Associated Banc-Corp Q4 FY2023 Earnings Call

Good afternoon, everyone, and welcome to Associated Banc-Corp's Fourth Quarter 2023 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 1, 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 29 through 31 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 Andy Harmening, President and CEO, for opening remarks. Please go ahead, sir.

Good afternoon, everyone, and welcome to our fourth quarter earnings call. I'm Andy Harmening, and I'm joined by Derek Meyer, our Chief Financial Officer, and Pat Ahern, our Chief Credit Officer. I'll begin with some highlights from the fourth quarter and the entire year of 2023. After that, Derek will provide an update on margin, income statement, and capital trends, followed by Pat who will discuss credit quality. It's clear that 2023 was a remarkable year for regional banks. We faced rapid interest rate hikes, credit concerns, and multiple bank failures, which created uncertainty in the first half of the year. At Associated, we were affected by the volatility that impacted the regional banking sector, but we successfully navigated these challenges through decisive actions that improved our liquidity and ensured transparent communication with our customers. Importantly, we maintained a forward-looking approach, allowing us to adapt quickly and keep up the momentum with our strategic plan. Throughout the year, we achieved several significant milestones in our Phase 1 initiatives, reaching nearly $700 million in combined balances in our asset-based lending and equipment finance sectors. We surpassed $2 billion in outstanding loans in our prime, super-prime auto book and expanded operations within our existing markets. We launched a new brand campaign, made various product enhancements, and improved our digital sales capabilities, resulting in a 19% increase in consumer checking household acquisition and a 7% decrease in attrition. We continued to excel in the digital space by launching 11 major platform upgrades and achieving the highest consumer digital customer satisfaction scores in three years. We maintained strong momentum in the mass affluent sector, adding over $730 million in net new deposits since the end of 2022. All these efforts contributed to a more than 3% growth in our core customer base in the latter half of 2023, with growth in both consumer and commercial segments. To build on this progress, we announced a comprehensive second phase of our strategic plan in November, focusing on expense control, organic growth, and balance sheet repositioning at the same time. The expense reductions and repositioning were finalized in the fourth quarter. We have already filled several leadership positions with top industry talent, and our hiring is ahead of schedule. In summary, we are on track. As we consider the ongoing macroeconomic questions regarding the economy, credit, and geopolitical factors, we're optimistic about our local markets, where unemployment rates in Wisconsin, Minnesota, and several other Midwestern states remain below the national average of 3.7%. We have confidence in our Associated Bank team, who consistently deliver best-in-class service while introducing innovative ideas. We're also confident in our strategic plan, which promotes growth and diversification to enhance our profitability while maintaining our foundational commitment to disciplined credit and expense management. With these factors aligned, we are well-positioned to provide increased value to all stakeholders in 2024 and beyond. Now, I would like to highlight some key points from the fourth quarter and the full year of 2023, starting with Page 2.

Thanks, Andy. I'll start with our asset and liability rate trends through the year-end on Slide 12. While Fed funds rates stabilized in the back half of 2023, our total asset yields have continued to rise due to our remixing loan book and the repricing nature of a large segment of commercial loans. Since the fourth quarter of 2021, total earning assets have increased by 292 basis points or roughly 56% of the increase in Fed funds target rate over the same period. This trend has been led by rising yields in commercial, CRE and auto, respectively. On the liability side, it's no secret that rising rates, liquidity pressures and a mix shift in customer deposits combined to create significant funding cost pressure for the industry in the first half of 2023. In the back half of the year, however, these trends stabilized meaningfully at Associated. In aggregate, our interest-bearing liability costs have now increased by 328 basis points since the fourth quarter of 2021 or roughly 62% of the move in Fed funds target. Our interest-bearing deposit beta has now climbed to roughly 59% since the start of the rate cycle. On the left side of Slide 13, you can see clear evidence of this stabilization pattern in our net interest income and net interest margin trends. Our NIM decreased by 27 basis points in Q2, 9 basis points in Q3, and only 2 basis points here in Q4. On a dollar basis, our Q4 NII was essentially flat, decreasing by less than $1 million during the quarter. While it's true that this flattening effect was a function of the stabilization I described previously, we also received partial benefit from the balance sheet repositioning we announced during Q4. Because the sale of mortgage loans did not officially settle until late December, the benefit we saw was primarily driven by the securities sale and reinvestment that settled in November. Assuming both transactions were completed at the beginning of Q4, this would have represented approximately 11 basis points of incremental lift to our NIM during the quarter. We expect the full impact of our balance sheet repositioning to take hold here in the first quarter.

