Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 001-31343

 

 

Associated Banc-Corp

(Exact name of registrant as specified in its charter)

 

 

 

Wisconsin		39-1098068
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

433 Main Street, Green Bay, Wisconsin		54301
(Address of principal executive offices)		(Zip Code)

(920) 491-7500

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		x		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares outstanding of registrant’s common stock, par value $0.01 per share, at October 30, 2014, was 151,985,246.

 

 

 

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Table of Contents

ASSOCIATED BANC-CORP

TABLE OF CONTENTS

 

		Page No.
PART I. Financial Information
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets — September 30, 2014 and December 31, 2013			3
Consolidated Statements of Income — Three and Nine Months Ended September 30, 2014 and 2013			4
Consolidated Statements of Comprehensive Income —Three and Nine Months Ended September  30, 2014 and 2013			5
Consolidated Statements of Changes in Stockholders’ Equity — Nine Months Ended September  30, 2014 and 2013			6
Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2014 and 2013			7
Notes to Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			53
Item 3. Quantitative and Qualitative Disclosures About Market Risk			84
Item 4. Controls and Procedures			84
PART II. Other Information
Item 1. Legal Proceedings			85
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			86
Item 6. Exhibits			86
Signatures			87

 

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Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1. Financial Statements:

ASSOCIATED BANC-CORP

Consolidated Balance Sheets

 

		September 30, 2014				December 31, 2013
		(Unaudited)				(Audited)
		(In Thousands, except share and per share data)
ASSETS
Cash and due from banks		$	381,287			$	455,482
Interest-bearing deposits in other financial institutions			74,945				126,018
Federal funds sold and securities purchased under agreements to resell			18,320				20,745
Investment securities held to maturity, at amortized cost			301,941				175,210
Investment securities available for sale, at fair value			5,345,422				5,250,585
Federal Home Loan Bank and Federal Reserve Bank stocks, at cost			188,875				181,249
Loans held for sale			141,672				64,738
Loans			17,159,090				15,896,261
Allowance for loan losses			(266,262	)			(268,315	)
Loans, net			16,892,828				15,627,946
Premises and equipment, net			272,283				270,890
Goodwill			929,168				929,168
Other intangible assets, net			69,201				74,464
Trading assets			34,005				43,728
Other assets			1,003,875				1,006,697
Total assets		$	25,653,822			$	24,226,920
LIABILITIES AND STOCKHOLDERS’ EQUITY
Noninterest-bearing demand deposits		$	4,302,454			$	4,626,312
Interest-bearing deposits			13,898,804				12,640,855
Total deposits			18,201,258				17,267,167
Federal funds purchased and securities sold under agreements to repurchase			765,641				475,442
Other short-term funding			664,539				265,484
Long-term funding			2,931,547				3,087,267
Trading liabilities			36,003				46,470
Accrued expenses and other liabilities			185,256				193,800
Total liabilities			22,784,244				21,335,630
Stockholders’ equity
Preferred equity			61,024				61,862
Common stock			1,719				1,750
Surplus			1,583,032				1,617,990
Retained earnings			1,466,525				1,392,508
Accumulated other comprehensive loss			(1,725	)			(24,244	)
Treasury stock, at cost			(240,997	)			(158,576	)
Total stockholders’ equity			2,869,578				2,891,290
Total liabilities and stockholders’ equity		$	25,653,822			$	24,226,920
Preferred shares issued			62,689				63,549
Preferred shares authorized (par value $1.00 per share)			750,000				750,000
Common shares issued			171,888,747				175,012,686
Common shares authorized (par value $0.01 per share)			250,000,000				250,000,000
Treasury shares of common stock			15,126,171				10,874,182

See accompanying notes to consolidated financial statements.

 

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ITEM 1. Financial Statements Continued:

 

ASSOCIATED BANC-CORP

Consolidated Statements of Income

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
		(In Thousands, except per share data)
INTEREST INCOME
Interest and fees on loans		$	152,030			$	146,219			$	442,046			$	438,642
Interest and dividends on investment securities
Taxable			25,037				21,544				77,403				64,603
Tax exempt			7,483				6,711				21,484				20,461
Other interest			1,503				1,260				4,814				3,740
Total interest income			186,053				175,734				545,747				527,446
INTEREST EXPENSE
Interest on deposits			6,621				7,617				18,975				23,927
Interest on Federal funds purchased and securities sold under agreements to repurchase			390				308				1,001				1,051
Interest on other short-term funding			233				434				629				1,291
Interest on long-term funding			6,179				6,866				18,836				22,833
Total interest expense			13,423				15,225				39,441				49,102
NET INTEREST INCOME			172,630				160,509				506,306				478,344
Provision for credit losses			1,000				(800	)			11,000				7,800
Net interest income after provision for credit losses			171,630				161,309				495,306				470,544
NONINTEREST INCOME
Trust service fees			12,218				11,380				35,946				33,695
Service charges on deposit accounts			17,961				18,407				51,773				52,679
Card-based and other nondeposit fees			12,407				12,688				37,493				37,229
Insurance commissions			7,860				11,356				33,828				32,750
Brokerage and annuity commissions			4,040				3,792				12,593				10,996
Mortgage banking, net			6,669				3,542				18,392				40,570
Capital market fees, net			2,939				2,652				7,360				10,309
Bank owned life insurance income			3,506				2,817				10,837				9,068
Asset gains, net			4,934				1,934				6,561				2,726
Investment securities gains, net			57				248				469				582
Other			2,317				2,100				5,424				6,622
Total noninterest income			74,908				70,916				220,676				237,226
NONINTEREST EXPENSE
Personnel expense			97,650				98,102				293,141				295,800
Occupancy			13,743				14,758				43,088				44,725
Equipment			6,133				6,213				18,636				18,842
Technology			13,573				12,323				40,891				36,482
Business development and advertising			7,467				5,947				17,606				15,512
Other intangible asset amortization			990				1,010				2,972				3,032
Loan expense			3,813				3,157				10,220				9,485
Legal and professional fees			4,604				3,482				13,228				14,310
Losses other than loans			677				(600	)			1,602				283
Foreclosure / OREO expense			2,083				2,515				5,554				7,239
FDIC expense			6,859				4,755				16,805				14,582
Other			14,261				13,509				43,693				41,190
Total noninterest expense			171,853				165,171				507,436				501,482
Income before income taxes			74,685				67,054				208,546				206,288
Income tax expense			24,478				21,396				66,775				65,354
Net income			50,207				45,658				141,771				140,934
Preferred stock dividends			1,255				1,285				3,777				3,885
Net income available to common equity		$	48,952			$	44,373			$	137,994			$	137,049
Earnings per common share:
Basic		$	0.31			$	0.27			$	0.86			$	0.82
Diluted		$	0.31			$	0.27			$	0.85			$	0.82
Average common shares outstanding:
Basic			155,925				164,954				159,090				166,586
Diluted			156,991				165,443				159,993				166,760

See accompanying notes to consolidated financial statements.

 

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ITEM 1: Financial Statements Continued:

 

ASSOCIATED BANC-CORP

Consolidated Statements of Comprehensive Income

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
		($ in Thousands)
Net income		$	50,207			$	45,658			$	141,771			$	140,934
Other comprehensive income (loss), net of tax:
Investment securities available for sale:
Net unrealized gains (losses)			(20,123	)			(20,558	)			36,061				(142,318	)
Reclassification adjustment for net gains realized in net income			(57	)			(248	)			(469	)			(582	)
Income tax (expense) benefit			7,757				8,031				(13,684	)			55,169
Other comprehensive income (loss) on investment securities available for sale			(12,423	)			(12,775	)			21,908				(87,731	)
Defined benefit pension and postretirement obligations:
Amortization of prior service cost			15				17				45				52
Amortization of actuarial losses			317				1,073				949				3,218
Income tax expense			(128	)			(420	)			(383	)			(1,262	)
Other comprehensive income on pension and postretirement obligations			204				670				611				2,008
Total other comprehensive income (loss)			(12,219	)			(12,105	)			22,519				(85,723	)
Comprehensive income		$	37,988			$	33,553			$	164,290			$	55,211

See accompanying notes to consolidated financial statements.

 

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ITEM 1. Financial Statements Continued:

 

ASSOCIATED BANC-CORP

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

 

		Preferred Equity				Common Stock				Surplus				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
		($ in Thousands, except per share data)
Balance, December 31, 2012		$	63,272			$	1,750			$	1,602,136			$	1,281,811			$	48,603			$	(61,173	)		$	2,936,399
Comprehensive income:
Net income			—				—				—				140,934				—				—				140,934
Other comprehensive loss			—				—				—				—				(85,723	)			—				(85,723	)
Comprehensive income																											55,211
Common stock issued:
Stock-based compensation plans, net			—				—				564				(17,057	)			—				23,368				6,875
Purchase of treasury stock			—				—				—				—				—				(93,294	)			(93,294	)
Cash dividends:
Common stock, $0.24 per share			—				—				—				(40,223	)			—				—				(40,223	)
Preferred stock			—				—				—				(3,885	)			—				—				(3,885	)
Purchase of preferred stock			(535	)			—				—				(82	)			—				—				(617	)
Stock-based compensation expense, net			—				—				11,368				—				—				—				11,368
Tax benefit of stock options			—				—				448				—				—				—				448
Balance, September 30, 2013		$	62,737			$	1,750			$	1,614,516			$	1,361,498			$	(37,120	)		$	(131,099	)		$	2,872,282
Balance, December 31, 2013		$	61,862			$	1,750			$	1,617,990			$	1,392,508			$	(24,244	)		$	(158,576	)		$	2,891,290
Comprehensive income:
Net income			—				—				—				141,771				—				—				141,771
Other comprehensive income			—				—				—				—				22,519				—				22,519
Comprehensive income																											164,290
Common stock issued:
Stock-based compensation plans, net			—				—				1,863				(20,556	)			—				29,824				11,131
Purchase of common stock returned to authorized but unissued			—				(31	)			(50,467	)			—				—				50,498				—
Purchase of treasury stock			—				—				—				—				—				(162,743	)			(162,743	)
Cash dividends:
Common stock, $0.27 per share			—				—								(43,299	)			—				—				(43,299	)
Preferred stock			—				—				—				(3,777	)			—				—				(3,777	)
Purchase of preferred stock			(838	)			—				—				(122	)			—				—				(960	)
Stock-based compensation expense, net			—				—				12,462				—				—				—				12,462
Tax benefit of stock options			—				—				1,184				—				—				—				1,184
Balance, September 30, 2014		$	61,024			$	1,719			$	1,583,032			$	1,466,525			$	(1,725	)		$	(240,997	)		$	2,869,578

See accompanying notes to consolidated financial statements.

 

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ITEM 1. Financial Statements Continued:

 

ASSOCIATED BANC-CORP

Consolidated Statements of Cash Flows

(Unaudited)

 

		Nine Months Ended September 30,
		2014				2013
		($ in Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	141,771			$	140,934
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses			11,000				7,800
Depreciation and amortization			38,023				36,738
Recovery of valuation allowance on mortgage servicing rights, net			(89	)			(14,097	)
Amortization of mortgage servicing rights			8,224				12,479
Amortization of other intangible assets			2,972				3,032
Amortization and accretion on earning assets, funding, and other, net			21,647				36,973
Tax impact of stock based compensation			1,184				448
Gain on sales of investment securities, net			(469	)			(582	)
Gain on sales of assets and impairment write-downs, net			(6,561	)			(2,726	)
Gain on mortgage banking activities, net			(11,668	)			(31,539	)
Mortgage loans originated and acquired for sale			(777,532	)			(1,977,357	)
Proceeds from sales of mortgage loans held for sale			735,565				2,152,286
Pension contributions			(21,270	)			(28,000	)
(Increase) decrease in interest receivable			(3,301	)			739
Decrease in interest payable			(6,451	)			(8,293	)
Net change in other assets and other liabilities			(2,333	)			42,721
Net cash provided by operating activities			130,712				371,556
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans			(1,292,718	)			(233,755	)
Purchases of:
Available for sale securities			(808,899	)			(1,305,155	)
Held to maturity securities			(126,602	)			(85,453	)
FHLB stock			(7,626	)			(28,520	)
Premises, equipment, and software, net of disposals			(35,507	)			(49,139	)
Other assets			(2,460	)			(1,401	)
Proceeds from:
Sales of available for sale securities			101,987				135,809
Prepayments, calls, and maturities of available for sale securities			620,606				1,082,290
Prepayments, calls, and maturities of held to maturity securities			6,170				—
FHLB stock			—				14,399
Prepayments, calls, and maturities of other assets			29,136				30,857
Net cash used in investing activities			(1,515,913	)			(440,068	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits			934,091				1,398,043
Net increase (decrease) in short-term funding			689,254				(700,059	)
Repayment of long-term funding			(155,058	)			(400,156	)
Purchase of preferred stock			(960	)			(617	)
Cash dividends on common stock			(43,299	)			(40,223	)
Cash dividends on preferred stock			(3,777	)			(3,885	)
Purchase of treasury stock			(162,743	)			(93,294	)
Net cash provided by financing activities			1,257,508				159,809
Net increase (decrease) in cash and cash equivalents			(127,693	)			91,297
Cash and cash equivalents at beginning of period			602,245				737,873
Cash and cash equivalents at end of period		$	474,552			$	829,170
Supplemental disclosures of cash flow information:
Cash paid for interest		$	46,026			$	57,310
Cash paid for income taxes			57,167				29,700
Loans and bank premises transferred to other real estate owned			17,125				21,962
Capitalized mortgage servicing rights			5,844				15,968

See accompanying notes to consolidated financial statements.

 

 

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ITEM 1. Financial Statements Continued:

 

ASSOCIATED BANC-CORP

Notes to Consolidated Financial Statements

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with U.S. generally accepted accounting principles have been omitted or abbreviated. The information contained in the consolidated financial statements and footnotes in Associated Banc-Corp’s 2013 annual report on Form 10-K, should be referred to in connection with the reading of these unaudited interim financial statements.

NOTE 1: Basis of Presentation

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position, results of operations and comprehensive income, changes in stockholders’ equity, and cash flows of Associated Banc-Corp (individually referred to herein as the “Parent Company,” and together with all of its subsidiaries and affiliates, collectively referred to herein as the “Corporation”) for the periods presented, and all such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of all subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform with the current period’s presentation. The consolidated statements of income were modified from prior periods’ presentation to conform with the current period presentation, which shows a new provision for credit losses line item comprised of the provision for loan losses and the provision for unfunded commitments. In prior periods’ presentation, the provision for unfunded commitments was reported as a component of losses other than loans in the consolidated statements of income. The presentation of the consolidated balance sheets remains unchanged with the allowance for loan losses presented as a valuation allowance with the related loan asset, while the allowance for unfunded commitments is included in accrued expenses and other liabilities.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the determination of the allowance for credit losses, goodwill impairment assessment, mortgage servicing rights valuation, and income taxes. Management has evaluated subsequent events for potential recognition or disclosure.

NOTE 2: New Accounting Pronouncements Adopted

In July 2013, the FASB issued an amendment to clarify the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This amendment is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013 and should be applied prospectively. The Corporation adopted the accounting standard during the first quarter of 2014, as required, with no material impact on its results of operations, financial position, or liquidity.

NOTE 3: Earnings Per Common Share

Earnings per share are calculated utilizing the two-class method. Basic earnings per common share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per common share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding adjusted for the dilutive effect of common stock awards (outstanding stock options, unvested restricted stock, and outstanding stock warrants). Presented below are the calculations for basic and diluted earnings per common share.

 

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		For the Three Months Ended September 30								For the Nine Months Ended September 30
		2014				2013				2014				2013
		(In Thousands, except per share data)
Net income		$	50,207			$	45,658			$	141,771			$	140,934
Preferred stock dividends			(1,255	)			(1,285	)			(3,777	)			(3,885	)
Net income available to common equity		$	48,952			$	44,373			$	137,994			$	137,049
Common shareholder dividends			(13,983	)			(13,167	)			(42,864	)			(39,849	)
Dividends on unvested share-based payment awards			(140	)			(100	)			(435	)			(374	)
Undistributed earnings		$	34,829			$	31,106			$	94,695			$	96,826
Undistributed earnings allocated to common shareholders			34,481				30,873				93,862				96,112
Undistributed earnings allocated to unvested share-based payment awards			348				233				833				714
Undistributed earnings		$	34,829			$	31,106			$	94,695			$	96,826
Basic
Distributed earnings to common shareholders		$	13,983			$	13,167			$	42,864			$	39,849
Undistributed earnings allocated to common shareholders			34,481				30,873				93,862				96,112
Total common shareholders earnings, basic		$	48,464			$	44,040			$	136,726			$	135,961
Diluted
Distributed earnings to common shareholders		$	13,983			$	13,167			$	42,864			$	39,849
Undistributed earnings allocated to common shareholders			34,481				30,873				93,862				96,112
Total common shareholders earnings, diluted		$	48,464			$	44,040			$	136,726			$	135,961
Weighted average common shares outstanding			155,925				164,954				159,090				166,586
Effect of dilutive common stock awards			1,066				489				903				174
Diluted weighted average common shares outstanding			156,991				165,443				159,993				166,760
Basic earnings per common share		$	0.31			$	0.27			$	0.86			$	0.82
Diluted earnings per common share		$	0.31			$	0.27			$	0.85			$	0.82

Options to purchase approximately 2 million and 3 million shares were outstanding for the three and nine months ended September 30, 2014, respectively, but excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive. Options to purchase approximately 3 million shares were outstanding for both the three and nine months ended September 30, 2013, but excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

 

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NOTE 4: Stock-Based Compensation

At September 30, 2014, the Corporation had one stock-based compensation plan, the 2013 Incentive Compensation Plan. All stock options granted under this plan have an exercise price that is equal to the closing price of the Corporation’s stock on the grant date.

The Corporation also issues restricted common stock and restricted common stock units to certain key employees (collectively referred to as “restricted stock awards”) under this plan. The shares of restricted stock are restricted as to transfer, but are not restricted as to dividend payment or voting rights. Restricted stock units receive dividend equivalents but do not have voting rights. The transfer restrictions primarily lapse over three or four years, depending upon whether the awards are service-based or performance-based. Service-based awards are contingent upon continued employment or meeting the requirements for retirement, and performance-based awards are based on earnings per share performance goals, relative total shareholder return, and continued employment or meeting the requirements for retirement. The plan provides that restricted stock awards and stock options will immediately become fully vested upon retirement from the Corporation of those colleagues whose retirement meets the early retirement or normal retirement definitions under the plan (“retirement eligible colleagues”).

The fair value of stock options granted is estimated on the date of grant using a Black-Scholes option pricing model, while the fair value of restricted stock awards is their fair market value on the date of grant. The fair values of stock options and restricted stock awards are amortized as compensation expense on a straight-line basis over the vesting period of the grants. Beginning with the 2014 grants, expenses related to stock options and restricted stock are fully recognized on the date the colleague meets the definition of normal or early retirement. Compensation expense recognized is included in personnel expense in the consolidated statements of income.

Assumptions are used in estimating the fair value of stock options granted. The weighted average expected life of the stock option represents the period of time that stock options are expected to be outstanding and is estimated using historical data of stock option exercises and forfeitures. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on the implied volatility of the Corporation’s stock. The following assumptions were used in estimating the fair value for options granted in the first nine months of 2014 and full year 2013.

 

		2014				2013
Dividend yield			2.00	%			2.00	%
Risk-free interest rate			2.00	%			0.99	%
Weighted average expected volatility			20.00	%			34.35	%
Weighted average expected life			6 years				6 years
Weighted average per share fair value of options		$	3.00			$	3.80

The Corporation is required to estimate potential forfeitures of stock grants and adjust compensation expense recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

 

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A summary of the Corporation’s stock option activity for the year ended December 31, 2013 and for the nine months ended September 30, 2014, is presented below.

 

Stock Options		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term				Aggregate Intrinsic Value (000s)
Outstanding at December 31, 2012			8,640,558			$	18.88
Granted			1,020,979				14.02
Exercised			(642,202	)			13.43
Forfeited or expired			(985,092	)			21.49
Outstanding at December 31, 2013			8,034,243			$	18.37				6.03			$	20,838
Options exercisable at December 31, 2013			4,923,720			$	21.48				4.62				8,580
Outstanding at December 31, 2013			8,034,243			$	18.37
Granted			1,389,452				17.45
Exercised			(754,470	)			13.74
Forfeited or expired			(589,238	)			24.36
Outstanding at September 30, 2014			8,079,987			$	18.21				6.12			$	17,762
Options exercisable at September 30, 2014			5,225,930			$	19.78				4.79				11,624

The following table summarizes information about the Corporation’s nonvested stock option activity for the year ended December 31, 2013, and for the nine months ended September 30, 2014.

 

Stock Options		Shares				Weighted Average Grant Date Fair Value
Nonvested at December 31, 2012			4,036,595			$	5.11
Granted			1,020,979				3.80
Vested			(1,680,981	)			5.10
Forfeited			(266,070	)			5.05
Nonvested at December 31, 2013			3,110,523			$	4.69
Granted			1,389,452				3.00
Vested			(1,492,733	)			4.95
Forfeited			(153,185	)			4.41
Nonvested at September 30, 2014			2,854,057			$	3.75

The intrinsic value of stock options exercised for the nine months ended September 30, 2014 was $3 million and $2 million for the year ended December 31, 2013, respectively. The total fair value of stock options that vested was $7 million for the first nine months of 2014 and $9 million for the year ended December 31, 2013. For the nine months ended September 30, 2014 and 2013, the Corporation recognized compensation expense for the vesting of stock options of $5 million and $6 million, respectively. For the full year 2013, the Corporation recognized compensation expense of $8 million for the vesting of stock options. Included in compensation expense for 2014 was approximately $250,000 of expense for the accelerated vesting of stock options granted to retirement eligible colleagues. At September 30, 2014, the Corporation had $6 million of unrecognized compensation expense related to stock options that is expected to be recognized over the remaining requisite service periods that extend predominantly through fourth quarter 2018.

 

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The following table summarizes information about the Corporation’s restricted stock awards activity for the year ended December 31, 2013, and for the nine months ended September 30, 2014.

 

Restricted Stock		Shares				Weighted Average Grant Date Fair Value
Outstanding at December 31, 2012			932,425			$	13.60
Granted			1,276,868				14.03
Vested			(626,480	)			13.68
Forfeited			(71,048	)			13.92
Outstanding at December 31, 2013			1,511,765			$	13.92
Granted			1,158,711				17.41
Vested			(526,784	)			14.13
Forfeited			(124,222	)			15.06
Outstanding at September 30, 2014			2,019,470			$	15.80

The Corporation amortizes the expense related to restricted stock awards as compensation expense over the vesting period specified in the grant. Restricted stock awards granted during 2013 to executive officers will vest ratably over a three year period, while restricted stock awards granted during 2014 will vest ratably over a four year period. Restricted stock awards granted to non-executives during 2014 and 2013 will vest ratably over a four year period. Expense for restricted stock awards of approximately $8 million and $6 million was recognized for the nine months ended September 30, 2014 and 2013, respectively. The Corporation recognized approximately $7 million of expense for restricted stock awards for the full year 2013. Included in compensation expense for 2014 was approximately $1.1 million of expense for the accelerated vesting of restricted stock awards granted to retirement eligible colleagues. The Corporation had $24 million of unrecognized compensation costs related to restricted stock awards at September 30, 2014 that is expected to be recognized over the remaining requisite service periods that extend predominantly through fourth quarter 2018.

The Corporation has the ability to issue shares from treasury or new shares upon the exercise of stock options or the granting of restricted stock awards. The Board of Directors has authorized management to repurchase shares of the Corporation’s common stock each quarter in the market, to be made available for issuance in connection with the Corporation’s employee incentive plans and for other corporate purposes. The repurchase of shares will be based on market and investment opportunities, capital levels, growth prospects, and regulatory constraints. Such repurchases may occur from time to time in open market purchases, block transactions, private transactions, accelerated share repurchase programs, or similar facilities.

 

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NOTE 5: Investment Securities

The amortized cost and fair values of investment securities available for sale and held to maturity were as follows.

 

September 30, 2014:		Amortized cost				Gross unrealized gains				Gross unrealized losses				Fair value
		($ in Thousands)
Investment securities available for sale:
U.S. Treasury securities		$	999			$	—			$	(3	)		$	996
Obligations of state and political subdivisions (municipal securities)			588,255				26,229				(48	)			614,436
Residential mortgage-related securities:
Government-sponsored enterprise (“GSE”)			3,725,218				59,047				(43,225	)			3,741,040
Private-label			2,475				9				(2	)			2,482
GNMA commercial mortgage-related securities			1,007,068				1,751				(28,217	)			980,602
Other securities (debt and equity)			5,806				60				—				5,866
Total investment securities available for sale		$	5,329,821			$	87,096			$	(71,495	)		$	5,345,422
Investment securities held to maturity:
Obligations of state and political subdivisions (municipal securities)		$	301,941			$	6,875			$	(934	)		$	307,882
Total investment securities held to maturity		$	301,941			$	6,875			$	(934	)		$	307,882
December 31, 2013:		Amortized cost				Gross unrealized gains				Gross unrealized losses				Fair value
		($ in Thousands)
Investment securities available for sale:
U.S. Treasury securities		$	1,001			$	1			$	—			$	1,002
Obligations of state and political subdivisions (municipal securities)			653,758				23,855				(1,533	)			676,080
Residential mortgage-related securities:
GSE			3,855,467				61,542				(78,579	)			3,838,430
Private-label			3,035				16				(37	)			3,014
GNMA commercial mortgage-related securities			673,555				1,764				(27,842	)			647,477
Asset-backed securities (1)			23,049				10				—				23,059
Other securities (debt and equity)			60,711				855				(43	)			61,523
Total investment securities available for sale		$	5,270,576			$	88,043			$	(108,034	)		$	5,250,585
Investment securities held to maturity:
Obligations of state and political subdivisions (municipal securities)		$	175,210			$	401			$	(5,722	)		$	169,889
Total investment securities held to maturity		$	175,210			$	401			$	(5,722	)		$	169,889

 

(1)	The asset-backed securities position is largely comprised of senior, floating rate, tranches of student loan securities issued by SLM Corp and guaranteed under the Federal Family Education Loan Program.

 

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The amortized cost and fair values of investment securities available for sale and held to maturity at September 30, 2014, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Available for Sale								Held to Maturity
($ in Thousands)		Amortized Cost				Fair Value				Amortized Cost				Fair Value
Due in one year or less		$	28,053			$	28,232			$	—			$	—
Due after one year through five years			224,059				236,326				765				774
Due after five years through ten years			333,788				347,187				105,931				106,998
Due after ten years			9,142				9,480				195,245				200,110
Total debt securities			595,042				621,225				301,941				307,882
Residential mortgage-related securities:
GSE			3,725,218				3,741,040				—				—
Private-label			2,475				2,482				—				—
GNMA commercial mortgage-related securities			1,007,068				980,602				—				—
Equity securities			18				73				—				—
Total investment securities		$	5,329,821			$	5,345,422			$	301,941			$	307,882
Ratio of Fair Value to Amortized Cost							100.3	%							102.0	%

The following represents gross unrealized losses and the related fair value of investment securities available for sale and held to maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2014.

 

		Less than 12 months												12 months or more												Total
September 30, 2014:		Number of Securities				Unrealized Losses				Fair Value				Number of Securities				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value
						($ in Thousands)
Investment securities available for sale:
U.S. Treasury securities			1			$	(3	)		$	996				—			$	—			$	—			$	(3	)		$	996
Obligations of state and political subdivisions (municipal securities)			5				(1	)		$	1,799				13				(47	)		$	5,647				(48	)		$	7,446
Residential mortgage-related securities:
GSE			30				(1,472	)			331,085				64				(41,753	)			1,389,945				(43,225	)			1,721,030
Private-label			1				(1	)			1,889				2				(1	)			30				(2	)			1,919
GNMA commercial mortgage-related securities			12				(1,927	)			363,315				15				(26,290	)			390,443				(28,217	)			753,758
Total						$	(3,404	)		$	699,084							$	(68,091	)		$	1,786,065			$	(71,495	)		$	2,485,149
Investment securities held to maturity:
Obligations of state and political subdivisions (municipal securities)			39			$	(55	)		$	14,443				119			$	(879	)		$	55,522			$	(934	)		$	69,965
Total						$	(55	)		$	14,443							$	(879	)		$	55,522			$	(934	)		$	69,965

 

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For comparative purposes, the following represents gross unrealized losses and the related fair value of investment securities available for sale and held to maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2013.

