Associated Banc-Corp

Good afternoon, everyone, and welcome to Associated Bank Corp's third quarter 2022 earnings conference call. My name is Kevin, and I'll 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 we'll be referencing 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 risk 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 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 21 and 22 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, thank you, and good afternoon, everyone. Welcome to our third quarter earnings call. I'm Andy Harmoning, and I'm joined here today by Derek Meyer, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. I'd like to start things off by sharing a few highlights from the quarter and providing a quick update on our strategic initiatives. From there, Derek will walk through the update on margins, income statement trends, and capital, and then Pat will round us out with an update on credit. In the past 18 months since I've joined Associated Bank, we have been building a digital forward growth-focused strategic path for the company that also plays to our foundational strengths. As we continue to execute against our plan, we've demonstrated an ability to drive positive operating leverage. improve our ROTC, and serve our customers more efficiently and effectively. We've seen promising momentum on several fronts. Since March of 21, we've expanded our commercial RM team by 33%. These high-quality additions have helped us drive added loan volume in focused markets like Milwaukee and Chicago, but they're also helping us drive a full banking relationship that includes deposits and services such as treasury management. We've added over $1 billion in high quality auto loans under our prime super prime strategy, and we have consistent growth in our new asset-based lending and equipment finance verticals, giving us additional leverage to drive balanced loan growth. And last month, we officially launched the most significant digital upgrade in our company's history with our new digital platform. This represents a big step forward for our customer experience, but in many ways, we're just getting started here. We expect to make regular upgrades going forward with the first enhancements on track for implementation by year end, in fact, by the end of this month, empowering us to further expand capabilities and deepen relationships with our customers. We're pleased with the momentum we've seen so far, and we're equally committed as ever to maintaining our discipline around credit quality and expense management. These foundational strengths have been developed over the course of a decade, and will continue to serve as our foundation as we look to deliver enhanced value for all of our stakeholders. Turning to the current environment, we have experienced the strength and resilience in our core Midwestern markets. While unemployment rates have ticked up slightly in recent months, states like Wisconsin and Minnesota remain well below the national average. The consumer remains healthy while our business customers continue to pursue growth and expansion opportunities with an increasing awareness of the uncertain macro environment. Last quarter, we talked about commercial line utilization trends normalizing for the first time in over two years. This trend has continued in the fall, and our customers are actually running slightly above historical average as they continue to grow and expand. On the consumer front, the housing market has cooled due to high interest rates, but this environment has allowed us to retain more mortgages on our balance sheet. We've also seen steady activity in our home equity and auto portfolios, but despite this steady consumer borrowing activity and healthy consumer spending, our consumer deposit balances grew again during the quarter. Taken together with the implementation of our initiatives, these trends have allowed us to enjoy another strong quarter here in Q3. We view this as both a reflection of the health and stability of our core markets as well as a sign that our initiatives are resonating in these core markets. As we look towards the remainder of the year in 2023, significant macroeconomic and geopolitical question marks remain, but we've put ourselves in a good position to support our customers and drive our stakeholders without stretching to take additional risk. With that, I'd like to highlight a few items outlined on slide two. Our third quarter results reflected strong loan and deposit growth, expanding margins and stable credit. Amid the continued strength in our markets, the execution of our initiatives and the impact of rising rates on our asset sensitive balance sheet, our total net interest income increased 22% from the prior quarter and 44% year over year. Total revenue growth outpaced expense growth by a wide margin. allowing us to deliver positive operating leverage and returns on tangible common equity north of 14% for the quarter. As mentioned, we also continue to see stability on the credit side. We saw just three basis points of net charge-offs in Q3. We did add to our loan loss provision during the quarter, but this was largely driven by the significant loan volume. as evidenced by our ACLL ratio, which held firm at 1.2% quarter over quarter. Now, let me give a little bit more color on our loan dynamics. Slide three helps us underscore the broad-based diversified nature of the loan growth story in 2022. As was the case in Q2, we reported growth in nearly every major loan vertical here in the third quarter. Residential mortgage led the way as we retained more loans on our balance sheet in the rising rate environment. But we also posted significant growth in several buckets within our core CRE, consumer, and commercial lines of business. This broad-based growth reflects the strength of our franchise, but it also highlights the diversifying nature of our initiatives. This gives us additional levers to pull when we need to drive balanced, diversified growth across the portfolio over time. without feeling like we need to stretch on credit in any area. As we move to slide four, we've been able to make significant progress against our initiative loan targets in 2022. In fact, as of September 30th, we've already passed our year-end target for core commercial loan growth and are well on track to either meet or exceed targets we set for our new ABL, equipment finance, and auto verticals. With respect to core commercial, the growth of our RM base, normalization of line utilization trends, and strong loan demand have combined to more than offset the moderation we expected from PPP and mortgage warehouse throughout the year, allowing us to surpass our year-end target by September. While we do not expect to maintain this pace of growth in Q4, pipelines do remain healthy, and we do expect to see some growth continue into the year-end. Our new ABL and equipment finance verticals have also gained momentum throughout the year, as each team is fully staffed and continues to develop their respective plans. We remain confident in our ability to hit the $300 million combined target we set for the end of the year. Turning to consumer lending, the auto team has continued to produce very high-quality loans that help diversify our consumer book. As I mentioned last quarter, this team joined Associated a little over a year ago, but they are by no means new to the auto industry. They have decades of experience in a prime, super prime strategy in a variety of environments. And