Associated Banc-Corp

NYSE:ASB

Earnings Call Transcript 2022-Q4

[Operator]

Good afternoon, everyone, and welcome to Associated Banc-Corp's Fourth Quarter 2022 Earnings Conference Call. My name is Dough 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 24 and 25 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, Dough and good afternoon, everyone and welcome to our yearend 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 then reflecting on 2022 as a whole. From there, Derek will walk through the update on margins, income statement trends and capital, and then Pat will provide an update on credit.

So no matter how you slice it 2022 was a statement year in Associated's 162 year history. It was driven by a relentless focus on customers and on our colleagues. We executed against our strategic plan with several milestones achieved in 2022. We staffed and ramped up new commercial and consumer verticals that have since met or exceeded their initial targets, given us a little bit more flexibility to drive balance, loan and balance deposit growth for the bank.

We attracted top talent from several major competitors within our footprint and added 20 net new commercial RMs during the year, giving us momentum as an employer of choice. We launched the most significant digital platform upgrade in our company's history with our new associated bank digital platform and then within 90 days we follow that up with a new account opening platform. This gives us a much improved digital experience for our customers and the ability to make future enhancements more frequently. And leveraging these digital enhancements we officially launched new mass affluent and digital sales strategies, giving us the ability to attract and deepen more quality customer relationships.

All of these efforts have enabled us to drive positive operating leverage, improved our returns and serve our customers more efficiently and more effectively. And while we've grown a lot in a lot of ways in 2022, it's important to reiterate that we've done so in a controlled fashion. We remain firmly committed 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.

These results also set the table for 2023. And in January, we continue to be impressed by the strength and resilience of our midwest markets in the face of macro uncertainty. Unemployment rates remain stable and with Wisconsin and Minnesota continuing to come in below the national average. Our consumers remain resilient with increased debit and credit card spending levels in December of '22 versus December of '21.

Our business customers continue to preserve and pursue growth and expansion opportunities where it makes sense but the uncertain macro environment is front and center in all conversations. Taken together with the rising rate environment these trends have enabled us to enjoy another strong quarter here in Q4 and have given us momentum into the new year. We continue to monitor the significant macroeconomic and geopolitical question marks that remain. But we believe we put ourselves in a good position to build on our momentum and drive value for our stakeholders without stretching to take additional risk.

With that, I'd like to highlight a few items outlined on slide 2. Our fourth quarter results reflected continued loan and deposit growth, further margin expansion and benign credit impacts. We once again saw strong long growth across all major segments. But as we anticipated, the pace of growth slowed somewhat versus the prior quarter in most key categories. Based on a combination of our customer activity in our markets, the execution of our strategic plan and the rising rate environment, our net interest income increased 9% quarter-over-quarter and 55% versus the same quarter in the prior year. With the expenses held flat for the quarter, we once again drove positive operating leverage, and we pushed our return on common equity north of 16% for the quarter.

On the credit side, we're continuing to closely monitor our portfolios, but fourth quarter trends remain benign. During the quarter, we saw just two basis points of net charge offs. We did add provision again this quarter, but as once again largely a function of our loan growth.

Looking at 2022 as a whole, our fourth quarter results were a fitting exclamation point on what has turned out to be the most profitable fiscal year in Associated's bank's history. Through a combination of strengthen our markets, execution of our growth initiatives and help from rising rates we drove a 41% increase in PTPP income, posted double digit operating leverage and added nearly $4.6 billion in high quality loan balances. Despite a $121 million provision driven headwind versus the prior year, we were still able to drive a 6% increase in our net income available to common equity year-over-year. And while we're proud of these accomplishments, our focus is on building off this momentum in 2023.

With that, I'd like to provide a little bit more color around our loan trends. Slide 3, once again, underscores the broad diversified impact of Associated's loan growth story. For the third consecutive quarter, we reported growth in nearly every major loan vertical. Our construction portfolio led the way with the bulk of balanced growth driven by funding of prior commitments and a slowdown and pay off activity as opposed to new production. We did see broad high quality long growth in several other businesses. But in most cases, the pace of growth slowed versus the prior quarter as expected.

Shifting to slide 4. This annual view of our loan trend shows a clear picture of the broad base growth and optionality provided by our various lending initiatives. As discussed in the past, this dynamic reflects the strength of our markets and franchise, but it also highlights the diversified nature of our initiatives. This gives us additional levers that we can pull to drive balanced, durable growth across the portfolio over time in different economic and different economic environments without feeling like we need to stretch in one particular area.

