Description

Investment Thesis 

Regional bank trading below book value (0.78x 2023 P/BV). ASB is currently pricing in a recession and ignoring the change in its deposit beta since the last downturn. Deposit beta currently is estimated at 23% compared to 42% during the last cycle as network deposits / other wholesale funding declined from 33.3% in Q2’16 to 15.6% in Q2’22. On a 1.3x P/BV ASB’s stock is worth $36.19, a 64.5% increase in value while a 0.7x downside is only an 11.4% downside, resulting in a 5.65x upside/downside ratio. H2’22 results are expected to continue to show loan growth, resilient credit losses and a low deposit beta.

Macro Environment

 Historic Performance

The NASDAQ KBW NASDAQ Bank Index (BKX) is down 28% year to date and 33% since its peak on 1/13/22. The S&P500 is down 24% year to date. Looking back over the history of the sector, this correction ranks near its historic correct as:

There have been 27 selloffs in the sector of 20%+ since 1966. During a bank market selloff, the S&P500 drops on average 30%.

In the past 56 years, bank stocks have dropped 40%+ only 7 times and just 4 times excluding the financial crisis. In the 7 times bank stocks reached peak selloff levels, they returned 30%+ the following 12 months.

The bank sector is today on average trading at 1.9x P/TBV (TBV as of 6/30/22) and 9.1x 2022 and 7.7x 2023 earnings. On average compared to the S&P500, banks are trading at a near 40% discount to forward earnings compared to a discount of 30 – 40% average.

Deposit beta, the amount the deposit rate goes up in response to a rise in market rates. A key focus is banks maintaining their deposits as accelerated fed activity allows banks to benefit from a larger balance sheet and higher NII (net interest income). In the current rising rate environment, a preference is for banks that are able to maintain balance sheet growth and maintain low deposit betas. Growth banks, are poorly positioned in a recessionary environment compared to banks with stable deposit bases as they can maintain their balances and extend their asset sensitivity benefits.

Higher rates will yield to margin expansion but risk credit concerns, as net interest income rises sharply concerns are focused on worsening credit quality that override NII upside.   Higher rates boost loan yields, historically low loan to deposit ratios along the largest banks will result in new competition for new loans.

Company Overview

Associated Banc-Corp is a bank holding company registered pursuant to the BHC Act. Bank subsidiary, Associated Bank traces its history back to the founding of the Bank of Neenah in 1861. Measured by total assets reported at December 31, 2021, ASB is the largest commercial bank holding company headquartered in Wisconsin. ASB is the largest bank holding company headquartered in Wisconsin, with approximately 4,000 workers, serving over one million customers, more than 220 banking locations serving more than 120 communities throughout Wisconsin, Illinois and Minnesota, and commercial financial services in Indiana, Michigan, Missouri, Ohio and Texas.

Key Characteristics

Asset sensitivity

ASB has its grown low-cost, granular consumer deposits while reducing wholesale funding. Since the last rate cycle, ASB has halved its utilization of higher-beta network and wholesale funding and replaced higher-beta deposits with core granular Community, Consumer & Business deposits while growing deposits overall across the bank. The company’s funding profile is resilient, has reduced beta since the last cycle and expects further positive deposit flows over the back half of 2022. Deposit beta currently is estimated at 23% compared to 42% during the last cycle as network deposits / other wholesale funding declined from 33.3% in Q2’16 to 15.6% in Q2’22. ASB’s historic shift in deposit beta has been largely ignored by the market.