Thanks, Derek. I'd like to start with an allowance update on Slide 18. We've utilized the Moody's November 2023 baseline forecast for our CECL forward-looking assumptions. The Moody's baseline forecast remains consistent with a resilient economy despite the high interest rate environment. The baseline forecast contains no additional rate hikes, slower but positive GDP growth rates, a cooling labor market and continued deceleration of inflation. Our ACLL increased by $5 million during the quarter to $386 million. Our allowance continues to be driven by loan growth in select areas such as auto, nominal credit movement and general macroeconomic trends that reflect the stability of our Midwest footprint. As such, our reserves-to-loan ratio increased by 6 basis points versus the prior quarter and by 10 basis points versus the same period a year ago, landing at 1.32% in Q4.

I'll close out our formal presentation by reiterating a couple of key points from our presentation on Slide 21. First, our strategy is designed to drive quality, relationship-focused loan growth that decreases our reliance on lower yielding, non-relationship balances and enhances our profitability profile. Based on the expected benefits of our plan and the current macro outlook, we expect total loan growth of between 4% and 6% in 2024. On the other side of the balance sheet, the deposit environment is much more stable than it was just six months ago, but it remains competitive. Coming off two straight quarters of core deposit growth gives us confidence we're on the right track with our initiatives, and we expect to benefit further as Phase II initiatives ramp up. As such, we expect core customer deposit growth of 3% to 5% in 2024. Shifting to the income statement. We adjusted our most recent forecast for balance sheet growth, deposit betas and the rate environment. Our current forecast assumes 6 Fed rate cuts beginning in March. Taking all these factors into account, we now expect to deliver net interest income growth of between 2% and 4% in 2024. And lastly, our disciplined approach to expenses remains a foundational focus for our company. While we'll continue to seek smart investments for organizational growth, we will look to offset those costs where possible by shifting dollars from underperforming areas. Taken together with current marketing conditions, we expect noninterest expense growth of 2% to 3% in 2024. With that, let's open it up for questions.

Thank you. And at this time, we will conduct a question-and-answer session. Our first question comes from Daniel Tamayo with Raymond James. Please state your question.

Thank you. Good afternoon, everybody. Maybe just starting with a clarification on the margin guidance, first. When you say you're not calling a bottom on the NIM, but it could move down slightly. I'm assuming you're taking into account the 11 basis point benefit of the restructuring in like a pro forma NIM before that? Or are you talking about on an absolute basis?

Let me start that off, and I'll have Derek finish that. Daniel, what we're saying is the core underlying business outside of the inorganic action is pretty close to bottom. Could it go down 1 basis point or 2 basis points? Perhaps. But we're pretty darn close. We don't see a lot of volatility in the underlying margin. On top of that, we expect to see the full force of the increase that we outlined from the inorganic actions starting in Q1. And then based on what we're doing on our production and balance sheet, we expect to have a positive trend throughout the year.

Yes, I think that's right. And you're right, we're talking about looking at our start point levels at the pro forma 279.

Okay. I just wanted to make sure. Please go ahead.

No, just following up on the NIM guidance. You've got six rate cuts in there. Wondering if you can kind of frame for us what that looks like either on a per cut basis or if it was going to be more in line with the Fed's guidance of three cuts in the back half of the year, how that would impact the guidance?

I appreciate that. For my second question, I wanted to take a broader view. Andy, since you joined Associated, you've implemented significant changes. Given the uncertainty ahead, I’m curious if you have any profitability targets or guiding principles that you can share as the bank navigates these transformations.

Daniel, I just want to say we expect profit to go up, and I was going to stop after that. But in all seriousness, what I would say is the plans that we've put together, when you expand your lending verticals, when you expand your product offering, when you modernize your digital platform and decrease your attrition, when you see a turning point on household growth, when you start deepening customer segments on the deposit side, the reason that we think that we have an opportunity is because we've put in the work in Phase I. Phase II is simply extending what we've done in the past. So when we extend on the commercial side, the pieces that we've had, when we extend on the marketing side to the platforms that we already have, with a company that has a large wholesale reliance on the funding side, we can either replace that or fund the loan growth we have. Either way, that leads to increased profitability. So what I would say is I don't have a specific number outside of the guidance we've just now given, but we feel very good about achieving the guidance that we've given.

