DBRS Ratings of Susquehanna Unchanged after 2Q11 Results – Senior at BBB (high), Negative Trend

DBRS Inc. (DBRS) has commented today that its ratings for Susquehanna Bancshares, Inc. (Susquehanna or the Company), including its BBB (high) Issuer & Senior Debt rating are unchanged following the release of 2Q11 results. The trend on all ratings is Negative. Reflecting lower credit costs, partially offset by sizable non-core expenses, Susquehanna reported net income of $11.1 million for 2Q11, up from $9.8 million for 1Q11. Specifically, on a linked-quarter basis, higher net income reflected a 20% decrease in provisions for loan loss reserves and a slight 0.5% increase in total revenues, partially offset by a material 5.5% expansion in non-interest expense.

The sizable quarter-over-quarter (q-o-q) contraction in provisions for loan loss reserves reflected continued improvement in the Company’s credit quality, despite the challenges associated with the slow growing economy. Meanwhile, the substantial increase in Susquehanna’s non-interest expense mostly reflected increased levels of employee compensation, which was exacerbated by a one-time $1.5 million restricted stock award, a $500,000 increase in merger related cost and higher FDIC insurance expense.

Reflecting the difficult operating environment, the modest q-o-q increase in total revenues was attributable to a 1.01% increase in net interest income, partially offset by a 1.1% decline in non-interest income. Higher net interest income reflected a 0.2% expansion in average earnings assets, partially offset by a 1 basis point narrowing of net interest margin (NIM) to a still solid 3.62%. The narrower NIM was driven by declining earning asset yields slightly outpacing decreasing liability costs. Positively, the Company had some success in growing loans. Excluding construction loans, which are being managed down, most loan types edged up during 2Q11.

Lower linked-quarter non-interest income was driven by a $1.6 million decrease in gain on sale of loans and to a lesser extent, lower securities related gains. Positively, net impairment losses recognized in earnings declined by $1.6 million to $613,000. As with most banks, Susquehanna’s fee revenues will continue to be pressured by the new regulatory environment, especially Reg. E and the Durbin amendment (interchange fees), which will be enacted during 4Q11. Company management anticipates that the impact of the Durbin amendment will be approximately $6 million in lost revenues per year. Nonetheless, DBRS notes that Susquehanna’s upcoming Abington Bancorp (Abington) acquisition, which closes in October 2011, and Tower Bancorp (Tower) transaction, which is expected to close in February 2012, will provide the Company with ample opportunity to grow additional fee revenues through cross sales, especially given Susquehanna’s broader menu of products and services.

Although macroeconomic headwinds continue to pressure Susquehanna’s asset quality, its credit metrics improved during 2Q11. At June 30, 2011 non-performing assets (NPAs) moderated to 2.26% of loans & leases, down from 2.49% at March 31, 2011. Meanwhile, 2Q11 net charge-offs (NCOs) contracted to 1.33% of average loans, down from 1.42% for 1Q11. Pointing to continuing improvement in credit quality, on a q-o-q basis, nonaccrual loans were down 10%, criticized loans declined by 10% and early stage delinquencies (loans 30-89 days past due) decreased by 49%. Finally, DBRS notes that the Company’s allowance for loan loss reserves remains acceptable at 99% of period-end nonaccrual loans and leases.

DBRS views the Company’s funding profile as adequate, reflecting a core deposit base that accounts for 84% of net loans. During 2Q11, Susquehanna’s deposits expanded by 1.3%, driven by a 4.4% increase in time deposits and a 2.5% increase in non-interest bearing demand deposits. The Company’s good quality securities portfolio, which represents 19% of total assets and access to the Federal Home Loan Bank and Federal Reserve round out its liquidity profile.

Susquehanna’s capital remains sound, and provides solid loss absorption capacity, especially at current loss rates. At June 30, 2011, Susquehanna’s tangible common equity ratio was 7.75% and Tier 1 common metric was 9.65%. DBRS notes that the capital accretion related to the Abington acquisition, which closes in 4Q11 will assist in the purchase of the recently announced Tower transaction.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Mark Nolan
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 7 March 2005
Most Recent Rating Update: 21 June 2011

For additional information on this rating, please refer to the linking document under Related Research.