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

Good afternoon. I'm Matt Kesselhaut, and I work with Jason Goldberg covering the U.S. bank stocks here at Barclays. Next up, we are glad to welcome back Associated Banc-Corp. From the company, we have a full lineup, with President and CEO, Andrew Harmening; CFO, Christopher Del Moral-Niles; CIO, Michael Meinolf; and Chief Credit Officer, Patrick Ahern. On the upper right-hand side of the screen, there's a question box that you can submit questions to, that I'll try to get to near the end of the session. There is some delay in getting the questions to me, so the sooner you get them in the better. With that, I'll hand it off to ASB for their presentation. Thank you.

Well, good afternoon. This is Andy Harmening and excited to be with you all today. I want to say it has been a busy 4.5 months since I took over at the helm of Associated Bank. And coming here, I was pretty clear that it was not a rebuild, that we had a good foundation on the credit side. But I also believe there is an opportunity for growth on the loan side and an opportunity to be more digitally focused. I think what you'll see when you look at these initiatives throughout this presentation is we have focused on our customer base. We have focused on the markets that we serve, and we've focused on the skill sets that we already have. On the digital front, we have already shifted what our spend will be, our organizational structure and our strategies. And what I find to be the best news about this entire presentation is that we've already begun on every single category of every single initiative. So switching to Slide 3. What I want to point out here is these -- we are serving strong markets but we're serving markets that are heavy in manufacturing, think equipment finance. We are deep into our communities and we have good brand recognition, which we expect to help us on the hiring front. And we have strong banking fundamentals. So our credit is solid. Our operational risk is strong, and our customer satisfaction was ranked #1 in the upper Midwest. So the question really becomes, how do you grow on that foundation? And what does growth look like? For us, we wanted to drive positive operating leverage and improve our ROATCE. The way we've defined this on Page 4 is in 4 categories. And you're going to hear more and more about each of these categories as we go. But we're going to expand our lending capabilities with 3 key verticals. We are going to focus on growing our core businesses, many in our core markets, invest in our digital transformation and redirect spend and, of course, optimize our capital structure. I want to emphasize again that we have already taken concrete actions. And you can see this in each of the categories below. I'm going to focus on each one of these categories individually as we dive into the rest of the presentation. But when I look at expanding our lending verticals, adding a little bit more color to these categories right now: Auto Finance. This is one that we've been in the process of for a few months. It's a category that takes some of our historical growth in mortgage and shifts it to the indirect auto, a very safe portfolio, and we are getting moving already. We've signed up 550 dealers so far and we expect to book our first loan next month. That leads us to believe that our $1 billion in expected balances by the end of 2022 is right on track. In the asset lending -- Asset-Based Lending space, again, an extension of middle market. We already have our origination and servicing systems in place. And now we've added a leader with 25-plus years of experience as of last week. Again, we believe strongly that our $150 million for 2022 is on track. And then finally, talking about the Midwest manufacturing base, equipment finance is a natural extension for us. Our service systems are in place, and we're very actively recruiting for our executive in this space and expect to add that executive in the fourth quarter and booking loans in the first quarter. All of these have anticipated yields of roughly 3%. So when we look at our lending capabilities, and this is in the absence of our deepening and our business as usual, we would expect a lift from these verticals through 2023 to be about $2.6 billion or about 12 -- about 10% of our overall loan portfolio. And again, this is in addition to our core growth. So let's talk about those core businesses. In our 3-state footprint, one of the first pieces of importance to us was to accelerate our core middle market growth. We're going to do that by adding 10 commercial relationship managers. The good news for us right now is we've already added 5 of them in the past 60 days. As these folks produce about $10 million to $20 million per person in production, we feel like we're well on track to $100 million in additional lift in 2022. Small Business: To be a good commercial bank, you have to be a good small business bank. This is a space I have a lot of experience in, and I love this space. It's local. We've already modified what our process is, our training process. We've partnered with our operations, our credit and sales to have ongoing training here. We've hired on the small business front and believe we will see an increased run rate in the second half of 2021, leading to a run rate increase of $50 million to $100 million in 2022. And finally, we'll retool our mass affluent strategy. Mass affluent in the midterm is a place where you often get a nice lift in deposits. We will expect the same in that over the midterm. But importantly, what it does is it marries your mass market approach to your middle market approach and ultimately, your private banking approach, where we'll be able to take advantage of what we already have in a well-established wealth management team. Transitioning to digital. This was an important shift that we're making and the shift is already underway in our spend. But we've had an investment in digital over the past years. In fact, our branch network and our call centers have done a very good job of getting digital penetration into our customers. 