Associated Banc-Corp

Good afternoon everyone and welcome to Associated Bank Corp's second quarter 2022 earnings conference call. My name is Alex 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's 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's 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 a reconciliation of the non-GAAP financial measures to the GAAP financial measures mentioned in this conference call, please refer to pages 23 and 24 of the slide presentation and to page 10 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 Andy Harmoning, President and CEO, for opening remarks. Please go ahead, sir.

Well, good afternoon, everyone, and welcome to our second quarter earnings call. I'm Andy Harmoning, and I'm joined here today by Chris Niles, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. I'd like to start things off by reflecting upon my first full year, sharing highlights for the quarter, and providing a quick update on our strategic initiatives. Chris will walk through an update on our funding and margins, statement trends, and capital. And then Pat will follow up with an update on trends. So last fall, we announced a new digital forward growth-focused strategic plan built on Associated Bank's foundation of strong credit and expense management. Our strategic plan is already well into the execution phase, and we are driving significant positive core operating leverage, improving our RODSI, and transforming our systems to more efficiently serve our customers over time. Our plan called for us to grow middle market lending. And as you'll see, we've significantly grown and deepened our core existing middle market and small business relationships. Our plan called for us to expand our lending capabilities by adding higher yielding asset classes in asset-based lending, equipment finance, and auto finance. All three of these verticals are now driving growth. And our plan called for us to shift investment dollars from brick and mortar assets to digital platforms. And we expect the first of these digital updates to be rolled out to our customers later this quarter. But let me be clear. While we're excited to see these investments in growth and digital come to life, we are also committed to sticking with the foundational principles that got us here. Our disciplined approach to credit and expense management. Taken together, after a full four quarters on the job, I'm even more impressed with the quality of the team and more convinced that we're on track to deliver higher revenue growth, continued positive operating leverage, and improving value for our stakeholders. Now, turning to the current environment in the most recent quarter. While the macroeconomic environment has shifted over the past year, here in our markets, we've continued to see signs of strength. Unemployment levels remain at near all-time lows in Wisconsin and Minnesota. Our business customers remain upbeat in their outlooks, and our core consumer households are proving financially resilient. On the commercial side, we hinted at improving commercial activity and upward line utilization trends back in the spring, and that activity continued to ramp up throughout the quarter. By June, line utilization reverted to pre-pandemic levels as our customers continue to grow and expand. On the consumer front, we saw steady activity as households purchased homes, put their home equity to work, and purchased autos, all while keeping steady deposit balances. These trends complemented by our selective additions of new RMs and our continued expansion of our initiative verticals contributed to one of the strongest loan growth quarters in our company's history. And importantly, we accomplish this while growing point-to-point deposits and seeing further improvements in credit. We see this as a testament to the stability and resilience of our customers and markets, but it's also a clear indication that our initiatives are having an impact. Looking ahead, there is no denying that there are significant question marks remaining in the economy. The continuing war in Ukraine, COVID lockdowns in China, Inflation and supply chain disruptions, they all pose risks. But our customer base remains strong, and we feel that we're very well positioned to support them with an expanding variety of products and services without stretching on credit. Our optimism stems from the fact that we are growing in our core markets with our core customers and are comfortable with our credit, capital, and liquidity outlook as we look to the back half of the year. With that, let me touch on a few highlights outlined on slide two. Our second quarter results reflected robust loan growth, expanding margins, stable deposits, and resilient credit trends. Through a combination of normalizing business trends, a ramp-up of our initiatives, and generally rising rates, our revenues increased 15% year-over-year, while expenses were held to just 4% year-over-year. This drove a significant improvement in pre-tax, pre-provision income and another quarter of 13% plus returns on tangible common equity. We also continue to see improving credit dynamics throughout our portfolios. In fact, we had less than one basis point of net charge-offs for the quarter. We also resolved several non-performing asset situations and saw significant declines in non-accrual asset levels throughout the quarter. Together, these improving credit factors allowed us to absorb this quarter's loan growth with zero net loan provision. Now, let me give some more color around our commercial loan dynamics. Shifting to slide three. As we move past the halfway point in 2022, the uptick in line utilization has clearly been a driver of our balances. On the left side, our PPP runoff has been more than offset by new activity and line uptick, Fueled by general commercial originations, CRE expansion, and growth from our new verticals, average total commercial balances have grown strongly over the past quarter. And line utilization has now reverted to pre-pandemic historical levels. Turning to slide four. While we are pleased with the rebound we've seen on the commercial side, we're also pleased to report growth in nearly every vertical. The chart on the right-hand side shows this diversified growth. While general commercial led the growth for the quarter, we also added significant balances in consumer, commercial real estate, and specialized portfolios. And as you can see, we have broad-based growth reflecting the strength of our franchise and the diversifying impact of our strategic initiatives. Based on the robust trends we've just discussed, we're revising our full-year loan targets targets higher on slide five. Given the continued strength in our markets, we now expect to end the year with approximately $17 billion of outstanding core commercial loan balances. This outlook includes expected further moderation in our mortgage warehouse portfolio runoff and the runoff of our remaining PPP book. We continue to drive progress in our new ABL and equipment finance verticals, with both teams adding new, high-quality balances to our books. We remain confident in the team's ability to hit the $300 million combined target we've set for the end of the year. Taken together, we expect our total commercial book to end the year at approximately $17.3 billion. Now, turning to consumer lending, we continue to be impressed with our auto team's ability to drive high-quality balances that help diversify our loan book. And while this team is relatively new to Associated, they've been doing this for decades in a variety of economic environments without sacrificing on quality. This makes the team a great fit for us from a risk mindset and cultural perspective, and we're confident we're on track to hit our year-end targets. We also continue to expect residential mortgage balances to remain relatively stable through the end of the year. So to summarize, The growth we saw in the second quarter was driven by the resilience of our core customers and the disciplined execution of our strategic plan and investments. Our results provide us optionality to pursue high-quality, risk-aware lending across a diversified set of business lines without the need to stretch on credit in the current environment. On slide six, we show a five-quarter trend of our PTPP income. A year ago, we drew a line in the sand and stated that $78 million was a baseline that we would improve upon. PTPP income has consistently performed above that level in each subsequent quarter, and we remain on track to deliver strong, positive operating leverage throughout the remainder of 2022. So let me pause there. I'm going to hand it over to Chris Niles, our Chief Financial Officer, to provide a little more detail on our funding, revenue, and income statement trends for the quarter.

