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Susquehanna Bancshares, Inc (NASDAQ:SUSQ)

Q2 2010 Earnings Call

July 29, 2010 11:00 am ET

Executives

Abram Koser - VP, IR

William Reuter - Chairman and CEO

Drew Hostetter - EVP and CFO

Michael Quick - EVP and Chief Corporate Credit Officer

Analysts

Matthew Clark - KBW

Steven Alexopoulos - JP Morgan

Gerard Cassidy - RBC Capital Markets

Andy Stapp - B. Riley & Co.

Matthew Schultheis - Boenning & Scattergood

Travis Lan - Stifel Nicolaus

Eric Beardsley - Barclays Capital

Steve Moss - Janney Montgomery Scott

David W Darst - Guggenheim Securities

Tom Alonso - Macquarie

Operator

Welcome to the Susquehanna second quarter 2010 Earnings Call. Today's call is being recorded. And at this time, participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions) Thank you.

Mr. Koser, you may begin your conference sir.

Abram Koser

Thank you. Good morning and welcome. I'm Abe Koser, Vice President, Investor Relations at Susquehanna Bancshares. By now, you should all have received a copy of the press release about our financial results for the second quarter of 2010, which we made available yesterday. You can find this and our other financial releases in the Investor Relations section of our Web site at www.susquehanna.net.

Certain statements made during this conference call may be considered to be forward-looking statements. In particular, certain statements made on this call may include forward-looking statements relating to our credit quality, the impact of recently enacted financial reform legislations and accompanying regulations and our financial goals for 2010.

Such statements are not guarantees of the future and are subject to certain risks and uncertainties. The factors that may affect these statements and our financial performance includes but are not limited to continued levels of our loan and lease quality and origination volume, changes in consumer confidence, spending and savings habits, compliance with applicable laws and regulations, competition from other financial institutions in originating loans and attracting deposits, adverse changes in the economy generally, and in particular, adverse changes relating to the risks set forth in our SEC filings, including our most recent Annual Report on Form 10-K, as well as our 10-Q report for the first quarter of 2010, and our success in managing the risks involved in the foregoing.

Forward-looking statements speak only as of the date they are made. We do not intend to publicly update any forward-looking statements to reflect circumstances or events that occur after the forward-looking statements are made or to reflect the occurrence of unanticipated events, except as required by law.

I will now turn the meeting over to your host, William J. Reuter, Chairman and Chief Executive Officer.

William Reuter

Thank you Abe, good morning everyone. We thank you joining us this morning on our report for our financial results for the second quarter of 2010. Joining me this morning is Drew K Hostetter, our Executive Vice President and Chief Financial Officer; and Michael M Quick, Executive Vice President and Chief Credit Officer who all will also participate in the question-and-answer period at the end of this call.

I would like to begin with a review of the financial results for the second quarter, which we announced on Wednesday. Net income for the quarter was $5.4 million compared to net loss of $7.8 million during the second quarter of 2009.

For the first six months of 2010, net income was $12.9 million compared to a net loss of $1.8 million during the same period last year. We saw increases in both net interest income of 6% from second quarter 2009 and non-interest income which was up almost 10%.

We also did a good job of controlling costs with non-interest expense down about 7% compared to last years second quarter. After taking into account $6.7 million in preferred dividends and other costs related to our participation in US Treasure capital purchase programs, we reported a net loss applicable to common share holders of $1.4 million or $0.01 per diluted share. This compares to a net loss to common shareholders of $11.9 million or $0.14 per diluted share during last year's second quarter.

Net income applicable to common shareholders for the first six months of the year was $2 million or $0.02 per diluted share compared to net loss applicable to common shareholders of $10.1 million or $0.12 per diluted share during the first half of 2009.

As a reminder, second quarter earning this year was reduced $4.8 million due to the acceleration of the accretion of the remaining discount on the 200 million in preferred stock issued under the capital purchase program, which we redeemed in April. The US treasury continues to hold a 100 million in preferred stock for which we will pay $1.4 million quarterly dividend going forward.

Now, net loans and leases were $9.8 million, a decrease of 1% when compared to that portfolio on June 2009. We saw a significant decline in real estate construction loans, down 26% or $335 million, which was expected, given our strategy to reduce our exposure in this part of our portfolio. Among the loan categories where we saw growth was residential real estate, up 13%.

