ASSOCIATED BANC-CORP annual report, FY2016

Associated Banc-Corp — 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. Associated Banc-Corp is a Wisconsin bank holding company operating primarily in Wisconsin, Illinois, and Minnesota through Associated Bank and related businesses. Its three reporting segments are Corporate and Commercial Specialty; Community, Consumer, and Business; and Risk Management and Shared Services.

Financial performance and condition

Metric	2016	2015
Total revenue (net interest income plus noninterest income)	$1.060 billion	$1.006 billion
Net interest income	$707 million	$676 million
Net interest margin, fully tax-equivalent	2.80%	2.84%
Provision for credit losses	$70 million	$38 million
Net income	$200 million	$188 million
Net income available to common equity	$191 million	$181 million
Diluted earnings per common share	$1.26	$1.19
Operating cash flow	$629 million	$302 million

Revenue, profit, and expense: Net interest income rose 5%; noninterest income increased 7% to $353 million, led by insurance commissions, mortgage banking, and capital-market fees. Noninterest expense increased 1% to $703 million. The fully tax-equivalent efficiency ratio improved to 65.46% from 68.24%.
Balance sheet at year-end: Total assets were $29.1 billion, up 5%; loans were $20.1 billion, up 7%; deposits were $21.9 billion, up 4%. Stockholders’ equity was $3.09 billion. Short- and long-term funding totaled $3.85 billion.
Credit quality: Net charge-offs rose to $65 million, or 0.33% of average loans, from $30 million, or 0.16%. Nonaccrual loans increased to $275 million (1.37% of loans) from $178 million (0.95%). The allowance for loan losses was $278 million, 1.39% of loans, and covered 101% of nonaccrual loans, compared with 154% coverage in 2015.
Cash and liquidity: Cash and cash equivalents ended the year at $642 million, up $169 million. Investing activities used $1.64 billion, principally reflecting loan growth and securities purchases; financing activities provided $1.18 billion. Management said the company met internal liquidity objectives and had sufficient asset-based liquidity under its stress scenario. The Bank had $2.8 billion available for FHLB advances and $2.1 billion available at the Federal Reserve discount window.
Capital: Common Equity Tier 1 ratio was 9.52%, total capital ratio 12.68%, and Tier 1 leverage ratio 7.83%. The Bank was categorized as well capitalized. Common dividends were $0.45 per share for 2016, versus $0.41 in 2015.

Material changes versus 2015

Net income available to common equity and diluted EPS increased, supported by loan growth and higher fee revenue; net interest margin nevertheless declined four basis points.
Average loans grew 8% to $19.7 billion and average deposits grew 6% to $21.0 billion. Year-end commercial real estate lending grew 14% to $5.0 billion.
Credit costs increased substantially. Oil-and-gas-related loans were a principal driver: year-end nonaccrual oil and gas loans rose to $147 million from $20 million, and three large oil and gas credits generated $59 million of charge-offs.
Funding costs rose: the average cost of interest-bearing liabilities increased to 0.42% from 0.40%. The Corporation redeemed $430 million of senior notes in February 2016, issued $97 million net proceeds of Series D preferred stock, and redeemed the remaining Series B preferred shares for approximately $59 million.
Cash from operating activities increased, while cash and cash equivalents rose by $169 million; in 2015, cash and cash equivalents had declined by $558 million.

Outlook, risks, contingencies, and unusual items

2017 outlook: Management expected mid-to-high single-digit annual average loan growth and a loan-to-deposit ratio below 100%. It expected a stable-to-improving net interest margin, assuming further Federal Reserve rate increases; improving fee-based and capital-markets revenue; lower mortgage banking income; increased tax-credit investment activity; and noninterest expense approximately 1% above 2016, with continued efficiency-ratio improvement. Credit-loss provision was expected to vary with risk grades, credit quality, and loan volume.
Concentrated credit risks: Commercial loans represented 62% of the portfolio. Oil and gas loans totaled $668 million outstanding, approximately 3% of loans, with $147 million nonaccrual. Management cited continued sensitivity to oil and gas prices. Commercial real estate loans were $5.0 billion; the filing also cautioned about elevated property values, competition, and market-cycle risk.
Regulatory and fair-lending matters: On August 31, 2016, the Bank received an OCC CRA rating of “Needs to Improve” for the 2006–2010 period. The rating restricts certain acquisitions, branch actions, and other activities pending release of the next rating; management expected an improved rating for the 2011–2014 period, expected in 2017. A separate HUD Conciliation Agreement, effective through May 22, 2018, requires fair-housing, training, lending-location, and community-investment commitments. Management did not expect its costs to materially affect financial condition or results.
Legal matters: The filing describes pending claims related to a bankruptcy financing and customer funds, and possible regulatory actions or customer remediation relating to consumer products and fees. Management said it could not assess the probability or reasonably estimate potential losses for these matters. In the Oxford-related lawsuit, summary judgment was granted to the Bank on January 31, 2017; the plaintiff appealed.
Accounting and valuation: Adoption of the CECL expected-credit-loss standard is required for the company after December 15, 2019. Management expected a one-time cumulative adjustment to the allowance but said the amount and overall impact could not yet be determined. Goodwill was $972 million; the May 2016 qualitative impairment test found no impairment. Mortgage servicing rights were $61 million net, with valuation sensitive to rates and prepayment assumptions.
Interest-rate exposure: Management characterized the balance sheet as asset sensitive. A modeled 100-basis-point rate increase raised 12-month earnings at risk by 1.4% under the dynamic forecast, while modeled market value of equity declined 2.9%; these are model estimates dependent on assumptions. A 1% rise in market rates was estimated to reduce the securities portfolio’s market value by approximately $266 million.
Other risks: The filing highlights deposit and wholesale-funding access, cybersecurity and third-party service-provider exposures, regulatory compliance costs, competition, and uncertainty around future financial regulation and economic conditions. At year-end, Moody’s outlook for the Corporation was negative; S&P’s was stable.

The independent auditor issued an unqualified opinion on the financial statements and internal controls. Management and the auditor concluded that internal control over financial reporting was effective as of December 31, 2016.

Important facts for investors to verify

Whether deterioration in oil-and-gas and other commercial credits continues, and how it affects nonaccrual loans, charge-offs, and allowance coverage.
Progress and public outcome of the Bank’s next CRA rating, and compliance with the HUD Conciliation Agreement through 2018.
Whether 2017 loan growth, deposit funding, and margin expectations were achieved, particularly if rates or deposit costs change differently than assumed.
The composition and stability of network deposits, which were $3.9 billion, or 18% of deposits, at year-end.
The eventual CECL transition adjustment and any changes in credit-loss estimates, goodwill, or mortgage-servicing-right valuations.
Developments in the pending legal and consumer-regulatory matters, for which potential losses were not reasonably estimable in the filing.