Associated Banc-Corp

NYSE:ASB

Earnings Call Analysis

Moderate Growth and Margin Stabilization in Q3

Associated Bank has shown resilience in Q3 amid a challenging landscape. Loan growth is expected to slow to 5-6% in 2023, while net interest income is forecasted to rise by 8-10%. Core customer deposits grew by over $500 million in Q3, contributing to a reduction in expensive funding dependencies. These deposits are projected to decline by 3% for 2023 but increase by 2% in year's second half. Increased provisioning for loan losses and credit quality reflects normalization to pre-COVID levels, with no looming credit concerns. Continued margin compression brings net interest margin (NIM) to 2.71%, with a recent decrease of 9 basis points, signaling a stabilization of earlier trends. Associated Bank remains focused on high-quality consumer and commercial lending, optimizing balance sheet management, and maintaining solid expense control.

Following Firm Economic Footsteps Amidst Turbulence

Amidst a challenging operating environment, shaped by regional employment resilience and customer stability, the bank has steadily pursued and accomplished initiatives aimed at reinforcing client relationships, balance sheet optimization, and profit enhancement. The execution of these initiatives is exemplified by a strategic focus on high-quality loan advancements and proactive deposit growth. Significant growth in core customer deposits of $527 million in the third quarter, along with robust digital platform upgrades, underline efforts to enhance customer satisfaction and foster a more reliant and gratified client base.

Enhanced Digital and Customer-Centric Approach Spurs Growth

Deposit inflation did not occur in isolation; a concerted effort in product and service enhancements, amplified by a focused brand campaign, resulted in a notable 20% increase in consumer household acquisition and a 17% drop in attrition rate year over year. Digital efficiency has played a cardinal role, and the adoption of a mass affluent strategy has contributed more than $550 million in net new deposits, greatly surpassing the initial year's aspiration.

Moderated Loan Growth Amid Industry-Wide Slowdown

While the bank observed continued growth across all major loan segments, amassing $344 million in the third quarter, there was an evident slowdown commensurate with industry trends. The bank's loan growth forecast has been cautiously adjusted to a range of 5% to 6% for 2023, reflecting a more circumspect attitude towards the prevailing higher for longer rate environment.

Robust Revenue Meets Systematic Expense Management

Notably, despite funding pressures across the industry, the bank has succeeded in increasing its year-to-date PTPP income by $68 million over 2023, marking a significant 20% uplift from the previous year. This financial fortitude is coupled with a disciplined approach to cost control, as indicated by non-interest expenses which remained stable compared to the same quarter last year.

Interest Income Gains and Capital Ratio Fortification

Rising total asset yields have benefited the bank, with expectations set for net interest income to grow by 8% to 10% in 2023. Capital ratios have also seen an uptick, strengthening the bank's financial position as it heads into the following year with a CET1 target range expanded to 9% to 9.75%.

Credit Quality Measures Adapt to Economic Pulse

The bank has remained watchful of macroeconomic shifts, reflected in stable credit trends and a diligent CECL allowance adjustment. Although increases in non-accrual loans, delinquencies, and charge-offs indicate a normalization in the portfolio, there is no discernible indication of significant credit stress. Moving forward, provisions will be consistently aligned with risk evaluations, economic conditions, and portfolio analytics.

Earnings Call Transcript 2023-Q3

[Operator]

Good afternoon, everyone, and welcome to Associated Banc-Corp's Third Quarter 2023 Earnings Conference Call. My name is Alicia, and I'll be your operator today. [Operator Instructions]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 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 the conference call, please refer to Pages 23 and 24 of the slide presentation and to Page 10 of the press release financial tables. Following today's presentation, instructions will be given for the question-and-answer session.At this time, I would like to turn the conference over to Andy Harmening, President and CEO, for opening remarks. Please go ahead, sir.

[Andrew Harmening, executive]

