ASB

Business Context and Reporting Period

Company: Associated Banc-Corp
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Overview: Associated Banc-Corp is a financial services corporation operating primarily through its banking subsidiary, Associated Bank, National Association. The reporting period reflects significant growth driven by the October 2004 acquisition of First Federal Capital Corp, which was fully integrated by the second quarter of 2005. The company also consummated the acquisition of State Financial Services Corporation on October 3, 2005, subsequent to the reporting period.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net income increased 24.1% year-over-year for the nine-month period, driven by a 26.0% increase in net interest income and a 38.9% increase in noninterest income. This growth is largely attributable to the First Federal acquisition and organic expansion.
• Balance Sheet Expansion: Total assets grew 28.5% to $20.7 billion, with loans increasing 30.3% and deposits rising 25.9% compared to September 2004.
• Margin Compression: The net interest margin decreased 17 basis points year-over-year (3.62% vs. 3.79%) due to a flattened yield curve and competitive pricing pressures, despite higher loan yields.
• Expense Increase: Noninterest expenses rose 32.5% year-over-year, primarily due to the larger employee base and operational footprint from the First Federal acquisition.
• Asset Quality: Nonperforming loans decreased as a percentage of total loans to 0.78% from 0.84% a year prior. Net charge-offs improved to 0.09% of average loans (annualized) from 0.17%.

Guidance, Outlook, and Risks

• Margin Outlook: Management anticipates the net interest margin will stabilize and improve in the fourth quarter. A new initiative is underway to reduce wholesale borrowings by $1.0 to $1.5 billion over the next twelve months using cash flows from maturing investments.
• Capital Management: The company plans to use capital freed up from the reduction in wholesale funding to repurchase shares. In May 2005, the company repurchased 2 million shares under an accelerated program, and in November 2005 (post-period), repurchased an additional 974,000 shares.
• Acquisition Integration: The company is integrating State Financial Services Corporation (acquired Oct 3, 2005) and expects to expand its branch network and revenue streams. Preliminary goodwill for this transaction is estimated at $0.2 billion.
• Material Weakness in Internal Controls: Management identified a material weakness in internal control over financial reporting related to the accounting for certain derivative financial instruments under SFAS 133. This resulted in a $6.7 million loss recorded in the second quarter of 2005. Remediation efforts include additional training and updated policies.
• Interest Rate Risk: The company faces risks from a flattened yield curve and rising short-term rates, which compress the spread between asset yields and liability costs.

Investor Verification Checklist

• Derivative Accounting: Verify the status of remediation for the material weakness in SFAS 133 compliance and monitor for any further adjustments to earnings related to hedge accounting.
• Acquisition Synergies: Monitor the integration progress and financial impact of the State Financial Services Corporation acquisition, including the finalization of goodwill and intangible asset valuations.
• Wholesale Funding Reduction: Track the execution of the plan to reduce wholesale borrowings by $1.0–$1.5 billion and its effect on the net interest margin in upcoming quarters.
• Asset Quality Trends: Continue to monitor the allowance for loan losses coverage ratio (currently 172% of nonperforming loans) and the impact of the larger loan portfolio on future charge-offs.
• Share Repurchases: Confirm the volume and pricing of future share repurchases under the authorized programs and their impact on earnings per share.