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

Good afternoon, and welcome back to day 2 of the Bank of America Financials Conference. With me from Associated Banc-Corp, I have Andy Harmening, President and Chief Executive Officer; and Chris Niles, Chief Financial Officer. Before we jump into questions and answers, Andy has a few prepared remarks that he will provide. With that, please take it away.

Well, thank you, Brandon. And first of all, I just want to say thank you for joining us this afternoon. I thought I'd start with some updates to our strategic plan and then, of course, open it up for questions for the majority of the time that we have today. First, as a bit of backdrop, I started almost exactly 6 months ago, April 28. Coming in, what I expected to find, a good capital position, a good brand, solid on the risk side from both an operational risk standpoint and a credit risk standpoint and good customer satisfaction. From my view, that is a really good way to enter a company. After having been here 6 months and a week, I've validated all of those things to be true. But then we've also found some opportunities. And so when I see opportunities, I think of that in really two ways. First of all, we have an opportunity to be a little bit more focused. And we have an opportunity to be even more digitally forward in our approach. So we've been very diligent, very hard at work in defining what strategies move us forward in these two areas over the last 6 months. And I believe that if we follow this path, we are going to sooner than later have positive core operating earnings, I mean, as sooner as in 2022, and really start to move the needle on ROATCE. And then I want to emphasize, and I will both to our team internally and externally, that we are quickly moving to execution. And with that said, I want to just quickly go through a few slides that show that I believe we have momentum. So if you're following along, you see on Slide 3, that's a quick outline of what we're trying to get accomplished. First of all, expanding lending verticals, the auto finance, equipment finance, asset-based lending; then really focusing on our footprint, footprint strategies, growing our commercial businesses and our small businesses; then redirecting our spend to really focus on transforming our digital platforms, with that, also exiting several legacy facilities that we have that we simply just may not need at this point; and then finally, optimizing our capital position. So if you go to Slide 4, in terms of updates, the auto is one that we've started to give additional guidance on. This is one that we have now launched. We launched on the last day of September. We have about 40 days under our belt. We started with a pilot of 60 dealerships roughly. We moved to 200-plus dealerships over the course of the last 30 days. We have 800 dealers signed up. And we're doing just under $2 million of business a day in new deals. On the asset-based lending side, again asset-oriented, we have 5 people in place. We'll add a couple or a few more. But we are actively looking at deals in that space with the leader starting in September. And then most recently but very excited about, equipment finance. You know what our footprint is. And within an 8-state, upper Midwest footprint, we have 30% of manufacturing jobs. Equipment finance, it seems that's a hand in glove for us. Excited that we've added Scott Dienes from Wells Fargo via GE Capital, who started with us on October 21. We have targets out there that we think are very achievable. So let me go to that next on Slide 5. Probably the biggest news that we have out there right now because it's the first one to start going live with deals, and that's auto. We've increased our outlook on auto because we've gone through this pilot stage. We're seeing what we're getting per dealer. We're seeing what kind of deals, what kind of FICOs, nearly 750 in average FICO, I believe it's 747. We have gotten through a month-end cycle to get dealer statements and invoicing now. So we're feeling very good about our trajectory on auto as we head into year-end. And the idea there is that we'll have about $2.5 billion on the books by the end of 2023. And then overall, between the three verticals alone, we expect to have balances just over $3 billion on the books by the end of 2023. If you move to Slide 6, you'll see this broken out in a few different segments. But this is the win at home strategy. And that is let's add some commercial bankers to what we're doing. We have listed 10 by the end of next year. We're well on our way there. We have a modest uptick of about $100 million in balances. We feel like we're very much on track there. On the small business side, there's no doubt that we have opportunity to expand in that space and frankly are seeing pipelines at their highest levels in the last 12 months. And we've hired new revenue producers in that space and have shown more options. So our $50 million to $100 million target there, we believe we're on track. And then finally, mass affluent. As we think about the future, maybe it's not 12 months or 24, but on the deposit front, the preponderance of deposits are in this space on the consumer side. That's a place that we think we have an opportunity to deepen. We've been conducting internal and external research of customers to understand what they want. That is a trend that you're going to see in almost everything we do from a sales, service and product standpoint is customer research and then translating that into products then that we believe will work. What's important about Slide 6 is these are inherently local strategies. They are in our sweet spot. And we believe they will help us move the needle when it comes to our operating leverage. Now moving to Slide 7. Our digital transformation is underway. So we've shifted our investment mix and we're moving away -- a little bit of away or evening out the mix from traditional brick-and-mortar to a little bit more digital and technology as we have talked about. And we expect to launch a flexible mobile and online platform by the end of Q1. This is foundational for us. It will allow -- it will have open architecture and integration layer. This will allow us to quickly integrate fintechs and create customization on our own. On the cost side, in October, we closed 8 branches already by the end of October. And we've also begun our Green Bay facilities consolidation. We expect total exit costs of about $4 million to $5 million, which we've previously stated in Q3 and Q4. And importantly, between those actions and a couple of efficiency plays, we have about $10 million going into the year that we believe we will be able to reduce in 2022 run rate in order to get to a 3% to 4% expense number. Now going to Slide 8. This leads to a discussion of our cost shift. And the digital investment, it is a cost shift. It's going from physical to digital and revenue-driving initiatives. Importantly, auto is largely in our 2021 run rate already as we've had a vast majority of these books starting in our business in February and March. Our 2022 expense guidance does incorporate the initiatives, it does incorporate the minimum wage increase that goes into effect November 21. But it does include overall compensation pressures or merit increase that we expect that we'll have to deal with to keep top talent in the company in 2022 and beyond. If we move to Slide 9, Slide 9 simply illustrates that because we've been able to get going so quickly, because we've made some important decisions on how we can cut some expenses, we believe that we will be generating positive operating leverage, which we outline here, in both fiscal year 2022 and fiscal year 2023. So leveraging people, leveraging technology, we believe we can be a more competitive and more efficient Associated Bank. Finally, when we go to Page 10, we've included some several multiyear targets here. Clearly, we've talked about being growth-focused. We've talked about being digitally-focused. We know that, that will help customers. We know that, that fits squarely into the communities. And I'll just reaffirm, the journey has begun. It is action-oriented, and we've gotten really good buy-in from the team. And mostly because our team, through our listing sessions and their ideas, essentially built this plan that we have out there right now. So with that, Brandon, those are the prepared remarks I've had. And I'd be happy to open it up to the Q&A session.