Overall, we continue to see a limited demand for loans, as both business and consumers remain cautious, given the slow and unsteady pace of the economic recovery.

Now, turning to the deposits, we achieved a 2% increase from June 30, 2009, to June 30, 2010. Total deposits were $9.2 billion. Following the strategy we outlined previously our higher cost time deposits decreased 14%, meanwhile interest bearing demand deposits were up 23%, and non interest bearing demand deposits increased by 5%, from the same period, last year.

As a result of these trends, net interest margin grew by 17 basis points, from 3.52% in the second quarter of 2009 to 3.69% in this years second quarter.

Our employees continue to successfully implement this strategy to control our cost of deposits and maintain a competitive margin.

Credit volume measurements continue to reflect the challenging market conditions. Net charge-offs as a percent of average loans and leases for the second quarter of 2010 were 1.46% compared to 1.01% for the same period last year. Non-performing assets as a percent of loans, leases and other real estate owned were 2.6% at June 30, 2010 compared to 2.26% a year earlier.

Looking at some other credit quality measures, however, we do see initial signs of stabilization. Our provision for loan and lease losses in second-quarter was $43 million, down slightly from $45 million in this year's first quarter and from $50 million in the second quarter of 2009.

When comparing linked quarters, net charge-offs of 1.46% in the second quarter were down from 1.56% in the first quarter of 2010 an improvement of 10 basis points. Non-performing assets at 2.6% for second quarter decreased from 2.69% in the previous quarter. Consequently, this reduced our non-performing asset generation from $63 million in the first quarter to $22.4 million in the second quarter. This represents our lowest level of NPA generation since second quarter of 2008.

We also saw a reduction in loans that are past due on a linked quarter basis. Loans 90 days past due declined from $20.4 million in the first quarter of 2010 to $13 million in the second quarter. Loans 30 to 89 days past due declined from $126.8 million in the first quarter to $59.6 million in the second quarter. While we remain cautious, it is good to see our numbers beginning to trend in this direction.

As I mentioned earlier, we reduced on interest expense, which is reflected in the significant improvement in our efficiency ratio. The efficiency ratio for year's this second quarter was 65.09% compared to 74.64% during the same period last year.

I like to spend a moment to addressing the recently enacted financial reform legislation. There is lot of speculation about what this will mean for industry. At this point probably the only thing we can say for sure is, that the true impact will not be known till the regulation results are finalized. With hundreds of new regulatory procedures pending, this process will roughly take months and certainly and possibly years.

We believe that as a regional financial service company, we are well positioned to handle changes that will inevitably come from this legislation. Portions of the Act are targeted at business lines operated by some the nation's largest financial institutions rather than the main street banking companies which is our primary focus. On the other side of the spectrum an increased regulatory reporting and scrutiny makes stress to resources of the smaller banks.

One aspect of legislation that we have been watching closely is the Collins amendment, under which Trust Preferred Securities would be phased out of the calculation of Tier I capital starting in 2013. As our assets size was less than $15 billion threshold at December 31st, 2009, our current 323 million in Trust Preferred Securities is grand fathered as Tier 1 until maturity. However, we will not be able to issue any new Trust Preferred Securities that qualify as Tier I capital.

We are confident that we have the resources to monitoring upcoming regulatory changes and update our operations accordingly. Our focus will be on continuing to serve our communities by providing credit to all our customers as well as valuable financial products and services. We also expect that there maybe opportunities for acquisitions, if other banks determine they don't have capabilities to implement upcoming changes.

In fact, we have already been taking advantage of opportunities for organic growth in many of our markets. With some competing financial institutions taken out by mergers or distracted by economic headwinds, we have been able to add new accounts and to build relationship with customers giving us an opportunity to grow market share.

At this point, I will turn call over to Drew who will review our results on a linked quarter basis.

Drew Hostetter

Thank you Bill. In my presentation, I want to focus on second quarter results for 2010 and our 2010 financial targets.

Net interest income decreased $2.1 million or 2% from the first quarter of 2010 due primarily to reduction in net interest margin of 11 basis points from 3.80% to 3.69%. This reduction was primarily caused by our slightly asset sensitive balance sheet position and the March 2010 issuance of 11% trust preferred securities. Noninterest expenses increased $1.9 million or 2% from the first quarter of 2010, due primarily to $1.5 million increase in credit cost.

