ASSOCIATED BANC-CORP quarterly report, Q3 FY2012

Associated Banc-Corp — Q3 2012 Form 10-Q

Business context and reporting period. Unaudited consolidated results for the quarter and nine months ended September 30, 2012; balance-sheet comparisons are to December 31, 2011. Associated Banc-Corp is a Wisconsin-based banking company with Commercial Banking, Consumer Banking, and Risk Management and Shared Services segments. Dollar amounts below are in millions unless stated otherwise.

Financial performance and position

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Net interest income	$155.6	$153.2	$464.5	$461.0
Noninterest income	$81.0	$69.0	$235.4	$201.6
Noninterest expense	$169.7	$159.5	$505.5	$478.2
Provision for loan losses	$0	$4.0	$0	$51.0
Net income	$46.4	$41.3	$132.3	$98.6
Net income available to common equity	$45.1	$34.0	$128.4	$75.0
Diluted EPS	$0.26	$0.20	$0.74	$0.43

Q3 revenue, calculated as net interest income plus noninterest income, was $236.6 million. Nine-month revenue was $699.9 million.
Net interest margin was 3.26% in Q3, versus 3.23% a year earlier; the nine-month margin was 3.29%, versus 3.28%. Management reported expected modest margin pressure from the low-rate environment.
The Q3 efficiency ratio was 72.81%, compared with 71.55% a year earlier; the fully taxable-equivalent ratio was 70.22%, versus 68.73%.
Mortgage banking, net, rose to $15.6 million in Q3 and $50.0 million year to date, with higher mortgage production and secondary-market sales. Core fee-based revenue declined 8% year over year in Q3 and 9% year to date.
At September 30, total assets were $22.7 billion, loans $15.0 billion, deposits $16.5 billion, and stockholders’ equity $3.0 billion. Loans increased $935 million and deposits increased about $1.36 billion from year-end; available-for-sale securities fell $441 million.
Cash and cash equivalents were $953.3 million, up $336.7 million since year-end. Nine-month operating cash flow was $318.0 million, investing cash outflow $653.5 million, and financing cash inflow $672.3 million.
Short-term funding was $1.75 billion and long-term funding $1.31 billion, totaling $3.06 billion, down from $3.69 billion at year-end. The company issued $155 million of 1.875% senior notes due 2014 in September. Long-term funding fair value exceeded its carrying amount; reported fair value was $1.36 billion versus $1.31 billion carrying value.
Capital ratios at September 30 included Tier 1 common equity to risk-weighted assets of 12.01%, Tier 1 risk-based capital of 13.57%, total risk-based capital of 15.00%, and Tier 1 leverage of 9.99%. The company reported capital above regulatory minimums and said it would have remained “well capitalized” under proposed capital rules.

Material changes and credit quality

Net income increased 12% in Q3 and 34% for the first nine months. Common EPS rose to $0.26 for Q3 and $0.74 year to date. Lower preferred dividends and accretion also contributed to the increase in income available to common shareholders.
Mortgage banking growth more than offset declines in core fees. Deposit service charges and card/nondeposit fees fell year to date by $6.0 million and $11.5 million, respectively; management cited customer behavior, regulatory changes, and interchange-fee restrictions.
Noninterest expense rose 6% in Q3 and 6% year to date. Personnel, data processing, and legal/professional costs increased; lower FDIC and foreclosure/OREO costs partly offset the rise.
Credit indicators improved: nonaccrual loans were $278 million, or 1.86% of loans, down from $403 million and 2.99% a year earlier. Nonperforming assets were $314 million versus $445 million; potential problem loans were $404 million versus $660 million.
Year-to-date net charge-offs were $63 million versus $128 million a year earlier. The allowance for loan losses declined to $315 million from $378 million at year-end; its ratio to loans was 2.11%, versus 2.70%. The allowance covered 113% of nonaccrual loans. No loan-loss provision was recorded in the first nine months despite charge-offs.
Commercial lending grew, while retail loans declined. Management attributed the lower allowance and provision primarily to improved credit quality and said it expected continued improvement and a modest provision for the remainder of 2012.

Outlook, risks, contingencies, and unusual items

Management expected modest net interest margin pressure for the balance of 2012, modest improvement in core fee-based revenues, and noninterest expense growth in the low-single-digit range, including ongoing BSA compliance work and retail-facility upgrades. No full-year EPS or revenue guidance is stated in the provided filing text.
The Bank was subject to an OCC Consent Order entered in Q1 2012 concerning Bank Secrecy Act compliance. Required work included an action plan, enhanced customer due diligence, a risk assessment, and independent testing. The filing says the Bank had not been informed of a civil money penalty.
A proposed $13 million settlement of overdraft-fee litigation received preliminary court approval in July 2012; it had already been accrued. The Bank also received $2.5 million from an insurer toward the settlement and about $1.5 million toward defense costs.
The company recorded a $14.6 million other-than-temporary impairment of mortgage servicing rights in 2012 amid persistent low interest rates. Net MSRs were $45 million; management estimated a 50-basis-point decline in refinance rates would reduce their value by about $5 million, while a 50-basis-point increase would raise it by about $7 million.
Other unusual costs included a $6 million software write-down, OREO losses and write-downs, and a $3 million impairment of certain limited-partnership investments. Gains on branch and securities sales partly offset these items.
Off-balance-sheet credit commitments were $5.14 billion, excluding commitments to originate residential mortgage loans held for sale; the contractual-obligations table separately reports $5.56 billion of commitments to extend credit. The filing cautions that commitment totals do not necessarily represent future cash needs.
Other exposures include mortgage-loan repurchase representations and warranties, mortgage-insurance reinsurance exposure estimated at $19 million (with a $9 million estimated liability), and pending legal matters. Management said existing securities unrealized losses were not believed to reflect credit deterioration.
Proposed Basel III and related U.S. capital rules could change capital requirements and the treatment of trust preferred securities; the final impact was uncertain. The company also disclosed exposure to interest-rate changes and noted ratings or funding-market changes could affect access to wholesale funding and its cost.
After quarter-end, the company announced consolidation of 12 branches. In October 2012 it redeemed $170 million of junior subordinated debentures and intended to redeem a further $15 million before year-end.

Key facts for investors to verify

Whether mortgage banking gains and elevated production can be sustained, and how much earnings depend on this comparatively volatile source versus recurring fees.
Whether continued zero or modest provisioning remains appropriate as loans grow, given charge-offs, the lower allowance-to-loan ratio, and commercial real estate exposure.
Progress under the OCC BSA Consent Order, associated costs, and whether any penalties or further regulatory actions arise.
MSR valuation assumptions and sensitivity to refinancing speeds and interest rates, including the effect of the low-rate environment.
Deposit growth and mix, liquidity under stress, funding costs, and the effect of debt redemptions and proposed capital rules on regulatory capital.
Final approval and payment of the overdraft settlement, and developments in other litigation, mortgage recourse, and reinsurance exposures.
Whether the stated outlook for margin, fee revenue, credit trends, and low-single-digit expense growth is achieved.