Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corp's first quarter 2021 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 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 those 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 Factors 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 18 and 19 of this slide presentation and to page eight 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. Welcome to our first quarter 2021 earnings call. Joining me today are Chris Niles, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. Before discussing our results for the first quarter, I should note that this will be my last time leading the quarterly earnings call for Associated. Next week, I'll be passing the baton to Andy Harmoning, who will be stepping in as president and chief executive officer on April 28th. Andy is a highly regarded banking leader with more than 25 years of experience and a track record of driving profitable growth and operational excellence, improving customers' experience, and spearheading innovative digital products. I'm proud of the progress the associated team has made as we pursued our vision of becoming one of the Midwest's premier financial institutions, and I'm highly confident that Andy will take Associated to our next phase of success and continue our profitable growth trajectory. I look forward to working with Andy as he takes over and serving in an advisory capacity to support the company. Let me now turn to our first quarter results. It's almost trite to say that the past 12 months have been unlike anything we've experienced before. But during the first quarter of 21, we've seen steadily increasing availability of COVID-19 vaccinations throughout our markets. Businesses have started to reopen. And encouraged by these trends, our frontline teams are back in front of clients and working directly with our customers. We've also continued to invest in and deploy technologies to meet our customers' banking needs when and where they need us. With the economy showing signs of improvement, credit dynamics have continued to improve across all of our portfolios. Our customers remain liquid, continue to pay down their credit lines, and are positioning themselves for the expected economic recovery later this year. As we celebrate our 160th year as a company, we see many signs of a strengthened economy in our markets. The first quarter's highlights are detailed on slide two. Our first quarter earnings per share were 58 cents, up 45% from the fourth quarter. We saw strong fee income trends in the first quarter. Mortgage banking income, capital markets, and wealth management all grew. Taken together, this strengthened fee income offset the impacts of LIBOR compression and mortgage refinancing activity, which weighed on our net interest margin. We also continued to see record levels of checking account deposit inflows, driven by additional government stimulus. While this added liquidity, also compressed margins, we continued to grow our lowest cost deposits, which accounted for 65% of total deposits at the end of the quarter. This liquidity positions us to meet what we expect will be rising loan demand later this year. Shifting to credit, we've been very pleased with the rapidly improving credit environment in early 21, which speaks to the strength of our markets in the upper Midwest. Non-accrual loans were down 23% quarter over quarter, while net charge-offs fell to just $5 million, or down about 83% from the fourth quarter. We also posted a negative provision for the quarter. Together, charge-offs and the negative provision drove a net reserve release of $28 million. We finished the quarter with strong capital and repurchased $18 million of common stock during Q1, Our tangible book value per share increased to $16.95 as of the end of the month, and all our capital ratios improved year over year. On slide three, we've provided a summary of our quarterly pre-tax, pre-provision income, which has remained relatively flat quarter over quarter. Adjusting for the branch and other sales activity, quarter over quarter change is even flatter. Turning to slide four, we highlight changes in quarterly loan trends. Compared to the first quarter of 20, average first quarter loans increased $1.2 billion or 5%. On a sequential quarter end of period basis, we saw solid growth in our specialty lending and construction portfolios along with renewed PPP activity. However, we continued to see liquidity driven pay down activity impact our general commercial portfolio driven by lower line utilization. Similarly, while Mortgage Warehouse and our own mortgage banking group benefited from the ongoing refi wave, the same activity drove our residential mortgage and HELOC balances lower during the quarter. We continue to enjoy strong mortgage originations, but as we've discussed previously, we've been reluctant to add low-rate mortgages to our balance sheet. Looking forward, we remain optimistic around loan growth going into the latter part of this year, specifically on commercial real estate lending, We expect construction lending to continue at a strong pace and to drive increasing average CRE balances by 4% to 6% during 2021. In addition, while we expect most of our outstanding PPP loans from rounds one and two to be paid off or forgiven during the first half of the year, we've seen good traction on round three PPP activity, where we've supported nearly 5,000 customers as of today. We expect round three originations to peak in Q2 at about $320 million. In total, we expect to have supported over 13,000 small and