Associated Banc-Corp - 10-K annual report

Operating Results
In thousands (except per share data and performance ratios)

1a     Associated Banc-Corp

Associated Banc-Corp is a diversified bank holding company providing financial solutions for small, mid-size and large businesses and individuals through more than 300 banking locations across Wisconsin, Illinois and Minnesota.

With financial services that go well beyond banking, and a diverse product portfolio, Associated provides complete financial solutions to its customers. The company’s 5,100 employees distinguish themselves in their abilities to uncover client needs and tailor strategies to help clients achieve their financial goals.

Associated provides a wide range of products and services, including:

Consumer Banking: Offering a complete selection of deposit, lending, investment and insurance services with personalized attention to individual needs.

Business Banking: Presenting a comprehensive collection of lending, deposit, cash management, leasing, investment and insurance tools that can be customized to create a financial plan unique to small business needs.

Commercial and Corporate Banking: Offering enhanced business solutions around lending, deposit, cash management, leasing, commercial real estate, insurance and international banking needs unique to mid-size and large businesses.

Insurance: Providing customized solutions to help businesses and individuals actively manage risk and protect their assets through services that include employee benefit plans, commercial insurance and human resources consulting, as well as individual life, health, disability, long-term care, auto and home insurance.

Trust and Investments: Supporting the financial planning goals for individual, business and institutional clients with an appropriate mix of equity, fixed income, mutual fund, annuity and specialty investments, as well as fiduciary trust services and employee retirement plans.

Associated Bank, N.A.
Green Bay, Wisconsin

Associated Commercial Finance, Inc.
Milwaukee, Wisconsin

Associated Community Development, LLC
Green Bay, Wisconsin

Associated Financial Group, LLC
Minnetonka, Minnesota

Associated Investment Management, LLC
Green Bay, Wisconsin

Associated Investment Services, Inc.
Green Bay, Wisconsin

Associated Risk Group, LLC
Green Bay, Wisconsin

Associated Trust Company, N.A.
Milwaukee, Wisconsin

Riverside Finance, Inc.
Red Wing, Minnesota

Statements made in this document which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. This includes any statements of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Outcomes related to such statements are subject to numerous risk factors and uncertainties including those listed in the company’s Annual Report filed on Form 10-K.

1b     Associated Banc-Corp

Associates: Treat others fairly and provide opportunities to learn and grow professionally.

Community: Support the financial and social health of the community.

Customer: Exceed customer expectations.

Integrity: Demonstrate trust, respect and high ethical standards.

Performance: Achieve organizational goals to improve shareholder value.

Relationships: Build and sustain mutually beneficial long-term relationships.

2006 Annual Report     1

2     Associated Banc-Corp

2006 was characterized by a challenging interest rate and economic environment for the banking industry; however, Associated continued to make significant progress in building upon our vision to be the preferred provider of financial services for businesses and individuals in the communities we serve.

Our focus throughout 2006 remained on strategies that helped us more effectively implement on our strategic priorities. Throughout the organization, we better aligned resources to high potential markets so our associates could better meet the needs of our customers and optimize sales, service and revenue potential.

Associated has established clearly defined performance expectations across all units within the company, ensuring proper commitment and accountability. Management’s obligation to our associates is to provide the tools and support that enable each associate to achieve the performance results we expect while providing our customers the best we have to offer.

We were also able to add more depth to our executive management team by hiring Lisa Binder as president and chief operating officer. Associated is fortunate to have someone of Lisa’s caliber as part of our executive management team.

As we move forward into 2007, we have a strong foundation to build upon and our associates are at the heart of our achievements. Their hard work and commitment are the reasons we have been able to reward our shareholders for their investment in Associated.

I would like to recognize our board of directors for their dedication and involvement. Their insight and leadership have been critical in guiding our company forward.

The strategies we’ve identified are the right ones to help Associated evolve, grow and thrive. We enter 2007 in a good position to continue delivering shareholder value and reward your investment in Associated.

Paul S. Beideman
Chairman and Chief Executive Officer

2006 Annual Report     3

By engaging customers in quality conversations, our bankers are able to identify needs and offer the right solutions.

4     Associated Banc-Corp

Associated has identified core strategies to fuel its vision of becoming the preferred provider of financial services for businesses and individuals in the communities it serves.

Throughout the company, associates and resources are aligned to support the following strategic priorities:

Deposits are a significant contributor to revenue and profit. Associated’s focus on increasing demand deposit accounts was augmented with the February 2006 introduction of new retail checking products that give customers clear value for maintaining higher balances and multiple accounts. This strategy, which increased new retail checking account growth and decreased customer attrition, will be complemented with new savings and money market options in 2007.

Other retail services also showed progress, as home equity loans continued a strong growth trend and Associated saw increased usage of its world-class online banking services.

In 2006, Associated better positioned its business banking associates to take advantage of large, mid-sized and small business sales opportunities in major metro markets. This new business model gives relationship managers the resources they need to have a greater impact on Associated’s profitability.

An improved focus on marketing, product management and pricing disciplines also enabled Associated to introduce new product packages designed to capitalize on extensive cross-sale opportunities within each business segment and better meet customer needs.

Further aligning marketing resources to support product sales in markets that have the highest potential is a priority for 2007.

2006 Annual Report     5

Working together, our associates reach out to both consumer and business customers to proactively address their financial needs while creating extended cross-sale opportunities.

6     Associated Banc-Corp

Key to continued improvement in Associated’s quality of earnings is the diversification of revenue streams.

Over the past few years Associated has shown steady growth in core fee income categories. Most importantly, the company has changed the composition of its fee income.

Until recently, Associated’s reliance on the revenues that came from its mortgage business was considerable, and the revenue shortfall was a challenge when mortgage volumes decreased.

Associated’s strategies have successfully changed the trajectory and source of its fee income in several areas, including trust service fees, service charges on deposits, insurance commissions, brokerage fees and card-based and other nondeposit fees. Year over year, this core fee income increased 8%.

The wealth management and insurance businesses proved to be key contributors to Associated’s fee income growth in 2006. This was aided by the performance of cross-functional sales teams representing business, consumer, insurance and wealth management that focused on maximizing cross-sales to customers and new prospects. Sales in wealth management and insurance continue to provide long-term, sustainable fee income growth opportunities.

Associated continued its branch leadership in attractive Midwest markets, with more than 300 banking offices serving more than 180 communities in Wisconsin, Illinois and Minnesota, and more banking locations in Wisconsin than any other bank.

In 2006, Associated increased its presence and penetration in selected markets. Investing in growth markets such as Madison, Wis., has proven to be a good investment as Associated experienced significant commercial and industrial loan growth in that market over the past year.

Associated also invested in new branches and additional resources in the Twin Cities area. Coupled with an agreement made in January 2007 to purchase First National Bank of Hudson, headquartered in Woodbury, Minn., a suburban community adjacent to Minneapolis and St. Paul, this expands Associated’s network of convenient locations in one of the most dynamic and fast-growing markets in the Midwest. Once the acquisition is complete, Associated will have 26 offices in the greater Twin Cities area and 35 total when including all Minnesota locations.

Aligning resources with market opportunities is an ongoing process, and Associated will continue evaluating and investing in its resources to ensure the company is positioned to take advantage of each market’s potential.

2006 Annual Report     7

Representatives from Associated Financial Group offer a broad array of insurance and benefit consulting services. This uniquely positions the company to offer many value-added services to consumers and businesses.

8     Associated Banc-Corp

Throughout the company, Associated emphasized that every associate is linked to the sales and service process and can identify and help capitalize on new and cross-sale opportunities.

Associated continued enhancing the customer experience through its Achieving Excellence program, a long-term initiative aimed at improving bankers’ ability to uncover customer needs and direct them to effective Associated products. This program supports the alignment of sales goals and objectives throughout the organization and emphasizes ongoing coaching to ensure all associates clearly understand their accountability in achieving sales and service goals, and how their actions affect priority revenue initiatives.

Backing these efforts, Associated’s sales and support specialists constantly take steps to improve operational efficiencies by streamlining procedures and centralizing routine banking processes so front-line associates can focus on better meeting their customers’ needs.

As part of the company’s ongoing commitment to service, Associated began measuring the customer experience within 48 hours of conducting a teller transaction or opening an account. Connecting with the customer within that time frame allows Associated to measure actionable behaviors and important events that drive customer satisfaction and loyalty.

Associated has a disciplined approach to managing expenses, and consistently falls in the top tier of all banks when comparing efficiency ratios. The company’s 2006 efficiency ratio of 50.31% reflects a core strength of Associated in effectively managing operational, employment and integration costs. This was demonstrated, in part, with the consolidation of State Financial Bank completed earlier in the year.

Another important focus throughout the year was maintaining strong credit quality. Historically, credit quality and the management of credit risk have been a hallmark of Associated, and this continued in 2006. Associated’s thorough underwriting and collateralization policies have served the company well.