Slide 5 provides a bit more color on the status of our strategic initiatives. As we discussed last quarter, our effort to bolster our commercial ranks with talented RMs in markets like Milwaukee and Chicago, have played a significant role in adding quality core commercial loans to our balance sheet. While some of the balances came from draws on existing lines, we also increase the volume of new commercial relationships by 57% year-over-year, with a vast majority of new names coming in our core three state footprint. This activity helped us achieved our four year commercial loan growth target by September, but it also sets us up to drive a more holistic relationship that includes deposits, treasury management and other services.

We expect to see additional core commercial loan growth in 2023 but at a slower pace compared to '22. Our new ABL and equipment finance verticals also established solid momentum throughout the year as each team developed their respective pipelines and steadily added balances as a natural fit for our customer base. As a result, the team's comfortably cleared their $300 million growth target for '22 and we expect to continue growing these businesses in 2023.

On the consumer front, our auto finance team has continued to produce high quality fixed rate loans that helped diversify our consumer loan book. With decades of experience executing a prime, super prime strategy in a variety of environments this team knows the auto business, and their approach is a natural fit for our conservative credit culture. With that said, I've also stated previously that the diversifying impact of our initiatives give us the ability to scale up or down without having to over index on any one approach. And with that in mind, we've intentionally slowed our auto production rates slightly to reflect current market conditions as we head into 2023.

We also continue to expect residential mortgage balances to remain relatively stable through the end of the year. And all in all, we expect to drive a total period end of its loan growth of 7% to 9% in 2023.

Turning to slide 6, we highlight our fourth quarter deposit trends. On an average basis, we grew deposits by 2% quarter-over-quarter and by 3%, versus the fourth quarter of 2021. This growth came despite inflation and increasing competitive pressures in the market and was a reflection of the strategic actions we've taken to cultivate our low cost, granular deposit base and attract and deepen holistic relationships. As we've discussed in the past, we recognized that generating low cost funding is more crucial than ever and particularly as we look to fund our growth strategies on the lending side. While we did add broker CDs and network deposits to our bounces in Q4, a majority of our balance growth for the year was driven by core customer deposits.

We're comfortable flexing wholesale and network funding levels in the short term, but we expect to hold this type of funding and check as we move through the year. We continue to monitor the competitive environment closely and remain confident in our ability to fund the bank at a reasonable cost in 2023 and beyond based on the initiatives we have in sight.

Slide 7 highlights an annual average view of our deposit flows. In 2022 we saw average deposit growth for the 11th consecutive year. Despite the steadily increasing inflationary and competitive pressures we saw throughout the year, we were still able to grow average annual deposits by 4%. On a quarterly year-over-year basis, core customer deposits were once again the driving force behind our growth led by savings, money market and interest bearing demand categories.

Shifting to slide 8. There is no denying that the competitive pressures will be amplified in 2023 as the battle for deposits continues. That's why we've been hard at work for the past year on several initiatives designed to help us cultivate customer relationships, fund growth with lower cost core deposits. In fact, some of these initiatives have already started to have an impact. In '22, we drove a 21% increase in commercial RMs compared to year in '21. This in turn led to a 57% year-over-year increase in new customer names, many of which brought deposits and non-loan business to the bank, as renewed our focus on driving holistic relationships.

These efforts have been complemented by a sharpened focus on businesses that allow us to deepen those commercial relationships, including treasury management, where we've increased sales activity by 50%. HSA where we've hired a new national sales director and other deposit centric businesses.

On the consumer side, we launched a new digital account opening platform providing customers and prospects with a modern simplified digital storefront. This upgrade gave us the confidence to launch our new acquisition focused mass affluent and digital sales initiatives in the fourth quarter. While it is still early, we've seen promising initial production in the segments such as savings and CDs.

With each of these initiatives launching over the course of '22 some have impacted our 2022 results more than others, but all of them are expected to provide a full year impact in 2023. And to further capitalize on this momentum in '23, we've shifted our marketing spend from a sponsorship focus to a customer acquisition with a new brand campaign set to launch next month. And beginning of the second quarter we intend to launch a new product or digital service every quarter in 2023, with an eye towards increased customer and deposit acquisition.

In summary, with the battle for deposits continuing to heat up, we are actively pursuing a variety of levers to drive core customer funding at a reasonable cost. I've directly experienced the launch of similar programs several times in previous stops, I'm confident that we can achieve positive results at Associated regardless of the environment. In 2023, we expect to drive total core customer deposit growth, 3% to 5%.