Well, good afternoon, and welcome to our third quarter earnings call. I'm Andy Harmening. I am joined once again by Derek Meyer, our Chief Financial Officer; and Pat Ahern, our Chief Credit Officer. I will start today by sharing some highlights for the quarter. From there, Derek will provide an update on margin, income, capital trends, and then Pat will share an update on credit.Now, I mentioned back in July that we are starting to see renewed stability after a volatile spring, and what we saw here at Associated in the third quarter was a definitive continuation of those stabilizing trends. Employment trends remain very strong in our footprint. With most mid-Western states seeing unemployment below the national average in Wisconsin coming in below 3%, our prime and super prime retail customers remain resilient in the face of macro uncertainty.What this means for us is that we've been able to focus squarely on execution of our initiatives as we look to attract and deepen customer relationships, optimize our balance sheet and improve our profitability profile. These initiatives have clearly taken hold in the face of challenging operating environments.On the asset side, we steadily added high-quality consumer and commercial loan balances that enable us to rely less heavily on lower-yielding, non-relationship balances. On the funding side, the customer acquisition and attrition trends we shared for Q2 look even stronger in Q3. Initiatives such as our new mass affluent strategy, product enhancements and brand campaign are clearly having an impact, and that led to $527 million in core customer deposit growth during the third quarter. This not only helps us fund our loan growth, but it enables us to decrease our reliance on wholesale and network funding sources now and in the future.And finally, on the digital side, we've regularly upgraded our online and mobile experiences since we launched our new platform a year ago. These changes have contributed significantly to higher customer satisfaction scores and decreased customer attrition. And while we've continued to get traction since launching Phase 1 of our strategic plan a little bit over 2 years ago, we haven't lost sight of what got us here in the first place, our foundational discipline on credit quality and expense management.As the banking environment continues to evolve in the coming quarters, that discipline is going to remain front and center for us. It's also important that we're thoughtful about what comes next for Associated Banc as we look to set the bank up for long-term success. That's why our team is working hard, putting the finishing touches on Phase 2 of our strategic plan, which we look forward to sharing in more detail later this quarter.With that, I'd like to highlight our results for the third quarter on Slide 2. Our third quarter results reflected the steady growth of our balance sheet and continued progress against our initiatives. As mentioned in the past, our stated goal is to fund the majority of our growth with core customer deposits.We grew these deposits meaningfully in 2022. And after a period of industry-wide volatility in the first half of this year, core customer deposits grew by over $500 million here in Q3 as we continue to realize the impacts of our customer acquisition and relationship deepening initiatives. This enabled us to pay down high-cost non-customer funding sources like brokered CDs during the quarter.On the loan side, all 3 of our major consumer and commercial loan segments once again saw net balance growth during the quarter, led by growth in our auto finance business. With that said, it's clear that lending activity has slowed in most categories as compared to 2022.Shifting to the income statement. Funding costs continue to be a pressure point for the entire industry in this rate environment. Here at Associated, however, the pace of downward pressure on margin has slowed. In Q3, our NIM decreased by 9 basis points to 2.71%. For the third quarter, we saw a slight increase in our non-interest income. Our third quarter non-interest income grew by 2% versus the prior quarter, partially offsetting the ongoing pressure on NII.And as always, we're continuing to monitor asset quality closely. Our net charge-off ratio came in at 25 basis points for the quarter as we added another $22 million in provision and held our ACLL ratio flat at 1.26%. While several key credit metrics have ticked up slightly compared to the prior quarter, we consider the data to be consistent with a gradual normalization to pre-COVID performance levels. We have not seen anything to suggest trouble on the horizon for a specific industry or geography.On Slide 3, we highlight our deposit trends for the third quarter. As you know, industry-wide volatility in the spring, combined with an ongoing battle for deposits to create significant funding headwinds for the first half of the year. While much of the volatility cleared up by June, short-term funding and liquidity pressures, combined with the mix shift in customer accounts had a lingering impact on Q2 balance flows. We continue to see some impact from mix shift during the quarter, but the situation has largely stabilized, providing a clearer view of the impacts from our deposit gathering initiatives that started to take hold in 2022.During the quarter, we saw net growth in both consumer and commercial balances and core customer deposits as a whole grew by $527 million or 2%. This growth enabled us to decrease our reliance on higher cost network and broker deposits, which decreased by $418 million or 8% during the quarter. As a reminder, our strategy is to fund our loan growth primarily with customer deposits.We expect to hold wholesale network funding levels in check as we move through the remainder of the year and into 2024. And we remain confident in our ability to fund our growth at a reasonable cost going forward based on our initiatives. Based on year-to-date trends and current market conditions, we're affirming our guidance and continue to expect total core customer deposits to decrease by 3% for 2023, but increase by 2% in the back half of the year.On Slide 4, you can see that the deposit growth hasn't come by accident. As we've discussed previously, our team has been hard at work to enhance our offerings with an eye towards attracting new relationships, deepening existing relationships and increasing retention. It's clear at this point our initiatives [ taken ] hold. Since 2022, we focus on upgrading product and service offerings and have promoted these new offerings with a customer-centric brand strategy.As of the third quarter, our consumer household acquisition rate was up 20% versus the same period a year ago, and our attrition rate was down 17%. Digital has also been instrumental to our success. And through the open architecture of our new platform, we've been able to move more quickly to deploy upgrades and enhancements to make our customers' lives easier. In a little more than a year since the platform launched, we've had 99.9% uptime and have already made 11 customer-facing upgrades leading to a multiyear high in customer satisfaction scores.And finally, since launching our new mass affluent strategy to deepen relationships with high potential customers, we've already added over $550 million in net new deposits, nearly doubling our full year goal by September 30. This growth represents a roughly 12% increase in our pre-launch baseline.So as we've said, our plan is to fund our loan growth with core customer relationships, deposit relationships, and we've steadily continued to execute this plan in the face of a challenging funding environment. As a result, we're bringing in new dollars and deepening relationships with a customer base that is more satisfied.Shifting to Slide 5. We've steadily added high-quality loan balances to our portfolio with another $344 million added here in the third quarter. This marks the [ 6 ] consecutive quarters, which all 3 of our major loan segments have reported net growth. While growth has continued throughout the year, the pace of growth has slowed. And it's clear that pipelines have also slowed as customers make a more cautious approach in what appears to be a higher for longer rate environment.During the third quarter, we again saw moderate growth in our auto finance portfolio where we continue to focus squarely on prime and super prime clientele. As a reminder, we do not intend to come disproportionately reliant on auto loans. But the portfolio continues to provide us a high-quality yield-friendly option to diversify our consumer loan book away from lower-yielding non-relationship assets such as third-party originated mortgage.On the commercial side, our mortgage warehouse business led the way during Q3, but that's not something we would expect to become a theme. Looking forward, it's clear that the lending environment has begun to slow for the industry, but we continue to seek selective growth that emphasizes relationships, quality and diversification while delivering accretive returns. This enables us to deemphasize lower yielding non-relationship asset classes over time. Given the slowdown in the lending environment, we now expect total loan growth of between 5% and 6% for 2023.So finally, on Slide 6. Our team once again [ impaired ] solid revenues with diligent expense management during the third quarter. Given the funding pressures facing the industry, our PTPP income dipped to $125 million or $8 million lower than the second quarter. But despite these funding pressures, our year-to-date PTPP income is $68 million higher in 2023 than it was in 2022, a 20% increase.With that, I'll hand it over to Derek Meyer, our Chief Financial Officer, to provide further detail on our margin, income statement and capital trends for the quarter. Derek?