Associated has also taken steps to manage expenses through continued investments in the overall productivity and efficiency of our associates.

In 2006, Associated began implementation of its new core banking systems that will enable the company to optimize performance by eliminating overlapping processes conducted in the branches and back office.

In addition, the new system will standardize communication and improve customer service by allowing branch-centric and operational-based associates to concurrently view all customer requests and correspondence. Associated will run the new systems in-house, providing increased flexibility and speed for bringing product and service enhancements to Associated’s customers. The new system conversion is slated for completion during the first quarter of 2008.

2006 Annual Report     9

Our people are our greatest strength. We believe in investing in their professional development and the communities they serve. It just makes good business sense.

10     Associated Banc-Corp

Aligning operations, sales and related activities with risk management continued to be a strong focus at Associated in 2006. The company constantly reviews its approaches using an enterprise risk model based upon its regulators’ recommendations to evaluate and limit inherent risk to the company.

These reviews are complemented by Associated’s Enterprise Risk Management Department, which analyzes and responds to new regulatory requirements, as well as monitors compliance practices across Associated’s businesses.

In 2006, Associated continued to recognize that taking care of its customers also means contributing to the welfare of the community. For well over 100 years, making a positive difference in the company’s communities has been an integral part of what Associated is.

The company’s philanthropy is community focused and delivered locally. Associated bankers know their community’s needs and guide Associated’s commitment to those needs. The past year’s grants ranged from small donations to youth-based organizations to major, multi-year commitments to large capital campaigns.

Through Associated Community Development, LLC, Associated continued to effectively work with government programs and community organizations that assist people with low to moderate incomes. This was done in part by taking advantage of tax credits that make it possible for Associated to champion projects that otherwise would not qualify for a bank loan. On the commercial side, Associated Community Development also invested in programs that provide jobs in distressed neighborhoods.

The individual generosity of associates once again emerged as Associated’s most vibrant form of philanthropy. Encouraged to become involved and use their professional expertise to address challenges impacting their communities, associates volunteered on average 10 hours each per month in 2006 — a true reflection of the caliber of the company’s associates.

     2006 Annual Report          11

2006

The strategies we’ve identified are the right ones to help Associated evolve, grow and thrive. We enter 2007 in a good position to continue delivering shareholder value and reward your investment in Associated.

12     Associated Banc-Corp

 

 

 

 

 

 

(Mark One)

 

ACT OF 1934 For the transition period from           to          

 

 

 

 

Registrant’s telephone number, including area code:(920) 491-7000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-Kor any amendment to thisForm 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2of the Exchange Act.

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2of the Exchange Act).

Yes o     No þ

 

As of June 30, 2006, (the last business day of the registrant’s most recently completed second fiscal quarter) the aggregate market value of the voting stock held by nonaffiliates of the registrant was approximately $4,109,205,000. Excludes approximately $61,685,000 of market value representing the outstanding shares of the registrant owned by all directors and officers who individually, in certain cases, or collectively, may be deemed affiliates. Includes approximately $266,678,000 of market value representing 6.39% of the outstanding shares of the registrant held in a fiduciary capacity by the trust company subsidiary of the registrant.

 

As of February 21, 2007, 127,287,376 shares of common stock were outstanding.

 

 

 

 

 

Statements made in this document and in documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions.

 

Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of Associated Banc-Corp and could cause those results to differ materially from those expressed in forward-looking statements contained or incorporated by reference in this document. These factors, many of which are beyond Associated Banc-Corp’s control, include the following:

 

 

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Forward-looking statements speak only as of the date they are made. Associated Banc-Corp undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

 

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,” “Associated,” “we,” “us,” or “our”) is a bank holding company registered pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We were incorporated in Wisconsin in 1964 and were inactive until 1969 when permission was received from the Board of Governors of the Federal Reserve System (the “FRB” or “Federal Reserve”) to acquire three banks. At December 31, 2006, we owned one commercial bank headquartered in Wisconsin, serving local communities within our three-state footprint (Wisconsin, Illinois, and Minnesota) and, measured by total assets held at December 31, 2006, was the second largest commercial bank holding company headquartered in Wisconsin. We also owned 28 limited purpose banking and nonbanking subsidiaries located in Arizona, California, Illinois, Minnesota, Nevada, Vermont, and Wisconsin, that are closely related or incidental to the business of banking.

 

We provide our subsidiaries with leadership, as well as financial and managerial assistance in areas such as corporate development, auditing, marketing, legal/compliance, human resources management, risk management, facilities management, security, purchasing, credit administration, asset and liability management and other treasury-related activities, budgeting, accounting and other finance support.

 

Responsibility for the management of the subsidiaries remains with their respective boards of directors and officers. Services rendered to the subsidiaries by us are intended to assist the local management of these subsidiaries to

expand the scope of services offered by them. At December 31, 2006, our bank subsidiary provided services through 314 locations in approximately 180 communities.

 

 

Through our banking subsidiary and various nonbanking subsidiaries, we provide a diversified range of banking and nonbanking products and services to individuals and businesses in the communities we serve. We organize our business into two reportable segments: Banking and Wealth Management. Our banking and wealth management activities are conducted predominantly in Wisconsin, Minnesota, and Illinois, and are primarily delivered through branch facilities in this tri-state area, as well as supplemented through loan production offices, supermarket branches, a customer service call center and24-hourphone-banking services, an interstate Automated Teller Machine (ATM) network, and internet banking services. See also Note 20, “Segment Reporting,” of the notes to consolidated financial statements within Part II, Item 8. As disclosed in Note 20, the banking segment represented approximately 90% of total revenues in 2006, as defined in the note. Our profitability is predominantly dependent on the net interest income, noninterest income, the level of the provision for loan losses, noninterest expense, and related income taxes of our banking segment.

 

Banking consists of lending and deposit gathering (as well as other banking-related products and services) to businesses, governments, and consumers, and the support to deliver, fund, and manage such banking services. We offer a variety of loan and deposit products to retail customers, including but not limited to: home equity loans and lines of credit, residential mortgage loans and mortgage refinancing, education loans, personal and installment loans, checking, savings, money market deposit accounts, IRA accounts, certificates of deposit, and safe deposit boxes. As part of our management of originating and servicing residential mortgage loans, nearly all of our long-term, fixed-rate residential mortgage loans are sold in the secondary market with servicing rights retained. Loans, deposits, and related banking services to businesses (including small and larger businesses, governments/municipalities, metro or niche markets, and companies with specialized lending needs such as floor plan lending or asset-based lending) primarily include, but are not limited to: business checking and other business deposit products, business loans, lines of credit, commercial real estate financing, construction loans, letters of credit, revolving credit arrangements, and to a lesser degree business credit cards and equipment and machinery leases. To further support business customers and correspondent financial institutions, we provide safe deposit and night depository services, cash management, international banking, as well as check clearing, safekeeping, and other banking-based services.

 

Lending involves credit risk.  Credit risk is controlled and monitored through active asset quality management including the use of lending standards, thorough review of potential borrowers, and active asset quality administration. Credit risk management is discussed under Part II Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” sections “Critical Accounting Policies,” “Loans,” “Allowance for Loan Losses,” and “Nonperforming Loans, Potential Problem Loans, and Other Real Estate Owned,” and under Part II Item 8, Note 1, “Summary of Significant Accounting Policies,” and Note 4, “Loans,” of the notes to consolidated financial statements. Also see Item 1A, “Risk Factors.”

 

The wealth management segment provides products and a variety of fiduciary, investment management, advisory and corporate agency services to assist customers in building, investing, or protecting their wealth. Customers include individuals, corporations, small businesses, charitable trusts, endowments, foundations, and institutional investors. The wealth management segment is comprised of a) a full range of personal and business insurance products and services (including life, property, casualty, credit and mortgage insurance, fixed annuities, and employee group benefits consulting and administration), b) full-service investment brokerage, variable annuities, and discount and on-line brokerage, and c) trust/asset management, investment management, administration of pension, profit-sharing and other employee benefit plans, personal trusts, and estate planning. See also Note 20, “Segment Reporting,” of the notes to consolidated financial statements within Part II, Item 8. As disclosed in Note 20, the wealth management segment represented approximately 10% of total revenues in 2006, as defined in the note.

 

We are not dependent upon a single or a few customers, the loss of which would have a material adverse effect on us. No material portion of our business is seasonal.

 

 

At December 31, 2006, we had 5,101 full-time equivalent employees. None of our employees are represented by unions. We consider our relationship with our employees to be good.

 

 

The financial services industry is highly competitive. We compete for loans, deposits, and financial services in all of our principal markets. We compete directly with other bank and nonbank institutions located within our markets, internet-based banks, without-of-marketbanks and bank holding companies that advertise or otherwise serve our markets, money market and other mutual funds, brokerage houses, and various other financial institutions. Additionally, we compete with insurance companies, leasing companies, regulated small loan companies, credit unions, governmental agencies, and commercial entities offering financial services products. Competition involves efforts to obtain new deposits, the scope and type of services offered, interest rates paid on deposits and charged on loans, as well as other aspects of banking. We also face direct competition from members of bank holding company systems that have greater assets and resources than ours.

