ASSOCIATED BANC-CORP quarterly report, Q2 FY2018

Associated Banc-Corp — Q2 2018 Form 10-Q

Business context and period: Unaudited results for the quarter and six months ended June 30, 2018. Associated Banc-Corp is a regional financial services company. Results include Bank Mutual from its February 1 acquisition; the bank conversion was completed June 24. Comparisons with 2017 are affected by the acquisition and other acquired businesses.

Financial performance and position

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net interest income	$226.4 million	$183.8 million	$436.2 million	$364.1 million
Noninterest income	$92.8 million	$82.4 million	$183.2 million	$162.2 million
Net income	$89.2 million	$58.0 million	$158.6 million	$114.3 million
Diluted earnings per share	$0.50	$0.36	$0.90	$0.71

Q2 net interest margin was 3.02% on a fully tax-equivalent basis, versus 2.83% a year earlier; the six-month margin was 2.97%, versus 2.83%.
Q2 noninterest expense was $211.3 million, including $7.1 million of Bank Mutual acquisition costs. Six-month expense was $424.2 million, including $27.7 million of acquisition costs. The six-month efficiency ratio was 68.18% under the Federal Reserve definition.
Six-month provision for credit losses was $4.0 million, down from $21.0 million. Net charge-offs were $17.8 million, or 0.16% of average loans. The allowance for loan losses was $252.6 million, 1.10% of loans, and covered 123.55% of nonaccrual loans.
At June 30, total assets were $33.7 billion, loans $23.0 billion, deposits $23.8 billion, and stockholders’ equity $3.8 billion. Loans grew 11% from year-end 2017; deposits grew 5%.
Cash and cash equivalents were $386.0 million on the balance sheet. For the six months, operating cash flow was $116.5 million, investing cash outflow $516.9 million, financing cash inflow $155.7 million, and cash, cash equivalents, and restricted cash declined $244.6 million.
FHLB advances were $4.8 billion, up $1.6 billion from year-end; total short- and long-term funding was $5.6 billion. The company cited declining network deposits and asset growth as drivers. FHLB advances had a 1.97% weighted average rate; $2.6 billion were putable, and management expected these to be called on their put dates.
Regulatory capital ratios included a 10.51% common equity Tier 1 ratio, 11.17% Tier 1 ratio, and 13.36% total capital ratio. Management said the Corporation and its banking subsidiaries exceeded regulatory minimums.

Material changes and management commentary

Bank Mutual added approximately $2.8 billion of assets, $1.9 billion of loans, and $1.8 billion of deposits at acquisition. The transaction was valued at approximately $482 million. Management cited expanded market presence and expected efficiency opportunities, while integration costs increased expenses.
Six-month net interest income increased 20%, primarily reflecting the acquisition and larger earning-asset balances; Bank Mutual loan discount accretion contributed $15 million, including about $7 million from prepayments. Funding costs rose as interest rates increased: the cost of interest-bearing liabilities was 0.99%, up 40 basis points year over year.
Management’s 2018 outlook: 1%–2% quarterly loan growth for the remainder of the year, loan-to-deposit ratio below 100%, and improving year-over-year net interest margin. It expected full-year noninterest income of $365–$370 million, noninterest expense of approximately $825 million, and an effective tax rate of about 20% for the year.
The July 5, 2018 reversal of a Minnesota tax court ruling was expected to add $6 million of tax expense in Q3; management’s tax outlook incorporates this item. The second-quarter effective tax rate of 14.19% also reflected one-time benefits from tax-planning actions following the Tax Cuts and Jobs Act.
Asset quality indicators were mixed: nonaccrual loans were $204.5 million, down from $208.5 million at year-end, while potential problem loans rose to $241.5 million from $176.9 million. Oil-and-gas nonaccrual loans declined to $45 million; the portfolio totaled $682 million, with a $17 million allowance.
Liquidity management reported compliance with internal objectives and $1.2 billion of available FHLB advances and $2.1 billion of discount-window borrowing capacity. Interest-rate models showed estimated 12-month net interest income rising 4.5% under a 100-basis-point increase in the dynamic forecast; market value of equity declined 2.6% under that shock.

Risks, contingencies, and unusual items

Interest-rate and funding risks include higher deposit and wholesale funding costs, repricing exposure, and reliance on FHLB advances as network deposits decline. Results are sensitive to interest rates, yield-curve shape, deposit behavior, and loan prepayments.
The securities portfolio recorded $123.1 million of gross unrealized losses on available-for-sale securities at June 30, largely attributed by management to interest rates rather than credit deterioration. A $2.0 million loss was recorded on securities sales in Q2.
Legal matters include ongoing litigation and potential consumer-product regulatory scrutiny. Management said it could not assess the probability or estimate a potential loss related to certain consumer matters. The Bank Mutual merger-related shareholder suits were settled through additional disclosures and dismissals; the Oxford-related matter had a settlement approved, with an appeal still noted.
Mortgage repurchase reserve was $1.1 million. The Corporation also had $8.6 billion of commitments to extend credit and $255.9 million of standby letters of credit; these are not equivalent to funded obligations.
The Economic Growth Act eased some regulatory thresholds, but remaining Dodd-Frank requirements and implementing rulemaking may continue to affect costs and operations. Expected adoption of the current expected credit loss standard (CECL) in Q1 2020 was still under evaluation.

Investor verification priorities

Separate Bank Mutual’s contribution and acquisition-related costs from underlying organic revenue, loan growth, margins, and expense trends.
Track deposit mix and pricing, network deposit runoff, FHLB borrowing levels, put dates, and the effect of rising funding costs on net interest margin.
Monitor potential problem loans, oil-and-gas exposures, nonaccrual trends, charge-offs, and whether the allowance remains adequate as the portfolio expands.
Assess delivery against the stated 2018 loan-growth, margin, fee-income, expense, and tax-rate outlook, including the anticipated $6 million Minnesota tax charge.
Review acquisition integration and expected efficiencies, securities valuation losses, legal and regulatory developments, and the eventual CECL impact.