DBRS Confirms Susquehanna Bancshares, Inc. at BBB (high); Trend Stable

DBRS has today confirmed the ratings of Susquehanna Bancshares, Inc. (Susquehanna or the Company) and its banking subsidiary, including Susquehanna’s Issuer & Senior Debt rating at BBB (high) and Short-Term Instruments rating at R-2 (high).

The rating action follows the Company’s Q2 2009 earnings release, in which Susquehanna reported a net loss applicable to common shareholders of $11.9, its first quarterly loss since the current recession began. Despite the loss, DBRS notes that the core earnings power of Susquehanna remains intact. Excluding one-time items, Susquehanna’s income before provisions and taxes (IBPT) increased by approximately $5 million to $40.9 million during Q2 2009 driven by higher earning assets, margin expansion and expense discipline.

Susquehanna’s ratings are based on its solid Pennsylvania franchise with sufficiently diversified revenue streams and historically strong asset quality. Moreover, the Company has made progress the past several quarters improving the mix of its deposit base by growing core deposits at the expense of more expensive single-service CDs. The ratings also take into account the Company’s below-peer profitability and elevated commercial real estate (CRE) and construction exposures, as well as its volatile automobile leasing business. DBRS notes that another quarterly loss, sustained below-peer earnings and/or a significant increase in nonperforming assets (NPAs) would likely lead to negative ratings pressure. As noted previously by DBRS, a further reduction in the dividend or any other action that would augment common equity would be viewed favorably and lessen the likelihood of a negative rating action.

With a weak Q1 2009 performance and the net loss in Q2 2009, Susquehanna’s year-to-date net loss totaled $10.1 million compared to net income of $57.2 million at this point last year. The weaker financial performance was driven by incremental loan loss provisioning of $61.4 million, an increase of 260%, and net interest margin (NIM) compression of 23 basis points (bps) to 3.46%. Furthermore, noninterest income has declined across many categories reflecting the more difficult economic environment. Positively, the Company has done a good job of controlling expenses within their control. Susquehanna achieved their goal of cutting expenses by $20 million a year in Q1 2009 and will continue to look for ways to reduce its cost structure including the recent consolidation of branches announced this quarter, which will save another $2 million a quarter.

Like most banks, asset quality deterioration represents the largest challenge. Historically one of the best banks in terms of overall asset quality, the recession has caused elevated levels of NPAs and net charge-offs (NCOs). Construction loans remain the most problematic and represented 13% of the total loan portfolio. During the second quarter, nonaccrual loans increased 30% with half of the increase from real estate construction. In total, NPAs were 2.57% of loans, leases and OREO, up from 1.73% in Q1 2009. Within the footprint, credit quality remains the softest along the I-95 corridor from Delaware to Washington D.C. and the I-81 corridor in Virginia. Meanwhile, NCOs reached 1.01% (annualized) of average loans and leases, up from 0.70% in the first quarter and 0.48% a year ago. Over half the NCOs in the quarter were from construction loans. While the economy has shown some signs of stabilization, unemployment is still increasing and it will take time for Susquehanna to work through problem loans. Therefore, DBRS expects NPAs, NCOs and loan loss provisioning to remain elevated the remainder of the year, which will mute earnings.

Positively, Susquehanna has delivered solid core deposit growth this year. More importantly, the deposit mix has improved. In the second quarter, more expensive single-source CDs were replaced with non-interest bearing, savings and interest bearing deposits. As a result of the improved deposit mix, NIM improved 12 bps to 3.52% since the end of Q1 2009. With close to $2 billion in higher cost CDs maturing over the next six months, the margin should further improve in the second half of the year.

With $300 million from the U.S. Treasury’s CPP, regulatory capital ratios are significantly over the well-capitalized threshold. However, the Company’s tangible common equity ratio has come under pressure from weaker financial performance, a dividend payout that has exceeded earnings the past several quarters and balance sheet growth. Indeed, the tangible common equity ratio is below 5% at 4.62% at the end the second quarter. Any improvement in common equity would be viewed favorably.

DBRS notes that liquidity at the holding company is strong as well, with no debt coming due in the next three years.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.