DBRS Comments on Associated Banc-Corp’s 4Q12 Results – Senior Debt at BBB; Trend Stable

DBRS, Inc. (DBRS) has today commented on the 4Q12 results of Associated Banc-Corp (Associated or the Company). Associated has an Issuer & Senior Debt rating of BBB with a Stable trend. For the quarter, the Company reported net income to common shareholders of $45.3 million, up from $45.1 million in 3Q12, and $29.8 million in 4Q11.

In DBRS’s view, Associated’s fourth quarter reflected good balance sheet trends that evidenced continued success with its various strategic initiatives. Highlights included average deposit growth of 7% QoQ, which DBRS sees as reflecting success with its treasury management product, as well as rewards from investments made in the branch network. Positively, fourth quarter deposit growth came entirely from core deposits with the largest increase seen in money market deposits. Meanwhile, time deposits continued to decline. Additionally, average loans grew a healthy 3% during the quarter, driven by steady growth in commercial loans, mortgage loans (80% 15 year and under fixed rate loans and 20% hybrid (3/5/7)ARMs), and commercial real estate. This growth was partially offset by lower retail balances, primarily from home equity loans, which declined $153 million in the quarter.

Importantly, earnings growth also reflected increased core earnings power as measured by income before provisions and taxes (IBPT). Sequentially, DBRS-calculated IBPT (adjusted to exclude one-time gains and expenses) increased $3.7 million to $67.0 million. DBRS notes 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 and represents true core earnings improvement. Positively, earnings continue to benefit from improving credit quality, which supported a provision for loan losses of only $3 million for the quarter reflecting new loan growth, not credit quality deterioration. Also noteworthy was the establishment of a $3 million mortgage repurchase reserve in the quarter given steadily increasing claims activity over 2012.

Total revenues, excluding $2.0 million of non-recurring interest income related to an income tax refund and $0.15 million of securities gains, increased approximately 2.7% from 3Q12 to $239.4 million. Like most peers, Associated is facing some margin pressure in the current rate environment. However, in 4Q12, the aforementioned loan growth coupled with strong low-cost deposit growth and the redemption of the remaining trust preferred securities helped offset the pressure on yields. As a result, Associated was able to grow net interest income modestly QoQ to $159.5 million (net of the aforementioned non-recurring income). The net interest margin (NIM) was 3.32% in 4Q12, up 6 bps from 3Q12. Nonetheless, Associated expects modest NIM compression in 2013 given the repricing at current low asset yields that will be somewhat offset by the maturity of higher cost funding.

Fourth quarter fee revenues declined 3.8% in the quarter to $77.9 million primarily due to the establishment of the $3 million repurchase reserve. Capital market and card-based fees improved over the quarter, but were offset by declines in insurance commissions and deposit service charges. However, the Company expects service charge revenues to improve over time, as the customer base grows.

DBRS anticipates that, given a sluggish revenue environment, consistent positive operating leverage will be important for sustaining growth in core profitability. Associated’s DBRS-adjusted QoQ revenue growth of 2.7% outpaced the adjusted 1.5% growth in non-interest expense generating positive operating leverage. Higher expenses in the fourth quarter reflected increases in personnel and occupancy expenses, the majority of which are being driven by the recently announced branch consolidation and efficiency initiatives.

On the credit side, Associated continued to take actions to improve its credit posture. In 4Q12, the Company completed a note sale of small commercial loans that resulted in $4 million of charge-offs and also implemented a change in accounting for consumer loans discharged in bankruptcy resulting in $5 million of additional charge-offs. DBRS sees these actions as neutral; essentially an acceleration of future losses. As a result, net charge-offs were $20.7 million, or 0.55% (annualized) of average total loans, up from 0.47% in 3Q12, yet down from 0.64% at 4Q11. Nonperforming assets declined 8.4% from 3Q12 to $287.8 million and represented 1.86% of total loans plus OREO. Potential problem loans declined an even steeper 10.6% QoQ, falling $43 million to $361 million. At quarter end, the allowance for loan losses represented 1.93% of total loans and covered 118% of nonaccrual balances. DBRS continues to view current reserve coverage as adequate.

The Company’s funding and liquidity remain sound, in DBRS’s view, and capital remains strong. The loan growth in the quarter was funded by deposit growth and the deposit to loan ratio remained stable at 110%. At December 31, 2012, Associated reported solid, albeit lower, capital ratios that included an estimated Tier 1 common equity ratio of 11.58% and an estimated Tier 1 ratio of 11.97%. Based on current proposed rules, the Company is already in compliance with fully phased in Basel III requirements.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]