Next, I want to present our updated financial target for 2010. FTE margin, 3.70%; loan growth, 1%; deposit growth. 2%; non interest income growth, negative 12%; non interest expense growth. 0%; tax rate, not meaningful; preferred dividend, $13.7 million; and this is broken down by quarter as follows.

The first quarter, $4.2 million; second quarter, $6.7 million; third quarter, $1.4 million; and fourth quarter, $1.4 million. These financial targets include no securitization activity in 2010, and the growth percentages are based upon 2009 reported numbers and not core numbers.

I will now turn the conference call back to Bill for his closing remarks.

William Reuter

Thank you, Drew. In a changing and competitive banking market place, we are stepping up our efforts to promote Susquehanna bank brand. This summer and fall, we are conducting an image advertising campaign, focused around the tag line, "Doing what Counts". TV commercials for the campaign feature our employees and customers and portray, our commitment to serving our neighbors in our local communities. The TV spots along with related print ads, and billboards have been well received in our markets.

I would also like focus briefly on our efforts to expand our business in markets where we see the potential. Philadelphia; earlier this month we opened our second branch in downtown Philadelphia, at Rittenhouse Square. We look forward to serving customers in this area, not only with traditional banking services, but also through our wealth management business.

We are pleased with the response to our first office in Center City, Philadelphia, at 17th and Market, which opened last October, and currently has $44 million in deposits.

Last week, the Administrator of the US Small Business Administration had a press conference at a New Philadelphia restaurant. It was funded through the Susquehanna Bank SBA loan. The focus of the event was on how small business lending creates jobs and we are pleased that the SBA choose to highlight one of our customers and the role the bank played in expanding his business.

The owner was [Mark Vitter], who now operates three Philadelphia restaurants and employs more than 100 people. Susquehanna Bank worked when SBA loans for his latest two restaurants and we believe this is a good example of ours to make credit available to local entrepreneurs.

Finally, we probably to be listed among the top charitable contributors to both Philadelphia and Baltimore Business Journal's this year. Susquehanna has longstanding tradition of supporting local communities where we do business.

We believe that customers appreciate company and show their dedication to the community through contributions. An initiative we are fortunate to have a team of employees who are dedicated not only to serving customers in the bank but to also generously volunteer their time to support local organizations. Many thanks for our employees who help us carry on this tradition of community involvement.

In closing, our focus during the third quarter will be on continued efforts to improve our credit quality metrics and are working to take advantage of the opportunities we seek at substantial new commercial banking customers.

We will now address any questions you may have.

Question-and-Answer Question

Operator

(Operator instructions) We'll take Matthew Clark with KBW.

Matthew Clark - KBW

Can you update us on the watch list special mentioned of substandard numbers, because I obviously saw a nice decline in your comps, but just curious as to where those number stand and try get a better sense of migration?

Drew Hostetter

We will not give those numbers at this point in time, but we had a general decrease across the board.

William Reuter

We had negative credit migration in the second quarter of about 8.5%.

Matthew Clark - KBW

Negative means a drop in…?

William Reuter

[Meeting our standards.]

Matthew Clark - KBW

Okay, great. Then on the margin it looks as though your guidance implies a five basis point decline in the second half on the margin. Just curious, what you might have in the way of CDs re-pricing here in the second half as well as any borrowings that might be running off because it looks as though that may help mitigate the decline here in the second half?

Drew Hostetter

Yes, we have that included in our estimate, but to give to some idea I do have in the third quarter 498 million worth of CDs that we run off at 2.43%. Then in the fourth quarter 574 million of CDs will be run off at 1.69%, but this included in our estimate.

One of the reasons that we're looking at a little lower for the second half of the year margin is we have continued to try to develop a little more assets sensitivity and in doing that we're lengthening our liabilities a little bit. So in doing that, we are creating a little higher cost of funds.

William Reuter

Hey Matt, Bill Reuter, let me give you some additional color on that, your question about credit migration. In addition to 8.5% negative credit migration in the second quarter, if you look at our Maryland Bank as example, it's had four quarters in a row of negative credit migration and that's pretty important because that's where we have the most construction LAD exposure. As I think you heard earlier in my presentation, our construction LAD portfolio itself is down lower by 300 million in the last 12 months. So that's good news.

Matthew Clark - KBW

Okay, great. Then just on the securities side. They were up in the quarter, just curious as to what the duration is on that portfolio today, relative to last quarter and what you might be buying?

