Susquehanna Bancshares, Inc. Q2 2008 Earnings Call Transcript

Susquehanna Bancshares, Inc. (SUSQ)

Q2 2008 Earnings Call Transcript

July 24, 2008 11:00 am ET

Executives

Abe Koser – VP, IR

William J. Reuter – Chairman and CEO

Drew K. Hostetter – CFO

Michael M. Quick – EVP and Chief Corporate Credit Officer

Analysts

John Pocari – JP Morgan Chase

Bob Hughes – KBW

John Boland – Maple Capital Management

Collyn Gilbert – Stifel Nicolaus

David Darst – FTN Midwest Securities

Avi Barak – Sandler O'Neill

Steve Moss – Janney Montgomery Scott

Presentation

Operator

Good morning and welcome to Susquehanna Bancshares second quarter 2008 earnings conference call. Today's call is being recorded. 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) At this time I would like to turn the conference over to Mr. Abe Koser. Go ahead, sir.

Abe Koser

Thank you. Good morning and welcome. I'm Abe Koser, Vice President, Investor Relations at Susquehanna Bancshares. By now, you should have all received a copy of our second quarter 2008 earnings release which we made available yesterday. If anyone still needs a copy, please call us at 717-625-6311 and we'll fax it to you. Our financial releases are also posted in the Investor Relations section of our Web site at www.susquehanna.net.

Before we begin, I'd like to remind you that during the course of our call, management may make projections and other forward-looking statements regarding events or the future financial performance of Susquehanna. We do want to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties.

For a more detailed description of the factors that may affect Susquehanna's operating results we refer you to our filings with the Securities and Exchange Commission including our Annual Report on Form 10-K for the year-ended December 31^st 2007 and our quarterly report on Form 10-Q for the quarter-ended March 31^st 2008. Susquehanna assumes no obligation to update the forward-looking statements made during the call.

Now I'll turn the meeting over to your host, William J. Reuter, Chairman and Chief Executive Officer.

William J. Reuter

Thank you, Abe, and good morning, everyone. Thank you for joining us for a review of the second quarter 2008 results. Also participating in today's call will be Drew K. Hostetter, Executive Vice President and Chief Financial Officer, and Michael M. Quick, Executive Vice President and Chief Corporate Credit Officer.

As we begin, I'd like to review the financial results we released yesterday. Net income for the second quarter was 29.2 million or $0.34 per diluted share compared to 9.8 million or $0.19 per diluted share during the same period last year. For the first six months of 2008, net income was 57.2 million or $0.67 per share compared to 30.5 million or $0.59 per share in the first half of 2007. When comparing these periods, please note that our second quarter 2007 earnings did include a pre-tax charge of 11.8 million related to the restructuring of the bank investment portfolio.

Net loans and leases continue to show strong growth, up 19% from June 30^th 2007 to the end of this year's second quarter. This growth excludes the impact of our acquisition of Community Banks, Inc. last November.

Total deposits, excluding the impact of Community Bank acquisition increased 1% from June 30^th 2007. While the deposit market has continued to be very competitive, we have been successful in generating new long-term deposits (inaudible) promotion that began early June. Promoted as the “Can't Lose CD”, these products offer an attractive guaranteed minimum rate on a 2.5 or five-year certificate of deposit, and the rate can adjust upward to the 91-day T-Bill floating rate on the first day of each month. So far, this product has been well received by customers bringing in more than 230 million in deposits.

Our net interest margin for the second quarter 2008 was 3.66%, down one basis point from last year's second quarter. Net charge-offs as percent of average loans and leases for the second quarter were 48 basis points compared to 14 basis points in second quarter 2007. Our net charge-offs during this year's first quarter were 25 basis points. However, the higher level of charge-offs occurred primarily due to a limited number of loans.

In the second quarter, free loans comprised 54% of total net charge-offs. A small number of stress [ph] loans also fueled an increase in our rate of accruing loans that are 90 days past due. This category increased by approximately 11 million during the quarter. Most of this increase was due to two construction loans. Loans that was delinquent 60 to 89 days showed only a slight increase while 30 to 59 day delinquent loans decreased more than 50% or 57 million.

Our non-accruals increased 5.3% quarter-to-quarter which was primarily due to a real estate loan led by another bank. This quarter's increase in non-accruals was significantly lower than the increase we saw in first quarter 2008 which was 31.2%. We are continuing to review all major credits with special attention paid to real estate credits that maybe stressed by the current economic climate.

