Associated Banc-Corp — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Associated Banc-Corp is a Wisconsin-based banking and financial services company. Figures below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.
Financial performance and condition
- Q2 earnings: Net loss was $2.8 million, versus a $17.3 million loss in Q2 2009; loss available to common shareholders was $10.2 million, or $0.06 per diluted share, versus a $24.7 million loss, or $0.19 per share.
- First-half earnings: Net loss was $29.2 million, compared with net income of $25.4 million in the first half of 2009. Loss available to common shareholders was $43.9 million, or $0.26 per diluted share, compared with income of $10.7 million, or $0.08 per share.
- Interest income and margin: Q2 net interest income was $159.8 million, down from $179.1 million a year earlier. First-half net interest income was $329.0 million, down from $368.4 million. Net interest margin was 3.22% for Q2 (3.40% in Q2 2009) and 3.29% for the first half (3.49% in the comparable 2009 period).
- Credit costs: Q2 provision for loan losses was $97.7 million, versus $155.0 million; first-half provision was $263.0 million, versus $260.4 million. First-half net charge-offs rose to $268.6 million from $118.7 million, or 3.97% of average loans annualized versus 1.47%.
- Other income and expenses: Q2 noninterest income was $80.9 million, down 20.6% year over year, chiefly because mortgage banking income fell as mortgage production normalized. First-half noninterest income was $178.9 million, down 6.3%; it included $23.4 million of net investment securities gains. Q2 noninterest expense was $155.0 million, down 8.8%; first-half expense was $306.9 million, down 1.4%.
- Assets and lending: Total assets were $22.76 billion at June 30, down $114 million from year-end 2009. Gross loans were $12.60 billion, down $1.53 billion; management attributed the decline to planned run-off, loan sales, charge-offs, and weak demand. Available-for-sale securities were $5.32 billion, down $513 million.
- Asset quality: Nonperforming loans were $1.02 billion, or 8.09% of loans, down from $1.21 billion and 9.10% at March 31, but up from $733 million and 4.79% a year earlier. The allowance for loan losses was $567.9 million, equal to 4.51% of loans and 55.7% of nonperforming loans. Other real estate owned was $51.2 million.
- Deposits, liquidity and debt: Deposits totaled $16.97 billion, up $242 million from year-end; brokered CDs were $571.6 million. Cash and cash equivalents were $2.55 billion, compared with $820.7 million at year-end. Short-term borrowings were $513.4 million and long-term funding was $1.84 billion, together down about $824 million from year-end.
- Cash flows: For the first half, operating activities provided $247.0 million, investing activities provided $1.60 billion, and financing activities used $119.7 million. Cash and cash equivalents increased $1.73 billion.
- Capital: Stockholders’ equity was $3.19 billion, up $448 million from year-end, principally reflecting a January common-stock offering that raised net proceeds of $478 million. The holding company’s Tier 1 common equity/risk-weighted assets ratio was 12.00%; its total risk-based capital ratio was 19.02%. The bank reported a 9.13% Tier 1 leverage ratio and 16.02% total capital ratio, above the 8% and 12% minimums specified in its OCC agreement.
Material changes and management commentary
- Compared with Q2 2009, lower loan balances and yields reduced interest income; reduced funding costs partly offset the decline. Management cited liquidity, weak loan demand, nonperforming loans, and competitive pricing as pressures on margin.
- Mortgage banking income fell substantially: first-half secondary mortgage production was $957 million, versus $2.4 billion a year earlier. Core fee-based revenue was nearly flat for the first half, while deposit service charges declined.
- Q2 results improved sequentially from Q1 2010, including a smaller net loss, lower loan-loss provision, and lower nonperforming loans. The quarter still recorded a loss, and charge-offs remained elevated.
- The company sold nonperforming loans with a beginning-of-quarter net book value of $216 million in Q2, recording $57 million of charge-offs. Management said charge-offs could remain elevated over the next few quarters and that further problem-loan sales may be considered.
- Management expected loan balances to continue declining during the remainder of 2010. It also expected FDIC and foreclosure/OREO expenses to remain elevated. No specific earnings or revenue guidance was provided.
- Liquidity actions followed January and February credit-rating downgrades by S&P and Moody’s. Management reported more than $4 billion of secured borrowing capacity and compliance with internal liquidity objectives; unsecured funding access was severely limited. S&P removed the company from negative credit watch on July 26.
Risks, contingencies and unusual items
- Credit risk: Commercial real estate and construction loans remain a key concern. Nonperforming loans were substantially higher year over year, and management noted uncertainty around economic conditions, collateral values, and the pace of credit deterioration.
- Regulatory oversight: The bank remained subject to an OCC Memorandum of Understanding requiring enhanced risk management and specified capital levels. The holding company entered a separate Federal Reserve memorandum requiring prior approval for specified dividends, debt actions, and share repurchases.
- Legal matter: A proposed class action filed in April 2010 alleges unfair overdraft-fee assessment and collection. Class certification was pending; the company could not estimate a loss range for proceedings generally.
- Other exposures: Off-balance-sheet commitments to extend credit were reported at $3.74 billion in the note disclosure; standby letters of credit were $440 million. Mortgage-loan representations and warranties, legacy mortgage recourse, and private mortgage insurance reinsurance create contingent exposure. The filing reports a $3.7 million liability for reinsurance losses and $25 million of potential reinsurance risk exposure.
- Unusual items: First-half 2010 included $23.6 million of realized securities gains and a $2.5 million early-termination penalty on repayment of $200 million of long-term funding. A $478 million common-equity offering materially increased capital and shares outstanding.
- Outlook risk: The July 2010 Dodd-Frank Act could increase compliance costs and change deposit, mortgage, derivatives, capital, and other requirements; management said effects were uncertain pending rulemaking. The company also identified sensitivity in mortgage-servicing-rights valuation: a 25% increase in prepayment speeds would reduce estimated value by about $6.2 million, holding other factors constant.
Important facts for investors to verify
- Whether nonperforming loans, charge-offs, and provision needs continue to improve, particularly in commercial real estate and construction.
- Whether the reported allowance remains adequate as problem loans are resolved, sold, or restructured.
- Whether deposit growth and secured funding capacity can offset restricted unsecured-market access without undue funding-cost or margin pressure.
- Whether loan contraction and weaker mortgage activity continue, and how they affect net interest income and fee revenue.
- Progress under the OCC and Federal Reserve agreements, capital requirements, and any restrictions affecting dividends or capital actions.
- Developments in the overdraft-fee litigation, mortgage-related recourse exposures, and implementation of Dodd-Frank requirements.