80% of digital activation among new-to-bank, and a peer-leading mobile check deposit usage of 33%. But where do we go from there is the question. Well, we increase our spend $50 million over 5 years. We've centralized our leadership under a single leader. And then one of the pleasant surprises I had upon coming here was that we actually already had a labs team. Associated Bank Labs or AB Labs, this is a team that already moved ab.com to the cloud and immediately got industry-leading response times on each page. It's a team that built a digital app during PPP, one of the few if only banks in our size that did that. And then in the last 90 days since I've arrived, we took customer data on our account opening and we've improved our top box satisfaction from 57% to 81%. So that's a good start in all of those pieces. But in addition to that, we intend to move off a platform that's a little bit more rigid. And so in the first quarter of 2022, we are positioning ourselves to outpunch our weight. The first piece of this -- or the next piece of this is building our digital platform. This gives us an ability to take ownership of our digital destiny. By that, I mean we're going to have open architecture in this. We'll be able to integrate fintechs more quickly and self-produce products and services more quickly into the digital experience, an experience that's impacted by our already-existing AB Labs team. The second piece of this, once you get that platform, is to transform your sales approach. And our point-of-sale strategy, we expect to start focusing on our consumer account opening, which as you know in the industry is becoming a bigger and bigger portion of where new accounts are opened. And we expect to get deep into that in the second and third quarters of next year. In the meantime, we're going to build out a road map that looks at deepening and products that attract new customers. So we had to make some quick and important decisions, and I'm very pleased that the team was able to quickly come up with $10 million in annual run rate savings. This annual run rate savings is going to be entirely reinvested back into our digital strategies. It's a shift away a little bit from brick-and-mortar and our corporate real estate, as you can see outlined on Page 11. Page 12. Page 12 is the lean in to some of the positive operating expectations that we have that you'll be able to see in the future pages. But what I'd highlight on this page is we largely haven't changed our underlying expense outlook. We have a little bit of money in for new initiatives, but we have a modest number in for onetime expenses that we expect to see in the fourth quarter. And to be clear, even with our new expense guidance, we still expect to deliver increasing PTPP income in each of the -- each of Q3 and Q4 of 2021 versus Q2 of 2021. Now on Page 13, this is where it all starts to come together: our growth initiatives as you can see how they're impacting our expected financial returns. First of all, we expect to have a CAGR on the revenue side in the high single digits, as you see, roughly 8%, and on the expense side in the low single digits of roughly 3.5%. We've hedged that bet, as you remember from the prior page, by taking a $10 million run rate save in our ongoing expenses. And then we expect positive and increasing operating leverage in both 2022 and 2023. Optimizing capital remains part of our plan. And you can see clearly on this page that we've already taken significant action in 2021, whether that's the increase of our dividend in the third quarter, whether that's the most recent $60 million in share repurchase completed in the third quarter of 2021, or in the bottom section, our continuation to redeem preferred stock. I hope you can sense we're excited about what these initiatives mean, the initiatives that we're rolling out. And with a simultaneous focus on growth and digital, we expect that we're going to be able to better serve our customers, make our colleagues' jobs easier and improve our financial performance. Slide 15 illustrates a little bit of how we expect to get there. And in addition to the 2022 and 2023 targets we've laid out throughout the deck, we've included several multiyear operating targets to help measure our progress over time. If the Fed were to move rates higher, we would expect to get there sooner, but we're not banking on the Fed to hit our operating targets. In fact, our plan assumes no rate action in 2022. Look, I think Slide 16 speaks for itself. But Associated Bank, we are repositioning our company to a place where growth is a focus. Digital is at the forefront. We are putting our capital to work and higher returns are the expectation. I do want to emphasize that this journey has already begun. It's action-oriented. And our collective team not only built this plan, but they've gotten behind it in a very short period of time and are taking action. With that, I'll open it up to questions.

Thank you. Really appreciate that. Just to remind everyone, in the upper right-hand corner of the screen, there should be a box that you can put questions in so that I can ask at -- towards the end of the presentation. That was a very important presentation and a lot to dive into there. I guess, in your presentation, you revealed the new efficiency target and mid-teens return on average tangible common equity target. I guess you touched on just now that not much of this depends on the rate environment. But how much does it depend on economics issues normalizing?

