Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corp's first quarter 2020 earnings conference call. My name is Shamali, and I'll be your operator today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session at the end of this conference. Copies of the slides that will be referred to during today's call are available on the company's website at investor.associatedbank.com. As a reminder, this conference call is being recorded. As outlined on slide two, during the course of the discussion today, management may make statements that constitute projections, expectations, beliefs, or similar forward-looking statements. Associated actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional detailed information concerning the important factors that could cause associated actual results to differ materially from the information discussed today is readily available on the SEC website in the risk factor section of associated most recent Form 10-K and subsequent SEC filings. These factors are incorporated herein by reference. For reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to page 21 of the slide presentation and to page 8 of the press release financial tables. Following today's presentation, instructions will be given for the question and answer session. At this time, I'd like to turn the conference over to Philip Flynn, President and CEO for opening remarks. Please go ahead, sir.

Thank you and welcome to our first quarter 2020 earnings call. Joining me today are Chris Niles, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. As you can see from our materials, Associated continued to meet the needs of our customers, grow, and generate net profit during the first three months of the year. We continue to benefit from a resilient core funding base, a strong market presence, and a high-quality lending portfolio. But I'll start by discussing our response to the radically changed environment we are now experiencing. The past two months were extraordinary. Let me highlight the actions we've taken to help our customers and protect our colleagues. We closed our branch lobbies on March 17th, becoming one of the first banks to transition to drive-through and by-appointment-only service. Our branch operations and IT teams have responded wonderfully to meet the needs of our customers. We began to send people to work remotely on March 13th and now have about 70% of our colleagues performing their jobs from home. We are continuing to pay all of our colleagues, including those whose jobs were curtailed by our social distancing measures. We are also quick to offer our own COVID-19 relief program, providing customers waivers of certain fees and deferrals of loan and mortgage payments. Through Tuesday, approximately 1,450 primarily consumer and small business loan customers have been granted some form of payment or fee relief. From a financial perspective, we were ready to meet all of our customers' needs with both lending availability and transactional liquidity as our core deposits increased even faster than loans. Our loan-to-deposit ratio strengthened during the quarter. In addition, since quarter end, We've continued to support our small business customers through the SBA Paycheck Protection Program. As of April 21st, we have funded nearly $900 million of loans for more than 3,600 businesses. We are ready to support our customers in the second round of the PPP program and other programs that may come from the Fed, the Treasury, or the SBA. We've also continued to support our communities in these difficult times. We continue to donate over $3 million a year to support local housing programs, food banks, and other essential services. In addition, we recently donated $300,000 to the United Way and other local COVID-19 relief efforts in our footprint. Standing up new loan programs and processes while working remotely has been hard, but we've met these challenges and stand ready to help our customers get through this difficult period. So now let me turn to the financial results. On slide four, our first quarter gap earnings were $0.27 per share, driven by resilient net interest income and reduced expenses. Excluding first stop and acquisition-related costs, our earnings were $0.28 per share. We had strong loan growth, particularly in our commercial and business lending portfolio, as customers drew on lines of credit for their own liquidity. The line draws, in turn, drove increased deposits as customers built up cash positions. The first Staunton acquisition, which closed on February 14th, also contributed to loan and core deposit growth. Our net interest margin increased one basis point from the fourth quarter, driven by a lower cost of funds and elevated LIBOR rates. The slightly higher margin, coupled with loan growth, resulted in a $20 million increase in our pre-tax, pre-provision income from the fourth quarter. Our CET1 ratio was 9.36%. giving us ample capital to fund our commitments and support additional loan growth, even after repurchasing $71 million of common stock in the quarter. We also implemented CECL as of January 1st, resulting in a one-time $131 million increase to our allowance for credit losses and a first quarter provision of $53 million, reflecting our economic outlook going forward. Average loan balances... are shown on slide 5. Total loan balances were up $525 million from the fourth quarter, as we saw increases in residential