Turning to our Wealth Management business, we completed our planned acquisition of Stratton Holding Company during the second quarter. It is now a wholly-owned subsidiary of Susquehanna Bancshares and part of the family of Susquehanna Wealth Management Companies. Stratton Holding is the parent company of Stratton Management Company, an investment management firm that provides management of assets for institutions, pensions, endowments, and high net worth individuals. It also manages and advises the Stratton Mutual Funds including Stratton Small-Cap Value Fund and Stratton Multi-Cap Fund. We are pleased to welcome the Stratton team of investment advisors and their clients to Susquehanna.

The addition of Stratton Holding provides even more investment management expertise and product diversity for our customers. And we can offer Stratton's clients a wide range of valuable banking and financial service products. Total assets under management and administration in our Wealth Management business now stands at 6.8 billion. Expansion in this business will continue to diversify our company's revenues. For the second quarter, wealth management fee income increased 37% to 11.1 million compared to second quarter 2007. Looking at another of our financial service subsidiaries, admission income from property and casualty insurance sales increased 4%, 3.1 million from last year's second quarter.

I'll now turn the call over to Drew for a more detailed look at some of our financial results.

Drew K. Hostetter

Thank you, Bill. My presentation, I want to focus on second quarter results for 2008 and our 2008 financial targets. Net interest income increased $877,000 or 1% from the first quarter, due to an increase in average earning assets of $255 million offset by a decline in the net interest margin of five basis points. The decline in margin was due primarily to competitive pricing in our market area for both loans and deposits.

Non-interest incomes increased $1.8 million or 4% from the first quarter due primarily to acquisition of Stratton in the second quarter. Non-interest expense declined $1.7 million or 2% from the first quarter due primarily to a decrease in advertising and marketing and other expense. This decline reduced our efficiency ratio to 61.55% from 63.95% in the first quarter and from historical levels greater than 65%.

Our updated financial targets for 2008 are as follows

FTE margin, 3.69%, loan growth excluding securitization, 10%, deposit growth, 2%, non-interest income growth, 45%, non-interest expense growth, 30%, and the tax rate, 28%. These financial goals include a $350 million auto lease sale scheduled for the third quarter. We estimate that this sale will result in a minimal pre-tax gain due to recent widening of credit spreads. The timing and amount of gain associated with this event is difficult to predict in this volatile environment.

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

William J. Reuter

Thank you, Drew. Although we're seeing economic pressures in our market, we're fortunate to work in a region which has not experienced the significant housing price declines and foreclosure rates seen elsewhere. This is reflected in a report by the Office of Federal Housing Enterprises about prices from first quarter 2007 to first quarter 2008. The report shows that in the metro areas we serve, home price changes range from relatively modest 1.71% appreciation in the Bethesda, Frederick, Gaithersburg area in Maryland to 2.77% [ph] appreciation in Lancaster, Pennsylvania.

In many of our Mid-Atlantic markets, our banks have been working for more than a century. These are markets that we know well, and we continue to enhance our branch network service in these communities. Since the beginning of the second quarter, for example, we opened new branches in Collegeville, outside of Philadelphia, and moved other branches into newly constructed facilities in Harrisburg, Halifax, and Lancaster here in central Pennsylvania.

Our long-standing service in local communities is the main reason that we have seen record performance mortgage loan originations this year. With the turmoil in the mortgage markets, customers are turning to their local banks as a reliable source to fund and close home loans. In addition to strong mortgage loan growth, we've also seen consistently solid growth in overall loans as I mentioned earlier in our presentation. Community banks such as Susquehanna with sufficient capital are well poised to continue to serve as drivers of economic growth in our markets.

In addition to serving customer needs, we're also working to enhance our operations through increased efficiency. As Drew indicated in his presentation, our efficiency ratio improved from 63.95% the first quarter to 61.55% in the second quarter. Our historical levels include efficiency ratios of more than 65%. We are pleased to see a continued reduction in the portion of non-interest expenses that are incurred to generate revenues.

As we sum things up this morning, I’d like to note that while current economic challenges have had an impact on our loan portfolio to increased credit cost, we are able to maintain stable operating earnings supported by strong geographic markets where we operate. Our company continues to maintain capital ratios that are considered well-capitalized by the regulators.

Finally, as announced last week, our board of directors has announced our regular third quarter dividend of $0.26 per share of common stock payable August 20^th 2008, the shareholders of record, August 1^st 2008. This continues our long-standing tradition of paying quarterly dividends since the formation of Susquehanna Bancshares in 1982.

At this point, I'd like to open the call for your questions and comments.

Question-and-Answer Session

Operator

(Operator instructions) We'll take our first question from John Pocari with JP Morgan.

John Pocari – JP Morgan

Good morning.

Michael M. Quick

Good morning, John.