 

		Less than 12 months												12 months or more												Total
December 31, 2013:		Number of Securities				Unrealized Losses				Fair Value				Number of Securities				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value
						($ in Thousands)
Investment securities available for sale:
Obligations of state and political subdivisions (municipal securities)			113			$	(1,525	)		$	47,044				1			$	(8	)		$	273			$	(1,533	)		$	47,317
Residential mortgage-related securities:
GSE			106				(57,393	)			1,887,784				15				(21,186	)			421,082				(78,579	)			2,308,866
Private-label			2				(37	)			2,105				1				—				35				(37	)			2,140
GNMA commercial mortgage-related securities			19				(23,854	)			443,462				1				(3,988	)			45,950				(27,842	)			489,412
Other debt securities			5				(43	)			6,452				—				—				—				(43	)			6,452
Total						$	(82,852	)		$	2,386,847							$	(25,182	)		$	467,340			$	(108,034	)		$	2,854,187
Investment securities held to maturity:
Obligations of state and political subdivisions (municipal securities)			298			$	(5,339	)		$	124,435				10			$	(383	)		$	5,010			$	(5,722	)		$	129,445
Total						$	(5,339	)		$	124,435							$	(383	)		$	5,010			$	(5,722	)		$	129,445

The Corporation reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. A determination as to whether a security’s decline in fair value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Corporation may consider in the other-than-temporary impairment analysis include, the length of time and extent to which the security has been in an unrealized loss position, changes in security ratings, financial condition and near-term prospects of the issuer, as well as security and industry specific economic conditions. In addition, with regards to its debt securities, the Corporation may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds, and the value of any underlying collateral.

Based on the Corporation’s evaluation, management does not believe any unrealized loss at September 30, 2014 represents an other-than-temporary impairment as these unrealized losses are primarily attributable to changes in interest rates and the current market conditions, and not credit deterioration. The unrealized losses reported for residential mortgage-related securities relate to private-label residential mortgage-related securities as well as residential mortgage-related securities issued by government-sponsored enterprises such as the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”). The unrealized losses reported for commercial mortgage-related securities relate to securities issued by GNMA. The unrealized losses reported for municipal securities relate to various state and local political subdivisions and school districts. The Corporation currently does not intend to sell nor does it believe that it will be required to sell the securities contained in the above unrealized losses table before recovery of their amortized cost basis. The improvement in the unrealized loss position of the investment securities portfolio was due to a reduction in the overall level of interest rates from December 31, 2013 to September 30, 2014, as well as spread compression on mortgage-related and municipal securities, which increased the fair value of investment securities.

 

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The following is a summary of the credit loss portion of other-than-temporary impairment recognized in earnings on debt securities for the year ended December 31, 2013 and the nine months ended September 30, 2014, respectively.

 

		Private-label Mortgage-Related Securities				Trust Preferred Debt Securities				Total
		($ in Thousands)
Balance of credit-related other-than-temporary impairment at December 31, 2012		$	(532	)		$	(6,336	)		$	(6,868	)
Reduction due to credit impaired securities sold			532				57				589
Balance of credit-related other-than-temporary impairment at December 31, 2013		$	—			$	(6,279	)		$	(6,279	)
Reduction due to credit impaired securities sold or abandoned			—				6,279				6,279
Balance of credit-related other-than-temporary impairment at September 30, 2014		$	—			$	—			$	—

Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank Stocks: The Corporation is required to maintain Federal Reserve stock and FHLB stock as a member of both the Federal Reserve System and the FHLB, and in amounts as required by these institutions. These equity securities are “restricted” in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other marketable equity securities and their fair value is equal to amortized cost. The Corporation had FHLB stock of $118 million at September 30, 2014 and $110 million at December 31, 2013 and Federal Reserve Bank stock of $71 million at both September 30, 2014 and December 31, 2013.

NOTE 6: Loans, Allowance for Credit Losses, and Credit Quality

The period end loan composition was as follows.

 

		September 30,				December 31,
		2014				2013
		($ in Thousands)
Commercial and industrial		$	5,603,899			$	4,822,680
Commercial real estate - owner occupied			1,014,335				1,114,715
Lease financing			52,600				55,483
Commercial and business lending			6,670,834				5,992,878
Commercial real estate - investor			3,043,361				2,939,456
Real estate construction			982,426				896,248
Commercial real estate lending			4,025,787				3,835,704
Total commercial			10,696,621				9,828,582
Home equity			1,676,525				1,825,014
Installment and credit cards			459,682				407,074
Residential mortgage			4,326,262				3,835,591
Total consumer			6,462,469				6,067,679
Total loans		$	17,159,090			$	15,896,261

 

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A summary of the changes in the allowance for credit losses was as follows.

 

		Nine Months Ended September 30, 2014				Year Ended December 31, 2013
		($ in Thousands)
Allowance for Loan Losses:
Balance at beginning of period		$	268,315			$	297,409
Provision for loan losses			8,500				10,000
Charge offs			(35,318	)			(88,061	)
Recoveries			24,765				48,967
Net charge offs			(10,553	)			(39,094	)
Balance at end of period		$	266,262			$	268,315
Allowance for Unfunded Commitments:
Balance at beginning of period		$	21,900			$	21,800
Provision for unfunded commitments			2,500				100
Balance at end of period		$	24,400			$	21,900
Allowance for Credit Losses		$	290,662			$	290,215

The level of the allowance for loan losses represents management’s estimate of an amount appropriate to provide for probable credit losses in the loan portfolio at the balance sheet date. In general, the change in the allowance for loan losses is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge offs, trends in past due and impaired loans, and the level of potential problem loans. Management considers the allowance for loan losses a critical accounting policy, as assessing these numerous factors involves significant judgment.

The allowance for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities (including unfunded loan commitments and letters of credit) and is included in accrued expenses and other liabilities on the consolidated balance sheets. The determination of the appropriate level of the allowance for unfunded commitments is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience and credit risk grading of the loan. Net adjustments to the allowance for unfunded commitments are included in provision for credit losses in the consolidated statements of income. See Note 12 for additional information on the allowance for unfunded commitments.

 

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A summary of the changes in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2014, was as follows.

 

$ in Thousands		Commercial and industrial				Commercial real estate - owner occupied				Lease financing				Commercial real estate - investor				Real estate construction				Home equity				Installment and credit cards				Residential mortgage				Total
Balance at Dec 31, 2013		$	104,501			$	19,476			$	1,607			$	58,156			$	23,418			$	32,196			$	2,416			$	26,545			$	268,315
Provision for loan losses			18,700				1,098				777				(14,292	)			(3,831	)			1,278				3,486				1,284				8,500
Charge offs			(11,421	)			(2,963	)			(29	)			(4,358	)			(1,761	)			(9,713	)			(1,751	)			(3,322	)			(35,318	)
Recoveries			9,501				1,427				6				9,693				503				2,546				481				608				24,765
Balance at Sep 30, 2014		$	121,281			$	19,038			$	2,361			$	49,199			$	18,329			$	26,307			$	4,632			$	25,115			$	266,262
Allowance for loan losses:
Ending balance impaired loans individually evaluated for impairment		$	14,006			$	1,672			$	735			$	1,829			$	1,140			$	11			$	—			$	588			$	19,981
Ending balance impaired loans collectively evaluated for impairment		$	3,590			$	2,404			$	4			$	2,429			$	1,021			$	12,480			$	339			$	11,503			$	33,770
Total impaired loans		$	17,596			$	4,076			$	739			$	4,258			$	2,161			$	12,491			$	339			$	12,091			$	53,751
Ending balance all other loans collectively evaluated for impairment		$	103,685			$	14,962			$	1,622			$	44,941			$	16,168			$	13,816			$	4,293			$	13,024			$	212,511
Total		$	121,281			$	19,038			$	2,361			$	49,199			$	18,329			$	26,307			$	4,632			$	25,115			$	266,262
Loans:
Ending balance impaired loans individually evaluated for impairment		$	45,242			$	17,927			$	1,938			$	21,204			$	6,026			$	1,025			$	—			$	10,390			$	103,752
Ending balance impaired loans collectively evaluated for impairment		$	42,856			$	17,987			$	9			$	28,342			$	2,966			$	30,818			$	1,759			$	60,252			$	184,989
Total impaired loans		$	88,098			$	35,914			$	1,947			$	49,546			$	8,992			$	31,843			$	1,759			$	70,642			$	288,741
Ending balance all other loans collectively evaluated for impairment		$	5,515,801			$	978,421			$	50,653			$	2,993,815			$	973,434			$	1,644,682			$	457,923			$	4,255,620			$	16,870,349
Total		$	5,603,899			$	1,014,335			$	52,600			$	3,043,361			$	982,426			$	1,676,525			$	459,682			$	4,326,262			$	17,159,090

The allocation methodology used by the Corporation includes allocations for specifically identified impaired loans and loss factor allocations (used for both criticized and non-criticized loan categories), with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. Management allocates the allowance for loan losses by pools of risk within each loan portfolio. The allocation of the allowance for loan losses by loan portfolio is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular category. The total allowance for loan losses is available to absorb losses from any segment of the loan portfolio.

 

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For comparison purposes, a summary of the changes in the allowance for loan losses by portfolio segment for the year ended December 31, 2013, was as follows.

 

$ in Thousands		Commercial and industrial				Commercial real estate - owner occupied				Lease financing				Commercial real estate - investor				Real estate construction				Home equity				Installment				Residential mortgage				Total
Balance at Dec 31, 2012		$	97,852			$	27,389			$	3,024			$	63,181			$	20,741			$	56,826			$	4,299			$	24,097			$	297,409
Provision for loan losses			12,930				(1,778	)			(1,429	)			(2,140	)			541				(8,213	)			(2,127	)			12,216				10,000
Charge offs			(35,146	)			(6,474	)			(206	)			(9,846	)			(3,375	)			(20,629	)			(1,389	)			(10,996	)			(88,061	)
Recoveries			28,865				339				218				6,961				5,511				4,212				1,633				1,228				48,967
Balance at Dec 31, 2013		$	104,501			$	19,476			$	1,607			$	58,156			$	23,418			$	32,196			$	2,416			$	26,545			$	268,315
Allowance for loan losses:
Ending balance impaired loans individually evaluated for impairment		$	7,994			$	1,019			$	—			$	3,932			$	254			$	123			$	—			$	315			$	13,637
Ending balance impaired loans collectively evaluated for impairment		$	3,923			$	1,936			$	29			$	3,963			$	2,162			$	13,866			$	487			$	11,872			$	38,238
Total impaired loans		$	11,917			$	2,955			$	29			$	7,895			$	2,416			$	13,989			$	487			$	12,187			$	51,875
Ending balance all other loans collectively evaluated for impairment		$	92,584			$	16,521			$	1,578			$	50,261			$	21,002			$	18,207			$	1,929			$	14,358			$	216,440
Total		$	104,501			$	19,476			$	1,607			$	58,156			$	23,418			$	32,196			$	2,416			$	26,545			$	268,315
Loans:
Ending balance impaired loans individually evaluated for impairment		$	29,343			$	24,744			$	—			$	32,367			$	3,777			$	929			$	—			$	10,526			$	101,686
Ending balance impaired loans collectively evaluated for impairment		$	40,893			$	17,929			$	69			$	50,175			$	6,483			$	33,871			$	1,360			$	56,947			$	207,727
Total impaired loans		$	70,236			$	42,673			$	69			$	82,542			$	10,260			$	34,800			$	1,360			$	67,473			$	309,413
Ending balance all other loans collectively evaluated for impairment		$	4,752,444			$	1,072,042			$	55,414			$	2,856,914			$	885,988			$	1,790,214			$	405,714			$	3,768,118			$	15,586,848
Total		$	4,822,680			$	1,114,715			$	55,483			$	2,939,456			$	896,248			$	1,825,014			$	407,074			$	3,835,591			$	15,896,261

 

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The following table presents commercial loans by credit quality indicator at September 30, 2014.

 

		Pass				Special Mention				Potential Problem				Impaired				Total
		($ in Thousands)
Commercial and industrial		$	5,268,521			$	113,864			$	133,416			$	88,098			$	5,603,899
Commercial real estate - owner occupied			900,306				29,107				49,008				35,914				1,014,335
Lease financing			45,506				1,360				3,787				1,947				52,600
Commercial and business lending			6,214,333				144,331				186,211				125,959				6,670,834
Commercial real estate - investor			2,930,817				34,524				28,474				49,546				3,043,361
Real estate construction			967,914				3,293				2,227				8,992				982,426
Commercial real estate lending			3,898,731				37,817				30,701				58,538				4,025,787
Total commercial		$	10,113,064			$	182,148			$	216,912			$	184,497			$	10,696,621

The following table presents commercial loans by credit quality indicator at December 31, 2013.

 

		Pass				Special Mention				Potential Problem				Impaired				Total
		($ in Thousands)
Commercial and industrial		$	4,485,160			$	153,615			$	113,669			$	70,236			$	4,822,680
Commercial real estate - owner occupied			959,849				55,404				56,789				42,673				1,114,715
Lease financing			52,733				897				1,784				69				55,483
Commercial and business lending			5,497,742				209,916				172,242				112,978				5,992,878
Commercial real estate - investor			2,740,255				64,230				52,429				82,542				2,939,456
Real estate construction			877,911				2,814				5,263				10,260				896,248
Commercial real estate lending			3,618,166				67,044				57,692				92,802				3,835,704
Total commercial		$	9,115,908			$	276,960			$	229,934			$	205,780			$	9,828,582

The following table presents consumer loans by credit quality indicator at September 30, 2014.

 

		Performing				30-89 Days Past Due				Potential Problem				Impaired				Total
		($ in Thousands)
Home equity		$	1,633,033			$	10,738			$	911			$	31,843			$	1,676,525
Installment and credit cards			456,101				1,818				4				1,759				459,682
Residential mortgage			4,250,223				3,231				2,166				70,642				4,326,262
Total consumer		$	6,339,357			$	15,787			$	3,081			$	104,244			$	6,462,469

The following table presents consumer loans by credit quality indicator at December 31, 2013.

 

		Performing				30-89 Days Past Due				Potential Problem				Impaired				Total
		($ in Thousands)
Home equity		$	1,777,421			$	10,680			$	2,113			$	34,800			$	1,825,014
Installment			404,514				1,150				50				1,360				407,074
Residential mortgage			3,758,688				6,118				3,312				67,473				3,835,591
Total consumer		$	5,940,623			$	17,948			$	5,475			$	103,633			$	6,067,679

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, and appropriate allowance for credit losses, nonaccrual and charge off policies.

For commercial loans, management has determined the pass credit quality indicator to include credits that exhibit acceptable financial statements, cash flow, and leverage. If any risk exists, it is mitigated by the loan structure, collateral, monitoring, or control. For consumer loans, performing loans include credits that are performing in accordance with the original contractual terms. Loans are

 

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considered past due if the required principal and interest payments have not been received as of the date such payments were due. Special mention credits have potential weaknesses that deserve management’s attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit. Potential problem loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness, or weaknesses that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Lastly, management considers a loan to be impaired when it is probable that the Corporation will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that commercial and consumer loan relationships that have nonaccrual status or have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. Commercial loans classified as special mention, potential problem, and impaired are reviewed at a minimum on a quarterly basis, while pass and performing rated credits are reviewed on an annual basis or more frequently if the loan renewal is less than one year or if otherwise warranted.

 

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The following table presents loans by past due status at September 30, 2014.

 

		30-59 Days Past Due				60-89 Days Past Due				90 Days or More Past Due *				Total Past Due				Current				Total
		($ in Thousands)
Accruing loans
Commercial and industrial		$	2,035			$	1,912			$	269			$	4,216			$	5,548,540			$	5,552,756
Commercial real estate - owner occupied			1,024				1,651				—				2,675				987,320				989,995
Lease financing			—				—				—				—				50,653				50,653
Commercial and business lending			3,059				3,563				269				6,891				6,586,513				6,593,404
Commercial real estate - investor			15,869				—				—				15,869				3,002,386				3,018,255
Real estate construction			299				100				—				399				973,840				974,239
Commercial real estate lending			16,168				100				—				16,268				3,976,226				3,992,494
Total commercial			19,227				3,663				269				23,159				10,562,739				10,585,898
Home equity			7,999				2,739				—				10,738				1,644,526				1,655,264
Installment and credit cards			1,106				712				1,369				3,187				455,842				459,029
Residential mortgage			2,944				287				52				3,283				4,271,478				4,274,761
Total consumer			12,049				3,738				1,421				17,208				6,371,846				6,389,054
Total accruing loans		$	31,276			$	7,401			$	1,690			$	40,367			$	16,934,585			$	16,974,952
Nonaccrual loans
Commercial and industrial		$	2,061			$	1,254			$	7,633			$	10,948			$	40,195			$	51,143
Commercial real estate - owner occupied			429				582				10,159				11,170				13,170				24,340
Lease financing			—				—				550				550				1,397				1,947
Commercial and business lending			2,490				1,836				18,342				22,668				54,762				77,430
Commercial real estate - investor			140				685				8,418				9,243				15,863				25,106
Real estate construction			64				56				1,061				1,181				7,006				8,187
Commercial real estate lending			204				741				9,479				10,424				22,869				33,293
Total commercial			2,694				2,577				27,821				33,092				77,631				110,723
Home equity			1,606				2,067				10,607				14,280				6,981				21,261
Installment and credit cards			57				49				138				244				409				653
Residential mortgage			3,934				2,657				22,117				28,708				22,793				51,501
Total consumer			5,597				4,773				32,862				43,232				30,183				73,415
Total nonaccrual loans **		$	8,291			$	7,350			$	60,683			$	76,324			$	107,814			$	184,138
Total loans
Commercial and industrial		$	4,096			$	3,166			$	7,902			$	15,164			$	5,588,735			$	5,603,899
Commercial real estate - owner occupied			1,453				2,233				10,159				13,845				1,000,490				1,014,335
Lease financing			—				—				550				550				52,050				52,600
Commercial and business lending			5,549				5,399				18,611				29,559				6,641,275				6,670,834
Commercial real estate - investor			16,009				685				8,418				25,112				3,018,249				3,043,361
Real estate construction			363				156				1,061				1,580				980,846				982,426
Commercial real estate lending			16,372				841				9,479				26,692				3,999,095				4,025,787
Total commercial			21,921				6,240				28,090				56,251				10,640,370				10,696,621
Home equity			9,605				4,806				10,607				25,018				1,651,507				1,676,525
Installment and credit cards			1,163				761				1,507				3,431				456,251				459,682
Residential mortgage			6,878				2,944				22,169				31,991				4,294,271				4,326,262
Total consumer			17,646				8,511				34,283				60,440				6,402,029				6,462,469
Total loans		$	39,567			$	14,751			$	62,373			$	116,691			$	17,042,399			$	17,159,090

 

*	The recorded investment in loans past due 90 days or more and still accruing totaled $2 million at September 30, 2014 (the same as the reported balances for the accruing loans noted above).

**	The percent of nonaccrual loans which are current was 59% at September 30, 2014.

 

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The following table presents loans by past due status at December 31, 2013.

 

		30-59 Days Past Due				60-89 Days Past Due				90 Days or More Past Due *				Total Past Due				Current				Total
		($ in Thousands)
Accruing loans
Commercial and industrial		$	3,390			$	3,436			$	1,199			$	8,025			$	4,776,936			$	4,784,961
Commercial real estate - owner occupied			1,015				2,091				—				3,106				1,081,945				1,085,051
Lease financing			—				—				—				—				55,414				55,414
Commercial and business lending			4,405				5,527				1,199				11,131				5,914,295				5,925,426
Commercial real estate - investor			9,081				14,134				—				23,215				2,878,645				2,901,860
Real estate construction			836				1,118				—				1,954				887,827				889,781
Commercial real estate lending			9,917				15,252				—				25,169				3,766,472				3,791,641
Total commercial			14,322				20,779				1,199				36,300				9,680,767				9,717,067
Home equity			8,611				2,069				346				11,026				1,788,821				1,799,847
Installment			885				265				637				1,787				404,173				405,960
Residential mortgage			5,253				865				168				6,286				3,781,673				3,787,959
Total consumer			14,749				3,199				1,151				19,099				5,974,667				5,993,766
Total accruing loans		$	29,071			$	23,978			$	2,350			$	55,399			$	15,655,434			$	15,710,833
Nonaccrual loans
Commercial and industrial		$	998			$	1,764			$	9,765			$	12,527			$	25,192			$	37,719
Commercial real estate - owner occupied			2,482				1,724				11,125				15,331				14,333				29,664
Lease financing			—				—				69				69				—				69
Commercial and business lending			3,480				3,488				20,959				27,927				39,525				67,452
Commercial real estate - investor			3,408				899				20,466				24,773				12,823				37,596
Real estate construction			2,376				—				2,267				4,643				1,824				6,467
Commercial real estate lending			5,784				899				22,733				29,416				14,647				44,063
Total commercial			9,264				4,387				43,692				57,343				54,172				111,515
Home equity			1,725				1,635				14,331				17,691				7,476				25,167
Installment			129				24				289				442				672				1,114
Residential mortgage			3,199				3,257				26,201				32,657				14,975				47,632
Total consumer			5,053				4,916				40,821				50,790				23,123				73,913
Total nonaccrual loans**		$	14,317			$	9,303			$	84,513			$	108,133			$	77,295			$	185,428
Total loans
Commercial and industrial		$	4,388			$	5,200			$	10,964			$	20,552			$	4,802,128			$	4,822,680
Commercial real estate - owner occupied			3,497				3,815				11,125				18,437				1,096,278				1,114,715
Lease financing			—				—				69				69				55,414				55,483
Commercial and business lending			7,885				9,015				22,158				39,058				5,953,820				5,992,878
Commercial real estate - investor			12,489				15,033				20,466				47,988				2,891,468				2,939,456
Real estate construction			3,212				1,118				2,267				6,597				889,651				896,248
Commercial real estate lending			15,701				16,151				22,733				54,585				3,781,119				3,835,704
Total commercial			23,586				25,166				44,891				93,643				9,734,939				9,828,582
Home equity			10,336				3,704				14,677				28,717				1,796,297				1,825,014
Installment			1,014				289				926				2,229				404,845				407,074
Residential mortgage			8,452				4,122				26,369				38,943				3,796,648				3,835,591
Total consumer			19,802				8,115				41,972				69,889				5,997,790				6,067,679
Total loans		$	43,388			$	33,281			$	86,863			$	163,532			$	15,732,729			$	15,896,261

 

*	The recorded investment in loans past due 90 days or more and still accruing totaled $2 million at December 31, 2013 (the same as the reported balances for the accruing loans noted above).

**	The percent of nonaccrual loans which are current was 42% at December 31, 2013.

 

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The following table presents impaired loans at September 30, 2014.

 

		Recorded Investment				Unpaid Principal Balance				Related Allowance				YTD Average Recorded Investment				YTD Interest Income Recognized(a)
		($ in Thousands)
Loans with a related allowance
Commercial and industrial		$	74,410			$	76,852			$	17,596			$	74,470			$	2,548
Commercial real estate - owner occupied			23,250				25,849				4,076				24,412				585
Lease financing			1,946				1,946				739				2,074				—
Commercial and business lending			99,606				104,647				22,411				100,956				3,133
Commercial real estate - investor			38,566				42,836				4,258				40,288				988
Real estate construction			5,778				8,576				2,161				6,702				158
Commercial real estate lending			44,344				51,412				6,419				46,990				1,146
Total commercial			143,950				156,059				28,830				147,946				4,279
Home equity			30,996				34,392				12,491				31,842				1,105
Installment and credit cards			1,759				1,979				339				1,864				41
Residential mortgage			62,916				67,457				12,091				63,920				1,526
Total consumer			95,671				103,828				24,921				97,626				2,672
Total loans		$	239,621			$	259,887			$	53,751			$	245,572			$	6,951
Loans with no related allowance
Commercial and industrial		$	13,688			$	21,230			$	—			$	16,781			$	46
Commercial real estate - owner occupied			12,664				14,996				—				13,775				36
Lease financing			1				—				—				—				—
Commercial and business lending			26,353				36,226				—				30,556				82
Commercial real estate - investor			10,980				17,169				—				12,556				133
Real estate construction			3,214				3,904				—				3,313				—
Commercial real estate lending			14,194				21,073				—				15,869				133
Total commercial			40,547				57,299				—				46,425				215
Home equity			847				859				—				864				15
Installment and credit cards			—				—				—				—				—
Residential mortgage			7,726				7,845				—				7,774				104
Total consumer			8,573				8,704				—				8,638				119
Total loans		$	49,120			$	66,003			$	—			$	55,063			$	334
Total
Commercial and industrial		$	88,098			$	98,082			$	17,596			$	91,251			$	2,594
Commercial real estate - owner occupied			35,914				40,845				4,076				38,187				621
Lease financing			1,947				1,946				739				2,074				—
Commercial and business lending			125,959				140,873				22,411				131,512				3,215
Commercial real estate - investor			49,546				60,005				4,258				52,844				1,121
Real estate construction			8,992				12,480				2,161				10,015				158
Commercial real estate lending			58,538				72,485				6,419				62,859				1,279
Total commercial			184,497				213,358				28,830				194,371				4,494
Home equity			31,843				35,251				12,491				32,706				1,120
Installment and credit cards			1,759				1,979				339				1,864				41
Residential mortgage			70,642				75,302				12,091				71,694				1,630
Total consumer			104,244				112,532				24,921				106,264				2,791
Total loans(b)		$	288,741			$	325,890			$	53,751			$	300,635			$	7,285

 

(a)	Interest income recognized included $4 million of interest income recognized on accruing restructured loans for the nine months ended September 30, 2014.

(b)	The implied fair value mark on all impaired loans at September 30, 2014, was 72% of their unpaid principal balance. The fair value mark is calculated as the recorded investment, net of the related allowance, divided by the unpaid principal balance.

 

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The following table presents impaired loans at December 31, 2013.

 

		Recorded Investment				Unpaid Principal Balance				Related Allowance				YTD Average Recorded Investment				YTD Interest Income Recognized (a)
		($ in Thousands)
Loans with a related allowance
Commercial and industrial		$	57,857			$	65,443			$	11,917			$	61,000			$	1,741
Commercial real estate - owner occupied			22,651				25,072				2,955				24,549				995
Lease financing			69				69				29				76				—
Commercial and business lending			80,577				90,584				14,901				85,625				2,736
Commercial real estate - investor			64,647				68,228				7,895				68,776				2,735
Real estate construction			8,815				12,535				2,416				9,796				236
Commercial real estate lending			73,462				80,763				10,311				78,572				2,971
Total commercial			154,039				171,347				25,212				164,197				5,707
Home equity			34,707				40,344				13,989				36,623				1,518
Installment			1,360				1,676				487				1,753				100
Residential mortgage			60,157				69,699				12,187				62,211				1,861
Total consumer			96,224				111,719				26,663				100,587				3,479
Total loans		$	250,263			$	283,066			$	51,875			$	264,784			$	9,186
Loans with no related allowance
Commercial and industrial		$	12,379			$	19,556			$	—			$	14,291			$	306
Commercial real estate - owner occupied			20,022				22,831				—				20,602				315
Lease financing			—				—				—				—				—
Commercial and business lending			32,401				42,387				—				34,893				621
Commercial real estate - investor			17,895				25,449				—				19,354				130
Real estate construction			1,445				1,853				—				1,576				13
Commercial real estate lending			19,340				27,302				—				20,930				143
Total commercial			51,741				69,689				—				55,823				764
Home equity			93				92				—				94				2
Installment			—				—				—				—				—
Residential mortgage			7,316				8,847				—				7,321				185
Total consumer			7,409				8,939				—				7,415				187
Total loans		$	59,150			$	78,628			$	—			$	63,238			$	951
Total
Commercial and industrial		$	70,236			$	84,999			$	11,917			$	75,291			$	2,047
Commercial real estate - owner occupied			42,673				47,903				2,955				45,151				1,310
Lease financing			69				69				29				76				—
Commercial and business lending			112,978				132,971				14,901				120,518				3,357
Commercial real estate - investor			82,542				93,677				7,895				88,130				2,865
Real estate construction			10,260				14,388				2,416				11,372				249
Commercial real estate lending			92,802				108,065				10,311				99,502				3,114
Total commercial			205,780				241,036				25,212				220,020				6,471
Home equity			34,800				40,436				13,989				36,717				1,520
Installment			1,360				1,676				487				1,753				100
Residential mortgage			67,473				78,546				12,187				69,532				2,046
Total consumer			103,633				120,658				26,663				108,002				3,666
Total loans (b)		$	309,413			$	361,694			$	51,875			$	328,022			$	10,137

 

(a)	Interest income recognized included $6 million of interest income recognized on accruing restructured loans for the year ended December 31, 2013.

(b)	The implied fair value mark on all impaired loans at December 31, 2013, was 71% of their unpaid principal balance. The fair value mark is calculated as the recorded investment, net of the related allowance, divided by the unpaid principal balance.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal

 

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payments, unless the loan is well secured and in the process of collection. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, amortization of related deferred loan fees or costs is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal and interest of the loan is collectible. If collectability of the principal and interest is in doubt, payments received are applied to loan principal.

While an asset is in nonaccrual status, some or all of the cash interest payments received may be treated as interest income on a cash basis as long as the remaining recorded investment in the asset (i.e., after charge off of identified losses, if any) is deemed to be fully collectible. The determination as to the ultimate collectability of the asset’s remaining recorded investment must be supported by a current, well documented credit evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s sustained historical repayment performance and other relevant factors. A nonaccrual loan is returned to accrual status when all delinquent principal and interest payments become current in accordance with the terms of the loan agreement, the borrower has demonstrated a period of sustained repayment performance, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. A sustained period of repayment performance generally would be a minimum of six months.

