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

Hi. I'm Matt Kesselhaut, and I cover large-cap banks at Barclays on Jason Goldberg's team. Next up, we're excited to welcome back Associated Bank. From the company, we have Andy Harmening, President and CEO; and Derek Meyer, CFO, who's in the audience. With that, I'll hand it off to ASB for prepared remarks.

Well, Good morning. For those of you that don't know me, I am Andy Harmening. And if you're less familiar with Associated Bank, I will tell you, we're a $37 billion bank. We are headquartered in Wisconsin. And we have deep roots in the markets that we're in. This, in fact, has allowed us to have a low-cost deposit base over an extended period of time. And in recent years, we've had a focus, and I'd say, over the last decade to 12 years through the cycle have had a focus, increased focus on credit quality expense management. I started with the company in April of 2021. And since that time, we've added a few initiatives to the fold to that foundation. And so when I think of where the bank is today, I'd like to break this down into about 5 key themes, and they all build off of each other. The first one, we have derisked our balance sheet from a lending perspective. If you think about what this looks like for us and taking the riskiest assets that you have as a bank over a 12-year period of time, what we've done is we've taken speculative land development, land deals, and we've taken that off the table largely going from 8% of our portfolio to 1%. And that, during the '09 to '11 time period was the source of our largest loss. Then, in 2016 to '22, the largest source was oil and gas, and we virtually eliminated that from our balance sheet, going from 4% to 0%. And you can see the largest part of our charge-offs. The reason that matters is what's remaining. So when you look at the book that is remaining, we have gone from 41% in our C&I and our RESI book to 69% in our commercial and our resi book. Through the crisis, that blended loss rate was 32 basis points. Over the last decade, that blended loss is 8 basis points, and a lot happened in that 12 years that's not on this page. When we think about bringing a credit discipline to the company in terms of dual risk rating, stress testing, key risk indicator monitoring, to name a few of the things that have occurred during that period of time. So fundamentally, a different company than we had before from a balance sheet and risk standpoint. The second thing we did is we looked at our funding over an extended period of time. And if you go back in time, you can see in 2016, a funding reliance on network deposit and wholesale funding of over 33%. And you fast forward, we have halved that reliance on network funding. And remember, we've been deeply rooted in small towns and communities across Wisconsin and now Illinois, Minnesota, for a long time. These are granular deposits in our base. So as we've seen another rate cycle, changing the foundational mix of the balance sheet has allowed us to handle the beta pretty effectively to date during this rate cycle. So those are really a little backward-looking features of the bank. On the forward-looking side, we have had a shift in spend from physical to digital over the last 12 months. So there are a lot of aspects to this that are exciting on Monday, we launch our new digital platform, and that's a big deal for us. That is simply a start for what we're doing, and I'll explain that quickly. We are going to have a cloud-based system. And that just means that people are going to be able to see their balances when they log in, which is a pretty big deal and a good place to start. But whether you're on mobile, whether you're on a tablet, whether you're on the web, having the same experience as an expectation, we'll have that. Those are a little bit of table stakes. The agile development aspect of this is a big deal for us. That means we can launch a platform this quarter, and then we can have new tools delivered in the fourth quarter, which is exactly what we plan to do. Whether that's a new account opening process, whether that's our personal financial tools for a customer, we can integrate fintechs into our platform like we haven't before. This will play a major role in acquisition and growth. Along that line, we just named, hired from outside the company, a new Chief Marketing and Product Officer. This person's background is steeped in analytics, customer research, digital sales, product development, all being delivered through the digital channel in some way, shape or form. The next piece, next theme we have is execution. And in our fourth theme, that is execution on the lending side of our business. Now, this is something we came out with last September. We're well into the execution phase of where we stand today. And I try to break this down not just in verticals of asset-based lending, equipment, finance, the auto business. But in our core business, if you add our core commercial business banking as well as the other commercial verticals, we've increased our relationship managers 34% -- 34% since last April. As you see, that has led to very good but diversified growth across every asset class at the bank, which gives us the optionality of what we expand in. We've taken auto down a little bit. We've just slowed the rollout of that because we have such diversified growth across the commercial, commercial real estate, business banking, and other verticals within the bank. And then finally, I would focus on our extending, our execution to the deposit side. Much like the lending side, we have a bit of a running head start here. So when we talk about expanding deposit capabilities, I would first start on the commercial side of the bank. We're highlighting this a little bit more, not because we just started because it is pretty important to the funding aspect in our industry right now. So when we look at the funding component, first, we stabilize that base and now we have initiatives, multiple initiatives, that will help grow it that we've been working on for months. We can start with the commercial RMs being up 34%. But what's not on here is our treasury management sales are up 50% year-over-year. That means we're having conversations about core business. We have multiple initiatives diving into the analytics behind the base to get more dollars and deposits from our customer base, and we're incenting on a balanced scorecard in a way that we hadn't in the past. And when we look at all that, bringing these people in, training them, changing incentive plans, changing the product mix and then going to market, we had publicly come out and said that we would increase deposit production by $500 million on the commercial side of the bank in the second half of the year. I'm equally excited about the consumer piece of our expanded capabilities. When we look at the consumer piece of the expanded capabilities, that includes our mass affluent program, which we'll roll out in the fourth quarter. That includes the account opening processes that opened, that start in the fourth quarter on the digital side of the bank. That includes our HSA business, which is a top 20 business in the country, expanding with a national sales manager and RMs in that field, which have been on board already and executing for us. But it also opens things up to change your marketing shift and spend in your marketing to drive them into digital. And then we'll continue to look at differentiation on the product side because while digital is exciting at the channel, the product side is what differentiates and drives people in and increases in those categories. So a few different things at play for the bank, and then I would sum this up and say that if you think about the core foundational aspects of our company on the credit risk and the expense side, we try to highlight that at the beginning of this conversation. But if you look at our bank from 12 years ago, we're foundationally different. If you look at our bank from 12 months ago, we are also different from a strategic view and what we're working towards to drive sustained growth. So with that, I will stop the prepared remarks and turn it over to Matt for some Q&A.