[Derek Meyer, executive]

Thanks, Andy. I'll start by highlighting our asset and liability rate trends through the third quarter on Slide 7. Our total asset yields have continued to rise due to rising rates and the repricing nature of a large segment of our loan book. Since the start of the rate cycle, total earning asset yields have increased by 277 basis points or roughly 53% of the increase of Fed funds target rate over the same period. Commercial and CRE yields have grown the most as we've continued to add new loans in categories such as asset-based lending and equipment finance, while our floating rate back book continues to reprice higher.On the liability side, rising rates, liquidity pressures and a mix shift in customer deposits, [ they ] converged to create significant funding cost pressure for the whole industry. While these pressures have stabilized meaningfully in Q3, they continue to pose a challenge for profitability in the near-term.Here at Associated, interest-bearing liability costs have now increased by 309 basis points since the fourth quarter of 2021. Specific to deposit betas, the S-curve we were planning to see in the rising rate environment has largely played out as expected, but the shape of the curve has steepened meaningfully in 2023 amid the funding cost pressures described previously. As such, our interest-bearing deposit beta has now climbed to roughly 56% since the start of the rate cycle.Moving to Slide 8. The funding cost pressures facing the industry combined to drive a 9 basis point compression in our NIM in Q3. While pressures remain, we view this trend as a clear sign of stabilization compared to margin trends in the first half of the year.This stabilization was also demonstrated by our dollar net interest income, which decreased by just $4 million after significant pressure in Q1 and Q2. As we mentioned previously, however, we're not relying solely on the rate environment to dictate our earnings going forward.We benefited from a natural asset sensitivity over the past couple of years as rates have risen, but we've also taken actions on both sides of the balance sheet to decrease that sensitivity and drive more durable interest income in future quarters.Whether it's adding high-quality customer loans, core customer deposits or layering in interest rate hedges, these actions have been designed to provide our company with additional flexibility to maintain our performance through the cycle.As a reminder, we do not intend to call the peak on the interest rate environment in the near-term, but we will continue to take reasonable steps over time to manage our asset sensitivity and downside rate risk.As you can see on the right-hand side of this slide, these efforts have gradually decreased our asset sensitivity over the past several quarters. We expect to continue benefiting in a rising rate or higher for longer scenario, but we're also better positioned for an eventual decrease in rates over time. The macro outlook remains uncertain, but based on our current expectations for balance sheet growth, deposit betas and Fed action, we now expect net interest income growth of between 8% and 10% in 2023.On Slide 9, we continue to manage our securities book in the third quarter to remain within our 18% to 20% target. Since the third quarter of 2022, the [indiscernible] securities book has risen by 74 basis points, but we've continued to [ reign ] in our durations to reduce our longer-term rate risk.After adjusting our CET1 capital ratio to include the impacts of AOCI, this impact would have represented a 101 basis point hit to CET1 in the third quarter. This impact is up slightly from the prior quarter, primarily driven by the rebound in rates. As a percentage of total assets, our investment, security and cash positions were maintained at roughly 20% for the second straight quarter. We continue to target investments to total assets of between 18% and 20% in 2023.On Slide 10, we highlight our non-interest income trends. Despite the downward pressure from market-driven headwinds and adjustments to our fee structure, non-interest income grew modestly for the third straight quarter and landed at $67 million. The primary factors for the quarter-over-quarter increase were a $1 million increase in asset gains and modest increases in service charges and deposit account fees and wealth management fees.With that said, we continue to expect total 2023 non-interest income to contract by -- between 8% and 10% versus 2022. As a reminder, this anticipated compression is driven by current market dynamics and moderation in deposit account fee income due to OD NSF changes we made in the back half of 2022.Moving to Slide 11. Our third quarter expenses increased by 3% versus the prior quarter but were flat with the same period a year ago. We continue to make targeted investments in people and technology to support our initiatives. Our FTE efficiency ratio rose to 58.5% during the quarter, but it remains 29 basis points lower than the same period a year ago. Additionally, our non-interest expense base has remained below 2% as a percent of average assets and is now down 18 basis points from the same period last year.While we continue to invest in strategies to support our growth aspirations in 2023, we are committed to keeping expense growth below revenue growth over the long-term. On an ongoing basis, we will continue to pursue opportunities to optimize our expense base where possible.With that in mind, we expect total non-interest expense growth in between 3% and 4% in 2023, but would note that this number excludes the impact of any non-recurring items incurred in the fourth quarter, such as FDIC's special assessment.Shifting to Slide 12. We continue to prioritize paying a competitive dividend and funding organic growth while managing capital levels towards the target ranges. Here in the third quarter, our capital ratios grew versus the prior quarter and versus year-end 2022. We remain comfortable with our capital levels as we look out over the remainder of the year.Given current market conditions and the expectation for short-term rates to remain elevated in the near-term, we continue to expect TCE to land at the 6.75% to 7.25% range by year-end. We've increased the upper end of our CET1 target range and are now targeting a range of 9% to 9.75%.I'll now hand it over to our Chief Credit Officer, Pat Ahern, to provide an update on credit quality.