Drew Hostetter

The duration is about four years and we are buying pretty short-term mortgage backed season, mortgage backed securities and agencies in the two and a three year range. So we stand pretty sure.

William Reuter

I mean, at the balance sheet, we are positioned to be slightly asset sensitive.

Operator

We will take our next question from Steven Alexopoulos with JP Morgan.

Steven Alexopoulos - JP Morgan

Could we start just on the guidance that you gave, the loan and deposit growth targets. Can you remind me are those for period end balances or average?

Drew Hostetter

Period end.

Steven Alexopoulos - JP Morgan

Okay. Switching gears, when you look at the drop in the NPA generation, can you talk about I n what portfolio you are seeing any improvement?

Michael Quick

This is Mike Quick. I would tell you it's across the board and in all of our various categories that we are seeing a lot of movement, a positive movement resolving some of our problems. We have had two excellent quarters in a row, and we are on target, and we have lot of things happening in this particular quarter. So we are optimistic about this quarter, but again it depends on how its getting everything done, by the end of the quarter.

William Reuter

I like to think with the time and effort we placed in systems and the pro activity of our management of that other credit portfolio's that we were ahead of the curve in recognizing our losses and reserving at the same time.

Steven Alexopoulos - JP Morgan

Okay, and looking at just a run off of time deposits, what is it that you guys were doing, to close that big of a drop, were you just cutting the rates you are paying, so people aren't renewing with you?

Drew Hostetter

Yes, what we are doing is, for our customers who are relationships customers, we are giving them slightly better than market rate on the CD's and we are retaining most of those CD's for our customers who are single sourced customers. They are recollecting how much is that CD's, we are pricing slightly below the market, and those are running out away from the bank.

William Reuter

Now, our preference would be at the branch level to have those single service CD customers, cross over to other products, like for them to have the "checking account", where there is a money market, we are certainly attempting to do that, as our first opportunity, and then if we can't do that, hopefully the customer will accept our lower rate or take the CD elsewhere or in some cases, we are trying to move them with brokerage operation and talk to them about the possibilities of a annuity.

Drew Hostetter

The other drop you will see too is, we had a 100 million of brokerage CD's and with our strong liquidity position, as they mature, we are just letting them run off, we are not replacing them.

Steven Alexopoulos - JP Morgan

Okay and may be just one final, I talked about liquidity, looking at the loans to deposit ratio, it is still over a 100%. Any thoughts on bringing that ratio down? Can it be more liquid as you anticipate a natural pick up of loan growth if we have the liquidity available?

Drew Hostetter

Yes, we believe over the next year or so that will probably come inside of 100%. As we were saying now is that our deposit growth is stronger than our loan growth right now.

Steven Alexopoulos - JP Morgan

Okay. Even with that run off to CDs you think it moves down below a 100?

William Reuter

Yes, I think it's in early next year it will run down below a 100.

Operator

We will take our next question from Gerard Cassidy with RBC.

Gerard Cassidy - RBC Capital Markets

In your comments about some expected maybe improvements in credit quality in the third quarter some stuff is in the pipeline that you are working on. What do you guys see the restructured loan total heading towards the end of the year from the current $80 million?

William Reuter

The TDRs?

Gerard Cassidy - RBC Capital Markets

Yes.

William Reuter

Higher, they will be higher.

Gerard Cassidy - RBC Capital Markets

Well, the growth is meaningful as we are seeing since the end of '09?

Michael Quick

Our strategy has been through out this recession to use a troubled debt restructure as a mean of helping customers get through this very difficult time. We go through a very lengthy process to determine whether that customer is going to make it or not. We believe he is going to make it, we use the TDR to work them through that process. Sometimes it just giving them an interest-only period for over 90 days, it could be from 90 days to a year. Other times it's creating A, B note where we take the B note and charge it off, but we do not give it or assign an actual note for the B Note and we have the A note, which is accruing. So it' still accruing and still earning, still giving us interest on it. It all through the process of taking a look and determining exactly who we think are going to make it through this cycle and we want to help them get through it.

William Reuter

I can tell that the $79 million in restructured loans is TDR. I think is a high a possibility as we get passed here in that you'll see a decrease in that $80 million number, because a number of those loans who have paid us has agreed for six months possible they would have passed the year-end timeframe. So I can't give you a specific number right now. We constantly take a look at quarterly projections in all these portfolios and they really move around a lot during the quarter as we get to the credit quality cycle each quarter.