Finally, on slide 9. Our initiatives have helped generate strong revenues for our company in 2022. Coupled with our diligent management of expenses, we've continued to deliver significant operating leverage and PTPP income growth. For the full year of 2022 our PTPP income grew by 41%. We remain committed to delivering positive operating leverage in 2023.

With that, I'll pull up there and 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 10 highlights our yield trends and the asset sensitive nature of our balance sheet. On the asset side average earning asset yields continue to expand meaningfully in the fourth quarter. Over the course of the year, earning asset yields increased by 187 basis points, or roughly 52% of the increase we've seen in the Fed funds target rate over the same period, reflecting our core asset sensitivity. On the liability side 2022 interest bearing liability costs have now increased 131 basis points or roughly 37% of the move in Fed funds target. While the pace of liability costs started to increase in the back half of the year this increase has largely tracked with our expectations, and we continue to monitor these costs closely.

Despite the rising liability costs in the fourth quarter, we continue to see significant quarter-over-quarter expansion in our net interest margin as shown on slide 10. I'm sorry, slide 11. We view this as a reflection of our recent loan growth coupled with our structural assets sensitivity. Here in Q4 our net interest margin expanded by 18 basis points versus the prior quarter. This expansion equated to a $25 million lift in our net interest income versus Q3 and then a full year basis our NII grew by 32% or $231 million as compared to 2021.

Moving to slide 12. Several factors have enabled us to continue benefiting from the current rate environment. As we've discussed, these factors include our natural assets sensitivity, reduced reliance on wholesale network funding versus the prior rate cycle and our ability to manage interest bearing deposit betas. While we do expect the betas to continue increase into 2023 these broader dynamics have us poised to continue benefiting in the near term.

With that said the lack of clarity around the macro economic forecast carries significant uncertainty for the industry into 2023. As a result, we continued to take meaningful actions to manage to this uncertainty and reduce our interest rate risk. Over the back half of 2022, we executed over 2 billion interest rate swaps. We did not intend to call the peak on the interest rate environment in 2023. But we will continue to take reasonable steps over time to dampen our asset sensitivity and manage our downside rate risk.

While the macro economic outlook remains uncertain, our current expectations are for short term interest rates to rise by 25 basis points, following each of the FOMC meetings in February and March, with a rate cut in October. Based on these assumptions in the balance sheet dynamics I just discussed, we expect net interest income to grow between 15% and 17% in 2023.

Shifting to slide 13. Non-interest income continues to see pressure from the market driven headwinds we've discussed throughout the year, and the customer friendly fee adjustments we implemented in Q3 of 2022. In the fourth quarter, modest increases in wealth management fees on both the income and stabilization and mortgage banking were more than offset by reduction in service charges, other fee based revenue and capital markets.

Also contributing to the quarter-over-quarter decrease was a $6 million investment securities gain recognized in Q3. As a reminder, we expected to see deposit account fee income moderate beginning the third quarter of 2022 based on implementation of the OD NSF changes we announced earlier in the year. These changes were both proactive and pro customer nature. When coupled with our relationship, focused deposit initiatives they give us additional competence in our ability to strengthen our low costs deposit base and enhance our broader profitability profile in 2023. With this in mind, we expect total non-interest income to remain under pressure throughout the year, with compression of 6% to 8% in 2023.

Moving to slide 14. Fourth quarter expenses came in at $197 million, as we continue to scale up our investments in people, technology and business development and advertising. For the full year expenses grew by 5% versus 2021 in support of our initiatives. Despite this expense growth, our efficiency ratio steadily improved throughout the year. On a point to point FTE basis, we've now decreased our efficiency ratio by approximately 11.38% compared to the same period last year reflecting our ability to maintain expense discipline while driving higher revenues.

This point is further underscored by the chart on the lower right, which shows our non-interest expense actually decreased in 2022 as a percent of assets. While we continue to invest in strategies that support our growth aspirations we remain committed to keeping expense growth below revenue growth. On an ongoing basis, we will continue to pursue opportunities to shift expense from underperforming assets to more productive means where possible. We expect total non-interest expense growth of approximately 4% to 6% in 2023.

Shifting to slide 15. We continue to manage capital levels towards our target ranges while supporting growth. We remain comfortable with our capital levels given the enhanced profitability we drove throughout 2022. Given current market conditions and the expectation for short term interest rates to remain elevated into 2023 we now expect to maintain TCE in the 6.75 to 7.25 range. We expect CET1 one to land between 9% and 9.5%.