Thank you for the update. And before I begin, I just remind anyone listening today that feel free to ask questions. I believe there's a chat to the right on the screen. And I will ask those questions on your behalf. From the sound of it from the update, it sounds like you guys are focused on growth, right, especially in auto. And just some comments from peers during the 3Q earnings cycle, it just seems like there's more competition in that space, right, whether it's showing up in pricing, underwriting, et cetera. Can you talk to us about how you think ASB -- Associated differentiates itself and will be able to achieve these targets?

Yes. Asked a different way, Brandon, often people say to me, "Well, how are you going to be able to break into this market?" And I would say this, this is a new business front to us, but it's not a new business to the 30 to 50 people that we brought on from KeyBanc. You can see that very clearly from the fact we go from 60 to 200 dealers in our pilot and the fact that we've already signed up 800 dealers. You can see that in the fact that we actually -- we purchased some software from team but also gotten some historical information to build a storefront. So when you think about a legacy team, when you think about the tools that you need, when you think about the scorecard and then the hope is that the market embraces you as early on it embraced us by having them sign up. And then when we go to pilot, they've embraced us by putting -- or giving us deals. So while we're a new entrant, we're about as deep and we're about as experienced as you could hope for entering into a vertical like this. So we were hopeful that this would be the track that we've taken. After 40 days in, we've been able to validate the benefit.

And maybe you could broaden that and comment a little bit on how we see our entrants or [ reassess ] to the asset-based and equipment finance in the same building.

Sure. I mean, again it's getting the leaders that have been there and done it. So we have been able to hire somebody in the asset-based lending space. We've hired them in September. They are literally looking at deals right now. So the first 30 to 45 days in, already getting into that. And we have 5 people onboard. And as the word has spread, it's both what happens externally, but what talent are you able to attract internally. And so we've had some pretty good success with people seeing our story and hearing our story and frankly, at this point, coming to us and inquiring about opportunities. So between the internal expertise, the folks that we've been able to hire and the conversations with customers on the asset-based lending, and we think it looks very promising on equipment finance as well.