I'm confident the team's ability to hit their $1.4 billion target by year end, but I'm just as confident that they're going to get there responsibly without stretching on credit. We also continue to expect residential mortgage balances to remain relatively stable through the end of the year. As I've stated, the loan growth we've seen in 2022 has been driven by the resilience of our core customers and disciplined execution of our strategic plan. This gives us a stronger balance sheet in the short term, but it also gives us more flexibility to pursue high-quality lending opportunities across a spectrum of business units over the long term without abandoning the credit discipline we've established over the past 12 years. Now, turning to slide five, we highlight our deposit trends for the third quarter. Despite inflation and increased competition in the market, we were pleased to see our deposits grew at an almost 9% annualized rate versus the prior quarter. This deposit growth has not come by accident. In fact, it's been driven by several strategic actions we've taken over time to set ourselves up for success. First, we've cultivated a low-cost granular deposit over time by focusing on deepening relationships with customers in our markets. This has led to a high degree of resilience and stability in our base and has limited our post-COVID surge outflows to date. Second, while I've been pleased with the loan growth we've seen from our strategic initiatives, the core focus of these initiatives has always been to attract and deepen holistic relationships. On the commercial side in particular, our efforts to grow our relationship manager base and move to a balanced scorecard model have already resulted in significant deposit inflows here in the fall. And third, while much of the growth thus far has been on the commercial side, we also have several consumer-focused strategies already in flight that are expected to bolster our deposit-gathering efforts going into 2023. Examples include our new mass affluence strategy targeting a high-potential segment of customers with up to 1 million in investable assets, and our new digital platform, which will fill a gap, allowing us to increase acquisition, retention, and deepening across consumer and business banking. We recognize that generating low-cost funding is more crucial now than ever, particularly as we look to fund our growth strategies on the lending side. Based on initiatives in flight, we feel confident in our ability to fund the bank at a reasonable cost in 2023 and beyond. On slide six, We show a five-quarter trend of our PTPP. As you can see, our strong revenue trends and diligent management of expenses have combined to deliver operating, significant operating leverage growth in 2022. We remain on track to deliver positive operating leverage in the final quarter of 2022 as well. So let me pause there. I'm going to hand it over to Derek Meyer, our Chief Financial Officer, to provide further detail on our margin, revenue, and income statement trends for the quarter. Derek?

Thanks, Andy. Slide seven highlights our asset sensitivity and our ability to manage funding costs in the current rising rate cycle. On the asset side, average earning asset yields have increased significantly in most key categories over the course of the year. Through September, earning asset yields have increased by 113 basis points, or roughly 38% of the increase we've seen in Fed funds target rate over the same period, reflecting our core asset sensitivity. On the liability side, Year-to-date interest-bearing liability costs have now increased by 54 basis points, or roughly 18% of the move in Fed funds target. We continue to lag on funding costs that raised rise and continue to see our margin expand accordingly throughout the year. Slide eight helps us to quantify the acceleration in margin expansion we've seen in recent quarters as a result of recent loan growth and our structural asset sensitivity. Here in Q3, our net interest margin expanded by 42 basis points versus the prior quarter, and on an NII basis, this expansion equated to a $48 million lift to revenue for the quarter. As we get into the home stretch of 2022, we now expect short-term interest rates to rise by 75 basis points following the Federal Open Market Committee meeting in November, and expect a 50 basis point increase following the FOMC's December meeting. Based on these assumptions, we now expect our net 2022 net interest income to exceed $935 million. Moving to slide nine, we've recently discussed several factors that have positioned us to benefit from the current rising rate environment. These factors include our sizable portfolio of variable rate loans, our reduced reliance on wholesale network funding, and our ability to lag on deposit betas due to our low-cost granular deposit base. We expect to continue benefiting from these dynamics in the near term. With that said, we also recognize that the macroeconomic forecast carries significant uncertainty as we look into 2023 and beyond. In order to start managing through this uncertainty and begin reducing our interest rate risk, we executed 850 million of interest rate swaps this quarter. While we don't expect to determine when interest rates will peak, we do expect to take modest steps over time to continue managing our downside interest rate risk. Shifting to slide 10, non-interest income remains pressured by the mortgage banking and service charge headwinds we've discussed previously. In the third quarter, modest increases in card-based fees and other fee-based revenues partially offset reductions in mortgage banking, service charges, and wealth management fees. As a reminder, we expect to see deposit account fee income moderate beginning in the third quarter based on the implementation of the ODNSF changes we announced earlier this year. Also, driven by rising rates, mortgage banking revenue continued to moderate during the third quarter. Six million of our Q3 non-interest income was driven by an investment securities gain that allowed us to make a contribution to our charitable foundation as we helped strengthen the communities we serve. Moving to slide 11, third quarter expenses came in at $196 million, with $6 million of the expense driven by the contribution to our charitable foundation. Year to date, expenses have grown by 4% versus the first nine months of 2021, consistent with our prior guidance. We've continued to scale up investments in people and technology, but remain committed to keeping expense growth below revenue growth. Elsewhere, our efficiency ratio continued to improve in the third quarter. On an FTE basis, we've now decreased our efficiency ratio by approximately 480 basis points as compared to the same period last year, which reflects our ability to maintain expense discipline while driving higher revenues. We now expect total non-interest expense of approximately $740 to $750 million for 2022. Moving to slide 12, capital levels have been managed near the lower end of our range as we continue to support customer loan growth. Nonetheless, we remain comfortable with our capital levels given our enhanced profitability profile in 2022. Given current market conditions and the expectation for short-term rates to remain elevated in Q4, we now expect TCE to end the year in the 7 to 7.25% range. We continue to expect CET1 to end the year between 9.25 and 9.75. I'll now hand it over to our Chief Credit Officer, Pat Ahern, to provide an update on credit quality.