mortgages, commercial and business lending, and commercial real estate. Residential mortgage growth was driven by solid origination trends and lower payoffs in the first two months of the quarter. While we anticipate payoffs to be elevated in the second quarter due to lower rates, our pipeline continues to be strong. We've taken about $2.5 billion... in mortgage applications this year through mid-April, which is about double the pace we saw over the same period last year. Growth in our commercial and business portfolio was driven by our power and utilities vertical. Additionally, general commercial lending and REITs had strong growth in the quarter. While customer draws in March contributed to the increase, we also had strong pipeline production. Offsetting these gains were a seasonal decline in mortgage warehouse through much of the quarter and the purposeful runoff of our oil and gas portfolio. We expect to continue the reduction of our oil and gas book as we pursue additional credit risk mitigation opportunities. We also saw solid results from our focus on growing commercial real estate term debt, particularly in January and February. Commercial real estate construction loans also increased as we funded construction loans in our pipeline. Turning to slide six, we show end-of-period loan trends which highlights activity we saw in March and April. In mid-March, we began experiencing a significant uptick in general commercial lending as customers drew on lines of credit and built up cash. We also had a large increase in mortgage warehouse loans as lower mortgage rates induced a refinancing wave in March. In CRE, customers increased line draws and delayed payoffs in March, and we expect CRE balances to remain elevated through the rest of the year. Customer demands for liquidity and refinancing activity have subsided in April, as shown in the right-hand graph. This chart also highlights the impact of our participation in the Paycheck Protection Program that we further detail on Slide 7. We began taking applications for the PPP on April 3rd, the first day it was offered by the SBA. Standing up a new loan program is always difficult. and this one was made more so by the tight timeline, changing guidance, and by working remotely. Through great effort and dedication of several hundred of our colleagues, we created all the forms and processes and modified systems to support the program in a matter of days. Through April 21, we had funded over 3,600 customers for nearly $900 million of loans, representing about 90% of the dollars and about 70% of the loans that were applied for. We have taken advantage of the Fed's PPP lending facility to fund these loans. We expect our customers will begin applying for loan forgiveness in late June and anticipate the bulk of the loans will be forgiven during the third quarter. With the expected extension of the PPP program, we expect to fund the remaining 1,300 applications we received representing an additional 80 million of loans. We've already taken all those applications through the process so that we'll be ready to get SBA authorization as soon as their portal opens. In turn, we expect to access the fund's PPP lending facility to fund these loans as well. On March 21st, we initiated our COVID relief program by offering loan deferrals and fee waivers to our business and consumer customers. Through April 21, we've approved deferrals or modifications for over 1,450 loans totaling approximately $733 million, which is about 3% of our total loans. The approved loans include $303 million, or about 5% of the commercial real estate book, mostly driven by our hotel and retail-oriented borrowers, $179 million, or 2% of our commercial and business lending book, and $250 million of residential and consumer loans we hold in our own portfolio. Additionally, in the first 30 days of our COVID-19 relief program, we waived or refunded $415,000 in fees for consumers and small businesses. We are pleased to be able to help relieve some of our customers' financial stress and to be part of the economic solution to this crisis. Turning to slide eight, the current environment has introduced new risks. On slide 8, we've laid out our exposures to several categories of commercial loans potentially impacted by COVID-19 and lower hydrocarbon prices. These balances represent 9% or $2.2 billion of outstanding loans at the end of the first quarter. We've increased portfolio monitoring activities across the bank and are proactively working with our borrowers to help them navigate the current environment. Our largest likely area of exposure representing nearly 5% of the loan book is to retailers and shopping centers. Approximately $528 million of the retailer category is in CRE. In addition, we have approximately $453 million loan to predominantly investment-grade retailer-oriented REITs. We continue to monitor our oil and gas portfolio, which now accounts for less than 2% of our loan book, with demand disruptions pushing the cost of oil down dramatically. We've set aside additional loan loss reserves against our oil and gas portfolio during the first quarter. While many of our customers have hedged their positions over the near term, and it may take a while for losses to develop, we expect a prolonged period of lower prices that will stress the industry. Our exposure to the hospitality industry is fairly limited, with just over $200 million of loans to hotels and