Well, great. Just switching gears a little bit to the digital side, right? So you guys plan to spend that $50 million of digital investments over the next 5 years. And a question that comes up, I think, a lot from investors is, especially when there's an announcement such as that, is where does management think the company was lacking in terms of tech and digital relative to peers, right? And then on Slide 26, just to add a second question to that, you guys provide a great update on digital engagement. And we can clearly see a pickup at the onset of the pandemic. Can you also tell us what are the right questions that outsiders such as ourselves on the sell side should be asking bank management teams with respect to tech and digital?

Well, really good questions. That could be a really long answer in and of itself. So I'll keep this brief, and I can -- any one-on-ones, I can follow up in a lot of detail. The first thing is our platform today, it's very cookie-cutter. You could swap out the logo and the colors, and it would look like a lot of other banks our size and smaller. So we don't have much ability to customize. We also don't have open architecture, meaning you can't ease in a fintech into your base and go. You also need an integration layer. You also need to connect your legacy core system and bring out the data. So we're working on bringing out the data. We've worked on our integration layer. And now we're going to launch a platform that can customize. So that's the beginning. But to me, those things are really exciting. I've seen this play before. I know what to expect in that. That's table stakes. And so I'm excited about it. The question is at launch, can we just go ahead and launch and integrate a fintech into our platform at the same time? So that's been the request of the team. And I will tell you the teams think, "Yes, we want to be challenged in that space, we're going to do that." So that's our expectation at launch. But we've already come out with something that's more custom than we've had before. So that's number one. But what I would say beyond that is -- and this sounds cliché, but it's very true, I experienced this from [indiscernible] is that when you listen to what the customer needs, you can execute here. So many people think about legacy systems data and your platform, absolutely necessary. I would say almost everybody has legacy systems and a platform. And many people have the ability to customize. The question that I have is can you differentiate? We've learned that from some of our fintech partners. I've studied those very closely. When you differentiate, usually your customer says, "I like it," because they've told you, "That's what I want. That's what I need." And so you don't build just for technology's sake, you built because there's a customer need. When you do that, that gives you -- typically gives satisfaction. It also becomes a vehicle for attraction of new customers over time.

Great. And then just taking this a step further, you guys reiterated your expectation for expenses to grow at a 3.5% CAGR over the next 2 years. When do you think investors can expect [indiscernible] expenses to see, within those results, the benefit of those investments?

Well, I think pretty quickly. I mean, look, the fourth quarter, we have a couple -- just as everyone else, we have PPP that's running off. We have a couple of portfolios that we're trying to clean up oil and gas, so we don't even need to talk about it as we get into 2022. As we get in the first quarter, if we start talking about booking nearly $2 million a day in auto, we start to look at deals on ABL, asset-based lending. I'd love to book something in the fourth quarter. I expect to book something in the first quarter. I expect to have something booked in equipment finance in the first quarter. Otherwise, we wouldn't go out and give a forecast to having a positive operating leverage. So we expect to see signs of life in the first quarter. We expect that you can see the growth of that in the second. And we expect to report on it. That's one thing the investment team has said very, very clearly to me and to Chris is, "Look, if you're going to do this, don't keep us in the dark. Each quarter, when you present, be clear and show transparency of where you are." So I think that the question we have a big -- we have a nice construction backlog in CRE, will they come out of the ground in January? It's pretty cold in Green Bay in January, Brandon. But there are some markets that are a little bit warmer. So maybe February, March, April, we'll see that start to draw. But I think overall, there should be clear evidence that the initiatives are starting to take hold in the first quarter. And we think each subsequent quarter, they'll have a little bigger financial impact.

Great. I'm glad you mentioned that being able to kind of -- your transparency with respect to the initiatives and stuff like that. If we kind of pare back the strategic update, the chart on, I believe, it's Slide 9 that also shows the revenue growth trajectory, just back of the envelope math would suggest that maybe legacy revenue growth decelerates between 2022 and 2023. And maybe that's not necessarily the expectation. But can you kind of walk us through what the organic growth opportunities are exist for a legacy bank?

