Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corp's fourth quarter 2020 earnings conference call. My name is Diego, and I will be your operator today. At this time, all participants are in the 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 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 reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to pages 22 and 23 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.

Thanks, Diego, and welcome to our fourth quarter 2020 earnings call. Joining me today are Chris Niles, our CFO, and Pat Ahern, our Chief Credit Officer. Before discussing our results for the fourth quarter and full year, I'd like to say a few words about the CEO transition we also just announced. After 11 years with Associated, I announced my plans today to retire at the end of 2021. I've been thinking about this for some time, and in consultation with the Board, we agreed this is the right time to initiate our succession process. As noted in the press release, I will continue as President and CEO until my successor is in place, at which time I'll step down from both of those roles and from the board. I'll be available to the new CEO in an advisory capacity thereafter to assure a smooth transition for our customers and colleagues. The board has commenced a search for a permanent successor and will consider our internal as well as external candidates. As you can appreciate, we cannot speculate on the timeline for that search, but the board and I are highly confident that we'll name a strong successor it will take associated to its next phase of success, continue our profitable growth trajectory. I look forward to working with my successor to ensure a smooth and seamless transition. But now let me turn to our fourth quarter and full year results. This was a year unlike any of us has experienced. In the midst of incredible challenges and uncertainty, the commitment of our colleagues shone through. COVID-19 changed every aspect of life, including how people and businesses bank. In navigating the unknown, it was essential that our customers were able to count on us and that our teams were safe and well-positioned to provide their support. As businesses and schools shut down, we found new ways to support both the health and financial well-being of our customers and communities. Through the efforts of our colleagues, we were able to support our customers with over a billion dollars of PPP loans and adapt our branch services as our customers shifted to remote banking. It goes without saying that 2021 will have many challenges. However, the arrival of the COVID-19 vaccines promise a return to normality. Perhaps it's only fitting this year we will celebrate our 160th year as a company and our rich history of supporting our customers and communities in their times of need. As we have through the decades, we stand eager to help build a stronger economy and better society. During 2020, we took several actions to prepare for the recovery we expect to see in 2021. On slide two, you can see the improving trends for a number of key items. With the sudden decline in interest rates this past year, we quickly moved to reduce funding costs and implement strategies to stabilize and increase our asset yields. Together, these actions helped drive margins higher during the fourth quarter. In addition, beginning in the second quarter, we took several steps to increase the efficiency of our organization. Included was the sale of associated benefits and risk consulting, the third quarter efficiency initiatives, reducing branches and personnel costs, and the recently announced sale of Whitnell, our family office subsidiary. Taken together, These actions will help drive further improvement in our efficiency and expense run rate as we move into 2021. We adopted CECL on January 1st, and as the pandemic began to unfold, we moved swiftly to increase our allowance in contemplation of the economy we saw through the middle of the year. As we moved further through the back half of the year, we were encouraged by the positive emerging trajectory of the economy. And as we closed out the year, we were very pleased with the low levels of deferrals and new problem loans, which allowed us to bring down our provisioning over the back half of 2020. Notably, we posted a net reserve release of $11 million during the fourth quarter. Collectively, these positive trends drove the EPS improvement we saw in the fourth quarter. We recorded $1.86 of GAAP earnings per share for the full year 2020, or $1.19 when adjusted for the gain on sale of associated benefits and risk consulting. Turning to slide three, let's drill further into some of these positive trends for the quarter. Our fourth quarter EPS was 40 cents, up more than 50 percent from the third quarter. We saw our net interest margin expand 18 basis points to 2.49 percent, driven by expanding commercial and industrial loan yields and PPP accretion from forgiveness. We ended the year with fourth quarter 2020 over fourth quarter 2019 average loan growth of 1.9 billion or 8%. Mortgage warehouse and CRE lending continued to be strong performers during the quarter. We continue to grow our lowest cost deposits, which accounted for 64% of total deposits at the end of 2020. The cost of interest-bearing deposits declined significantly throughout the year. During the fourth quarter, the cost of interest-bearing deposits, excluding time deposits, was just seven basis points. The provision for credit losses was $17 million during the quarter, down from $43 million in the third quarter. Loan deferrals fell to less than $80 million, and both non-accruals and potential problem loans declined. Our allowance reserve covered 1.76% of loans at the end of the year. We finished the year on a strong capital note, Tangible book value per share increased to $16.67, and all our regulatory capital ratios were higher year over year. On slide four, we've provided a summary of our 2020 pretax pre-provision income. We've also highlighted several significant initiatives which we executed over the year and their impact on PTPP. Adjusted for these significant items, PTPP