Troubled Debt Restructurings (“Restructured Loans”):

Loans are considered restructured loans if concessions have been granted to borrowers that are experiencing financial difficulty. The concessions granted generally involve the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included and treated with all other nonaccrual loans. In addition, all accruing restructured loans are reported as troubled debt restructurings, which are considered and accounted for as impaired loans. Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual status. The Corporation had a $26 million recorded investment in loans modified in a troubled debt restructuring for the nine months ended September 30, 2014, of which $10 million were in accrual status and $16 million were in nonaccrual pending a sustained period of repayment.

All restructured loans are considered impaired in the calendar year of restructuring. In subsequent years, a restructured loan may cease being classified as impaired if the loan was modified at a market rate and has performed according to the modified terms for at least six months. A loan that has been modified at a below market rate will return to performing status if it satisfies the six month performance requirement; however, it will remain classified as a restructured loan. The following table presents nonaccrual and performing restructured loans by loan portfolio.

 

		September 30, 2014								December 31, 2013
		Performing Restructured Loans				Nonaccrual Restructured Loans *				Performing Restructured Loans				Nonaccrual Restructured Loans *
		($ in Thousands)
Commercial and industrial		$	36,956			$	4,759			$	32,517			$	6,900
Commercial real estate - owner occupied			11,574				8,031				13,009				10,999
Commercial real estate - investor			24,439				17,472				44,946				18,069
Real estate construction			805				2,833				3,793				2,065
Home equity			10,582				6,729				9,633				5,419
Installment and credit cards			1,106				230				246				451
Residential mortgage			19,141				23,260				19,841				15,682
Total		$	104,603			$	63,314			$	123,985			$	59,585

 

*	Nonaccrual restructured loans have been included with nonaccrual loans.

 

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The following table provides the number of loans modified in a troubled debt restructuring by loan portfolio during the three and nine months ended September 30, 2014, and the recorded investment and unpaid principal balance as of September 30, 2014.

 

		Three Months Ended September 30, 2014												Nine Months Ended September 30, 2014
		Number of Loans				Recorded Investment (1)				Unpaid Principal Balance (2)				Number of Loans				Recorded Investment (1)				Unpaid Principal Balance (2)
		($ in Thousands)
Commercial and industrial			10			$	7,383			$	7,384				13			$	7,695			$	7,707
Commercial real estate - owner occupied			—				—				—				2				1,123				1,260
Commercial real estate - investor			3				5,603				5,918				4				6,096				6,425
Real estate construction			1				8				8				2				14				14
Home equity			42				1,428				1,486				94				3,407				3,593
Installment and credit cards			2				25				25				3				34				45
Residential mortgage			45				4,057				4,347				85				8,004				8,555
Total			103			$	18,504			$	19,168				203			$	26,373			$	27,599

 

(1)	Represents post-modification outstanding recorded investment.

(2)	Represents pre-modification outstanding recorded investment.

The following table provides the number of loans modified in a troubled debt restructuring by loan portfolio during the three and nine months ended September 30, 2013, and the recorded investment and unpaid principal balance as of September 30, 2013.

 

		Three Months Ended September 30, 2013												Nine Months Ended September 30, 2013
		Number of Loans				Recorded Investment (1)				Unpaid Principal Balance (2)				Number of Loans				Recorded Investment (1)				Unpaid Principal Balance (2)
		($ in Thousands)
Commercial and industrial			19			$	5,479			$	6,384				58			$	11,379			$	14,028
Commercial real estate - owner occupied			7				3,373				3,488				17				9,313				9,596
Commercial real estate - investor			10				1,222				1,304				18				5,013				5,320
Real estate construction			3				227				248				9				2,006				2,084
Home equity			16				933				985				74				4,149				4,554
Installment			—				—				—				2				187				193
Residential mortgage			19				1,664				1,826				71				6,744				7,619
Total			74			$	12,898			$	14,235				249			$	38,791			$	43,394

 

(1)	Represents post-modification outstanding recorded investment.

(2)	Represents pre-modification outstanding recorded investment.

Restructured loan modifications may include payment schedule modifications, interest rate concessions, maturity date extensions, modification of note structure (A/B Note), non-reaffirmed Chapter 7 bankruptcies, principal reduction, or some combination of these concessions. During the three and nine months ended September 30, 2014, restructured loan modifications of commercial and industrial, commercial real estate and real estate construction loans primarily included maturity date extensions and payment schedule modifications. Restructured loan modifications of home equity and residential mortgage loans for the three and nine months ended September 30, 2014, primarily included maturity date extensions, interest rate concessions, payment schedule modifications, non-reaffirmed Chapter 7 bankruptcies, or a combination of these concessions.

 

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The following table provides the number of loans modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three and nine months ended September 30, 2014, as well as the recorded investment in these restructured loans as of September 30, 2014.

 

		Three Months Ended September 30, 2014								Nine Months Ended September 30, 2014
		Number of Loans				Recorded Investment				Number of Loans				Recorded Investment
		($ in Thousands)
Commercial and industrial			—			$	—				1			$	52
Commercial real estate - owner occupied			—				—				2				203
Commercial real estate - investor			1				493				2				1,613
Real estate construction			—				—				1				160
Home equity			12				367				25				939
Installment and credit cards			1				10				3				34
Residential mortgage			18				1,502				50				4,743
Total			32			$	2,372				84			$	7,744

The following table provides the number of loans modified in a troubled debt restructuring during the previous 12 months which subsequently defaulted during the three and nine months ended September 30, 2013, as well as the recorded investment in these restructured loans as of September 30, 2013.

 

		Three Months Ended September 30, 2013								Nine Months Ended September 30, 2013
		Number of Loans				Recorded Investment				Number of Loans				Recorded Investment
		($ in Thousands)
Commercial and industrial			8			$	506				18			$	1,626
Commercial real estate - owner occupied			2				464				4				578
Commercial real estate - investor			1				405				5				1,992
Real estate construction			1				118				2				158
Home equity			4				147				12				699
Residential mortgage			8				1,150				15				2,385
Total			24			$	2,790				56			$	7,438

All loans modified in a troubled debt restructuring are evaluated for impairment. The nature and extent of the impairment of restructured loans, including those which have experienced a subsequent payment default, is considered in the determination of an appropriate level of the allowance for loan losses.

 

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NOTE 7: Goodwill and Other Intangible Assets

Goodwill: Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded book value, “step one.” If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues (“step two”) by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill.

The Corporation conducted its annual impairment testing in May 2014, utilizing a qualitative assessment. Factors that management considered in this assessment included macroeconomic conditions, industry and market considerations, overall financial performance of the Corporation and each reporting unit (both current and projected), changes in management strategy, and changes in the composition or carrying amount of net assets. In addition, management considered the increases in both the Corporation’s common stock price and in the overall bank common stock index (based on the NASDAQ bank index), as well as the Corporation’s earnings per common share trend over the past year. Based on these assessments, management concluded that the 2014 annual qualitative impairment assessment indicated that it is more likely than not that the estimated fair value exceeded the carrying value (including goodwill) for each reporting unit. Therefore, a step one quantitative analysis was not required. There were no impairment charges recorded in 2013 or through September 30, 2014.

At September 30, 2014, the Corporation had goodwill of $929 million. There was no change in the carrying amount of goodwill for the nine months ended September 30, 2014, and the year ended December 31, 2013.

Other Intangible Assets: The Corporation has other intangible assets that are amortized, consisting of core deposit intangibles, other intangibles (primarily related to customer relationships acquired in connection with the Corporation’s insurance agency acquisitions), and mortgage servicing rights. For core deposit intangibles and other intangibles, changes in the gross carrying amount, accumulated amortization, and net book value were as follows.

 

		Nine Months Ended September 30, 2014				Year Ended December 31, 2013
		($ in Thousands)
Core deposit intangibles:
Gross carrying amount		$	36,230			$	36,230
Accumulated amortization			(33,878	)			(31,565	)
Net book value		$	2,352			$	4,665
Amortization during the period		$	2,313			$	3,122
Other intangibles:
Gross carrying amount		$	19,283			$	19,283
Accumulated amortization			(13,423	)			(12,764	)
Net book value		$	5,860			$	6,519
Amortization during the period		$	659			$	921

The Corporation sells residential mortgage loans in the secondary market and typically retains the right to service the loans sold. Upon sale, a mortgage servicing rights asset is capitalized, which represents the then current fair value of future net cash flows expected to be realized for performing servicing activities. Mortgage servicing rights, when purchased, are initially recorded at fair value. As the Corporation has not elected to subsequently measure any class of servicing assets under the fair value measurement method, the Corporation follows the amortization method. Mortgage servicing rights are amortized in proportion to and over the

 

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period of estimated net servicing income, and assessed for impairment at each reporting date. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other intangible assets, net, in the consolidated balance sheets.

The Corporation periodically evaluates its mortgage servicing rights asset for impairment. Impairment is assessed based on fair value at each reporting date using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans (predominantly loan type and note interest rate). As mortgage interest rates fall, prepayment speeds are usually faster and the value of the mortgage servicing rights asset generally decreases, requiring additional valuation reserve. Conversely, as mortgage interest rates rise, prepayment speeds are usually slower and the value of the mortgage servicing rights asset generally increases, requiring less valuation reserve. A valuation allowance is established, through a charge to earnings, to the extent the amortized cost of the mortgage servicing rights exceeds the estimated fair value by stratification. If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings. An other-than-temporary impairment (i.e., recoverability is considered remote when considering interest rates and loan pay off activity) is recognized as a write-down of the mortgage servicing rights asset and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings. A direct write-down permanently reduces the carrying value of the mortgage servicing rights asset and valuation allowance, precluding subsequent recoveries. See Note 12 for a discussion of the recourse provisions on sold residential mortgage loans. See Note 13 which further discusses fair value measurement relative to the mortgage servicing rights asset.

A summary of changes in the balance of the mortgage servicing rights asset and the mortgage servicing rights valuation allowance was as follows.

 

		Nine Months Ended September 30, 2014				Year Ended December 31, 2013
		($ in Thousands)
Mortgage servicing rights:
Mortgage servicing rights at beginning of period		$	64,193			$	61,425
Additions			5,844				18,256
Amortization			(8,224	)			(15,488	)
Mortgage servicing rights at end of period		$	61,813			$	64,193
Valuation allowance at beginning of period			(913	)			(15,476	)
Recoveries, net			89				14,563
Valuation allowance at end of period			(824	)			(913	)
Mortgage servicing rights, net		$	60,989			$	63,280
Fair value of mortgage servicing rights		$	69,940			$	74,444
Portfolio of residential mortgage loans serviced for others (“servicing portfolio”)			8,012,000				8,084,000
Mortgage servicing rights, net to servicing portfolio			0.76	%			0.78	%
Mortgage servicing rights expense (1)		$	8,135			$	925

 

(1)	Includes the amortization of mortgage servicing rights and additions/recoveries to the valuation allowance of mortgage servicing rights, and is a component of mortgage banking, net, in the consolidated statements of income.

 

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The following table shows the estimated future amortization expense for amortizing intangible assets. The projections of amortization expense are based on existing asset balances, the current interest rate environment, and prepayment speeds as of September 30, 2014. The actual amortization expense the Corporation recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements, and events or circumstances that indicate the carrying amount of an asset may not be recoverable.

 

Estimated amortization expense:		Core Deposit Intangibles				Other Intangibles				Mortgage Servicing Rights
		($ in Thousands)
Three months ending December 31, 2014		$	555			$	220			$	2,773
Year ending December 31, 2015			1,404				839				9,760
Year ending December 31, 2016			281				803				8,084
Year ending December 31, 2017			112				770				6,727
Year ending December 31, 2018			—				740				5,621
Year ending December 31, 2019			—				441				4,721
Beyond 2019			—				2,047				24,127
Total Estimated Amortization Expense		$	2,352			$	5,860			$	61,813

NOTE 8: Short and Long-Term Funding

The components of short-term funding (funding with original contractual maturities of one year or less) and long-term funding (funding with original contractual maturities greater than one year) were as follows.

 

		September 30, 2014				December 31, 2013
		($ in Thousands)
Short-Term Funding
Federal funds purchased		$	272,190			$	56,195
Securities sold under agreements to repurchase			493,451				419,247
Federal funds purchased and securities sold under agreements to repurchase			765,641				475,442
FHLB advances			605,000				200,000
Commercial paper			59,539				65,484
Other short-term funding			664,539				265,484
Total short-term funding		$	1,430,180			$	740,926
Long-Term Funding
FHLB advances		$	2,500,268			$	2,500,297
Senior notes, at par			430,000				585,000
Other long-term funding and capitalized costs			1,279				1,970
Total long-term funding		$	2,931,547			$	3,087,267
Total short and long-term funding		$	4,361,727			$	3,828,193

Short-term funding:

The FHLB advances included in short-term funding are those with original contractual maturities of one year or less. The securities sold under agreements to repurchase represent short-term funding which is collateralized by securities of the U.S. Government or its agencies.

Long-term funding:

FHLB Advances: Long-term FHLB advances had a weighted-average interest rate of 0.10% for both September 30, 2014 and December 31, 2013. During the fourth quarter of 2013, the Corporation executed $2.5 billion of five year, variable rate FHLB advances that can be repaid, at our option, without penalty. The FHLB advances are indexed to the FHLB discount note and reprice at varying intervals, including $1.0 billion repricing at four week intervals, $750 million repricing at 13 week intervals, and $750 million repricing daily. The advances offer flexible, low cost, long-term funding that improves the Corporation’s liquidity profile.

 

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2011 Senior Notes: In March 2011, the Corporation issued $300 million of senior notes due March 2016, and callable February 2016, with a 5.125% fixed coupon at a discount. In September 2011, the Corporation “re-opened” the offering and issued an additional $130 million of the same notes at a premium. The Corporation intends to refinance the 2011 Senior Notes prior to their maturity.

2012 Senior Notes: In September 2012, the Corporation issued $155 million of senior notes, due March 2014, and callable February 2014, at a discount. These notes were called and redeemed in February 2014.

NOTE 9: Income Taxes

The Corporation recognized income tax expense of $67 million for the first nine months of 2014, compared to income tax expense of $65 million for the comparable period in 2013. The effective tax rate was 32.02% for the first nine months of 2014, compared to an effective tax rate of 31.68% for the first nine months of 2013.

NOTE 10: Derivative and Hedging Activities

The Corporation facilitates customer borrowing activity by providing various interest rate risk management solutions through its capital markets area. To date, all of the notional amounts of customer transactions have been matched with a mirror swap with another counterparty. The Corporation has used, and may again use in the future, derivative instruments to hedge the variability in interest payments or protect the value of certain assets and liabilities recorded on its consolidated balance sheet from changes in interest rates. The predominant derivative and hedging activities include interest rate-related instruments (swaps and caps), foreign currency exchange forwards, written options, purchased options, and certain mortgage banking activities. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amounts to be exchanged between the counterparties. The Corporation is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. To mitigate the counterparty risk, interest rate-related instruments generally contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined from the credit ratings of each counterparty. The Corporation was required to pledge $11 million of investment securities as collateral at September 30, 2014, and pledged $42 million of investment securities as collateral at December 31, 2013. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, as of June 10, 2013, the Corporation must clear all LIBOR interest rate swaps through a clearing house if it can be cleared. As such, the Corporation is required to pledge cash collateral for the margin. At September 30, 2014, the Corporation posted cash collateral for the margin of $10 million, compared to $6 million at December 31, 2013.

The Corporation’s derivative and hedging instruments are recorded at fair value on the consolidated balance sheets. The fair value of the Corporation’s interest rate-related instruments is determined using discounted cash flow analysis on the expected cash flows of each derivative and also includes a nonperformance / credit risk component (credit valuation adjustment). See Note 13 for additional fair value information and disclosures.

 

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The table below identifies the balance sheet category and fair values of the Corporation’s derivative instruments not designated as hedging instruments.

 

												Weighted Average
($ in Thousands)		Notional Amount				Fair Value				Balance Sheet Category		Receive Rate(1)				Pay Rate(1)				Maturity
September 30, 2014
Interest rate-related instruments — customer and mirror		$	1,665,024			$	31,862			Trading assets			1.62	%			1.62	%			41 months
Interest rate-related instruments — customer and mirror			1,665,024				(34,071	)		Trading liabilities			1.62	%			1.62	%			41 months
Interest rate lock commitments (mortgage)			145,037				1,440			Other assets			—				—				—
Forward commitments (mortgage)			247,000				(623	)		Other liabilities			—				—				—
Foreign currency exchange forwards			69,737				2,143			Trading assets			—				—				—
Foreign currency exchange forwards			65,277				(1,932	)		Trading liabilities			—				—				—
Purchased options (time deposit)			111,163				6,943			Other assets			—				—				—
Written options (time deposit)			111,163				(6,943	)		Other liabilities			—				—				—
December 31, 2013
Interest rate-related instruments — customer and mirror		$	1,821,787			$	42,980			Trading assets			1.63	%			1.63	%			45 months
Interest rate-related instruments — customer and mirror			1,821,787				(45,815	)		Trading liabilities			1.63	%			1.63	%			45 months
Interest rate lock commitments (mortgage)			102,225				416			Other assets			—				—				—
Forward commitments (mortgage)			135,000				1,301			Other assets			—				—				—
Foreign currency exchange forwards			25,747				748			Trading assets			—				—				—
Foreign currency exchange forwards			24,413				(655	)		Trading liabilities			—				—				—
Purchased options (time deposit)			115,953				7,328			Other assets			—				—				—
Written options (time deposit)			115,953				(7,328	)		Other liabilities			—				—				—

 

(1)	Reflects the weighted average receive rate and pay rate for the interest rate swap derivative financial instruments only.

The table below identifies the income statement category of the gains and losses recognized in income on the Corporation’s derivative instruments not designated as hedging instruments.

 

		Income Statement Category of Gain /(Loss) Recognized in Income		Gain /(Loss) Recognized in Income
				($ in Thousands)
Nine Months Ended September 30, 2014
Interest rate-related instruments — customer and mirror, net		Capital market fees, net		$	626
Interest rate lock commitments (mortgage)		Mortgage banking, net			1,024
Forward commitments (mortgage)		Mortgage banking, net			(1,924	)
Foreign currency exchange forwards		Capital market fees, net			118
Nine Months Ended September 30, 2013
Interest rate-related instruments — customer and mirror, net		Capital market fees, net		$	2,600
Interest rate lock commitments (mortgage)		Mortgage banking, net			(4,234	)
Forward commitments (mortgage)		Mortgage banking, net			(4,406	)
Foreign currency exchange forwards		Capital market fees, net			4

Free standing derivatives

The Corporation enters into various derivative contracts which are designated as free standing derivative contracts. These derivative contracts are not designated against specific assets and liabilities on the balance sheet or forecasted transactions and, therefore, do not qualify for hedge accounting treatment. Such derivative contracts are carried at fair value on the consolidated balance sheet with changes in the fair value recorded as a component of Capital market fees, net, and typically include interest rate-related instruments (swaps and caps).

Free standing derivative products are entered into primarily for the benefit of commercial customers seeking to manage their exposures to interest rate risk. The Corporation’s market risk from unfavorable movements in interest rates related to these derivative contracts is generally economically hedged by concurrently entering into offsetting derivative contracts. The offsetting derivative contracts have identical notional values, terms and indices.

 

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Mortgage derivatives

Interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments, and the fair value of these commitments is recorded on the consolidated balance sheets with the changes in fair value recorded as a component of mortgage banking, net.

Foreign currency derivatives

The Corporation provides foreign exchange services to customers. The Corporation may enter into a foreign currency forward to mitigate the exchange rate risk attached to the cash flows of a loan or as an offsetting contract to a forward entered into as a service to our customer.

Written and purchased option derivatives (time deposit)

The Corporation has periodically entered into written and purchased option derivative instruments to facilitate an equity linked time deposit product (the “Power CD”). During September 2013, the Corporation terminated its Power CD product. The Power CD was a time deposit that provided the purchaser a guaranteed return of principal at maturity plus a potential equity return (a written option), while the Corporation received a known stream of funds based on the equity return (a purchased option). The written and purchased options are mirror derivative instruments which are carried at fair value on the consolidated balance sheets.

 

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NOTE 11: Balance Sheet Offsetting

Interest Rate-Related Instruments (“Interest Agreements”)

The Corporation enters into interest rate-related instruments to facilitate the interest rate risk management strategies of commercial customers. The Corporation mitigates this risk by entering into equal and offsetting interest rate-related instruments with highly rated third party financial institutions. The interest agreements are free-standing derivatives and are recorded at fair value in the Corporation’s consolidated balance sheet. The Corporation is party to master netting arrangements with its financial institution counterparties; however, the Corporation does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all interest agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, usually in the form of investment securities and cash, is posted by the counterparty with net liability positions in accordance with contract thresholds. See Note 10 for additional information on the Corporation’s derivative and hedging activities.

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

The Corporation enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Corporation may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Corporation to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Corporation’s consolidated balance sheet, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts (i.e., there is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities). The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Corporation be in default (e.g., fails to make an interest payment to the counterparty). In addition, the Corporation does not enter into reverse repurchase agreements; therefore, there is no such offsetting to be done with the repurchase agreements.

 

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The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of September 30, 2014 and December 31, 2013. The swap agreements we have with our commercial customers are not subject to an enforceable master netting arrangement, and therefore, are excluded from this table.

 

September 30, 2014		Gross amounts recognized				Gross amounts offset in the balance sheet				Net amounts presented in the balance sheet				Gross amounts not offset
														in the balance sheet
														Financial instruments				Collateral				Net amount
		($ in Thousands)
Derivative assets:
Interest rate-related instruments		$	1,406			$	—			$	1,406			$	(1,406	)		$	—			$	—
Derivative liabilities:
Interest rate-related instruments		$	31,898			$	—			$	31,898			$	(1,406	)		$	(21,149	)		$	9,343
December 31, 2013
Derivative assets:
Interest rate-related instruments		$	3,084			$	—			$	3,084			$	(3,082	)		$	—			$	2
Derivative liabilities:
Interest rate-related instruments		$	41,786			$	—			$	41,786			$	(3,082	)		$	(33,405	)		$	5,299

NOTE 12: Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities

The Corporation utilizes a variety of financial instruments in the normal course of business to meet the financial needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include lending-related and other commitments (see below) and derivative instruments (see Note 10). During the second quarter of 2014, the Corporation reclassified certain letters of credit from commercial letters of credit to standby letters of credit. The letters of credit balances for December 31, 2013, have also been adjusted to reflect this change in classification. The following is a summary of lending-related commitments.

 

		September 30, 2014				December 31, 2013
		($ in Thousands)
Commitments to extend credit, excluding commitments to originate residential mortgage loans held for sale(1)(2)		$	6,703,718			$	6,367,771
Commercial letters of credit (1)			8,705				12,034
Standby letters of credit (3)			352,445				370,773

 

(1)

These off-balance sheet financial instruments are exercisable at the market rate prevailing at the date the underlying transaction will be completed and, thus, are deemed to have no current fair value, or the fair value is based on fees currently charged to enter into similar agreements and is not material at September 30, 2014 or December 31, 2013.

(2)	Interest rate lock commitments to originate residential mortgage loans held for sale are considered derivative instruments and are disclosed in Note 10.

(3)	The Corporation has established a liability of $4 million at both September 30, 2014 and December 31, 2013, as an estimate of the fair value of these financial instruments.

Lending-related Commitments

As a financial services provider, the Corporation routinely enters into commitments to extend credit. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Corporation, with each customer’s creditworthiness evaluated on a case-by-case basis. The commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. The Corporation’s exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of those instruments. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the customer. Since a significant portion of commitments to extend credit are subject to specific restrictive loan covenants or may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements. An allowance for unfunded

 

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commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded commitments (including unfunded loan commitments and letters of credit). For September 30, 2014 and December 31, 2013, the Corporation had an allowance for unfunded commitments totaling $24 million and $22 million, respectively, included in accrued expenses and other liabilities on the consolidated balance sheets. See Note 6 for additional information on the allowance for unfunded commitments.

Lending-related commitments include commitments to extend credit, commitments to originate residential mortgage loans held for sale, commercial letters of credit, and standby letters of credit. Commitments to extend credit are legally binding agreements to lend to customers at predetermined interest rates, as long as there is no violation of any condition established in the contracts. Interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments, and the fair value of these commitments is recorded on the consolidated balance sheets. The Corporation’s derivative and hedging activity is further described in Note 10. Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party, while standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.

Other Commitments

The Corporation has principal investment commitments to provide capital-based financing to private and public companies through either direct investments in specific companies or through investment funds and partnerships. The timing of future cash requirements to fund such commitments is generally dependent on the investment cycle, whereby privately held companies are funded by private equity investors and ultimately sold, merged, or taken public through an initial offering, which can vary based on overall market conditions, as well as the nature and type of industry in which the companies operate. The Corporation also invests in low-income housing, small-business commercial real estate, new market tax credit projects, and historic tax credit projects to promote the revitalization of low-to-moderate-income neighborhoods throughout the local communities of its bank subsidiary. As a limited partner in these unconsolidated projects, the Corporation is allocated tax credits and deductions associated with the underlying projects. The aggregate carrying value of these investments at September 30, 2014 was $28 million, included in other assets on the consolidated balance sheets, compared to $33 million at December 31, 2013. Related to these investments, the Corporation had remaining commitments to fund of $15 million at September 30, 2014 and $16 million at December 31, 2013.

Contingent Liabilities

The Corporation is party to various pending and threatened claims and legal proceedings arising in the normal course of business activities, some of which involve claims for substantial amounts. Although there can be no assurance as to the ultimate outcomes, the Corporation believes it has meritorious defenses to the claims asserted against it in its currently outstanding matters, including the matters described below, and with respect to such legal proceedings, intends to continue to defend itself vigorously. The Corporation will consider settlement of cases when, in management’s judgment, it is in the best interests of both the Corporation and its shareholders.

On at least a quarterly basis, the Corporation assesses its liabilities and contingencies in connection with all pending or threatened claims and litigation, utilizing the most recent information available. On a matter by matter basis, an accrual for loss is established for those matters which the Corporation believes it is probable that a loss may be incurred and that the amount of such loss can be reasonably estimated. Once established, each accrual is adjusted as appropriate to reflect any subsequent developments. Accordingly, management’s estimate will change from time to time, and actual losses may be more or less than the current estimate. For matters where a loss is not probable, or the amount of the loss cannot be estimated, no accrual is established.

Resolution of legal claims is inherently unpredictable, and in many legal proceedings various factors exacerbate this inherent unpredictability, including where the damages sought are unsubstantiated or indeterminate, it is unclear whether a case brought as a class action will be allowed to proceed on that basis, discovery is not complete, the proceeding is not yet in its final stages, the matters present legal uncertainties, there are significant facts in dispute, there are a large number of parties (including where it is uncertain how liability, if any, will be shared among multiple defendants), or there is a wide range of potential results.

A lawsuit, R.J. ZAYED v. Associated Bank, N.A., was filed in the United States District Court for the District of Minnesota on January 29, 2013. The lawsuit relates to a Ponzi scheme perpetrated by Oxford Global Partners and related entities (“Oxford”) and individuals and was brought by the receiver for Oxford. Oxford was a depository customer of Associated Bank, N.A. (the “Bank”). The lawsuit claims that the Bank is liable for failing to uncover the Oxford Ponzi scheme, and specifically alleges the Bank aided and abetted (1) the fraudulent scheme; (2) a breach of fiduciary duty; (3) conversion; and (4) false representations and omissions. The lawsuit seeks

 

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unspecified consequential and punitive damages. The District Court granted the Bank’s motion to dismiss the complaint on September 30, 2013, and the plaintiff has appealed such dismissal to the U.S. Court of Appeals for the Eighth Circuit. It is not possible for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. A lawsuit by investors in the same Ponzi scheme, Herman Grad, et al v. Associated Bank, N.A., brought in Brown County, Wisconsin in October 2009 was dismissed by the circuit court, and the dismissal was affirmed by the Wisconsin Court of Appeals in June 2011 in an unpublished opinion.

A purported class action lawsuit, Wanda Boone v. Associated Banc-Corp, was filed on April 10, 2014 in the United States District Court for the Eastern District of Wisconsin. The lawsuit claimed that loan coordinators employed by the Bank were not compensated for all hours worked, including the payment of overtime, in violation of the Fair Labor Standards Act of 1938 and Wisconsin wage laws. On July 30, 2014, the case was dismissed with prejudice. As part of the resolution of this matter, the Corporation made an immaterial payment to the plaintiff.

The Office of the Comptroller of the Currency (OCC) and the Department of Housing and Urban Development (HUD) are examining the Bank’s compliance with fair housing laws, particularly from the period 2008-2011. The Corporation believes it has been in compliance in all material respects with all applicable laws and regulations related to fair housing. It is not possible at this time for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss related to such examinations by the OCC and HUD.

During the last year, the Corporation has reviewed a variety of legacy products provided by third parties, including debt protection and identity protection products. In connection with this review, the Corporation has made, and plans to make, remediation payments to affected customers and former customers. See Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections “Noninterest Income,” “Comparable Third Quarter Results,” and “Sequential Quarter Results,” for additional information. These types of products have recently received increased regulatory scrutiny, and it is possible that regulatory authorities could bring enforcement actions, including civil money penalties, or take other actions against the Corporation in regard to these legacy products. It is not possible at this time for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss related to this matter.

