Associated Banc-Corp

NYSE:ASB

Earnings Call Transcript 2022-Q3

[Operator]

Good afternoon, everyone, and welcome to Associated Banc-Corp's Third Quarter 2022 Earnings Conference Call. My name is Kevin, 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 will be referenced during today's call are available on the company's website at investor.associatedbanc.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 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 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 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 Harmening, President and CEO for opening remarks. Please go ahead, sir.

[Andrew Harmening, CEO]

Well, thank you, and good afternoon, everyone. Welcome to our third quarter earnings call. I'm Andy Harmening, 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 ROATCE 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 is 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 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 2. 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 3 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 helped firm at 1.2% quarter-over-quarter.

Now let me give a little bit more color on our loan dynamics. Slide 3 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 retain more loans on 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 4, we've been able to make significant progress against our initiative loan targets in 2022. In fact, as of September 30, 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 continue 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 there 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 the 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 5, we highlight our deposit trends for the third quarter. Despite inflation and increased competition in the market, we are 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 affluent 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 20223 and beyond.

On Slide 6, 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?

[Derek Meyer, CFO]

Thanks, Andy. Slide 7 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 decreased -- increased by 54 basis points or roughly 18% of the move in Fed funds target. We continue to lag on funding costs at rates rise and continue to see our margin expand accordingly throughout the year.

Slide 8 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 9, we 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 began 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 down -- managing our down side 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 OD NSF changes we announced earlier this year. Also driven by rising rates, mortgage banking revenue continued to moderate during the third quarter. $6 million of our Q3 non-interest income was driven by an investment securities gain that allowed us to make contribution to our charitable foundation as we help 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 we 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 million 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.

[Pat Ahern, Chief Credit Officer]

Thanks, Derek. I’d like to start by providing an update on our allowance as shown on Slide 13. We've utilized the Moody's August 2022 baseline forecast for our CECL forward-looking assumptions. The Moody's baseline forecast remains fairly consistent with recent trends and assumes increasing Fed rate actions and minimal COVID impact.

On a dollar basis, ACLL at September 30, settled at $333 million. While this figure represents a $15 million increase from Q2, the build was largely driven by significant growth in our loan portfolios. This dynamic is more clearly reflected in our ratio of reserve to loans which has held flat at 1.2% during the quarter.

On Slide 14, we highlight our quarterly credit trends. Overall credit metrics remained stable throughout the third quarter. While non-performing assets and non-accrual loans increased slightly from the prior quarter, they remained down 21% and 14% respectively from the same period a year ago.

Delinquencies a leading indicator of potential problem loans were held flat at 7 basis points at quarter end, while our year-to-date net charge-offs have been just $110,000. Following a Net Zero provision in the prior quarter and five consecutive net reserve releases prior to that, we added $17 million of provision in the third quarter. As mentioned, this provision build was largely a function of loan growth and was not a reflection of credit quality concerns within our portfolio.

As we've discussed previously, the recent growth in our loan portfolios has been driven by investing in our core business, growing our core relationships and expanding our engagement with customer segments with which we are very familiar. We spent more than a decade bolstering the credit foundation of Associated with a disciplined underwriting culture and a focus on quality.

With that said, we are fully aware of the warning signs in the economy and we remain stringent in our portfolio management with underwriting reflecting elevated inflation, supply chain disruption and labor cost to name just a few economic concerns, as well as continued interest rate sensitivity analysis across all lines of business. Going forward, we expect any provision adjustments to reflect changes to risk rates, economic conditions, loan volumes and other indications of credit quality.

With that, I will now hand it back to Andy to share some closing thoughts.

[Andrew Harmening, CEO]

Thank you, Pat. I'd like to reiterate a couple of points from our discussion this afternoon on Slide 15. First, we remain confident in our ability to drive quality loan growth over the remainder of the year. While we've technically already achieved our $1.7 billion in total commercial loan growth target for 2022, pipelines remain healthy and we expect to see continued growth between now and year end.

Next, we remain asset sensitive and we expect to continue benefiting from the rising rate environment in the near term. We now anticipate a 75 basis point increase in November's FOMC meeting and another 50 basis point increase in December. As such, we expect our full year 2022 net interest income to exceed $935 million.

Lastly, we continue to invest strategically in our initiatives and now expect between $740 million and $750 million of non-interest expense in 2022. With that said, we will remain disciplined on expenses as we work to continue delivering positive operating leverage in future quarters.

With that, let's open it up for questions.

[Operator]

Thank you. And I'll be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Jared Shaw from Wells Fargo. Your line is now live. Hello, Jared. Perhaps your phone is on mute. Please pick up your handset.