Gerard Cassidy - RBC Capital Markets

Sure. Absolutely. You talked about the success of the Philadelphia branch with $44 million in deposits. How does that break out time CD type deposits versus DDAs like account?

William Reuter

I don't have that available with me right now. I can tell it's mostly core deposits. It's not a lot of CDs. We actually been able to move a lot of really good customers into that branch. I think the key to the Philadelphia market is, we have a good branch presence in Montgomery and Chester County as people working the city itself they're appreciate of the fact the have an opportunity to bank at lunch time in the bank rather in the city obviously then if someone got to lead you back into the rural areas or county areas.

So our strategy in Philadelphia is to put two, three, four branches that kind of ring the city and get us great penetration everywhere. The Rittenhouse Square area is kind of what I call a high net worth area. So that particular office we not only offer traditional banking products but it will have a strong emphasis on our wealth management companies and high net worth management of assets at the same time.

Gerard Cassidy - RBC Capital Markets

Okay. You guys talked about possibly building new relationships with commercial accounts, partially due to the disruption in your footprint from the consolidation that has gone on. When you look at the loan growth going out to the end of next year, do you think you are going to be able to grow the C&I portfolio? It's down, as you know from the end of '09 by about, I guess, $100 million.

How challenging is that going to be considering every bank that is talking about growing loans over the next 18 months is focusing in on the C&I area and according to the senior loan officer's survey, we are already seeing credit underwriting standards weaken in this category. Is it really feasible to be able to grow that portfolio?

William Reuter

I think that's a great question and a great observation. The overall growth of our loan portfolio is going to be dependent upon a couple of things. First of all, how will the economy pick up in the next two to four quarters? We have a little headwind in the loan growth when the construction LAD portfolio went down. So as an example, if we let 350 million rundown in the construction LAD portfolio, that represents about 3% loan growth to us. So we've got to make up 3% loan growth to offset because of the 350 runoff in the construction LAD portfolio. That portfolio is going to continue to rundown to a degree. Eventually we would like to see that portfolio at about 10% of our total loan portfolio.

Now where we see the most weakness is, in the small business side. Small business customers are still little reluctant to borrow. We have got some great systems and processes in place to accommodate small business. We have invested a lot of time and effort, and talent in our small business credit solutions product, which underwrites loans of above $750,000 or more up to our credit supporting models that supports our 220 branches very nicely.

So I think a lot of the pick up is going to have to do, but know how effective we can be from a distribution standpoint, but what really does happen to the economic outlook to make small business feel better.

Now on top of that I could tell you that in the last sixty days, I have personally visited with at least, a dozen major corporate clients, that didn't bank with us a year ago, and everyone of those corporate clients, have come out of the disruption in the market places I talk about. Some in Maryland, some in Philadelphia, some in Central Pennsylvania, and so we continue to see a really great opportunity to bank some really nice sized accounts, in the middle market lending group, that are well known, that have long track record of success in their markets and it is not they bank with us to have the right model, it is just they don't have the right model for them.

We are very high touch, highly personal organization, who understand, I think, probably understand better than most to what the needs of that customer are, go across and contact with them, who want to be flexible in how we deal with them, how we approve loans at a time we fashion. So I think the answer to your questions are very difficult one. There are clearly will be some headwinds and increase in the loan portfolio, but I believe we are as well-positioned as anybody can be to do that.

Operator

We will take our next question from Andy Stapp with B. Riley & Co.

Andy Stapp - B. Riley & Co.

A lot of banks are reporting that a number of customers or adding them all due to the prolonged weak economic environment. To what extent you see in this?

William Reuter

Again it's pretty broad question. I think it's varies. I think we are through most of it with the consumer, I mean we don't know about the economy and believe in that the economy will continue to improve but on a very uneven basis. I think we are through most of it with the consumer. Our restructuring of residential loans is example for the consumer, it's not really been a lot. Our home equity loan portfolio, which has held up very, very well. I would say that most of our customer base has learned to live with what's volume and have consultation with them, they have learned to adjust overhead perhaps make less money.

So I think they are all the reasons for not borrowing, but I am not going to sit here and say that we have a customer data come to us, but that's not the case. You're always going to have some select situations you are into but I think most of those situations I would like to think based on we know they are behind us.

