Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corps' second quarter 2020 earnings conference call. My name is Devin, and I will 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 today's conference. Copies of the slides that will be referenced during the 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 one, during the course of 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's most recent Form 10-K and subsequent SEC filings. These factors are incorporated herein by reference. For a reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in the conference call, please refer to page 23 on the slide presentation and to page 10 on the press release financial tables. Following today's presentation, instructions will be given for a question and answer session. At this time, I would like to turn the conference over to Philip Flynn, President and CEO, for opening remarks. Please go ahead, sir.

Thanks, and welcome to our second quarter 2020 earnings call. Joining me today are Chris Niles, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. Associated had an unusual but successful second quarter. I'm proud of how my thousands of colleagues have responded to the challenges. We focused on protecting the health of our customers and colleagues while meeting the needs of our customers. We met those needs with PPP loans, payment deferrals, fee waivers, and the distribution of stimulus funds. We ensured our ability to meet the future needs of our communities and customers with a significant increase in our capital through the sale of associated benefits and risk consulting and a preferred stock issuance. We've seen record inflows of deposits and have abundant liquidity. With the revenue challenge brought on by near-zero interest rates, we managed our expenses down. While no one could predict the ultimate impact of the COVID pandemic on credit, we saw some encouraging early signs from our borrowers. So let's look at our financial results. Turning to slide two, our second quarter GAAP earnings were $0.94 per share, including the $163 million gain on sale of associated benefits and risk consulting. Average loans grew considerably during the quarter, largely driven by PPP loans and commercial line draws. Loan funding, along with government stimulus programs and overall increased savings rates, led to higher deposit balances as well. Our loan-to-deposit ratio was 94% at the end of the quarter, 90% without PPP, and 61% of our total deposits were made up of low-cost deposits. While we haven't seen significant changes in credit metrics yet, our reserve for loan losses increased $35 million during the second quarter, and as of June 30th, our allowance to loan ratio was 1.73% or 1.8%, excluding PPP loans. The sale of ABRC and the issuance of $100 million of preferred stock lifted our capital ratios, CET1 increased 89 basis points from the first quarter to 10.25. Our tangible book value per share also increased, moving up 11% from last quarter to $16.21. Average loan balance trends are shown on slide 3. Commercial and business lending grew nearly $1.7 billion, driven predominantly by PPP loans, an active mortgage warehouse market, and increased draws on general commercial lines of credit. While we saw unusually high commercial line draws at the end of the first quarter, as the second quarter progressed, these lines paid down. Growth in CRE was primarily driven by new loans plus continued funding of construction loans. On average, residential mortgages declined during the second quarter as we continued to sell new production and some portfolio loans to the agencies. Turning to slide four, we show end-of-period loan trends, which will highlight second quarter activity. We ended the second quarter with $24.8 billion of loans, a net increase of $467 million from the first quarter. Included in these balances was over $1 billion of outstanding PPP loans. This was partially offset by $559 million of paydowns on general commercial lines during the quarter. We view the repayment of these lines as a sign our customers have a more optimistic outlook regarding their liquidity than they did at the end of the first quarter. As previously mentioned, our commercial real estate portfolios continued to grow during the quarter. At quarter end, we still had nearly $2 billion of unfunded commitments which we expect will continue to fund up over the balance of 2020 and into 2021. We expect to continue to grow our commercial real estate balances over the course of the year. Turning to slide five, let's look at our portfolio composition at the end of the second quarter. In the second column, we identified our key COVID loan exposures, which I'll highlight on the next page. We've also broken out our deferred loans and our non-accrual loans, which remain minimal. As the pandemic's impact on the economy expanded during the second quarter, we responded to our customers' needs by underwriting PPP loans and by deferring and modifying certain loans as shown on slide five. Approximately 35% of key COVID commercial loan exposures have received a modification or deferral, 19% received a PPP loan, and 4% received both. Now let's look at our key COVID commercial loan exposures on slide six. This is an update of the slide we introduced in the first quarter. We continue to monitor risks in the loan portfolio. The table on slide six details our exposures