Yes, I'm going to start that one out and then turn it over to Chris. When we had heard that question, we thought it was a really good one because it actually is not our BAU business decelerating. What it is, is a bit of a deceleration in the securities book. So we've come out and said we're at a pretty low point on what securities we own, we're going to take that cash and we're going to put it into a higher-performing, higher-yielding vehicle. And we've started to do that. As you do that at the end of this year, at the beginning of next year, you get a lift. We don't expect to then redeploy cash again in that same manner in 2023. So Chris, maybe you want to walk through that a little bit more.

Yes. So Brandon, I think we look at it as a bridge, right? We've laid out here an accelerating path for our core business. We expect and are seeing evidence that auto is off to a good start. And we expect it's going to accelerate on the trend line that we've outlined. We are hopeful and optimistic that our asset-based and equipment finance is all the same. As we sit here today, we can look back in the last 6 months and see line utilization in our core middle market commercial business has been inching higher month-after-month. We expect it to continue to inch higher as we move into next year. But it's going to be a bridge period as we get to full utilization and full balance sheet realization for our capital. And so as we looked at the year 2022, we said we have excess capital. We have excess liquidity today. We think the best thing to do is put some of that work here -- to work here over the next 6 to 9 months through a securities layer. And that will give us a little bit of lift at the early part of 2022 as we work our way into the balance sheet that's emerging later in '22 and into '23. But we're not going to, as Andy said, double up on that lift as we move into '23. So what you're seeing is core acceleration of our commercial-centric middle market businesses offset by a deceleration, yes, of the investment strategies because we'll execute on that for the next 9 months.

Perfect. Andy, in one of your earlier answers, you talked about the -- where you guys are going with your tech investments and the open architecture, the scalability, hopefully. And you -- some of your other executive leadership hirings as of late have come from much larger banks. How do you think about the growth of Associated? How large -- what is the size of the bank that you expect -- you think this bank can get to?

Well, I feel like that's a fun conversation to have. I usually -- when somebody asks me that internally, I answer a question with a question. And that is does scale equal performance? I think bigger isn't always better, but better is always better. So when we think about the initiatives that we have, we think that the growth initiatives and the technology initiatives, they will have an impact both on our revenue trend, it will have an impact on our customer experience trend. And then if you do those things really, really well, that gives you the ability to enhance your scale and basically operate at a bigger size in a very positive way from a growth and a digital perspective and in other words, add fuel to the momentum that you currently have. So I wouldn't put it in terms of an exact size. I would say that for us, that we have to be a growth-oriented bank right now and a growth mindset. That means both growth in the balance sheet and growth of the experience delivered via digital. If we can do those two things, we can really take advantage of an increased scale, whether that's through growth or that's through merger and acquisition. And then I don't know, rinse and repeat, do the same thing over again.

I see. And so just switching gears a little bit -- and for us, I think this is a good kind of question back to you. You talked about the deceleration of the investment securities portfolio and the -- the deployment of cash there. As part of your strategic plan, right, you guys have the net interest margin expected to increase about 35 basis points over a medium-term outlook, right? What do you think about continued funding optimization, right? How do you, Associated Bank, think about the threat from neobanks, who haven't necessarily seen the same amount of deposit growth that the traditional banking industry has? So I guess, another way of asking the question is do you see the risk of them raising deposit costs at a faster rate this cycle from last cycle, impacting how do you guys think about deposit costs in the next cycle?

