Q3 2020 Associated Banc-Corp Earnings Call
2020, <unk> earnings Conference call. My name is Diego and I will be your operator today.
This time all participants are in a listen only mode, we'll 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 Dot associated back Dotcom 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.
Dictation beliefs or similar forward looking statements associated actual results could differ materially from the results anticipated or projected any forward looking statements.
Additional detailed information concerning the important factors that could cause associated <unk> actual results to differ materially from the information discussed today is readily available obviously see website in the risk factor section of associate its 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 21, and 22 of the slide presentation. That's a pages 10, and 11 of the press release financial tables.
Following todays 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 and welcome to our third quarter 2020 earnings call. Joining me today are Chris Niles, Our Chief Financial Officer, and Patti Hart, Our Chief Credit Officer.
It goes without saying that this has been a challenging an unusual year.
We pivoted in March in response to the pandemic and I've been retooling our delivery channels since the best meet our customers needs we didn't.
We deployed ourselves to seamlessly interact through virtual channels, and I've seen an accelerating shift to mobile and online banking.
With a likely very low interest rate environment, they've seen us for an extended period. It became critical to respond in areas we can control.
Let's start with the actions we took during the third quarter.
On slide two we have detailed our optimization efforts and the restructuring of our securities and real estate lending subsidiaries.
During the third quarter, we announced the sale and planned consolidation of 22 of our branches.
We also announced the strategic streamlining up several corporate managerial and back office functions as it was.
As a result of these actions, we incurred $16 million a pre tax charges in Q3, but we expect these changes to drive a $40 million per year reduction in our run rate expenses.
As we move into this quarter and 2021.
We also deployed about half of our excess liquidity position to repay $950 million of FHLB advances.
This prepayment resulted in a $45 million Q3 pre tax expense. However, we expect this to improve annualized net interest income by $20 million beginning in Q4 2020, continuing through 21 with diminishing but continuing savings.
Through 22 and into 23.
Finally, we were able to unlock capital losses through the restructuring over securities and real estate lending subsidiaries and this resulted in a 49 million dollar after tax benefit during the quarter.
Turning to slide three we highlighted the impact of our Q3 initiatives on our pre tax pre provision income.
Adjusting for the 60 million of restructuring in prepayment costs third quarter, PT pp would have been $90 million.
On slide four we provide.
We've provided a walk forward of Aes, which breaks down the various initiatives executed during the quarter you'll.
You'll notice when tax affected the onetime costs of our efficiency initiatives were more than covered by the tax benefits, we realized from the reorganization of our subsidiaries.
You were to exclude both the restructuring charges and the tax benefits from our EPS for the third quarter. The adjusted 24 cent result is within two cents of our reported GAAP EPS of 26 cents. So in effect the items largely offset each other.
The actions this quarter, where net additive to our tangible book value.
Turning to slide five average loan balance trends are shown.
Total average loans came in at $25 billion down slightly from the prior quarter's average commercial.
Commercial real estate grew 312 million driven by the continuing funding of construction loans and at September Thirtyth, We still had 1.9 billion of unfunded commercial real estate commitments.
Commercial and business lending on the other hand declined by $271 million on average as our general commercial customers largely used their increased excess liquidity balances to paid out open lines of credit.
Turning to slide six we highlight changes in the end of period loan balances.
Period end loans were up 171 million or 1% for the quarter driven again by strong growth in commercial real estate lending, which was up 298 million.
Mortgage activity remains strong.
It was reflected in our elevated mortgage warehouse lending balances at quarter end.
Power and utilities lending along with commercial real estate construction and industrial loans have continued to grow throughout 2020.
I'll also call out well oil and gas, which declined nearly $100 million during Q3, and now represents only 1.3% of our total loan portfolio.
Consumer lending balances came down during the quarter, driven by refinancing activity and our decision to sell $70 million.
Prepayments susceptible mortgages.
Now, let me provide an update on our deferral programs on slide.
On slide seven you can.
You can see our commercial deferrals have continued to steadily decline.
As of October 19, we have a.
We have approximately 227 million of active commercial loan deferrals down 73% from Gen. Our.
Commercial deferrals have largely rolled off their initial 90 day terms and the remaining deferrals are primarily related to covert impacted portfolios.
Commercial real estate loan deferrals were 182 million of that to 27 and our.
And our primarily related to a hotel and retail borrowers.
Commercial and business lending referrals have declined to just 45 million at October 19th and they now comprise less than 1% of the commercial and business loans loan book take.
Taken together, the 227 million of active commercial and commercial real estate deferrals at October 19th make up about 1.4% of our total commercial loans outstanding.