I will 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 16. We've utilized the Moody's November 2022 baseline forecasts for CECL forward looking assumptions. Moody's baseline forecast remains fairly consistent with recent trends and assumes continued Fed rate action, minimal GDP growth, and modest employment deceleration in 2023. On a dollar basis, our ACLL settled at $351 million at year end. This figure represents another increase in the prior quarter. But that build was once again largely driven by significant growth in our loan portfolios. In alignment with this dynamic, our reserves to loan ratio increased just two basis points from 1.2 to 1.22 during the quarter.

Moving to slide 17. Our quarterly credit trains remained largely benign during the fourth quarter. Non-performing assets, non-accrual loans and net charge offs all decreased from the prior quarter and the same time period a year ago. The slight increase in delinquencies as compared to recent periods largely reflects the normalization of our maturing auto book.

Following a $17 million provision built in Q3, we added another $20 million of provision in the fourth quarter. As mentioned, this provision bill was largely a function of loan growth and not a reflection of larger credit quality concerns within the portfolio. With 2022 representing one of the strongest loan growth years in our history, I'd like to reiterate that this growth has not come from an expansion of our credit box or overextending ourselves in one particular area. The recent growth in our loan portfolios has been driven by investments in our core business, growth of core relationships, and expanding our engagement with familiar customer segments. Our strong credit foundation in place at Associated today was built over the course of a decade. We have an experienced team that continues to work hard to bolster this foundation with a disciplined underwriting culture, improved risk controls and a proactive approach to portfolio management.

With that said, we are fully aware of the warning signs in the economy and we remain stringent in our credit discipline, with current underwriting reflecting elevated inflation, supply chain disruption and labor cost to name a few of the economic concerns, as well as continued interest rate sensitivity analysis across the portfolio. 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. Before we move to Q&A I want to reiterate a couple points from our discussion this afternoon on slide 18. First, we remain confident in our ability to drive quality balanced loan growth throughout the year, but not at the pace we saw in 2022. With that in mind, we expect total end of period loan growth between 7% and 9% in 2023. We continue to work on dampening our asset sensitivity, but we expect to continue to benefit from the rising rate environment in the near term. Based on our current forecasts for balance sheet growth, deposit betas and Fed action, we expect to deliver a net interest income growth of between 15% and 17% in 2023. Lastly, we continue to invest strategically in people and technology and expect non-interest expense to grow by 4% to 6% in 2023. As always, we 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. Ladies and gentlemen, at this time, we will be conducting your question and answer session. [Operator Instructions] Our first question comes from the line of Jared Shaw from Wells Fargo. Please proceed with your question.

[Jared Shaw, Wells Fargo]

Everybody good evening.

[Andrew Harmening, CEO]

Hey Jared.

[Jared Shaw, Wells Fargo]

Maybe starting on loan growth. You had great growth in construction this year. What does the visibility look like into the pipeline heading into '23? And are there any areas you're focusing on or shying away from as we go forward?

[Andrew Harmening, CEO]

Yes. That's a really good question. I'll just speak to the CRE construction that that's a point in time rather than a trend in my mind. We saw the growth because of the funding up of some of the construction loans. And then a brief hesitation on some folks to refinance in the permanent market as opposed to new production that we put out there. We see very little new production, particularly in the industrial side of the equation. The pipelines are significantly down in commercial real estate. So I think you'll see that category moderate, as we go throughout the year.

We expect to have very balanced growth between consumer and commercial and that's purposeful. As you know, we have several levers right now. So we can start to maximize higher performing portfolios, portfolios that are more holistic as opposed to single deals, businesses that will deemphasize third party origination already have we did that in December. And that pipelines frankly flowing through in December and diminishing as we go into January.

So we expect C&I to continue to be solid, but really within our footprint and with holistic relationships. And we've already seen the evidence of that as we brought on RMs throughout the year. That's why we feel like bringing those RMs on during the year it has a full year effect in 2023 and even stronger focus on ancillary business, including deposits and TM.

[Jared Shaw, Wells Fargo]

Okay, and then as we look at margin and spread income, I guess where could we see margins are peaking with some of the changes you took. And then just to confirm as the NII growth target 7% to 9% is that full year '23 over full year '22? Or is that from annualized fourth quarter levels?