Thanks, Andy. Thank you. Appreciate the update. Maybe we'll dig deeper first, into your updated outlook that you posted last week. You increased your NII guidance for 2022 to $910 million plus, up from $890 million plus. It looks like you added a note that the benefits of additional loan growth is driving us. Can you talk about the loan growth trends quarter-to-date and what you're seeing?

Well, we talked a little bit about the momentum we've had. We clearly had a strong growth quarter in the second quarter -- about $2 billion in loan growth. But what I would say is if you look at the second half of the year and look at what our forecasts are for that, the RMs that you bring on, when you increase 34%, you don't bring them on in 1 day and they don't do a loan in the first week they're here no matter how much we want them to. So those folks, we just started the initiatives you think about it this way, in the fourth quarter of '21, bringing in the leaders of some of those. We started the RM hiring shortly thereafter in those segments and really went full in on the commercial and the business banking. So those people have been hired throughout the year this year. Those folks continue to get their pipelines increased. The market is a little bit dampened, but with that kind of RM increase and them getting their footings under them and the initiatives gaining traction. That led us to say, look, across the board, we're going to have, we're going to have growth in the second half of the year. It may not look like the second quarter, but we now can kind of pull the right levers in the right place for the second half.

Helpful. And with respect to your new lending verticals, there's a perception amongst some that you're growing into the teeth of a recession. Can you walk us through the rationale of why you're growing loans now?

Sure. And I would say not just loans, but loans and deposits. But with regards to loans, in that space, if you think about ABL, asset-based lending, you think about equipment finance, and then you look at our geography, I mean, we are smack dab in the middle of the manufacturing belt. So we're not expanding our customer base. We're protecting it. So we don't have people coming in and taking equipment finance loans and taking the entire relationship because we have that capability right now, and they've asked us to do this type of lending for them. The auto is a natural hedge. We're asset-sensitive. And so as we're putting on fixed rate loans on equipment finance or auto finance, it puts us in a pretty good position. We have worked on our balance sheet and derisking it for 12 years. I give a lot of credit to the prior regime, Phil Flynn and team for bringing in a methodology and approach and a discipline to credit that maybe wasn't there before his arrival. So we're operating off a pretty strong base. And then frankly, the markets in the Upper Midwest are quite good. I mean Minnesota, Minneapolis, I think unemployment is under 2%. Wisconsin, it's under 3%. And then finally, I will say we have a challenge in our economy, and that is finding people to work. By doing equipment financing, you're not just bringing on leverage. You're actually bringing efficiency to businesses. So as people are having challenges finding folks, they're bringing in equipment that can bring efficiency. So it is a good business decision for them as well.