Our consumer related covered relief efforts are highlighted on slide eight.
In the beginning of the pandemic, we granted deferrals to virtual any virtually any customers who asked for assistance.
Deferrals granted were for six months. So the bulk of those deferrals began to expire during September and.
At October 19, we had $269 million back to deferrals down 63% from Jim He's loan.
These loans now represent approximately 3% of outstanding consumer loan balances. It's important to note. However that of the remaining 269 million of acted deferrals 263 million of that is still on their first deferral period.
The bulk of those deferrals will expire during the balance of October and we expect most will not require additional assistance. So of those loans that have come off deferral in the consumer book at this point only $6 million have asked for additional assistance.
Among consumers who's deferrals of ended 97%, our current or less than 30 days past due the trends were seen as deferrals roll off continue to be positive we feel.
We feel confident many of these borrowers will go back to their pre cobot performance.
On slide nine we provided an allowance update.
We utilized the Moody's September 2020 baseline forecast for our C sold forward looking assumptions the base.
The baseline forecast assumes additional stimulus continuing low rates and a couple of vaccine that becomes widely available in Q2 of 21.
For Q3 of 20.
Our net allowance build was only $13 million down from $35 million in the prior quarter.
I'll direct you to the top right chart, where we illustrate the CLL trend. During 2020, you can see our net reserve build has tapered off throughout the year. This.
This reflects the overall stability of our loan portfolio and our real time outlook for all our credit exposure is at quarter end.
As you can see from the lower table on this page during Q3, we actually released reserves in for lending categories and added reserves in three largest net bill was in our commercial real estate investor portfolio, where we added to our reserves related to shopping malls and other retailers.
Measures.
Reserves on our oil and gas portfolio declined $33 million as we continue to manage that portfolio down.
As of September Thirtyth.
Our total allowance was 442 million and covered 1.8% of total loans.
Credit metrics are presented on slide 10 as it.
As a reminder, these metrics reflect our real time risk rating and credit evaluations with the expectation that substantially all of the active deferral activity will come to some conclusion of remediation this quarter.
Potential problem loans decreased $14 million, primarily driven by the migration of covered affected loans to nonaccrual overall non accrual loans increased 60 million driven primarily by the migration of two commercial real estate mall oriented reach and our only sand fracking company into now.
On accrual loan.
Loans included in our key cobot commercial exposures made up 37% non accrual loans at the end of Q3.
This inflow was partially offset by nonaccrual oil and gas loans, which declined to $42 million due to charge offs noted sales and pay offs.
Charge offs for the quarter were $30 million outside of oil and gas net charge offs were again less than $10 million for the quarter.
Reserves on the remaining oil and gas book remain over 15%.
Turning to slide 11.
Average deposits were 26.8 billion up nearly 700 million or 3% over the second quarter.
Average deposit growth again came from low cost savings and checking accounts this quarter liquidity.
Liquidity remains high and our deposit mix continues to improve low cost.
Low cost deposits accounted for nearly 63% of our balances at the end of the third quarter.
Turning to slide 12 third quarter net interest income was 182 million for the net interest margin of 2.31%.
We previously guided that net interest margin would bottom out during Q3 and begin to pick up in Q4 and as we expected margin hit bottom in July and August and then rebounded up to 235 in September.
Asset yield stabilized during the third quarter, while our liability cost trended downward we continue to expect to see margin expansion further into Q4 and into 21.
We expect spreads to widen 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 so for and other indices later in 21.
On the liability side, our time deposit levels have both been declining and repricing lower.
When Cds renew or rollover today, they're generally repricing for approximately 1.2% to below 15 basis points, we expect.
We expect this repricing to provide margin lift going into 21 additional heat.
Additionally, we will see a full quarter impact during Q4 from the prepayment of our FHLB advances and we expect this will provide a $5 billion benefit to net interest margin in the.
In the fourth quarter and about a 20 million dollar improvement.
21.
Turning to slide 14 second quarter noninterest income came in at 76 million.
Noninterest income was lower in Q3 than two however, this was driven by the large gain from the sale of associated benefits and risk consulting in Q2 and of course, the lack of revenue from a BRC going forward.
Service charges and deposit account fees came in at $14 million, an increase of nearly 3 million quarter over quarter card based fees increased 15% from the second quarter up to 10 million. So the combination of Kobin relief winding down as well as more normalized economic.
Activity is driving these fee lines.
Our mortgage banking activity remained strong this quarter with nearly $600 million of mortgage is sold to the agencies generating $13 million in net fee revenue at.