The Corporation sells residential mortgage loans to investors in the normal course of business. Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages originated under our usual underwriting procedures, and are most often sold on a nonrecourse basis, primarily to the government-sponsored enterprises (“GSEs”). The Corporation’s agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold, related to credit information, loan documentation, collateral, and insurability. Subsequent to being sold, if a material underwriting deficiency or documentation defect is discovered, the Corporation may be obligated to repurchase the loan or reimburse the GSEs for losses incurred (collectively, “make whole requests”). The make whole requests and any related risk of loss under the representations and warranties are largely driven by borrower performance.

As a result of make whole requests, the Corporation has repurchased loans with principal balances of $4 million and $3 million during the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively, and paid loss reimbursement claims of $500,000 and $3 million during the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively. The Corporation had a mortgage repurchase reserve for potential claims on loans previously sold of $3 million at September 30, 2014, compared to $6 million at December 31, 2013. Make whole requests during 2013 and the first nine months of 2014 generally arose from loans sold during the period January 1, 2006 to September 30, 2014, which totaled $18.4 billion at the time of sale, and consisted primarily of loans sold to GSEs. As of September 30, 2014, approximately $7.6 billion of these sold loans remain outstanding.

 

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The balance in the mortgage repurchase reserve at the balance sheet date reflects the estimated amount of potential loss the Corporation could incur from repurchasing a loan, as well as loss reimbursements, indemnifications, and other settlement resolutions. The following summarizes the changes in the mortgage repurchase reserve.

 

		For the Nine Months Ended September 30, 2014				For the Year Ended December 31, 2013
		($ in Thousands)
Balance at beginning of period		$	5,700			$	3,300
Repurchase provision (recovery) expense			(1,883	)			5,909
Charge offs			(417	)			(3,509	)
Balance at end of period		$	3,400			$	5,700

The Corporation may also sell residential mortgage loans with limited recourse (limited in that the recourse period ends prior to the loan’s maturity, usually after certain time and / or loan paydown criteria have been met), whereby repurchase could be required if the loan had defined delinquency issues during the limited recourse periods. At September 30, 2014, and December 31, 2013, there were approximately $44 million and $56 million, respectively, of residential mortgage loans sold with such recourse risk. There have been limited instances and immaterial historical losses on repurchases for recourse under the limited recourse criteria.

The Corporation has a subordinate position to the FHLB in the credit risk on residential mortgage loans it sold to the FHLB in exchange for a monthly credit enhancement fee. The Corporation has not sold loans to the FHLB with such credit risk retention since February 2005. At September 30, 2014 and December 31, 2013, there were $190 million and $233 million, respectively, of such residential mortgage loans with credit risk recourse, upon which there have been negligible historical losses to the Corporation.

NOTE 13: Fair Value Measurements

Fair value represents the estimated price at which an orderly transaction to sell an asset or to transfer a liability would take place between market participants at the measurement date under current market conditions (i.e., an exit price concept). As there is no active market for many of the Corporation’s financial instruments, estimates are made using discounted cash flow or other valuation techniques. Inputs into the valuation methods are subjective in nature, involve uncertainties, and require significant judgment and therefore cannot be determined with precision. Accordingly, the derived fair value estimates presented herein are not necessarily indicative of the amounts the Corporation could realize in a current market exchange. Assets and liabilities are categorized into three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy in which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Corporation’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Below is a brief description of each fair value level.

 

Level 1 inputs		Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Corporation has the ability to access.
Level 2 inputs		Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.
Level 3 inputs		Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.

 

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Following is a description of the valuation methodologies used for the Corporation’s more significant instruments measured on a recurring basis at fair value, including the general classification of such instruments pursuant to the valuation hierarchy.

Investment securities available for sale: Where quoted prices are available in an active market, investment securities are classified in Level 1 of the fair value hierarchy. Level 1 investment securities primarily include U.S. Treasury, certain Federal agency, and exchange-traded debt and equity securities. If quoted market prices are not available for the specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate, and are classified in Level 2 of the fair value hierarchy. Examples of these investment securities include certain Federal agency securities, obligations of state and political subdivisions (municipal securities), mortgage-related securities, asset-backed securities, and other debt securities. Lastly, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, securities are classified within Level 3 of the fair value hierarchy. Level 3 securities primarily include pooled trust preferred and other debt securities. To validate the fair value estimates, assumptions, and controls, the Corporation looks to transactions for similar instruments and utilizes independent pricing provided by third party vendors or brokers and relevant market indices. While none of these sources are solely indicative of fair value, they serve as directional indicators for the appropriateness of the Corporation’s fair value estimates. The Corporation has determined that the fair value measures of its investment securities are classified predominantly within Level 1 or 2 of the fair value hierarchy. See Note 5 for additional disclosure regarding the Corporation’s investment securities.

Derivative financial instruments (interest rate-related instruments): The Corporation has used, and may again use in the future, interest rate swaps to manage its interest rate risk. In addition, the Corporation offers customer interest rate-related instruments (swaps and caps) to service our customers’ needs, for which the Corporation simultaneously enters into offsetting derivative financial instruments (i.e., mirror interest rate-related instruments) with third parties to manage its interest rate risk associated with these financial instruments. The valuation of the Corporation’s derivative financial instruments is determined using discounted cash flow analysis on the expected cash flows of each derivative and, also includes a nonperformance / credit risk component (credit valuation adjustment). See Note 10 for additional disclosure regarding the Corporation’s derivative financial instruments.

The discounted cash flow analysis component in the fair value measurement reflects the contractual terms of the derivative financial instruments, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. More specifically, the fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments), with the variable cash payments (or receipts) based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Likewise, the fair values of interest rate options (i.e., interest rate caps) are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fall below (or rise above) the strike rate of the floors (or caps), with the variable interest rates used in the calculation of projected receipts on the floor (or cap) based on an expectation of future interest rates derived from observable market interest rate curves and volatilities.

The Corporation also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative financial instruments for the effect of nonperformance risk, the Corporation has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB’s fair value measurement guidance, the Corporation made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

While the Corporation has determined that the majority of the inputs used to value its derivative financial instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. The Corporation has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions as of September 30, 2014, and December 31, 2013, and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivative financial instruments. Therefore, the Corporation has determined that the fair value measures of its derivative financial instruments in their entirety are classified within Level 2 of the fair value hierarchy.

Derivative financial instruments (foreign currency exchange forwards): The Corporation provides foreign currency exchange services to customers. In addition, the Corporation may enter into a foreign currency exchange forward to mitigate the exchange rate risk attached to the cash flows of a loan or as an offsetting contract to a forward entered into as a service to our customer. The valuation of the Corporation’s foreign currency exchange forwards is determined using quoted prices of foreign currency exchange forwards with similar characteristics, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate, and are classified in Level 2 of the fair value hierarchy. See Note 10 for additional disclosures regarding the Corporation’s foreign currency exchange forwards.

 

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Derivative financial instruments (mortgage derivatives): Mortgage derivatives include interest rate lock commitments to originate residential mortgage loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Corporation relies on an internal valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups.

The Corporation also relies on an internal valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Corporation would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Corporation has determined that the majority of the inputs significant in the valuation of both of the mortgage derivatives fall within Level 3 of the fair value hierarchy. See Note 10 for additional disclosure regarding the Corporation’s mortgage derivatives.

Following is a description of the valuation methodologies used for the Corporation’s more significant instruments measured on a nonrecurring basis at the lower of amortized cost or estimated fair value, including the general classification of such instruments pursuant to the valuation hierarchy.

Loans Held for Sale: Loans held for sale, which consist generally of current production of certain fixed-rate, first-lien residential mortgage loans, are carried at the lower of cost or estimated fair value. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics, which the Corporation classifies as a Level 2 nonrecurring fair value measurement.

Impaired Loans: The Corporation considers a loan impaired when it is probable that the Corporation will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that commercial and consumer loan relationships that have nonaccrual status or have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. See Note 6 for additional information regarding the Corporation’s impaired loans.

Mortgage servicing rights: Mortgage servicing rights do not trade in an active, open market with readily observable prices. While sales of mortgage servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its mortgage servicing rights. The valuation model incorporates prepayment assumptions to project mortgage servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The valuation model considers portfolio characteristics of the underlying mortgages, contractually specified servicing fees, prepayment assumptions, discount rate assumptions, delinquency rates, late charges, other ancillary revenue, costs to service, and other economic factors. The Corporation periodically reviews and assesses the underlying inputs and assumptions used in the model. In addition, the Corporation compares its fair value estimates and assumptions to observable market data for mortgage servicing rights, where available, and to recent market activity and actual portfolio experience. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the fair value hierarchy. The Corporation uses the amortization method (i.e., lower of amortized cost or estimated fair value measured on a nonrecurring basis), not fair value measurement accounting, for its mortgage servicing rights assets. See Note 7 for additional disclosure regarding the Corporation’s mortgage servicing rights.

 

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The table below presents the Corporation’s investment securities available for sale and derivative financial instruments measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis
						Fair Value Measurements Using
		September 30, 2014				Level 1				Level 2				Level 3
		($ in Thousands)
Assets:
Investment securities available for sale:
U.S. Treasury securities		$	996			$	996			$	—			$	—
Obligations of state and political subdivisions (municipal securities)			614,436				—				614,436				—
Residential mortgage-related securities:
Government-sponsored enterprise (GSE)			3,741,040				—				3,741,040				—
Private-label			2,482				—				2,482				—
GNMA commercial mortgage-related securities			980,602				—				980,602				—
Other securities (debt and equity)			5,866				2,666				3,000				200
Total investment securities available for sale		$	5,345,422			$	3,662			$	5,341,560			$	200
Derivatives (trading and other assets)		$	42,388			$	—			$	40,948			$	1,440
Liabilities:
Derivatives (trading and other liabilities)		$	43,569			$	—			$	42,946			$	623
						Fair Value Measurements Using
		December 31, 2013				Level 1				Level 2				Level 3
		($ in Thousands)
Assets:
Investment securities available for sale:
U.S. Treasury securities		$	1,002			$	1,002			$	—			$	—
Obligations of state and political subdivisions (municipal securities)			676,080				—				676,080				—
Residential mortgage-related securities:
Government-sponsored enterprise (GSE)			3,838,430				—				3,838,430				—
Private-label			3,014				—				3,014				—
GNMA commercial mortgage-related securities			647,477				—				647,477				—
Asset-backed securities			23,059				—				23,059				—
Other securities (debt and equity)			61,523				3,238				57,986				299
Total investment securities available for sale		$	5,250,585			$	4,240			$	5,246,046			$	299
Derivatives (trading and other assets)		$	52,773			$	—			$	51,056			$	1,717
Liabilities:
Derivatives (trading and other liabilities)		$	53,798			$	—			$	53,798			$	—

 

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The table below presents a rollforward of the balance sheet amounts for the year ended December 31, 2013 and the nine months ended September 30, 2014, for financial instruments measured on a recurring basis and classified within Level 3 of the fair value hierarchy.

 

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)
		Investment Securities Available for Sale				Derivative Financial Instruments
($ in Thousands)
Balance December 31, 2012		$	480			$	7,647
Total net losses included in income:
Mortgage derivative loss			—				(5,930	)
Total net losses included in other comprehensive income:
Unrealized investment securities loss			(70	)			—
Sales of investment securities			(111	)			—
Balance December 31, 2013		$	299			$	1,717
Total net losses included in income:
Mortgage derivative loss			—				(900	)
Sales of investment securities			(99	)			—
Balance September 30, 2014		$	200			$	817

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2014, the Corporation utilized the following valuation techniques and significant unobservable inputs.

Derivative financial instruments (mortgage derivative – interest rate lock commitments to originate residential mortgage loans held for sale): The significant unobservable input used in the fair value measurement of the Corporation’s mortgage derivative interest rate lock commitments (“IRLC”) is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data, (particularly the change in the current interest rates from the time of initial rate lock). The closing ratio is periodically reviewed for reasonableness and reported to the Mortgage Risk Management Committee. At September 30, 2014, the closing ratio was 88%.

Impaired loans: For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note, resulting in average discounts of 20% to 30%.

Mortgage servicing rights: The discounted cash flow analyses that generate expected market prices utilize the observable characteristics of the mortgage servicing rights portfolio, as well as certain unobservable valuation parameters. The significant unobservable inputs used in the fair value measurement of the Corporation’s mortgage servicing rights are the weighted average constant prepayment rate and weighted average discount rate, which were 13.4% and 10.1% at September 30, 2014, respectively. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement.

These parameter assumptions fall within a range that the Corporation, in consultation with an independent third party, believes purchasers of servicing would apply to such portfolios sold into the current secondary servicing market. Discussions are held with members from Treasury and Consumer Banking to reconcile the fair value estimates and the key assumptions used by the respective parties in arriving at those estimates. The Associated Mortgage Group Risk Committee is responsible for providing control over the valuation methodology and key assumptions. To assess the reasonableness of the fair value measurement, the Corporation also compares the fair value and constant prepayment rate to a value calculated by an independent third party on an annual basis.

 

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The table below presents the Corporation’s loans held for sale, impaired loans, and mortgage servicing rights measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
						Fair Value Measurements Using
		September 30, 2014				Level 1				Level 2				Level 3
		($ in Thousands)
Assets:
Loans held for sale		$	142,097			$	—			$	142,097			$	—
Impaired loans (1)			83,771				—				—				83,771
Mortgage servicing rights			69,940				—				—				69,940
						Fair Value Measurements Using
		December 31, 2013				Level 1				Level 2				Level 3
		($ in Thousands)
Assets:
Loans held for sale		$	64,738			$	—			$	64,738			$	—
Impaired loans (1)			88,049				—				—				88,049
Mortgage servicing rights			74,444				—				—				74,444

 

(1)	Represents individually evaluated impaired loans, net of the related allowance for loan losses.

Certain nonfinancial assets measured at fair value on a nonrecurring basis include other real estate owned (upon initial recognition or subsequent impairment), nonfinancial assets and nonfinancial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment.

During the first nine months of 2014 and the full year 2013, certain other real estate owned, upon initial recognition, was re-measured and reported at fair value through a charge off to the allowance for loan losses based upon the estimated fair value of the other real estate owned, less estimated selling costs. The fair value of other real estate owned, upon initial recognition or subsequent impairment, was estimated using appraised values, which the Corporation classifies as a Level 2 nonrecurring fair value measurement. Other real estate owned measured at fair value upon initial recognition totaled approximately $19 million for the first nine months of 2014 and $29 million for the year ended December 31, 2013. In addition to other real estate owned measured at fair value upon initial recognition, the Corporation also recorded write-downs to the balance of other real estate owned for subsequent impairment of $2 million and $4 million to asset losses, net for the nine months ended September 30, 2014 and the year ended December 31, 2013, respectively.

Fair Value of Financial Instruments:

The Corporation is required to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Corporation’s financial instruments.

 

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The estimated fair values of the Corporation’s financial instruments at September 30, 2014 and December 31, 2013, were as follows.

 

		September 30, 2014
		Carrying Amount				Fair Value				Fair Value Measurements Using
										Level 1				Level 2				Level 3
		($ in Thousands)
Financial assets:
Cash and due from banks		$	381,287			$	381,287			$	381,287			$	—			$	—
Interest-bearing deposits in other financial institutions			74,945				74,945				74,945				—				—
Federal funds sold and securities purchased under agreements to resell			18,320				18,320				18,320				—				—
Investment securities held to maturity			301,941				307,882				—				307,882				—
Investment securities available for sale			5,345,422				5,345,422				3,662				5,341,560				200
FHLB and Federal Reserve Bank stocks			188,875				188,875				—				188,875				—
Loans held for sale			141,672				142,097				—				142,097				—
Loans, net			16,892,828				17,038,692				—				—				17,038,692
Bank owned life insurance			571,422				571,422				—				571,422				—
Accrued interest receivable			69,609				69,609				69,609				—				—
Interest rate-related instruments			31,862				31,862				—				31,862				—
Foreign currency exchange forwards			2,143				2,143				—				2,143				—
Interest rate lock commitments to originate residential mortgage loans held for sale			1,440				1,440				—				—				1,440
Purchased options (time deposit)			6,943				6,943				—				6,943				—
Financial liabilities:
Noninterest-bearing demand, savings, interest-bearing demand, and money market deposits		$	16,687,892			$	16,687,892			$	—			$	—			$	16,687,892
Brokered CDs and other time deposits			1,513,366				1,513,366				—				1,513,366				—
Short-term funding			1,430,180				1,430,180				—				1,430,180				—
Long-term funding			2,931,547				2,922,749				—				2,922,749				—
Accrued interest payable			1,543				1,543				1,543				—				—
Interest rate-related instruments			34,071				34,071				—				34,071				—
Foreign currency exchange forwards			1,932				1,932				—				1,932				—
Standby letters of credit (1)			3,526				3,526				—				3,526				—
Forward commitments to sell residential mortgage loans			623				623				—				—				623
Written options (time deposit)			6,943				6,943				—				6,943				—

 

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		December 31, 2013
		Carrying Amount				Fair Value				Fair Value Measurements Using
										Level 1				Level 2				Level 3
		($ in Thousands)
Financial assets:
Cash and due from banks		$	455,482			$	455,482			$	455,482			$	—			$	—
Interest-bearing deposits in other financial institutions			126,018				126,018				126,018				—				—
Federal funds sold and securities purchased under agreements to resell			20,745				20,745				20,745				—				—
Investment securities held to maturity			175,210				169,889				—				169,889				—
Investment securities available for sale			5,250,585				5,250,585				4,240				5,246,046				299
FHLB and Federal Reserve Bank stocks			181,249				181,249				—				181,249				—
Loans held for sale			64,738				64,738				—				64,738				—
Loans, net			15,627,946				15,599,094				—				—				15,599,094
Bank owned life insurance			568,413				568,413				—				568,413				—
Accrued interest receivable			66,308				66,308				66,308				—				—
Interest rate-related instruments			42,980				42,980				—				42,980				—
Foreign currency exchange forwards			748				748				—				748				—
Interest rate lock commitments to originate residential mortgage loans held for sale			416				416				—				—				416
Forward commitments to sell residential mortgage loans			1,301				1,301				—				—				1,301
Purchased options (time deposit)			7,328				7,328				—				7,328				—
Financial liabilities:
Noninterest-bearing demand, savings, interest-bearing demand, and money market deposits		$	15,581,971			$	15,581,971			$	—			$	—			$	15,581,971
Brokered CDs and other time deposits			1,685,196				1,687,198				—				1,687,198				—
Short-term funding			740,926				740,926				—				740,926				—
Long-term funding			3,087,267				3,085,893				—				3,085,893				—
Accrued interest payable			7,994				7,994				7,994				—				—
Interest rate-related instruments			45,815				45,815				—				45,815				—
Foreign currency exchange forwards			655				655				—				655				—
Standby letters of credit (1)			3,754				3,754				—				3,754				—
Written options (time deposit)			7,328				7,328				—				7,328				—

 

(1)	The commitment on standby letters of credit was $352 million and $371 million at September 30, 2014 and December 31, 2013, respectively. See Note 12 for additional information on the standby letters of credit and for information on the fair value of lending-related commitments.

Cash and due from banks, interest-bearing deposits in other financial institutions, federal funds sold and securities purchased under agreements to resell, and accrued interest receivable - For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities (held to maturity and available for sale) - The fair value of investment securities is based on quoted prices in active markets, or if quoted prices are not available for a specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.

FHLB and Federal Reserve Bank stocks – The carrying amount is a reasonable fair value estimate for the Federal Reserve Bank and Federal Home Loan Bank stocks given their “restricted” nature (i.e., the stock can only be sold back to the respective institutions (Federal Home Loan Bank or Federal Reserve Bank) or another member institution at par).

Loans held for sale – The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics.

 

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Loans, net - The fair value estimation process for the loan portfolio uses an exit price concept and reflects discounts the Corporation believes are consistent with liquidity discounts in the market place. Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial and industrial, real estate construction, commercial real estate (owner occupied and investor), lease financing, residential mortgage, home equity, other installment, and credit cards. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar maturities. The fair value analysis also included other assumptions to estimate fair value, intended to approximate those a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, and credit spreads, as appropriate.

Bank owned life insurance – The fair value of bank owned life insurance approximates the carrying amount, because upon liquidation of these investments, the Corporation would receive the cash surrender value which equals the carrying amount.

Deposits - The fair value of deposits with no stated maturity such as noninterest-bearing demand deposits, savings, interest-bearing demand deposits, and money market accounts, is equal to the amount payable on demand as of the balance sheet date. The fair value of Brokered CDs and other time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. However, if the estimated fair value of Brokered CDs and other time deposits is less than the carrying value, the carrying value is reported as the fair value.

Accrued interest payable and short-term funding - For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Long-term funding - Rates currently available to the Corporation for debt with similar terms and remaining maturities are used to estimate the fair value of existing long-term funding.

Interest rate-related instruments - The fair value of interest rate-related instruments is determined using discounted cash flow analysis on the expected cash flows of each derivative. The Corporation also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.

Foreign currency exchange forwards – The fair value of the Corporation’s foreign currency exchange forwards is determined using quoted prices of foreign currency exchange forwards with similar characteristics, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate.

Standby letters of credit - The fair value of standby letters of credit represent deferred fees arising from the related off-balance sheet financial instruments. These deferred fees approximate the fair value of these instruments and are based on several factors, including the remaining terms of the agreement and the credit standing of the customer.

Interest rate lock commitments to originate residential mortgage loans held for sale - The Corporation relies on an internal valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups.

Forward commitments to sell residential mortgage loans - The Corporation relies on an internal valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Corporation would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available.

Purchased and written options - The fair value of the Corporation’s purchased and written options is determined using quoted prices of the underlying stocks.

Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current

 

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economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

NOTE 14: Retirement Plans

The Corporation has a noncontributory defined benefit retirement plan (the Retirement Account Plan (“RAP”)) covering substantially all full-time employees. The benefits are based primarily on years of service and the employee’s compensation paid. Employees of acquired entities generally participate in the RAP after consummation of the business combinations. Any retirement plans of acquired entities are typically merged into the RAP after completion of the mergers, and credit is usually given to employees for years of service at the acquired institution for vesting and eligibility purposes. In connection with the First Federal acquisition in October 2004, the Corporation assumed the First Federal pension plan (the “First Federal Plan”). The First Federal Plan was frozen on December 31, 2004 and qualified participants in the First Federal Plan became eligible to participate in the RAP as of January 1, 2005. Additional discussion and information on the RAP and the First Federal Plan are collectively referred to below as the “Pension Plan”.

The Corporation also provides healthcare access for eligible retired employees in its Postretirement Plan (the “Postretirement Plan”). Retirees who are at least 55 years of age with 5 years of service are eligible to participate in the Postretirement Plan. The Corporation has no plan assets attributable to the Postretirement Plan. The Corporation reserves the right to terminate or make changes to the Postretirement Plan at any time.

The components of net periodic benefit cost for the Pension and Postretirement Plans for the three and nine months ended September 30, 2014 and 2013, and for the full year 2013 were as follows.

 

		Three Months Ended September 30,								Nine Months Ended September 30,								Year Ended December 31,
		2014				2013				2014				2013				2013
		($ in Thousands)
Components of Net Periodic Benefit Cost
Pension Plan:
Service cost		$	2,975			$	2,975			$	8,925			$	8,925			$	12,078
Interest cost			1,790				1,548				5,370				4,643				6,237
Expected return on plan assets			(4,855	)			(4,305	)			(14,565	)			(12,915	)			(17,647	)
Amortization of prior service cost			15				17				45				52				72
Amortization of actuarial loss			326				1,073				975				3,218				4,344
Total net periodic benefit cost		$	251			$	1,308			$	750			$	3,923			$	5,084
Postretirement Plan:
Interest cost		$	39			$	40			$	116			$	120			$	142
Amortization of actuarial gain			(9	)			—				(26	)			—				—
Total net periodic benefit cost		$	30			$	40			$	90			$	120			$	142

The Corporation’s funding policy is to pay at least the minimum amount required by the funding requirements of federal law and regulations, with consideration given to the maximum funding amounts allowed. The Corporation regularly reviews the funding of its Pension Plan. The Corporation made contributions of $21 million and $28 million to its Pension Plan in the first nine months of 2014 and 2013, respectively.

NOTE 15: Segment Reporting

The Corporation utilizes a risk-based internal profitability measurement system to provide strategic business unit reporting. The profitability measurement system is based on internal management methodologies designed to produce consistent results and reflect the underlying economics of the units. Certain strategic business units have been combined for segment information reporting

 

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purposes where the nature of the products and services, the type of customer and the distribution of those products and services are similar. The three reportable segments are Corporate and Commercial Specialty; Community, Consumer, and Business, and Risk Management and Shared Services, with no segment representing more than half of the assets, liabilities or Tier 1 common equity of the Corporation as a whole.

The financial information of the Corporation’s segments has been compiled utilizing the accounting policies described in the Corporation’s 2013 annual report on Form 10-K with certain exceptions. The more significant of these exceptions are described herein. The Corporation allocates interest income or interest expense using a funds transfer pricing methodology that charges users of funds (assets) interest expense and credits providers of funds (liabilities, primarily deposits) with income based on the maturity, prepayment and / or repricing characteristics of the assets and liabilities. The net effect of this allocation is recorded in the Risk Management and Shared Services segment. A credit provision is allocated to segments based on the expected long-term annual net charge off rates attributable to the credit risk of loans managed by the segment during the period. In contrast, the level of the consolidated provision for credit losses is determined using the methodologies described in the Corporation’s 2013 annual report on Form 10-K to assess the overall appropriateness of the allowance for credit losses. The net effect of the credit provision is recorded in Risk Management and Shared Services. Indirect expenses incurred by certain centralized support areas are allocated to segments based on actual usage (for example, volume measurements) and other criteria. Certain types of administrative expense and bank-wide expense accruals (including amortization of core deposit and other intangible assets associated with acquisitions) are generally not allocated to segments. Income taxes are allocated to segments based on the Corporation’s estimated effective tax rate, with certain segments adjusted for any tax-exempt income or non-deductible expenses. Equity is allocated to the segments based on regulatory capital requirements and in proportion to an assessment of the inherent risks associated with the business of the segment (including interest, credit and operating risk).

The management accounting policies and processes utilized in compiling segment financial information are highly subjective and, unlike financial accounting, are not based on authoritative guidance similar to U.S. generally accepted accounting principles. As a result, reported segments and the financial information of the reported segments are not necessarily comparable with similar information reported by other financial institutions. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in previously reported segment financial data. During 2014, certain organization and methodology changes were made and, accordingly, 2013 results have been restated and presented on a comparable basis.

A description of each business segment is presented below.

Corporate and Commercial Specialty – The Corporate and Commercial Specialty segment serves a wide range of customers including, larger businesses, developers, non-profits, municipalities, and financial institutions. In serving this segment we compete based on an in-depth understanding of our customers’ financial needs, the ability to match market competitive solutions to those needs, and the highest standards of relationship and service excellence in the delivery of these services. Delivery of services is provided through our corporate and commercial units, our commercial real estate unit, as well as our specialized industries and commercial financial services units. Within this segment, the following products and services are provided: (1) lending solutions, such as commercial loans and lines of credit, commercial real estate financing, construction loans, letters of credit, leasing, and asset based lending; for our larger clients we also provide loan syndications; (2) deposit and cash management solutions such as commercial checking and interest-bearing deposit products, cash vault and night depository services, liquidity solutions, payables and receivables solutions; and information services; and (3) specialized financial services such as swaps, capital markets, foreign exchange, and international banking solutions.

Community, Consumer, and Business – The Community, Consumer, and Business segment serves individuals, as well as small and mid-size businesses. In serving this segment we compete based on providing a broad range of solutions to meet the needs of our customers in their entire financial lifecycle, convenient access to our services through multiple channels such as branches, phone based services, online and mobile banking, and a relationship based business model which assists our customers in navigating any changes and challenges in their financial circumstances. Delivery of services is provided through our various Consumer Banking, Community Banking, and Private Client units. Within this segment, the following products and services are provided: (1) lending solutions such as residential mortgages, home equity loans and lines of credit, personal and installment loans, real estate financing, business loans, and business lines of credit; (2) deposit and transactional solutions such as checking, credit, debit and pre-paid cards, online banking and bill pay, and money transfer services; (3) investable funds solutions such as savings, money market deposit accounts, IRA accounts, certificates of deposit, fixed and variable annuities, full-service, discount and on-line investment brokerage; as well as trust and investment management accounts; and (4) insurance, benefits related products and services, and fiduciary services such as administration of pension, profit-sharing and other employee benefit plans, fiduciary and corporate agency services, and institutional asset management.

 

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Risk Management and Shared Services – The Risk Management and Shared Services segment includes Corporate Risk Management, Credit Administration, Finance, Treasury, Operations and Technology, which are key shared functions. The segment also includes Parent Company activity, intersegment eliminations and residual revenue and expenses, representing the difference between actual amounts incurred and the amounts allocated to operating segments, including interest rate risk residuals (funds transfer pricing mismatches) and credit risk and provision residuals (long term credit charge mismatches). The earning assets within this segment include the Corporation’s investment portfolio and capital includes both allocated as well as any remaining unallocated capital.

Information about the Corporation’s segments is presented below.

