Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corp's third quarter 2020 earnings conference call. My name is Diego, 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 this conference. Copies of the slides that will be referenced 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 one, 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 forward-looking statement. 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 Factors 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 pages 21 and 22 of the slide presentation and to pages 10 and 11 of the press release financial tables. Following today's presentation, instructions will be given for the 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. Thank you, and welcome to our third quarter 2020 earnings call. Joining me today are Chris Niles, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. It goes without saying that this has been a challenging and unusual year. We pivoted in March in response to the pandemic and have been retooling our delivery channels since to best meet our customers' needs. We deployed ourselves to seamlessly interact through virtual channels and have seen an accelerating shift to mobile and online banking. With a likely very low interest rate environment facing us for an extended period, it became critical to respond in areas we can control. Let's start with the actions we took during the third quarter. On slide two, we have detailed our optimization efforts and the restructuring of our securities and real estate lending subsidiaries. During the third quarter, we announced the sale and planned consolidation of 22 of our branches. We also announced the strategic streamlining of several corporate, managerial, and back office functions. As a result of these actions, we incurred $16 million of pre-tax charges in Q3 we expect these changes to drive a $40 million per year reduction in our run rate expenses as we move into this quarter and 2021. We also deployed about half of our excess liquidity position to repay $950 million of FHLV advances. This prepayment resulted in a $45 million Q3 pretax expense. However, We expect this to improve annualized net interest income by $20 million beginning in Q4 2020, continuing through 21 with diminishing but continuing savings through 22 and into 23. Finally, we were able to unlock capital losses through the restructuring of our securities and real estate lending subsidiaries, and this resulted in a $49 million after-tax benefit during the quarter. Turning to slide three, we've highlighted the impact of our Q3 initiatives on our pre-tax, pre-provision income. Adjusting for the 60 million of restructuring and prepayment costs, third quarter PTPP would have been $90 million. On slide four, we've provided a walk forward of EPS, which breaks down the various initiatives executed during the quarter. You'll notice when tax affected, one-time costs of our efficiency initiatives were more than covered by the tax benefits we realized from the reorganization of our subsidiaries if you were to exclude both the restructuring charges and the tax benefits from our eps for the third quarter the adjusted 24 cent result is within two cents of our reported gap eps of 26 cents so in effect the items largely offset each other the actions this quarter were net additive to our tangible book value. Turning to slide five, average loan balance trends are shown. Total average loans came in at $25 billion, down slightly from the prior quarter's average. Commercial real estate grew 312 million, driven by the continuing funding of construction loans, and at September 30th, we still had 1.9 billion of unfunded commercial real estate commitments. Commercial and business lending, on the other hand, declined by $271 million on average as our general commercial customers largely used their increased excess liquidity balances to pay down open lines of credit. Turning to slide six, we highlight changes in the end of period loan balances. Period end loans were up 171 million or 1% for the quarter. driven again by strong growth in commercial real estate lending, which was up $298 million. Mortgage activity remained strong, which was reflected in our elevated mortgage warehouse lending balances at quarter end. Power and utilities lending, along with commercial real estate construction and investor loans, have continued to grow throughout 2020. I'll also call out oil and gas, which declined nearly $100 million during Q3, and now represents only 1.3% of our total loan portfolio. Consumer lending balances came down during the quarter, driven by refinancing activity and our decision to sell $70 million of prepayment-susceptible mortgages. Now let me provide an update on our deferral programs. On slide seven, you can see our commercial deferrals have continued to steadily decline. As of October 19th, we have approximately 227 million of active commercial loan deferrals down 73% from June. Our commercial deferrals have largely rolled off their initial 90-day terms, and the remaining deferrals are primarily related to COVID-impacted portfolios. Commercial real estate loan deferrals were 182 million of that 227 and are primarily related to hotel and retail borrowers. Commercial and business lending deferrals have declined to just $45 million at October 19th, and they now comprise less than 1% of the commercial and business loan loan book. Taken together, the $227 million of active commercial and commercial real estate deferrals at October 19th make up about 1.4% of our total commercial loans outstanding. Our consumer-related COVID relief efforts are highlighted on slide 8. In the beginning of the pandemic, we granted deferrals to virtually any customers who asked for assistance. The deferrals granted were for six months, so the bulk of those deferrals began to expire during September. At October 19th, we had 269 million of active deferrals down 63% from June. These loans now represent approximately 3% of outstanding consumer loan balances. It's important to note, however, that of the remaining $269 million of active deferrals, $263 million of that is still on their first deferral period. The bulk of those deferrals will expire during the balance of October, and we expect most will not require additional assistance. So of those loans that have come off deferral in the consumer book, at this point only $6 million have asked for additional assistance. Among consumers whose deferrals have ended, 97% are current or less than 30 days past due. The trends we're seeing as deferrals roll off continue to be positive. We feel confident many of these borrowers will go back to their pre-COVID performance. On slide nine, we've provided an allowance update. We utilized the Moody's September 2020 baseline forecast for our CECL forward-looking assumptions. The baseline forecast assumes additional stimulus, continuing low rates, and a COVID vaccine that becomes widely available in Q2 of 21. For Q3 of 20, our net allowance bill was only $13 million, down from 35 million in the prior quarter. I'll direct you to the top right chart where we illustrate the ACLL trend during 2020. You can see our net reserve bill has tapered off throughout the year. This reflects the overall stability of our loan portfolio and our real-time outlook for all our credit exposures at quarter end. As you can see from the lower table on this page, during Q3, we actually released reserves in four lending categories and added reserves in three. The largest