 

 

Financial institutions are highly regulated both at the federal and state levels. Numerous statutes and regulations affect the business of the Corporation.

 

As a registered bank holding company under the BHC Act, we are regulated and supervised by the FRB. Our nationally chartered bank subsidiary is supervised and examined by the Office of the Comptroller of the Currency (the “OCC”). All subsidiaries of us that accept insured deposits are subject to examination by the Federal Deposit Insurance Corporation (the “FDIC”).

 

 

We are subject to various regulatory capital requirements administered by the federal banking agencies noted above. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. We have consistently maintained regulatory capital ratios at or above the well capitalized standards. For further detail on capital and capital ratios see sections, “Liquidity” and “Capital,” and Note 18, “Regulatory Matters,” of the notes to consolidated financial statements.

 

Under the risk-based capital requirements for bank holding companies, the minimum requirement for the ratio of total capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) is 8%. At least half of the total capital (as defined below) is to be composed of common stockholders’ equity, retained earnings, qualifying perpetual preferred stock (in a limited amount in the case of cumulative preferred stock), minority interests in the equity accounts of consolidated subsidiaries, and qualifying trust preferred securities, less goodwill and certain intangibles (“tier 1 capital”). The remainder of total capital may consist of qualifying subordinated debt and redeemable preferred stock, qualifying cumulative perpetual preferred stock and allowance for loan losses (“tier 2 capital”, and together with tier 1 capital, “total capital”). At December 31, 2006, our tier 1 capital and total capital ratios were 9.42% and 11.92%, respectively.

 

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These requirements provide for a minimum leverage ratio of tier 1 capital to adjusted average quarterly assets less certain amounts (“leverage ratio”) equal to 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of at least 4%. Our leverage ratio at December 31, 2006, was 7.82%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to

maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activity. The Federal Reserve has not advised us of any specific minimum leverage ratio or tier 1 leverage ratio applicable to us.

 

Our subsidiary national bank is subject to similar capital requirements adopted by the OCC. The OCC has not advised our subsidiary bank of any specific minimum leverage ratios applicable to it. The risk-based capital requirements identify concentrations of credit risk and certain risks arising from non-traditional activities, and the management of those risks, as important factors to consider in assessing an institution’s overall capital adequacy. Other factors taken into consideration by federal regulators include: interest rate exposure; liquidity, funding and market risk; the quality and level of earnings; the quality of loans and investments; the effectiveness of loan and investment policies; and management’s overall ability to monitor and control financial and operational risks, including the risks presented by concentrations of credit and non-traditional activities.

 

In December 2006, the federal banking agencies issued a notice of proposed rulemaking seeking comment on various possible changes to the existing risk-based capital requirements. 71 F.R. 77446. These rules, referred to as “Basel IA,” would apply to the majority of U.S. banks that would not be subject to the proposed more advanced capital adequacy rules, known as Basel II. The notice suggests that most U.S. domestic institutions would be able to choose to remain under the existing Basel I risk-based capital system. Proposed modifications to the Basel I system under Basel IA would include: (1) expanding the number of risk-weightings from 4 to 8, with the highest being 200%; (ii) expanding the use of external credit ratings as an indicator of credit risk for externally-rated exposures; (iii) expanding the range of collateral and guarantors that may qualify an exposure for a lower risk-weighting; (iv) usingloan-to-valueratios (and possibly, credit assessments and other broad measures of credit risk) for assigning risk weightings for residential mortgages; (v) imposing a capital charge for certain short-term commitments; (vi) assessing a risk-based capital charge to reflect the risks in securitizations backed by revolving retail exposures with early amortization provisions; (vii) removing the 50% limit on the risk-weighting for credit equivalent amounts of derivatives; and (viii) a possible reduction of the risk-weight for small loans to business. We would be subject to the Basel IA rules upon their adoption and are evaluating the effect on our capital requirements if these rules are adopted in their proposed form.

 

 

As a bank holding company, we are required to obtain prior Federal Reserve approval before acquiring more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the Community Reinvestment Act (“CRA”).

 

 

The Parent Company is a legal entity separate and distinct from its banking (and other) subsidiaries. A major portion of our revenues results from amounts paid as dividends to us by our national bank subsidiary. The OCC’s prior approval is required if the total of all dividends declared by a national bank in any calendar year will exceed the sum of that bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits national banks from paying dividends that would be greater than the bank’s undivided profits after deducting statutory bad debt in excess of the bank’s allowance for loan losses.

 

Under the foregoing dividend restrictions and certain restrictions applicable to certain of our nonbanking subsidiaries, as of December 31, 2006, our subsidiaries, without obtaining affirmative governmental approvals, could pay aggregate dividends of $50 million to us. This amount is not necessarily indicative of amounts that may be available in future periods. In 2006, our subsidiaries paid $354 million in cash dividends to us.

 

In addition, we and our banking subsidiary are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank or bank holding company that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The appropriate federal regulatory authorities have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings.

 

 

The Gramm-Leach-Bliley Act of 1999 significantly amended the BHC Act. The amendments, among other things, allow certain qualifying bank holding companies that elect treatment as “financial holding companies” to engage in activities that are financial in nature and that explicitly include the underwriting and sale of insurance. The Parent Company thus far has not elected to be treated as a financial holding company. Bank holding companies that have not elected such treatment generally must limit their activities to banking activities and activities that are closely related to banking.

 

The BHC Act’s provisions governing the scope and manner of the FRB’s supervision of bank holding companies, the manner in which activities may be found to be financial in nature or closely related to banking, and the extent to which state laws on insurance will apply to insurance activities of banks and bank subsidiaries were also amended. The FRB has issued regulations implementing these provisions. The BHC Act, as amended, allows for the expansion of activities by banking organizations and permits consolidation among financial organizations generally. Under the BHC Act, we are required to act as a source of financial strength to each of our subsidiaries pursuant to which we may be required to commit financial resources to support such subsidiaries in circumstances when, absent such requirements, we might not otherwise do so. The BHC Act also requires the prior approval of the FRB to enable us to acquire direct or indirect control of more than five percent of any class of voting shares of any bank or bank holding company. The BHC Act further regulates our activities, including requirements and limitations relating to capital, transactions with officers, directors and affiliates, securities issuances, dividend payments, inter-affiliate liabilities, extensions of credit, and expansion through mergers and acquisitions.

 

 

The federal regulatory authorities have broad authority to enforce the regulatory requirements imposed on us. In particular, the provisions of the Federal Deposit Insurance Act (“FDIA”), and its implementing regulations carry greater enforcement powers. Under the FDIA, all commonly controlled FDIC insured depository institutions may be held liable for any loss incurred by the FDIC resulting from a failure of, or any assistance given by the FDIC to, any commonly controlled institutions. Pursuant to certain provisions of the FDIA, the federal regulatory agencies have broad powers to take prompt corrective action if a depository institution fails to maintain certain capital levels. Prompt corrective action may include, without limitation, restricting the ability of us to pay dividends, restricting acquisitions or other activities, and placing limitations on asset growth. At this time, our capital levels exceed the levels specified by the federal banking agencies, below which prompt corrective action could be taken.

 

 

Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), an adequately capitalized and managed bank holding company may acquire banks in states other than its home state without regard to the permissibility of such acquisitions under state law, but remain subject to state requirements that a bank has been organized and operating for a period of time. Subject to certain other restrictions, theRiegle-NealAct also authorizes banks to merge across state lines to create interstate branches. The Riegle-Neal Amendments Act of 1997 and the Regulatory Relief Act of 2006 provides further guidance on the application of host state laws to any branch located outside the host state.

 

 

The FDIC maintains the Deposit Insurance Fund (“DIF”) by assessing depository institutions an insurance premium on a quarterly basis. The amount of the assessment is a function of the institution’s risk category and assessment base. An institution’s risk category is determined according to its supervisory ratings and capital levels, and is used to determine the institution’s assessment rate. The assessment rate for the lowest risk category (Risk Category I) is calculated according to a formula, which for banks with less than $10 billion in assets, relies on supervisory ratings and certain financial ratios. An insured bank’s assessment base is determined by the balance of its insured deposits, and for an institution with more than $1 billion in assets, is calculated based on the average daily deposit balances of that institution. This system is risk-based and allows banks to pay less assessments to the FDIC as their capital level and supervisory ratings improve. By the same token, if these indicators deteriorate, the institution will have to pay higher assessments to the FDIC.

 

Under the FDIA, the FDIC Board has the authority to set the annual assessment rate range for the Risk Category I (and the assessment rate for the other categories), within certain regulatory limits, in order to maintain the DIF reserve ratio at the requisite level, which at December 31, 2006 was 1.35%. The FDIC has currently set the assessment rate range for Category I at 5-7 basis points of the balance of insured deposits.