[Patrick Ahern, executive]

Thanks, Derek. I'd like to start on Slide 13 with an update on our allowance trends. We utilized the Moody's August 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 a continued deceleration of inflation. Our ACLL increased by $4 million during the quarter to $381 million.Our allowance continues to be driven by a combination of portfolio loan growth, nominal credit movement and general macroeconomic trends that reflect the stability of our Midwest footprint. Accordingly, our reserves to loans ratio remained flat to the prior quarter and 6 basis points higher than the same period a year ago at 1.26%.Moving to Slide 14. Our quarterly credit trends remained relatively stable across the portfolio during the third quarter with migration reflecting a broad-based normalization in portfolio performance. We did see moderate increases in non-accrual loans, delinquencies and charge-offs during the third quarter, but as previously discussed, we anticipated these shifts as a sign of normalization back to pre-pandemic levels as opposed to an indication of broader issues in the portfolio. As Andy mentioned, we have not seen anything to suggest a pattern of credit stress in a specific industry or geography.We added another $22 million in provision during the third quarter, which matches our second quarter provision build and is consistent with the past 4 quarters. As mentioned, this provision build was largely a function of loan growth, limited credit movement and macro trends. We remain focused on monitoring the uncertainty of the macro economy to ensure current underwriting reflects elevated inflation, supply chain disruption and labor cost, to name just a few economic concerns.In addition, we continue to maintain specific attention to the effects of elevated interest rates on the portfolio, including ongoing interest rate sensitivity analysis bank-wide. Going forward, we expect any provision adjustments to continue to reflect changes to risk rates, economic conditions, loan volumes and other indications of credit quality.On Slide 15, I'll remind you that our conservative approach to credit has been optimized over the course of the past several years as we've built a diverse portfolio of high-quality commercial loans and a focus on prime and super prime consumer portfolio.While CRE has been cited as an area of risk in the media for the past several quarters, we feel well-positioned given the conservative approach we've applied across the bank. In building our CRE portfolio, we focused on partnering with well-known developers in stable Midwest markets.Over 2/3s of our portfolio is based in the Midwest with an emphasis on multi-family and industrial properties. Office loans represent just 3.4% of our total loans as a bank. And within that portfolio, we are weighted towards suburban Class A properties. While we feel well-positioned given our business model approach and the markets we operate in, we continue to monitor this in all of our portfolios closely.With that, I will now hand it back to Andy to share some closing thoughts.

[Andrew Harmening, executive]

Thank you. I'd like to close out by reiterating a couple of key points from our presentation on Slide 16. First, we've set ourselves up to drive quality, relationship-focused loan growth that decreases our reliance on lower yielding, non-relationship balances and enhances our profitability profile. However, given the recent slowdown in the lending environment, we now expect a total loan growth of between 5% and 6% in 2023.Second, the deposit environment has clearly stabilized following a volatile first half of the year. The stabilized environment, combined with our deposit initiatives, drove strong core customer deposit growth in the third quarter. With that said, we're leaving our guidance unchanged for the full year, given the seasonality we typically see in balance flows as we approach year-end.Shifting to revenue. We've adjusted our most recent forecast for balance sheet growth, deposit betas and rate environment. We now expect to deliver net interest income growth between 8% and 10% in 2023. And lastly, our disciplined approach to expenses remains a foundational focus for our company. As such, we are maintaining our non-interest expense guidance for the year, but would note that this guidance excludes non-recurring items incurred in Q4, such as the FDIC's special assessment.With that, let's open up for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Daniel Tamayo with Raymond James.

[Daniel Tamayo, analyst]

Maybe first, just on the non-accruals, the increase in C&I. I know you mentioned there was not really a pattern to that increase. But if it's just a normalization of credit costs, just curious how you're thinking about what we should, or how we should be thinking about what normalization of net charge-offs or even provision could look like?

[Andrew Harmening, executive]

I would say, in terms of net charge-offs, we saw a little bit of a spike this quarter, but I think last quarter was probably a little more normal than what we saw this quarter. I think these are just a handful of things. I think non-accruals could be -- going forward, we're going to watch as credits normalize back. Where they settle at, it's hard to say right now. And for provision, we're probably pretty consistent over the last couple of quarters and I would expect similar pattern.

[Daniel Tamayo, analyst]

And then looking at the loan growth, I'm just curious what the thought is in terms of future loan growth, where that might come from? And then if you could touch on where new loan yields are for those categories, that would be helpful.