[Derek Meyer, CFO]

Jared, this is Derek. Those are full year numbers. And so -- in our guidance on it is based on the yield curve assumptions we made and the loan growth that we outlined in terms of expectation. So we're not giving guidance on where we're calling the peak on race. We sort of talked about that. I talked about that in the script. When we saw, as we went into this year and looked at all the plans, the rate moves even while we were planning in December and even in the first weeks of January, I think it's pretty dangerous to try and call that. What we're really anchored on are the fundamentals are going to drive durable margin.

We came into this very asset sensitive. We are going to remain asset sensitive but we're taking some of that asset sensitivity down which we talked a little bit about with our hedging, but we also are putting a stake in the ground with the outperformance on deposit growth. And you saw that this year, you put that into perspective with the initiatives we put in place. So we've outlined on slide 8, many of which have year-over-year impacts on our ability to generate deposit growth beyond just interest rates. Then you have new initiatives that will have a full year impact this year going out. And then you start to fill in the blanks behind that other kinds of funding that we might need to support that level of loan growth. We're still committed to our 95% loan to deposit ratio. And we still expect our wholesale funding to be below what we had historically during the last time. We had rising rates.

[Jared Shaw, Wells Fargo]

To get to the NII guide, I guess that implies a pretty significant step down in margin as we go through the years is that the right way to be looking at that, even though you're still asset sensitive and we're still expecting a little bit of rate moves up earlier on.

[Derek Meyer, CFO]

Yes, I think what year-over-year it's a full year basis, it's a step up. I think when you look at sequential quarter, you're still trying to and everybody's trying to figure out where is your peak quarter and we're not making that call.

[Jared Shaw, Wells Fargo]

Okay. Okay. And then on capital. Should we expect that you could be more active in capital management to potentially get to the lower end of that range? Or is that just a function of the natural movement of the balance sheet and we shouldn't really be expecting a buyback or any significant change to capital return strategies?

[Derek Meyer, CFO]

Yes we're not looking to change our capital return strategies. It's still dividend in organic growth.

[Jared Shaw, Wells Fargo]

Okay, thanks. I'll sit back. Thank you.

[Andrew Harmening, CEO]

Thanks, Jared.

[Operator]

Our next question comes from the line of Scott Siefers with Piper Sandler. Please proceed with your question.

[Scott Siefers, Piper Sandler]

Good afternoon guys. Thanks for taking the question. I wanted to also ask about sort of NII and trajectory there. So I guess, just looking at guidance suggests that the quarterly average of NII for the full year '23 will be about $10 million a quarter less than what we did in the fourth quarter. Now, granted, fourth quarter was just an extraordinarily strong number. But maybe do you have Derek, a sense for how NII in dollar terms would traject throughout the year? In other words, would we stay high for say, the first half of the year, as long as the Fed is still raising rates and we get that benefit? And then does it taper off? Or was there anything in the fourth quarter that would have kind of elevated it? And then we maybe step down, but have a steadier dollar average throughout the year?

[Derek Meyer, CFO]

Yes, I don't. Again, I don't think I'm going to be that specific. I think we recognize that deposit betas are catching up. When exactly they, which quarter, they catch up, and you see some of that quarterly compression I don't again, I don't think we have that called. So I think we're more comfortable giving the full year guidance. And with the options we've got, we think we can get to that number.

[Scott Siefers, Piper Sandler]

Okay. All right, perfect. And then just given some of the hedging actions that you've taken, or took in the second half of the year, do you have sort of a sense where, like, maybe what, like what might represent a floor for the margin, once it does begin to taper off by any chance?

[Derek Meyer, CFO]

No, we don't. I think you can back into some scenarios, using our asset sensitivity that we have there. if you do some little bit of cowboy math, that a 25 basis point shock might impact you $7.5 million, $7 million on a full year basis. And you can see, we've been managing that down to combination of the swaps and the evolution of the portfolio. Because as far as I'd go with that the biggest [indiscernible]. One of the things that [whether] everybody's faced with and I know everybody on the call is interested in is how do you continue to the hedging strategy with the shape of the yield curve and so, if your natural balance sheet isn't offering you protection or is with some of the growth we've got in the auto book, then you might start thinking about swaps or floors. But we're not at that point yet. And we're still monitoring each quarter and we'd like the progress we're making. And we want to stay asset sensitive.

[Scott Siefers, Piper Sandler]

Yes. Okay. Perfect. Thank you guys very much. Really appreciate it again.

[Andrew Harmening, CEO]

Thanks, Scott.

[Operator]

Our next question comes from the line of Daniel Tamayo with Raymond James. Please proceed with your question.