 

The FDIC is authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency. The termination of deposit insurance for our subsidiary national bank could have a material adverse effect on our earnings, operations and financial condition.

 

 

Under federal law, deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the “liquidation or other resolution” of such an institution by any receiver.

 

 

Our bank subsidiary is subject to periodic CRA review by our primary federal regulators. Associated Bank, National Association, underwent a CRA examination by the Comptroller of the Currency on November 10, 2003, for which it received a Satisfactory rating.

 

 

In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA Patriot Act) Act of 2001 (the “Patriot Act”). The Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to implement additional policies and procedures with respect to additional measures designed to address any or all of the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.

 

The laws and regulations to which we are subject are constantly under review by Congress, the federal regulatory agencies, and the state authorities. These laws and regulations could be changed drastically in the future, which could affect our profitability, our ability to compete effectively, or the composition of the financial services industry in which we compete.

 

 

Our earnings and growth, as well as the earnings and growth of the banking industry, are affected by the credit policies of monetary authorities, including the FRB. An important function of the Federal Reserve is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments

of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits, and changes in the Federal Reserve discount rate. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.

 

In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, and loan demand, or their effect on our business and earnings or on the financial condition of our various customers.

 

 

We file annual, quarterly, and current reports, proxy statements, and other information with the SEC. These filings are available to the public on the Internet at the SEC’s web site at www.sec.gov. Shareholders may also read and copy any document that we file at the SEC’s public reference rooms located at 450 Fifth Street, NW, Washington, DC 20549. Shareholders may call the SEC at1-800-SEC-0330for further information on the public reference room.

 

Our principal Internet address is www.associatedbank.com. We make available free of charge on or through our website our annual report onForm 10-K,quarterly reports onForm 10-Q,current reports onForm 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. In addition, shareholders may request a copy of any of our filings (excluding exhibits) at no cost by writing, telephoning, faxing, ore-mailing us at the following address, telephone number, fax number ore-mailaddress: Associated Banc-Corp, Attn: Shareholder Relations, 1200 Hansen Road, Green Bay, WI 54304; phone920-431-8034;fax920-431-8037;or e-mail to shareholders@associatedbank.com. Our Code of Ethics for Directors and Executive Officers, corporate governance guidelines and Board of Directors committee charters are all available on our website.

 

Information contained on any of our websites is not deemed to be a part of this Annual Report.

 

An investment in Associated’s common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below, together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. See also, “Special Note Regarding Forward-Looking Statements.”

 

If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

 

 

Our Stock Price can be Volatile — Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

 

 

 

General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of operating results.

 

Our Articles of Incorporation, Bylaws, and Certain Banking Laws may have an Anti-Takeover Effect — Provisions of our articles of incorporation, bylaws, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may prohibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

 

An Investment in Our Common Stock is not an Insured Deposit — Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. An investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

 

Our Profitability Depends Significantly on Economic Conditions in the States within which We do Business — Our success depends on the general economic conditions of the specific local markets in which we operate. Local economic conditions have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans, and the stability of our deposit funding sources. A significant decline in general local economic conditions, caused by inflation, recession, unemployment, changes in securities markets or other factors could impact local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations.

 

The Earnings of Financial Services Companies are Significantly Affected by General Business and Economic Conditions — Our operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the United States economy, all of which are beyond our control. A deterioration in economic conditions could result in an increase in loan delinquencies and nonperforming assets, decreases in loan collateral values, and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our financial condition and results of operations.

 

Our Earnings are Significantly Affected by the Fiscal and Monetary Policies of the Federal Government and Its Agencies — The policies of the Federal Reserve impact us significantly. The Federal Reserve regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Those policies determine to a significant extent our cost of funds for lending and investing. Changes in those policies are beyond our control and are difficult to predict. Federal Reserve policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve could reduce the demand for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could have a material adverse effect on our financial condition and results of operation.

 

We Operate in a Highly Competitive Industry and Market Area — We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

 

Our ability to compete successfully depends on a number of factors, including, among other things:

 

 

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.

 

Consumers may Decide not to Use Banks to Complete Their Financial Transactions — Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying billsand/ortransferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

 

Severe Weather, Natural Disasters, Acts of War or Terrorism, and Other External Events could Significantly Impact Our Business — Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenueand/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

 

 

Our Financial Condition and Results of Operations could be Negatively Affected if We Fail to Grow or Fail to Manage Our Growth Effectively — Our business strategy includes significant growth plans. We intend to continue pursuing a profitable growth strategy. Our prospects must be considered in light of the risks, expenses and

difficulties frequently encountered by companies in significant growth stages of development. We cannot assure you that we will be able to expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations and could adversely affect our ability to successfully implement our business strategy. Also, if we grow more slowly than anticipated, our operating results could be materially adversely affected.

 

Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. While we believe we have the management resources and internal systems in place to successfully manage our future growth, there can be no assurance growth opportunities will be available or growth will be successfully managed.

 

Acquisitions May Disrupt Our Business and Dilute Stockholder Value — We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services.

 

Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things:

 

 

We Continually Encounter Technological Change — The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

 

New Lines of Business or New Products and Services May Subject Us to Additional Risk — From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are

substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of businessand/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of businessand/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of businessand/or a new product or service. Furthermore, any new line of businessand/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of businessand/or new products or services could have a material adverse effect on our business, results of operations and financial condition.

 

 

Negative Publicity could Damage Our Reputation — Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct. Because we conduct most of our business under the “Associated Bank” brand, negative public opinion about one business could affect our other businesses.

 

Unauthorized Disclosure of Sensitive or Confidential Client or Customer Information, Whether Through a Breach of Our Computer Systems or Otherwise, could Severely Harm Our Business — As part of our business, we collect, process and retain sensitive and confidential client and customer information on our behalf and on behalf of other third parties. Despite the security measures we have in place, our facilities and systems, and those of our third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programmingand/or human errors, or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer information, whether by us or by our vendors, could severely damage our reputation, expose us to the risk of litigation and liability, disrupt our operations and have a material adverse effect on our business.

 

Ethics or Conflict of Interest Issues could Damage Our Reputation — We have established a Code of Conduct and related policies and procedures to address the ethical conduct of business and to avoid potential conflicts of interest. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our related controls and procedures or failure to comply with the established Code of Conduct could have a material adverse effect on our reputation, business, results of operations,and/orfinancial condition.

 

 

We are Subject to Lending Concentration Risks — As of December 31, 2006, approximately 64% of our loan portfolio consisted of commercial, financial, and agricultural, real estate construction, commercial real estate loans, and lease financing (collectively, “commercial loans”). Commercial loans are generally viewed as having more inherent risk of default than residential mortgage loans or retail loans. Also, the commercial loan balance per borrower is typically larger than that for residential mortgage loans and retail loans, inferring higher potential losses on an individual loan basis. Because our loan portfolio contains a growing number of commercial loans with balances over a $25 million internal threshold, the deterioration of one or a few of these loans could cause a significant increase in nonperforming loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses, and an increase in loan charge offs, all of which could have a material adverse effect on our financial condition and results of operations.

 

Changes in Economic and Political Conditions could Adversely Affect Our Earnings, as Our Borrowers’ Ability to Repay Loans and the Value of the Collateral Securing Our Loans Decline — Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies.

Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings. Consequently, any decline in the economy in our market area could have a material adverse effect on our financial condition and results of operations.

 

Our Allowance for Loan Losses may be Insufficient — All borrowers carry the potential to default and our remedies to recover (seizureand/or sale of collateral, legal actions, guarantees, etc.) may not fully satisfy money previously lent. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable credit losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance for loan losses reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks using existing qualitative and quantitative information, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of additional loan charge offs, based on judgments different than those of management. An increase in the allowance for loan losses results in a decrease in net income, and possibly risk-based capital, and may have a material adverse effect on our financial condition and results of operations.

 

We are Subject to Environmental Liability Risk Associated with Lending Activities — A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

 

Lack of System Integrity or Credit Quality Related to Funds Settlement could Result in a Financial Loss — We settle funds on behalf of financial institutions, other businesses and consumers and receive funds from clients, card issuers, payment networks and consumers on a daily basis for a variety of transaction types. Transactions facilitated by us include debit card, credit card and electronic bill payment transactions, supporting consumers, financial institutions and other businesses. These payment activities rely upon the technology infrastructure that facilitates the verification of activity with counterparties and the facilitation of the payment. If the continuity of operations or integrity of processing were compromised this could result in a financial loss to us due to a failure in payment facilitation. In addition, we may issue credit to consumers, financial institutions or other businesses as part of the funds settlement. A default on this credit by a counterparty could result in a financial loss to us.