Yes. So Brandon, I'll take that and I'll turn it over to Andy. Because Andy has some personal views on this as well. But I'll start with some observational points, which is I think we're fundamentally in the trust business. And what I mean by that is our customers fundamentally trust us to be the stewards of their deposits and to help them with their day-to-day business and their day-to-day household needs. That trust is hard to replicate. That trust has been built here over 150 years. And we frankly do everything we can to nurture and maintain that trust across the board. There's a lot of exciting, you could say, shiny new neo folks out there. We wish them all the best as they develop new tools and new capabilities. And I think we'll be very thoughtful about which ones make sense to bring to our customers over time as people open our APIs and our networks and have abilities to pull those in. But we're going to do everything we can to keep and nurture that trust. And right now, that trust has rewarded us with the highest level of core deposit funding we've ever enjoyed, the best mix of core deposit funding and profile we've ever enjoyed. And as we sit here today, if you had asked us 6 months ago how do we think this would unfold, we would have said probably, "Well, we think that tide will somewhat ebb and we'll start to see some funds flow out." And the reality is it hasn't. And if I look back over 80 years of FDIC data, it appears that the money supply tends to grow linearly positively over time. And it doesn't necessarily spring backwards. And while liquidity might shift from one type of institution or one type of product to another in different rate and regulatory environments, the reality is the money stays in the system and the amount of dollars in the money supply tend to grow and they tend not to shrink. So our view has perhaps evolved to the point that we think the funds are here. They're likely to stay with us. And that will likely bode well for core funded traditional banks like ourselves. Andy, do you want to elaborate?

I think any good bet is worth hedging. And when I think of our near-term opportunity, I think in 2022, we clearly have some verticals that are on the lending side. As I think of our medium-term second half of '22 into '23, I think of the businesses that -- investments that we're making in deposit-rich categories, commercial banking, small business banking and then mass affluent, where roughly 70% to 75% of consumer deposits originate and where we have opportunity to grow our balance sheet. And I think of the wealth business, one that we have $13 billion in assets under management and just assigned a new executive to. So we are -- we have a balanced approach here. We think that we get a nice lift on the lending verticals because they fit what we need at this point in time. But we're also a relationship business. Neo, and I assume means new -- and we're not new, but we are fintech, we have financial technology. So when we marry those two things together, we get in commercial, we get in small business, we get better at the mass affluent space. And we give some shelf space, digital enhancement and leadership, additional benefit to wealth. I think it creates a pretty balanced view even if there's a slight decrease in the deposits over time.

Great. And then you just -- you mentioned the benefit from the loan -- the asset side of the balance sheet. And I guess, I just want to take our conversation there a little bit. So Associated is among one of the banks that are more exposed to the manufacturing sector. You guys did sound, you do sound now, rather optimistic about the prospects. Can you just expand on the health of your markets, the customers, the impact of the supply issues that had, will have and whether or not you think the infrastructure bill, which just passed the House, have any ramifications, good or bad?

Yes. So well, first, I just -- let's point to Wisconsin as a microcosm of the manufacturing health and seeing that the unemployment rates here that are well below national levels. Clearly, an economy driven by manufacturing that's performing quite well. But when you think about the manufacturers and the businesses, I was in northeast Wisconsin in Green Bay with customers last week, and we're hearing a couple of things that are interesting. Some are saying, "Look, I'm not relying as much on just-in-time inventory management because we're not sure when sometimes we get the inventory, so we are ordering ahead. Whether that's 3 months ahead, 4 months ahead, we would expect to keep a little higher inventory. I think that's pretty interesting to us. And simultaneously, they've been telling us that we have seen usage on lines inch up. I would say inch up is, I think, Chris, up 4% since April in line utilization, which is about 8% below -- in gross numbers, below our historic numbers. So what they're telling us and what we're seeing seems to make sense. The other thing that we're seeing and hearing from manufacturers is when you think about labor force participation rates, getting employees, that's a question mark. Some people will come back into labor force as they need to, as funds are required as with the safety. But over time, the belief is that labor force participation will be down. And what that means to them is they need to be more efficient. They need to bring in ways to be efficient, whether that's cutting the complexity of the line or adding equipment. And so when we think of every manufacturer that would rely less on human workforce because of decreased labor participation, then we think of our equipment finance group getting started in the exact same period of time, we think those things all fit together for us. And they're their comments that we have heard pretty consistently over the last 30 to 45 days.

And just to add to that, Andy, just [indiscernible], there was a time when equipment finance perhaps meant forklifts. But today, it's warehouse inventory control and management systems, right? It's all the conveyor belts and the logic and the software that gets something off of a 30-foot-high shelf and brings it down and [indiscernible] to the truck loading deck without having to have 4 people touch it somewhere along the way. That kind of distribution technology is part of equipment and logistics evolution that we're seeing unfolding rapidly here in our footprint. If you drive back and forth between Chicago and Milwaukee and go to either side of the highway, it is practically warehouse after warehouse after warehouse. And it's all the names you'd expect to see. And there's trucks rolling in every given direction all over this country. That's an awesome thing that's been developing here in the last couple of years. And it's continuing to roll out quite nicely.

