DBRS Initiates Coverage of Associated Banc-Corp – Issuer & Senior Debt at BBB, Trend Negative

DBRS has today initiated coverage of Associated Banc-Corp (Associated or the Company) and its related entities. DBRS has assigned an Issuer & Senior Debt rating of BBB to Associated Banc-Corp and a Deposits & Senior Debt rating of BBB (high) to Associated’s bank subsidiaries. Associated Banc-Corp has been assigned a Short-Term Instruments rating of R-2 (middle), while Associated Bank N.A. (The Bank) and Associated Trust Co., N.A. have been assigned Short-Term Instrument ratings of R-2 (high). The trend on all ratings is Negative.

The ratings are underpinned by Associated’s well-established Midwest super-community banking franchise featuring stable and solid earnings generation capacity and a well-entrenched deposit business. The ratings are also supported by the Company’s consistent and better than peer income before provision and taxes (IBPT) and capital levels through a number of economic cycles and its historically conservative operating philosophy. Associated’s low-cost operating platform is reflected in an efficiency ratio which compares favorably to peers and has remained in the 50% range for a decade despite numerous acquisitions. DBRS credits the Company’s low expense base to its structure as well as its diligent management of operational, employment and integration costs. Ratings also consider the recently completed common equity offering which raised net proceeds of approximately $478 million and significantly increased Associated’s loss absorption capacity.

Associated’s ratings level also reflects the challenge of managing asset quality given the impact of unprecedented national real estate valuation declines on its loan portfolio. The ratings and Negative trend incorporate the Company’s delayed reaction in recognizing the likely loss content embedded in its construction and commercial real estate loan portfolios, the uncertainty created by recent management turnover and increased regulatory oversight. Due to the Company’s new focus on early recognition of loan losses, DBRS expects a significant increase in loan sales that may result in additional losses and also pressure net interest income.

Associated’s franchise strength is enhanced by the Company’s adequate deposit franchise that includes a top-three market share position in 54% of the 174 cities in which it operates including a dominant position in 35 cities. Also noteworthy is the Company’s dominant 50% share in its home city of Green Bay, Wisconsin.

The real estate downturn has contributed to the significant deterioration in Associated’s asset quality and is exerting pressure on the Company’s earnings. DBRS remains concerned about the potential embedded loss content in the Company’s loan portfolio. Net charge-offs (NCOs) and non-performing assets (NPAs) rose considerably in the fourth quarter. Furthermore, after showing some signs of stabilization in the third quarter, early stage delinquencies increased 37% to $241 million in the fourth quarter. The Negative trend reflects the likelihood of continued stress in the loan portfolio, resulting in provisions remaining elevated, possibly exceeding IBPT and invading recently strengthened capital. That said, DBRS anticipates that the outsized Q4 2009 provision was, for the most part, a one-time event reflecting the extensive portfolio review initiated by the new CEO which concluded that the large provision was needed to bring loan loss reserves to an appropriate level to manage the potential stresses in the loan portfolio. The provision was not a reflection of a sudden material worsening in the outlook for the Company’s portfolio, but rather reflects management’s new philosophy toward early recognition of loan loss. A return to historic levels of provisioning coupled with stable IBPT performance could result in the trend on Associated’s ratings reverting to Stable.

The recently completed capital raise will enable Associated to downstream capital to Associated Bank N.A., which is expected to keep the subsidiary comfortably in compliance with its recently announced Memorandum of Understanding (MOU) with the Comptroller of the Currency, its primary regulator. The MOU requires that Associated Bank N.A., beginning March 31, 2010, maintain a Leverage ratio above 8% and Total capital ratio above 12% that are in excess of the normal 5% Leverage and 10% for Total capital regulatory well-capitalized requirements. Accounting for the net proceeds of the capital raise, Associated Bank, N.A.’s pro forma Leverage ratio as of December 31, 2009 was 10.49% and its pro forma Total capital ratio was 16.34%, giving the Bank a $535 million cushion above the MOU required leverage level and $651 million above the required total capital level. While DBRS expects that the Company will downstream only a portion of proceeds to the Bank in order to maintain capital flexibility, it is clear that Associated now has a new-found flexibility to operate comfortably within the MOU while absorbing the losses necessary to return asset quality metrics to a normalized range.

Parent company liquidity has historically been weak relative to peers, though it improved somewhat subsequent to the Company’s participation in the U.S. Treasury’s capital purchase program. Associated issued $525 million of preferred shares and related warrants out of the Parent Company to the U.S. Treasury in conjunction with the program. DBRS believes repayment of the TARP capital is likely to be a medium-term event given the near-term headwinds and the lack of regulatory clarity on repayment requirements.

DBRS notes that a sustained improvement in Associated’s organic growth (another key challenge given the slow-growth nature of some of the Company’s core geographies), an enhanced business mix and diversification of the loan portfolio coupled with a return to the Company’s historic levels of asset quality could result in positive rating actions. Conversely, a sustained deterioration in core profitability or a longer than expected persistence of elevated credit costs, could have negative rating implications. DBRS also notes that sizable losses on loan sales or losses substantially beyond current expectations would also pressure Associated’s ratings.

Associated Banc-Corp, a bank holding company with headquarters in Green Bay, Wisconsin, reported $23 billion in assets at December 31, 2009.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.