Andy Stapp - B. Riley & Co.

What are you seeing in financial statements?

William Reuter

We are seeing companies deleveraged, we are seeing the companies pay down debt both at the owner consumer side as well as the business side. We are seeing some companies who are being opportunistic, we are also seeing some companies borrowed some money take advantage of what I call market dislocation in their lines of business.

Andy Stapp - B. Riley & Co.

Not seeing a lot of deterioration

William Reuter

No.

Andy Stapp - B. Riley & Co.

Okay, good.

William Reuter

Let me also mentioned this to you too, One of the things I am optimistic about here is the Central Pennsylvania market has held up relatively well. Central Pennsylvania is where about 50% of our assets are. If you look at the Maryland marketplace, where about 25% of our assets are, I feel better about the Maryland economy than I do abut any markets that we are in. I feel pretty good about most of the markets, but the Maryland economy I feel we better about. I feel good about it, because and I think I may have mentioned this in some other call, but now we're actually seeing it.

Its basically realignment process that's occurring in Maryland where albeit in proven grounds of Harford County, and Fort Meade and Anne Arundel County are being the beneficiary of significant job increases, because of the principal military contractors, sub-contractors are relocated into those areas. We got couple of [flex billings] down in Harford County that were fully leased on the very first day because again, all the military contractors are coming in.

The other thing that just came to light in the last several weeks, which was long anticipated is that in Anne Arundel County at Fort Meade, the new Cyberspace command is going to be located there, which will be right next N. The Cyberspace Command is anticipated to employ a lot of people. I mean as in tens of thousands of people. So the Maryland market is being buoyed very nicely by the base realignment process by the major subcontractors who are relocating to support those bases, by this new Cyberspace Command, by government jobs in general. As a consequence, you are starting to see some solidification of land prices and actually some rise in land prices in the unidentified corridor between Harford County to Anne Arundel County including Howard County.

Andy Stapp - B. Riley & Co.

Okay. Can you talk about the outlook for reserve building?

William Reuter

Mike?

Michael Quick

Well our reserve did build this quarter and it will continue to build slightly over the next several quarters as we go through this cycle. Part of that is due to the formula we use and part of it is due to the fact that we are continuing to look at the credits and analyze them correctly. When I tell you the formula, we are penalized for the most recent four quarters in charge-offs, which does effect our past loans and our loss loans and we've seen the percentage that we put against those particular loans rise substantially over this three quarter period in this year, fourth quarter of last year and the first two quarters of this year.

Andy Stapp - B. Riley & Co.

Okay. Can you talk about the success you are having on the Reg E front and the potential impact?

Michael Quick

The potential negative impact for us is $12 million annually that we collect and that is related to point of sale in ATM. Based upon the communications we've made with those customers, our anticipation right now is based upon the current opt-in rate we have now is that we will probably retain approximately $9 million of that $12 million.

William Reuter

I think we have done a pretty good job, of putting together, a really comprehensive game plan of mail, telephones, direct contact at the branches, internet, and we have a very detailed business plan in place to retains as much of that cost we can,

Operator

I will take the next question from Matt Schultheis with Boenning & Scattergood

Matthew Schultheis - Boenning & Scattergood

Couple of quick questions and some of them are fairly open ended news. You haven't been involved in the securitization market? What will get you back in that market?

Michael Quick

One thing that might is that if closes down with discount windows, right now we have to put our leases up as collateral with discount window, and that is a lot cheaper borrowing across for us than the securitization markets.

Matthew Schultheis - Boenning & Scattergood

Along those lines obviously there was something to Frank Dodd bill with regard to raiding agencies and risks, and they didn't do very good job, with regard to securitization, Ford was trying to do, we do need that particular provision to be corrected.

Michael Quick

That is a good question. I am not sure, I mean the securitization market is open now, we could do our lease securitization if we wanted to, but the cost of it, would be greater than our cost of keeping it on balance sheet, right now, by a fair amount.

So economically, this doesn't make sense to it, and on the home equity side the market is still not open there, the cost to do it is just too expensive.

William Reuter

Our balance sheet is big enough, that we can accommodate all the volumes that [Horne] can give us and it's one of the cleanest portfolio we have from a delinquency standpoint. So we typically, in the past as you know we done securitization, because its creating liquidity for us and secondarily there were some gains involved of course at the same time. If the security market doesn't come back or doesn't come back to our liking it won't affect our business one iota.