Helpful. You just touched on auto a little bit, so I have noted that it's awkward that ASP is getting to auto at a time when other banks are pulling back or exiting, how do you respond?

It doesn't feel awkward to me. What I would say is we're dealing with the same prime and super prime borrowers that we dealt with on the residential lending side. If you go back to the numbers on that, we've had great success with people that have high credit scores, they pay back. So from a credit risk standpoint, we feel very good about this. We've said all along, we saw a cycle coming with mortgage and a decrease in that space, and this was a natural offset there for us. We don't have to stretch on credit. We have many, many levers that we're pulling right now. So we're comfortable from that perspective. And then finally, it creates a natural hedge for us from an interest rate sensitivity standpoint. So across the board, I'd say we're in pretty good shape. Sometimes when you see growth numbers like you see with us, you say, well, gosh, these guys are lending way more than other people. And I would say we don't have a balance sheet in that space. So we don't have the runoff that our competitors have. I mean, I've noted multiple competitors who say they're dampening that space, they're growing. They grew last quarter, and they had very big runoffs. So they're producing car loans and good ones, and that's our approach.

You noted that commercial loans grew very strongly in the first half of the year. But with the potential of an economic downturn looming, are you hearing concerns from your customers? What are they thinking?

You know, it's interesting. We don't see pipelines going down much. They've been pretty solid for us. We see markets that have virtually, I mean basement, lowest level unemployment rates. Supply chains improved maybe a little bit, but the usage line utilization is something people have said, look, we have people buying this and therefore we're going to bring that into what we do. Now has it changed our approach to make sure we understand our customers a little bit better? Have we had a standard number of questions that we're asking them from a relationship manager perspective? You bet. And when you think about the changes we've made to credit risk management, we brought those all into the portfolio management, whether that's C&I, whether that's CRE. So we don't need to stretch for credit. We have a 34% increase in RMs, if a deal is one that we're not comfortable with, we just won't do it. When we're underwriting a commercial real estate loan, we have pretty high interest rates that we've already underwritten too. So we've put ourselves in a position for our customers to sustain a little upward pressure on rate as well.

Helpful. In your presentation, you talked about the launch of your digital platform next week. Can you speak about how you think about the next phases of your digital strategy?

Well, I have to say, just saying that out loud for Associated Bank and seeing a quarterly pipeline of pieces that we're going to put there. Hiring both Derek Meyer, as our new CFO, who has a strength in FP&A and treasury for many, many years is really good timing for us. Then you pair that with somebody on the product and marketing side that over an extended period of time and said, "Hey, I understand the customer." And so a lot of times, people get excited about digital and the platforms, frankly, they're a lot the same, a little bit different label. But what you do on that platform, and how you listen to the customers is where the magic happens. So if you differentiate a product and you get it on that platform, they buy it. If you have an easy process to open an account, they'll open it. If there's a layout that's good for the customer and it's not all about the bank, they'll deal with you and you'll get high marks on your mobile platform. So those are all things that we're doing and having somebody that is an expert on product, customer research and analytics, married with that digital platform so that when we're launching something for a customer, we shouldn't have to guess that it's something they want because we will have gone out and asked them, we'll ask them multiple different questions below that to say, is this a priority for you?

Now moving on to deposits. You reported a slight increase in deposits in Q2 while other banks were flat to down. Where can we expect deposits to trend going forward, particularly as you look to fund loan growth?

Well, at the risk of being too optimistic, we did come out and say that we thought we'd produce an additional $500 million in loans from commercial. And you can say that when you have some low-hanging fruit. When you look at your loan book, and you say, "Hey, this customer has been with us a long time, perhaps we're not a primary depository institution with them." When you have a group of people that are, what they say gets recognized gets done and that's what's happening on treasury management sales and deposit production. When people rally around that as they have on the lending side, that's happening right now for us on the deposit side. So we certainly can't control the market. But right now, we see an uptick in deposits as we've given that guidance on the additional commercial business that we're getting.

