ASB - Associated Banc-Corp Is Too Cheap Even Though Risks Are Low

2023-04-27 21:08:59 ET

Summary

• I’ve decreased my earnings estimate because I’ve revised downwards both my loan growth and margin estimates. Nevertheless, I’m expecting earnings to grow this year.
• The risk level appears low because ASB has enough liquidity to completely cover uninsured deposits without feeling compelled to sell its securities at a loss.
• The December 2023 target price suggests a very high upside from the current market price. Further, ASB is offering a high dividend yield.

Earnings of Associated Banc-Corp ( ASB ) will most probably continue to grow this year on the back of loan growth. I’m expecting the company to report earnings of $2.63 per share for 2023, up 12% year-over-year. Compared to my last report on the company, I’ve slightly reduced my earnings estimate because I’ve revised downwards both my loan growth and margin estimates. The year-end target price suggests a very high upside from the current market price. Further, the risk level appears low compared to other banks. Therefore, I’m maintaining a buy rating on ASB stock.

Revising Down my Loan Growth Estimate

As expected, loan growth slowed down to 1.4% in the first quarter of 2023 from 3.5% in the fourth quarter of 2022. Loan growth will likely slow down even further in the second quarter because interest rates are now higher. Further, Associated Banc-Corp decided to terminate its third-party originated mortgage business during the first quarter. This too will weaken loan growth in the year ahead.

One factor that is still positive for loan growth is the strong job market. Associated Banc-Corp is well diversified geographically with loan production offices in Indiana, Michigan, Missouri, New York, Ohio, and Texas. Therefore, the national average is a good proxy for Associated Banc-Corp’s markets. The Federal Reserve projects the unemployment rate to rise in the country, but it will still remain low compared to the last decade.

The management has reduced its loan growth projection from 7%-9% to 6%-8% and core-customer deposit projection from 3%-5% to 1%-3%, as mentioned in the earnings presentation . Considering the factors mentioned above, especially the third-party business shutdown, I’m revising downwards my loan growth estimate to 5.2% from my previous estimate of 6.1%.

Further, I’m expecting deposits to grow in line with loans. I was pleased to see that the deposit run that plagued SVB Financial ( OTC:SIVBQ ) and First Republic Bank ( FRC ) in March didn’t seem to affect Associated Banc-Corp. In fact, ASB’s deposit growth outpaced loan growth in the first quarter. The following table shows my balance sheet estimates.

Risk Level Appears Low

Associated Banc-Corp’s risk level is low amid the current stress in the banking sector. The company is relatively safe compared to its peers because it has 103% liquidity coverage for uninsured and uncollateralized deposits, as mentioned in the presentation. In the unlikely case of a deposit run, Associated Banc-Corp can access this liquidity without having to resort to selling its securities and realizing a loss on the sale.

Although there is very little chance that Associated Banc-Corp will need to sell its securities at a loss, there is still a possibility that the company will intentionally sell and realize some loss. The management could adopt this strategy if it could use the sale proceeds to grow income or reduce costs. In other words, the management may decide to take a small hit now for the sake of growth in the longer term.

Maintaining a Buy Rating

Associated Banc-Corp is offering a high dividend yield of 4.7% at the current quarterly dividend rate of $0.21 per share. The earnings and dividend estimates suggest a payout ratio of 32% for 2023, which is close to the five-year average of 35%. Therefore, I’m not expecting an increase in the dividend level this year.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Associated Banc-Corp. The stock has traded at an average P/TB ratio of 1.19 in the past, as shown below.

The stock has traded at an average P/E ratio of around 9.6x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $24.3 , which implies a 35.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 40.3%.

Under normal circumstances, I would adopt a Strong Buy rating if the total expected return was this high. However, due to the current panic in the banking sector, I’ve decided to maintain a buy rating on Associated Banc-Corp.

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