ASSOCIATED BANC-CORP quarterly report, Q2 FY2016

Business context and reporting period

Associated Banc-Corp, a Wisconsin-based bank holding company, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. Comparisons below are with the second quarter or six-month period of 2015, unless otherwise stated. Amounts are in U.S. dollars; financial statement amounts are in millions unless indicated.

Financial results and position

• Revenue and margin: Q2 total net interest and noninterest income was $258.9 million, up from $253.0 million. Net interest margin was 2.81%, compared with 2.83% a year earlier; it was unchanged from Q1 2016. Six-month fully tax-equivalent net interest margin was 2.81%, down 5 basis points year over year.
• Balance sheet at June 30: Total assets were $29.0 billion, up 5% from year-end 2015. Loans were $19.8 billion, up 6%; deposits were $20.3 billion, down 3%. Investment securities totaled approximately $6.0 billion.
• Credit: The allowance for loan losses was $267.8 million, or 1.35% of loans, covering 95% of nonaccrual loans. Six-month net charge-offs were $37.5 million, or 0.39% of average loans, versus $14.3 million, or 0.16%, in the prior-year period.
• Cash flow and liquidity: For the first half, operating cash flow was $105.3 million, investing cash outflow was $1.24 billion, and financing cash inflow was $1.14 billion; cash and cash equivalents increased $4.2 million to $477.9 million. The company reported $1.2 billion available in FHLB advances and $1.9 billion in Federal Reserve discount-window borrowing capacity.
• Funding and capital: Short- and long-term funding totaled $5.4 billion, up $1.9 billion from year-end, including increased FHLB advances; the company redeemed $430 million of senior notes in February. Regulatory capital ratios were 9.17% common equity Tier 1, 9.73% Tier 1, and 12.16% total capital. Tangible common equity to tangible assets was 6.85%.

Material changes and management outlook

• Loan growth was broad-based, with total loans increasing $1.1 billion from year-end. Average loans rose 4% sequentially in Q2; commercial lending accounted for 75% of that quarterly average-loan growth.
• Credit quality weakened, particularly in oil and gas. Nonaccrual loans rose to $282.6 million from $178.3 million at year-end 2015, and potential problem loans increased to $456.7 million from $301.7 million. Oil and gas nonaccrual loans were $129 million, or 17% of that portfolio; the portfolio totaled $756 million. Three large oil and gas credit charge-offs contributed to higher first-half net charge-offs.
• Q2 net income was broadly flat year over year; first-half net income declined. Higher net interest income and lower expenses were offset by a substantially higher credit provision and weaker noninterest income. First-half mortgage banking income was down 52%, including higher mortgage-servicing-rights expense and unfavorable mortgage-derivative valuation changes.
• Management expected high-single-digit annual average loan growth for the remainder of 2016, a loan-to-deposit ratio below 100%, and approximately flat net interest margin absent Federal Reserve rate increases. It expected noninterest income and expense to be approximately flat with the prior year. Credit provision was expected to vary with loan growth and changes in risk grades or other credit indicators. These are management expectations, not guaranteed results.
• Interest-rate modeling showed a slightly asset-sensitive profile: a 100-basis-point increase was estimated to raise 12-month net interest income by 0.8% in the static forecast and 1.4% in the dynamic forecast. The modeled market value of equity declined 2.8% under a 100-basis-point increase.
• Mortgage servicing rights were sensitive to refinancing assumptions: a 50-basis-point decrease in refinance rates was estimated to reduce their value by about $11 million; a 50-basis-point increase was estimated to raise it by about $9 million. Potential recovery of prior valuation charges was limited by a $3 million reserve.

Risks, contingencies, and unusual items

• Pending litigation includes the Oxford Global Ponzi-scheme-related case, two World Marketing bankruptcy complaints, and potential regulatory remediation or enforcement involving certain consumer products. The company stated it could not assess the probability of a material adverse outcome or reasonably estimate potential losses for these matters.
• The HUD conciliation agreement requires community lending, branch and loan-office, financing, grant, outreach, and education commitments over several years; management did not expect a material financial impact.
• Mortgage repurchase reserve was $1.3 million at June 30. Repurchases during the first half were about $1 million, with negligible related loss reimbursement and settlement claims. Additional limited-recourse mortgage exposure remains.
• In July, the company sold $118 million of residential mortgages to FNMA for an approximately $4 million gain. The board declared quarterly common and preferred dividends and called for redemption of all outstanding Series B depositary shares on September 15, 2016, at $25 per share plus declared unpaid dividends.
• The annual goodwill assessment in May 2016 found no impairment indicated; goodwill was $972 million. Management cautioned that actual results may differ from forward-looking statements. Key estimation areas include credit allowances, goodwill, mortgage servicing rights, and income taxes.

Important facts for investors to verify

• Whether oil and gas and broader commercial credit migration leads to further nonaccrual growth, charge-offs, or reserve increases.
• Whether loan growth can be sustained while deposits declined from year-end and wholesale funding increased materially.
• Whether the stated margin, loan-growth, and flat-revenue/expense expectations remain achievable as rates and competition change.
• The sensitivity of mortgage-servicing-rights values and mortgage banking revenue to refinancing activity and derivative valuations.
• Developments and potential financial exposure in the identified litigation, consumer-product reviews, mortgage representations and warranties, and other commitments.
• Capital and liquidity effects of continued growth, funding mix changes, dividends, and the planned Series B preferred-share redemption.