One thing that you guys both touched upon, either directly or indirectly, was the reduction in labor force. And even part of your strategy, I mean, you're shifting 10% of employees who work -- to work primarily remotely. Is there an expectation that your commercial real estate customer will take a similar approach and -- when evaluating their physical footprint? And if so, right, what is the risk to growth from your perspective? What is the risk to the opportunities to replace those balances in 5, 7 years?

Well, you asked two very separate questions. I think the opportunity to replace balances is already happening right now. So we've gone from 15% to 20% of our production being in office a year or 2 ago to about 5% of our production being in office right now. So clearly, other industrial, multifamily categories emerge there. We have already terminated some downtown leasing opportunities. So we know that's happening. But what I'd say is I think there's a little bit of time. We'd note that strong tenants, they have not moved yet. They've not stopped paying. So I'm sure that other people are experiencing similarities to what we have. Some of the smaller groups are still upping just in smaller size of real estate. So I think there will be a transition period and a little bit less usage. For us, we've tried to adjust for that with regards to our reserves and appropriately reserve for what we have. But we don't see a fast lightning change. And I think this is one that will become more evident as the pandemic subsides as we see movement into '22 and '23. But clearly, there's a little bit of early movement that is out there.

Great. So we have 5 minutes left before the end of the session. And I just want to going to turn a little bit to credit, which just in the pandemic really hasn't gotten right now a lot of the focus. During your 3Q earnings call, you guys indicated provisions in 4Q to reflect changes to the risk ratings. How does a management team, especially you, Andy, coming in, you said 6 months in the seat, how do you reevaluate the credit of the bank from your -- with new eyes? Do you expect any credit migrations over the next 6, 12 months at a bank or even an industry?

Yes. Well, I think you hit on one of the areas that we look at pretty closely and that's on my mind because it's emerging. But you have your COVID-related industries. And of course, we have that, whether that's hospitality, transportation we've been looking really closely at. But we've seen improvement there. So then the question, when you're looking with a critical eye across what you do, is what could be next? And for us, we've looked more closely at office. And we've made sure that we do a deep dive, and we understand clearly what we have. But we have really strong borrowers. We have strong folks that we work with. And so we feel good about where Associated is right now. And now as a point of conversation that I've had, we actually have an incredibly strong and experienced commercial real estate team. And so that's one place that we look. We don't see any major concerns on the near-term horizon. For us, personally, we had a few names on the problem loan. And so we took a look at that and said is it just several names? And is there a plan? Yes. Is it systemic now? We don't believe that it is. So those are the kind of questions that you ask coming in as opposed to, for me, I wanted to validate where we were. I believe that I have. I meet with Pat Ahern, our Chief Credit Officer, almost on a weekly basis and review where we are in detail. And so I don't want to assume we're in a good spot. And the good news is the dives that we've done have served their purpose and kind of satisfied needs at this point that we're appropriately reserved. And we're always thinking about what could be next.

And on that topic, your allowance for credit losses is already below the CECL day 1 level. How much further can this ratio decline? And what is the backdrop that you guys need to see for there to be incremental improvement from here?

Well, I feel like I'd turn it to Chris because we made comments that we would be at CECL day 1 by the year-end, and we achieved that in the third quarter releases.

We did. And further, I think if we go back on [indiscernible], CECL day 1 had a few special items in it, including perhaps some elevated reserves for oil and gas. And kind of the oil consisting over $80 a barrel here recently, that's worked out better than perhaps feared in the grand scheme of things. And so really, the better benchmark might be CECL day 1 excluding oil and gas. And I think that's a reasonable thought to look forward to as is we're moving in that direction overall and probably continue to move in that direction here for a bit.

Okay. Got you. Well, those are all my prepared remarks. And I don't necessarily see anything from those on the line. So on behalf of my colleagues at Bank of America and everyone listening, everyone participating, I want to thank you guys for speaking to us today, and thank everybody for listening to us. Thank you, and have a great day.

Appreciate it. Thank you, Brandon.

Thank you, Brandon.