was $393 million for the year. On slide five, we provide a similar view for the fourth quarter. Excluding the gain on sale of branches, fourth quarter PTPP was 94 million. Average annual loan balance trends are shown on slide six. Total average loans came in at 24.5 billion, up 1.4 billion or 6% for the year. PPP lending and CRE activity accounted for most of the year's growth. Commercial and business lending increased 983 million, or 12%, from 2019. This was driven by PPP lending and mortgage warehouse financing. We also continued to reduce our oil and gas exposure to only 296 million at the end of the year. Oil and gas outstandings now represent just a little more than 1% of our total loans. Average commercial real estate loans grew over 660 million as customers continue to build projects particularly industrial and distribution center projects, across our footprint. Construction lending has been particularly resilient in the upper Midwest, and our unfunded commercial real estate commitments stood at $1.9 billion at year end, reflecting a healthy amount of expected further growth as we move into 21. We originated a record $4.5 billion of mortgages during the year, driven by the lower mortgage rate environment. Despite this, Average consumer loans finished the year at $9.3 billion, down $230 million. The low rate environment encouraged refinancing activity across our markets and contributed to the further rundown in our home equity book. We've been reluctant to add low rate mortgages to our balance sheet, but we have benefited from the sale of originated mortgage loans in the form of mortgage banking fees. Turning to slide seven, we highlight changes in the quarterly loan trend. Compared to Q4 of 2019, average fourth quarter loans increased $1.9 billion. Commercial real estate loans increased $963 million, and commercial and business lending increased $1.2 billion, including PPP loans. On a sequential quarter basis, fourth quarter average loans fell $281 million from the third quarter. This decline was mostly attributable to PPP forgiveness, which we began to see in the fourth quarter, through year end, about 25% of our PPP loans have been repaid or forgiven. Looking out to 21, outstanding 2020 PPP Round 1 and 2 loans should be largely paid off or forgiven during the first half. We are currently originating new 2021 Round 3 PPP loans and expect these to peak in Q2 and then decline toward year end. With respect to residential mortgages, we project balances to be flattish throughout the year as new mortgage portfolio production and increasing home equity production and utilization are more or less offset by the negative impacts of the ongoing refi market on these categories. We are optimistic about commercial loan demand in 21. Specifically, we expect commercial real estate growth to continue at a strong pace and to increase average CRE balances by 4% to 6% during the year. We're also anticipating commercial line utilization expansion that should add 1 to 2% to outstandings, particularly as we move into the back half of this year. Taken together, we expect full year commercial loan growth, that is commercial real estate and commercial and industrial combined, of 2 to 4%. On slide 8, we've summarized our COVID-19 relief efforts for the year. During the second quarter, deferrals peaked at approximately $1.6 billion. At year end, Deferrals were just $79 million. We saw very positive trends throughout the year and are very pleased with where we ended. Most customers who received deferrals have not needed additional assistance and have been able to resume making normal payments. Total deferrals make up just 32 basis points of our total loans at year end. The remaining deferrals are primarily residential mortgage borrowers that are still in their initial six-month deferral period. We expect substantially all of these consumer deferrals to be cured or expire without any credit implications in the coming quarter. Our allowance update is shown on slide nine. We utilize Moody's December 2020 baseline forecast for our CECL forward-looking assumptions. The baseline forecast assumes additional stimulus, continuing low rates through 2023, and a COVID vaccine that becomes widely available late in this quarter. We had previously indicated that we expected to taper our reserving as we move through the year, and in fact, our fourth quarter reflects a net reserve release of $11 million. While we set aside $17 million as a provision for the quarter, we also charged off $28 million, resulting in a net lower quarter-over-quarter total allowance. This net release was driven by a $27 million gross reduction in our allowance related to our general commercial and business lending portfolios, This gross release was partially offset by $15 million of additional reserves set aside for commercial real estate loans. The commercial real estate reserves are driven by the fact that our construction loan portfolio has grown by over 30% year-to-date and that we reserve for the full committed amount on a construction loan at inception. As of December 31st, our total allowance was $431 million, down from $442 million at the end of the third quarter to Similarly, our ratio of reserves to loans was about flat, 1.76% to 1.77%. Our credit metrics are presented on slide 10. Potential problem loans, non-accrual loans, and net charge-offs all declined during the quarter. Our key COVID commercial exposures also continued to decline, and notably our oil and gas, retail, and restaurant exposure all declined during the quarter. We'd also note that we had no oil and gas net charge-offs this quarter, and we're comforted that with oil prices currently holding above $50 a barrel, we are well-reserved going into 2021. Assuming the positive credit dynamics continue, we expect our full-year 2021 provision to be no more than $70 million with some quarterly variability. Turning to slide 11, Annual average deposits were $26 billion, up nearly $1.3 billion, or 5% over 2019. At the end of 2020, low-cost deposits grew approximately $3.6 billion compared to the end of 2019. At the same time, we reduced high-cost time deposits and