representing less than 1% of total loans. We also carry approximately $100 million in loans to restaurants and other food service companies. Beyond that, we have limited exposures with just one customer in each of the casino, movie theater, or fracking sand mining business. Turning to slide 9, we've outlined the bank's transition to CECL in the first quarter. We implemented CECL leveraging Moody's baseline forecast at both the beginning and the end of the quarter. Our day one allowance for credit losses adjustment came in at $131 million, which was reserved as of January 1st. The higher level of day one adoption relative to our prior guidance was largely driven by an increase in identified probable trouble debt restructurings in our oil and gas portfolio and the fracking signed mining company. With respect to our provision for the quarter, we leveraged the Moody's March 27th baseline forecast and identified additional probable TDRs in the oil and gas book, given changes in price and the dynamics in the industry. Further, in response to the overall economic environment, we also added additional reserves for our key commercial loan exposures, which we highlighted on the prior slide, and bolstered our unfunded commitment provision by $16 million. These factors drove the majority of our $53 million provision for the quarter. Our net Q1 reserve bill of $40 million reflects the provision, net of charge-offs, and changes in our CECL modeling, along with the increased expected prepayments on mortgages. In aggregate, our total allowance for credit losses on loans was $394 million at quarter end, as compared to $223 million at year end. We believe this $171 million reserve build, a 76% increase, adequately reflects the life of loan risks in our portfolio given the economic outlook at March 31st. Our current allowance levels also cover over 65% of our potential losses as produced in our last internal severely adverse stress test scenario. $64 million of the reserve build was specific to our remaining oil and gas portfolio and we ended the quarter with an ACLL reserve of nearly 17% against oil and gas. Our overall blended ACLL represents 162 basis points of total loans, with nearly 2% set against our CRE exposures and just under 1% set against our predominantly first mortgage consumer loan portfolio. Turning to slide 10, Prior to the outbreak of COVID-19, the credit environment remained benign outside of oil and gas. Given the sudden economic downturn in customer relief programs, our credit metrics outside of oil and gas remained relatively steady. During the quarter, potential problem loans increased $73 million to $234 million, driven by a few CRE credits along with some additional oil and gas names. Non-accrual loans saw an $18 million uptick, with $5 million coming from oil and gas, and the majority of the remaining increase attributed to general CNI and residential mortgages. Net charge-offs were $17 million, with about half coming from oil and gas, and the rest in general CNI. To address the disruption brought on by COVID-19, the company has taken a proactive approach to monitor customers impacted. Loan officers have reached out to their customers to understand their capital and liquidity needs. This outreach has been an essential component of the company's relief programs, as we support our customers through this turbulent time. Along with our customer outreach, we've undertaken a deep examination of our loan portfolio to identify industries with additional risk exposure. We continue detailed monitoring of these specific industries in addition to the overall portfolio as we analyze delinquencies and deferrals as leading indicators of credit issues in this evolving environment. Turning to slide 11, Average deposits were up nearly $190 million from the fourth quarter. The average deposit balance growth was driven by the first Staunton acquisition, which added about $440 million of deposits in mid-February. Our end-of-period balances increased nearly $1.9 billion, including $1.6 billion of low-cost demand and savings deposits that came later in the quarter as our customers built up cash. These inflows resulted in a beneficial mix shift and low-cost deposits made up 58% of our overall deposits at the end of the quarter. Turning to slide 12, the inflow of deposits has also enabled us to maintain strong liquidity. Our wholesale funding ratio has remained stable, demonstrating our continuing ability to fund most of our loans with deposits. While we expect to continue funding loans with deposits, we have $11 billion of wholesale funding available, including $6 billion of capacity at the FHLB in Chicago. These figures did not include the additional liquidity that's available to us through the Fed's PPP lending facility. Our loan-to-deposit ratio was 95%, well within our historical range, which gives us flexibility to maintain deposit pricing discipline, and we expect to maintain this ratio below 100%. Turning to slide 13, our net interest income was $203 million, an increase of $3 million from the previous quarter, and our net interest margin was 2.84%, up one basis point from the fourth quarter. There were several factors that drove the modest increase in NII and NIM. On the asset side, one-month LIBOR remained significantly elevated over Fed fund rates, particularly in March, positively impacting CRE and commercial and business lending yields. This benefit was