Source: Q2’22 Investor Presentation

Geographic Drivers 

While the macroeconomic environment has shifted over the past year, in ASB’s Wisconsin and Minnesota local markets the company continues to see strength. Unemployment levels remain at near all-time lows in Wisconsin and Minnesota. Wisconsin employment grew 2.1% in 2021 and is expected to expand 2.3% in 2022 and 1.1% in 2023, reaching the pre-pandemic level by late 2023. Wisconsin personal income growth will slow to 2.3% in 2022. A very shallow recession is expected for Minnesota. A three-quarter recession is expected beginning in the fourth quarter of 2022 with annual real GDP to grow 1.7 percent in 2022 and decline 0.5 percent in 2023. This mild recession will have a weak recovery beginning in the third quarter of 2023. For years 2023 and 2024, the forecast for real GDP growth is now 1.3 percent in 2024 and 2.0 percent in 2025. Illinois FY 2022 economic performance was strong. Illinois GDP grew 8.9% in CY 2021, Continued increased disposable personal income above pre-pandemic levels. Seasonally adjusted unemployment rate reached its lowest point since the pandemic began coming in at 4.4% in July. FYE 2023 (June end) began on a positive note with July state source revenues hitting estimates. August state source revenues exceeded estimates by 11%. Seasonably adjusted unemployment rate reached its lowest point since the pandemic began coming in at 4.4%1in July. While fears of a recession loom, additional state stimulus should help support economic activity in late 2022 and early 2023. The below chart lays out additional state stimulus, with Illinois a key beneficiary.

Source: 10/7/22 Deutsche Bank State stimulus may stoke near-term spending spree

Growth Drivers

New CEO Harmening joined ASB in 2021 and focused on accelerating indirect auto, middle market lending, asset based lending (ABL) and equipment finance verticals. Growth verticals are likely to drive H2’22 and 2023 loan growth. The company’s growth initiatives couple with a closure of branches to optimize physical assets and reduce employee headcount.

Management

Andy Harmening, President and Chief Executive Officer

Andy Harmening joined Associated Bank in 2021 as president and chief executive officer. He also serves on the Company’s Board of Directors and as the president of Associated Trust, N.A.

Harmening has more than 25 years of industry experience in consumer, small business and commercial banking. Prior to joining Associated Bank, he served as senior executive vice president, consumer and business banking director for Huntington Bank. At Huntington, Harmening led the bank’s digital and omni-channel strategy, which transformed its sales and service experience and earned industry-wide recognition for customer satisfaction.

Earlier, Harmening was vice chairman of the consumer banking division of Bank of the West. He also spent nine years with U.S. Bank in several roles of increasing responsibility within its small business and commercial banking divisions.

Harmening served 12 years on the Consumer Bankers Association Board of Directors. He earned a bachelor’s degree from DePauw University and an MBA from the University of Cincinnati.

Financial Review

ASB’s recent results benefited from strong loan growth, expanding margins, stable deposits and resilient credit trends.

The company’s growth initiatives and rising rates contributed to Q2’22 revenues growing 15% y/y with expenses only 4% y/y, driving an improvement in pretax pre-provision income and a 13% gain tangible ROE. ASB had under 1bp of net charge-offs in the recent quarter and zero net loan provision growth. Going forward, in order for ASB to re-rate in-line with peers must show continued loan growth and a deposit base that that continues to show stability.

 Technical Analysis

Technical support at the 50 day MA places the stock at 20.60, near the .7x forward P/BV downside.

Valuation

ASB traded as low as 0.6x book value in the COVID selloff and 2011 selloff. ASB traded to 0.89x in the 2016 correction, before rallying to 1.3x P/BV after the cycle turned. Compared to the 2016 bank selloff, ASB’s deposit base has changed to higher stability and lower beat. Today’s valuation of 0.78x 2023 P/BV prices in the same high beta deposit base of 2016, ignoring the mix change since 2016. ASB is currently pricing in a recession with the same balance sheet as 2016. As the cycle progresses, ASB will demonstrated greater resiliency and re-rate in line with peers. On a 1.3x P/BV ASB’s stock is worth $36.19, a 64.5% increase in value while a 0.7x downside is only an 11.4% downside, resulting in a 5.65x upside/downside ratio. 

Risks

Credit quality – strong today but a 2023 potential recession looms. If a recession occurs, higher credit losses are to follow, even though current levels are below normal.

Monetary policy – operates on a delay. After a strong 2022 banks face a difficult comparison as companies will no longer receive a tall wind from reserve releases and mortgage banking income. In addition, higher rates and increased inflation may strain borrowers and increase credit costs.

Regional Comps

Catalyst

H2’22 results are expected to continue to show loan growth, resilient credit losses and a low deposit beta.