After $17 million of MSR impairment in the first half of the year impairment for the third quarter was just over 1 million, we expect positive fee trends heading into Q4.
On slide 14, we highlight our expenses third quarter came in at 228 million, including 60 million of restructuring costs previously mentioned.
Core expenses continued to trend lower largely driven by the reduction of expense following the sale of baby RC We expect.
We expect expense initiatives executed in Q3 to provide further savings as we move into 2021.
And as you can see from the lower right chart on an adjusted a run rate basis, our expenses to average assets ratio is already trending below 2%.
As shown on slide 15, our regulatory capital levels remain strong at the end of Q3, a regulatory capital levels were at or above where we ended the year for 2019, and our tangible common equity ratio increased 25 basis points to 7.5% 10.
Tangible book value per share also increased to $16.37 per share up from 16 to 21 in the prior quarter, reflecting the net additive benefit to shareholders of the actions we took during the quarter.
On slide 16, we're updating select items for the remainder of 2020 and reiterating our expense guidance for 2021.
We expect the net interest margin of 2.5% or slightly higher in the fourth quarter. We expect fee revenue to continue on a positive trend through the end of 2020 excel.
<unk> expenses for Q4 are expected to come in at 175 million, including about $3 million of remaining restructuring costs.
We reiterate our full year 2021 expenses are expected to be approximately $685 million the fee.
The full year 2020 tax rate will be.
We'll be in the low to mid single digits, and we expect the full year 21 tax rate to be between 15 and 17%.
Thank you and with that we'd be happy to answer your questions.
Thank you ladies.
Ladies and gentlemen at this time, we will conduct our question and answer session if.
If you would like to ask a question. Please press star one on your telephone keypad that the star key followed by the number one key on your telephone keypad a confirmation total indicate that your line is in the question queue. You May Press star followed by the number two key 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 poll for questions.
Our first question comes from Michael Young with Truth Securities. Please state your question.
Hi, Thanks for taking the question.
Wanted to ask about loan growth.
You mentioned the commercial construction pipeline.
I think you said 1.9 billion yet to be funded so it sounds like that's a pretty nice tailwind or potential bridge to a return to stronger loan growth is that the right way to think about that are there. Some other offsets that we should be thinking of and some of the other commercial categories.
Yes, Thanks, Michael So, yes, certainly commercial real estate as you've seen throughout the year, we'll continue to provide loan growth.
Based upon the backlog, we have and there is some amount of new business being done in that area as well our specialty areas Howard utilities, the mortgage warehouse business continue to show good growth and we expect certainly the power.
Certainly the power utilities area to keep growing our mortgage warehouse will depend upon refinance activity.
Mortgage business still has some tailwind and we may choose to retain some of our mortgage production going forward.
General commercial lending probably somewhat slow we don't have great visibility into that line item.
Into next year, yet, but we expect to have me.
More information on that as we get through the fourth quarter and get to the January call.
Paul So there are certain areas that continue to show good growth.
There are areas that continue to have the backlog flexi area that will fund up.
[music].
But you know general activity in the commercial loan.
Lending space needs to show some more growth going forward, we'll see what happens as we go along.
Okay.
And just maybe on a on a core basis as were thinking about the margin for next year is really kind of loan growth the main driving factor.
The upside from kind of what you've already talked about in terms of the funding cost coming down.
So we expect you know our liabilities to continue to grind lower we took the actions on the FHLB prepayment, which is a significant.
Significant improvement to Eni next year.
We're getting decent traction on imposing floors on our LIBOR based loans, which is the bulk of our loans will continue to work on that so the combination of grinding liability costs down the FHLB prepayment.
LIBOR floors, and then transitioning to new indices.
Should provide stable to growing NIM as we look forward, but we'll have better guidance for you in January on that.
Okay, and if I could just sneak in one last one just on the commercial.
Paroles I understand obviously both come down.
But yeah I guess are there some that have been modified their large portion that's maybe paying interest only or some other modification has been made but maybe not captured in that deferral number [noise].
Yes, So you know we're down to 1.4% of the total commercial and commercial.
That have requested some additional deferral Pat do you have a little more color on that for Michael.
Yes, I would say and the commercial book, it's really.
He's by case, how we're looking at those.
There's definitely a mix where we've got clients that have moved to may be an interest only we have some hotel the hotel industry, obviously, he's going to need some more time. So those modifications are little more customized.
To kind of bridge them for at least the next year plus so there is a lot of nuances that kind of go with each credit from that standpoint.