Chris? Thanks, Andy. Turning to slide seven, we recognize that having access to core customer deposits and other low-cost funding sources is more important than ever, particularly as we look to fund growth on the asset side of the balance sheet. That's why we've taken meaningful steps in recent years to grow our core customer deposit base while reducing our reliance on higher-cost wholesale funding sources. As we sit here today, we've started this rate cycle from a much better funding position than where we were in 2016. We expect to hold wholesale funding to approximately 15% of total funding going forward. Despite recent macro volatility, our core deposit customers have remained resilient. While we typically would expect to see deposit outflows in the first half of the calendar year, we've actually seen modest net deposit growth versus the prior quarter and year end. And our consumer and commercial mix has remained stable, reflecting consistent balances by business segments over the last several quarters. Our consistent growth in low cost deposit categories has resulted in a franchise with deposit costs well below pure medians. Given our profile, we feel well positioned to control our deposit betas going forward. Slide eight highlights our asset sensitivity and our ability to manage funding costs in a rising rate cycle. Year to date, we've seen a significant uptick in the average yields of most of our earning asset categories. Since the fourth quarter of last year, earning asset yields have increased by 38 basis points on average, or roughly 55% of the increase we've seen in average fed funds over the same period. Our assets are fundamentally positioned to participate with further rate increases. On the liability side, year-to-date interest earning liability costs have only increased by nine basis points, or roughly 13% of the move in average Fed funds. This reflects our ability to lag funding costs as rates rise and to capture margin in higher rate level environments. This widening gap between rapidly rising asset yields and more moderately increasing liability costs is the core benefit of our structural asset-sensitive profile. Slide 9 highlights the resulting NIM expansion that comes from this structural asset sensitivity and the related growth in net interest income that is derived from that profile. Our net interest margin expanded from 2.5% in the month of March to 2.78% for the month of June, consistent with our quarterly expansion of 29 basis points in the average On a dollar NII basis, our growth and structural asset sensitivity provided a $28 million lift to revenue in the quarter. Moving on to slide 10, we've laid out several of the factors that give us confidence that we're well positioned for the cycle ahead. First, as demonstrated during the second quarter, Associated is more asset sensitive today than we were heading into the last cycle. roughly 90% of our commercial portfolio will reprice or reset within the year, which boosts our one-year cumulative repricing gap. Second, as previously mentioned, we work to improve the mix of low-cost core customer funding to liabilities. Since 2016, low-cost deposits have grown from less than half to more than two-thirds of our total deposits. This has also contributed to our increasing asset-sensitive profile. We would also like to highlight that associated benefits from a highly granular deposit base relative to our peers. This reflects our emphasis on building stable, sticky household and small business relationships throughout our footprint. Bottom line, we are structurally in a better place today than we were in the last cycle, and we're confident that we're operating from a position of strength as we head into back half of this year. We now expect the Fed to raise short-term rates by 75 basis points at the July FOMC meeting and potentially an additional 25 basis points at each remaining FOMC meeting later this year. Based on these assumptions and our loan growth expectations, we now expect our full-year net interest income to exceed $890 million. Turning to slide 11, we've highlighted some non-interest income trends. While fee income continues to be a headwind for the industry, we actually saw modest net growth versus the prior quarter and the same period last year. In Q2, increases in card-based fees and other fee-based revenues partially offset the anticipated reductions in mortgage banking and wealth management fees. I'll remind you that we expect to see fee income moderate beginning in the third quarter based on the implementation of the new ODNSF changes we announced last quarter. We also expect commercial deposit account fees to move slightly lower as higher rates translate into higher ECRs. With the expectation for continued rise in rates, we also see mortgage banking revenue further moderating as we move through the back half of the year. Nonetheless, we remain confident in our most recent full-year non-interest income guidance and continue to expect total non-interest income of between $290 and $300 million in 2022. Moving on to slide 12, second quarter expenses came in at $181 million. This represents a 4% year-over-year increase in expenses consistent with our prior guidance. Driven by higher revenues and controlled expenses, our efficiency ratio continues to improve. As I stated previously, we expect to continue to scale up investments in people and technology but remain committed to keeping expense growth below revenue growth. Taking all of our initiatives into consideration, we are tightening our expense guidance for the full year. We now expect full year 2022 non-ish expense to come in between $730 million and $740 million, which is within our prior range. Moving on to capital, slide 13, we manage capital levels towards the lower end of our range as we supported customer loan growth during the quarter. Nonetheless, given our enhanced profitability trends, we fully expect TCE will grow through year end, and we will end the year in the seven and a quarter to seven and a half range. We also expect CET1 will end the year between nine and a quarter and 975. Now let me turn it over to Chief Credit Officer Pat Ahern to provide an update on credit.