ASSOCIATED BANC-CORP annual report, FY2010

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Associated Banc-Corp — 2010 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2010, with fourth-quarter results also discussed. Associated Banc-Corp is a Wisconsin-based bank holding company operating primarily in Wisconsin, Illinois, and Minnesota. Banking accounted for 91% of segment-defined revenue; wealth management accounted for 10% (rounding and segment eliminations apply). The consolidated financial statements received an unqualified audit opinion, as did management’s assessment of internal control over financial reporting.

Financial performance and condition

  • Earnings: Net loss was $0.9 million, compared with a $131.9 million loss in 2009. After $29.5 million of preferred dividends and discount accretion, the loss available to common shareholders was $30.4 million, or $0.18 per diluted share, versus a $161.2 million loss, or $1.26 per share, in 2009. Fourth-quarter common income was $6.6 million ($0.04 per share), compared with a $180.6 million common loss in fourth-quarter 2009.
  • Interest income and margin: Net interest income was $633.8 million, down 12.7% from $726.0 million. Taxable-equivalent net interest income was $657.4 million, down 12.4%. Net interest margin fell 32 basis points to 3.20% from 3.52%; the 2010 fourth-quarter margin was 3.13%, down 46 basis points year over year.
  • Credit costs: Provision for loan losses was $390.0 million, down from $750.6 million. Net charge-offs increased to $486.7 million, or 3.69% of average loans, from $442.5 million, or 2.84%. The year-end allowance was $476.8 million, 3.78% of loans and 83% of nonaccrual loans, compared with 4.06% and 53% a year earlier.
  • Other income and expenses: Noninterest income was $345.5 million, down 1.5%; core fee-based revenue fell 6.1%, including a 17.3% decline in deposit service charges. Net mortgage banking income declined 18.9% to $33.1 million. Noninterest expense rose 3.1% to $630.3 million, including higher personnel and FDIC costs. The fully taxable-equivalent efficiency ratio increased to 64.32% from 55.73%.
  • Balance sheet: Total assets were $21.8 billion, down 4.8%; loans were $12.6 billion, down 10.7%; deposits were $15.2 billion, down 9.0%. Available-for-sale securities totaled $6.1 billion. Stockholders’ equity was $3.16 billion, up from $2.74 billion, principally reflecting a January 2010 common stock offering that generated about $478 million net.
  • Liquidity and cash flow: Year-end cash and cash equivalents were $868.2 million, up $47.5 million. Operating and investing activities provided $506 million and $617 million, respectively; financing activities used $1.08 billion. Year-end short-term borrowings were $1.75 billion and long-term funding was $1.41 billion. Management said liquidity objectives were met; average cash equivalents were unusually high at $2.1 billion during 2010, largely in response to rating-related funding constraints.
  • Capital: Corporation Tier 1 risk-based, total risk-based, and leverage ratios were 17.58%, 19.05%, and 11.19%, respectively. The Bank’s corresponding ratios were 15.10%, 16.38%, and 9.55%. The Bank remained above the higher minimums specified under its OCC agreement. Tangible common equity to tangible assets was 8.12%.

Material changes versus 2009

  • Credit indicators improved, though losses remained elevated: nonaccrual loans fell 47% to $574 million and potential problem loans declined 40% to $964 million. Management attributed much of the reduction to loan sales and discounted resolutions; these actions also contributed to higher charge-offs.
  • Commercial loans fell $1.7 billion, including a 60.4% decline in real estate construction loans. Residential mortgage loans increased $398 million; the Corporation began retaining 15-year fixed-rate mortgages.
  • Net interest income and margin declined amid lower earning-asset yields, fewer average loans, and a large liquidity position. Average loans fell 15%; average securities and short-term investments increased 28.6%.
  • The Corporation raised common equity, increased capital ratios, and reduced reliance on certain wholesale funding. Common dividends fell to $0.04 per share from $0.47; the annual report lists $0.01 per quarter in 2010.

Outlook, risks, and unusual items

  • Management outlook: For 2011, management expected mid-single-digit growth in average loans, modest customer deposit growth, and continued reductions in network and brokered deposits. It expected a significant decrease in loan-loss provision and net charge-offs, modest net interest margin expansion (particularly in the second half, assuming stable rates), and moderate expense increases for personnel, systems, and infrastructure investment. Core fee income and mortgage production were expected to face challenges.
  • Regulatory constraints: The Bank remained subject to an OCC Memorandum of Understanding requiring enhanced credit-risk processes and minimum capital ratios. The Corporation’s Federal Reserve agreement required prior approval for specified dividends, debt payments, borrowing increases, guarantees, and share repurchases. Management said it believed it had addressed the agreements’ conditions; they nevertheless constrain financial flexibility.
  • Funding and debt maturities: $170 million of 2001 subordinated notes remained outstanding and were due in August 2011; the company was exploring replacement funding. The Corporation also received $525 million under the Treasury Capital Purchase Program, with restrictions on common dividends and repurchases. Management identified repayment of CPP as a 2011 strategic priority, but the filing does not provide a completed repayment plan or date.
  • Credit, valuation, and economic risks: Commercial loans represented 55% of loans; real-estate collateral values and economic conditions remained important uncertainties. Allowance adequacy, goodwill, mortgage servicing rights, and deferred-tax-asset recoverability depend on estimates. Goodwill was $929 million; net deferred tax assets were about $129 million, and management cited the two-year pretax-loss history as negative evidence in assessing realization.
  • Legal and contingent matters: A class action alleging unfair overdraft-fee practices was pending in consolidated multidistrict litigation; the company denied the claims. Management could not estimate the likelihood or range of loss for certain proceedings. Other exposures included mortgage representations and warranties, private mortgage insurance reinsurance, and unfunded credit commitments.
  • Unusual items: 2010 included $24.9 million of net investment-securities gains, partly offset by $3.9 million of credit-related impairment write-downs; a $3.2 million increase in the unfunded-commitment reserve; and early-termination costs associated with debt repayments. The company reported no goodwill impairment.

Investor verification priorities

  1. Track nonaccrual, potential problem, and impaired loans, charge-offs, and allowance coverage; distinguish portfolio improvement from the effects of loan sales and discounted resolutions.
  2. Verify the basis for management’s expected lower 2011 credit costs and loan growth, and monitor whether margin improvement occurs as projected.
  3. Confirm progress under the OCC and Federal Reserve agreements, the Bank’s capital cushion above required floors, and restrictions on parent-company dividends and debt service.
  4. Assess the refinancing or repayment of the August 2011 subordinated notes and the timing, funding, and regulatory approval for CPP repayment.
  5. Review deferred tax asset assumptions, goodwill and mortgage-servicing-rights valuations, and the potential financial effect of overdraft litigation and other contingencies.