Well, sure. I think, Matt, in our overall outlook, we're expecting to see here somewhat more of a return to normal. Obviously, our current utilization rates, for example, in our core commercial and corporate banking books, are well below normal. We're in the low 30s. In a normalized environment, we would expect that to be closer to mid-40s. And so those types of lifts in our core business are assumed to unfold at some point here over the next 3 years or so. And as we sit here today, what we see is a backlog in CapEx activity. It gives us a fairly bullish context in which to sort of look forward. And so that's built into the plan as some expectation that the world comes back to a more normal place.

Great. That's very helpful. And if rates do rise, would you expect to be at the better end of these target ranges?

Yes. So we're not expecting anything to happen in '22, but clearly, the sooner things happen in '23 the better, and the more we'll hit our 3-year target sooner rather than later.

Got you. That makes sense. And then in terms of the strategic initiatives, do you expect the benefits to results to be gradual over the next few years? Or should we see a large step up in 2023 versus 2022?

Well, I think you'll see on the page what we expect the financial impact -- Chris, is that Page 7? Page 7 shows what the financial impact. Clearly, it's a growing number. However, we don't believe that we're waiting until the end of 2022 to see a material impact. So in the first quarter, we expect Auto to be up and running on a pretty good run rate by the time we get there. The second thing that we're committed to doing is showing a series of KPIs on a quarterly basis. We'll probably start that after the fourth quarter. But then on a quarterly basis, show what are our early indicators, whether that's hiring people, whether that's production, whether that's usage, we'll come out with a one pager to show the progress and how that's going to tie back into our financial performance.

Perfect. You're pointing to a NIM of 2.75% over time compared to your [ Q2 ] '21 NIM of 2.38%. Can you talk about the drivers of increasing your NIM over time and when the likely timetable for this?

Sure. So I think there's probably 4 key drivers to that. One that you've been seeing unfold over the course of this year has been our continuing liability management actions: retiring the debt, remixing the commercial -- sorry, the CD portfolio, optimizing our Federal Home Loan Bank advances. We'll continue to do those things here over time. What we're doing incrementally, as we called out in our guidance page, is we're beginning the process of investing, that's moving our excess liquidity from cash at the Fed at 15 basis points to some modest leg into the investment portfolio at a slightly better yield. And then what we're expecting to see, as we commented earlier, is we're expecting to move the needle on line utilization over the next year or 2 and to grow the verticals. And the combination of remixing our assets into these higher-yielding asset classes, reigniting the growth in our core business and moving a little bit more cash into the investment portfolio will all contribute to the 2.75% margin, along with managing our liquidity, of course, and our cost of funds.

Understood. Thank you. And you've mentioned you're investing in areas like auto and launching equipment finance lending business, both of which are very competitive areas. What gives you confidence that ASB can take market share and compete in these areas?

Well, I'll speak to that. The Auto Finance is a relationship business. And so we've had this group join us from KeyBank. These are folks that have extensive experience in the industry. They know the dealers, they understand how to run the business. We've been able to get data to build a custom scorecard so we'll be able to turn the business, and in a pretty short period of time. In fact, when we printed this deck, we had signed up 550 dealers. In the last 10 days, 2 weeks, we've added another 50. So this happens when you have relationships already. So our Auto business, I feel very good about where we stand and the fact that we'll get that fully launched or get production in the fourth quarter of this year. When we think about equipment finance, I think of it this way, we're a known brand, particularly in Wisconsin, where there's heavy, heavy manufacturing. We're doing a lot of commercial business. But essentially, we are -- we've moved ourselves out of the market in an important aspect, and that's equipment leasing. So these are our customers today that are doing these leases. We simply don't have the product set to fulfill on that. So we don't believe that it's simply meeting new folks to get this type of business. We believe there's a pent-up demand, as you can see, many articles coming around about equipment purchase. And we're right in the heart of the manufacturing belt. So for us, this is a logical extension of a commercial and middle market strategy.

Understood. I guess moving on towards capital. And in the second quarter, your CET1 ratio was 10.7% compared to your target of 9.5%. As you invest in your new strategies, does your target change? And how are you balancing investment versus return of capital to shareholders?

Sure. So our CET1 target is 9.5%. And that reflects the fact -- I'll let Pat perhaps comment on this. But that reflects the fact that our target new asset classes are really to our same core customers: prime and super prime consumers, and our core middle market commercial customer base. Pat?

That's correct. Just to echo Chris's comments. We're not looking to shift our credit profile here within the new lines of business. And as Andy mentioned earlier, it should be a nice continuation of the relationships and the credit profile that we're looking at right now.