 

Segment Income Statement Data
($ in Thousands)		Corporate and Commercial Specialty				Community,  Consumer, and Business				Risk Management and Shared Services				Consolidated Total
Nine Months Ended September 30, 2014
Net interest income		$	209,212			$	236,687			$	60,407			$	506,306
Noninterest income			33,711				170,547				16,418				220,676
Total revenue			242,923				407,234				76,825				726,982
Credit provision *			34,983				18,572				(42,555	)			11,000
Noninterest expense			103,383				353,258				50,795				507,436
Income before income taxes			104,557				35,404				68,585				208,546
Income tax expense			35,568				12,391				18,816				66,775
Net income		$	68,989			$	23,013			$	49,769			$	141,771
Return on average allocated capital (ROT1CE) **			12.5	%			5.4	%			10.5	%			9.8	%
Nine Months Ended September 30, 2013
Net interest income		$	222,705			$	253,716			$	1,923			$	478,344
Noninterest income			32,175				191,236				13,815				237,226
Total revenue			254,880				444,952				15,738				715,570
Credit provision *			38,161				18,029				(48,390	)			7,800
Noninterest expense			93,806				364,609				43,067				501,482
Income before income taxes			122,913				62,314				21,061				206,288
Income tax expense			43,019				21,810				525				65,354
Net income		$	79,894			$	40,504			$	20,536			$	140,934
Return on average allocated capital (ROT1CE) **			14.7	%			9.4	%			3.9	%			9.8	%
Segment Balance Sheet Data
($ in Thousands)		Corporate and Commercial Specialty				Community, Consumer, and Business				Risk Management and Shared Services				Consolidated Total
Average Balances for YTD 3Q 2014
Average earning assets		$	8,606,965			$	7,973,138			$	5,933,220			$	22,513,323
Average loans			8,595,980				7,973,138				85,115				16,654,233
Average deposits			4,841,852				10,159,818				2,347,059				17,348,729
Average allocated capital (T1CE) **		$	736,285			$	565,588			$	585,539			$	1,887,412
Average Balances for YTD 3Q 2013
Average earning assets		$	7,942,744			$	7,696,572			$	5,252,541			$	20,891,857
Average loans			7,933,954				7,696,572				3,927				15,634,453
Average deposits			4,964,426				10,050,400				2,273,966				17,288,792
Average allocated capital (T1CE) **		$	724,974			$	575,382			$	575,654			$	1,876,010

 

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Segment Income Statement Data
($ in Thousands)		Corporate and Commercial Specialty				Community, Consumer, and Business				Risk Management and Shared Services				Consolidated Total
Three Months Ended September 30, 2014
Net interest income		$	71,716			$	81,916			$	18,998			$	172,630
Noninterest income			11,888				54,601				8,419				74,908
Total revenue			83,604				136,517				27,417				247,538
Credit provision *			11,074				6,773				(16,847	)			1,000
Noninterest expense			35,044				122,722				14,087				171,853
Income before income taxes			37,486				7,022				30,177				74,685
Income tax expense			12,608				2,458				9,412				24,478
Net income		$	24,878			$	4,564			$	20,765			$	50,207
Return on average allocated capital (ROT1CE) **			13.3	%			3.1	%			14.2	%			10.4	%
Three Months Ended September 30, 2013
Net interest income		$	75,677			$	85,477			$	(645	)		$	160,509
Noninterest income			11,142				55,366				4,408				70,916
Total revenue			86,819				140,843				3,763				231,425
Credit provision *			13,097				6,041				(19,938	)			(800	)
Noninterest expense			32,094				122,450				10,627				165,171
Income before income taxes			41,628				12,352				13,074				67,054
Income tax expense			14,569				4,324				2,503				21,396
Net income		$	27,059			$	8,028			$	10,571			$	45,658
Return on average allocated capital (ROT1CE) **			14.8	%			5.6	%			6.2	%			9.3	%
Segment Balance Sheet Data
($ in Thousands)		Corporate and Commercial Specialty				Community, Consumer, and Business				Risk Management and Shared Services				Consolidated Total
Average Balances for 3Q 2014
Average earning assets		$	8,761,870			$	8,310,839			$	6,024,008			$	23,096,717
Average loans			8,750,207				8,310,839				79,915				17,140,961
Average deposits			5,092,314				10,337,637				2,443,427				17,873,378
Average allocated capital (T1CE) **		$	744,605			$	583,148			$	543,493			$	1,871,246
Average Balances for 3Q 2013
Average earning assets		$	8,080,676			$	7,647,106			$	5,311,685			$	21,039,467
Average loans			8,074,076				7,647,106				3,183				15,724,365
Average deposits			5,124,746				10,066,487				2,418,586				17,609,819
Average allocated capital (T1CE) **		$	726,588			$	567,073			$	596,736			$	1,890,397

 

*	The consolidated credit provision is equal to the actual reported provision for credit losses.

**

The Federal Reserve establishes capital adequacy requirements for the Corporation, including Tier 1 capital. Tier 1 capital is comprised of common capital and certain redeemable, non-cumulative preferred stock. Average allocated capital represents average Tier 1 common equity which is defined as average Tier 1 capital excluding qualifying perpetrual preferred stock and qualifying trust preferred securities. This is a non-GAAP financial measure. For segment reporting purposes, the ROT1CE reflects return on average allocated Tier 1 common equity (“T1CE”). The ROT1CE for the Risk Management and Shared Services segment and the Consolidated Total is inclusive of the annualized effect of the preferred stock dividends.

 

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Note 16: Accumulated Other Comprehensive Income (Loss)

The following table summarizes the components of accumulated other comprehensive income (loss) at September 30, 2014 and 2013, changes during the nine and three month periods then ended, and reclassifications out of accumulated other comprehensive income during the nine and three month periods ended September 30, 2014 and 2013, respectively. The amounts reclassified from accumulated other comprehensive income for the investment securities available for sale are included in investment securities gains, net on the consolidated statements of income, while the amounts reclassified from accumulated other comprehensive income for the defined benefit pension and post retirement obligations are a component of personnel expense on the consolidated statements of income.

 

($ in Thousands)		Investments Securities Available For Sale				Defined Benefit Pension and Post Retirement Obligations				Accumulated Other Comprehensive Income (Loss)
Balance January 1, 2014		$	(11,396	)		$	(12,848	)		$	(24,244	)
Other comprehensive income before reclassifications			36,061				—				36,061
Amounts reclassified from accumulated other comprehensive income (loss)			(469	)			994				525
Income tax expense			(13,684	)			(383	)			(14,067	)
Net other comprehensive income during period			21,908				611				22,519
Balance September 30, 2014		$	10,512			$	(12,237	)		$	(1,725	)
Balance January 1, 2013		$	86,109			$	(37,506	)		$	48,603
Other comprehensive loss before reclassifications			(142,318	)			—				(142,318	)
Amounts reclassified from accumulated other comprehensive income (loss)			(582	)			3,270				2,688
Income tax (expense) benefit			55,169				(1,262	)			53,907
Net other comprehensive income (loss) during period			(87,731	)			2,008				(85,723	)
Balance September 30, 2013		$	(1,622	)		$	(35,498	)		$	(37,120	)
		Investments Securities Available For Sale				Defined Benefit Pension and Post Retirement Obligations				Accumulated Other Comprehensive Income (Loss)
Balance July 1, 2014		$	22,935			$	(12,441	)		$	10,494
Other comprehensive loss before reclassifications			(20,123	)			—				(20,123	)
Amounts reclassified from accumulated other comprehensive income (loss)			(57	)			332				275
Income tax (expense) benefit			7,757				(128	)			7,629
Net other comprehensive income (loss) during period			(12,423	)			204				(12,219	)
Balance September 30, 2014		$	10,512			$	(12,237	)		$	(1,725	)
Balance July 1, 2013		$	11,153			$	(36,168	)		$	(25,015	)
Other comprehensive loss before reclassifications			(20,558	)			—				(20,558	)
Amounts reclassified from accumulated other comprehensive income (loss)			(248	)			1,090				842
Income tax (expense) benefit			8,031				(420	)			7,611
Net other comprehensive income (loss) during period			(12,775	)			670				(12,105	)
Balance September 30, 2013		$	(1,622	)		$	(35,498	)		$	(37,120	)

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-Looking Statements

This report contains statements that may constitute forward-looking statements within the meaning of the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference into this report. These forward-looking statements include statements with respect to the Corporation’s financial condition, results of operations, plans, objectives, future performance and business, including statements preceded by, followed by or that include the words “believes,” “expects,” or “anticipates,” references to estimates or similar expressions. Future filings by the Corporation with the Securities and Exchange Commission, and future statements other than historical facts contained in written material, press releases and oral statements issued by, or on behalf of the Corporation may also constitute forward-looking statements.

All forward-looking statements contained in this report or which may be contained in future statements made for or on behalf of the Corporation are based upon information available at the time the statement is made and the Corporation assumes no obligation to update any forward-looking statements, except as required by federal securities law. Forward-looking statements are subject to significant risks and uncertainties, and the Corporation’s actual results may differ materially from the expected results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to, the risk factors in Item 1A, Risk Factors, in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013, and as may be described from time to time in the Corporation’s subsequent SEC filings.

Overview

The following discussion and analysis is presented to assist in the understanding and evaluation of the Corporation’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith.

Critical Accounting Policies

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change include the determination of the allowance for credit losses, goodwill impairment assessment, mortgage servicing rights valuation, and income taxes.

The consolidated financial statements of the Corporation are prepared in conformity with U.S. generally accepted accounting principles and follow general practices within the industries in which it operates. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Management believes the following policies are both important to the portrayal of the Corporation’s financial condition and results of operations and require subjective or complex judgments and, therefore, management considers the following to be critical accounting policies. The critical accounting policies are discussed directly with the Audit Committee of the Corporation’s Board of Directors.

Allowance for Credit Losses: Management’s evaluation process used to determine the appropriateness of the allowance for credit losses (which includes the allowance for loan losses and the allowance for unfunded commitments) is subject to the use of estimates, assumptions, and judgments. The evaluation process combines many factors: management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience, trends in past due and nonaccrual loans, risk characteristics of the various classifications of loans, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the appropriateness of the allowance for credit losses, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for credit losses. Such agencies may require additions to the allowance for credit losses or may require that certain loan balances be charged off or downgraded into criticized loan categories when their credit evaluations differ from those of management, based on their judgments about information available to them at the

 

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time of their examination. The Corporation believes the level of the allowance for credit losses is appropriate as recorded in the consolidated financial statements. See Note 6, “Loans, Allowance for Credit Losses, and Credit Quality,” of the notes to consolidated financial statements and section “Allowance for Credit Losses.”

Goodwill Impairment Assessment: Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded book value, “step one”. If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues (“step two”) by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill.

The Corporation conducted its annual impairment testing in May 2014, utilizing the qualitative assessment. Factors that management considered in this assessment included macroeconomic conditions, industry and market considerations, overall financial performance of the Corporation and each reporting unit (both current and projected), changes in management strategy, and changes in the composition or carrying amount of net assets. In addition, management considered the increases in both the Corporation’s common stock price and in the overall bank common stock index (based on the NASDAQ bank index), as well as the Corporation’s earnings per common share trend over the past year. Based on these assessments, management concluded that the 2014 annual qualitative impairment assessment indicated that it is more likely than not that the estimated fair value exceeded the carrying value (including goodwill) for each reporting unit. Therefore, a step one quantitative analysis was not required. There were no impairment charges recorded in 2013 or through September 30, 2014. See also Note 7, “Goodwill and Other Intangible Assets”, of the notes to consolidated financial statements.

Mortgage Servicing Rights Valuation: The fair value of the Corporation’s mortgage servicing rights asset is important to the presentation of the consolidated financial statements since the mortgage servicing rights are carried on the consolidated balance sheet at the lower of amortized cost or estimated fair value. Mortgage servicing rights do not trade in an active open market with readily observable prices. As such, like other participants in the mortgage banking business, the Corporation relies on an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its mortgage servicing rights. The use of a discounted cash flow model involves judgment, particularly of estimated prepayment speeds of underlying mortgages serviced and the overall level of interest rates. Loan type and note interest rate are the predominant risk characteristics of the underlying loans used to stratify capitalized mortgage servicing rights for purposes of measuring impairment. The Corporation periodically reviews the assumptions underlying the valuation of mortgage servicing rights. While the Corporation believes that the values produced by the discounted cash flow model are indicative of the fair value of its mortgage servicing rights portfolio, these values can change significantly depending upon key factors, such as the then current interest rate environment, estimated prepayment speeds of the underlying mortgages serviced, and other economic conditions. The proceeds that might be received should the Corporation actually consider a sale of some or all of the mortgage servicing rights portfolio could differ from the amounts reported at any point in time.

Mortgage servicing rights are carried at the lower of amortized cost or estimated fair value and are assessed for impairment at each reporting date. Impairment is assessed based on the fair value at each reporting date using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans (predominantly loan type and note interest rate). As mortgage interest rates fall, prepayment speeds are usually faster and the value of the mortgage servicing rights asset generally decreases, requiring additional valuation reserve. Conversely, as mortgage interest rates rise, prepayment speeds are usually slower and the value of the mortgage servicing rights asset generally increases, requiring less valuation reserve. However, the extent to which interest rates impact the value of the mortgage servicing rights asset depends, in part, on the magnitude of the changes in market interest rates and the differential between the then current market interest rates for mortgage loans and the mortgage interest rates included in the mortgage servicing portfolio. Management recognizes that the volatility in the valuation of the mortgage servicing rights asset will continue. To better understand the sensitivity of the impact of prepayment speeds and refinance rates on the value of the mortgage servicing rights asset at September 30, 2014 (holding all other factors unchanged), if refinance interest rates were to decrease 50 basis points (bp), the estimated value of the mortgage servicing rights asset would have been approximately $10 million (or 14%) lower. Conversely, if refinance interest rates were to increase 50 bp, the estimated value of

 

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the mortgage servicing rights asset would have been approximately $8 million (or 11%) higher. However, the Corporation’s potential recovery recognition due to valuation improvement is limited to the balance of the mortgage servicing rights valuation reserve, which was approximately $1 million at September 30, 2014. The Corporation believes the mortgage servicing rights asset is properly recorded in the consolidated financial statements. See Note 7, “Goodwill and Other Intangible Assets,” and Note 13, “Fair Value Measurements,” of the notes to consolidated financial statements and section “Noninterest Income.”

Income Taxes: The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgment concerning certain accounting pronouncements and federal and state tax laws and regulations. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. Quarterly assessments are performed to determine if valuation allowances are necessary against any portion of the Corporation’s deferred tax assets. Assessing the need for, or sufficiency of, a valuation allowance requires management to evaluate all available evidence, both positive and negative, including the recent trend of quarterly earnings. Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carryback and carryforward periods is available under the tax law, including the use of tax planning strategies. When negative evidence (e.g., cumulative losses in recent years, history of operating loss or tax credit carryforwards expiring unused) exists, more positive evidence than negative evidence will be necessary. The Corporation has concluded that based on the level of positive evidence, it is more likely than not that the deferred tax asset will be realized. However, there is no guarantee that the tax benefits associated with the deferred tax assets will be fully realized. The Corporation believes the tax assets and liabilities are properly recorded in the consolidated financial statements. See also Note 9, “Income Taxes,” of the notes to consolidated financial statements and section “Income Taxes.”

Segment Review

As discussed in Note 15, “Segment Reporting,” of the notes to consolidated financial statements, the Corporation’s reportable segments have been determined based upon its internal profitability measurement system, which is organized by strategic business unit. Certain strategic business units have been combined for segment information reporting purposes where the nature of the products and services, the type of customer, and the distribution of those products and services are similar. The reportable segments are Corporate and Commercial Banking, Community and Consumer Banking, and Risk Management and Shared Services.

The financial information of the Corporation’s segments was compiled utilizing the accounting policies described in Note 15, “Segment Reporting,” of the notes to consolidated financial statements. The management accounting policies and processes utilized in compiling segment financial information are highly subjective and, unlike financial accounting, are not based on authoritative guidance similar to U.S. generally accepted accounting principles. As a result, reported segments and the financial information of the reported segments are not necessarily comparable with similar information reported by other financial institutions. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in previously reported segment financial data. During 2014, certain organization and methodology changes were made and, accordingly, 2013 results have been restated and presented on a comparable basis.

Year to Date Segment Review

The Corporate and Commercial Specialty segment consists of lending and deposit solutions to larger businesses, developers, non-profits, municipalities, and financial institutions, and the support to deliver, fund, and manage such banking solutions. The Corporate and Commercial Specialty segment had net income of $69 million for the first nine months of 2014, down $11 million compared to $80 million for the comparable period in 2013. Segment revenue decreased $12 million to $243 million for the first nine months of 2014 compared to $255 million for the first nine months of 2013 primarily due to changes in the long-term funding rates utilized in the funds transfer pricing methodology for allocating interest credits. The credit provision decreased $3 million to $35 million during the first nine months of 2014 due to improvement in the loan credit quality. Average loan balances were $8.6 billion for the first nine months of 2014, up $662 million from the first nine months of 2013, while average deposit balances were $4.8 billion for the first nine months of 2014, down $123 million from the first nine months of 2013. Average allocated capital increased $11 million to $736 million for the first nine months of 2014 reflecting the increase in the segment’s loan balances.

The Community, Consumer, and Business segment consists of lending and deposit solutions to individuals and small to mid-sized businesses and also provides a variety of investment and fiduciary products and services. The Community, Consumer, and Business segment had net income of $23 million for the first nine months of 2014, down $18 million compared to $41 million in the first nine months of 2013. Earnings decreased as segment revenue declined $38 million to $407 million for the first nine months of 2014, primarily due to lower mortgage banking income as refinancing activity has slowed and changes in the long-term funding rates utilized in the funds transfer

 

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pricing methodology for allocating interest credits. The credit provision was level at $18 million for the first nine months of 2014 and 2013. Total noninterest expense decreased $11 million to $353 million for the first nine months of 2014, primarily due to less mortgage banking activity. Average loan balances were $8.0 billion for the first nine months of 2014, up $277 million from the first nine months of 2013. Average deposits were $10.2 billion for the first nine months of 2014, up $109 million from the first nine months of 2013. Average allocated capital decreased $10 million to $566 million for the first nine months of 2014.

The Risk Management and Shared Services segment had net income of $50 million in the first nine months of 2014, up $29 million compared to $21 million for the comparable period in 2013. The increase was due to a $61 million increase in total revenue primarily due to changes in the long-term funding rates utilized in the funds transfer pricing methodology for allocating interest credits to the Corporate and Commercial Specialty and Community, Consumer, and Business segments. Average earning asset balances were $5.9 billion for the first nine months of 2014, up $681 million from an average balance of $5.3 billion for the comparable period in 2013.

Comparable Quarter Segment Review

The Corporate and Commercial Specialty segment had net income of $25 million for the third quarter of 2014, down $2 million compared to $27 million for the comparable quarter in 2013. Segment revenue decreased $3 million to $84 million for the third quarter of 2014 compared to $87 million for the third quarter of 2013 primarily due to changes in the long-term funding rates utilized in the funds transfer pricing methodology for allocating interest credits. The credit provision decreased $2 million to $11 million for the third quarter of 2014 due to improvement in the loan credit quality. Average loan balances were $8.8 billion for the third quarter of 2014, up $676 million compared to the third quarter of 2013, while average deposit balances were $5.1 billion for the third quarter of 2014, down $32 million from the third quarter of 2013. Average allocated capital increased $18 million to $745 million for the third quarter of 2014.

The Community, Consumer, and Business segment had net income of $5 million for the third quarter of 2014, down $3 million compared to $8 million for the third quarter of 2013. Segment revenue decreased $4 million to $137 million for the third quarter of 2014, primarily due to changes in the long-term funding rates utilized in the funds transfer pricing methodology for allocating interest credits. The credit provision increased $1 million to $7 million for the third quarter of 2014. Total noninterest expense was level at $123 million for the third quarter of 2014 and 2013. Average loan balances increased $664 million to $8.3 billion for third quarter of 2014 compared to $7.6 billion for the third quarter of 2013. Average deposits were $10.3 billion for the third quarter of 2014, up $271 million from the third quarter of 2013. Average allocated capital increased $16 million to $583 million for the third quarter of 2014.

The Risk Management and Shared Services segment had net income of $21 million for the third quarter of 2014, up $10 million compared to $11 million for the comparable quarter in 2013. The primary component of the increase was a $24 million increase in total revenue primarily due to changes in the long-term funding rates utilized in the funds transfer pricing methodology for allocating net interest income credits to the Corporate and Commercial Specialty and Community, Consumer, and Business segments. Average earning asset balances were $6.0 billion for the third quarter of 2014, up $712 million from an average balance of $5.3 billion for the comparable quarter in 2013.

Results of Operations – Summary

The Corporation recorded net income of $142 million for the nine months ended September 30, 2014, compared to net income of $141 million for the nine months ended September 30, 2013. Net income available to common equity was $138 million for the nine months ended September 30, 2014, or net income of $0.86 for basic earnings per common share and $0.85 for diluted earnings per common share. Comparatively, net income available to common equity for the nine months ended September 30, 2013, was $137 million, or net income of $0.82 for both basic and diluted earnings per common share. The net interest margin for the nine months ended September 30, 2014 was 3.09% compared to 3.15% for the nine months ended September 30, 2013.

 

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TABLE 1

Summary Results of Operations: Trends

($ in Thousands, except per share data)

 

		3rd Qtr 2014				2nd Qtr 2014				1st Qtr 2014				4th Qtr 2013				3rd Qtr 2013
Net income (Quarter)		$	50,207			$	46,365			$	45,199			$	47,758			$	45,658
Net income (Year-to-date)			141,771				91,564				45,199				188,692				140,934
Net income available to common equity (Quarter)		$	48,952			$	45,087			$	43,955			$	46,485			$	44,373
Net income available to common equity (Year-to-date)			137,994				89,042				43,955				183,534				137,049
Earnings per common share – basic (Quarter)		$	0.31			$	0.28			$	0.27			$	0.28			$	0.27
Earnings per common share – basic (Year-to-date)			0.86				0.55				0.27				1.10				0.82
Earnings per common share – diluted (Quarter)		$	0.31			$	0.28			$	0.27			$	0.28			$	0.27
Earnings per common share – diluted (Year-to-date)			0.85				0.55				0.27				1.10				0.82
Return on average assets (Quarter)			0.78	%			0.75	%			0.76	%			0.80	%			0.78	%
Return on average assets (Year-to-date)			0.76				0.75				0.76				0.81				0.81
Return on average equity (Quarter)			6.93	%			6.43	%			6.35	%			6.60	%			6.33	%
Return on average equity (Year-to-date)			6.57				6.39				6.35				6.52				6.50
Return on average tangible common equity (Quarter)			10.35	%			9.56	%			9.45	%			9.87	%			9.48	%
Return on average tangible common equity (Year-to-date)			9.79				9.51				9.45				9.73				9.68
Return on average Tier 1 common equity (Quarter) (1)			10.38	%			9.56	%			9.38	%			9.78	%			9.31	%
Return on average Tier 1 common equity (Year-to-date) (1)			9.78				9.47				9.38				9.77				9.77
Efficiency ratio (Quarter) (2)			69.44	%			69.70	%			70.41	%			73.70	%			71.45	%
Efficiency ratio (Year-to-date)(2)			69.85				70.05				70.41				71.04				70.14
Efficiency ratio, fully taxable equivalent (Quarter)(2)			69.04	%			68.23	%			68.86	%			72.59	%			70.10	%
Efficiency ratio, fully taxable equivalent (Year-to-date) (2)			68.71				68.54				68.86				69.56				68.53
Net interest margin (Quarter)			3.06	%			3.08	%			3.12	%			3.23	%			3.13	%
Net interest margin (Year-to-date)			3.09				3.10				3.12				3.17				3.15

 

(1)	Return on average Tier 1 common equity = Net income available to common equity divided by average Tier 1 capital excluding qualifying perpetual preferred stock and qualifying trust preferred securities. This is a non-GAAP financial measure.

(2)	See Table 1A for a reconciliation of this non-GAAP measure.

 

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TABLE 1A

Reconciliation of Non-GAAP Measure

 

		3rd Qtr 2014				2nd Qtr 2014				1st Qtr 2014				4th Qtr 2013				3rd Qtr 2013
Efficiency ratio (Quarter) (a)			69.44	%			69.70	%			70.41	%			73.70	%			71.45	%
Taxable equivalent adjustment (Quarter)			(1.36	)			(1.32	)			(1.35	)			(1.49	)			(1.50	)
Asset gains, net (Quarter)			1.36				0.26				0.22				0.80				0.59
Other intangible amortization (Quarter)			(0.40	)			(0.41	)			(0.42	)			(0.42	)			(0.44	)
Efficiency ratio, fully taxable equivalent (Quarter) (b)			69.04	%			68.23	%			68.86	%			72.59	%			70.10	%
Efficiency ratio (Year-to-date) (a)			69.85	%			70.05	%			70.41	%			71.04	%			70.14	%
Taxable equivalent adjustment (Year-to-date)			(1.34	)			(1.34	)			(1.35	)			(1.45	)			(1.45	)
Asset gains, net (Year-to-date)			0.61				0.24				0.22				0.39				0.27
Other intangible amortization (Year-to-date)			(0.41	)			(0.41	)			(0.42	)			(0.42	)			(0.43	)
Efficiency ratio, fully taxable equivalent (Year-to-date) (b)			68.71	%			68.54	%			68.86	%			69.56	%			68.53	%

 

(a)	Efficiency ratio is defined by the Federal Reserve guidance as noninterest expense divided by the sum of net interest income plus noninterest income, excluding investment securities gains / losses, net.

(b)

Efficiency ratio, fully taxable equivalent, is noninterest expense, excluding other intangible amortization, divided by the sum of taxable equivalent net interest income plus noninterest income, excluding investment securities gains / losses, net and asset gains / losses, net. This efficiency ratio is presented on a taxable equivalent basis, which adjusts net interest income for the tax-favored status of certain loans and investment securities. Management believes this measure to be the preferred industry measurement of net interest income as it enhances the comparability of net interest income arising from taxable and tax-exempt sources and it excludes certain specific revenue items (such as investment securities gains / losses, net and asset gains / losses, net).

Net Interest Income and Net Interest Margin

Net interest income on a taxable equivalent basis for the nine months ended September 30, 2014, was $521 million, an increase of $27 million (6%) versus the first nine months of 2013. The increase in taxable equivalent net interest income was attributable to favorable volume variance (as balance sheet changes in both volume and mix increased taxable equivalent net interest income by $26 million), and favorable rate variances (as the impact of changes in the interest rate environment and product pricing increased taxable equivalent net interest income by $1 million).

The net interest margin for the first nine months of 2014 was 3.09%, 6 bp lower than 3.15% for the same period in 2013. This comparable period decrease was comprised of a 4 bp decrease in interest rate spread (the net of a 15 bp decrease in yield on earning assets and a 11 bp decrease in the cost of interest-bearing liabilities) and a 2 bp lower contribution from net free funds.

The Federal Reserve left interest rates unchanged during 2013 and the first nine months of 2014. The Federal Reserve has affirmed that it is unlikely that the short-term interest rates will increase until 2015.

The yield on earning assets was 3.32% for the first nine months of 2014, 15 bp lower than the comparable period last year. Loan yields were down 20 bp, (to 3.57%), due to the repricing of adjustable rate loans and competitive pricing pressures in a low interest rate environment. The yield on investment securities and other short-term investments increased 6 bp (to 2.62%), and was also impacted by the low interest rate environment and slowing prepayment speeds of mortgage-related securities purchased at a premium.

The rate on interest-bearing liabilities of 0.30% for the first nine months of 2014 was 11 bp lower than the same period in 2013. Rates on interest-bearing deposits were down 5 bp (to 0.19%), reflecting the low interest rate environment and a reduction of higher cost deposit products. The cost of short and long-term funding decreased 57 bp (to 0.62%) with the cost of short-term funding unchanged at 0.15%, while long-term funding decreased 306 bp (to 0.85%) mainly due to favorable rates on FHLB advances.

Average earning assets were $22.5 billion for the first nine months of 2014, an increase of $1.6 billion (8%) from the comparable period last year. Average loans increased $1.0 billion, including increases in commercial loans (up $904 million) and residential mortgage loans (up $439 million), while retail loans decreased (down $324 million). Average investment securities and other short-term investments increased $602 million, primarily in mortgage-related securities.

 

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Average interest-bearing liabilities of $17.6 billion for the first nine months of 2014 increased $1.7 billion (11%) from the comparable period last year. On average, short and long-term funding increased $1.6 billion between the comparable nine month periods, attributable to a $2.2 billion increase in long-term funding partially offset by a $583 million decrease in short-term funding. Average interest-bearing deposits increased $114 million, while noninterest bearing deposits decreased $54 million.

