This will save us about $10 million in run rate expenses. In addition, with the sale of those branches and also the sale of the insurance brokerage that we announced previously, we've done some very difficult internal efficiency efforts, which includes an early retirement option. We have streamlined and will be streamlining our corporate managerial and back offices to reduce full-time equivalent employees by about 200 by year-end. This will result in a $30 million run rate expense reduction. Last week, we prepaid just under $1 billion of more expensive FHLB advances and took a $45 million prepayment charge to do that. We prepaid tranches of FHLB debt during the periods '21/'22 into '23. This will give us about a $5 million per quarter run rate NII improvement starting now going through '21, into '22 and declining thereafter. And in addition, we did a reorganization of our securities and real estate lending subsidiaries, which will drive a Q3 net income tax benefit of approximately $40 million. So let's dive into each of those and give you a little bit more detail. So on the branch optimization, we are consolidating in the state of Wisconsin 14 branches, just under $400 million of deposits. Most of those branches are within 3 miles of each other. Given our past consolidation experience, we'll retain about 80% of those deposits. And in order to accomplish this, we'll take restructuring charges of about $2 million this quarter and about $2 million in the fourth quarter. We are exiting the Peoria, Illinois market with the sale of 5 branches and about $200 million of deposits to Morton Community Bank, a bank that's active in that part of the state of Illinois. We have signed a definitive agreement. We expect to close that transaction in December. Morton is paying us a 4% deposit premium for the deposits being transferred, and the sale includes 6 properties, and we are not selling any of the loans in that marketplace. In addition, we're selling 2 branches in the Southwest area of Wisconsin, which are some distance away from our core market in Madison, about $56 million in deposits. Again, no loans going with that transaction. Again, we've signed a definitive agreement. We expect to close in December. We're receiving a 4% deposit premium from Royal Bank, another community bank active in that area, for the sale of the branch in Prairie du Chien and Richland Center. So that's what's going on with branches. If you look at the next page, a little history on what we've done with branches. If you roll this chart even farther back, you would see we had more branches back in the day. But including acquisitions in the last 10 years, we have reduced our total branch count by about 40%. And this is all driven by what I started the presentation with, continued migration of our customers to mobile and online channels, reduction of branches as the center distribution strategy for the company, declining foot traffic. And for those branches that are open, of course, as I mentioned, prescheduled appointments are up 75% now. People want to come into the branch to do something that they might need to do in person, but they want to know exactly what time they're going to get served and spend their time more wisely. So moving on to the next slide. Let's talk about the reorganization and balance sheet restructuring that I mentioned. So internal efficiency initiatives are going to reduce our run rate by about $30 million. This impacts about 200 of our colleagues, and we will incur $7 million in restructuring charges. As I mentioned, we've offered an early retirement option for retiree -- retirement-eligible colleagues. That option will expire this week, so we'll have a good feel of how many people have taken that. But as I mentioned, we expect a significant amount of the eligible retirees to take that. As I mentioned, we've prepaid some of the earlier tranches of fixed-rate FHLB advances at a cost of $45 million. That helps in a number of ways. It deploys our excess capital. As we sit today, we've been running more than $2 billion of cash. So we've reduced our liquidity. We improve our capital ratios. NIM will go up 6 to 7 basis points in '21 and '22, and we'll pick up an NII benefit of $5 million per quarter through '21, slowly declining thereafter, and we'll pick up overall more than $45 million of NII through the end of 2023. We also are recognizing a built-in capital loss within our investment in real estate subsidiaries, which generates a $40 million bottom line tax benefit this quarter. So together with the restructuring initiatives above, we'll record a net income tax benefit for the period. All of this, on the next slide, leads to a more efficient Associated. So at the end of June, we had about 4,700 people working at the company. By the end of this year, we'll have about 4,000 people. 400 went with the sale of Associated Benefits and Risk Consulting, and then the efficiency initiatives and the branch optimization is another 300 people. Importantly, in 2019, our expenses ran $794 million. The sale of ABRC and other things that we've done year-to-date reduces that run rate by $69 million, plus the $30 million efficiency initiative, plus the $10 million for the branch optimization. We expect our 2021 expense run rate to drop all the way down to $685 million. If you look at the next page, you can see some longer-term trends for the company. Since 2012, our average assets have increased from $22 billion to about $36 billion at the end of this year. Our noninterest expenses back in 2012 were $685 million. We will reduce that run rate over the balance of this year to about $685 million next year. So in other words, we're running a company that's grown by more than 50% at the same expense level next year as we did back in 2012. And then our noninterest expense to average assets will have declined over that period of time from more than 3% to under 2%. Let me just touch on a couple of other areas of interest. Our loan portfolio update, if you wanted to just roll that back, as of the end of October of -- I'm sorry, August 31, you can see what's been going on with end-of-period loans. We've had good growth in the mortgage warehouse business, as you would expect, with this very active mortgage market. Our Power & Utilities business continues to grow. As we've said, we expected commercial real estate to grow because of the large backlog of unfunded commitments we had there. And then we're continuing to see shrinkage in the oil and gas business and quite a bit of prepayment activity or repayment activity from our commercial borrowers who had drawn down lines back in March. Turning to our COVID relief efforts. In the commercial space, loan deferral and modification requests dropped dramatically over the course of the third quarter. 39% of the loan deferrals that were granted have ended. 53% of commercial real estate loan deferrals have also ended. The number of deferred and modified loans in the commercial and commercial real estate space have dropped by more than half at the end of August. So good trends as far as what's going on with deferrals and loans that are coming off deferral in the commercial area. Likewise, in the consumer space, we granted deferrals of 6 months, so we're just getting into that period of time where we're having conversations with our customers. But those conversations have been quite encouraging, and we'll know more as we get into September, October. But generally, customers with these deferrals are indicating they don't need to continue the deferral. So encouraging signs in the consumer space. With that, let me just take us to Slide 23 and give you an updated outlook for 2020, and then we'll throw it open for your questions. We continue to expect our loan-to-deposit ratio to be about 90%, excluding PPP loans. We have reduced our investment portfolio to about 15%, excluding PPP. We expect PPP to begin to forgive in Q4 and into '21, but that all has sort of pushed out from what the industry expected if you were asking this all 3 or 4 months ago. We are opening up our forgiveness portal tomorrow for all of our customers. We've taken a number of customers through the portal on a test basis. We've built our own proprietary system to do that, which should be very easy for customers to use. But the SBA has 90 days to act on these forgiveness requests. To date, they haven't acted on any of the couple of dozen that we've put through. So time will tell how quickly the SBA gets to this, but we would expect to start to see PPP forgiveness kicking in, in Q4 but probably the bulk of it getting into early next year. Mortgage banking continues to be elevated. We have a significant amount of activity still going on in that space. Service charges are returning to normal levels over the back half of this year. Of course, we have no insurance revenue after the sale of ABRC. We're affirming our expense run rate of $175 million for Q3 and Q4, which excludes the prepayment costs and some of these restructuring costs. We're quite comfortable we'll be, of course, under that in Q4. We're targeting 2021 full year run rate expenses of about $685 million. And with the tax restructuring we did, we expect our full year effective tax rate this year to be only 6% to 9%. Capital will continue to build over the course of the year. Our share repurchase program remains suspended. And as we've said before, now that we're into September, we continue to expect our loan loss provisioning over the back half of the year to be less than it was during the first half of the year. So Matt, that's the prepared remarks. There's a lot of other information in this deck that we provided for you to take a chance to look through, but happy to answer questions.