to several categories of commercial loans potentially impacted by COVID-19 and lower hydrocarbon prices. The $2.2 billion represents less than 9% of outstanding loans at the end of the second quarter. Making up 5% of our loan book, retailers and retail commercial real estate remain our largest area of exposure. $664 million of these loans are to retail real estate, of which the majority is collateralized by malls, shopping centers, and non-grocery store anchored strip centers. These loans had an average loan-to-value ratio of approximately 57% at origination, providing a significant cushion for potential deterioration. We would highlight amongst our retail-oriented REITs, which are predominantly investment-grade credits, balances paid down about 54 million from last quarter to about 400 million. Oil and gas loans also declined 35 million from last quarter and account for 1.7% of our loan balances. In the second quarter, we grew reserves further on this portfolio. Despite the price of oil creeping back up from the first quarter, we still remain concerned about the outlook for this industry. Outside retail and oil and gas, our remaining exposure is limited. Hotels and restaurants are our next largest portfolios, and each of these categories represent less than 1% of total loans. Overall, we believe our exposure to COVID-affected industries remains manageable. We're seeing positive dynamics, and our exposures remain relatively unchanged quarter over quarter. Now let me comment on our COVID relief efforts for our commercial customers highlighted on slide 7. At June 30, we had just over $820 million of completed commercial loan deferrals. The loan deferrals included $638 million of commercial real estate, primarily comprising the hotel and retailer borrowers, representing about 11% of the commercial real estate loan book. Commercial and business lending had $184 million of deferrals, or about 2% of that book. New commercial loan deferral requests slowed as the quarter progressed, and many customers with deferrals ending in June have not asked for additional assistance. Our consumer-related COVID relief efforts are highlighted on slide 8. We finished the second quarter with $725 million of consumer loan deferrals, or 8% of the total residential and consumer loan book. New deferral requests have slowed substantially since the peak in May and have essentially ceased since the latter half of June. We also supported many of our customers with waived or refunded fees during the pandemic. Since implementing our COVID-19 relief program, we've refunded or waived nearly $2 million in fees for consumers and small businesses through June 30. Turning to slide nine, early signs are positive. as many customers who receive payment deferrals are returning to normal payment structures. Despite having been granted payment waivers, about 27% of consumers with completed loan deferrals have made at least one subsequent payment. In corporate banking and small business, $46 million of loan deferrals ended during June, and of those, over 90% of customers are expected to resume making payments. Based on early discussions, we expect nearly all of the remaining customers with deferrals in corporate banking and small business to return to making payments. Commercial real estate had $116 million in loan deferrals expire during June. About half of those customers are expected to start making payments again. The other half, consisting either of hotels or retail properties, have requested further extensions. Of the additional loans on deferral, we expect about one-third of these customers to require some form of assistance, with the majority being in the hotel sector. Turning to slide 10, you can see we have built reserves by about $35 million during the second quarter. This brings our total allowance to $429 million at the end of June. Our reserve covers 1.7% of total loans or 1.8%, excluding PPP loans. We've modeled our reserves against the June Moody's baseline with our own qualitative overlays. Additional reserves were set aside for certain industries affected by the COVID-19 pandemic. Reserves on COVID-affected loans covered 6.2% of loan balances compared to about 1.4% for non-COVID-affected loans. As you can see, the bulk of our reserve build is attributed to commercial real estate and oil and gas. During the quarter, we built up our CRE reserves by $27 million reflecting the increased risk profile we see in our retail and hotel portfolios. Additional reserves were also built up on oil and gas loans, which increased by $6 million and now cover 19.4% of the portfolio. Turning to slide 11, you can see our credit metrics have drifted up slightly but remain fairly stable. Potential problem loans increased $73 million, driven by General C&I, and commercial real estate within the key COVID commercial loan exposures portfolio. Non-accrual loans increased 35 million, but are only slightly elevated over the second quarter of 2019. 