Associated Banc-Corp — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results; balance-sheet comparisons are to December 31, 2013 unless otherwise noted. Amounts are in U.S. dollars.
Business context and key financial results
Associated Banc-Corp is a bank holding company with Corporate and Commercial Banking, Community and Consumer Banking, and Risk Management and Shared Services segments. Total assets were $25.7 billion at June 30, up 6% from year-end, largely reflecting loan growth.
- Q2 earnings: Net income was $46.4 million versus $47.9 million in Q2 2013; net income available to common equity was $45.1 million. Diluted EPS was $0.28, unchanged year over year.
- First-half earnings: Net income was $91.6 million versus $95.3 million; net income available to common equity was $89.0 million. Diluted EPS was $0.55, unchanged.
- Interest income and margin: Q2 net interest income increased to $168.7 million from $160.2 million. First-half net interest income was $333.7 million versus $317.8 million. Net interest margin narrowed to 3.08% in Q2 from 3.16%, and to 3.10% for the first half from 3.17%.
- Noninterest income: Q2 fell 14% to $72.2 million; first-half income fell 12% to $145.8 million. The principal drag was lower mortgage banking income as refinancing activity slowed. First-half net mortgage banking income declined to $11.7 million from $37.0 million.
- Expenses and efficiency: Q2 noninterest expense was $167.9 million, down 0.5%; first-half expense was $335.6 million, down 0.2%. The efficiency ratio was 69.70% in Q2 versus 69.01% a year earlier, and 70.05% for the first half versus 69.51%.
- Credit costs: Q2 provision for credit losses was $5.0 million versus $5.3 million. First-half provision was $10.0 million versus $8.6 million. First-half net charge-offs declined to $8.0 million from $28.2 million; annualized net charge-offs were 0.10% of average loans.
- Loans and credit quality: Loans were $17.0 billion, up 7% from year-end, including growth in commercial lending and residential mortgages. Nonaccrual loans were $179 million, down from $217 million a year earlier and $185 million at year-end. Potential problem loans were $288 million, up from $235 million at year-end, with the increase attributed primarily to downgrades of several shared national credits in Q2.
- Allowance: Allowance for loan losses was $271.9 million, or 1.59% of loans; the total allowance including unfunded commitments was $292.3 million. Loan-loss allowance covered 152% of nonaccrual loans.
- Cash flow: For the first half, operating activities provided $116.5 million, investing activities used $1.46 billion, and financing activities provided $1.39 billion. Cash and cash equivalents ended at $646.3 million, up $44.0 million. Loan growth was a major use of funds; increased short-term funding supplied much of the financing.
Balance sheet, funding and capital
- Deposits totaled $17.32 billion, nearly unchanged from year-end. Noninterest-bearing demand deposits declined to $4.21 billion from $4.63 billion.
- Short- and long-term funding totaled $5.27 billion, up from $3.83 billion at year-end. Short-term funding rose to $2.34 billion from $740.9 million, primarily reflecting short-term FHLB advances used to fund loan growth; long-term funding declined to $2.93 billion, including repayment of $155 million of senior notes.
- Stockholders’ equity was $2.93 billion. Equity-to-assets was 11.39%; Tier 1 common equity to risk-weighted assets was 10.72%, down from 11.46% at year-end. Management reported capital ratios above regulatory minimums.
- The company repurchased approximately 4.0 million shares for $69 million during the first half, in addition to shares acquired for employee tax withholding. It paid common dividends of $0.18 per share during the first half.
Changes, outlook, risks and unusual items
- Drivers of year-over-year results: Lower funding costs and balance-sheet growth supported net interest income, but margin compression and the sharp decline in mortgage banking revenue weighed on results. Core fee-based revenue rose 7% for the first half, led by insurance commissions and trust fees.
- Management outlook: For the second half of 2014, management expected continued gradual net interest margin compression while net interest income grows. It expected second-half noninterest income to be in line with first-half levels, full-year noninterest expense to be flat year over year, and provision for credit losses to grow during the remainder of 2014 based on expected loan growth and other factors.
- Rate and valuation exposure: Simulations projected net interest income would increase about 1.1% under an immediate 100-basis-point rate increase and 2.5% under a 200-basis-point increase. Management said results were within policy limits. A 50-basis-point decline in refinance rates was estimated to reduce mortgage servicing rights value by about $9 million; a 50-basis-point increase was estimated to raise it by about $8 million. The filing notes that these estimates depend on assumptions and that the valuation reserve was only $1 million.
- Unusual and subsequent items: The Bank paid a $500,000 OCC civil money penalty in June related to BSA/AML deficiencies; the prior consent order was terminated in March. A wage-and-hour class action was dismissed with prejudice in July 2014 after an immaterial payment. In July, the company repurchased approximately 4.7 million additional shares for $90 million under accelerated repurchase programs and declared a $0.09-per-share quarterly common dividend.
- Legal and contingent exposures: The Zayed lawsuit concerning the Oxford Global Partners Ponzi scheme remained on appeal after dismissal of the complaint; management said it could not assess the probability of a material adverse outcome or reasonably estimate potential loss. Mortgage loan representations and warranties also create repurchase exposure; the reserve was $3.3 million at June 30, down from $5.7 million at year-end.
- Other risks and caveats: Management identified the allowance for credit losses, goodwill impairment, mortgage servicing rights valuation, and income taxes as critical estimates. It reported no goodwill impairment through June 30 and did not consider securities’ unrealized losses to be other-than-temporary, attributing them mainly to interest rates and market conditions rather than credit deterioration. The filing cautions that forward-looking statements are subject to significant risks and actual results may differ.
Important facts for investors to verify
- Whether loan growth can continue to outpace deposit growth without sustained reliance on higher short-term wholesale funding.
- Whether net interest margin compression and weak mortgage production will offset growth in net interest income and core fee revenue.
- Whether the increase in potential problem loans, including downgraded shared national credits, leads to higher provisions or charge-offs.
- How mortgage servicing rights valuations, repurchase claims and related reserves evolve under changing rates and prepayment assumptions.
- The status and potential financial impact of the Zayed appeal, and any other material legal, regulatory or contingent exposures.
- Whether post-quarter share repurchases and dividends remain consistent with capital, liquidity and growth needs.