[Daniel Tamayo, Raymond James]

Good afternoon, guys. Thanks for taking my questions.

[Andrew Harmening, CEO]

Sure.

[Daniel Tamayo, Raymond James]

Maybe another stab at the NII from a different point of view. But just looking at the balance sheet. Would you say you're at the point with excess liquidity now, where you expect that the balance sheet growth to more or less matched loan growth at this point?

[Derek Meyer, CFO]

Yes. So the way I'd characterize it, I mean, that's a shorthand, I haven't done that view, we are going to, we have bottomed out on securities as a percent of fixed assets. So there is a component of our funding plan and deposit growth that includes supporting investments and securities. So it probably gets you closer to what you're talking about.

[Daniel Tamayo, Raymond James]

Yes, that makes sense. Okay and then I appreciate your comment on expecting positive operating leverage in 2023. Is there any kind of environment from a rate perspective that would restrict that the ability to achieve that or you feel pretty comfortable with that guidance?

[Andrew Harmening, CEO]

Yes. Look, that the rate question, the yield question, the impact in the market is being asked on almost every call and just there are obvious reasons. And that's because there's a lot of contradictory information out there to understand what the future might be. With regards to what we see in our portfolio, the tailwind that we have from the growth that we've already experienced in '22 heading into '23, the initiatives that we have that show that we're able to find a little bit, we've been able to fund on the deposit side a little bit ahead of what the marketplace is. Our ability to shift expenses from a low return area to a higher return area all those things at this stage, give us confidence in what our forecast is.

The economy doesn't seem to be falling down quickly in our mind. And there could be a slow roll towards that. We also see pipelines and have conversations about automation, and what that can mean on the loan demand side. And we have a lot of levers there. That's really choosing which levers we want to go forward with. But we believe those exists. Those will match largely what our deposit funding is and that is our expectation. And the other point that I'll make is and I know we're talking about '23, but we're talking about actions we're taking as a company to structurally change how we fund our balance sheet over time.

So that starts to give you more and more competence that we have opportunity for improvement. As we drive those core deposits that means that you over time lessen the wholesale funding. So the answer, the short answer is yes, we have as much confidence as we can have in an uncertain world on what will happen, because we have many tactics and strategies both on the loan side, the deposit side, but also where we invest our capital and where we invest our money on people. And also where we invest in digital versus shifting the digital spend, shifting to digital spend from physical spend. So taking all those things together and the environment we're in we today have a confidence level in the 2023 forecasts.

[Daniel Tamayo, Raymond James]

Appreciate all that color Andy. Just lastly, on the expense guide. It came in below actually where I was looking for it. And I'm just curious in terms of the pace of expense growth through the year, if there's anything that we need to keep in mind or if it's just you're considering rather steady growth through the year. Thanks.

[Andrew Harmening, CEO]

Are you disappointed that's not higher Daniel? Sorry, rhetorical. Sorry, no. The reason that we feel confident in this space is because we've taken an approach, frankly since I've been here, which is we're look very strongly at the expenses that we have and say, are we spending in the right place? Let's start with that. And then we cut expenses in those areas going into the year. We've targeted in the first year of taking out I think it was roughly $10 million. And we have a similar approach going into the year on what do we do in our physical branches, what are we doing in third party origination, which has less, typically less margin in return on it, then we took action with our staffing and as we brought that lever down, so it's not just a function of investing in new areas, it's also simultaneously taking the expense off the table in areas that cannot yield as much to us on the long term.

So when we say 4% to 6%, it's because we are taking actions proactively to cut expenses before we grow expenses. As long as the increase in expense leads to an increase in revenue, we will continue on that path. But we will ask the team also, if it doesn't, where do we proactively slow down the investment. And that exercise already is, already a course of business for our team.

So to answer your question, I like the discipline in an environment where we've been able to grow revenue. I very much like the discipline that we've had with regards to expenses. We also happen to bring in a CFO that has years and years of experience as the head of FP&A. I will tell you, that's not an accident, bringing disciplined execution is very important, not often talked about, but incredibly important when you're trying to balance growth and bring in that discipline towards expense management.

So I feel quite good about the 4% to 6% range. And I will tell you, we're not immune from the issues that everybody has, which is consistently looking at different areas of your business and knowing that we're competing for talent. So we have factored in increases that we have already had to make or going to make with regards to count talents and key areas to retain them.

[Daniel Tamayo, Raymond James]

Okay, great. Appreciate all that. That's all for me. Thanks for taking my questions.