Terrific. Thank you for all the color.

Good afternoon, everyone. Thank you for your question. Derek, I want to be as clear as possible regarding the margin. Should we expect the margin to increase from this point?

Yes.

Okay, good. And the starting point for sort of the core at this point is like the 279 and we get some additional benefit due to the full-quarter impact of the restructuring, is that a good way to frame it?

Yes. So just to connect the dots, we expected about a 16 basis point improvement, right? We ended up getting about five of it this quarter. We got another 11 to go, and so any other movement in NIM is the underlying BAU. And I think that's what Andy is trying to get out about what they were calling the bottom. But on a reported basis, we expect to go up.

Yes. I don't mean to sound repetitive, but our focus is on loans and deposits. If we face a significant challenge in the deposit market, it could pose an issue. However, I'm confident moving into 2024 because of the second half of 2023, where despite market challenges, we experienced a growth rate of 3% over six months. While rising funding costs can create challenges, we don't currently see that as a trend. Additionally, we stress to our team the importance of having strong commercial bankers. We have a skilled team and have successfully attracted talent over the past two years. We're also retaining capable individuals from prior years. When we add 10 bankers in a short span, we are bringing on high-quality professionals. It takes about 90 days for them to ramp up, followed by acceleration over six, nine, to twelve months. Therefore, the key question is how quickly we can onboard quality bankers, and so far, our progress has been quite swift.

Perfect. Okay. Good. Thank you very much.

Hi. Good evening, everybody. Maybe just start with an expense question. Could you maybe just talk about the trajectory of quarterly expenses in 2024, given kind of some of the hiring plans and initiatives throughout the year?

Terry, this is Derek. Our current forecast indicates that expenses will remain relatively flat for most quarters this year. This suggests a slight reduction from the core fourth quarter, followed by stability going forward. Our hiring plans began this quarter, and we have been pleased with the speed and interest we've observed, so we don't intend to slow this down. Additionally, we are examining other areas where we can manage discretionary expenses to ensure we maintain a balanced approach. There isn't an expectation for a significant spike, as we are aware of how we want to conclude the year in terms of performance and are also preparing for 2025.

And then the company has aggressive deposit growth goals this year versus peers, and Andy just ran through what gives you guys the confidence. Derek, I guess, for you, how are you modeling deposit betas? Where do you think they'll peak? And if the forward curve is correct and we get the rate cuts, how are you thinking about betas on the way down?

Yes. We anticipate that they will reach their peak at the end of the first quarter, around 61% to 62%. There are various ways to analyze them, but if the betas begin to decrease, we are likely looking at a range of 45% to 55%. The difficulty, as you know, is determining how long after the last rate hike—hopefully, we've already experienced this—competitors will maintain high rates before they start to reduce them.

Thanks. Good afternoon.

Hi, Jon.

Hi, Jon.

Quick question on loan growth drivers, that Slide 10 that you lay out, I guess it could be 11 as well. But what do you think that looks like in a year? Where are you seeing the opportunities to generate that kind of loan growth?

We expect modest growth in commercial real estate and are aware of the current market conditions. If we bring in 20 to 25 new commercial bankers, we anticipate an increase in their productivity. For the year, we expect this to result in approximately a $0.25 billion increase compared to our current run rate. However, the actual run rate can be ambiguous. Last year, utilization was slightly down, and I believe we won’t see a repeat of that this year due to the ongoing dislocation in the regional banking market.

Okay. Fair enough.

Hi, good afternoon, everyone.

Hey, Brody.

I just wanted to ask a handful of questions on the NII. Derek, I just want to put a finer point on the beta commentary. Was that 45 to 55 what you expect to achieve by year-end 2024? Or is that more of a comment about where it will be over the next couple of years?

That's March to December of this year.

Got it. And then just last for me, you mentioned this briefly in your prepared comments, but maybe can you just talk to the cadence of office paydowns in '24?

We observed a positive trend in office paydowns in 2023, with about half of our deals involving payoffs as they matured at the end of the year. I anticipate that this trend will continue, although it will vary on a case-by-case basis. For the first half of 2024, roughly 40% of the identified cases are expected to either refinance or sell, which is the strategy we have implemented.