Got you. And it's clear that the ASP team has taken steps to decrease reliance on network deposits and wholesale funding versus the prior cycle. But the Fed has shown no signs of slowing down its rate hikes. So what confidence do you have in your deposit beta forecast?

Well, I try to make this as simple as I can so that I understand and we're asset sensitive. Rates go up, that's good for our profitability. So I could start and end there. But what I would say is you've seen in the second quarter a controlled beta. We've also believed that that beta would go up through the cycle. We think it will be slightly less than it was in the last rate cycle. We don't think that is a heroic gesture, knowing that we're 33% wholesale and network funded. And now we're 15% wholesale and network funded. We think it's an S curve. We think it will be lower at the beginning and then go up. So we fully baked into our forecast that we would have to increase customer rates and that beta percentage would increase as well. But we are starting from a far different position than we were before. And we're seeing some good traction on the deposit side.

Are you seeing competitive deposit pricing pressure within your markets?

It's a great question. We're seeing with the digital-only banks immediately on the consumer. But remember, we've been in the state of Wisconsin for over 100 years. We're deep there. And so naturally, on the consumer side, we have a little lag typically on those low-cost deposits. We are not seeing the major competitors move yet. We've watched the data just as everyone does intra-quarter and seen what's going on. But to date, it's been a little surprising. So a little bit lower beta at the beginning because of the lack of that competitive pressure. We expect that to change over the coming weeks and months. But the initiatives and the focus we've had over the last 9 months, we think will serve us well over the next 12 months.

Helpful. And you appear to be one of the more asset-sensitive banks, which is good in the current rising rate environment. But how are you thinking about it and are you dampening sensitivity as we head into 2023?

I could jokingly say that that view changes almost every day as we saw the inflation report come out at 8.3%, right, a little bit higher than we expected. What I would say is we have to be cognizant of that. We have a CFO in place that was the Treasurer of a Fortune 500 company. He understands what synthetic means that we might have to hedge that risk. We'll look very closely at what is happening in the marketplace to make sure that we're doing it at the right time. But we're entering this from a position of strength because we've been able to control the beta, because of the asset sensitivity that we have. When we look outward and what, how we handle that peak, we have some time, and the question will be the right time.

Given all the uncertainty in the markets, do you have any broad concerns about the strength of customers in your Midwest footprint?

I don't think the customer base has ever been stronger. It's strong across the country. And when you look at 1.8% unemployment in Minnesota and 2.8% unemployment in Wisconsin, that's pretty darn strong. We don't typically have the highs that you might have on the coast when it comes to real estate prices. And conversely, we don't have the lows of that either. It's a little bit more moderate. I mean so that's a, you could argue that that's a built-in hedge against the up-and-down nature of an economy. And so we feel good about where we are, but we're not oblivious to cycles. And I would say that's not something we just started thinking, Phil Flynn and the team started thinking about that 12 years ago and changed the structure of the balance sheet. Now it's our job to not get ahead of ourselves and say, this is not about just growth, it's about being a good banker and kind of holding those fundamental approaches to the business, which I feel like we are controlling those controllables right now.

Helpful. And moving back to your 2022 outlook, it looks like you bumped up your full year guide for noninterest expense am I correct that it's mostly driven by one-timers?

I think that's a good way to think about it. We are looking, going into every year, what can we decrease cost in to increase cost in another area. And our physical branch network, we announced some closures. We looked at the mortgage business and have downsized the staff and have some severance associated with that. So it's a pretty modest uptick. I feel good that we're controlling expenses, but we certainly do have a couple of one-timers coming.

Very helpful. And what is the expected impact of wage inflation, broader inflation, on associates and your customers?