[Andrew Harmening, CEO]

Thank you.

[Operator]

Our next question comes from the line of Terry McEvoy with Stephens. Please proceed with your question.

[Terry McEvoy, Stephens]

Hi, thanks. Good afternoon. In prior presentations, you provided the 2023 loan growth outlook by those three categories commercial down to auto finance. So I guess my question is kind of in an ideal world, what bucket would you like to grow and how would you like that mix of growth to be in 2023 and is auto finance kind of the filler so to speak, because to allow you to hit that target, given just some of the lower returns that we hear in the marketplace?

[Andrew Harmening, CEO]

Yes, it's a great call out Terry. And what I would say is we have a lot of levers. And we want to see where the year is going, as opposed to going in the middle of the year and say, we're going to go hard in this asset class, only to find out that maybe that is not the area offering the best returns.

And so we look very closely at our mortgage business. Now our mortgage business in production is off 80% so far, versus the prior January. So how do I want to forecast that out in a year where we're seeing pay downs at historic lows, and we're still seeing that grow. So we're trying to pull these levers through, but what we know is, we have the ability to manage what our long growth number is, because we've taken action with quality people in quality segments.

And then we're going to look at what the returns in those areas are. So what I give as guidance during this period, I'll also say asset based lending and equipment finance, while they're new businesses to us [their] middle market, that is middle market lending all day long.

So to call those out at this point, we feel like it's part of our business, it's how we're selling, it's integrated into our process. Then we'll look at the consumer side and try to create bounce growth between that residential and then pick up the slack with our auto lending. I'm not sure I'd call it a filler product. And I'm certain our division would not really like that as the label. I would say we have professionals that look for Prime paper that have low risk to them in a high risk, higher risk, potentially environment.

So I like the position we're in there. So I finished that commentary by saying we have optionality within where we are. Our goal over time is to drive margin. We think we have an opportunity we look at, we look at that very closely in the industry. And we see what that mix shift can be. So the idea is that we can drive higher yielding assets over time. But for 2023, what I would like to do is drive balanced growth. We are not the auto lending company. We are a company that can choose between consumer and commercial and try to balance the growth between those two, while maximizing the areas on margin. So that's a little bit of why we haven't broken that out going into the year. It's also the reason that I have confidence that we can hit some of our projections.

[Terry McEvoy, Stephens]

Appreciate that and then just as a follow up, I mean, what do you say to investors who are concerned with what they might feel is late cycle loan growth and how those loans may perform in a downturn. When I look at page 4, that right hand category, there has been significant growth for a bank your size in commercial and CRE and construction and even auto finance or especially auto finance. What's your response?

[Andrew Harmening, CEO]

Well, I would say if you look at 12 months, you probably started too late. And what I would say is we've worked on fundamentally changing the balance sheet to derisk it over in that case. And specifically, I could call out, for instance, our residential real estate portfolio, we're oversized in residential real estate, but we're oversized in a portfolio that is prime and super prime, in a market that doesn't have large fluctuations up and down.

So inherently, our balance sheet is less risky, in our opinion, going into that, and that has seen some growth. When we look at auto and calling that out specifically, it is the oldest new business I've ever experienced. And by that, I mean, we have people that joined us with decades of experience across the board in that space. Not only do they have decades of experience, we also brought the data, the historical data to understand how the portfolio operates.

So we know how that operates. Then on top of that, we went into prime and super prime. And I'll specifically say to the investors that by traditional standards, 97% of that book is prime and super prime. If we take a scorecard approach, which takes a lot of other factors, and we think is a better way to look at it, it's 99% of our portfolio. And we know that because we can check that against historical data. So those would be the things that I would say with regards to what the portfolio is.

The next thing that I'd say is we did not expand our credit box anywhere. In fact, we've tightened up our credit box, as we've seen, the world change. So we've tighten that up on commercial real estate underwriting. We tighten that up on commercial underwriting. And we already had a pretty conservative approach. So we've added balances in areas that we know quite well. I get a lot of passion on this. And I'm looking across the table at our chief risk, Chief Credit Risk Officer, I think maybe he should make a final comment on this.

[Pat Ahern, Chief Credit Officer]

No, I would agree with everything you said. We did not change our credit box relative to the growth you've seen. And we are continuing to look at, like as Andy said, what's going on in the marketplace, whether that's interest rate adjustments, whether it's sizing, whether it's underwriting to an exit. So all that stuff is kind of evolves in relative to the marketplace. And what it's also done is the growth you're seeing again, it kind of reflects the core client that we've been focusing on. So we didn't stretch to add in a new vertical. We didn't stretch to add in some new geography or anything like that. So we feel we're comfortable with the core focus we had coupled with the adjustments we're making to reflect what's going on in the economy.