net bill was in our commercial real estate investor portfolio, where we added to our reserves related to shopping malls and other retailer exposures. Reserves on our oil and gas portfolio declined $33 million as we continue to manage that portfolio down. As of September 30th, our total allowance was $442 million and covered 1.8% of total loans. Credit metrics are presented on slide 10. As a reminder, these metrics reflect our real-time risk rating and credit evaluations with the expectation that substantially all the active deferral activity will come to some conclusion or remediation this quarter. Potential problem loans decreased $14 million, primarily driven by the migration of COVID-affected loans to non-accrual. Overall non-accrual loans increased $60 million, driven primarily by the migration of two commercial real estate mall-oriented REITs and our only sand fracking company into non-accrual. Loans included in our key COVID commercial exposures made up 37% of non-accrual loans at the end of Q3. This inflow was partially offset by non-accrual oil and gas loans, which declined $42 million due to charge-offs, note sales, and payoffs. Charge-offs of the quarter were $30 million. Outside of oil and gas, net charge-offs were again less than $10 million for the quarter. Reserves on the remaining oil and gas book remain over 15%. Turning to slide 11, average deposits were 26.8 billion, up nearly 700 million, or 3% over the second quarter. Average deposit growth again came from low-cost savings and checking accounts this quarter. Liquidity remains high, and our deposit mix continues to improve. Low-cost deposits accounted for nearly 63% of our balances at the end of the third quarter. Turning to slide 12, third quarter net interest income was $182 million with a net interest margin of 2.31%. We previously guided that net interest margin would bottom out during Q3 and begin to pick up in Q4. And as we expected, margin hit bottom in July and August and then rebounded up to 235 in September. Asset yield stabilized during the third quarter while our liability cost trended downwards. we continue to expect to see margin expansion further into Q4 and into 21. We expect spreads to widen on our LIBOR-based commercial loans as we continue to implement new LIBOR floors into our new and renewing loans. This will happen over time or in conjunction with other repricing or credit actions, including the anticipated migration to SOFR and other indices later in 21. On the liability side, our time deposit levels have both been declining and repricing lower. When CDs renew or roll over today, they're generally repricing from approximately 1.2% to below 15 basis points. We expect this repricing to provide margin lift going into 21. Additionally, we'll see a full quarter impact during Q4 from the prepayment of our FHLB advances, and we expect this will provide a $5 million benefit to net interest margin in the fourth quarter and about a $20 million improvement in 21. Turn to slide 14, second quarter non-interest income came in at $76 million. Non-interest income was lower in Q3 than 2. However, this was driven by the large gain from the sale of associated benefits and risk consulting in Q2 and, of course, the lack of revenue from ABRC going forward. Service charges And deposit account fees came in at $14 million, an increase of nearly $3 million quarter over quarter. Card-based fees increased 15% from the second quarter up to $10 million. So the combination of COVID relief winding down as well as more normalized economic activity is driving these fee lines. Our mortgage banking activity remained strong this quarter with nearly $600 million of mortgages sold to the agencies. generating $13 million in net fee revenue. After $17 million of MSR impairment in the first half of the year, impairment for the third quarter was just over $1 million. We expect positive fee trends heading into Q4. On slide 14, we highlight our expenses. The third quarter came in at $228 million, including $60 million of restructuring costs previously mentioned. Poor expenses continue to trend lower, largely driven by the reduction of expense following the sale of ABRC. We expect the expense initiatives executed in Q3 to provide further savings as we move into 2021. And as you can see from the lower right chart, on an adjusted or run rate basis, our expenses to average assets ratio is already trending below 2%. As shown on slide 15, our regulatory capital levels remain strong. At the end of Q3, our regulatory capital levels were at or above where we ended the year for 2019, and our tangible common equity ratio increased 25 basis points to 7.5%. Tangible book value per share also increased to $16.37 per share, up from $16.21 in the prior quarter, reflecting the net added benefit to shareholders of the actions we took during the quarter. On slide 16, we're updating select items for the remainder of 2020 and reiterating our expense guidance for 2021. We expect a net interest margin of 2.5% or slightly higher in the fourth quarter. We expect fee revenue to continue on a positive trend through the end of 2020. Expenses for Q4 are expected to come in at $175 million, including about $3 million of remaining restructuring costs. We reiterate our full year 2021 expenses are expected to be approximately $685 million. The full year 2020 tax rate will be in the low to mid single digits, and we expect the full year 21 tax rate to be between 15 and 17%. Thank you, and with that, we'd be happy to answer your questions. Thank you. Ladies and gentlemen, at this time, we will conduct our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. That's the star key followed by the number 1 key on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star followed by the number 2 key 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 pull for questions. Our first question comes from Michael Young with Truist Securities.

Please state your question. Hey, thanks for taking the question. I wanted to ask about loan growth. You mentioned the commercial construction pipeline with, I think you said, $1.9 billion yet to be funded, so it sounds like that's a pretty nice tailwind or potential bridge to return to stronger loan growth. Is that the right way to think about that, or are there some other offsets that we should be thinking of in some of the other commercial categories?

Yeah, thanks, Michael. So, yes, certainly commercial real estate, as you've seen throughout the year, will continue to provide loan growth based upon the backlog we have, and there is some amount of new business being done in that area as well. Our specialty areas, power and utilities, the mortgage warehouse business, continue to show good growth, and we expect Certainly the power and utilities area to keep growing. Mortgage warehouse will depend upon refinance activity. The mortgage business still has some tailwind, and we may choose to retain some of our mortgage production going forward. General commercial lending, probably somewhat slow. We don't have great visibility into that line item into next year yet, but we expect to have more information on that. as we get through the fourth quarter and get to the January call. So there are certain areas that continue to show good growth. There are areas that continue to have the backlog, like CRE, that will fund up. But general activity in the commercial lending space needs to show some more growth going forward. We'll see what happens as we go along.