Well, we're not immune from that. However, we have one major market, one of the larger markets in the country in Chicago, and that's a place where we have had to raise compensation. We have looked at pockets of groups that are most at risk, and we've already changed compensation schedules for those, for many of those folks. We changed our minimum wage to $17, and you hear new numbers coming out. I don't know that we need to do that across the board for the markets that we're in to get to where some of the others are. But we're not immune from it. We forecasted that in. We expect that there'll be continued pressure there as you see, I guess, for every job opening, how they say 2 applicants. I think that, that continues for us and it's something we need to be cognizant of as we build out our expense forecast. But we had the same thing coming into this year and we feel good about how we've managed the expenses overall.

I know you're targeting around 4% expense growth in 2022. How are you thinking about expense growth for 2023?

We're going through that process right now. We're looking at the loan growth and what we are supporting. We're looking at what the deposit growth forecasts are. We're looking at, of course, being asset sensitive and what that means to revenue. What I will say is we will not stop having discipline around how we manage our expenses. We are looking right now, the reason we have an increase in one-timers forecasted for expenses because we're looking at the run rate for next year right now. So we haven't come out with the guidance on the expense number, but we have to be cognizant of the puts and takes of the economy right now and make sure we're very disciplined.

You talked about how your investments in technology and curious, how is that benefiting revenue growth and consequently, your efficiency ratio?

Well, you can't cut to succeed. And so we have made some cuts and reinvested, and that's impacted our efficiency ratio. As you see, forecasted over $3 billion in loan growth and associated revenue that comes with that. On the technology side, basically, you can do more with fewer people or more with the same number of people. So as we've continued to grow, it's not just the digital platform, it's hollowing out our core, it's bringing technology to substantiate back-end processes. We'll do that on disputes on card because that's a pain point. We'll serve more customers using technology, perhaps with the same number of people. Then we'll look for places that maybe aren't as relevant to a customer that we can cut expenses, and then invest, continue to make that investment back into digital.

Helpful. And that has been a good story for banks, but there appears to be continued pressure on fee income. Are there any opportunities to grow fees in the near future?

When I think about fee income, I think about the long game on that. So we'll launch a mass affluent strategy. That's people with $1 million or less in liquidity. When you get the conversation right with those folks, that is a natural path to our wealth business. And we have roughly $14 billion assets under management and wealth. But we've just rebranded our wealth business. We are launching our mass affluent business. And frankly, taking care of people's personal finance, we now have a road map that will deliver on the technology side for wealth that is relevant in today's day and age. So we have a lot of pieces that we're working on right now. For 2023, mass affluent is what I want to see thrive, particularly on the deposit side. As we get through the launch of mass affluent and get good at that conversation and we launch more technology, we'll start to focus on wealth as the next step of that, which can drive some fee income. And then on the commercial side, whether that's treasury management or capital markets, when you increase that business, you can drive some fees there as well.

Helpful. And throughout this conference, a common theme has been a benign asset quality is, if there's one canary in the coal mine of asset quality, what will yours be?

I'm looking for that canary every day, every week. In fact, I talked to our Chief Credit Officer before I came down to make sure there are no canaries between when I left town yesterday and today. And we don't see anything emerging even for us right now. We don't want to get lulled to sleep by that of what could be. So we dig into that on a very granular level. I would say on out-years, the piece that we're looking at, specifically for me, I don't want to lose touch with the real estate office. And when I think about office, it's a slow burn. This is one that I think it can lull you to sleep. And so we continue to make sure we understand renewal rates, rent rules, how we're getting into it, not stretching on that because it is uncertain what return to office and office occupancy looks like on a, maybe a 1- to 3-year period looking out.

Helpful. And with bank stocks continuing to struggle are share buybacks back on the table for ASB in 2022?

We think that we can deploy the capital towards our loans. We've executed in multiple different ways. We think that's the most profitable way for us to operate. We have ideas, and we have ideas on how we can use that capital within our business. If for some reason, we would see loan growth slow, stop, not meet expectations, we do have approvals for $80 million in share buyback. But frankly, if we execute, my hope, belief, is that we probably wouldn't go down that path.

Helpful. And what are your thoughts on M&A?

I've been looking at the readers and people have been pulling questions on that. I think 0% is the interest and focus on that. That's roughly ours. We're looking at organic growth and bringing value to the customer. We're looking at core operating earnings and growing revenue much faster than expenses and outperforming. I mean, that's how we're going to bring value to the customer. At some point when we do that for an extended period of time, then we can maybe ask that question again. But I think it's 0% for people that are not in our situation.