medium-sized businesses with more than $1.3 billion in loans. We remain optimistic about commercial loan demand in the back half of the year and still expect full-year commercial loan growth that is CRE and CNI combined, excluding the PPP loans, of approximately 2 to 4%. With respect to residential mortgage, we continue to expect balanced contraction from the ongoing refinancing activity. However, we expect any revenue contraction will be offset by incremental mortgage banking fee income as we saw in Q1. We'd also like to update you on our new auto lending initiative. We're expanding our consumer lending platform to add indirect auto lending to our product set. To date, we've hired over 40 people from KeyBank including all the senior leadership, and expect to end the year with a total of 55 to 60 full-time equivalent employees as we build out this business. We expect to begin originating indirect auto paper by the fall with production of $200 million or more in 2021, adding to and diversifying our total consumer portfolio. We expect the portfolio's net yields to exceed those in our residential mortgage book as we achieve scale. We expect the indirect auto financials will be more or less run rate neutral by year end with income derived from Q4 loan volumes offsetting the ongoing costs. We expect this business to be accretive in 2022 and of course beyond. We aspire to grow our indirect auto outstandings into a multi-billion dollar loan portfolio over time. Moving to slide five, we continue to see all time record deposit levels for associated customers, reflecting our ability to retain our core customers in a low rate and largely remote banking environment. Our retention rates have been improving now for seven years and reflecting more than half of attrition over that time period. Our customer interaction and call center survey data continues to suggest our customers have been well served despite the challenges posed by the pandemic. I'm particularly excited to tell you that we are currently in first place and leading the Upper Midwest region in the J.D. Power Retail Banking Study, and we expect to be recognized by J.D. Power as number one for the Upper Midwest when final results are released next week. These positive customer dynamics are reflected in the strong growth of first quarter average deposits, which were up $2.5 billion, or 10% over the first quarter of 2020. This growth reflects strong trends in our lowest-cost deposit categories, which grew by approximately $3.5 billion from the same period a year ago, while we continued to reduce higher cost network and time deposits by over $1.3 billion. From a quarter-over-quarter standpoint, end-of-period non-interest-bearing checking and savings were up $834 million and $383 million, respectively, from the fourth quarter, driving our low-cost deposits to their highest levels ever. At the end of the first quarter, low-cost deposits accounted for approximately 65% of our balances, marked by steady growth in checking and savings categories specifically. Turning to slide six, we had previously indicated that dollar net interest income would be reduced by day count, LIBOR, and refinancing pressures during Q1. And in fact, first quarter net interest income was $176 million, down $12 million from the fourth quarter. As you can see from the chart on the right, the most significant drop in our realized yields was in our residential mortgage portfolio, which came down by 21 basis points, reflecting the impact of prepayments and refi activity on the books. The declining asset yields were partially offset by continuing improvement on the interest expense side, where the additional influx of low-cost customer deposits combined with lower levels of borrowing continued to drive our interest expense lower. While the 10 basis point quarterly drop in margin was more than we had expected, as we look forward, we continue to expect our net interest margin to gradually expand over the course of the second through fourth quarters. Slide seven shows a breakdown of the specific factors that impacted net interest income in Q1. As we indicated on the prior slide, key factors for the quarter were mortgage refinance driven impacts such as premium and origination cost amortization, which depressed net interest income by approximately $9 million for the quarter. However, these costs were offset by an increase in net mortgage banking income over the course of the quarter, and we expect mortgage yields to rebound as the current refinance wave slows in Q2. On the commercial side, our LIBOR-based loans were impacted by day count, the LIBOR rate compression in February and March, and slower PPP forgiveness relative to Q4. While these impacts played a significant role in Q1. We expect them to moderate as we move through the year. Further, 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 or other indices later this year. We also still have over $140 million in consumer CDs with weighted average rates above 2% set to mature by the end of the third quarter. Given the first quarter's margin, current rates, and ongoing refi activity, we're revising our margin outlook for the full year to 245 to 255. Turning to slide eight, first quarter non-interest income came in at 95 million, up over 11% from the fourth quarter, reflecting the positive side of the mortgage refinance wave expanding fee-based revenues and strong capital markets activity. As can be seen on the right side of this slide, mortgage banking income was up $9 million quarter over quarter as we recovered much of the MSR valuation we wrote down last