DBRS Confirms Associated Banc-Corp at BBB; Stable Trend

DBRS, Inc. (DBRS) has today confirmed the ratings of Associated Banc-Corp (Associated or the Company) and its related entities, including Associated’s Issuer & Senior Debt rating of BBB. The trend for all ratings remains Stable.

Associated’s ratings are underpinned by its well-established Midwest super-community banking franchise and its well-entrenched deposit business, which proved to be quite resilient in the downturn. This franchise includes a top-three market share position in 53% of the cities in which it operates which is in-line with the medians for DBRS’s rated bank universe. Also noteworthy is the Company’s dominant 47% share in its home city of Green Bay, Wisconsin. At the end of 2Q12, core deposits funded the Company’s entire loan portfolio and DBRS expects to see positive core deposit trends continue, benefiting from the Company’s investment in branch upgrades as well as new treasury management offerings.

With the bulk of its asset quality problems behind it and with still solid levels of capital and liquidity, DBRS sees Associated’s financial profile as improved. Reflecting some success in growing loans in targeted areas and benefiting from much lower credit costs, Associated has returned to consistent profitability, generating positive earnings for the last eight quarters. Most recently, Associated reported net income to common shareholders of $42.0 million for 2Q12, up from $41.3 million in 1Q12. Earnings growth in the quarter reflected lower expenses, improved core fee revenues and still-low credit costs.

DBRS views positively the Company’s ability to sustain earnings momentum and continue to grow loans despite the challenging rate environment and stiff competition for quality credits. However, excluding securities gains and one-time items, DBRS calculated income before provisions and taxes (IBPT) declined about $3 million from the first quarter to approximately $60 million for 2Q12. As a result, DBRS sees further improving core earnings capacity as a key challenge for Associated. DBRS also notes, however, that a sustained increase in IBPT could put upward pressure on the Company’s ratings provided it is not the result of a materially higher risk profile.

While Associated’s net interest income has been relatively resilient reflecting better-than-peer loan growth and the ability to fund that growth through securities runoff, the Company is not immune from the pressures presented by the persistent low rate environment. The net interest margin (NIM) was 3.30% in 2Q12, down 1 basis point from 1Q12. The Company anticipates its full year NIM to be around 2011’s 3.26%, and currently expects a NIM of around 3.25% for 2H12. Fee revenues, which DBRS notes typically comprise a better than peer 33% of Associated’s operating revenues, contribute to IBPT stability, but certain key fee lines have been pressured by new regulations. As mortgage refinancing activity inevitably slows, DBRS expects that Associated will be challenged to maintain overall fee revenues at current levels.

Given revenue headwinds, Associated’s ability to manage expenses and generate positive operating leverage will be key for improving core earnings. At 69.2% in 2Q12 and 68.7% for all of 2011, the Company’s efficiency ratio continues to be higher than historic levels and is above the median for BBB rated peers. However, DBRS sees the elevated level of expenses as due, in part, to management’s ongoing investment in the franchise. These investments include investments in personnel to support new lending initiatives and in new products areas (notably treasury management). They also include expenses related to remodeling existing branches, an area that prior management had neglected. DBRS sees these investments in the franchise as important steps that should enhance revenues in the medium-term and create a more diversified bank. Nevertheless, DBRS comments that as the pace of investment slows, a return to positive operating leverage will be an important driver for any positive rating action.

As noted, earnings have benefited from improving credit quality that has supported a zero loan loss provision for both the first and second quarters. Total nonperforming assets declined 1% from 1Q12 to $357.9 million and were $155.4 million below 2Q11 levels. Potential problem loans were $410 million at June 30, 2012, down 15% from 1Q12. Net charge-offs did tick up slightly from 1Q12, but at $24 million, or 0.65% (annualized) of average loans, NCOs remain manageable. At quarter-end, the allowance for loan losses represented 2.26% of total loans and covered 105% of nonaccrual balances. DBRS notes that even with continued moderate loan growth, Associated’s outlook is for very modest provisioning in coming quarters.

Associated’s capitalization remains solid. At June 30, 2012, Associated reported a Tier 1 common equity ratio of 12.04% and a Tier 1 ratio of 13.64%. The Company’s 9% TCE ratio also compares favorably to peers. Given current capital levels and reflective of Associated’s asset mix and its limited capital markets activities, the Company is already compliant with proposed Basel III capital requirements. In light of the changing capital treatment for trust preferreds, Associated is redeeming its outstanding 7.625% trust preferred securities as well as $30 million of lower coupon trust preferreds over the next few months. DBRS anticipates that Associated will maintain solid capital levels, even as it seeks to deploy excess capital.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Schaller
Approver: Alan G. Reid
Initial Rating Date: 14 January 2010
Most Recent Rating Update: 14 September 2012

For additional information on this rating, please refer to the linking document under Related Research.