Very true. And you recently brought in a couple of former Huntington colleagues and Derek Meyer, CFO; and Brian Carson, Chief Product Marketing Officer, what would investors expect them to bring to Associated?

Well, I mean, if you think about them individually, they are both very talented executives. I'm thrilled they chose to join us. I think about what mattered to us when we're building a team and the fact that they've integrated into the team, it's been about 6 weeks, give or take, for each of them. They've already integrated with their own teams and the executive leadership team. But on their own basis, we have had a lot of initiatives. And the question is how much discipline and rigor can you put towards those. And we've done a pretty good job of that, but we're bringing somebody in in Derek, who's run FP&A for, I think, Derek, 8 years at a large company. He understands that rigor. He knows how to break down a P&L and a balance sheet and decide where the next dollar is spent. So I could expect, I expect that is something that he will do. On the treasury and liquidity management when you're talking about interest rate risk, when you're talking about deposits, what a great time to have a former treasurer on your team. Now I pivot to that and I think about a Brian Carson on the product side and the marketing side. And I think of the future of customer acquisition as a 3-legged stool, you have marketing, you have product and you have digital. That's Brian Carson's sweet spot. And not only that, he does happen to know Derek. And so when we're thinking about our liquidity strategy, having that connection between your centralized CFO, and somebody that is running your deposit acquisition marketing process. They don't have to learn about each other. They know each other. They like each other. They've worked together. And so individually, they add a lot. Together, it's an even bigger deal for us.

Helpful. We have a few minutes left. Does audience have any questions?

Given that you have a full agenda in your own business and are not in the M&A market at this point. Do you have any thoughts on the markets you serve, there are obviously still a fairly large number of smaller community banks out there. What's your sense as to what's on their management and Board's thoughts? Are they looking to partner up? Are they wanting to buy up their smaller neighbors, kind of your sense as to what's going on in your community, even if you're not looking at these things right now?

Well, that's a fair question. And the 0% for the larger bank certainly is an impact. You've seen some smaller deals that have happened. And certainly, they're not feeling pressure from a credit standpoint right now. Probably, there's going to be a question about deposit acquisition pressure and the enhancement of digital over time will matter ultimately. So you've seen the consolidation in the industry over the last 10 years, over the last 20 years, and you'd have to believe that consolidation continues at some point. I expect that that's dampened even for the smaller institutions right now with the uncertainty of the marketplace.

Anyone else?

I have one more question. In terms of tech spend, some of the larger banks we cover throughout these massive tech spend numbers. How can ASB compete with these larger budgets and deliver the same quality of service?

Well, we'll see. What I said when I was at my last stop when I got asked the exact same question was we were #1 in satisfaction. That wasn't on accident because we listened to the customer. When you're with a bigger company, you have a lot of constituents that have an opinion, and that's great to a point. But there's one that really matters, and that is the customer. The customer, the customer, the customer. And so when we think about the core pillars of our bank, people think about technology a lot, and that's great. You have to have a foundation, it has to be connected. But if you deliver what a customer wants, your satisfaction will be good. And so I hired somebody to come in that basically their expertise is to interpret data, talk to customers and understand what they need next. What I'm very hopeful for of is that when we launch our platform, we'll continue to ask that question, ask questions of them. And what we deliver on our platform will be simple and it will be what they're asking for. When you do that, satisfaction should go up. It has in the past, in multiple different lines of business that I've been a part of. And so I do think we can compete in that space. The open architecture, the agile development, the cloud-based system, all of those things matter. That's just the framework. Now the fun starts. We create a product that they care about. And by the way, when they log on and they see that. And by the way, when they log on and it responds quickly and you can see your numbers, that's a big head start. We'll have that. And then you'll put products and services in there that they care about. So it is, you do have to spend money, and we have shifted that spend. But frankly, it is not just a technology play. It is a customer play through a different channel. And I think that's where I'm hopeful we'll get it right.

Thank you. And with that, thank you, Andy, and thank you Associated. Really appreciate it.

Thank you, Matt.