[Timur Braziler, Wells Fargo]

Hi. Good afternoon. Sorry about that. This is Timur Braziler filling in for Jared. How are you guys?

[Andrew Harmening, CEO]

Good.

[Timur Braziler, Wells Fargo]

So maybe just starting a little bit more broadly. We've heard some other banks today talk about economic activity slowing in their markets, particularly in the second half of the quarter. Clearly that doesn't seem to be the case for you guys. Maybe just talk of what you're hearing more broadly from your client base, how those conversations have progressed throughout the quarter and whether or not you're seeing any kind of signs of caution from them looking to extend borrowings, build operations, whatever may be the case?

[Andrew Harmening, CEO]

Well, look, I think it actually would be the same answer from us. We look at the second quarter and we had record growth of about $2 billion point to point. The third quarter benefited an average loan growth as a result of that second quarter. But we saw point to point growth slow, I believe is right around $1.3 billion. So it's a matter of scale there.

What I would say is, we have seen commercial pipeline to peak mid-year and they do seem to be managing down a little bit. However, they're still on pace something close to where they were in the first quarter. So it's hard to determine what the final trend is here, what is seasonal and what is a trend, but we have seen a little bit of dampening and we expect that to continue.

When we look at increasing our underwriting variables interest rate, underwriting variables, that inherently could dampen a pipeline as we go forward, when you're looking at a deal, perhaps a customer needs to put a little bit more money in or they're maybe not wanting to do that. On the commercial side, it can also change the cash flow assumptions in the credit. So it's not a falling off a cliff as much as a dampening situation.

For us, we've been able to maintain some diversified growth because we've had some strategic initiatives heading into this point in time. But we are hearing and seeing some discussion of that. And then from a final perspective, I'll say that particularly in Wisconsin and Minnesota, the economies have remained pretty strong with regards to being heavily manufacturing influence and that being a pretty strong place in the market.

The other piece is unemployment remained extremely low in those two markets for the time being. So part of it is initiatives, we have seen some dampening and part of it is the resilience of the Midwest markets that we're in.

[Timur Braziler, Wells Fargo]

That's good color. Thanks. Maybe switching to the deposit side. Are you able to parse out what portion of the deposit growth in the quarter is coming from the new lending initiatives? And then, as a corollary to that, just given the continued build out and the growth in those lending initiatives, are you able to kind of buck broader industry trends in both growing and maintaining deposit balances or do you think you'll come to some of the same industry pressures that we've seen elsewhere?

[Andrew Harmening, CEO]

Yes. Let me answer the first part of that and I'll turn it over to Derek for the -- I'm going to answer the second part first and then turn it over to Derek for the other piece. Clearly, the initiatives that we've had going on for quite some time are having a positive impact for us. So what we're able to do, can you -- how much can you say is strictly from adding in RM? Well, when you see your treasury management sales go up by 50% year-over-year, you get a pretty good idea that you're talking about liquidity management with the customer. That's exactly what we've seen.

The income from that treasury management is not what changes our income trajectory as much as it is, the balances come with that. When you create a balanced scorecard that incents them to focus on that a year before you need it, you start to see the resulting trends starting to emerge. We know on the mass affluent side, which we're starting training for literally this week and full launch by the end of next month.

We know that we're under indexed in dollars per customer in this mass affluent segment and we know that that segment carries about 70% of the deposits of a consumer bank. So in as much as we're under indexed, getting to average gives us a lift in growth versus the marketplace.

Certainly, we will be impacted by the pressures of the marketplace in some way, shape or form. But coming into this situation, we have multiple initiatives in our commercial bank. We have multiple initiatives in our consumer bank. Now I could go through the entire litany, but when you think about product enhancements in consumer, marketing shift, spend, change, digital acquisition, sales process and frankly bringing in a new executives that has expertise in deposit acquisition that was not on accident.

Our new Chief Marketing and Chief Product Officer has launched many of these products in past and once launched has gotten traction in those. So that's what gives us some optimism in this category heading into 2023, but we certainly are impacted by the broader market. Derek, I don't know if you want to take that.

[Derek Meyer, CFO]

Yeah. I think you've covered about all of it. The only thing I would add is, what we saw in the actual quarter was broad, which is what we've suggested in our discussions. It was broad based through the commercial and CRE side of the business across the products both end of period and average balance. So you'll expect the rest of the initiatives that Andy referred to the start to pull through on the consumer side and carry us through into next year.

[Timur Braziler, Wells Fargo]

Okay. Great. And then just last one for me. It looks like the asset remix with the new loan production is helping to accelerate NIM trends. Can you disclose what the production rate was in the loan book in the third quarter? And then just how should we think about net interest margin once the Fed does stop hiking. With the continued remix, do you see additional NIM expansion opportunities past that point or are we kind of nearing an inflection point with the Fed moves?