 

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TABLE 2

Net Interest Income Analysis

($ in Thousands)

 

		Nine Months Ended September 30, 2014												Nine Months Ended September 30, 2013
		Average Balance				Interest Income/ Expense				Average Yield/ Rate				Average Balance				Interest Income/ Expense				Average Yield/ Rate
Earning assets:
Loans: (1)(2)(3)
Commercial and business lending		$	6,419,328			$	160,189				3.34	%		$	5,785,024			$	156,541				3.62	%
Commercial real estate lending			3,965,242				109,681				3.70				3,695,150				109,298				3.95
Total commercial			10,384,570				269,870				3.47				9,480,174				265,839				3.75
Residential mortgage			4,105,892				101,503				3.30				3,666,556				91,074				3.31
Retail			2,163,771				73,538				4.54				2,487,723				84,487				4.54
Total loans			16,654,233				444,911				3.57				15,634,453				441,400				3.77
Investment securities(1)			5,559,398				110,273				2.64				4,930,195				97,340				2.63
Other short-term investments			299,692				4,814				2.14				327,209				3,740				1.53
Investments and other			5,859,090				115,087				2.62				5,257,404				101,080				2.56
Total earning assets			22,513,323				559,998				3.32				20,891,857				542,480				3.47
Other assets, net			2,339,067												2,328,652
Total assets		$	24,852,390											$	23,220,509
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits		$	1,244,483			$	715				0.08	%		$	1,185,059			$	693				0.08	%
Interest-bearing demand deposits			2,930,236				2,903				0.13				2,819,585				3,470				0.16
Money market deposits			7,413,513				8,906				0.16				7,178,857				10,304				0.19
Time deposits			1,600,472				6,451				0.54				1,891,026				9,460				0.67
Total interest-bearing deposits			13,188,704				18,975				0.19				13,074,527				23,927				0.24
Federal funds purchased and securities sold under agreements to repurchase			860,732				1,001				0.16				696,343				1,051				0.20
Other short-term funding			610,055				629				0.14				1,357,230				1,291				0.13
Total short-term funding			1,470,787				1,630				0.15				2,053,573				2,342				0.15
Long-term funding			2,955,797				18,836				0.85				779,079				22,833				3.91
Total short and long-term funding			4,426,584				20,466				0.62				2,832,652				25,175				1.19
Total interest-bearing liabilities			17,615,288				39,441				0.30				15,907,179				49,102				0.41
Noninterest-bearing demand deposits			4,160,025												4,214,265
Other liabilities			191,802												200,123
Stockholders’ equity			2,885,275												2,898,942
Total liabilities and equity		$	24,852,390											$	23,220,509
Interest rate spread											3.02	%											3.06	%
Net free funds											0.07												0.09
Net interest income, taxable
equivalent, and net interest margin						$	520,557				3.09	%						$	493,378				3.15	%
Taxable equivalent adjustment							14,251												15,034
Net interest income						$	506,306											$	478,344

 

(1)	The yield on tax exempt loans and securities is computed on a taxable equivalent basis using a tax rate of 35% for all periods presented and is net of the effects of certain disallowed interest deductions.

(2)	Nonaccrual loans and loans held for sale have been included in the average balances.

(3)	Interest income includes net loan fees.

 

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TABLE 2

Net Interest Income Analysis

($ in Thousands)

 

		Three Months Ended September 30, 2014												Three Months Ended September 30, 2013
		Average Balance				Interest Income/ Expense				Average Yield/ Rate				Average Balance				Interest Income/ Expense				Average Yield/ Rate
Earning assets:
Loans: (1)(2)(3)
Commercial and business lending		$	6,652,227			$	54,990				3.28	%		$	5,876,745			$	52,215				3.53	%
Commercial real estate lending			4,019,286				37,780				3.73				3,768,895				37,630				3.96
Total commercial			10,671,513				92,770				3.45				9,645,640				89,845				3.70
Residential mortgage			4,309,121				35,264				3.27				3,714,459				30,479				3.28
Retail			2,160,327				24,968				4.60				2,364,266				26,816				4.51
Total loans			17,140,961				153,002				3.55				15,724,365				147,140				3.72
Investment securities(1)			5,619,982				36,486				2.60				4,980,228				32,282				2.59
Other short-term investments			335,774				1,503				1.79				334,874				1,260				1.51
Investments and other			5,955,756				37,989				2.55				5,315,102				33,542				2.52
Total earning assets			23,096,717				190,991				3.29				21,039,467				180,682				3.42
Other assets, net			2,375,335												2,274,110
Total assets		$	25,472,052											$	23,313,577
Interest-bearing liabilities:
Interest-bearing deposits:
Savings deposits		$	1,269,994			$	254				0.08	%		$	1,204,743			$	249				0.08	%
Interest-bearing demand deposits			3,096,712				1,111				0.14				2,810,962				1,101				0.16
Money market deposits			7,721,167				3,153				0.16				7,556,050				3,449				0.18
Time deposits			1,545,851				2,103				0.54				1,773,760				2,818				0.63
Total interest-bearing deposits			13,633,724				6,621				0.19				13,345,515				7,617				0.23
Federal funds purchased and securities sold under agreements to repurchase			927,904				390				0.17				633,594				308				0.19
Other short-term funding			665,647				233				0.14				1,417,113				434				0.12
Total short-term funding			1,593,551				623				0.16				2,050,707				742				0.14
Long-term funding			2,931,714				6,179				0.84				614,708				6,866				4.47
Total short and long-term funding			4,525,265				6,802				0.60				2,665,415				7,608				1.14
Total interest-bearing liabilities			18,158,989				13,423				0.29				16,010,930				15,225				0.38
Noninterest-bearing demand deposits			4,239,654												4,264,304
Other liabilities			197,330												175,453
Stockholders’ equity			2,876,079												2,862,890
Total liabilities and equity		$	25,472,052											$	23,313,577
Interest rate spread											3.00	%											3.04	%
Net free funds											0.06												0.09
Net interest income, taxable
equivalent, and net interest margin						$	177,568				3.06	%						$	165,457				3.13	%
Taxable equivalent adjustment							4,938												4,948
Net interest income						$	172,630											$	160,509

 

(1)	The yield on tax exempt loans and securities is computed on a taxable equivalent basis using a tax rate of 35% for all periods presented and is net of the effects of certain disallowed interest deductions.

(2)	Nonaccrual loans and loans held for sale have been included in the average balances.

(3)	Interest income includes net loan fees.

 

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Provision for Credit Losses

The provision for credit losses (which includes the provision for loan losses and the provision for unfunded commitments) for the first nine months of 2014 was $11 million, compared to $8 million for the first nine months of 2013 and $10 million for the full year of 2013. Net charge offs were $11 million for the first nine months of 2014, compared to $34 million for the first nine months of 2013 and $39 million for the full year of 2013. Annualized net charge offs as a percent of average loans for the first nine months of 2014 were 0.08%, compared to 0.29% for the first nine months of 2013 and 0.25% for the full year of 2013. At September 30, 2014, the allowance for credit losses (which includes the allowance for loan losses and the allowance for unfunded commitments) was $291 million, compared to $293 million at September 30, 2013 and $290 million at December 31, 2013. The ratio of the allowance for loan losses to total loans at September 30, 2014, was 1.55%, compared to 1.74% at September 30, 2013 and 1.69% at December 31, 2013. Nonaccrual loans at September 30, 2014 were $184 million, compared to $208 million at September 30, 2013, and $185 million at December 31, 2013. See Tables 7 and 8.

The provision for credit losses is predominantly a function of the Corporation’s reserving methodology and judgments as to other qualitative and quantitative factors used to determine the appropriate level of the allowance for credit losses (which includes the allowance for loan losses and the allowance for unfunded commitments). This reserving methodology focuses on changes in the size and character of the loan portfolio, changes in levels of impaired and other nonaccrual loans, historical losses and delinquencies on each portfolio category, the level of loans sold or transferred to held for sale, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. See additional discussion under sections “Credit Risk,” “Allowance for Credit Losses,” and “Nonaccrual Loans, Potential Problem Loans, and Other Real Estate Owned.”

Noninterest Income

Noninterest income for the first nine months of 2014 was $221 million, down $17 million (7%) from the first nine months of 2013, primarily due to declines in net mortgage banking income as refinancing activity has drastically slowed.

TABLE 3

Noninterest Income

($ in Thousands)

 

		3rd Qtr 2014				3rd Qtr 2013				Dollar Change				Percent Change				YTD 2014				YTD 2013				Dollar Change				Percent Change
Trust service fees		$	12,218			$	11,380			$	838				7.4	%		$	35,946			$	33,695			$	2,251				6.7	%
Service charges on deposit accounts			17,961				18,407				(446	)			(2.4	)			51,773				52,679				(906	)			(1.7	)
Card-based and other nondeposit fees			12,407				12,688				(281	)			(2.2	)			37,493				37,229				264				0.7
Insurance commissions			7,860				11,356				(3,496	)			(30.8	)			33,828				32,750				1,078				3.3
Brokerage and annuity commissions			4,040				3,792				248				6.5				12,593				10,996				1,597				14.5
Core fee-based revenue			54,486				57,623				(3,137	)			(5.4	)			171,633				167,349				4,284				2.6
Mortgage banking income			9,140				6,015				3,125				52.0				26,527				38,952				(12,425	)			(31.9	)
Mortgage servicing rights expense			2,471				2,473				(2	)			(0.1	)			8,135				(1,618	)			9,753				N/M
Mortgage banking, net			6,669				3,542				3,127				88.3				18,392				40,570				(22,178	)			(54.7	)
Capital market fees, net			2,939				2,652				287				10.8				7,360				10,309				(2,949	)			(28.6	)
Bank owned life insurance (“BOLI”) income			3,506				2,817				689				24.5				10,837				9,068				1,769				19.5
Other			2,317				2,100				217				10.3				5,424				6,622				(1,198	)			(18.1	)
Subtotal			69,917				68,734				1,183				1.7				213,646				233,918				(20,272	)			(8.7	)
Asset gains, net			4,934				1,934				3,000				155.1				6,561				2,726				3,835				140.7
Investment securities gains, net			57				248				(191	)			(77.0	)			469				582				(113	)			(19.4	)
Total noninterest income		$	74,908			$	70,916			$	3,992				5.6	%		$	220,676			$	237,226			$	(16,550	)			(7.0	)%
N/M – Not meaningful.

Core fee-based revenue was $172 million, an increase of $4 million (3%) versus the first nine months of 2013. Trust service fees were $36 million for the first nine months of 2014, up $2 million (7%) from the first nine months of 2013. The market value of assets under management at September 30, 2014 and 2013 was $7.7 billion and $7.1 billion, respectively. Insurance commissions were $34 million, up $1 million (3%) from the first nine months of 2013. The increase in insurance commissions was primarily due to a $2 million increase in employee benefit commissions from new business activity, partially offset by a $1 million increase to the reserve

 

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for legacy insurance products provided by third parties (a $4 million reserve was established in 2014 for remediation on legacy debt protection products, compared to a $3 million reserve established in 2013 related to third party insurance products sold in prior years). Brokerage and annuity commissions were up $2 million (15%) between the comparable nine month periods of 2014 and 2013, primarily in brokerage commissions due to an increased focus on Investment Advisory accounts. All remaining core-fee based revenue categories on a combined basis were relatively unchanged.

Net mortgage banking income was $18 million for the first nine months of 2014 and $41 million for the first nine months of 2013. Net mortgage banking consists of gross mortgage banking income less mortgage servicing rights expense. Gross mortgage banking income includes servicing fees, the gain or loss on sales of mortgage loans to the secondary market, changes to the mortgage loan repurchase reserve, and the fair value adjustments on the mortgage derivatives. Gross mortgage banking income decreased $12 million compared to the first nine months of 2013, due to lower gains on sales (down $27 million), partially offset by an $8 million favorable change in the fair value of the mortgage derivatives, and an $8 million reduction in the mortgage loan repurchase reserve provision. See Note 12 “Commitments, Off-Balance Sheet Arrangements and Contingent Liabilities,” of the notes to consolidated financial statements for additional information concerning the mortgage loan repurchase reserve. Secondary mortgage production was $778 million for the first nine months of 2014 and $2.0 billion for the first nine months of 2013.

Mortgage servicing rights expense includes both the amortization of the mortgage servicing rights asset and changes to the valuation allowance associated with the mortgage servicing rights asset. Mortgage servicing rights expense is affected by the size of the servicing portfolio, as well as the changes in the estimated fair value of the mortgage servicing rights asset. Mortgage servicing rights expense was $10 million higher than the comparable nine-month period in 2013, with a $14 million lower recovery of the valuation reserve, partially offset by a $4 million reduction in amortization due to slower prepayments. Mortgage servicing rights are considered a critical accounting policy given that estimating their fair value involves a discounted cash flow model and assumptions that involve judgment, particularly of estimated prepayment speeds of the underlying mortgages serviced and the overall level of interest rates. See section “Critical Accounting Policies,” as well as Note 7 “Goodwill and Other Intangible Assets,” and Note 13, “Fair Value Measurements,” of the notes to consolidated financial statements for additional disclosure.

Net capital market fees decreased $3 million primarily due to a $2 million reduction in fees on interest rate risk related services provided to our customers due to lower demand and a $2 million lower contribution from favorable changes in the credit risk of interest-rate related derivative instruments, partially offset by a $1 million increase in fee income from foreign currency transactions. Bank owned life insurance income was $11 million, up $2 million from the first nine months of 2013 primarily due to death benefits received during the first nine months of 2014. Other income decreased $1 million from the comparable nine-month period in 2013 primarily due to one-time charges related to some customer reimbursements paid in the second quarter of 2014. Net assets gains of $7 million for the first nine months of 2014 were primarily attributable to gains of $7 million on the sale of real estate, partially offset by losses of $1 million on the sales and other write-downs of other real estate owned. Net asset gains of $3 million for the first nine months of 2013 were primarily attributable to gains of $5 million on the sale of real estate and miscellaneous assets, partially offset by losses of $2 million on the sales and other write-downs of other real estate owned.

Noninterest Expense

Noninterest expense was $507 million for the first nine months of 2014, up $6 million (1%) from the comparable period in 2013. Personnel expense was down $3 million (1%), while nonpersonnel noninterest expenses were up $9 million (4%) on a combined basis.

 

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TABLE 4

Noninterest Expense

($ in Thousands)

 

		3rd Qtr 2014				3rd Qtr 2013				Dollar Change				Percent Change				YTD 2014				YTD 2013				Dollar Change				Percent Change
Personnel expense		$	97,650			$	98,102			$	(452	)			(0.5	)%		$	293,141			$	295,800			$	(2,659	)			(0.9	)%
Occupancy			13,743				14,758				(1,015	)			(6.9	)			43,088				44,725				(1,637	)			(3.7	)
Equipment			6,133				6,213				(80	)			(1.3	)			18,636				18,842				(206	)			(1.1	)
Technology			13,573				12,323				1,250				10.1				40,891				36,482				4,409				12.1
Business development and advertising			7,467				5,947				1,520				25.6				17,606				15,512				2,094				13.5
Other intangible asset amortization			990				1,010				(20	)			(2.0	)			2,972				3,032				(60	)			(2.0	)
Loan expense			3,813				3,157				656				20.8				10,220				9,485				735				7.7
Legal and professional fees			4,604				3,482				1,122				32.2				13,228				14,310				(1,082	)			(7.6	)
Losses other than loans			677				(600	)			1,277				(212.8	)			1,602				283				1,319				466.1
Foreclosure / OREO expense			2,083				2,515				(432	)			(17.2	)			5,554				7,239				(1,685	)			(23.3	)
FDIC expense			6,859				4,755				2,104				44.2				16,805				14,582				2,223				15.2
Other			14,261				13,509				752				5.6				43,693				41,190				2,503				6.1
Total noninterest expense		$	171,853			$	165,171			$	6,682				4.0	%		$	507,436			$	501,482			$	5,954				1.2	%

Personnel expense (which includes salary-related expenses and fringe benefit expenses) was $293 million for the first nine months of 2014, down $3 million (1%) from the first nine months of 2013. Average full-time equivalent employees were 4,435 for the first nine months of 2014, down 7% from 4,776 for the first nine months of 2013. Salary-related expenses increased $4 million (2%). This increase was primarily the result of higher compensation and performance based incentives. Fringe benefit expenses were down $7 million (14%) versus the first nine months of 2013, primarily due to a decrease in health insurance costs.

Nonpersonnel noninterest expenses on a combined basis were $214 million, up $9 million (4%) from the first nine months of 2013. Technology was up $4 million (12%), as we continue to invest in solutions that will drive operational efficiency. Business development and advertising increased $2 million (14%) from the first nine months of 2013, primarily related to the timing of the Corporation’s fall marketing campaign. Losses other than loans increased $1 million mainly due to a more favorable than expected resolution of a litigation matter in the third quarter of 2013. Foreclosure/OREO expenses of $6 million decreased $2 million (23%), primarily attributable to a decline in legal and collection expenses related to the improvement in credit quality. FDIC expense of $17 million, was $2 million (15%) higher than the comparable period in 2013 reflecting growth in risk-weighted assets. All remaining noninterest expense categories on a combined basis were relatively unchanged (up 0.2%) compared to the first nine months of 2013.

Income Taxes

The Corporation recognized income tax expense of $67 million for the first nine months of 2014, compared to income tax expense of $65 million for the comparable period in 2013. The effective tax rate was 32.02% for the first nine months of 2014, compared to an effective tax rate of 31.68% for the first nine months of 2013.

Income tax expense recorded in the consolidated statements of income involves the interpretation and application of certain accounting pronouncements and federal and state tax laws and regulations, and is, therefore, considered a critical accounting policy. The Corporation is subject to examination by various taxing authorities. Examination by taxing authorities may impact the amount of tax expense and / or reserve for uncertain tax positions if their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations. See Note 9, “Income Taxes,” of the notes to consolidated financial statements and section “Critical Accounting Policies.”

Balance Sheet

At September 30, 2014, total assets were $25.7 billion, up $1.4 billion (6%) from December 31, 2013. Loans of $17.2 billion at September 30, 2014 were up $1.3 billion (8%) from December 31, 2013, with increases in commercial loans of $868 million and increases in consumer loans of $395 million. Investment securities were $5.6 billion at September 30, 2014, an increase of $222 million (4%) from year-end 2013.

 

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At September 30, 2014, total deposits of $18.2 billion were up $934 million (5%) from December 31, 2013. Short and long-term funding increased $533 million (14%) since year-end 2013, including an increase of $689 million in short-term funding (primarily short-term FHLB advances), partially offset by a decrease of $156 million in long-term funding due to the early retirement of $155 million of senior notes in February 2014.

Since September 30, 2013, loans increased $1.6 billion (10%), with commercial loans up $1.1 billion and consumer loans up $461 million. Deposits decreased $137 million (1%) since September 30, 2013, primarily in noninterest-bearing demand deposit accounts. Short and long-term funding increased $2.1 billion, including a $2.3 billion increase in long-term funding as the Corporation took advantage of favorable interest rates on five year, putable, variable rate FHLB advances, partially offset by a $197 million reduction in short-term funding.

TABLE 5

Period End Loan Composition

($ in Thousands)

 

		September 30, 2014								June 30, 2014								March 31, 2014								December 31, 2013								September 30, 2013
		Amount				% of Total				Amount				% of Total				Amount				% of Total				Amount				% of Total				Amount				% of Total
Commercial and industrial		$	5,603,899				33	%		$	5,616,205				33	%		$	5,222,141				32	%		$	4,822,680				31	%		$	4,703,056				30	%
Commercial real estate - owner occupied			1,014,335				6				1,070,463				7				1,098,089				7				1,114,715				7				1,147,352				8
Lease financing			52,600				—				51,873				—				52,500				—				55,483				—				51,727				—
Commercial and business lending			6,670,834				39				6,738,541				40				6,372,730				39				5,992,878				38				5,902,135				38
Commercial real estate - investor			3,043,361				17				2,990,732				17				3,001,219				18				2,939,456				18				2,847,152				18
Real estate construction			982,426				6				1,000,421				6				969,617				6				896,248				6				834,744				5
Commercial real estate lending			4,025,787				23				3,991,153				23				3,970,836				24				3,835,704				24				3,681,896				23
Total commercial			10,696,621				62				10,729,694				63				10,343,566				63				9,828,582				62				9,584,031				61
Home equity revolving lines of credit			880,435				5				866,042				5				856,679				5				874,840				5				875,703				6
Home equity loans first liens			619,774				4				659,598				4				705,835				4				742,120				5				794,912				5
Home equity loans junior liens			176,316				1				187,732				1				199,488				1				208,054				1				220,763				1
Home equity			1,676,525				10				1,713,372				10				1,762,002				10				1,825,014				11				1,891,378				12
Installment and credit cards			459,682				3				469,203				3				393,321				3				407,074				3				420,268				3
Residential mortgage			4,326,262				25				4,132,783				24				3,942,555				24				3,835,591				24				3,690,177				24
Total consumer			6,462,469				38				6,315,358				37				6,097,878				37				6,067,679				38				6,001,823				39
Total loans		$	17,159,090				100	%		$	17,045,052				100	%		$	16,441,444				100	%		$	15,896,261				100	%		$	15,585,854				100	%
Farmland		$	8,428				—	%		$	8,475				—	%		$	8,286				—	%		$	8,591				—	%		$	14,278				1	%
Multi-family			1,030,131				34				951,698				32				965,568				32				951,348				33				896,819				31
Non-owner occupied			2,004,802				66				2,030,559				68				2,027,365				68				1,979,517				67				1,936,055				68
Commercial real estate - investor		$	3,043,361				100	%		$	2,990,732				100	%		$	3,001,219				100	%		$	2,939,456				100	%		$	2,847,152				100	%
1-4 family construction		$	305,719				31	%		$	293,361				29	%		$	273,470				28	%		$	259,031				29	%		$	248,294				30	%
All other construction			676,708				69				707,060				71				696,147				72				637,217				71				586,450				70
Real estate construction		$	982,427				100	%		$	1,000,421				100	%		$	969,617				100	%		$	896,248				100	%		$	834,744				100	%

 

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Credit Risk

Total loans were $17.2 billion at September 30, 2014, an increase of $1.3 billion or 8% from December 31, 2013. Commercial and business loans were $6.7 billion, up $678 million (11%) from December 31, 2013, to represent 39% of total loans at September 30, 2014. Commercial real estate totaled $4.0 billion at September 30, 2014 and represented 23% of total loans, an increase of $190 million (5%) from December 31, 2013. Consumer loans were $6.5 billion, up $395 million (7%) from December 31, 2013, and represented 38% of total loans at September 30, 2014.

The Corporation has long-term guidelines relative to the proportion of Commercial and Business, Commercial Real Estate, and Consumer loans within the overall loan portfolio, with each targeted to represent 30-40% of the overall loan portfolio. The targeted long-term guidelines were unchanged during 2013 and the first nine months of 2014. Furthermore, certain sub-asset classes within the respective portfolios were further defined and dollar limitations were placed on these sub-portfolios. These guidelines and limits are reviewed quarterly and approved annually by the Enterprise Risk Committee of the Corporation’s Board of Directors. These guidelines and limits are designed to create balance and diversification within the loan portfolios.

The commercial and business lending portfolio, which consists of commercial and business loans and owner occupied commercial real estate loans, was $6.7 billion at September 30, 2014, up $678 million (11%) since year-end 2013. The commercial and business lending classification primarily includes commercial loans to large corporations, middle market companies and small businesses. At September 30, 2014, the largest industry groups within the commercial and business loan category included the manufacturing sector which represented 8% of total loans and 21% of the total commercial and business loan portfolio. The next largest industry group within the commercial and business loan category was the wholesale trade sector, which represented 4% of total loans and 10% of the total commercial and business loan portfolio at September 30, 2014. The remaining portfolio is spread over a diverse range of industries, none of which exceeds 4% of total loans. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

The commercial real estate lending portfolio, which consists of investor commercial real estate and construction loans, totaled $4.0 billion at September 30, 2014, up $190 million (5%) from December 31, 2013. Within the commercial real estate lending portfolio, commercial real estate lending to investors totaled $3.0 billion at September 30, 2014, an increase of $104 million (4%) from December 31, 2013. Commercial real estate primarily includes commercial-based loans to investors that are secured by commercial income properties or multi-family projects. Commercial real estate loans are typically intermediate to long-term financings. Loans of this type are mainly secured by commercial income properties or multi-family projects. Credit risk is managed in a similar manner to commercial and business loans by employing sound underwriting guidelines, lending primarily to borrowers in local markets and businesses, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationship on an ongoing basis. Real estate construction loans were $982 million, an increase of $86 million (10%) compared to December 31, 2013. Loans in this classification are primarily short-term or interim loans that provide financing for the acquisition or development of commercial income properties, multi-family projects or residential development, both single family and condominium. Real estate construction loans are made to developers and project managers who are generally well known to the Corporation, and have prior successful project experience. The credit risk associated with real estate construction loans is generally confined to specific geographic areas but is also influenced by general economic conditions. The Corporation controls the credit risk on these types of loans by making loans in familiar markets to developers, reviewing the merits of individual projects, controlling loan structure, and monitoring project progress and construction advances.

The Corporation’s current lending standards for commercial real estate and real estate construction lending are determined by property type and specifically address many criteria, including: maximum loan amounts, maximum loan-to-value (“LTV”), requirements for pre-leasing and / or presales, minimum borrower equity, and maximum loan to cost. Currently, the maximum standard for LTV is 80%, with lower limits established for certain higher risk types, such as raw land which has a 50% LTV maximum. The Corporation’s LTV guidelines are in compliance with regulatory supervisory limits. In most cases, for real estate construction loans, the loan amounts include interest reserves, which are built into the loans and sized to fund loan payments through construction and lease up and / or sell out.

Consumer loans totaled $6.5 billion at September 30, 2014, up $395 million (7%) compared to December 31, 2013. Loans in this classification include residential mortgage, home equity, installment loans and credit cards. Residential mortgage loans totaled $4.3 billion at September 30, 2014, up $491 million (13%) from December 31, 2013. Residential mortgage loans include conventional first lien home mortgages and the Corporation generally limits the maximum loan to 80% of collateral value without credit enhancement (e.g. private mortgage insurance). As part of management’s historical practice of originating and servicing residential mortgage loans, generally the Corporation’s 30-year, fixed-rate residential real estate mortgage loans are sold in the secondary market with servicing

 

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rights retained. The Corporation may retain a portion of its 15-year and under, fixed-rate residential real estate mortgages in its loan portfolio. At September 30, 2014, the residential mortgage portfolio was comprised of $1.4 billion of fixed-rate residential real estate mortgages and $2.9 billion of adjustable-rate residential real estate mortgages.

The Corporation’s underwriting and risk-based pricing guidelines for residential mortgage loans include minimum borrower FICO and maximum LTV of the property securing the loan. Residential mortgage products generally are underwritten using FHLMC and FNMA secondary marketing guidelines.

Home equity totaled $1.7 billion at September 30, 2014, down $148 million (8%) compared to December 31, 2013, and consists of home equity lines, as well as home equity loans, approximately half of which are first lien positions. Home equity balances declined as customers continued to deleverage and refinance into lower-priced, first lien residential mortgage loans. Loans and lines in a junior position at September 30, 2014 included approximately 34% for which the Corporation also owned or serviced the related first lien loan and approximately 66% where the Corporation did not service the related first lien loan.

The Corporation’s credit risk monitoring guidelines for home equity is based on an ongoing review of loan delinquency status, as well as a semi-annual review of FICO score deterioration and property devaluation. The Corporation does not routinely obtain appraisals on performing loans to update LTV ratios after origination; however, the Corporation monitors the local housing markets by reviewing the various home price indices and incorporates the impact of the changing market conditions in its ongoing credit monitoring process. For second lien home equity loans, the Corporation is unable to track the performance of the first lien loan if it does not own or service the first lien loan. However, the Corporation obtains a refreshed FICO score on a semi-annual basis and monitors this as part of its assessment of the home equity portfolio.

The Corporation’s underwriting and risk-based pricing guidelines for home equity lines and loans consist of a combination of both borrower FICO and the original LTV of the property securing the loan. Currently, for home equity products, the maximum acceptable LTV is 90% for customers with FICO scores exceeding 670. Home equity loans generally have a 20 year term and are fixed rate with principal and interest payments required. As of September 30, 2014, approximately 40% of the home equity loan first liens have a remaining maturity of more than 10 years. Home equity lines are variable rate, interest only lines of credit which do not require the payment of principal during the initial revolving period, after which principal payments are required. Based upon outstanding balances at September 30, 2014, the following table presents the periods when home equity lines of credit revolving periods are scheduled to end.

 

Home Equity Lines of Credit - Revolving Period End Dates		$ in Thousands				% to Total
2014 - 2015		$	5,558				1	%
2016 - 2017			4,187				<1	%
2018 - 2020			36,202				4	%
2021 - 2025			234,742				27	%
2026 and later			599,746				68	%
Total home equity revolving lines of credit		$	880,435				100	%

Installment and credit cards totaled $460 million at September 30, 2014 up $53 million (13%) compared to December 31, 2013, primarily due to the purchase of a participation in the Associated Bank branded credit card portfolio on June 30, 2014. The installment and credit cards consist of student loans, short-term and other personal installment loans and credit cards. The Corporation had $298 million and $330 million of student loans at September 30, 2014 and December 31, 2013, respectively, the majority of which are government guaranteed. Credit risk for non-government guaranteed student, short-term and personal installment loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral. Risks of loss are generally on smaller average balances per loan spread over many borrowers. Once charged off, there is usually less opportunity for recovery on these smaller retail loans. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and guarantee positions.

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, and appropriate allowance for credit losses, nonaccrual and charge off policies.

 

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An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed and graded on an ongoing basis for early identification of potential problems. Further analyses by customer, industry, and geographic location are performed to monitor trends, financial performance, and concentrations.