Thanks, Philip. Really appreciate the update. A lot in there. Why don't we -- if the audience can answer the second ARS question that the operator should be putting up right now. The question asked, which factors would be most influential in -- to increasing your long position in ASB? A, net interest income bottoming and beginning to grow; B, reserve build substantially slowing; C, Midwest economy rebounding quicker than expected; D, resumption of its share repurchase; and E, the announcement of a new expense program. [Voting]

And while we collect those responses, why don't we just dig a little more into your new expense program that you just updated us with. Do you see them when -- the benefits, can you discuss like the cadence of the expense saves? Do you expect any of it to start benefiting this year? Or do you expect most of it to happen in 2021?

So if you exclude the restructuring charges that go with it, we'll start to see the benefit in Q4.

Got you. And do you expect most of the expense saves to fall to the bottom line? Or do you expect it to be partially offset by investments in other areas?

We expect it to fall to the bottom line.

Great. The one clarification I had is the branch sales won't close until December. So the $10 million of savings related from the branch savings really won't begin to accrue to us until 2021.

Right. But if you exclude the restructuring charges, some of the other corporate initiatives we've undertaken will start to kick in.

Great. And then in terms of asset quality, it seems like trends are moving pretty favorably versus how they were. And you reconfirmed your second half provision guidance, so they've been less than half of 1H '20. With only a few weeks left in the quarter, are things tracking better than you forecast at the end of 2Q or in line? Yes.