[Derek Meyer, executive]

Yes. So obviously, the auto has been pretty steady and we expect that to continue. We haven't moved the credit box. It's getting bigger, so you would normally expect the rate of growth to drop, but we also expanded into our footprint states. And so the dollar increases are -- is steady. I think this quarter, we -- like most quarters, we expected balanced growth. So you would have -- we would have, in our prior guidance that we just took down, expected similar growth in C&I.And while we've continued to have more new names this year and grow that year-over-year because of our RM hires, we saw the back of our pipeline not replenish and pull through into additional fundings at the pace we saw earlier in the year. And so that has pulled through into our guidance. And then we'll think about how we position that for next year when we give 2024 guidance. We really haven't been sharing new production yields. So I won't go there, but that's how things have been materializing.

[Andrew Harmening, executive]

But I'll say, with regards to portfolio growth, it's important to know where you're growing and where you're not. And where we're not growing is on the third-party originated mortgages and that by far has been the lowest yielding portfolio that we have. So when we stopped origination of that portfolio, which in its peak, I believe, in 2020, was just around $1.5 billion in production and a $1 billion and then we shut it down. So basically, you'll see a runoff on the balance sheet or decrease in that category, which means that our residential real estate most likely won't grow at the pace of the market. We believe that over time, we'll be able to replace that with quality C&I business.Today, clearly, CRE is a very stable, low to no growth category, although pay-downs have been a little bit slow. So I think over time, you'll see that in the C&I. With regards to fourth quarter numbers -- we just took a hard look at our pipeline and we also took a hard look at relationships that may not have -- be [ full ] relationships. And so, we won't extend or be aggressive in those that are lower yielding and those that are not full relationships and usually those are tied together. So that's a little bit of the reason that we've adjusted the year-end forecast on full growth.

[Daniel Tamayo, analyst]

And then just lastly, a high-level question. You touched on third-party origination mortgages. But I guess just for that asset class overall, have you thought about or would it -- is there a way that it might make sense to sell perhaps some of those loans to kind of reset the margin to a certain extent? Or is there a breakeven point or a place where rates could get to where that could be more attractive?

[Andrew Harmening, executive]

Well, I mean, Dan, you know it's been a pretty interesting market the last 6 months. And so over that period of time, we've looked at every loan category. We've looked at every security. We've looked at tranches of tranches. And what I would say is we know our portfolio as well as we could know it right now. If there comes a time when there's an opportunity in one of those tranches, we'll be prepared for that. Right now, we're not prepared to speak to that.

[Operator]

Our next question comes from Jon Arfstrom with RBC Capital Markets.

[Jon Arfstrom, analyst]

Looking at Slide 8, and I don't know if this is Derek or Andy, but can you talk about just the cadence of when you think your margin might bottom out? I mean when I look at Slide 8 and Slide 7, it sure seems like some of the pressure on interest-bearing liabilities is starting to fade a little bit and you're getting the asset repricing. But would you guys say we're at or near a bottom on your margin?

[Andrew Harmening, executive]

Well, Jon, it's a good question. I can tell you I feel a lot more certainty than I did on March 10. When we look at the last few months, it's been pretty interesting. The one encouraging sign -- several encouraging signs, I would say, is we've seen a decrease -- I talked about the decrease in attrition that we've experienced. That helps us understand what the volatility is going to be. We've seen a -- I think we're pretty near the bottom on our non-interest-bearing deposit percentage. We don't see it going down significantly from where it is. And that slowdown that we saw this quarter, we actually expect it to slow down again in the fourth quarter. And that's why we have confidence that we're getting near the bottom.We think knowing that, that non-interest-bearing is where it is, then the question becomes, what is your asset growth, what can you put on at higher yields. And that's what is to be determined what the market will allow. We won't force it. We're not going to force growth for growth's sake as we go into the end of this year and the beginning of next year. But we think there will be some modest growth out there for us.When you put that in at higher yields, that, of course, takes the place of -- creates less pressure on that margin. So we expect the margin pressure to continue to decrease in the fourth quarter. We do believe that in 2024, we will see an inflection point in there. Of course, it's based on multiple variables, but the number one positive that I see right now is hitting a terminal number, getting close to the terminal number on non-interest-bearing deposits.

[Derek Meyer, executive]

Yes, I don't think I -- there's not a lot to add from my standpoint.

[Jon Arfstrom, analyst]

Slide 3 on the customer CDs versus brokered CDs, can you talk a little bit about what you did there and how you attracted the customer CD balances? And should we expect more of that in the next couple of quarters?

[Derek Meyer, executive]

Yes. Our customer CD balances have been largely the same rates for quite some time, I think even towards the end of the last quarter. And in fact, now we're [ toiling ] with the idea of dropping the promo rates a little bit this quarter, the [indiscernible] continue to hold. It sounds like we're getting some interference, but [ let's ] see if we can continue to hold their production. So that strategy has worked well and we stayed fairly short. Most of our production all along this year has been in the 7-month CD. And that -- it really -- that's about the only story there. The brokered CDs, we've stayed short all along when we first went into them. After Silicon Valley, we mostly went into 3 months with -- for almost everything.And then as things progressed and we wanted to make sure we had secured funding coverage, we've -- that grew a little bit more. And then we've just spread out the maturity buckets so that we don't have a large lump anywhere. And then as we get short-term deposit growth or long-term deposit growth, we have the option each month, whether we want a rollover piece or just pay it down. And that was very helpful this quarter, obviously.