Just to answer how we prioritize it, though, our prioritization is on growth. Almost -- under almost all circumstances, we believe that's going to be a good bet for us. If we are able to grow our business, grow our revenue, change our financial metric numbers, build a foundation on the digital side, under almost any circumstances, we think that sets us up for the future. Of course, we actually believe that we're going to be able to fund our growth as well as taking capital actions, additional capital actions on share repurchase.

Interesting. And then in terms of asset quality, any indication when you expect NCOs to normalize? And do you expect to continue to release reserves in the second half of this year?

Yes. I would say I think we've built in here, we've got kind of a 20 to 35 basis points projection that's through the cycle. Right now, the portfolio is still performing very well. We don't expect any issues to come up with Delta variant, et cetera. So we feel pretty good about that, and we think the 20 to 35 basis points is a good reflection of where we're headed.

And Matt, we have called out that we do expect a further negative reserve release in the third quarter.

Got you. And then would you point -- will the CECL Day 1 for each of the rate benchmark for ASB as economic conditions normalize?

We would expect we'll probably be a little bit lower than CECL Day 1, just given at that time, we still had a larger oil and gas portfolio that we've continued to exit over the last 1.5 years. So going forward without that piece and the buildup that we had at that point, we would expect it to be lower than Day 1.

Got you. And then -- we appreciate if you'd update your guide or your 2021 guidance. It seems like you're now pointing to the lower end of your loan growth range of 2% to 4% for the year. Can you just discuss the recent trends you're seeing across your footprint?

Sure. So we've stayed pretty steady with our 2% loan growth number excluding PPP. We've seen some nice signs, we had thought, in June and July. However, August seemed to be significantly more flat. So we believe it is directly related to the Delta variant and a pause. When we look at the rest of the year, our pipelines remain elevated. And so there's reason for optimism on that. And we expect to get some of the verticals launched to give us a slight tailwind. But overall, we'd still stand with that 2% number, excluding PPP for the rest of the year. And Chris talked about the capacity that our borrowers have. I mean, we are right around 30% on utilization when typical utilization is between 40% and 45%. That gives extraordinary capacity. We don't have to see big increases in that for us to hit the number. But we believe as we head into year-end, that's a positive for us.

Thank you. And then in the second quarter, your quarter NII started increasing. Do you believe it's reached an inflection point?

Yes.

Great.

I think that was well said, Matt.

[ It's all we have now ]. And then I guess in terms of PPP forgiveness, I guess it's different across banks, we've noticed. Have you seen forgiveness pick up? And do you think you'd be complete with that process by the end of the year?

At this point, it's starting to become a rounding error. We're -- we just have just over, I believe, $200 million in outstanding PPP loans. So we've considered to see that. We've consistently seen that pay down. We think we'll end the year at a pretty nominal number. I wouldn't say that it's going to be 0, but we expect it to be less than $100 million by the end of the year.

Perfect. And then just a reminder to everyone in the audience, you can ask a question and I will be able to ask the management team here. I guess you still have a lot of excess hopefully in your balance sheet, largely driven by deposit growth during the pandemic. Like how do you think about deploying these deposits? And do you think deposits are stickier in any 1 spot?

Yes. In fact, the surprising thing here has been not only that they've been sticky so far and stayed with us so far, but that actually liquidity levels continue to rise as we move towards the end of the year. And so whereas in the perhaps past, we have been waiting for the outflow of deposits. As we sit here today, we are taking the view that these will be longer-duration deposit levels. And that's part of the reason why we increased our investment targets as we move into year-end. We're going to move cash off the balance sheet at 15 basis points in [ interest in ] securities, in part because we don't see the liquidity moving on the way we thought we would.

In terms of fees, can you talk about trends quarter-to-date? What areas are you seeing the most strength?

So I'm not sure I'll talk so much about quarter-to-date, but we've seen clearly strength throughout the year in our wealth management fees, our capital markets fees and our core deposit customer service charge fees, as customers have started to use their cards again and spending has improved. As I think about the future, we anticipate we'll see a slowdown in mortgage banking fees, but we anticipate that will be significantly offset by continued future growth in capital markets fees, syndications activity, card use and, of course, wealth management fees as the markets continue to remain strong. So far, that looks like it's on track and should be a nice offset to otherwise what would be a downtick likely in mortgage banking income. I would note that in 2021, we've recorded over $10 million of mortgage banking MSR recovery income, which obviously won't be repeated.