[Derek Meyer, CFO]

Yeah. I think the progress we're saying is that we're going to continue to remain asset sensitive. I think for this year, our guidance pretty much lays out what you're likely to expect in terms of further margin expansion, you can sort of back into that. And then the rest is we've laid out if you look at the table, it talks about asset sensitivity, that's probably as far as we'll go. It's playing out how much upside we have, which structurally we have quite a bit, even though we're starting to put in some downside protection. So I think that's as far as we'll take it, but we feel very good about it.

What we are concerned about is, as we get into later innings is the fact that we have put hedging program in place and that will start to lag into that over time to protect us from the downside. And that's probably a new strategy that we'd like to lay out, so that we've got some of this locked in.

[Andrew Harmening, CEO]

I’ll also -- this is Andy. I'll also make another point, which is more of a reiteration that we had before, which is we see this as a bit of an S-curve. So you go up and then deposits slowly cash. What we've said was in the last rate cycle, I believe, we're around a 50% beta. Because we've changed the structure of our balance sheet and are about 85% core funded versus wholesale network, being about 15% and last time going into the cycle, we're at 33% wholesale network funded.

That's what makes us believe that we can keep that beta at about 40% or below through the cycle. That hasn't changed. It's held very true to what we're seeing. Now we're seeing some extraordinary increases from the Fed unlike many of us have seen in maybe our career in short period of time. And that's why we're not giving long term guidance. I think that we stick to the basics of where we are and what we're doing and the impact that we're seeing. So right now, it's on track to what we've given guidance for in the past.

[Timur Braziler, Wells Fargo]

Understood. Thanks for the color and congrats on the good quarter.

[Andrew Harmening, CEO]

Thank you.

[Operator]

Thank you. Next question is coming from Scott Siefers from Piper Sandler. Your line is now live.

[Scott Siefers, Piper Sandler]

Good afternoon, guys. Thanks for taking the question. I think I wanted to take another stab at that margin question. I guess the guidance for the fourth quarter or the full year implied somewhere around $267 million of NII in the fourth quarter. So it’s still up, but much less of trajectory than in the last couple quarters. It sounds like there should still be balance sheet growth into the fourth quarter, but I think like the $935 million side of the range would imply not much margin expansion in there. So I guess maybe sort of the puts and takes of what does it take to get you to the plus side of the $935 million?

[Andrew Harmening, CEO]

Well, Scott, thank you for asking that question and making this just continue to be uncomfortable. You get made us, if we miss a number. And so, we always put a plus at the end of that $935 million. We have -- we're well into the fourth quarter. We see the trends where we are and we have confidence in the forecast that we have out there. We don't want to get ahead of ourselves with understanding what the reactions of the customer base could be.

When you have a market that is fluctuating the way it is. We want to make sure that regardless of our actions for the next two months that we do what we say. And so we feel very comfortable with that $935 million. I feel very comfortable putting a plus at the end of that $935 million. I don't think I would have a lot more color to that than to tell you that clearly, we have had a relationship manager increase of 33%. That puts us in a unique position to continue to have growth both on the deposit side and the loan side.

And so we think we'll have some growth in the fourth quarter, but there are also some things on the long term side of what's happening with permanent money and the take out of existing products. And so the question on what gets paid off in the fourth quarter is an open question for us. So we wanted to make sure we put out a number that we could hit. There could be timing of what gets paid off.

We're seeing historically low pay down, monthly paydowns on residential, which has allowed us to grow when we've seen significant decrease in production. So with some of that uncertainty bouncing around on what the payoff side of it is. We put the plus out there. We will say that we will expect to grow in the fourth quarter, but I wouldn't want to get over my skis on this particular number. So I’d probably leave it at a 935 plus.

[Scott Siefers, Piper Sandler]

Okay. Perfect. That context is helpful. So it sounds like it's -- as it's based just a very, very conservative outlook then with hopefully that we're on the plus side fairly easily. So got it. I appreciate it.

[Andrew Harmening, CEO]

We are bankers, Scott.

[Scott Siefers, Piper Sandler]

Yes. Good point, 2s (ph). And then when we talked about moderating the asset sensitivity, maybe a little more color regarding what the ultimate goal is in terms of sensitivity one way or the other. And if swaps are sort of the main -- when the avenue to get there, in your mind how much more might it take to get to where you want to be?