[Terry McEvoy, Stephens]

Great. Thanks for taking my questions.

[Andrew Harmening, CEO]

Good question. Thank you.

[Operator]

Our next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question.

[Jon Arfstrom, RBC Capital Markets]

Hey, thanks. Good afternoon, guys.

[Andrew Harmening, CEO]

Hello. Good afternoon Jon.

[Jon Arfstrom, RBC Capital Markets]

Just a quick follow up on that for you, Pat. On slide 17 you mentioned some normalization, driving the delinquencies up. And I know these are small numbers, but what do you expect that to look like in a couple of quarters just so we're not surprised by that?

[Pat Ahern, Chief Credit Officer]

I think it's going to revert back to kind of pre-pandemic numbers. How long that takes year ago, we were thought maybe we'd be there by now, but it's not. I think, again as we've mentioned, the portfolio continues to outperform. We're seeing the loan book, the auto, indirect auto book is a little over a year now. So we're kind of reaching some normalization there. But really, the rest of some of the consumer delinquencies that we saw this quarter are really small and we haven't really seen a significant trends. So when we get back to say 2018, 2019 numbers is to still to be determined.

[Jon Arfstrom, RBC Capital Markets]

That helps. I was just going to ask about the delinquencies as well. Non-financial question for you, Andy. The brand campaign you talked about, what is the message on that and what do you think needs to refresh your emphasized in terms of messaging?

[Andrew Harmening, CEO]

I sure hate to spoil it for you, Jon. I feel like I'm going to email those commercials to you though, as we're launching. But what I'll say the interesting part to me is we brought in a new chief marketing and product officer and his expertise is in customer research. And so when you launch something that's about the brand, first you want to know what you're about. But then you also want to know what your customers are about.

And so we are going to combine what the messaging is, that's kind of true to us and what we do, but it's also going to be what's in it for me. And as we think about [marrying] a marketing message, we also think about our product execution. So we will, the significance of the products that we're going to launch in the second, third and fourth quarter should marry up with that brand message. And it does, that's a big deal.

And then, when you think about the triumvirate, you think about the new branding, you think about the product, and then you think about digital, because at the end of the day, you're driving them to your digital platform, and you need to be relevant.

And the final thing I'll say on that is, you want to make sure you're relevant, particularly to the people that are switching banks. And those are typically people that are 40 years old and under. So that is right in the sweet spot of what we're doing in digital. It's right in the sweet spot of the ease of use and satisfaction, we are seeing from our digital account opening. It will be consistent with the message. And it will also be with those folks in that range have told us are important from a product standpoint.

So it's been a heck of a lot of work going into all of that. And we've been on that path for more than 12 months even before our new product and marketing executive came on board, but it's coming together nicely. So I'm making a note to myself, email Jon all the commercials.

[Jon Arfstrom, RBC Capital Markets]

I'm sure I'll see them. Okay and then just a couple of more cleanups, just back on Terry's question on slide 5, on auto, I understand what you're saying there, but do you expect auto to grow very materially from here and you kind of achieved what you wanted to get in terms of some of the portfolio diversification?

[Andrew Harmening, CEO]

I would say that we have the option to grow it. I would say that we have to look at our mortgage portfolio is initially set up as a natural hedge to a decreasing mortgage emphasis. And we're seeing right now why that's important. And so we believe that it will have growth in 2023. The exact number on that will be dependent upon what our overall position is, what the other categories do, what mortgage specifically does, what we can find in liquidity, as well. So a little bit too early to put a finer point on that, which is why we really kind of message that it's more of a balanced growth between commercial and consumer.

[Jon Arfstrom, RBC Capital Markets]

All right, I'll just leave it at that. Thanks, guys. I appreciate it.

[Andrew Harmening, CEO]

All right. Thank you.

[Operator]

There are no further questions. Thank you. I'd like to hand the call back to management for closing remarks.

[Andrew Harmening, CEO]

Well, look, I really appreciate the interest that you've had in Associated bank. We will be on the road, telling our story of what's happening with the company and look forward to speaking with many of you later this quarter at various locations. In the meantime, if you have questions, contact our leadership team me, or contact Ben. And again, thank you for your interest in Associated bank.

[Operator]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.