 

Financial Services Companies Depend on the Accuracy and Completeness of Information about Customers and Counterparties — In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into

unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

 

 

Liquidity is Essential to Our Businesses — Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

 

We Rely on Dividends from Our Subsidiaries for most of Our Revenue — Our Parent Company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on our common stock, repurchase our common stock, and to pay interest and principal on our Parent Company’s debt. Various federaland/or state laws and regulations limit the amount of dividends that Associated Bank, National Association, and certain nonbank subsidiaries may pay to the Parent Company. Also, the Parent Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event Associated Bank, National Association, is unable to pay dividends to the Parent Company, the Parent Company may not be able to service debt, pay obligations, or pay dividends on our common stock. The inability to receive dividends from Associated Bank, National Association, could have a material adverse effect on our business, financial condition, and results of operations.

 

 

We are Subject to Interest Rate Risk — Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

Although management believes it has implemented effective asset and liability management strategies, including the limited use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.

 

The Impact of Interest Rates on Our Mortgage Banking Business can be Large and Complex — Changes in interest rates can impact our mortgage related revenues. A decline in mortgage rates generally increases the demand for mortgage loans as borrowers refinance, but also generally leads to accelerated payoffs. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in payoffs. Although we use models to assess the impact of interest rates on mortgage related revenues, the estimates of revenues produced by these models are dependent on estimates and assumptions of future loan demand, prepayment speeds and other factors which may differ from actual subsequent experience.

 

Changes in Interest Rates could also Reduce the Value of Our Mortgage Servicing Rights and Earnings — We have a portfolio of mortgage servicing rights. A mortgage servicing right (MSR) is the right to service a mortgage loan (i.e, collect principal, interest, escrow amounts, etc.) for a fee. We acquire MSRs when we originate mortgage

loans and keep the servicing rights after we sell or securitize the loans or when we purchase the servicing rights to mortgage loans originated by other lenders. We carry MSRs at the lower of amortized cost or estimated fair value. Fair value is the present value of estimated future net servicing income, calculated based on a number of variables, including assumptions about the likelihood of prepayment by borrowers.

 

Changes in interest rates can affect prepayment assumptions and thus fair value. When interest rates fall, borrowers are more likely to prepay their mortgage loans by refinancing them at a lower rate. As the likelihood of prepayment increases, the fair value of our MSRs can decrease. Each quarter we evaluate our MSRs for impairment based on the difference between carrying amount and fair value at quarter end. If temporary impairment exists, we establish a valuation allowance through a charge to earnings for the amount the carrying amount exceeds fair value. We also evaluate our MSRs forother-than-temporaryimpairment. If we determine thatother-than-temporaryimpairment exists, we will recognize a direct write-down of the carrying value of the MSRs.

 

 

We are Subject to Extensive Government Regulation and Supervision — We, primarily through Associated Bank, National Association, and certain nonbank subsidiaries, are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds, and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer,and/orincrease the ability of nonbanks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties,and/orreputation damage, which could have a material adverse effect on our business, financial condition, and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

 

We are Subject to Examinations and Challenges by Tax Authorities — We are subject to federal and state income tax regulations. Income tax regulations are often complex and require interpretation. Changes in income tax regulations could negatively impact our results of operations. In the normal course of business, we are routinely subject to examinations and challenges from federal and state tax authorities regarding the amount of taxes due in connection with investments we have made and the businesses in which we have engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base, apportionment and tax credit planning. The challenges made by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in our favor, they could have a material adverse effect on our financial condition and results of operations.

 

We are Subject to Claims and Litigation Pertaining to Fiduciary Responsibility — From time to time, customers make claims and take legal action pertaining to the performance of our fiduciary responsibilities. Whether customer claims and legal action related to the performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liabilityand/oradversely affect the market perception of us and our products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

 

We may be a Defendant in a Variety of Litigation and Other Actions, Which may have a Material Adverse Effect on our Financial Condition and Results of Operation — We may be involved from time to time in a variety of litigation arising out of our business. Our insurance may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect

on our financial condition and results of operation. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.

 

 

Changes in Our Accounting Policies or in Accounting Standards could Materially affect how We Report Our Financial Results and Condition — Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

 

From time to time the Financial Accounting Standards Board (FASB) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

 

Our Internal Controls may be Ineffective — Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, and financial condition.

 

Impairment of Goodwill or Other Intangible Assets could Require Charges to Earnings, which could Result in a Negative Impact on Our Results of Operations — Under current accounting standards, goodwill and certain other intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of goodwill and such other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified.

 

We may not be able to Attract and Retain Skilled People — Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the best people in most activities engaged in by us can be intense and we may not be able to hire sufficiently skilled people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. We do not currently have employment agreements with any of our executive officers.

 

Loss of Key Employees may Disrupt Relationships with Certain Customers — Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While we believe our relationship with our key producers is good we cannot guarantee that all of our key personnel will remain with our organization. Loss of such key personnel, should they enter into an employment relationship with one of our competitors, could result in the loss of some of our customers.

 

Because the Nature of the Financial Services Business Involves a High Volume of Transactions, We Face Significant Operational Risks — We operate in many different businesses in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational

deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to our reputation.

 

We Rely on Other Companies to Provide Key Components of Our Business Infrastructure — Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

 

Revenues from Our Investment Management and Asset Servicing Businesses are Significant to Our Earnings — Generating returns that satisfy clients in a variety of asset classes is important to maintaining existing business and attracting new business. Administering or managing assets in accordance with the terms of governing documents and applicable laws is also important to client satisfaction, and failure to do so can generate liability.

 

Our Information Systems May Experience an Interruption or Breach in Security — We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of our information systems, we cannot assure you that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

The Potential for Business Interruption Exists Throughout Our Organization - Integral to our performance is the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and the vast array of associates and key executives in ourday-to-dayand ongoing operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or technical failures, ineffectiveness or exposure due to interruption in third party support as expected, as well as, the loss of key individuals or failure on the part of key individuals to perform properly.

 

None.

 

Our headquarters are located in the Village of Ashwaubenon, Wisconsin, in a leased facility with approximately 30,000 square feet of office space. We entered into a five-year lease with one consecutive five-year extension and are currently 3 years into the five-year extension.

 

At December 31, 2006, our bank subsidiary occupied 314 offices in approximately 180 different communities within Illinois, Minnesota, and Wisconsin. The main office of Associated Bank, National Association, is owned. Most bank subsidiary branch offices are freestanding buildings that provide adequate customer parking, including drive-through facilities of various numbers and types for customer convenience. Some bank branch offices are in supermarket locations or in retirement communities. In addition, we own other real property that, when considered in aggregate, is not material to our financial position.

 

In the ordinary course of business, the Corporation may be named as defendant in or be a party to various pending and threatened legal proceedings. Since it is not possible to formulate a meaningful opinion as to the range of possible outcomes and plaintiffs’ ultimate damage claims, management cannot estimate the specific possible loss or range of loss that may result from these proceedings. Management believes, based upon current knowledge, that liabilities arising out of any such current proceedings will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Corporation.

 

There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2006.

 

Information in response to this item is incorporated by reference to the discussion of dividend restrictions in Note 10, “Stockholders’ Equity,” of the notes to consolidated financial statements included under Item 8 of this document. The Corporation’s common stock is traded on The Nasdaq Stock Market LLC under the symbol ASBC.

 

The approximate number of equity security holders of record of common stock, $.01 par value, as of February 14, 2007, was 11,400. Certain of the Corporation’s shares are held in “nominee” or “street” name and the number of beneficial owners of such shares is approximately 36,000.

 

Payment of future dividends is within the discretion of the Board of Directors and will depend, among other factors, on earnings, capital requirements, and the operating and financial condition of the Corporation. At the present time, the Corporation expects that dividends will continue to be paid in the future.

 

Following are the Corporation’s monthly common stock purchases during the fourth quarter of 2006. For a detailed discussion of the common stock repurchase authorizations and repurchases during the period, see section “Capital” included under Item 7 of this document and Note 10, “Stockholders’ Equity,” of the notes to consolidated financial statements included under Item 8 of this document.

 

 

In March 2006 the Board of Directors authorized the repurchase of the Corporation’s outstanding shares, not to exceed approximately 6.8 million shares. During the fourth quarter of 2006, the Corporation repurchased 2.0 million shares of its outstanding common stock for approximately $65 million (or $32.40 per share) under an accelerated share repurchase agreement and settled a previously announced 2006 accelerated share repurchase agreement in shares. At December 31, 2006, approximately 1.4 million shares remain authorized to repurchase under the March 2006 authorization.

 

 

The following represents selected market information of the Corporation for 2006 and 2005.

 

 

Annual dividend rate: $1.16

 

Set forth below is a line graph (and the underlying data points) comparing the yearly percentage change in the cumulative total shareholder return (change in year-end stock price plus reinvested dividends) on Associated’s common stock with the cumulative total return of the Nasdaq Bank Index and the S&P 500 Index for the period of five fiscal years commencing on January 1, 2002, and ending December 31, 2006. The Nasdaq Bank Index is prepared for Nasdaq by the Center for Research in Securities Prices at the University of Chicago. The graph assumes that the value of the investment in Common Stock and for each index was $100 on December 31, 2001. Historical stock price performance shown on the graph is not necessarily indicative of the future price performance.