Michael Quick

I am not sure, we it will ever get back to the efficient market it was three, four years ago.

William Reuter

In terms of liquidity at bank and the parent company we have significant levels of liquidity.

Matthew Schultheis - Boenning & Scattergood

Okay. Whenever the last time your lead regulators went through your bank.

Drew Hostetter

The fourth quarter of 2009.

William Reuter

The fourth quarter of 2009, Yes.

Matthew Schultheis - Boenning & Scattergood

Right,

William Reuter

Then they just visit with our Board this past month.

Matthew Schultheis - Boenning & Scattergood

Okay. As far as your loan review process, I think with regard to construction C&I commercial real estate, how often does each existing loans go through a loan review update process and how much they of it has been done say in the past nine months or six months?

Michael Quick

Well, I will answer that is in several fronts. First of all any loan rate that is watched through doubtful is reviewed every quarter, each loan in a credit quality meeting we go over it, look at current financial information, look at current appraisal information and determine whether the present strategy is correct or not, whether this loan should be moved further down or the rating scale should be upgraded, as we did see some upgrades this past quarter, which contributed to the negative migration. Our loan review cycles through the portfolio concentrating on the larger loans. Every 18 months they go through that whole portfolio looking at concentrating on the larger loans.

We also have each of one of our managing directors at our three divisions, meet on a quarterly basis with the lending group underneath them and go over all the loans and discuss and take a look at the current trends in those particular loans.

In addition, every loan that's over $0.5 million collective relationship must come in for review once a year into our credit committee. We have officer's loan committee and we have executive loan committee and they have to be brought in once a year. So, we're probably touching somewhere in the 60% to 70% in a yearly basis and that's rotating through. That's on the total portfolio, probably a little bit higher on the commercial portfolio.

William Reuter

Yes, in addition to that, any new loan we do over a certain dollar figure is reviewed by the loan review within the first 90 days. In addition to that, we ask the loan review group to do some targeted exams periodically that might be industry specific. We had them do one last year on a small [strip] shopping centers. We had them do one on storage facilities. We had one on one hotel portfolio. So there are a lot of targeted effects that we do along with us the loan review.

Michael Quick

Let me just direct one other question with our lead regulator, which is the Fed Reserve Bank of Philadelphia wherein even though the safety is done once a year we are in constant contact with them. We send our Board packages each month and they are able to review that, which includes credit quality and trends etcetera. We have conversations with them throughout the year on various things that are happening in this. So it's not an isolated situation, we are in constant communication with our lead regulator and we share with them everything that we take to our Board.

William Reuter

We actually invited them into our loan credit quality meetings just to see how we do things and I think we are comfortable with that.

Michael Quick

Yes. They will be coming in the August loan credit quality meetings. They will be sitting through those meetings as they did in last November when they sat through them.

William Reuter

Just to reiterate the point I made earlier, we've been very proactive with the portfolio. We've managed the portfolio relatively well through this downturn.

Michael Quick

Matt, the other thing on your securitization question too, another major headwind is the change in accounting rules too. We did all our securitizations through QSPEs Special Purpose Entities, which now don't get [sale] treatment under the new accounting rules and that's why we had to bring back the equity lines onto the balance sheet. So that makes it a lot less desirable too.

Operator

Next question from Collyn Gilbert with Stifel Nicolaus.

Travis Lan - Stifel Nicolaus

Hi, this is actually Travis Lan. I am for Collyn today, but all of our questions have been answered. So, thank you guys.

Operator

We will take our next question from Eric Beardsley with Barclays Capital.

Eric Beardsley - Barclays Capital

Just want you to comment a bit on your plans to repay the remainder of the TARP.

William Reuter

I think as soon as we see some additional credit stability, we will take our next step.

Eric Beardsley - Barclays Capital

In terms of capital ratios, are you hearing anything from the regulators or are you comfortable with where you are now?

William Reuter

Very comfortable.

Drew Hostetter

Very comfortable, where we are now. We still haven't heard anything from the regulators. What we are hearing is that by the end of the year, they will have the new regulations in capital level set.

Eric Beardsley - Barclays Capital

So in terms of that credit progression, are your thinking two quarters, three quarters, how much more do you need see after this, nice I guess decrease in NPAs this quarter?