network deposits by over $1 billion. These are all-time record deposit levels for associated customers and are a testament to the resiliency of our systems and our ability to continue to attract and retain core customers in a low-rate and largely remote banking environment. We're also happy to report our customer satisfaction ratings have never been higher. Our customer interaction and call center survey data suggest our customers have been well served despite many of our branch lobbies being closed for part of this year. Further, our mobile applications continue to be refreshed and have been very well received by our customers. who've given us a 4.8-star rating out of five on the most popular mobile platform. Turning to slide 12, fourth quarter average deposits were $26.7 billion. Low-cost non-interest bearing and savings were up from the third quarter, while network and time deposits declined yet again. Low-cost deposits accounted for nearly 64% of our balances at the end of the year. Turning to slide 13, Fourth quarter net interest income was $188 million, up $6 million from the third quarter, and net interest margin of 2.49% was up 18 basis points from the third quarter. We had previously guided that net interest margin would bottom out during the third quarter and pick up in Q4. As expected, margin hit bottom in July and August and then rebounded to 2.56% in December. Asset yields benefited from our implementation of LIBOR floors, reduced investment activity, and generally widening spreads on new loans. On the liability side, we benefited from lower levels of borrowings driven by the influx of customer deposits, which drove our funding costs down. This persistent customer liquidity encouraged us to repay $1 billion of PPP loan fund funding in November. We also aggressively repriced our consumer deposit book, yet still have $288 million in 1% plus CDs, which will mature in the first half of 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 away from LIBOR later in 21. We continue to expect to see our margin expand as we move throughout the year. We expect our net interest margin to be relatively flat in the first quarter and to gradually expand over the course of the second through fourth quarters. We expect the full year's margin to be between 2.55% and 2.65%. Turning to slide 14, fourth quarter non-interest income came in at $86 million. Mortgage banking, service charges, and wealth management fees all contributed to this quarter's growth. We also recorded $7 million of deposit premiums on our previously announced branch sales. Our mortgage banking activity remained strong this quarter, with nearly $340 million of mortgages sold to the agencies, generating $14 million in net fee revenue. We also picked up nearly $1 million of MSR recovery during the fourth quarter and still have over $17 million in temporarily impaired MSR at year end. We expect mortgage banking activity to remain somewhat elevated as we move into the year. Service charges and deposit account fees came in at $15 million, an increase of $1 million quarter over quarter. Wealth fees also increased nearly $1 million, reflecting the strong equity market dynamics. On January 5th, we announced the sale of our Whitnell Family Office subsidiary, which constitutes a little less than 10% of the wealth management revenues and is focused on the ultra-high net worth market. Pro forma for the sale, we retain approximately $12 billion of assets under management. As we look forward and net of the pending Wittenell sale, we expect non-interest income of $280 to $300 million in 2021. On slide 15, we highlight our expenses. The third quarter came in at $173 million inside of the $175 million level we were targeting. Core expenses continue to trend lower, largely driven by the reduction of expense following the sale of ABRC and the branch sales, which mostly closed in December. We expect expense initiatives to provide further savings as we move into 2021. As you can see from the charts on the right, our efficiency trends continue to improve, and our adjusted expenses to average assets ratio is already trending to 2%. Given these positive dynamics and the pending sale of Whitnell, we're revising our full year 2021 expense guidance down to approximately $675 million. As shown on slide 16, our regulatory capital levels remain strong. Our common equity tier one ratio increased 23 basis points from the third quarter and has grown 109 basis points from the first quarter as we conserved capital in light of economic uncertainty. Our TCE ratio grew 44 basis points from the third quarter, benefiting from solid earnings. and lower asset levels as we used excess cash to reduce higher cost deposits and our PPP loans began to be forgiven. As we look forward into 21, we expect to resume opportunistic share repurchases this quarter. We will continue to target TCE levels at or above 7.5% and CET1 at or above 9.5%. So to wrap up on slide 17, we're providing guidance for 2021. We expect full year net interest margin of 255 to 265 basis points. We expect mortgage banking revenue to moderate, but non-interest income still to come in between 280 to 300 million. We're revising our 2021 expense guidance down to approximately 675 million from the 685 million previously guided. Our provision for credit losses has trended down since the second quarter to an annualized fourth-quarter run rate of about $70 million. With the positive credit trends we're seeing and assuming the economy behaves positively, as is generally expected, we believe our 2021 full-year provision will be at or better than $70 million with some quarterly variability. And we expect our annual tax rate to normalize in the 18% to 21% range. With that, we'd be happy to take any of your questions.

Thank you. At this time, we'll 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 that your line is in the question queue. You may press the star key followed by the number 2 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 keys. One moment, please, while we pull for questions. Our first question comes from Jared Shaw with Wells Fargo Securities. Please state your question.