offset by a decrease in long-term interest rates, resulting in in elevated refinancing in the residential mortgage book, and the payoff of higher coupon loans in March. Additionally, this increased prepayment rate drove accelerated recognition of deferred origination costs, further reducing our mortgage yield. On the liability side, our total interest-bearing deposit costs decreased 19 basis points as we reduced pricing across our full suite of deposit products. Total interest-bearing liabilities decreased 17 basis points aided by a beneficial mixed shift toward low-cost deposits and reduced wholesale funding costs. These factors were most pronounced in March, resulting in a NIM for 2.89% for that month. Looking ahead, we expect that commercial loan yields will continue to benefit from elevated LIBOR rates in April and at least somewhat into May. We anticipate the LIBOR Fed Fund spread will normalize later in 2020 as economic conditions become less uncertain. We also expect our deposit costs to continue to decline in the second quarter as we benefit from CD runoff and a full quarter impact from our reduced pricing, and would note that our month-to-date April cost of interest-bearing deposits is already running at approximately 36 basis points. Turning to slide 14, first quarter non-interest income of $98 million was up $5 million from the last quarter and up $7 million year-over-year. Our insurance income was seasonally higher as we received property and casualty contingency fees in the quarter, and our capital markets groups saw revenue lifts driven by market volatility. We also benefited from $15 million of gross mortgage banking revenue in the first quarter, but that was partially offset by a $9 million MSR impairment resulting in $6 million of net mortgage banking income. However, most other fee categories were softer in Q1 due to due in part to our COVID-19 relief program and lower market levels, impacting assets under management and investment activity. These declines and other fee categories were largely offset by net gains realized on the further sell-down of prepayment-sensitive mortgage-backed securities. Moving to slide 15, non-interest expense of $192 million was down $11 million from the fourth quarter. This decrease was primarily due to lower personnel costs, as we have reduced expected incentive compensation, had less hiring in response to the current environment, and are seeing the benefits of the restructuring done in the fourth quarter. Business development and advertising costs were $2 million lower during the quarter due to less business travel and the planned reduction of advertising spend. Technology costs also decreased $2 million from the reduction of third-party consultants, which took place at the end of last year. Turning to slide 16, we look at our customer activity. As you'd expect, branch traffic is down since the pandemic began, with April branch transactions about 17% lower than January. We also saw a 32% drop in ATM transactions over the same time period, as our customers increasingly chose to stay home. However, with the significant investments we've made in digital technology over the last several years, our customers were able to shift their activity from our branches to online and mobile. We saw an 86% uptick in mobile sessions since January and an increase in the use of our uOpen application, which allows customers to open accounts online or from their mobile devices. Call center volume has also increased 32% as we move communications with our customers into non-branch channels. As shown on slide 17, Our regulatory capital levels remain strong, and we have sufficient capital to support further loan growth if our customers continue to seek liquidity. CET1 was 9.36% at the end of the first quarter, and we anticipate it will build through the remainder of 2020. We repurchased $71 million of common stock in the quarter, but suspended our repurchase program on March 13th. We expect our repurchase program to remain suspended for the remainder of the year. On slide 18, we discuss our outlook. Given the extraordinary economic uncertainty, our previous quantitative guidance should no longer be relied upon. However, we'd like to provide more general expectations for the remainder of the year. While we have ample liquidity and funding sources, we expect to be able to fund loan growth with deposit growth and expect our loan-to-deposit ratio will remain under 100%. Given the lack of attractive investments for our portfolio, we're now targeting a and investments to total assets ratio of 15%. We expect our mortgage banking business to continue to do well, but it will likely be offset by lower service charges as we provide relief to our customers. We will also face headwinds in wealth management due to lower market valuations. We often speak about costs as being one factor that we control. We will continue our disciplined approach and expect our expense run rate for the rest of the year to be in line with that of the first quarter. As mentioned, we suspended our stock repurchase program on March 13 and expect it will remain as suspended for the remainder of the year as we build capital. With that, I'd be happy to take your questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star, too, if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Our first question comes from Casey Hare from Jefferies. Please proceed with your questions.