[Andrew Harmening, CEO]

I think the firm has taken the view that we look at the rate of growth and the change of our structural balance sheet first. And then when you take a look at what kind of hedging we want to put afterwards. And we took a first bite at that because we saw that the fixed rate growth was being matched by the variable rate growth of our loan book. So as we look out into our guidance for next year, which we will put out in January, we'll do that same reevaluation.

We will take a look at what we expect to do structurally with our business and then where the interest rate risk is sitting and then what we can use in our tool bag to manage that and take some of the downside risk off the table. So that sort of lays out the process by which we're going to make that determination and when we're willing to share that impact. But I don't see us doing any esoteric. I think we took the first straightforward simple steps that were available and I think most people understand that and be happy about it.

[Scott Siefers, Piper Sandler]

Perfect. All right. Wonderful. I appreciate the thoughts.

[Andrew Harmening, CEO]

Thanks, Scott.

[Operator]

Thank you. Next question coming from Chris McGratty from KBW. Your line is now live.

[Chris McGratty, KBW]

Good afternoon. Thanks. Can you speak to the – just the outlook for the loan to deposit ratio. Remind us of targets and where you see that trending over the next couple of quarters?

[Derek Meyer, CFO]

Yeah. I think we've been shooting to maintain a 95% loan to deposit ratio or less. I would say, plus or minus 2% or 3% and that's sort of the benchmark we shoot for. We got a little on the high end of that this quarter, but there's some seasonality involved with that and there's some pull forward of our loan production that we saw. And so that's how I would think about it if I'm -- and you see is modeling it. As we look out going forward, we'll be pricing our products and our deposit initiatives to keep that balance.

[Andrew Harmening, CEO]

Say the other piece of that is not just loan to deposit, but we also think about our funding source and we've been trying very hard to keep our core to network and wholesale ratio in line. I think you'll notice that we've done that in the fourth quarter being in at about an 85%, 15% split. We talked last quarter somebody said, well, could that go up?

And the answer is yes, it could go up. It could shift for a short period of time. It could bulge depending on what asset growth is. Clearly, we saw a very large asset growth in the second quarter. We saw that asset growth that was strong in the third quarter, but decreased and we're seeing a pipeline that has slowly decreased as well. So our target is still to remain over time in that 85%, 15% range as well.

[Chris McGratty, KBW]

Okay. Great. Maybe I missed this, but did you provide or could you provide the spot rate for your loan yields and also interest bearing deposit costs?

[Derek Meyer, CFO]

We have not provided those spot rates. We've got the asset yields -- the quarterly asset yields, I think they are on Page 7 of the presentation. And I think that's where we're going to leave it. I think what we did try and lay out was how much asset sensitivity we still have on the loan side and the deposit side on the interest-bearing liabilities. And I think that sensitivity, even though we put the hedging program in place is still relatively high and it still offers a lot of upside.

[Chris McGratty, KBW]

Okay. Great. Thanks.

[Operator]

Thank you. Next question is coming from Terry McEvoy from Stephens. Your line is now live.

[Terry McEvoy, Stephens]

Hi. Good afternoon, everyone.

[Andrew Harmening, CEO]

Good afternoon, Terry.

[Terry McEvoy, Stephens]

Hi. So first question, are all the expected banker hires and the investments you're making in digital, are those built into your fourth quarter expense outlook? And the reason I ask is I'm just trying to look ahead into that first quarter and make sure I've got kind of a decent run rate to think about at the beginning of next year.

[Andrew Harmening, CEO]

Yeah. Fair question. So clearly, we've been up significantly in our RMs. And the way that I answered that question really on that front is that if we have a strong performer that becomes available in the market, we're going to hire them. That's a really valuable commodity in the markets that we serve. And so I'll put that piece out. So we would expect some small level of hiring. We're not going to see anything similar to what we've seen over the past 18 months. We don't need to, frankly.

What we've seen is we brought in talented people and we brought them in throughout the year, and as you know, Terry, it takes some period of time to establish that pipeline and relationship at the new company. So we're still benefiting from those hires and we'll benefit from those hires throughout 2024 without the need to have as significant of an investment on that front.

The way that I look at the expense side, we've given the guidance for the year, and I think you can see -- and we tried to point out, we had one opportunistic expense in the third quarter. And we had an investment gain that specifically when I saw that gain, an extraordinary gain, I saw an opportunity to put that in our foundation about a $6 million expense we pulled through there. That's above what you've seen historically in that space and wouldn't expect those are recurring type of quarterly expenses for us. So we remain firmly in the space where we had said we were in the 4% to 5% expense growth range.