William Reuter

I could answer that at the end of the third quarter.

Eric Beardsley - Barclays Capital

Okay. Well, thanks a lot.

William Reuter

If I see another progression of the third quarter; I will be standing on the doors.

Operator

We will take our next question comes from Steve Moss with Janney Montgomery Scott.

Steve Moss - Janney Montgomery Scott

Most of my questions have been answered, but just on the M &A front. Are you seeing a pick up in activity and where do you think you have the most opportunities in the near-term?

William Reuter

Yeah. There is lot of chatter, a lot of chatter ongoing and just some talking going on the M&A front. We have looked at two or three situations have 90 days all which we passed on to wealth management-related companies.

One was a bank and we've actually passed on those, because they just didn't fit our criteria. I suspect that as the year progresses, you will see some additional pick up in talk and maybe even some things done. I'm talking about industry-wide and maybe even our market segments.

We are certainly going to be part of the dialogue, and we are just being vigilant and I want to make sure that next transaction we do is obviously the good transaction and the right transaction.

Steve Moss - Janney Montgomery Scott

Okay, thanks very much, and that good quarter, in terms of driven on the asset quality front.

Operator

We'll take our next question from David Darst with Guggenheim Securities.

David Darst - Guggenheim Securities

Bill your conversation on Maryland was very helpful. I wonder if you could comment a little further specifically on the land portfolio in Maryland, and if you expect to see some [resolution] of repayment of that portfolio? Also within the construction portfolio, what subcategories are you seeing improvement in?

Michael Quick

This is like Mike Quick. I'll talk a little bit about that. In the Maryland area, one of the things that are encouraging to us is that we've seeing the major builders knocking on our door at this point in time.

In fact, we are negotiating with them on some of the pieces of lands that with in conjunction with our borrowers, which is always a good sign and in particular, 12 months ago they were scraping the bottom with offers. Now, they are more realistic in the marketplace.

So, we see that as a good sign and we've only seen it in the Maryland area. We haven't seen it in this Pennsylvania area, and of course as Bill mentioned, Central Pennsylvania has really not had that issue and that has not had face this.

As for our present structure, our present numbers, we have seen pretty much a drop across the board in commercial and construction in the particular areas with the numbers of the land going down, our raw land in construction when a full family is approximately almost little under $5 million, $4.7 million in our raw land and commercial is approximately about $50 million.

As I look at what it was, it's down from a previous periods, so we are seeing some movement in that particular area, but we are encouraged by the lease in Maryland, and we've seen some of the major builders come back in the market and that's always a good sign.

William Reuter

Some of our customers, as they are buying land to happen to go through a period of time where the land they want to buy might not be necessarily on to their liking, so sometimes there is a lead time in getting this land ready for ultimate sale, but in general we are pretty pleased when we see them from a decrease in exposure period.

Operator

(Operator Instruction). We'll take our next question from Tom Alonso with Macquarie.

Tom Alonso - Macquarie

Just two relatively quick ones here for you. One, on the asset management line. Are those fees based on the prior quarter end's AUM, or is it an average?

William Reuter

In the mutual fund area, it's an average in the high net worth at the quarter end.

Tom Alonso - Macquarie

So, some of the revenues in this quarter are based on 1Q of that quarter end?

William Reuter

Some are billed in the beginning of the quarter, some are billed at the end of the quarter, some are based upon second quarter end too.

Tom Alonso - Macquarie

Then just on the borrowing cost this quarter. I know some of that's related to the troughs, but do guys extend any borrowings as you are trying to get a bit more assets revenue did that push up the rates there?

Drew Hostetter

Yes. Back in February of 2009, we entered into forward swap for $250 million that took overnight money, we swapped the overnight money to a 288 fixed rate for five years.

Operator

It appears there are no further questions at this time. I would like to turn conference back over to Mr. Reuter for any additional or closing remarks.

William Reuter

Well, thank you for your good questions. Our next quarterly conference call will be held on Thursday, October 28, 2010 at 11.00 AM Eastern Time. It will be available via webcast on our website, www.susquehanna.net. Thank you for your time this morning and for your continued interest in Susquehanna Bancshares.

Operator

That concludes today's conference. Thank you for your participation.

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Source: Susquehanna Bancshares, Inc. Q2 2010 Earnings Call Transcript
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