Is there an amount that's just been modified I mean would it be would it closely match kind of an initial 800 million or is it more like 600 million I don't know if there's any way to kind of.
Paul Park that.
Well the the modified loans Pat correct me if I'm wrong are included in the 227 million that you see Michael.
Right the bulk of pilots have rolled off and don't need any further assistance or modifications.
Okay. So they are fully captured the number thank you appreciate it.
Yep.
Our next question comes from Scott Cyphers with Piper Sandler. Please state your question.
Afternoon, guys. Thanks for taking my question.
First one that hopefully it's a pretty basic one I'm just given all the moving parts I just want to make sure I understand sort of what you guys think the run rate cost base is in the third quarter I'm just trying to square what's on slide 14 with the commentary in the text. So if we just take that one Oh no.
Hi.
And 69 that would give us somewhere around $178 million and core expenses. So you have that that 50 million of restructuring costs.
Which I think is the FHLB as well as the real estate, where exactly do the 10 million of severance costs.
Where do where do you see those.
But that 10 million is embedded in that one on nine so you can take it out of there too Scott Yeah. Okay. Perfect. So then we're talking about a core number of folks you know somewhere in like a $167 million range that fairway fair approximation.
For that quarter, yes.
Yeah, Okay, perfect Yeah, sorry for kind of basic one that's just trying to get their old part.
All right perfect and then moving parts really.
Yes, [laughter] [laughter] and then.
Margins at a top level one on how this credit cycle kind of plays out.
Like every every 90 days, we sort of push out the time until we see more accelerated last migration I guess with the benefit of a at least a bit more clarity visa be say 90 days ago, Phil maybe.
Phil maybe how are you thinking about when we should expect losses to begin to accelerate it at some point in 2021 is that like a mid or even later 2021 event or hi, how are you guys preparing for thanks.
It's always hard to tell you know you can see that our AR reserve build is moderating to being pretty flattish at this point.
Yes.
I think so much depends on is there more stimulus.
What's the economy look like as we get into next year, but there's from here, there's probably putting aside oil and gas.
But from here.
You know you probably couple of three quarters out before you kind of push push this lump of troubled credits.
Through the pipeline and see what comes out so I think theres I think theres a lag to go and of course, you saw in our oil and gas that we've done I think a good job of winding that down and getting that behind us. So we still have the fall redetermination period to come were about a third of the way through that without any issues, but.
We're still holding significant reserves in the event that we have on the addition.
Some additional troubled credits there.
Okay, perfect all right well. Thank you guys very much I appreciate it.
Sure.
Thank you. Our next question comes from Terry Mcevoy with Stephens. Please state your question.
Hi, good afternoon guys.
On your capital Slide you typically prioritize your usage for excess capital I didn't see it this quarter I was wondering if you could kind of run through how you're thinking about excess capital specifically the buyback just given where the share prices relative to tangible book value.
Sure so the debt.
The leaving out the chart caused a question that we havent changed our our level of priorities, but it is more than fair to say.
When we're trading at a discount to book, which frankly, we don't understand why we are given all.
Given all of our actions and given our outlook, but when we're trading at that type of level share buybacks.
Only become interesting to us.
It's probably still.
A little bit early but.
But as we get into next year Kerry I clearly.
As we sit with growing capital and depending on where we're trading at share buybacks become a great interest.
Thanks, and then just as a follow up the billion plus of retail and shopping centers.
Much of that is just what I'll call typical your typical mall, which was may have been struggling pre cove it.
And we just haven't seen charge offs at all just for the whole bank what are your thoughts there in terms of when the deferrals run out what's the most susceptible is is it that traditional mall and if so how big is the portfolio and do you have any kind of stats average LTV or something like that to give us some color on the portfolio.
Sure Pat do you want to give some color on the the mall based.
Sure.
In general the stuff that we're.
We're seeing that continues to struggle is all going to be the enclosed mall kind of space, where you just with the social discontinued et cetera people are struggling to get into.
Our majority of our retailers are in that what are called neighborhood.
Strip Center mall net lease space in those.
And those have all seen rent collections come back almost to normal levels 80, 590%.
Lot of those have come off deferral. So we feel pretty good about them. There is still a handful that we're dealing with.
And then in terms of.
We really only have a handful one or two maybe other enclosed mall exposures to public read that.
That have been so far those remaining ones have been performing well other than the two Phil mentioned earlier with the non accrual. So right now we feel pretty we have a pretty good trajectory on the retail client base.
Client base.
Right.
Thank you Pat and thank you Phil as well.
Thanks.
Just a reminder to ask a question press star one.