And then I guess, for Andrew, since joining ASB in April, can you reflect on the last few months as CEO and what have been your main takeaways? Any surprises?

The only surprises I've had have been on the good side. What I would hoped is that we had, had a stable balance sheet and credit profile and we do. Some of the things you can't anticipate coming in is, what is the leadership team's reaction going to be to a bold strategic plan? And frankly, not only have they supported it, they've built it. So seeing the team come forward with that kind of plan. And having talked to, before coming in, investment bankers, analysts, former colleagues, and then getting in front of our own colleagues, asking the question about what we should do next. I was hoping there wouldn't be a huge disconnect between what the market thought and what our colleagues thought, and there's not a disconnect at all. Our folks said, look, make sure we have a reason for people to bank with us. Make sure that we have bold plans, make sure we focus on growth, ensure that we actually have operational effectiveness. We make the job of the colleague easier. Let's invest in digital tools and think about journey work from the beginning of a process to an end. And so when we did our 100 days of listening and we came up with 7 major themes, and we marry that with what our strategic initiatives are, the overlap is incredible. And so I would say it's been a busy 4.5 months. I would say the biggest thing that I'm pleased with is our leadership team coming together, having a collaborative approach when we're building out these plans. Typically, people execute on plans that they believe in, that they have input on, and we've had input through 400 individual meetings with colleagues that I've had. Our leadership team has had their own listening sessions with their colleagues. And then our rollout meetings with our executive leadership team have gone through every initiative in detail. And sometimes that can become tedious and it can lead to very long days. But they've rolled up their sleeves and signed up for what we have both in our business as usual, our core business as well as our initiatives. And I don't think there are any surprises at any level of the organization at this point.

Thank you. And in your presentation, you talked a lot about digital and how you guys are investing in digital. How do you view fintechs? Do you view it more as a competitor? Or do you partner with them?

Both. And maybe I'll have Mike Meinolf, our CIO, speak to that.

Yes. So we are definitely in the situation where our fintechs -- our competitors are also our partners. I think when it comes to customer experience, [ we ] definitely focus on the partnership angle of fintechs, where they can help drive and move the needle more quickly. And in a lot of cases, provide specific customer experience opportunities that, quite frankly, would be a little bit out of our reach to develop ourselves internally. The real powerful combination we're going to have going forward is the ability to provide our personalization into those fintechs to leverage our data, leverage our internal capabilities, as Andy mentioned, our open architecture, to really provide that personalization and that personalized experience to our customers via a fintech platform.

Perfect. I guess, through the COVID crisis, I guess what have you learned from your increase in digital engagement? It sounds like you're consolidating your branch footprint. Is there more you can do there? How are you thinking about that?

Well, I think that will be -- like any good retailer, you look at what the trends are, usage from your customers. We found out a couple of things. People matter. We are a people-led digitally enabled company. And so whether that is people in our commercial bank, whether that is our branch personnel, whether that's our backroom, constantly understanding what the key trends are, but giving yourself optionality. And so on the digital side, we have closed a few branches. We will close a few branches in this next round. But the important thing is we're going to be able to deliver capabilities on the digital front to our customers. We'll be prudent in how we think about our distribution. We won't close things for the sake of closing because our branches still serve and open the most valuable accounts in the industry -- across our industry. So while there's an increase in digital accounts being open, it's not a water, it doesn't fall off a cliff, and all good accounts are opened digitally. That's not what is happening. There's a bigger number, but still high-quality folks. They want to know you have a presence that you're there when it's difficult. So that will be a constant discussion, a view of data, customer insights. The branch networks will continue, but however, digital will play a predominantly more important role. I'd say probably the longer the pandemic goes on, the more reliant people are on new habits that they've formed. I will say though that the human -- basic human interaction, there are some things that are difficult to recreate if not in person. That collaboration piece is very important, understanding people: whether that is what they're working on, a facial expression or reaction, an intensity to the role, there are still things in person that matter. And so whether that's how you look at hybrid work environments or customer interaction, it's very simple. We saw a group come back and they hadn't seen each other for months. They're high-fiving when they're seeing each other in person. And so I think it's important to remember that technology matters, but it doesn't replace the human experience.

Well, with that, I think we're out of time, guys. We, at Barclays, want to thank you guys for coming again. We really appreciate it. And hopefully the Packers bounce back.

They'll be back, Matt. They'll be back.

Yes, I hope so. Thank you, guys.

Thank you.

Great, thank you.

Have a good one.