John Pocari – JP Morgan

In terms of your securitization gains, I believe you just indicated that you expected a minimal pre-tax gain on your expected securitizations. I mean does that imply that you're not seeing a favorable secondary market at this point, and you're lowering your expectations on that front in terms of the amount of gains that you can get on the securitizations at this point?

Drew K. Hostetter

That's correct. We're basically doing it now for purposes of liquidity (inaudible) it will give a 350 million worth of liquidity, still reasonable rate, but not anywhere near what we used to be able to (inaudible) spread widening in the market.

John Pocari – JP Morgan

Okay.

William J. Reuter

And John, although historically we liked the gain involved in these transactions, we've also said historically that as Drew indicated that we do these transactions also for liquidity as well as to diversify credit risk.

John Pocari – JP Morgan

Okay. I'm sorry if I missed it, I hopped on late, but how did that impact your underwriting here? And obviously, we got to expect that volumes are going to slow there in that business given the economy, but how did that impact your willingness to underwrite on the auto side at this point?

Drew K. Hostetter

We have plenty of room on our own balance sheet to take these – keep these loans and leases. We used to securitize them because of concentration risk, but because of our increased size with the Community acquisition and the fact that Hann now originates about 250 million of leases a year instead of 450 million, no longer becomes a concentration issue. So, if we ever had to, we could just keep these on our balance sheet for a period of time as well, because they are only two to three year leases, so it won't accumulate to more than half a million to 750 million in a year – I mean, over a period of time.

John Pocari – JP Morgan

Okay. And I'm sorry if I missed this point as well, but have you provided an update on your expectations for the profitability of Hann this year, for the back half of the year?

Drew K. Hostetter

Because the fact is our residual value is locked in for a three-year period of time, the original projection we gave at the beginning of the year is still pretty close to where we expect to be.

John Pocari – JP Morgan

Despite the lower top-line volumes?

Drew K. Hostetter

Actually, Hann is – the volumes that we see here are – if you – the actual volume for the second quarter was $76 million compared to 67 million last year, second quarter. And it's ahead of our forecast. Our forecast was 72 million for the second quarter, so, actually, the volumes are doing pretty well. The decrease you see in the securitization, on the line for the auto lease business is on the securitization fees. Even though we record gains up front in this deal, there is continual income coming in from those because it's only done on a present value basis with conservative estimate. So the fact that we haven't got a deal done yet in '08 has caused that decrease in that line. So, once we get a deal done here in '08, that piece of the income will continue to rebound then for us.

John Pocari – JP Morgan

Okay.

Michael M. Quick

So, John, what we're saying that – and I saw your write-up pre-call, but what we're really saying is based on what Hann is seen as of the moment that we think the volumes will be right on where we think they'll be for the rest of this year.

John Pocari – JP Morgan

Okay. Then one question actually on the credit side is the, I know you had previously provided charge-off expectations of 25 to 30 basis points, I believe you had indicated that last quarter. I did not hear you reiterate that at this point. Do you have an update on that front?

Michael M. Quick

Yes, we're not going to provide guidance on that front. In other words, you saw what we did in the first quarter and the second quarter, we're relatively comfortable where we are today, but it's such a moving target, it's really tough to predict what's going to happen for the rest of the year.

John Pocari – JP Morgan

Okay. Thank you.

Operator

And we'll go next to Bob Hughes with KBW Southside [ph] Research.

Bob Hughes – KBW

Hi, good morning, guys.

Michael M. Quick

Good morning, Bob.

Bob Hughes – KBW

I guess a couple of questions. The construction book continue to grow a little bit this quarter. Is that largely just related to advances, or are you still originating construction credits?

Drew K. Hostetter

I would say we're originating very little on the construction side, that would be just advances under typical (inaudible) we've made before.

Bob Hughes – KBW

And given that, when would you expect to see the size of that portfolio peak?

Drew K. Hostetter

My guess is by the latter portion of this year.

Bob Hughes – KBW

Okay. And then, I was intrigued by the commentary on OFHEO and the housing price metrics that they provide, do you use that as a guide somewhat in thinking about making adjustments to your reserving methodology for severity, the severity component?

William J. Reuter

Well, I'll let Mike quick answer that question, but let me just comment. We look at a lot of different data relative to housing including Hanley Wood's. Mike, do you want to comment? Mike Quick?

Michael M. Quick

Yes, we're going through on a quarterly basis a very exhaustive review of all our construction loans both commercial and real estate and residential. And we're taking a look at the information in the marketplace and we're making adjustments as we see each loan, and where it stands in its development stage, and where we see the market. So, we are counting that into our loan loss reserve.

Bob Hughes – KBW

Okay.