The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas within our core footprint. Significant loan concentrations are considered to exist when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2014, no significant concentrations existed in the Corporation’s portfolio in excess of 10% of total loans.

TABLE 6

Period End Deposit and Customer Funding Composition

($ in Thousands)

 

		September 30, 2014								June 30, 2014								March 31, 2014								December 31, 2013								September 30, 2013
		Amount				% of Total				Amount				% of Total				Amount				% of Total				Amount				% of Total				Amount				% of Total
Noninterest-bearing demand		$	4,302,454				24	%		$	4,211,057				24	%		$	4,478,981				26	%		$	4,626,312				27	%		$	4,453,663				24	%
Savings			1,256,567				7				1,275,493				7				1,252,669				7				1,159,512				7				1,195,944				7
Interest-bearing demand			3,637,411				20				2,918,900				17				3,084,457				18				2,889,705				17				2,735,529				15
Money market			7,491,460				41				7,348,650				43				7,069,173				40				6,906,442				40				8,199,281				45
Brokered CDs			9,242				—				44,809				—				51,235				—				50,450				—				56,024				—
Other time			1,504,124				8				1,517,350				9				1,573,412				9				1,634,746				9				1,697,467				9
Total deposits		$	18,201,258				100	%		$	17,316,259				100	%		$	17,509,927				100	%		$	17,267,167				100	%		$	18,337,908				100	%
Customer funding			493,451								489,886								548,179								419,247								515,555
Total deposits and customer funding		$	18,694,709							$	17,806,145							$	18,058,106							$	17,686,414							$	18,853,463
Network transaction deposits included above in interest-bearing demand and money market		$	2,207,055							$	2,238,923							$	2,141,976							$	1,936,403							$	2,222,810
Total network transaction deposits and Brokered CDs			2,216,297								2,283,732								2,193,211								1,986,853								2,278,834
Total deposits and customer funding, excluding Brokered CDs and network transaction deposits		$	16,478,412							$	15,522,413							$	15,864,895							$	15,699,561							$	16,574,629

Allowance for Credit Losses

Credit risks within the loan portfolio are inherently different for each loan type. Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and ongoing review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses. Credit risk management for each loan type is discussed briefly in the section entitled “Credit Risk.”

The allowance for credit losses is comprised of the allowance for loan losses and the allowance for unfunded commitments. The level of the allowance for loan losses represents management’s estimate of an amount appropriate to provide for probable credit losses in the loan portfolio at the balance sheet date. The allowance for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities (including unfunded loan commitments and letters of credit) and is included in accrued expenses and other liabilities on the consolidated balance sheets.

The level of the allowance for credit losses represents management’s estimate of an amount appropriate to provide for probable credit losses in the loan portfolio at the balance sheet date. In general, the change in the allowance for credit losses is a function of a number of factors, including but not limited to changes in the loan portfolio (see Table 5), net charge offs (see Table 7) and nonperforming assets (see Table 8). The Corporation’s process, designed to assess the appropriateness of the allowance for credit losses, focuses on

 

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an evaluation of facts and issues related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of potential problem loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. While management uses currently available information to recognize losses on loans, future adjustments to the allowance for credit losses may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect our customers. Management considers the allowance for credit losses a critical accounting policy (see section “Critical Accounting Policies”), as assessing these numerous factors involves significant judgment.

The methodology used for the allowance for loan losses at September 30, 2014 and December 31, 2013 was generally comparable, whereby the Corporation segregated its loss factors (used for both criticized and non-criticized loan categories) into a component primarily based on historical loss rates and a component primarily based on other qualitative factors that may affect loan collectability. Management allocates the allowance for loan losses by pools of risk within each loan portfolio. The allocation methodology consists of the following components: First, a valuation allowance estimate is established for specifically identified commercial and consumer loans determined by the Corporation to be impaired, using discounted cash flows, estimated fair value of underlying collateral, and / or other data available. Second, management allocates the allowance for loan losses with loss factors, for criticized loan pools by loan type as well as for non-criticized loan pools by loan type, primarily based on historical loss rates after considering loan type, historical loss and delinquency experience, and industry statistics. Loans that have been criticized are considered to have a higher risk of default than non-criticized loans, as circumstances were present to support the lower loan grade, warranting higher loss factors. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels or other risks. Lastly, management allocates the allowance for loan losses to absorb unrecognized losses that may not be provided for by the other components due to other factors evaluated by management, such as limitations within the credit risk grading process, known current economic or business conditions that may not yet show in trends, industry or other concentrations with current issues that impose higher inherent risks than are reflected in the loss factors, and other relevant considerations. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular category. The total allowance for loan losses is available to absorb losses from any segment of the loan portfolio.

The methodology used for the allowance for unfunded commitments at September 30, 2014 and December 31, 2013 was also generally comparable. Management evaluated the unfunded credit facilities, including an assessment of historical commitment utilization experience and credit risk grading of the loan.

At September 30, 2014, the allowance for credit losses was $291 million compared to $293 million at September 30, 2013, and $290 million at December 31, 2013. At September 30, 2014, the allowance for loan losses to total loans was 1.55% and covered 145% of nonaccrual loans, compared to 1.74% and 131%, respectively, at September 30, 2013, and 1.69% and 145%, respectively, at December 31, 2013. The ratio of net charge offs to average loans on an annualized basis was 0.08%, 0.29%, and 0.25% for the nine months ended September 30, 2014, and 2013, and the full year 2013, respectively. Tables 7 and 8 provide additional information regarding activity in the allowance for loan losses, impaired loans, and nonperforming assets. See Note 6, “Loans, Allowance for Credit Losses, and Credit Quality,” of the notes to consolidated financial statements for additional allowance for credit losses disclosures.

Management believes the level of allowance for credit losses to be appropriate at September 30, 2014 and December 31, 2013.

 

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TABLE 7

Allowance for Credit Losses

($ in Thousands)

 

		At and For the Nine Months Ended September 30,								At and For the Year Ended December 31,
		2014				2013				2013
Allowance for Loan Losses:
Balance at beginning of period		$	268,315			$	297,409			$	297,409
Provision for loan losses			8,500				8,000				10,000
Charge offs			(35,318	)			(69,320	)			(88,061	)
Recoveries			24,765				35,635				48,967
Net charge offs			(10,553	)			(33,685	)			(39,094	)
Balance at end of period		$	266,262			$	271,724			$	268,315
Allowance for Unfunded Commitments:
Balance at beginning of period		$	21,900			$	21,800			$	21,800
Provision for unfunded commitments			2,500				(200	)			100
Balance at end of period		$	24,400			$	21,600			$	21,900
Allowance for credit losses (A)		$	290,662			$	293,324			$	290,215
Provision for credit losses (B)		$	11,000			$	7,800			$	10,100
Net loan charge offs (recoveries):			(C	)			(C	)			(C	)
Commercial and industrial		$	1,920	5		$	1,726	5		$	6,281	14
Commercial real estate - owner occupied			1,536	19			5,168	59			6,135	53
Lease financing			23	6			4	1			(12	)  (2)
Commercial and business lending			3,479	7			6,898	16			12,404	21
Commercial real estate - investor			(5,335	)  (24)			2,748	13			2,885	10
Real estate construction			1,258	18			994	17			(2,136	)  (27)
Commercial real estate lending			(4,077	)  (14)			3,742	14			749	2
Total commercial			(598	)  (1)			10,640	15			13,153	14
Home equity revolving lines of credit			3,660	56			6,894	102			7,860	88
Home equity loans first liens			972	19			2,283	34			2,655	31
Home equity loans junior liens			2,535	176			4,791	263			5,902	250
Home equity			7,167	55			13,968	91			16,417	82
Installment and credit cards			1,270	41			367	11			(244	)  (6)
Residential mortgage			2,714	9			8,710	32			9,768	26
Total consumer			11,151	24			23,045	50			25,941	42
Total net charge offs		$	10,553	8		$	33,685	29			$39,094	25
CRE & Construction Net Charge Off Detail:			(C	)			(C	)			(C	)
Farmland		$	—	—		$	366	318			$366	252
Multi-family			(6,089	)  (83)			536	8			499	5
Non-owner occupied			754	5			1,846	12			2,020	10
Commercial real estate - investor		$	(5,335	)  (24)		$	2,748	13			$2,885	10
1-4 family construction		$	(170	)  (8)		$	(1,112	)  (66)		$	(3,796	)  (163)
All other construction			1,428	29			2,106	52			1,660	30
Real estate construction		$	1,258	18		$	994	17		$	(2,136	)  (27)
(A) – Includes the allowance for loan losses and the allowance for unfunded commitments.
(B) – Includes the provision for loan losses and the provision for unfunded commitments.
(C) – Annualized ratio of net charge offs to average loans by loan type in basis points.
Ratios:
Allowance for loan losses to total loans			1.55	%			1.74	%			1.69	%
Allowance for loan losses to net charge offs (annualized)			18.9x				6.0x				6.9x

 

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TABLE 7 (continued)

Allowance for Credit Losses

($ in Thousands)

 

Quarterly Trends:		September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013				September 30, 2013
Allowance for Loan Losses:
Balance at beginning of period		$	271,851			$	267,916			$	268,315			$	271,724			$	277,218
Provision for loan losses			(3,000	)			6,500				5,000				2,000				—
Charge offs			(14,850	)			(9,107	)			(11,361	)			(18,742	)			(20,288	)
Recoveries			12,261				6,542				5,962				13,333				14,794
Net charge offs			(2,589	)			(2,565	)			(5,399	)			(5,409	)			(5,494	)
Balance at end of period		$	266,262			$	271,851			$	267,916			$	268,315			$	271,724
Allowance for Unfunded Commitments:
Balance at beginning of period		$	20,400			$	21,900			$	21,900			$	21,600			$	22,400
Provision for unfunded commitments			4,000				(1,500	)			—				300				(800	)
Balance at end of period		$	24,400			$	20,400			$	21,900			$	21,900			$	21,600
Allowance for credit losses (A)		$	290,662			$	292,251			$	289,816			$	290,215			$	293,324
Provision for credit losses (B)		$	1,000			$	5,000			$	5,000			$	2,300			$	(800	)
Net loan charge offs (recoveries):			(C	)			(C	)			(C	)			(C	)			(C	)
Commercial and industrial		$	572	4		$	(1,377	)  (10)		$	2,725	22		$	4,555	38		$	(447	)  (4)
Commercial real estate - owner occupied			2,210	84			(550	)  (20)			(124	)  (5)			967	34			2,076	72
Lease financing			(6	)  (5)			29	22			—	—			(16	)  (12)			—	—
Commercial and business lending			2,776	17			(1,898	)  (12)			2,601	17			5,506	37			1,629	11
Commercial real estate - investor			(4,065	)  (54)			(239	)  (3)			(1,031	)  (14)			137	2			(414	)  (6)
Real estate construction			350	14			795	33			113	5			(3,130	)  (145)			(303	)  (15)
Commercial real estate lending			(3,715	)  (37)			556	6			(918	)  (10)			(2,993	)  (32)			(717	)  (8)
Total commercial			(939	)  (3)			(1,342	)  (5)			1,683	7			2,513	10			912	4
Home equity revolving lines of credit			1,098	50			1,380	64			1,182	55			966	44			767	34
Home equity loans first liens			118	7			448	26			406	23			372	19			564	27
Home equity loans junior liens			728	159			948	196			859	171			1,111	205			800	140
Home equity			1,944	45			2,776	64			2,447	55			2,449	52			2,131	44
Installment and credit cards			910	78			247	25			113	11			(611	)  (59)			124	11
Residential mortgage			674	6			884	9			1,156	12			1,058	11			2,327	25
Total consumer			3,528	22			3,907	25			3,716	25			2,896	19			4,582	30
Total net charge offs		$	2,589	6		$	2,565	6		$	5,399	14		$	5,409	14		$	5,494	14
CRE & Construction Net Charge Off Detail:			(C	)			(C	)			(C	)			(C	)			(C	)
Farmland		$	—	—		$	—	—		$	—	—		$	—	—		$	—	—
Multi-family			(6,022	)  (243)			(18	)  (1)			(49	)  (2)			(37	)  (2)			127	5
Non-owner occupied			1,957	38			(221	)  (4)			(982	)  (20)			174	4			(541	)  (11)
Commercial real estate - investor		$	(4,065	)  (54)		$	(239	)  (3)		$	(1,031	)  (14)		$	137	2		$	(414	)  (6)
1-4 family construction		$	(53	)  (7)		$	4	1		$	(121	)  (18)		$	(2,684	)  (413)		$	(904	)  (143)
All other construction			403	23			791	48			234	15			(446	)  (29)			601	41
Real estate construction		$	350	14		$	795	33		$	113	5		$	(3,130	)  (145)		$	(303	)  (15)
(A) – Includes the allowance for loan losses and the allowance for unfunded commitments.
(B) – Includes the provision for loan losses and the provision for unfunded commitments.
(C) – Annualized ratio of net charge offs to average loans by loan type in basis points.

 

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TABLE 8

Nonperforming Assets

($ in Thousands)

 

		September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013				September 30, 2013
Nonperforming assets by type:
Commercial and industrial		$	51,143			$	40,846			$	38,488			$	37,719			$	36,105
Commercial real estate - owner occupied			24,340				31,725				26,735				29,664				28,301
Lease financing			1,947				1,541				172				69				99
Commercial and business lending			77,430				74,112				65,395				67,452				64,505
Commercial real estate - investor			25,106				28,135				33,611				37,596				49,841
Real estate construction			8,187				6,988				6,667				6,467				18,670
Commercial real estate lending			33,293				35,123				40,278				44,063				68,511
Total commercial			110,723				109,235				105,673				111,515				133,016
Home equity revolving lines of credit			10,154				10,056				10,356				11,883				11,991
Home equity loans first liens			4,664				4,634				5,341				6,135				6,131
Home equity loans junior liens			6,443				6,183				6,788				7,149				7,321
Home equity			21,261				20,873				22,485				25,167				25,443
Installment and credit cards			653				771				915				1,114				1,269
Residential mortgage			51,501				48,347				48,905				47,632				47,866
Total consumer			73,415				69,991				72,305				73,913				74,578
Total nonaccrual loans (“NALs”)			184,138				179,226				177,978				185,428				207,594
Commercial real estate owned			10,733				9,498				8,224				8,359				10,003
Residential real estate owned			4,676				6,182				6,313				5,217				8,975
Bank properties real estate owned			1,431				2,049				4,636				4,542				6,099
Other real estate owned (“OREO”)			16,840				17,729				19,173				18,118				25,077
Total nonperforming assets (“NPAs”)		$	200,978			$	196,955			$	197,151			$	203,546			$	232,671
Commercial real estate & Real estate construction NALs detail:
Farmland		$	—			$	—			$	—			$	—			$	109
Multi-family			2,518				3,929				3,713				3,782				5,260
Non-owner occupied			22,588				24,206				29,898				33,814				44,472
Commercial real estate - investor		$	25,106			$	28,135			$	33,611			$	37,596			$	49,841
1-4 family construction		$	1,350			$	1,843			$	1,900			$	1,915			$	12,654
All other construction			6,837				5,145				4,767				4,552				6,016
Real estate construction		$	8,187			$	6,988			$	6,667			$	6,467			$	18,670
Accruing loans past due 90 days or more:
Commercial		$	269			$	289			$	16			$	1,199			$	1,198
Consumer			1,421				1,487				707				1,151				865
Total accruing loans past due 90 days or more		$	1,690			$	1,776			$	723			$	2,350			$	2,063
Restructured loans (accruing):
Commercial		$	73,774			$	83,999			$	88,329			$	94,265			$	86,468
Consumer			30,829				30,382				28,595				29,720				30,575
Total restructured loans (accruing)		$	104,603			$	114,381			$	116,924			$	123,985			$	117,043
Nonaccrual restructured loans (included in nonaccrual loans)		$	63,314			$	72,388			$	74,231			$	59,585			$	69,311
Ratios:
Nonaccrual loans to total loans			1.07	%			1.05	%			1.08	%			1.17	%			1.33	%
NPAs to total loans plus OREO			1.17	%			1.15	%			1.20	%			1.28	%			1.49	%
NPAs to total assets			0.78	%			0.77	%			0.79	%			0.84	%			0.98	%
Allowance for loan losses to NALs			144.60	%			151.68	%			150.53	%			144.70	%			130.89	%
Allowance for loan losses to total loans			1.55	%			1.59	%			1.63	%			1.69	%			1.74	%

 

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TABLE 8 (continued)

Nonperforming Assets

($ in Thousands)

 

		September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013				September 30, 2013
Loans 30-89 days past due by type:
Commercial and industrial		$	3,947			$	2,519			$	4,126			$	6,826			$	6,518
Commercial real estate - owner occupied			2,675				6,323				5,342				3,106				8,505
Lease financing			—				556				567				—				1,000
Commercial and business lending			6,622				9,398				10,035				9,932				16,023
Commercial real estate - investor			15,869				2,994				7,188				23,215				21,747
Real estate construction			399				258				679				1,954				820
Commercial real estate lending			16,268				3,252				7,867				25,169				22,567
Total commercial			22,890				12,650				17,902				35,101				38,590
Home equity revolving lines of credit			6,739				6,986				5,344				6,728				6,318
Home equity loans first liens			1,503				1,685				1,469				1,110				1,376
Home equity loans junior liens			2,496				2,138				3,006				2,842				2,206
Home equity			10,738				10,809				9,819				10,680				9,900
Installment and credit cards			1,818				1,734				1,269				1,150				1,170
Residential mortgage			3,231				7,070				4,498				6,118				6,722
Total consumer			15,787				19,613				15,586				17,948				17,792
Total loans past due 30-89 days		$	38,677			$	32,263			$	33,488			$	53,049			$	56,382
Commercial real estate & Real estate construction loans 30-89 days past due detail:
Farmland		$	—			$	—			$	—			$	—			$	—
Multi-family			—				—				2,524				14,755				216
Non-owner occupied			15,869				2,994				4,664				8,460				21,531
Commercial real estate - investor		$	15,869			$	2,994			$	7,188			$	23,215			$	21,747
1-4 family construction		$	345			$	242			$	327			$	987			$	579
All other construction			54				16				352				967				241
Real estate construction		$	399			$	258			$	679			$	1,954			$	820
Potential problem loans by type:
Commercial and industrial		$	133,416			$	187,251			$	109,027			$	113,669			$	112,947
Commercial real estate - owner occupied			49,008				57,757				64,785				56,789				61,256
Lease financing			3,787				2,280				3,065				1,784				207
Commercial and business lending			186,211				247,288				176,877				172,242				174,410
Commercial real estate - investor			28,474				31,903				34,790				52,429				87,526
Real estate construction			2,227				4,473				4,870				5,263				7,540
Commercial real estate lending			30,701				36,376				39,660				57,692				95,066
Total commercial			216,912				283,664				216,537				229,934				269,476
Home equity revolving lines of credit			224				277				310				303				170
Home equity loans first liens			—				—				—				—				—
Home equity loans junior liens			687				822				741				1,810				2,067
Home equity			911				1,099				1,051				2,113				2,237
Installment and credit cards			4				844				—				50				67
Residential mortgage			2,166				2,445				2,091				3,312				5,342
Total consumer			3,081				4,388				3,142				5,475				7,646
Total potential problem loans		$	219,993			$	288,052			$	219,679			$	235,409			$	277,122

 

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Nonaccrual Loans, Potential Problem Loans, and Other Real Estate Owned

Management is committed to a proactive nonaccrual and problem loan identification philosophy. This philosophy is implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified quickly and the risk of loss is minimized. Table 8 provides detailed information regarding nonperforming assets, which include nonaccrual loans and other real estate owned.

Nonaccrual Loans: Nonaccrual loans are considered one indicator of potential future loan losses. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments, unless the loan is well secured and in the process of collection. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, amortization of related deferred loan fees or costs is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash and a determination has been made that the principal and interest balance of the loan is collectible. If collectability of the principal and interest is in doubt, payments received are applied to loan principal.

Nonaccrual loans were $184 million at September 30, 2014, compared to $208 million at September 30, 2013 and $185 million at December 31, 2013. Total nonaccrual loans were down $24 million (11%) since September 30, 2013, and decreased $1 million (1%) from December 31, 2013. The ratio of nonaccrual loans to total loans was 1.07% at September 30, 2014, compared to 1.33% at September 30, 2013 and 1.17% at December 31, 2013. The Corporation’s allowance for loan losses to nonaccrual loans was 145% at September 30, 2014, up from 131% at September 30, 2013 and level compared to 145% at December 31, 2013, respectively.

Accruing Loans Past Due 90 Days or More: Loans past due 90 days or more but still accruing interest are classified as such where the underlying loans are both well secured (the collateral value is sufficient to cover principal and accrued interest) and are in the process of collection. At September 30, 2014, accruing loans 90 days or more past due totaled $2 million, relatively unchanged from both September 30, 2013 and December 31, 2013.

Troubled Debt Restructurings (“Restructured Loans”): Loans are considered restructured loans if concessions have been granted to borrowers that are experiencing financial difficulty. The concessions granted generally involve the modification of terms of the loan, such as changes in payment structure or interest rate, which generally would not otherwise be considered. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included and treated with all other nonaccrual loans. In addition, all accruing restructured loans are reported as troubled debt restructurings, which are considered and accounted for as impaired loans. Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual status.

Potential Problem Loans: The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the appropriate level of the allowance for credit losses. Potential problem loans are generally defined by management to include loans rated as substandard by management but that are not considered impaired (i.e., nonaccrual loans and accruing troubled debt restructurings); however, there are circumstances present to create doubt as to the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Corporation expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial loans covering a diverse range of businesses and real estate property types. At September 30, 2014, potential problem loans totaled $220 million, compared to $277 million at September 30, 2013 and $235 million at December 31, 2013, respectively.

Other Real Estate Owned: Other real estate owned was $17 million at September 30, 2014, compared to $25 million at September 30, 2013 and $18 million at December 31, 2013, respectively. Write-downs on other real estate owned were $2 million for the first nine months of 2014 and 2013, and $4 million for the full year 2013. Management actively seeks to ensure properties held are monitored to minimize the Corporation’s risk of loss.

 

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Liquidity

The objective of liquidity management is to ensure that the Corporation has the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to satisfy the cash flow requirements of depositors and borrowers and to meet its other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries or acquisitions, and satisfy other operating requirements. In addition to satisfying cash flow requirements in the ordinary course of business, the Corporation actively monitors and manages its liquidity position to ensure sufficient resources are available to meet cash flow requirements in adverse situations.

The Corporation’s internal liquidity management framework includes measurement of several key elements, such as various funding components (i.e., wholesale funds, top funds providers) as a percent of total assets and liquid asset levels. Strong capital ratios, credit quality, and core earnings are essential to maintaining cost-effective access to wholesale funding markets. A downgrade or loss in credit ratings could have an impact on the Corporation’s ability to access wholesale funding at favorable interest rates. In addition to static liquidity measures, the Corporation performs dynamic scenario analysis in accordance with industry best practices. Measures have been established to ensure the Corporation has sufficient high quality short-term liquidity to meet cash flow requirements under stressed scenarios. At September 30, 2014, the Corporation was in compliance with its internal liquidity policies.

While core deposits and loan and investment securities repayments are principal sources of liquidity, funding diversification is another key element of liquidity management. Diversity is achieved by strategically varying depositor type, term, funding market, and instrument. The Parent Company and its subsidiary bank are rated by Moody’s and Standard and Poor’s (“S&P”). Credit ratings by these nationally recognized statistical rating agencies are an important component of the Corporation’s liquidity profile. Credit ratings relate to the Corporation’s ability to issue debt securities and the cost to borrow money, and should not be viewed as an indication of future stock performance or a recommendation to buy, sell, or hold securities. Among other factors, the credit ratings are based on financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core deposits, and the Corporation’s ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets but also the cost of these funds. Ratings are subject to revision or withdrawal at any time and each rating should be evaluated independently. The senior credit ratings of the Parent Company and its subsidiary bank are displayed below.

 

		September 30, 2014
		Moody’s				S&P
Bank short-term			P2				—
Bank long-term			A3				BBB+
Corporation short-term			P2				—
Corporation long-term			Baa1				BBB
Outlook			Stable				Stable

The Corporation also has multiple funding sources that could be used to increase liquidity and provide additional financial flexibility. The Parent Company has filed a shelf registration with the SEC under which the Parent Company may, from time to time, offer shares of the Corporation’s common stock in connection with acquisitions of businesses, assets or securities of other companies. The Parent Company has also filed a universal shelf registration statement, under which the Parent Company may offer securities, either separately or in units: debt securities, preferred stock, depositary shares, common stock, and warrants. The Parent Company also has a $200 million commercial paper program, of which, $60 million was outstanding at September 30, 2014.

While dividends and service fees from subsidiaries and proceeds from issuance of capital are primary funding sources for the Parent Company, these sources could be limited or costly (such as by regulation or subject to the capital needs of its subsidiaries or by market appetite for bank holding company stock). The Parent Company received dividends of $135 million during the first nine months of 2014 from subsidiaries.

The Bank has established federal funds lines with counterparty banks and has the ability to borrow from the Federal Home Loan Bank ($3.1 billion of Federal Home Loan Bank advances were outstanding at September 30, 2014). The Bank also has significant excess loan and investment securities collateral which could be pledged to secure additional deposits or to counterparty banks, the Federal Home Loan Bank or other parties as necessary. Associated Bank may also issue institutional certificates of deposit, network transaction deposits, and brokered certificates of deposit.

 

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Investment securities are an important tool to the Corporation’s liquidity objective. As of September 30, 2014, the majority of investment securities are classified as available for sale, with only a portion of municipal securities (approximately $300 million) classified as held to maturity. Of the $5.6 billion investment securities portfolio at September 30, 2014, a portion of these securities were pledged to secure collateralized deposits and repurchase agreements and for other purposes as required or permitted by law. The majority of the remaining investment securities of $2.4 billion could be pledged or sold to enhance liquidity, if necessary.

For the nine months ended September 30, 2014, net cash provided by operating activities and financing activities was $131 million and $1.3 billion, respectively, while net cash used in investing activities was $1.5 billion, for a net decrease in cash and cash equivalents of $128 million since year-end 2013. During the first nine months of 2014 assets increased $1.4 billion, including a $1.3 billion increase in loans and a $222 million increase in investment securities. On the funding side, deposits increased $934 million and short-term funding increased $689 million, while long-term funding decreased $156 million. The net increase in assets was used to fund $163 million of common stock repurchases and $47 million of cash dividends to the Corporation’s stockholders (common and preferred stock).

For the nine months ended September 30, 2013, net cash provided by operating activities and financing activities was $371 million and $160 million, respectively, while net cash used in investing activities was $440 million, for a net increase in cash and cash equivalents of $91 million since year-end 2012. During the first nine months of 2013, loans increased $175 million and loans held for sale decreased $159 million, while investment securities were relatively flat (down $2 million). On the funding side, deposits increased $1.4 billion, while short-term funding decreased $700 million and long-term funding decreased $401 million. The net increase in funding during 2013 was used to fund $93 million of common stock repurchases and $44 million of cash dividends to the Corporation’s stockholders (common and preferred stock).

Quantitative and Qualitative Disclosures about Market Risk

Market risk and interest rate risk are managed centrally. Market risk is the potential for loss arising from adverse changes in the fair value of fixed income securities, equity securities, other earning assets and derivative financial instruments as a result of changes in interest rates or other factors. Interest rate risk is the potential for reduced net interest income resulting from adverse changes in the level of interest rates. As a financial institution that engages in transactions involving an array of financial products, the Corporation is exposed to both market risk and interest rate risk. In addition to market risk, interest rate risk is measured and managed through a number of methods. The Corporation uses financial modeling simulation techniques that measure the sensitivity of future earnings due to changing rate environments to measure interest rate risk.

Policies established by the Corporation’s Asset / Liability Committee (“ALCO”) and approved by the Board of Directors are intended to manage these risks. The Board has delegated day-to-day responsibility for managing market and interest rate risk to ALCO. The primary objectives of market risk management is to minimize any adverse effect that changes in market risk factors may have on net interest income and to offset the risk of price changes for certain assets recorded at fair value.

Interest Rate Risk

In order to measure earnings sensitivity to changing market interest rates, the Corporation uses a simulation model to measure the impact of various interest rate shocks and other yield curve scenarios on earnings and the fair value of the financial assets and liabilities of the Corporation. The Corporation compares earnings between a static balance sheet scenario and balance sheets with projected growth scenarios to quantify the potential impact on such earnings of various balance sheet management and business strategies.

Simulation of earnings: Determining the sensitivity of short-term future earnings is accomplished through the use of simulation modeling. Assumptions involving projected balance sheet growth, market spreads, loan and deposit rates, prepayments of rate-sensitive instruments, and the cash flows from maturing assets and liabilities are incorporated in these simulation analyses. These analyses are designed to project net interest income based on various interest rate scenarios, compared to a baseline scenario. The

 

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Corporation runs numerous scenarios including instantaneous and gradual changes to market interest rates, yield curve slope changes, deposit rate sensitivities, and prepayment sensitivities. It then compares such scenarios to the baseline scenario to quantify its earnings sensitivity.

