Having inflicted heavy dilution on shareholders once during his 14 months at Associated Banc-Corp, Chief Executive Phil Flynn is eager to keep from doing it again.
Just days after the anniversary of a $500 million common stock sale and an 80% cut in the dividend, Flynn tried to assure shareholders Thursday that he would do what he could to "minimize any potential dilutions" as the company aims to repay its Troubled Asset Relief Program funding.
His comments, on a conference call discussing Associated's fourth-quarter results, underscored the balancing act for banks that want to be shareholder-friendly in their negotiations to repay Tarp funds. The long-term benefits to investors — namely, the potential for dividend reinstatements and stock buybacks — would still come at a cost, at least for companies that return to the equity markets to meet regulators' conditions for exiting Tarp.
Promising to be "very deliberate about how we do this," Flynn signaled that Associated's shareholders had suffered enough last year. But in the stock market, the message was either not heard, not believed or simply outweighed by other concerns, such as earnings prospects.
Shares in the Green Bay, Wis., company have drifted downward nearly 4% since Thursday, when the company reported earnings that were about 2 cents below the average of analysts' estimates after stripping out one-time items from a quarter that was full of them.
But Flynn delivered other bits of good news for patient investors to grab hold of.
As other banks' net interest margins were contracting, Associated's widened by 5 basis points from the third quarter, to 3.13%, and the company predicted another 10 to 20 basis points of expansion during this year. It also showed continued improvement in credit trends; nonaccrual loans were down 21% from the third quarter, and the ratio of nonperforming assets to total assets declined from 3.47%, to 2.84%.
"The credit-quality improvement is by far the most important thing," said Rick Lane, the head of Broadview Advisors, a Milwaukee firm that owns Associated shares. "I feel that they've really gotten their arms around it and that they're well reserved," he said.
With that in mind, Lane is holding on to a position he questioned owning last year when the company took drastic action to shore up capital.
"I still maintain that we could have gotten through it with less dilution, but I understand why [Flynn] did it: He wanted to make them, in his mind, as bullet-proof as he could, and he only wanted to come back to the market once," Lane said.
And if he winds up having to return to the capital market for the sake of repaying Tarp?
"It wouldn't be the end of the world," Lane said, especially if the equity raise were capped at about $50 million, or about a 2% dilution for existing shareholders. He suggested that the rest of the company's $525 million in Tarp funds could be repaid with a future debt issuance and excess liquidity.
Liquidity management was a key theme for Associated last quarter, as the company ran down balances raised in the overnight financing markets, from a peak of about $2 billion earlier in 2010 to about $500 million at yearend. The company redeployed about $1.7 billion of cash as it invested $810 million in securities, funded $160 million in net loan growth and reduced net funding by $670 million.
Those actions, combined with declining rates paid on deposits, reversed a slide in the net interest margin and should fuel continued expansion this year. The pickup should accelerate as the year progresses, Flynn said, "as projected loan growth later in 2011 begins to contribute more strongly to our expected margins."
Despite the margin expansion the company enjoyed in the fourth quarter, the bottom line fell short of analysts' forecasts, primarily because of lower fee revenue, higher expenses and a loss provision that was bigger than expected.
Excluding adjustments for asset-sale gains, a tax benefit, securities losses and other special items, R. Scott Siefers, an analyst at Sandler O'Neill & Partners LP, estimated that Associated had "core" earnings of 2 cents a share, versus his 4-cent forecast.
Nonetheless, the company "strikes us as well-positioned" to exit Tarp this year, he wrote in a research note.
So rather than timing, the question about Associated's repayment appears to be one of method, something that is at least as much in the hands of regulators as the company itself, Flynn suggested.
"We believe that, given our cash position and given our extraordinarily high capital levels, that we should be able to repay Tarp without significantly diluting our shareholders. But we don't control that," Flynn said. "We are going to be very deliberate in the way we go about this and very deliberate as we talk to our regulators and the Treasury to do the very best we can."
Other banks awaiting regulatory approval for Tarp repayment include SunTrust Banks Inc.
"Our priorities are repaying Tarp and, in due time after that, increasing the common dividend," Chairman and Chief Executive James M. Wells 3rd said Friday during a conference call to discuss SunTrust's fourth-quarter results.
Flynn was more reluctant to talk about dividends or any other step that might follow a release from the bailout program.
"I'm highly certain we'll pay back Tarp in 2011, hopefully sooner than later. And then, when that's done and we see continued growth in core earnings, we could start to revisit those kind of questions," Flynn said in response to an analyst who asked about the company's plans for putting excess capital to use, "but we're a ways away from that in all honesty."