[Andrew Harmening, executive]

And so, I maybe expand on that even a little bit, Jon. When I -- you started with how we've attracted customers in CDs and I would even stop that question short and say how have we attracted customers. And when I look at -- one thing that gives me confidence heading into 2024 is we have made purposeful actions towards product, marketing, digital in our approach to business. What we're seeing is we are reversing -- literally in the process of reversing a multiyear trend on customer growth. And it's going in the right direction. And we've reversed that trend and what many would argue as one of the most volatile years we've had for regional banks in the past decade.So when we look at that -- those customers, when you marry that customer growth with customer deepening tactics, whether that goes into a CD, whether that is managing the back-end tranche of a CD, whether that goes into a money market, whether it goes into non-interest-bearing, there's no doubt that when you have customer growth, you create a tailwind for yourselves. So in a market that is normalizing to some extent, we've put ourselves through the initiatives we've had in a pretty good position on the foundational customer growth.

[Jon Arfstrom, analyst]

And then just last thing. Andy, I travel a lot, and I'm trying to look at my calendar, but when do we expect the timing on the big reveal of Phase 2? And is this strategic, quantitative or both? What can we expect when you give us Phase 2?

[Andrew Harmening, executive]

I was a little nervous that you're going to ask me to predict the future of the packers here in the fourth quarter when you did that lead-in. We're putting that together right now, Jon. It's not long. I mean, we're nearing the end of October going into November. We will be in the fourth quarter just as fast as we can put the right, accurate presentation together. So it's been something we've been working on for a little bit, but it will be later in the fourth quarter. Exact times shared in the near future.

[Jon Arfstrom, analyst]

Strategic and quantitative, both, is that what we can expect?

[Andrew Harmening, executive]

With regards to the plan, of course, it will be strategic. We will give indication of what key metrics are going to happen on the financial side. We don't want to put every number into your model, Jon, and put a lot of pressure on us.

[Jon Arfstrom, analyst]

No, I'm waiting. I'm just here waiting.

[Operator]

Our next question comes from Scott Siefers with Piper Sandler.

[Robert Siefers, analyst]

I guess I wanted to take another stab on the NII. So it looks like it's a fairly wide range of possible outcomes for the fourth quarter, anywhere from down just a bit to actually up to several percentage points. I guess just, sort of in your view, what would have to happen for NII to have bottomed out at the current level? And I know that there must be some confidence that it may have bottomed out or could even go higher. I mean, what are sort of the puts and takes as you sort of think about that range of outcomes?

[Derek Meyer, executive]

So the way things look right now, Scott, the rate of non-interest-bearing DDA runoff and the impact that had on our margin abated considerably. That was really a bigger story, Q1 to Q2. And so you still have a fair amount of low-cost deposits moving into higher cost deposit products. It was probably a little stronger than we thought. For things to bottom out, you really need to get to a spot -- And this is where most of the longer-range scenarios start to look like for us even with a few rate cuts next year, where loans continue to reprice. We've got a big fixed rate book in those -- the old ones reprice into pay-down and new ones get booked in at much higher rates, particularly in auto.And then the deposits finally stabilized. And so you see these scenarios where you get 2 or 3 or 4 basis points of asset rate increases and -- because of both mix change, a little bit of rate curve. And then you just see the deposits stop increasing and that abating. That's very -- we think there's a big psychological lever there if the Fed stops raising rates because consumers don't look at the back of the yield curve and think about should they be doing something else with their money as much as they do the headlines of continued rising rates. When that happens, you start to model out slower increases in deposit rates than the repricing of the fixed rate loans. It's very subtle. That's why it's hard to call. You can be off by a couple of basis points, and it goes the other way [ on you ].

[Robert Siefers, analyst]

And then I guess, Andy, just -- I guess, maybe the answer is stay-tuned to December. But I know in the past you've alluded quite a few times to the importance of positive operating leverage creation. Are you thinking that's something that's kind of important and doable in 2024? Or should we sort of think about it -- like the way you think about it, is that sort of a broader -- is important over the long-term as opposed to in each individual year?

[Andrew Harmening, executive]

Well, it will take a lot for me to give up on that in 2024. So for any of my own colleagues listening, I'll tell you, that's our goal for 2024. And so we're looking at both sides. We're looking at what the expense side is and we're looking at what our investment -- strategic investment when we start to look at the shift in our balance sheet. And my question to the team will be, is, how fast can we do it? And part of that's market-driven and part of it's execution. On the execution front, I'm gaining a lot of confidence in our leadership team. They've shown their ability to execute over the period since we've launched that initial plan in September of 2021. Albeit we had an interesting 4 or 5 months this year, but you can see the fundamentals still coming through.So as we put that plan together, the challenge put out to the team is to try to drive towards positive operating leverage in 2024. We'll see what the market looks like and what that allows, but that is the message of what we're trying to work for. We don't have the final numbers in place yet for 2024, but that's still the direction.

[Operator]

Our next question comes from Terry McEvoy with Stephens.

[Terence McEvoy, analyst]

Going back to the increase in commercial non-accruals, and I saw at the end of the release, the potential problem loans, I think they were investor CRE. How much of it -- how much of that increase would fall into legacy bucket versus new lending relationships since the end of 2021 and maybe give you a platform to push back on some of the fears out there that Associated was a late cycle grower in commercial and as such may see, I'll call it, a faster normalization of credit trends?