The resulting simulations for September 30, 2014, and December 31, 2013 projected that net interest income would increase by approximately 0.9% and 0.4%, respectively, if rates rose instantaneously by a 100 bp shock and projected that net interest income would increase by approximately 2.1% and 0.9%, respectively, if rates rose instantaneously by a 200 bp shock. As of September 30, 2014, the simulations of earnings results were within the limits of the Corporation’s interest rate risk policy.

Market value of equity: The Corporation uses the market value of equity as a measure to quantify market risk from the impact of interest rates. The market value of equity is the fair value of assets, liabilities, and off-balance sheet financial instruments derived from the present value of the future cash flows. While the net interest income simulation model highlights exposures over a short time horizon, the market value of equity incorporates all cash flows over all of the balance sheet and derivative positions.

These results are based on multiple path simulations using an interest rate simulation model calibrated to market traded instruments. Sensitivities are measured assuming several factors including immediate and sustained parallel and non-parallel changes in market rates, yield curves and rate indexes. These factors quantify yield curve risk, basis risk, options risk, repricing mismatch risk, and market spread risk. The results are considered to be conservative estimates due to the fact that no management action to mitigate potential income variances is included within the simulation assumption set. These potentially mitigating factors include future balance sheet growth, changes in yield curve relationships, and changing product spreads. As of September 30, 2014, the projected changes for the market value of equity were within the limits of the Corporation’s interest rate risk policy.

Contractual Obligations, Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities

The Corporation utilizes a variety of financial instruments in the normal course of business to meet the financial needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include lending-related commitments and derivative instruments. A discussion of the Corporation’s derivative instruments at September 30, 2014, is included in Note 10, “Derivative and Hedging Activities,” of the notes to consolidated financial statements. A discussion of the Corporation’s lending-related commitments is included in Note 12, “Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities,” of the notes to consolidated financial statements. See also Note 8, “Short and Long-Term Funding,” of the notes to consolidated financial statements for additional information on the Corporation’s short-term and long-term funding.

Table 9 summarizes significant contractual obligations and other commitments at September 30, 2014, at those amounts contractually due to the recipient, including any premiums or discounts, hedge basis adjustments, or other similar carrying value adjustments.

 

TABLE 9: Contractual Obligations and Other Commitments
		One Year or Less				One to Three Years				Three to Five Years				Over Five Years				Total
		($ in Thousands)
Time deposits		$	949,273			$	370,001			$	192,321			$	1,771			$	1,513,366
Short-term funding			1,430,180				—				—				—				1,430,180
Long-term funding			—				431,331				2,500,034				182				2,931,547
Operating leases			10,699				21,505				17,759				33,206				83,169
Commitments to extend credit			3,417,726				1,717,583				1,599,889				113,557				6,848,755
Total		$	5,807,878			$	2,540,420			$	4,310,003			$	148,716			$	12,807,017

Capital

Stockholders’ equity at September 30, 2014 was $2.9 billion, down slightly ($22 million) from December 31, 2013. At September 30, 2014, stockholders’ equity included $2 million of accumulated other comprehensive loss compared to $24 million of accumulated other comprehensive loss at December 31, 2013. Cash dividends of $0.27 per share were paid in the first nine months of 2014 and $0.24 per share were paid in the first nine months of 2013. The ratio of total stockholders’ equity to assets was 11.19% and 11.93% at September 30, 2014 and December 31, 2013, respectively.

During the first nine months of 2014, 9.0 million shares were repurchased for $159 million (or an average cost per common share of $17.76), of which, approximately 3.1 million shares were returned to authorized but unissued shares and the remaining shares were

 

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added to treasury stock. For the full year 2013, 7.7 million shares were repurchased for $120 million (or an average cost per common share of $15.57), all of which were added to treasury stock. The Corporation also repurchased shares for minimum tax withholding settlements on equity compensation totaling approximately $4 million (221,243 shares at an average cost per common share of $16.47) during the first nine months of 2014, compared to repurchases of shares for minimum tax withholding settlements on equity compensation totaling approximately $3 million (239,215 shares at an average cost per common share of $14.00) for the full year 2013. At September 30, 2014, the Corporation had approximately $55 million remaining under repurchase authorizations previously approved by the Board of Directors. See section “Recent Developments” for additional information on the October 2014 common stock repurchases and the October 2014 Board of Directors share repurchase authorization. See Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” for additional information on the shares repurchased during the third quarter of 2014. The repurchase of shares will be based on market and investment opportunities, capital levels, growth prospects, and regulatory constraints. Such repurchases may occur from time to time in open market purchases, block transactions, private transactions, accelerated share repurchase programs, or similar facilities.

Management actively reviews capital strategies for the Corporation and each of its subsidiaries in light of perceived business risks, future growth opportunities, industry standards, and compliance with regulatory requirements. The assessment of overall capital adequacy depends on a variety of factors, including asset quality, liquidity, stability of earnings, changing competitive forces, economic condition in markets served, and strength of management. The capital ratios of the Corporation and its banking affiliate were in excess of regulatory minimum requirements. The Corporation’s capital ratios are summarized in Table 10.

 

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TABLE 10

Capital Ratios

(In Thousands, except per share data)

 

		Quarter Ended
		September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013				September 30, 2013
Total stockholders’ equity		$	2,869,578			$	2,929,946			$	2,901,024			$	2,891,290			$	2,872,282
Tangible stockholders’ equity(1)			1,932,198				1,991,576				1,961,663				1,950,938				1,930,919
Tier 1 capital(2)			1,933,923				1,980,675				1,973,240				1,975,182				1,966,797
Tier 1 common equity(3)			1,872,899				1,919,651				1,912,083				1,913,320				1,904,060
Tangible common equity(1)			1,871,174				1,930,552				1,900,505				1,889,076				1,868,182
Total risk-based capital(2)			2,160,143				2,205,423				2,187,637				2,184,884				2,198,219
Tangible assets(1)			24,716,442				24,789,416				23,866,836				23,286,568				22,747,312
Risk weighted assets(2)			18,031,157				17,911,201				17,075,004				16,694,148				16,358,823
Market capitalization			2,695,623				2,883,398				2,907,877				2,829,640				2,545,053
Book value per common share		$	18.15			$	17.99			$	17.64			$	17.40			$	17.10
Tangible book value per common share			12.09				12.11				11.80				11.62				11.37
Cash dividend per common share			0.09				0.09				0.09				0.09				0.08
Stock price at end of period			17.42				18.08				18.06				17.40				15.49
Low closing price for the period			17.42				16.82				15.58				15.34				15.29
High closing price for the period			18.90				18.39				18.35				17.56				17.60
Total stockholders’ equity / assets			11.19	%			11.39	%			11.69	%			11.93	%			12.13	%
Tangible common equity / tangible assets (1)			7.57				7.79				7.96				8.11				8.21
Tangible stockholders’ equity / tangible assets (1)			7.82				8.03				8.22				8.38				8.49
Tier 1 common equity / risk-weighted assets (3)			10.39				10.72				11.20				11.46				11.64
Tier 1 leverage ratio(2)			7.87				8.26				8.46				8.70				8.76
Tier 1 risk-based capital ratio(2)			10.73				11.06				11.56				11.83				12.02
Total risk-based capital ratio(2)			11.98				12.31				12.81				13.09				13.44
Common shares outstanding (period end)			154,743				159,480				161,012				162,623				164,303
Basic common shares outstanding (average)			155,925				159,940				161,467				162,611				164,954
Diluted common shares outstanding (average)			156,991				160,838				162,188				163,235				165,443

 

(1)

Tangible stockholders’ equity, tangible common equity, and tangible assets are non-GAAP financial measures. Additionally, any ratios utilizing these financial measures are non-GAAP measures. These financial measures have been included as they are considered to be critical metrics with which to analyze and evaluate financial condition and capital strength. Tangible stockholders’ equity is defined as stockholders’ equity excluding goodwill and other intangible assets. Tangible common equity is defined as common stockholders’ equity excluding goodwill and other intangible assets. Tangible assets is defined as total assets excluding goodwill and other intangible assets.

(2)

The FRB establishes capital adequacy requirements, including well-capitalized standards for the Corporation. The OCC establishes similar capital adequacy requirements and standards for the Bank. Regulatory capital primarily consists of Tier 1 risk-based capital and Tier 2 risk-based capital. The sum of Tier 1 risk-based capital and Tier 2 risk-based capital equals our total risk-based capital. Risk-based capital guidelines require a minimum level of capital as a percentage of risk-weighted assets. Risk-weighted assets consist of total assets plus certain off-balance sheet and market items, subject to adjustment for predefined credit risk factors.

(3)

Tier 1 common equity, a non-GAAP financial measure, is used by banking regulators, investors and analysts to assess and compare the quality and composition of our capital with the capital of other financial services companies. Management uses Tier 1 common equity, along with other capital measures, to assess and monitor our capital position. Tier 1 common equity is defined as Tier 1 capital excluding qualifying perpetual preferred stock and qualifying trust preferred securities.

Comparable Third Quarter Results

The Corporation recorded net income of $50 million for the three months ended September 30, 2014, compared to net income of $46 million for the three months ended September 30, 2013. Net income available to common equity was $49 million for the three months ended September 30, 2014, or net income of $0.31 for both basic and diluted earnings per common share. Comparatively, net income available to common equity for the three months ended September 30, 2013, was $44 million, or net income of $0.27 for both basic and diluted earnings per common share (see Table 1).

 

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Taxable equivalent net interest income for the third quarter of 2014 was $178 million, $12 million higher than the third quarter of 2013 (see Table 2). Changes in the balance sheet volume and mix increased taxable equivalent net interest income by $12 million, while changes in the rate environment remained relatively level. The Federal funds target rate was unchanged for both the third quarter of 2014 and the third quarter of 2013. The net interest margin between the comparable quarters was down 7 bp, to 3.06% in the third quarter of 2014. Average earning assets increased $2.1 billion to $23.1 billion in the third quarter of 2014, with average loans up $1.4 billion (predominantly in commercial loans) and investments and other short-term investments up $641 million (predominantly in mortgage related securities). On the funding side, average short and long-term funding was up $1.9 billion (primarily long-term FHLB advances), while average interest-bearing deposits were up $288 million (primarily interest-bearing demand deposits).

Credit quality continued to improve with nonaccrual loans declining to $184 million (1.07% of total loans) at September 30, 2014, compared to $208 million (1.33% of total loans) at September 30, 2013 (see Table 8). Compared to the third quarter of 2013, potential problem loans were down 21% to $220 million. The provision for credit losses was $1 million, up $2 million compared to the third quarter of 2013 (see Table 7). Annualized net charge offs represented 0.06% of average loans for the third quarter of 2014 compared to 0.14% for the third quarter of 2013. The allowance for loan losses to loans at September 30, 2014 was 1.55%, compared to 1.74% at September 30, 2013. See discussion under sections, “Provision for Credit Losses,” “Allowance for Credit Losses,” and “Nonaccrual Loans, Potential Problem Loans, and Other Real Estate Owned.”

Noninterest income for the third quarter of 2014 increased $4 million (6%) to $75 million versus the third quarter of 2013. Core fee-based revenue decreased $3 million primarily in insurance commissions due to a $4 million reserve established for remediation on legacy debt protection products. Net mortgage banking income was $7 million, up $3 million from the third quarter of 2013, predominantly due to an increase in the gain on sales of mortgage loans. Net asset gains increased $3 million, primarily due to two corporate real estate gains during the third quarter of 2014.

On a comparable quarter basis, noninterest expense increased $7 million (4%) to $172 million in the third quarter of 2014. FDIC expense increased $2 million (44%) from the third quarter of 2013 reflecting the growth in risk-weighted assets. Business development and advertising expenses increased $2 million (26%) from the third quarter of 2013 as the Corporation increased advertising related to our fall marketing campaign. Technology increased $1 million as we continue to invest in solutions that will drive operational efficiency. Losses other than loans increased $1 million mainly due to a more favorable than expected resolution of a litigation matter in the third quarter of 2013. All remaining noninterest expense categories on a combined basis were relatively unchanged (up 0.4%) compared to the third quarter of 2013.

For the third quarter of 2014, the Corporation recognized income tax expense of $24 million, compared to income tax expense of $21 million for the third quarter of 2013. The effective tax rate was 32.77% and 31.91% for the third quarter of 2014 and the third quarter of 2013, respectively.

 

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TABLE 11

Selected Quarterly Information

($ in Thousands)

 

		Quarter Ended
		September 30, 2014				June 30, 2014				March 31, 2014				December 31, 2013				September 30, 2013
Summary of Operations:
Net interest income		$	172,630			$	168,703			$	164,973			$	167,199			$	160,509
Provision for credit losses			1,000				5,000				5,000				2,300				(800	)
Noninterest income
Trust service fees			12,218				12,017				11,711				11,938				11,380
Service charges on deposit accounts			17,961				17,412				16,400				17,330				18,407
Card-based and other nondeposit fees			12,407				12,577				12,509				12,684				12,688
Insurance commissions			7,860				13,651				12,317				11,274				11,356
Brokerage and annuity commissions			4,040				4,520				4,033				3,881				3,792
Core fee-based revenue			54,486				60,177				56,970				57,107				57,623
Mortgage banking, net			6,669				5,362				6,361				8,277				3,542
Capital market fees, net			2,939				2,099				2,322				2,771				2,652
BOLI income			3,506				3,011				4,320				2,787				2,817
Asset gains, net			4,934				899				728				2,687				1,934
Investment securities gains (losses), net			57				34				378				(18	)			248
Other			2,317				665				2,442				2,262				2,100
Total noninterest income			74,908				72,247				73,521				75,873				70,916
Noninterest expense
Personnel expense			97,650				97,793				97,698				101,215				98,102
Occupancy			13,743				13,785				15,560				14,684				14,758
Equipment			6,133				6,227				6,276				6,509				6,213
Technology			13,573				14,594				12,724				12,963				12,323
Business development and advertising			7,467				5,077				5,062				7,834				5,947
Other intangible asset amortization			990				991				991				1,011				1,010
Loan expense			3,813				3,620				2,787				3,677				3,157
Legal and professional fees			4,604				4,436				4,188				5,916				3,482
Losses other than loans			677				381				544				1,559				(600	)
Foreclosure / OREO expense			2,083				1,575				1,896				2,829				2,515
FDIC expense			6,859				4,945				5,001				4,879				4,755
Other			14,261				14,501				14,931				16,091				13,509
Total noninterest expense			171,853				167,925				167,658				179,167				165,171
Income tax expense			24,478				21,660				20,637				13,847				21,396
Net income			50,207				46,365				45,199				47,758				45,658
Preferred stock dividends			1,255				1,278				1,244				1,273				1,285
Net income available to common equity		$	48,952			$	45,087			$	43,955			$	46,485			$	44,373
Taxable equivalent net interest income		$	177,568			$	173,360			$	169,629			$	172,237			$	165,457
Net interest margin			3.06	%			3.08	%			3.12	%			3.23	%			3.13	%
Effective tax rate			32.77	%			31.84	%			31.35	%			22.48	%			31.91	%
Average Balances:
Assets		$	25,472,052			$	24,858,072			$	24,213,213			$	23,558,725			$	23,313,577
Earning assets			23,096,717				22,537,515				21,892,503				21,242,065				21,039,467
Interest-bearing liabilities			18,158,989				17,711,534				16,962,190				16,135,174				16,010,930
Loans			17,140,961				16,646,389				16,164,617				15,748,284				15,724,365
Deposits			17,873,378				17,172,832				16,990,272				17,881,531				17,609,819
Short and long-term funding			4,525,265				4,612,012				4,138,223				2,606,958				2,665,415
Stockholders’ equity		$	2,876,079			$	2,891,118			$	2,888,768			$	2,872,638			$	2,862,890

 

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Sequential Quarter Results

The Corporation recorded net income of $50 million for the three months ended September 30, 2014, compared to net income of $46 million for the three months ended June 30, 2014. Net income available to common equity was $49 million for the third quarter of 2014, or net income of $0.31 for both basic and diluted earnings per common share. Comparatively, net income available to common equity for the second quarter of 2014, was $45 million, or net income of $0.28 for both basic and diluted earnings per common share (see Table 1).

Taxable equivalent net interest income for the third quarter of 2014 was $178 million, $5 million higher than the second quarter of 2014, as changes in the balance sheet volume and mix increased taxable equivalent net interest income by $5 million. The Federal funds target rate was unchanged for both quarters. The net interest margin in the third quarter of 2014 was down 2 bp, to 3.06%. Average earning assets increased $559 million to $23.1 billion in the third quarter of 2014, with average loans up $495 million (predominantly in commercial and residential mortgage loans) and average investments and other short-term investments up $64 million (primarily in municipal securities and interest bearing deposits in other banks partially offset by decreases in residential mortgage-related and asset back securities). On the funding side, average short and long-term funding was down $87 million (primarily short-term FHLB advances), while average interest-bearing deposits were up $534 million (primarily money market and interest-bearing demand deposits).

Nonaccrual loans were up slightly, to $184 million (1.07% of total loans) at September 30, 2014, compared to $179 million (1.05% of total loans) at June 30, 2014 (see Table 8). Potential problem loans decreased to $220 million, down $68 million from the second quarter of 2014. The provision for credit losses for the third quarter of 2014 was $1 million, down $4 million compared to the second quarter of 2014 (see Table 7). Annualized net charge offs represented 0.06% of average loans for the second and third quarter of 2014. The allowance for loan losses to loans at September 30, 2014 was 1.55%, compared to 1.59% at June 30, 2014 (see Table 8). See discussion under sections, “Provision for Credit Losses,” “Allowance for Credit Losses,” and “Nonaccrual Loans, Potential Problem Loans, and Other Real Estate Owned.”

Noninterest income for the third quarter of 2014 increased $3 million (4%) to $75 million versus the second quarter of 2014. Core fee-based revenue decreased $6 million (10%) from the second quarter of 2014, primarily due to a $6 million decrease in insurance commissions. Insurance commissions declined from the second quarter of 2014, primarily due to a $4 million reserve established for remediation on legacy debt protection products. Net mortgage banking income was $7 million, up $1 million (24%) from the second quarter of 2014, predominantly due to an increase in the gain on sales of mortgage loans. Net asset gains increased $4 million, primarily due to two corporate real estate gains during the third quarter of 2014. Other income increased $2 million from the second quarter of 2014 primarily due to one-time charges related to some customer reimbursements paid in the second quarter of 2014.

On a sequential quarter basis, noninterest expense increased $4 million (2%) to $172 million. Business development and advertising expenses increased $2 million (47%) from second quarter of 2014 as the Corporation increased advertising related to our fall marketing campaign. FDIC expense increased $2 million (39%) from the second quarter of 2014 reflecting the growth in risk-weighted assets. All remaining noninterest expense categories on a combined basis were relatively unchanged (down 0.2%) compared to the second quarter of 2014.

For the third quarter of 2014, the Corporation recognized income tax expense of $24 million, compared to income tax expense of $22 million for the second quarter of 2014. The effective tax rate was 32.77% and 31.84% for the third quarter of 2014 and the second quarter of 2014, respectively.

Future Accounting Pronouncements

New accounting policies adopted by the Corporation are discussed in Note 2, “New Accounting Pronouncements Adopted,” of the notes to consolidated financial statements. The expected impact of accounting pronouncements recently issued or proposed but not yet required to be adopted are discussed below. To the extent the adoption of new accounting standards materially affects the Corporation’s financial condition, results of operations, or liquidity, the impacts are discussed in the applicable sections of this financial review and the notes to the consolidated financial statements.

In August 2014, the FASB issued an amendment to clarify how creditors are to classify certain government-guaranteed mortgage loans upon foreclosure. This amendment requires that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) The loan has a government guarantee that is not separate from the loan before foreclosure and (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under the claim and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This

 

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amendment is effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to foreclosures that occur after the date of adoption or (b) modified retrospective transition using a cumulative-effect adjustment (through a reclassification to a separate other receivable) as of the beginning of the annual period of adoption. Prior periods should not be adjusted. The Corporation intends to adopt the accounting standard during the first quarter of 2015, as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.

In June 2014, the FASB issued an amendment to the stock compensation accounting guidance to clarify that a performance target that affects vesting of a share-based payment and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This amendment is effective for annual reporting periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The Corporation intends to adopt the accounting standard during the first quarter of 2016, as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.

In June 2014, the FASB issued an amendment to clarify the current accounting and disclosures for certain repurchase agreements. The amendments in this Update require two accounting changes: (1) change the accounting for repurchase-to-maturity transactions to secured borrowing accounting and (2) require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The amendments in this Update also require additional disclosures for certain transactions on the transfer of financial assets, as well as new disclosures for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. This amendment is effective for public business entities for the first interim or annual period beginning after December 15, 2014. Early application is prohibited. The Corporation intends to adopt the accounting standard during the first quarter of 2015, as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.

In May 2014, the FASB issued an amendment to clarify the principles for recognizing revenue and to develop a common revenue standard. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” In applying the revenue model to contracts within its scope, an entity should apply the following steps: (1) Identify the contract(s) with a customer, (2) Identify the performance obligations in the contract, (3) Determine the transaction price, (4) Allocate the transaction price to the performance obligations in the contract, and (5) Recognize revenue when (or as) the entity satisfies a performance obligation. The standard applies to all contracts with customers except those that are within the scope of other topics in the FASB Codification. The standard also requires significantly expanded disclosures about revenue recognition. The amendment is effective for annual reporting periods beginning after December 15, 2016 (including interim reporting periods within those periods). Early application is not permitted. The Corporation intends to adopt the accounting standard during the first quarter of 2017, as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.

In January 2014, the FASB issued an amendment to clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar agreement. In addition, the amendments require interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure in accordance with local requirements of the applicable jurisdiction. This amendment is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. An entity can elect to adopt the amendments using either a modified retrospective method or a prospective transition method. Early adoption is permitted. The Corporation intends to adopt the accounting standard during the first quarter of 2015, as required, with no expected material impact on its results of operations, financial position, or liquidity.

In January 2014, the FASB issued an amendment which permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax

 

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expense (benefit). For those investments in qualified affordable housing projects not accounted for using the proportional method, the investment should be accounted for as an equity method investment or a cost method investment. The decision to apply the proportional amortization method of accounting is an accounting policy decision that should be applied consistently to all qualifying affordable housing project investments rather than a decision to be applied to individual investments. This amendment should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. This amendment is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Corporation intends to adopt the accounting standard during the first quarter of 2015, as required, with no expected material impact on its results of operations, financial position, or liquidity.

Recent Developments

On October 28, 2014, the Board of Directors declared a regular quarterly cash dividend of $0.10 per common share, payable on December 15, 2014, to shareholders of record at the close of business on December 1, 2014. This is an increase of $0.01 from the previous quarterly cash dividend. The Board of Directors also declared a regular quarterly cash dividend of $0.50 per depositary share on Associated Banc-Corp’s 8.00% Series B Perpetual Preferred Stock payable on December 15, 2014, to shareholders of record at the close of business on December 1, 2014. These cash dividends have not been reflected in the accompanying consolidated financial statements.

On October 28, 2014, the Board of Directors authorized the repurchase of up to $120 million of the Corporation’s common stock. This repurchase authorization is in addition to the previously authorized common stock repurchase program announced on March 18, 2014. There remains approximately $55 million under the previous authorization, or approximately $175 million in the aggregate. Repurchases under such programs are subject to regulatory limitations and may occur from time to time in open market purchases, block transactions, accelerated share repurchase programs or similar facilities.

On October 29, 2014, the Corporation repurchased approximately 3 million shares of common stock for $50 million under an accelerated share repurchase program. After these common stock repurchases, the Corporation has approximately $125 million remaining under repurchase authorizations previously approved by the Board of Directors.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Information required by this item is set forth in Item 2 under the captions “Quantitative and Qualitative Disclosures about Market Risk” and “Interest Rate Risk.”

ITEM 4. Controls and Procedures

The Corporation maintains disclosure controls and procedures as required under Rule 13a-15 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of September 30, 2014, the Corporation’s management carried out an evaluation, under the supervision and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures. Based on the foregoing, its Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2014. No changes were made to the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act of 1934) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

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PART II – OTHER INFORMATION

ITEM 1. Legal Proceedings

A lawsuit, R.J. ZAYED v. Associated Bank, N.A., was filed in the United States District Court for the District of Minnesota on January 29, 2013. The lawsuit relates to a Ponzi scheme perpetrated by Oxford Global Partners and related entities (“Oxford”) and individuals and was brought by the receiver for Oxford. Oxford was a depository customer of the Bank. The lawsuit claims that the Bank is liable for failing to uncover the Oxford Ponzi scheme, and specifically alleges the Bank aided and abetted (1) the fraudulent scheme; (2) a breach of fiduciary duty; (3) conversion; and (4) false representations and omissions. The lawsuit seeks unspecified consequential and punitive damages. The District Court granted the Bank’s motion to dismiss the complaint on September 30, 2013, and the plaintiff has appealed such dismissal to the U.S. Court of Appeals for the Eighth Circuit. It is not possible for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss at this time. A lawsuit by investors in the same Ponzi scheme, Herman Grad, et al v. Associated Bank, N.A., brought in Brown County, Wisconsin in October 2009 was dismissed by the circuit court, and the dismissal was affirmed by the Wisconsin Court of Appeals in June 2011 in an unpublished opinion.

A purported class action lawsuit, Wanda Boone v. Associated Banc-Corp, was filed on April 10, 2014 in the United States District Court for the Eastern District of Wisconsin. The lawsuit claimed that loan coordinators employed by the Bank were not compensated for all hours worked, including the payment of overtime, in violation of the Fair Labor Standards Act of 1938 and Wisconsin wage laws. On July 30, 2014, the case was dismissed with prejudice. As part of the resolution of this matter, the Corporation made an immaterial payment to the plaintiff.

The OCC and the Department of Housing and Urban Development (HUD) are examining the Bank’s compliance with fair housing laws, particularly from the period 2008-2011. The Corporation believes it has been in compliance in all material respects with all applicable laws and regulations related to fair housing. It is not possible at this time for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss related to such examinations by the OCC and HUD.

During the last year, the Corporation has reviewed a variety of legacy products provided by third parties, including debt protection and identity protection products. In connection with this review, the Corporation has made, and plans to make, remediation payments to affected customers and former customers. See Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections “Noninterest Income,” “Comparable Third Quarter Results,” and “Sequential Quarter Results,” for additional information. These types of products have recently received increased regulatory scrutiny, and it is possible that regulatory authorities could bring enforcement actions, including civil money penalties, or take other actions against the Corporation in regard to these legacy products. It is not possible at this time for management to assess the probability of a material adverse outcome or reasonably estimate the amount of any potential loss related to this matter.

 

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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

Following are the Corporation’s monthly common stock purchases during the third quarter of 2014. For a detailed discussion of the common stock repurchase authorizations and repurchases during the period, see section “Capital” included under Part I Item 2 of this document.

 

Period		Total Number of Shares Purchased(a)				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans				Maximum Number of Shares that May Yet Be Purchased Under the Plan(b)
July 1, 2014 - July 31, 2014			4,736,608			$	18.17				4,736,608				—
August 1, 2014 - August 31, 2014			—				—				—				—
September 1, 2014 -September 30, 2014			217,191				18.17				217,191				—
Total			4,953,799			$	18.17				4,953,799				3,209,068

 

(a)

During the third quarter of 2014, the Corporation repurchased 5,343 shares for minimum tax withholding settlements on equity compensation. These purchases are not included in the monthly common stock purchases table above and do not count against the maximum number of shares that may yet be purchased under the Board of Directors’ authorization.

(b)

On March 18, 2014, the Board of Directors authorized the repurchase of $120 million of common stock, of which approximately $55 million remained available to repurchase as of September 30, 2014. Using the closing stock price on September 30, 2014 of $17.42, a total of approximately 3.2 million common shares remained available to be repurchased under the authorization as of September 30, 2014. This amount excludes the fact that on October 28, 2014, the Board of Directors also authorized the repurchase of up to an additional $120 million, which is in addition to the $55 million remaining under the March 2014 common stock repurchase authorization. See section, “Recent Developments,” in Part I, Item 2 for additional information on the October 28, 2014 repurchase authorization.

 

ITEM 6.

Exhibits

 

(a)

Exhibits:

Exhibit (11), Statement regarding computation of per-share earnings. See Note 3 of the notes to consolidated financial statements in Part I Item 1.

Exhibit (31.1), Certification Under Section 302 of Sarbanes-Oxley by Philip B. Flynn, Chief Executive Officer.

Exhibit (31.2), Certification Under Section 302 of Sarbanes-Oxley by Christopher J. Del Moral-Niles, Chief Financial Officer.

Exhibit (32), Certification by the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley.

Exhibit (101), Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Unaudited Consolidated Balance Sheets, (ii) Unaudited Consolidated Statements of Income, (iii) Unaudited Consolidated Statements of Comprehensive Income, (iv) Unaudited Consolidated Statements of Changes in Stockholders’ Equity, (v) Unaudited Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

		ASSOCIATED BANC-CORP
		(Registrant)
Date: October 31, 2014		/s/ Philip B. Flynn
		Philip B. Flynn
		President and Chief Executive Officer
Date: October 31, 2014		/s/ Christopher J. Del Moral-Niles
		Christopher J. Del Moral-Niles
		Chief Financial Officer and Principal Accounting Officer

 

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