 

 

 

The Stock Price Performance Graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Statement onForm 10-Kinto any filing under the Securities Act or under the Exchange Act, except to the extent Associated specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.

 

 

 

 

The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of the Corporation. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.

 

The detailed financial discussion that follows focuses on 2006 results compared to 2005. Discussion of 2005 results compared to 2004 is predominantly in section “2005 Compared to 2004.”

 

Management continually evaluates strategic acquisition opportunities and other various strategic alternatives that could involve the sale or acquisition of branches or other assets, or the consolidation or creation of subsidiaries. Therefore, the financial discussion that follows may refer to the effect of the Corporation’s business combination activity, detailed under section, “Business Combinations,” and Note 2, “Business Combinations,” of the notes to consolidated financial statements. The Corporation announced in January 2007 the signing of a definitive agreement to acquire a community bank with total assets of approximately $0.4 billion, which is expected to close in mid-2007 (see section “Subsequent Events”).

 

 

The Corporation is a bank holding company headquartered in Wisconsin, providing a diversified range of banking and nonbanking services to individuals and businesses primarily in its three-state footprint (Wisconsin, Illinois and Minnesota). The Corporation, through its wholly owned banking subsidiary, provides a wide range of services, including business and consumer loan and depository services, as well as other traditional banking services. Through its nonbanking subsidiaries, the Corporation’s wealth business provides a variety of products and services to supplement the banking business including insurance, brokerage, and trust/asset management.

 

The Corporation’s recent acquisition activity impacts financial results between the annual periods, as 2006 includes full year operating results of State Financial Services Corporation (“State Financial”), a $2 billion financial services company at acquisition, while 2005 includes three months of State Financial operating results. See also section “Business Combinations” and Note 2, “Business Combinations,” of the notes to consolidated financial statements.

 

The Corporation’s primary sources of revenue are net interest income (predominantly from loans and deposits, and also from investment securities and other funding sources), and noninterest income, particularly fees and other revenue from financial services provided to customers or ancillary services tied to loans and deposits. Business volumes and pricing drive revenue potential, and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth, and competitive conditions within the marketplace as well.

 

In 2006, the Corporation actively managed its balance sheet, balancing the commitment to penetrate growth markets with disciplined pricing and awareness of softer lending sectors, as well as reducing borrowings and investments in the inverted/flat yield curve environment and repurchasing stock. The Corporation made meaningful progress toward improving the quality of its earnings (i.e., increasing earnings potential from core banking and the wealth business) and carrying out its strategic objectives. Wholesale funding was measurably reduced, core fee-based revenues increased, and asset quality was maintained. Even with the progress in these key areas, the 2006 operating and rate environments were challenging, and as a result, net income in 2006 was $317 million (1% lower than 2005), diluted earnings per share of $2.38 (2% lower than 2005), net interest margin of 3.62% (compared to 3.64% for 2005), and net charge offs to average loans of 0.12% (compared to 0.09% for 2005).

 

From year-end 2005 to year-end 2006, the Corporation reduced higher-costing wholesale borrowings by nearly $2 billion, and decreased lower-yielding assets by more than $1 billion. This shrinking of the balance sheet impacted net interest income in absolute terms, leaving 2006 net interest income and average earning assets relatively unchanged from 2005 (down 0.4% and up 0.3%, respectively). However, the restructuring of the balance sheet, coupled with growth in average deposits (up 9% between 2006 and 2005), contributed to the net interest margin improving in each of the last three quarters of 2006, despite the unfavorable yield curve.

 

Increasing net interest income and growth in loans and deposits are the Corporation’s greatest opportunities for 2007 earnings growth. Yet, these are also subject to various risks, such as competitive pricing pressures that are expected to continue in 2007, softening loan markets (particularly commercial real estate in our footprint), future changes in customer behavior relative to loan and deposit products, and challenges to deposit growth (as noted below). Additionally, without normalization and steepening of the yield curve, we expect continued pressure on the net interest margin in 2007 and possible margin compression, despite our balance sheet management efforts in 2006. We believe that our strategy of allocating more resources into our higher growth markets (such as Milwaukee and Madison, Wisconsin, Chicago, Illinois, and Minneapolis, Minnesota) from our more mature markets and a continued discipline in product pricing will enhance the franchise and improve the trajectory of growth.

 

Total deposits grew $0.7 billion or 5% between year-end 2006 and 2005. Deposit growth remains a key factor behind improving net interest income and the quality of earnings in 2007. Yet competition for deposits has increased in recent years. Challenges to deposit growth include a cyclical decline in deposits historically experienced during the first quarter, price increases on deposit products given the rate environment, other competitive pricing pressures, and customer preference for higher-costing deposit products or to non-deposit investment alternatives. We anticipate our focus on deposit growth initiatives, particularly toward business customers, coupled with our incentive programs should aid 2007 deposit growth, coming principally in the second half of 2007.

 

Total loans declined $0.3 billion (2%) between year-end 2006 and 2005; however, excluding a $0.3 billion transfer of residential mortgages to loans held for sale in December 2006, loans were unchanged. Commercial, financial, and agricultural loans grew $260 million (8%) and home equity grew $140 million (7%), offsetting decreases in residential mortgage and installment loans, while commercial real estate loans (including real estate construction) were level. Loan growth in 2006 was tempered in part by the Corporation purposefully adhering to its risk/reward pricing discipline (particularly in commercial real estate and residential mortgage), as well as from competitive pricing in the inverted/flat yield curve environment, and lower loan demand in general. For 2007, loan demand is expected to be similar to 2006, yet our increased sales focus in targeted markets and on commercial and industrial customers is anticipated to improve 2007 loan growth, particularly starting in the second half of 2007.

 

Asset quality measures deteriorated during 2006 from the strong levels experienced during 2005, though were comparable to the levels of 2004. Nonperforming loans in absolute terms were up 44% (from $99 million at year-end 2005 to $142 million for 2006), and grew as a percentage of total loans (from 0.65% at year-end 2005 to 0.96% at year-end 2006), with $40 million of the increase coming from several large commercial credits among various industries. For 2006, net charge offs to average loans were reasonably controlled (at 0.12% versus 0.09% for 2005), and the provision for loan losses (at $19 million versus $13 million for 2005) approximated net charge offs each year. At December 31, 2006, the allowance for loan losses to loans ratio of 1.37% was deemed adequate by management, covering 143% of nonperforming loans, compared to 1.34% at December 31, 2005, covering 206% of nonperforming loans. Management expects that the 2007 provision for loan losses will be higher than in 2006, but anticipates it will be commensurate with loan growth, credit quality indicators, net charge off levels, and unique circumstances of individual credits.

 

Noninterest income of $296 million in 2006 was up $4 million (2%) over 2005, with moderate increases in core fee-based revenues reduced by a decline in net mortgage banking income. The majority of noninterest income comes from core fee-based revenues, which include trust service fees, service charges on deposit accounts, card-based and other nondeposit fees, and retail commissions. Core fee-based revenues totaled $233 million in 2006, up $17 million (8%) over 2005, due to a combination of increased volumes and improved pricing. Net mortgage banking income, representing a smaller portion of noninterest income, was $15 million for 2006, $22 million lower than 2005, with the majority of the decline attributable to a $2 million unfavorable market valuation adjustment associated with the December 2006 transfer of $0.3 billion of portfolio residential mortgage loans to loans held for sale, a $5 million gain on a bulk servicing sale in fourth quarter 2005, and less favorable valuation recoveries (down $5 million) on the mortgage servicing rights asset between 2006 and 2005. Cross selling of services and greater penetration into higher-growth markets remain as priorities, and pricing and product offerings are routinely evaluated; therefore, core fee-based revenues are expected to improve in 2007. The Corporation also continues to evaluate risk/reward of its mortgage portfolio serviced for others, as well as other banking products, services and locations, and may take actions in 2007 to recover the capital invested in such that provide lower overall returns.

 

Noninterest expense of $496 million grew a modest 3% over 2005, reflecting rising costs and a larger operating base on average between 2006 and 2005, mitigated by lower performance-based bonuses and monitored discretionary spending. Personnel expenses were up 3%, as the Corporation paid on average 3% more full time equivalent employees during 2006 than during 2005, paid merit increases in 2006 and incurred higher health benefit costs between the years. These increases were offset in part by lower performance-based bonuses in light of 2006 corporate financial resultsand/orbusiness line/regional performance results. Nonpersonnel noninterest expenses on an aggregate basis were up nearly 4% primarily due to the larger average operating base of the company, and generally rising costs, mitigated partly by controlling discretionary spending. The efficiency ratio (defined as noninterest expense divided by “total revenue,” with total revenue calculated as the sum of taxable equivalent net interest income plus noninterest income, excluding net asset and securities gains) was 50.31% for 2006 and 48.99% for 2005. Noninterest expense will increase in 2007 as employment costs rise, particularly considering higher variable incentives expected to be earned, health benefits, and stock awards expense, as well as internal efforts toward converting operational systems to a different platform by early 2008. The Corporation remains committed to monitoring costs.