We take very seriously what we're going to look like in 2023. We're all faced with some pressure on increased cost of doing business. But for us, what we've tried to do is identify cost saves going into the year. And we pulled a couple of those levers or made those decisions heading into the fourth quarter. So whether that be some branch consolidations or decreasing the size of our mortgage business commensurate with the current volume.

So what I would say is that $6 million, we do invest in the foundation typically about $3 million to $4 million a year. This is higher than that, and it all came in 1 quarter. So that is not likely recurring in the fourth quarter at any similar type of level. So that's how I would think of expenses for the rest of this year within that guidance that we gave. And frankly, we would have been within our prior guidance had I not seen an opportunity to take care of our local markets in a way that we think is significant and meaningful.

So when I think about that, and we haven't provided guidance for '23, but I will tell you we're not going to say, we're going to spend the gain from every basis point of margin that we're getting. We're going to remain disciplined in that space. And I wouldn't have a change in the expense outlook based on that. So really, when we talk about the digital cost and what we do, what I had explained before is it's more a shift in spend.

So it's a shift from dealing with physical spend to digital spend. And I still feel the same way. And frankly, are pretty enthusiastic about what I've seen in as much as launching a platform in September and following up in October, beginning of November with another asset in that space. And then following up in the first quarter with another one because we're able to plug in a fintech into that. So I know that wasn't your question, but we're able to do these things as we shift spend from physical to digital and the run rate, it is factored in there.

[Terry McEvoy, Stephens]

I appreciate that, Andy. And maybe as a follow-up, one might argue there's risk next year that deposit costs are higher, wholesale costs are higher. And I guess my question is, would you be willing to scale back loan growth if funding just becomes too expensive? And how do you think about that risk and manage that risk? And I asked that question because when I look on Slide 4, you've got $1 billion of commercial growth and another $1 billion of auto finance, which is unique for -- relative to your peers and their need to fund asset growth next year?

[Andrew Harmening, CEO]

Yeah. We have a lot of levers that we can consider and are considering. I mean, I'll give you an example. We backed off on TPO in the last quarter. I mean we're down 44% in originations, but we're only down 20% in our core market residential lending originations. So that's on purpose. And so when we think about what we can slow and how we should look at our businesses, we'll look at all of the businesses that in and we'll bias towards relationship business.

And so whether that is residential, whether that is commercial with deposits, whether that's a small business customer that brings deposits, whether that's mass affluent or we go out to market, which can bring deposits. But the answer is if need be, we can dampen that growth. What we'll have to do is look at the cost and the benefit of what we're doing so that we're not running in place on any of those initiatives. But certainly, we'll look at all those levers.

[Terry McEvoy, Stephens]

Great. Thanks again.

[Andrew Harmening, CEO]

Thank you, Terry.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from Daniel Tamayo from Raymond James. Your line is now live.

[Daniel Tamayo, Raymond James]

Thanks, guys. Good afternoon.

[Andrew Harmening, CEO]

Hi, Daniel.

[Daniel Tamayo, Raymond James]

Maybe just wanted to -- just a quick one here on reserves. Curious, the contribution of the qualitative side of the ACL, trying to think through how a change in the Moody's economic forecast could impact the overall reserves. Thanks.

[Pat Ahern, Chief Credit Officer]

Well, in terms of the qualitative piece, it's relatively a small part of our reserve is about 12% or so. The reserves this quarter, as we mentioned, were really largely driven by the loan growth we had and really a continued stable credit metric and credit portfolio. In terms of going forward, we're obviously watching the Moody's forecast. We feel like we've got a pretty good handle on allocation in terms of our overall ACLL. So we feel good about where we're going into next year. We're constantly watching that, obviously, given the macro headwinds that we've been talking about.

[Daniel Tamayo, Raymond James]

Okay. And would you say it's more the reserve calculation for you given that the footprint is more focused on the regional numbers and more specifically within the states or you cast a wider net in terms of the forecast?

[Pat Ahern, Chief Credit Officer]

No, it's probably -- it's a little more weighted to the regional for sure. I mean as Andy mentioned, we've got some pretty strong numbers coming out of Wisconsin and Minnesota, et cetera. We don't typically get the large upswings and the -- conversely, the large downswings you might see in some of the other markets here in the Midwest. So we're definitely using that as a big piece of what we're looking at.

[Daniel Tamayo, Raymond James]

Makes sense. That’s all I had. Thank you.

[Andrew Harmening, CEO]

Thank you.

[Operator]

Thank you. We reach out of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

[Andrew Harmening, CEO]

Well, look, this is Andy. I'll just say in closing. We appreciate your interest in Associated Banc. And if there are any follow-up questions, we'll be happy to answer that. We know we're in a dynamic time, and we like our relative position heading into year-end. Thank you.

[Operator]

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.