ASSOCIATED BANC-CORP quarterly report, Q3 FY2011

Associated Banc-Corp — 2011 Q3 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2011. Unaudited consolidated results; balance-sheet comparisons are to December 31, 2010 unless noted. The company’s primary business is banking, with a smaller wealth-management segment.

Financial results and position

Metric	Q3 2011	Q3 2010	Nine months 2011	Nine months 2010
Net interest income	$153.2 million	$153.9 million	$461.0 million	$482.9 million
Noninterest income	$71.7 million	$81.9 million	$208.6 million	$260.8 million
Net income (loss)	$41.3 million	$14.3 million	$98.6 million	$(14.9) million
Net income (loss) available to common equity	$34.0 million	$6.9 million	$75.0 million	$(37.0) million
Diluted EPS	$0.20	$0.04	$0.43	$(0.22)

Margin and operating performance: Net interest margin was 3.23% in Q3, up 15 basis points year over year but down 6 basis points sequentially. Nine-month margin was 3.28% versus 3.22%. The Q3 efficiency ratio was 71.89%, compared with 67.36% a year earlier.
Credit costs: Provision for loan losses was $4 million in Q3 and $51 million year to date, versus $64 million and $327 million, respectively, in 2010. Nine-month net charge-offs were $128 million, or 1.32% of average loans annualized, versus $379 million and 3.78% in 2010.
Balance sheet: Assets were $21.9 billion; loans were $13.5 billion, up $887 million since year-end; and available-for-sale securities were $5.5 billion, down $648 million. Deposits were $14.8 billion, down $443 million. Short- and long-term funding totaled about $4.0 billion, up approximately $848 million.
Capital and debt: Stockholders’ equity was $2.85 billion, down $308 million, primarily reflecting redemption of Treasury CPP preferred stock. The corporation’s Tier 1 risk-based and total risk-based capital ratios were 14.35% and 15.81%, respectively; management said capital ratios exceeded regulatory minimums. Long-term funding was $1.48 billion; total short- and long-term funding was $4.01 billion.
Cash flow: For the first nine months, operating activities provided $242.7 million, investing activities used $368.7 million, and financing activities used $76.7 million. Cash and cash equivalents declined $202.7 million to $665.5 million.

Changes and management commentary

Profitability improved substantially year over year, largely alongside sharply lower loan-loss provisions and improved credit indicators. Net interest income and noninterest income both declined for the first nine months; aggregate net interest income plus noninterest income was $669.6 million, down from $743.7 million.
Noninterest income fell 20% year to date. Deposit-account service charges declined $18.2 million, and net mortgage-banking income declined $16.9 million. The prior-year period included $26.8 million of net investment-securities gains; 2011 recorded a net loss of $0.8 million.
Noninterest expense increased 4.7% year to date to $485.2 million, mainly due to a 12.2% rise in personnel expense. Management expected moderate expense increases for the remainder of 2011 as it invested in personnel, systems, and its branch network.
Credit quality improved: nonaccrual loans were $403 million, or 2.99% of loans, versus $574 million at year-end 2010 and $728 million a year earlier. Potential problem loans fell to $660 million from $964 million at year-end. Accruing restructured loans rose to $113 million from $80 million at year-end; nonaccrual restructured loans were $80 million.
Management expected a moderate 2–3% pace of loan growth in Q4 2011, lower provision expense, and net charge-offs to remain flat. It anticipated modest margin pressure from the low-rate environment, modest loan growth, and funding the CPP preferred-stock redemption. It also expected continued pressure on core fee income.

Outlook, risks, and unusual items

The Durbin Amendment was expected to reduce card-based fees by approximately $4 million in Q4 2011 and $17–$19 million on an annualized basis thereafter.
The Bank’s 2009 OCC Memorandum of Understanding was terminated in Q3 2011. A separate 2010 Federal Reserve Bank of Chicago memorandum remained in effect and required prior approval for specified capital, debt, dividend, and share-repurchase actions.
The company redeemed all $525 million of Treasury CPP preferred stock during 2011, funded by issuing $430 million of senior notes and $65 million of 8% perpetual preferred depositary shares. The senior notes carry a 5.125% coupon and mature in 2016. CPP warrants remained outstanding.
Management reported that the annual May 2011 goodwill test found reporting-unit fair values above carrying values; no impairment was recorded. Mortgage-servicing rights, loan-loss reserves, derivatives, and deferred tax assets depend on estimates and assumptions. A 25% increase in estimated prepayment speeds would have reduced the estimated MSR value by about $7.6 million, according to the filing.
A putative class action alleges unfair overdraft-fee practices. Management considered a loss probable and recorded an accrual it described as immaterial; the potential claim amount had not been determined. Other disclosed exposures include mortgage repurchase representations and warranties, PMI reinsurance, and off-balance-sheet lending commitments.
Management stated the company was in compliance with internal liquidity objectives. It disclosed $4.18 billion of commitments to extend credit, $47.7 million of commercial letters of credit, and $330.2 million of standby letters of credit. A $0.01-per-share dividend declared after quarter-end was payable November 16, 2011.

Important facts for investors to verify

Whether improving nonaccrual, potential-problem-loan, and charge-off trends continue, and whether the allowance remains adequate as it declines.
How much earnings are affected by ongoing low interest rates, margin pressure, deposit and funding mix, and the cost of the new senior notes and preferred shares.
Whether fee-income declines—including the anticipated Durbin Amendment impact—and higher personnel and strategic investment costs affect future profitability.
The ongoing status and potential financial consequences of the Federal Reserve memorandum, overdraft litigation, mortgage-related recourse and reinsurance exposures, and unfunded commitments.
The sustainability of reported earnings, which benefited from lower provisions, and the extent to which cash, liquidity, and capital ratios withstand further credit or funding stress.