 

 

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 expense 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 loan losses, mortgage servicing rights valuation, derivative financial instruments and hedging activities, 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 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.

 

Allowance for Loan Losses: Management’s evaluation process used to determine the adequacy of the allowance for loan losses is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors: management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience, trends in past due and nonperforming 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 adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Corporation believes the allowance for loan losses is adequate as recorded in the consolidated financial statements. See Note 1, “Summary of Significant Accounting Policies,” and Note 4, “Loans,” of the notes to consolidated financial statements and section “Allowance for Loan Losses.”

 

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 internal discounted cash flow model to estimate the fair value of its mortgage servicing rights. The use of an internal 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 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. In addition, the Corporation consults periodically with third parties as to the assumptions used and to determine that the Corporation’s valuation is consistent with the third party valuation. While the Corporation believes that the values produced by its internal 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. To better understand the sensitivity of the impact on prepayment speeds to changes in interest rates, if mortgage interest rates moved up 50 basis points (“bp”) at December 31, 2006 (holding all other factors unchanged), it is anticipated that prepayment speeds would have slowed and the modeled estimated value of mortgage servicing rights could have been $2 million higher than that determined at December 31, 2006 (leading to more valuation allowance reversal and an increase in net mortgage banking income). Conversely, if mortgage interest rates moved down 50 bp, prepayment speeds would have likely increased and the modeled estimated value of mortgage servicing rights could have been $2 million lower (leading to adding more valuation allowance and a decrease in net mortgage banking income). 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. The Corporation believes the mortgage servicing rights asset is properly recorded in the consolidated financial statements. See Note 1, “Summary of Significant Accounting Policies,” and Note 5, “Goodwill and Intangible Assets,” of the notes to consolidated financial statements and section “Noninterest Income.”

 

Derivative Financial Instruments and Hedge Accounting: In various aspects of its business, the Corporation uses derivative financial instruments to modify exposures to changes in interest rates and market prices for other financial instruments. Derivative instruments are required to be carried at fair value on the balance sheet with changes in the fair value recorded directly in earnings. To qualify for and maintain hedge accounting, the Corporation must meet formal documentation and effectiveness evaluation requirements both at the hedge’s inception and on an ongoing basis. The application of the hedge accounting policy requires strict adherence to documentation and effectiveness testing requirements, judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings, and measurement of changes in the fair value of hedged items. If in the future derivative financial instruments used by the Corporation no longer qualify for hedge accounting, the impact on the consolidated results of operations and reported earnings could be significant. When hedge accounting is discontinued, the Corporation would continue to carry the derivative on the balance sheet at its fair value; however, for a cash flow derivative changes in its fair value would be recorded in earnings instead of through other comprehensive income, and for a fair value derivative the changes in fair value of the hedged asset or liability would no longer be recorded through earnings. Effective in second quarter 2005, the Corporation determined that the hedge accounting applied to certain interest rate swaps and an interest rate cap needed to be changed under the requirements of Statement of Financial Accounting Standard (“SFAS”) 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”). Consequently, the Corporation recorded a $6.7 million loss in other income effective for the quarter ended June 30, 2005, which after tax was a $4.0 million reduction to net income, or $0.03 to both basic and diluted earnings per share in that quarter. Certain derivative instruments that lost hedge accounting treatment were terminated in the third quarter of 2005 at a net gain of $1.0 million recorded in other income. Prior to March 31, 2006, the Corporation had been using the short cut method of assessing hedge effectiveness for a fair value hedge with $175 million notional balance, hedging a long-term, fixed-rate subordinated debenture. Effective March 31, 2006, the Corporation de-designated the hedging relationship under the short cut method and re-designated the hedging relationship under a long-haul method utilizing the same instruments. This hedging relationship accounts for the majority of ineffectiveness recorded in 2006. In December 2006, the Corporation terminated all swaps hedging long-term, fixed-rate commercial loans for a net gain of approximately $0.8 million. At December 31, 2006, the only remaining hedge accounting is on interest rate swaps hedging a $175 million long-term, fixed-rate subordinated debenture. See also Note 1, “Summary of Significant

Accounting Policies,” and Note 15, “Derivative and Hedging Activities,” of the notes to consolidated financial statements and section “Interest Rate Risk.”

 

Income Tax Accounting: 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 codes. 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. The Corporation believes the tax assets and liabilities are adequate and properly recorded in the consolidated financial statements. See Note 1, “Summary of Significant Accounting Policies,” and Note 13, “Income Taxes,” of the notes to consolidated financial statements and section “Income Taxes.”

 

 

The Corporation’s business combination activity is detailed in Note 2, “Business Combinations,” of the notes to consolidated financial statements. All the Corporation’s business combinations since 2002 were accounted for under the purchase method of accounting; thus, the results of operations of the acquired institutions prior to their respective consummation dates were not included in the accompanying consolidated financial statements. In each acquisition, the excess cost of the acquisition over the fair value of the net assets acquired were allocated to the identifiable intangible assets, if any, with the remainder then allocated to goodwill.

 

In 2005 there was one completed business combination: State Financial Services Corporation (“State Financial”): On October 3, 2005, the Corporation consummated its acquisition of 100% of the outstanding shares of State Financial. Based on the terms of the agreement, the consummation of the transaction included the issuance of approximately 8.4 million shares of the Corporation’s common stock and $11 million in cash. As of the acquisition date, State Financial was a $2 billion financial services company based in Milwaukee, Wisconsin, with 29 banking branches in southeastern Wisconsin and northeastern Illinois, providing commercial and retail banking products. The Corporation expected to expand its branch distribution network, improve its operational efficiencies, and increase revenue streams with the State Financial acquisition. During the fourth quarter of 2005, the Corporation integrated and converted State Financial onto its centralized operating systems and merged State Financial into its banking subsidiary, Associated Bank, National Association.

 

In 2004 there were two completed business combinations: First Federal Capital Corp (“First Federal”): On October 29, 2004, the Corporation consummated its acquisition of 100% of the outstanding shares of First Federal, based in La Crosse, Wisconsin. Based on the terms of the agreement, the consummation of the transaction included the issuance of approximately 19.4 million shares of the Corporation’s common stock and $75 million in cash. As of the acquisition date, First Federal operated a $4 billion savings bank with over 90 banking locations serving more than 40 communities in Wisconsin, northern Illinois, and southern Minnesota, building upon and complementing the Corporation’s footprint. As a result of the acquisition, the Corporation expected to enhance its current branch distribution (including supermarket locations which were new to the Corporation’s distribution model), improve its operational and managerial efficiencies, increase revenue streams, and strengthen its community banking model. In February 2005, the Corporation completed its conversion of First Federal onto its centralized operating systems and merged the thrift charter into its banking subsidiary, Associated Bank, National Association.

 

Jabas Group, Inc. (“Jabas”): On April 1, 2004, the Corporation (through its subsidiary, Associated Financial Group, LLC) consummated its cash acquisition of 100% of the outstanding shares of Jabas. Jabas is an insurance agency specializing in employee benefit products headquartered in Kimberly, Wisconsin. Jabas operates as part of Associated Financial Group, LLC.

 

 

As described in Part I, Item I section “Services,” and in Note 20, “Segment Reporting,” of the notes to consolidated financial statements, the Corporation’s primary reportable segment is banking. Banking consists of lending and deposit gathering (as well as other banking-related products and services) to businesses, governments, and consumers and the support to deliver, fund, and manage such banking services. The Corporation’s wealth management segment provides products and a variety of fiduciary, investment management, advisory, and

Corporate agency services to assist customers in building, investing, or protecting their wealth, including insurance, brokerage, and trust/asset management.

 

Note 20, “Segment Reporting,” of the notes to consolidated financial statements, indicates that the banking segment represents 90% of total revenues in 2006, as defined in the Note. The Corporation’s profitability is predominantly dependent on net interest income, noninterest income, the level of the provision for loan losses, noninterest expense, and taxes of its banking segment. The consolidated discussion therefore predominantly describes the banking segment results. The critical accounting policies primarily affect the banking segment, with the exception of income tax accounting, which affects both the banking and wealth management segments (see section “Critical Accounting Policies”).

