Associated Banc-Corp — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; financial statements are unaudited. Amounts below are in U.S. dollars.
Business context and reporting period
Associated Banc-Corp is a Wisconsin-based financial services company. On February 1, 2018, it completed its approximately $482 million stock acquisition of Bank Mutual, expanding its presence and adding about $2.8 billion of assets, $1.9 billion of loans and $1.8 billion of deposits. It also acquired Diversified Insurance Solutions for approximately $19 million. Q1 results include acquisition-related costs and only two months of Bank Mutual operations.
Financial and operating results
- Revenue and earnings: Net interest income was $209.9 million, up 16% year over year; net interest margin was 2.92%, versus 2.84%. Noninterest income rose 13% to $90.4 million. Net income was $69.5 million, versus $56.3 million; net income available to common shareholders was $67.1 million. Diluted EPS was $0.40, versus $0.35.
- Expenses and credit costs: Noninterest expense increased 23% to $213.0 million, including $20.6 million of Bank Mutual acquisition costs. No provision for credit losses was recorded, compared with $9.0 million a year earlier. Net charge-offs were $9.3 million, or 0.17% of average loans on an annualized basis.
- Balance sheet: Total assets were $33.4 billion; loans were $22.8 billion and deposits $23.8 billion at quarter end. Loans and deposits grew 10% and 5%, respectively, from year-end, with acquisition effects contributing materially. Management reported an approximately 96% period-end loan-to-deposit ratio.
- Credit quality: Nonaccrual loans were $208.6 million, or 0.91% of loans, down from 1.00% at year-end. Nonperforming assets were $232.6 million. Potential problem loans increased to $282.2 million from $176.9 million at year-end. The allowance for loan losses was $257.1 million, or 1.13% of loans, covering 123% of nonaccrual loans.
- Funding and liquidity: Short- and long-term funding totaled $5.4 billion, up from $4.1 billion at year-end, including a marked increase in short-term funding. Cash, cash equivalents and restricted cash declined to $433.2 million from $716.0 million at year-end. Operating cash flow was $43.1 million; investing activities used $350.3 million and financing activities provided $24.4 million. Management said the company met internal liquidity objectives and had $2.4 billion available in FHLB advances and $2.2 billion available at the Federal Reserve discount window.
- Capital: The common equity Tier 1 ratio was 10.51%, Tier 1 capital ratio 11.19%, total capital ratio 13.45%, and Tier 1 leverage ratio 8.48%. Management stated regulatory capital ratios exceeded minimum requirements.
Material changes versus the prior comparable period
- Bank Mutual drove much of the growth in assets, loans, deposits and earning assets. The acquisition also contributed $6.1 million of net accreted purchase-loan discount to Q1 net interest income.
- Net interest income and margin improved year over year, while interest expense rose as funding balances and rates increased. The cost of interest-bearing liabilities was 0.90%, compared with 0.52% a year earlier.
- Net income increased despite higher operating costs; the effective tax rate declined to 20.43% from 27.31%, reflecting the lower federal corporate tax rate and higher pretax income.
- Available-for-sale securities had $108.1 million of gross unrealized losses at quarter end. Management attributed the losses primarily to interest-rate and market changes, not credit deterioration, and said it did not intend or expect to need to sell the securities before recovery. Other comprehensive loss was $44.9 million for the quarter.
Guidance, risks and unusual items
- Management outlook: For the remainder of 2018, management expected quarterly loan growth of 1% to 2%, a loan-to-deposit ratio below 100%, and improving year-over-year net interest margin. It projected 2018 noninterest income of approximately $365 million to $375 million and noninterest expense of approximately $825 million, including about $40 million of acquisition-related costs. Provision expense is expected to vary with credit quality and loan volume.
- Integration: Bank Mutual integration and conversion costs are significant near-term items; the filing anticipated system conversion in late June 2018. Management expected efficiency opportunities and economies of scale, but did not quantify realized savings in this filing.
- Credit and market risks: Oil-and-gas loans totaled $657 million, including $69 million nonaccrual; the related allowance was $19 million. Management also highlighted growth in potential problem loans. Interest-rate modeling indicated higher rates could increase 12-month net interest income, while a 100-basis-point increase was estimated to reduce market value of equity by 3.4%.
- Legal and regulatory matters: The filing describes pending and threatened matters and heightened regulatory scrutiny of certain consumer products; management said it could not assess the probability or amount of a material loss for those product-related matters. The Bank expected the Zayed litigation settlement to have no material adverse impact. The filing also identifies cybersecurity and acquired-company integration as risks.
- Subsequent developments: In April, the board declared a $0.15 common dividend and authorized up to $100 million of additional common-stock repurchases. The company also entered into additional interest-rate swaps, bringing the stated total notional amount to $500 million, intended to benefit from rising rates.
Important facts for investors to verify
- Whether Bank Mutual integration delivers the expected efficiencies and whether total acquisition costs remain within management’s approximately $40 million 2018 estimate.
- Whether potential problem loans, nonaccrual balances and charge-offs improve or deteriorate, especially in oil and gas and commercial lending.
- How deposit pricing, wholesale funding and further rate changes affect net interest margin, liquidity and market value of equity.
- Whether the securities portfolio’s unrealized losses, acquisition-related goodwill and other valuation estimates change materially.
- Developments in consumer-product regulatory matters, litigation and cybersecurity exposures, including risks during systems integration.