year in the declining rate environment. We anticipate Q2 21 will reflect continued strength in mortgage banking income, but we expect this activity to moderate as we move later into the year. Capital markets fees came in at $8 million, an increase of 38% quarter over quarter, reflecting an active syndications and risk management market. Wealth management fees also increased slightly for the first quarter, buoyed by strong equity markets. We note that the sale of Whitnell closed on March 1st, and we still ended the quarter with over $12.5 billion of assets under management, a more than 20% year-over-year growth rate. As a further positive, we've seen increasing card activity and purchase levels throughout our customer base, including record credit and debit card spend in the month of March. We also recorded gains on the sale of Whitnell to Rockefeller, the further disposition of branches during the quarter, and other investments which totaled nearly $6 million. Given the above, we are updating and increasing our full-year fee income outlook by $30 million to reflect non-interest income expectations of $310 million to $330 million in 2021. On slide nine, we highlight our expenses. The first quarter came in at $175 million, a slight increase from the fourth quarter. Personnel expenses rose by $6 million for the quarter, driven by increased compensation and incentives, higher mortgage commission expense, and the addition of the team we've brought in to support our new indirect auto lending initiative. As a partial offset, other core expenses continued to trend lower, driven by a reduction of expense following the sale of Whitnell and an additional branch sale that closed during the quarter. After combining the added expenses tied to compensation and incentives, mortgage commissions, and the indirect auto initiative, we're revising our initial full year 21 expense outlook from approximately 675 to between 690 and 695 million. The allowance update is shown on slide 10. We utilize the Moody's March 2021 baseline forecast for our CECL forward looking assumptions. The Moody's baseline forecast assumes additional stimulus, a continuing low rate environment, and widely available and effective COVID vaccines. Following a net reserve release of 11 million in the fourth quarter, we posted a further net reserve release of an additional 28 million in the first quarter of 21. This net release was driven by gross reductions in our allowance for all of our core business units with a $15 million gross reduction in our allowance related to our general commercial and business lending portfolio, a $9 million reduction in our CRE allowance, and a $4 million reduction in retail lending. As of March 31, our total allowance was $404 million, down from $431 million in the prior quarter. Similarly, our ratio of reserves to loans declined to 1.67% from 1.76% during the quarter. We expect the allowance to loans to drop back down to approximately Cecil day one levels by the end of 2021. Our quarterly credit trends are presented on slide 11. Potential problem loans, non-accrual loans, and net charge-offs all declined during the quarter. Our key COVID commercial exposures also continued to decline, notably oil and gas, retail and restaurant exposures all declined during the quarter. After peaking at $1.6 billion in the second quarter of 20, our quarterly active loan deferrals have continued to decline and fell to a total of just $37 million across all our core business units in the first quarter. Total deferrals now make up just 15 basis points of total loans a quarter end. We've continued to see positive trends here, very pleased with where we've ended. Most customers who received deferrals have not needed additional assistance and have been able to resume making normal payments. Assuming the positive credit dynamics continue, we would expect a very nominal net provision for the year. As shown on slide 12, our regulatory capital levels remain strong. Our common equity tier one ratio increased 31 basis points from the fourth quarter and has grown 140 basis points from the first quarter of 20. as we conserved capital in light of economic uncertainty. We'll continue to target TCE levels at or above 7.5% and CET1 at or above 9.5%. And so on slide 13, we recap our updated guidance for 21. We're revising our net interest margin guidance down to reflect the ongoing prepayment dynamics to reflect a full-year margin of approximately 2.45% to 2.55%. We're revising our non-interest income guidance up by 30 million, reflecting our positive fee income trends. We now expect the full year to come in between 310 million and 330 million. We expect this additional strength in our fee businesses to outpace the downward pressure on the margin. We're revising our expense guidance upward to approximately 690 to 695 million, driven by additional incentive and compensation expense, additional mortgage commissions, and additional personnel expense to support our new indirect auto initiative. Given the credit trends we continue to see, and assuming the economy continues to perform positively as we generally expect, we now believe the 21 full-year provision will be very nominal. Finally, given higher levels of profitability, we expect our annual tax rate to normalize in the 19 to 21 percent range, assuming no change in the corporate tax rate. 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 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, as we pull for questions. Our first question comes from the line of Scott Cyphers with Piper Sandler. Please proceed with your question.