 

The contribution from the wealth management segment compared to consolidated net income and total revenues (as defined and disclosed in Note 20, “Segment Reporting,” of the notes to consolidated financial statements) was 6% and 10% for 2006, compared to 5% and 9%, respectively, for 2005, and 5% and 10%, respectively, for 2004. Wealth management segment revenues were up $9 million (10%) between 2006 and 2005, and up $13 million (16%) between 2005 and 2004. Wealth management segment expenses were up $7 million (11%) between 2006 and 2005, and up $7 million (12%) between 2005 and 2004. Wealth management segment assets (which consist predominantly of cash equivalents, investments, customer receivables, goodwill and intangibles) were up $5 million between year-end 2006 and 2005, and up $9 million between year-end 2005 and 2004. The $9 million increase in wealth management segment revenues between 2006 and 2005 was attributable principally to higher trust service fees and insurance commissions, while the $7 million increase in expenses between 2006 and 2005 was primarily a function of higher personnel and other general operating costs. The $5 million increase in wealth management segment assets from 2005 to 2006 was comprised largely of higher levels of cash and cash equivalents. Increases to revenues, expenses, and assets of the segment between 2005 and 2004 are principally due to the Jabas acquisition (April 2004). The major components of wealth management revenues are trust fees, insurance fees and commissions, and brokerage commissions, which are individually discussed in section “Noninterest Income.” The major expenses for the wealth management segment are personnel expense (between 71% and 74% for 2006, 2005, and 2004), as well as occupancy, processing, and other costs, which are covered generally in the consolidated discussion in section “Noninterest Expense.” See also Note 2, “Business Combinations,” and Note 5, “Goodwill and Intangible Assets,” of the notes to consolidated financial statements for additional disclosure.

 

 

The Corporation’s recent acquisition activity impacts financial results between the annual periods, as 2006 includes full year operating results of the State Financial acquisition, while 2005 includes three months of State Financial operating results.

 

The Corporation recorded net income of $316.6 million for the year ended December 31, 2006, a decrease of $3.5 million or 1.1% from 2005. Basic earnings per share for 2006 were $2.40, a 2.0% decrease from 2005 basic earnings per share of $2.45. Earnings per diluted share were $2.38, a 2.1% decrease from 2005 diluted earnings per share of $2.43. Return on average assets was 1.50% for 2006 compared to 1.53% for 2005. Return on average equity was 13.89% and 15.24% for 2006 and 2005, respectively. Cash dividends of $1.14 per share paid in 2006 increased by 7.5% over 2005. Key factors behind these results are discussed below.

 

 

 

 

 

Net interest income in the consolidated statements of income (which excludes the taxable equivalent adjustment) was $669.5 million in 2006 compared to $672.3 million in 2005. The taxable equivalent adjustments (the adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that income been subject to a taxation using a 35% tax rate) of $26.2 million and $25.5 million for 2006 and 2005, respectively, resulted in fully taxable equivalent net interest income of $695.8 million in 2006 and $697.8 million in 2005.

 

Net interest income is the primary source of the Corporation’s revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, repricing frequencies, and the use of interest rate swaps and caps.

 

Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and stockholders’ equity, also support earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt loans and securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

 

Table 2 provides average balances of earning assets and interest-bearing liabilities, the associated interest income and expense, and the corresponding interest rates earned and paid, as well as net interest income, interest rate spread, and net interest margin on a taxable equivalent basis for the three years ended December 31, 2006. Tables 3 through 5 present additional information to facilitate the review and discussion of taxable equivalent net interest income, interest rate spread, and net interest margin.

 

Taxable equivalent net interest income of $695.8 million for 2006 was $2.0 million or 0.3% lower than 2005. The decrease in taxable equivalent net interest income was a function of unfavorable interest rate changes (as the impact of changes in the interest rate environment and product pricing reduced taxable equivalent net interest income by $21.5 million), substantially offset by favorable volume variances (with balance sheet changes in both volume and mix adding $19.5 million to taxable equivalent net interest income). The growth and change in mix of earning assets added $20.9 million to taxable equivalent net interest income, while the growth and composition of interest-bearing liabilities cost an additional $1.4 million, for a net favorable volume impact of $19.5 million. Rate changes on earning assets increased interest income by $165.2 million, while changes in rates on interest-bearing liabilities raised interest expense by $186.7 million, for a net unfavorable rate impact of $21.5 million. See additional discussion in section “Interest Rate Risk.”

 

The net interest margin for 2006 was 3.62%, compared to 3.64% in 2005. The 2 bp compression in net interest margin was attributable to a 19 bp decrease in interest rate spread (the net of a 114 bp increase in the cost of interest-bearing liabilities and a 95 bp increase in the yield on earning assets), largely offset by 17 bp higher contribution from net free funds (attributable to the higher interest rate environment in 2006 which increased the value of noninterest-bearing demand deposits, a principal component of net free funds).

 

The Federal Reserve raised interest rates by 300 bp since the beginning of 2005. At December 31, 2006 the Federal Funds rate was 5.25%, 100 bp higher than 4.25% at December 31, 2005. On average, the Federal funds rate was 4.97% for 2006, 177 bp higher than 2005, and the prime rate was 7.96% for 2006, 177 bp higher than the previous year. The prolonged flattening of the yield curve (i.e., rising short-term interest rate without commensurate increases to longer-term rates), together with competitive pricing on both loans and deposits put downward pressure on the interest rate spread.

 

For 2006, the yield on earning assets of 6.79% was 95 bp higher than 2005, aided in part by higher-yielding loans representing a larger percentage of earning assets. Loan yields increased 101 bp (to 7.22%). Although short-term interest rates were rising throughout all of 2005 and the first half of 2006, the favorable impact on loan yields was moderated by competitive pricing on new and refinanced loans in the flatter yield curve environment and the portion of the loan portfolio that is fixed rate and, therefore, not subject to repricing. The yield on securities and short-term investments increased 36 bp (to 5.08%), favorably impacted, in part, by the sale of $0.7 billion of a pool of lower-yielding investment securities in March 2006. See Note 3, “Investment Securities,” of the notes to consolidated financial statements and section, “Investment Securities Portfolio,” for additional information on the March 2006 investment securities sale. Overall, earning asset rate changes added $165.2 million to interest income, the

combination of $148.2 million higher interest on loans and $17.0 million higher interest on securities and short-term investments.

 

The cost of interest-bearing liabilities of 3.71% in 2006 was 114 bp higher than 2005, principally reflecting the higher interest rate environment, yet benefiting in part as lower-costing interest-bearing deposits represented a greater percentage of interest-bearing liabilities. The average cost of interest-bearing deposits was 3.23% in 2006, 114 bp higher than 2005, given aggressive pricing to attract and retain business and municipal deposits. In addition, as interest rates rose, most interest-bearing deposit products repriced and customers switched balances from lower-priced transaction accounts to higher paying deposit products. The cost of wholesale funds (comprised of short-term borrowings and long-term funding) increased 140 bp to 4.76% for 2006. The cost of short-term borrowings, most directly impacted by increases in the Federal Funds rate, was up 168 bp to 4.91%, while long-term funding costs increased by 116 bp to 4.62%. The interest-bearing liability rate changes resulted in $186.7 million higher interest expense, with $111.7 million attributable to interest-bearing deposits and $75.0 million due to wholesale funding.

 

Average earning assets were $19.2 billion in 2006, up slightly ($48,000 or 0.3%) from 2005, with the full year impact of State Financial and organic growth adding to earning assets, while corporate initiatives reduced the level of investment securities. Loan balances grew $1.0 billion, or 7.1%, to an average of $15.4 billion in 2006 and represented 79.9% of average earning assets compared to 74.8% for 2005. The overall growth in average loans was comprised of increases in commercial loans (up $952 million or 11.1%) and retail loans (up $185 million or 6.4%), offset by a decrease in residential mortgage loans (down $115 million or 4.0%). Balances of average securities and short-term investments combined were lower by $1.0 billion, or 20.2%, due principally to the corporate initiative whereby cash flows from maturing or sold investments were not reinvested, but used to reduce wholesale funding and repurchase stock. Taxable equivalent interest income in 2006 increased $20.9 million due to earning asset volume changes, the net of a $69.9 million increase from loan growth and a $49.0 million reduction in securities and short-term investments.

 

Average interest-bearing liabilities of $16.4 billion in 2006 were up nominally ($24,000 or 0.1%) versus 2005, while net free funds increased $24 million, or 0.9%. Average interest-bearing deposits grew $1.1 billion, or 10.5%, to $11.3 billion while average noninterest-bearing demand deposits (a component of net free funds) increased by $90 million, or 4.0%, to $2.3 billion. Average interest-bearing deposits represented 68.6% of average interest-bearing liabilities for 2006, compared to 62.2% for 2005. Average wholesale funding balances decreased by $1.0 billion, with long-term funding down $930 million and short-term borrowings down $117 million, as a result of the wholesale funding reduction strategy cited above. On average for 2006, long-term funding represented 15.3% of interest-bearing liabilities compared to 21.0% for 2005. In 2006, interest expense increased $1.4 million due to volume changes, with a $39.2 million increase due to growth in interest-bearing deposits, substantially offset by a $37.8 million decline from lower volumes of wholesale funding.