Our next question comes from Jon Arfstrom with RBC capital markets. Please state your question.
Hey, Thanks, good afternoon.
Yeah.
Like a little bit about the timing of the expense reductions for the branch optimization project, we should roll but.
Sure so.
You know the consolidations internal will be done this quarter.
The sales in Peoria and have two branches.
In southwest, Wisconsin will complete this quarter, we expect them to complete this quarter and the remaining one branch.
We're selling to a third party will.
I will close sometime in the first quarter. So you should expect to see.
Okay everything clean starting January one with a very minor exception of one branch.
Okay.
So the message is similar to your commentary on net interest income were 5 million.
You're saying that it could be as simple as just putting them extra time, taking 10 million out of expenses for Q1 is that fair.
Well you know the Chris what's what's the.
I think we have all the charges through in the fourth quarter.
Correct, Yes. So as you said 2021 should be a clean from January one so John I think you're thinking about it the right way.
Okay. Good thank you for that.
Any comments on the service charge rebound.
The magnitude of what you expect or is that just I know, there's a bit of a bounce back but any commentary there.
Yes, so we expect to see continued growth there you know as you know at the start of the.
The pandemic, we gave quite a bit a relief to customers on that.
That is now complete the roll off as we get into.
Q4, and you know rightly or wrongly economic activity has picked up particularly in the Wisconsin footprint.
And so we're seeing more activity there as well. So you know our guidance that we expect to see fee income continuing to grow into the fourth quarter.
Based on those factors.
Okay.
And then one more maybe not an easy question, but you've had some really good deposit growth was few quarters.
And do you all think about how much of this might be permanent versus.
Temporary.
Thanks returned to normal.
Chris you have a view on that you want express.
Yeah. So I think you'd ask a couple quarters ago, certainly weakness that we saw at all a surge as we sit here you know moving into October and the balances that stayed through the entire third quarter, they're staying as it is that as we move into the fourth quarter were starting to feel the balances a lot stickier, which is part of the reason.
We are comfortable.
Repaying the 950 million the federal home loan bank advances because we think a good portion of this is sticky and the dollars that were still continue to see come in we think will continue to be sticky isn't it.
So as we sit here today it feels a lot stickier than we would've expected and it feels like we have to move things around.
Okay, all right. Thanks, what helped us.
Yes.
Our next question comes from Chris Mcgratty with KBW. Please state your question.
Hi, This is actually Kelly Kelly Motta in for Chris Thanks for taking my question.
Taking my question.
I guess.
You've talked a lot about.
Well done on the funding side with prepaying that they tell the borrowing.
Your selling price is lower I'm just.
Wondering if you can give us color on screen basket.
Hey, Karen needs and how often you long yelps compared to one.
What you have right now.
Yeah, Chris I handle that.
Sure. So on the reinvestment Securities I think by the keep in mind is we're not aggressively growing the balance is and so what you're seeing is essentially.
Relatively stable levels to what you will see our reported for the third quarter averages.
And not a lot of net movement because of incremental significant investment activity. So I don't expect you to see that.
Continuing drift downward because there just isn't a lot of net new that we're expecting to put into that portfolio on.
On the commercial loan I think we'd show the trends on the slide and again, we tried to highlight.
Monthly trends. So if you take a look at the slide page 12, you'll notice that commercial loan yield.
Actually bottomed in June and after the commercial and business lending and we've been working with a lot of the business on spread and.
Floors in order to sort of bounce back up a few basis points on hold that line above 250 on the commercial book into the whole over the last several quarters and that seems to have gone successfully and.
That reflects the activity. We're doing on you you can also see that commercial real estate has held steady and again, what we're holding in portfolio is holding steady on the residential book as well. So I think those month to month trend lines give you a good indication of where the new volumes coming in.
Great. Thank you and then last question for me on tax rate.
Potentially to attach rates going up again from Washington.
Is there any you know differences and how we should think about it or is kind of looking at it or what.
What happened in 2018.
So kind of a valid proxy thank you.
Well Hey, your your guess on on what happens is as good as ours, but our best guess right. Now is that we've got tax rates in that 15 to 17 ish percent.
Change but.
Economic change.
Hi, Thank you.
Yes.
Ladies and gentlemen, there are no further questions at this time I'll turn it back to Philip Flynn for closing remarks. Thank you.
Thanks, well everybody. Please.
They say thanks for joining us today, we look forward to talking to you again in January and as always if you have any questions give us a call and thanks as always for your interest in associated.
Thank you. This concludes today's conference all parties may disconnect have a good day.