Yes. So we still have another 2 to 3 weeks left in the quarter. We're comfortable with the guidance that we provided of less provision in the back 6 months than the first 6 months. Things are tracking, but it's still early days. So the deferrals are maybe a canary indicating that customers are doing maybe a little bit better, things are improving. But we based some of that -- some of the loan-loss provisioning guidance on the expectation there would be some more stimulus for consumers. That doesn't appear like it's going to happen in the short run. That said, we don't expect that to change the guidance we provided, but time will tell as to whether consumers are going to feel some stress with no additional stimulus from Washington, D.C.

Have you started to see a rebound in activity in customer sentiment as the health crisis has gotten more under control during the quarter?

Yes. There was a slide that showed increasing debit and credit card usage. So that's a reasonable sign that people are out spending money. Certainly, in the state of Wisconsin, there's a lot of activity, just anecdotally, going by restaurants. I haven't eaten in a restaurant since mid-March, although I go into takeout, but that's not stopping a whole lot of other people. That said, COVID cases are on the rise almost everywhere. Well, not everywhere, but in this part of the world, unfortunately, COVID cases are up. People are out and about. It's good for the economy. Hopefully, it won't cause a second surge.

Yes. And oil and gas, which is like just under 2% of your loans, 1.7%, has got a lot of attention, especially in March when prices dropped considerably. Are you concerned about the outlook for the industry? And what are you doing to mitigate risk?

Sure. So we're very concerned about the injury -- about the industry. Injury, that was -- we are still sitting here with significant reserves up against our remaining portfolio. At the end of June, we had 19% reserves against the balance. However, we were fairly early in recognizing just how bad this was going to be. We have about half the amount of loans outstanding than we did about 2 years ago. So we've been working hard to reduce our exposures. We continue to do that. This will be a declining portfolio. You'll see further decline when we announced end-of-September numbers. So we remain highly concerned about the outlook. At prices of 40 or under where we are today, many, many, many reserve secured loans, which should have been traditionally in good shape for the banking industry, are underwater.

Great. And in terms of when you -- NCO rates really picking up, do you have a time line on when you think that could be, if it's like first half of 2021, second half? How do you think about that?

Yes. So when you think about how credit works, you've got early signs, and then you've got lagging indicators. So downgrades in loan grades that we have, additional provisioning, the workout process, net charge-offs come at the end of that process. So I'd say for the industry and for us, you'll see a pickup in charge-offs starting sometime next year for second quarter, say. That doesn't necessarily mean that provisioning will follow. As you reserve first, we charge off later. So we've built, as you know, our overall level of reserves quite dramatically between CECL day 1, first and second quarter. We expect to continue to provide but at a lesser rate. When we get to charge-offs, we won't necessarily be needing to fill the reserves up with additional provision.

Great. I just got the answers from the automatic response question. So it looks like 25% are in favor of net interest income bottoming, 20% reserve build substantially slowing, 10% Midwest economy rebounding, 20% announcement of a new expense program. In terms of...

[ Pretty even ].

Yes. So pretty even across the board there. And now it actually just got up. I just had an update. 45% net interest income bottoming, beginning to grow. In terms of NII, outside of PPP forgiveness, is there room to still bring down -- what else are drivers that could cause it to increase? Is there room to still bring down deposit costs? I know you relatively -- some CDs rolling off. What other actions are you guys doing?

Chris, you want to take that?

Sure. So look at Page 18 of the deck, you'll see that the overall funding costs have continued a downward trend. The most significant that I could point out, Matt, is, in fact, the CDs. And so our CDs will continue to roll off and in fact, we'll see a good amount of those roll off over the first half of next year. So the next 3 quarters, you'll continue to see that trend down. The positive we would say is as we're rolling off the CD book, the vast majority of those rolled right back into consumer deposits. And Dave, I think we've chatted about this earlier. If you want to sort of chime in here, apologies.

Yes. What we've seen most recently, say, for the last 6 months is a significant repricing of our CD book. So we retain the vast majority of maturing CDs, but we've seen the rate paid going from the [ 120 ] range to 10, 15 basis points or less. So pretty significant pickup on a not insignificant amount of our CD book.

Great. And the other side of that we would offer is that if you look at the blue lines, which are the commercial loan yield lines, you'll see those have already bottomed and are stabilizing. And in fact, we would expect those margins to marginally expand as we continue to move through the cycle as a result of 2 initiatives that we're running internally. One is to, as things come up for renewal, have different conversations with each borrower about the appropriate spread in the new world that we're sort of operating in as well as introducing, wherever we can, additional floors. And so for a number of years, we've sort of moved away from requiring floors. As we move forward in time, we're looking to reinsert floors wherever we can.