[Patrick Ahern, executive]

Yes. We're not seeing that at all in what's happened this last quarter. We had a handful of deals that moved into non-accrual. And I think -- I don't see -- any of the growth we went through the last couple of years isn't coming back to haunt us. In terms of some of the migration, we've got -- our real estate book we feel is really still holding up strong. The real estate asset class is -- still gets hit by rising interest rates. You've got inflationary pressures, whether it be on insurance, real estate taxes, all the operating expenses that go in there.So I think they're still -- we're still comfortable with how they're weathering the storm, but there's -- as you -- these costs remain elevated, there will be a little more added pressure there. But in our real estate book, the stuff we're doing is with longstanding relationships. We're not outdoing transactional work with one-off customers. These are relationships we've targeted and grown throughout the years.

[Derek Meyer, executive]

Maybe speak to the non-accrual nature and trend of the real estate footprint?

[Patrick Ahern, executive]

Yes, really, I mean, in terms of non-accruals, we haven't seen a lot in real estate. I mean, it's really been more on the C&I side that moved the needle here this quarter. We've had some pretty strong, stable performance in the book.

[Andrew Harmening, executive]

I mean, in fact, the non-accruals have been down each of the past 5 quarters and net charge-offs have been negative over that 5-quarter period. So if that would be the specific question, Terry, we see no evidence of that.

[Terence McEvoy, analyst]

And then maybe just to follow up. I think Scott and Jon asked a similar question. Does the fourth quarter expense guide -- I saw non-recurring items, I was thinking related to the Phase 2 of the strategic plan, not the FDIC expense. So does the fourth quarter guide reflect any strategic Phase 2 expenses? And will we see a step-up in expenses next year due to this announcement that will come out this quarter?

[Andrew Harmening, executive]

I'll speak to -- even though we haven't given guidance on 2024, our approach has been the same each of the last 2 years. We've gone into each year. And when I came into this role, folks suggested that maybe there was no room to cut. There's always room to cut. There's always room to cut for the next best investment that you need to make. We've made those in each of the last 2 years. We see opportunity for investment right now. And before we do that, we see opportunity to decrease expenses in some areas. So that will be the approach that we have.When we think about new initiatives, people say, gosh, well, you're going to have very high expenses. We have not in 2 years. We will not next year. So that's what allows me to feel like we're in the game with regards to positive operating leverage next year, even though we need to fine tune and see where we end up. With regards to expenses, we don't necessarily have any extraordinary initiative -- spike in the fourth quarter as a result of initiatives that we're planning.

[Terence McEvoy, analyst]

Yes, I was one of those people and you proved me wrong. So I hear you loud and clear, Andy.

[Operator]

Our next question comes from the line of Timur Braziler with Wells Fargo.

[Timur Braziler, analyst]

Looking at the auto finance book, I'm just wondering how close that book is to reaching a point of maturity, meaning that you're starting to have some loans pay off? I'm assuming that starts to accelerate somewhat in '24. And as that process happens, I'm just wondering what your expectation for growth is there? Is it expansion into some newer markets? Is that enough to offset that level of maturity? Or at some point should we see payoffs and kind of maturing loans in that space eat into the growth?

[Andrew Harmening, executive]

Yes. That -- the payoffs already happened. I mean that book is interesting. The duration of it has typically been -- historically been and for us been 36 months or less. And so you're seeing that -- we're seeing that already on a monthly basis. And so it's -- one of the positives about a book like that is that you do work through it. With regards to what happens in the future and the growth of that, we'll be purposeful in having a exposure to auto. And you'll see that start to peak out in what the growth is, hold steady and then probably go down a little bit over time.Which quarter that happens in is -- I wouldn't predict exactly what that quarter is, but it won't be a runaway portfolio. Our goal is not to be simply known as the auto bank. We have and continue to invest in commercial. We think we have a significant opportunity. In fact, market data shows us that we're underpenetrated in deposits in key markets for commercial. We've been working very diligently on bridging that gap. We think that we are. And so when we look at that and we look at the loan side, we think there's opportunity in commercial.

[Timur Braziler, analyst]

And then maybe from a credit standpoint and how the growth in auto corresponds with CECL accounting, I mean the look back has been nothing so far really just given how new that business line is. However, historically, consumer auto tends to have a higher level of charge-offs. I'm just wondering how you're thinking about growth in that portfolio and how you're modeling that from a CECL standpoint? And could we actually see a meaningful step-up once that book does start to normalize and we see charge-offs move to more or less of a normal level there?

[Andrew Harmening, executive]

Yes, Tim, I'll start that and I'll flip it over to Pat. But I saw that in a note that you had talking about the higher level of charge-off and I wonder for mixing strategies. And by that, I mean, this is a prime and super prime book. We know that the charge-off rate is [ what ] through the cycle, about 35 basis points to 45 basis points. I consider it a low-risk book. We have about $10 billion in consumer finance on our books of prime and super prime, primarily in real estate between home equity and residential. And we don't see -- we see that we're lending to very similar customers in a balanced scorecard model.So we've actually seen an increase in credit bureaus over the last 12 -- credit bureau scores and those scores that we lent into this portfolio in the last month, for example, is a FICO of 783. And I believe it was around 780 the month before and the overall book is between 760 and 770. So I don't consider this a high-risk book at all, and -- because we're lending to people that pay us back and we're lending in a fashion that takes in multiple variables to calculate the risk parameters.How else would you answer that, Pat?