21 million of the increase came from oil and gas, with most of the rest coming from commercial real estate. Our net charge-offs continue to be almost exclusively in the oil and gas space. Our oil and gas reserve increased 273 basis points from last quarter, The loans in this portfolio are all shared with other banks, and our high level of reserves reflects a conservative view of the ultimate outcome for some of these credits as we wind down the business. Turning to slide 12, average deposits were up nearly 1.9 billion or 8% over the first quarter. Most of this growth came from low-cost, non-interest-bearing checking accounts and savings accounts. Deposits remained elevated due to PPP loans staying in accounts, government stimulus money, and generally higher savings rates amongst consumers. Our low-cost deposit mix continues to improve as these balances made up 61% of overall deposits at the end of the second quarter. Turning to slide 13, second quarter net interest income was $190 million, and year-to-date margin came in at 2.66%. Pressure on the margin is being driven by asset yield compression relative to our ability to reduce liability costs as a result of the Fed cutting rates to near zero. Total cost of interest-bearing deposits dropped to 25 basis points in June as we reduced pricing across the board. While second quarter NIM declined 35 basis points from the first quarter, we expect NIM to stabilize in Q3 and recover somewhat in Q4. Total interest-bearing liabilities fell to 57 basis points in June, driven by the remix of our deposit base and interest rate reductions. Turning to slide 14, second quarter non-interest income came in at $254 million. The mortgage business remains active, resulting in an increase of $6 million from the first quarter. Gross mortgage banking income was $20 million, offset by $8 million of MSR impairment, resulting in $12 million of net mortgage banking income. We saw a decline in service charges and deposit account fees during the second quarter of about 4 million, driven by less customer and economic activity during Q2. We expect activity to recover as we go through the year. The gain on sale of assets was 157 million during the quarter. We've further broken that down on the next slide. We closed the sale of ABRC on June 30th. The sale resulted in 266 million of proceeds and a gap gain of $163 million after personnel and transaction costs were accounted for. The net after-tax gain was $104 million, and second quarter earnings per share, excluding the gain, was $0.26. Separately, we recognized about $6 million in losses on non-AVRC-related write-downs. The bulk of this was driven by the write-down of an equity interest in a company related to a restructured oil and gas loan. Turning to slide 16, we look at our customer activity. Branch activity has slowly started to come back since April. However, customers have moved away from using the lobby and continue to use the drive-thrus. Prior to COVID, about 65% of transactions took place in the lobby, but this has shifted to only 30% as of late. Customers are also resuming normal spending levels as debit and credit card spend increased 23% from April to June. During the COVID outbreak, we've seen a strong shift to mobile banking. Even with branch lobbies reopening, active mobile application users have increased 15% from January to June. This is a positive trend, which we feel will provide efficiency opportunities in the long run. On slide 17, you can see our continuing downward trend of expenses. Total non-interest expense was 183 million, down 9 million from the first quarter. The decrease in expense was spread across several categories. Personnel expense was down 3 million due to lower benefits. Fringe and equity plan expenses partially offset by higher commissions. Occupancy was down 2 million since we weren't plowing snow. Business development and advertising were down 2 million as we had less business travel and marketing activity during the quarter. As shown on slide 18, our regulatory capital levels remain strong. The sale of ABRC added 41 basis points to our CET1 ratio and 27 basis points to our TCE ratio. Overall, CET1 increased to 10.25 from 9.36 in the first quarter. Our tangible common equity ratio also increased to 7.25, up from 6.9 in Q1. As I mentioned, tangible book value per share is now $16.21, up 11% from the first quarter. We expect capital to continue to build through the remainder of 2020. Finally, on slide 19, we discuss our outlook, which includes several updated items. We expect our margin to stabilize in Q3 and to improve in Q4 as we see PPP loans pay down. For the full year, we expect our margin to come in between 255 and 2.6%. This assumes the pay down of our PPP loans in Q4 and early 21. Mortgage banking will continue to be elevated in Q3, and service charges will start to return to normal levels as COVID-related fee waivers have expired and consumer activity continues to pick up. Our quarterly expense run rate is expected to be about $175 million due to $15 million in quarterly expense reductions from the sale of ABRC. With an outlook for low rates stretching through next year, We're currently taking a look at our expense base beyond our current guidance, and we'll have more to discuss later this quarter. Based on our expected view of economic activity within our footprint, we anticipate loan loss provisions over the second half of the year to be less than they were in the first half. And with that, we'd be happy to answer 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 one on your telephone keypad. A confirmation zone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. One moment, please, as we poll for questions. Our first question comes to the line of John Ashbrook with RBC. Please, speak with your question.