DBRS Confirms SUSQ at BBB (high) and Changes Trend to Stable

DBRS, Inc. (DBRS) has today confirmed the ratings of Susquehanna Bancshares, Inc. (Susquehanna or the Company) and its related entities, including its Issuer & Senior Debt rating of BBB (high). At the same time, DBRS placed the Company’s ratings on Stable trend. Finally, DBRS discontinued the ratings of Susquehanna Capital Trust I & II, due to redemption. The rating actions follow a detailed review of the Company’s operating results, financial fundamentals, and future prospects.

The change in trend to Stable from Negative reflects Susquehanna’s successful sequential integrations of Tower Bancorp Inc. and Abington Bancorp Inc. (Abington), both of which, in aggregate, represented a sizable 27% of the Company. Furthermore, the Stable trend also considers Susquehanna’s improved core earnings generation and strengthening capital position. With its Stable trend, DBRS sees Susquehanna as being well placed in its rating category for the near to medium term.

Overall, the ratings confirmation is underpinned by Susquehanna’s solid mid–Atlantic banking franchise, sufficiently diversified revenue streams, and adequate capital position. The ratings also consider the Company’s still slightly below-peer profitability, elevated concentrations in commercial real estate/construction lending, and higher than peer cost of funds.

Despite the slow growth economic environment, the Company exhibits sound balance sheet fundamentals. During 3Q12, period-end loans increased 0.7%, driven by higher levels of residential mortgages (up 2.0%), commercial & industrial exposures (C&I: up 3.2%) and consumer loans (up 3.0%). Partially offsetting growth in these categories, commercial real estate (CRE) loans and construction loans declined by 2.1% and 3.5%, respectively. DBRS notes that Susquehanna continues to manage down its construction loan portfolio. Supporting loan growth, period-end deposits increased 0.3%, QoQ, led by a 5.4% increase in interest bearing demand deposits, mostly offset by a 5.8% decrease in time deposits. DBRS notes that the run-off of higher cost time deposits has, in part, helped the Company bring down its cost of funds, but at 0.83% (3Q12) this metric still trails those of its peers. Finally, Susquehanna’s asset quality continues to trend positively, reflecting lower levels of nonperforming assets (NPAs) and net charge-offs (NCOs).

Importantly, Susquehanna’s core earnings generation or its adjusted income before provisions and taxes (IBPT: DBRS calculated and excludes non-core items) improved during 9M12. Specifically, the Company’s IBPT totaled $77 million for 3Q12, up from $73 million for 2Q12 and $64 million for 1Q12. On a QoQ basis, higher 3Q12 IBPT was attributable to improved adjusted fee income and lower core expenses. Higher linked-quarter adjusted fee income reflected increased levels of service charges on deposit accounts and other commissions and fees. Meanwhile, operating expenses, which exclude merger and debt extinguishment charges, declined $2.2 million QoQ, and fully reflect the Company’s recent expense reduction initiatives. The bulk of the decline in core costs was attributable to lower salaries & employee benefits.

During the past year, Susquehanna’s balance sheet management efforts benefited its earnings generation capability. The Company utilized a sizable gain associated with its acquisition of Abington, as well as proceeds from the issuance of senior notes to reposition its balance sheet. Specifically, the Company prepaid and redeemed higher cost funding, including $679 million in Federal Home Loan Bank advances (in 4Q11), $175 million in trust preferred securities (in 3Q12) and $21 million in subordinated debt (in 4Q12).

Another rating consideration is Susquehanna’s relatively sound asset quality, which continues to improve. Specifically, NPAs contracted to a moderate 1.16% of loans and leases (excludes restructured loans) at September 30, 2012, from 1.26% at June 30, 2012. Lower levels of sequential NPLs reflected a broad-based decline across most loan categories, except for CRE, which increased slightly. Meanwhile, NCOs decreased to a manageable, but still elevated 0.62% of average loans for 3Q12, from 0.65% for 2Q12. Finally, the Company’s loan loss reserves remain adequate at 158% of nonaccrual loans and leases and 1.47% of loans.

DBRS views the Company’s funding profile as adequate, as core deposits (DBRS calculated) mostly fund loans. Susquehanna’s relatively good quality securities portfolio, which represents approximately 16% of total assets, and it’s access to the Federal Home Loan Bank and Federal Reserve round out its liquidity profile.

Capital remains sound and provides good loss absorption capacity, especially at current loss rates. Specifically, the Company’s tangible common equity (TCE) ratio was a solid 7.84% at September 30, 2012, up from 7.61%, at June 30, 2012. Meanwhile, its estimated Tier 1 common to risk-weighted asset metric was 10.07%, up from 9.97% at June 30, 2012.

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 DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the Federal Reserve, 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Mark Nolan
Rating Committee Chair: William Schwartz
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.