[Patrick Ahern, executive]

No, I think that's a good summary. I mean we haven't seen the maturation level yet, but we're -- metrics in terms of charge-offs, delinquencies, et cetera, are tracking in how we would expect it. And we've been very happy with the deals that have gone into it and how they've performed. Like Andy said, we're in that prime and super prime space. So it's really kind of aligned with what our expectations were.

[Timur Braziler, analyst]

And then just last one there. Can you provide an update on how big that dealer network is and what that growth rate is expected to be in '24?

[Patrick Ahern, executive]

Yes, [ we've ] about [ 1,300 ] dealers right now. And as Derek said, we're expanding within the footprint. I would say we'll go through the same course of our business model in terms of adding dealers where it makes sense based on their quality and how they fit our model.

[Andrew Harmening, executive]

Tim, we haven't provided guidance for 2024 yet.

[Operator]

Our next question comes from the line of Chris McGratty with KBW.

[Christopher McGratty, analyst]

Just a quick one on the capital change on Slide 16. The bump up on the high end, Andy, is that just a function of where you're running 9 months through the year? Or is it -- are you trying to signal that you're looking to run with a little bit more capital in this kind of economy?

[Andrew Harmening, executive]

Chris, I wanted to answer your question. Derek literally called me off right here.

[Derek Meyer, executive]

I didn't know such thing. So the question we would have gotten if we didn't move it is, oh, I see you above your target range because it was [ 9.50% ] before, is how you're going to do a buyback. So we're not -- so we bumped the high end up. It's as simple as that.

[Andrew Harmening, executive]

He really did want to answer that question, Chris.

[Christopher McGratty, analyst]

It took 52 minutes, sorry.

[Andrew Harmening, executive]

I think we have one more in queue, [ Ben ], do we know?

[Patrick Ahern, executive]

Alicia?

[Andrew Harmening, executive]

Alicia, are you there?

[Operator]

Yes. Sorry about that. The next question comes from the line of Brody Preston with UBS.

[Brody Preston, analyst]

So unfortunately, like Jon, I also travel a lot, and so I'm in an airport right now. So if there's background noise and/or if you can't hear me, I apologize in advance, all right? I wanted to just quickly ask you about the fees. I know you maintained the guidance, but just given this quarter's results, when you kind of flow through the guide, it implies a bit of a step-down in the fourth quarter. And I just wanted to know if there was anything specific driving that?

[Derek Meyer, executive]

There's not. We've had pretty strong mortgage fees the last 2 quarters related to MSR valuations going up. That won't continue at that level. But otherwise, there's no specific guidance that would suggest a step-down from our standpoint.

[Brody Preston, analyst]

And I also wanted to just ask generically on the loan book. If you could give us the portion of the loan portfolio that has shared national credits? And of that, what's your -- the lead agent on?

[Patrick Ahern, executive]

In terms of the makeup of our SNC portfolio, the largest concentration of that portfolio is within both Power & Utilities and our REIT business. Both those lending verticals reflect the successful business model we've had there for many years. Those lines of business as well as the full SNC portfolio continue to perform very well from a credit standpoint. So we're happy with it. We view SNCs as something that we review both on the front-end very specifically to make sure it fits the business model. And we're doing -- we continue to do from an underwriting and portfolio management standpoint, we do the same from a credit standpoint with those deals as direct deals.

[Brody Preston, analyst]

Do you happen to have what portion of the loan portfolio it is?

[Andrew Harmening, executive]

Yes. Brody, that's not something we disclose. And with regards to what were the lead-in, for me, when I think of it, we're trying to lend into industries and customers that we understand. And with that, we see this as a fairly low-risk portfolio. From my perspective, the question I have for the team is not that would we get out of these credits from a risk standpoint, but would we get out of these credits from a return standpoint. And so we've spent the last, I don't know, 4 months looking credit by credit across all of our portfolios. And I see credits in every single -- almost every single portfolio of the bank that I believe that we could replace with a higher-yielding asset.And so as we go quarter-by-quarter, that will be the goal. But with regards to SNCs, there's not a view that this is a high-risk portfolio and we've not seen the emergence of that or indication of it, particularly in businesses that we've been in for an extended period of time that have those type of loans.

[Brody Preston, analyst]

And then on the office portfolio, do you have what the reserve that you're setting aside against the office loans is?

[Patrick Ahern, executive]

Just a second here. I want to say we've been building that. I don't have that specific number in front of me, but we've been building that over the last couple of quarters. Our office portfolio has continued to remain pretty stable. We have not seen a lot of degradation there, but we do have an outsized reserve against it, just given the uncertainty in that market.

[Brody Preston, analyst]

And then Andy, I do just want to ask one last one just on the 2.0 version of the plan that we're going to get here down the road. Are those going to have kind of like any medium or longer-term profitability targets that you're going to set out to achieve?

[Andrew Harmening, executive]

Yes. Brody, what I'll say about that is I try very hard not to get in front of the board. And so we'll be meeting with them over the course of the next 10 days to go over in detail. Once I make sure that I have proper governance, I am very prepared. In fact, they're holding me back from sharing what we're going to do. So they're fair questions, they are good questions and we intend to have something later this quarter before year-end that announces specifically what actions we intend to take. So I hate to delay it that way, but I must in this case.I think that's it, Alicia. Thank you all for the interest. We appreciate that and we look forward to further conversations.

[Operator]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.