William J. Reuter

Bob, basically, throughout our footprint, really, project by project is looked at differently. Some projects are going along relatively well with some support from the developer relative to incentives, some are more challenged, but it really depends on – it really varies from project to project to project. I'd also tell you that our mortgage company has been pretty active in terms of making sure there are conduits for helping some of our customers move product at the same time. We're going to make sure we have mortgage money available, and so they've been working with a lot of our developer customers to make sure we can do product at the same time.

Bob Hughes – KBW

Yeah. Okay. I think some would argue that the – and my whole point is asking about OFHEO, some would argue that the metrics they provide are not as relevant as the other indices like Case-Shiller which have actually shown more significant declines, but….

William J. Reuter

As I said we use a number of different sources of data, Case-Shiller is actually one of them also.

Bob Hughes – KBW

Yeah. And Bill, another question on the credit front now. I know you mentioned that there are a few construction loans I guess that helped drive the uptake in maybe 90 plus days past due and MPLs in the quarter. Are you doing additional reserving today for construction credits that are not yet in latter stages of delinquencies?

Michael M. Quick

I would tell you that – this is Mike Quick speaking. We are looking at that and we are increasing our reserve for construction loans. We have gone since the end of the quarter – allocated to construction and land loans which would be residential, we've gone from 20.5 million to up to 25.1 million in the first six months, allocated to that area.

Bob Hughes – KBW

Okay. Is there – there's clearly been a lot of skepticism over construction credit among investors, and I think there was some expectation that there would be a greater recognition of potential problems in construction portfolios in the second quarter. Is there a case to be made that perhaps you'd be waiting to see how things play out through the entire selling season that third quarter is more of a day of reckoning than the second quarter?

William J. Reuter

I think we've recognized what we have to recognize up through June 30^th in terms of what we see in the portfolio. If you look at our loan loss reserve as an example that's attributed specifically to real estate construction, it's gone from about $20 million at year-end to $23 million in the first quarter to 25 million at the end of the six month time frame, so we've been slowly increasing some of the reserves there. But that's only based on our dissecting of the markets and our dissecting of the customer base.

Bob Hughes – KBW

Okay. And, Bill, on a separate topic, I presume when I look at the roughly 12% decline in tangible per share this quarter from last and the decline in your tangible common, I presume a fair amount of that was related to the Stratton acquisition? Could you dissect that maybe for us?

Michael M. Quick

Sure. 69 million was due to the Stratton acquisition, and the rest was basically due to a change in OCI due to a market value decline in our investment portfolio due to the rise in rate.

Bob Hughes – KBW

Okay.

William J. Reuter

Hey, Bob, let me backtrack on one other issue that you asked about, concentration of real estate construction loans. According to data I have here in front of me if you look at construction lending as a percent of our total loan portfolio at year-end, it was about 15%, it was at 15% at the end of the first quarter, and it dropped to 14% at the end of the second quarter. So, it trended down by about 1%, but I would suspect you'll start to see that trend down more in the future.

Bob Hughes – KBW

Okay. Very good. That's all I have. Thanks, guys.

Operator

And we'll take our next question from John Boland with Maple Capital Management.

William J. Reuter

Good morning, John.

John Boland – Maple Capital Management

Good morning. How are you?

William J. Reuter

Good.

Michael M. Quick

Good morning, John.

John Boland – Maple Capital Management

Just two quick questions on the credit issues. You mentioned two specific credits accounted for the bulk of the charge-offs, is that correct?

William J. Reuter

No, I think we mentioned two specific credits attributed to the 90 days in still accruing category of about $11 million.

Drew K. Hostetter

Three credits in the charge-off.

William J. Reuter

Yeah, three credits in the charge-off.

John Boland – Maple Capital Management

Okay. Last quarter you mentioned the masonry contractor and another developer that had issues there so are these new credits in addition to those two or are they – do you have any – can you shed any light on what comprise the new credits?

Michael M. Quick

Are we talking – may I ask the question, are we talking about charge-offs or are we talking about 90 days accruing?

Drew K. Hostetter

I think we're talking about charge-offs.

Michael M. Quick

In the charge-off, the masonry contractor was part of that as well as the – masonry contract was part of it, a clean up of another C&I loan that we had that we resolved was another part of that in the charge-off, and that's pretty much the (inaudible) loans in that particular area. The C&I loan was a clean up, and the masonry contract was another portion of it.

William J. Reuter

So that masonry contractor we did in two quarters based on some changes in the situation.

Michael M. Quick

On that particular one, we were closing out that company and were finishing off jobs, so it's kind of a moving target. So we're taking as we recognize what the value of the receivables are, we're taking the charges accordingly.

Drew K. Hostetter

We had a residential construction line too.

Michael M. Quick

That's correct. That's the third one, residential construction.

William J. Reuter

Yeah, I mean, from our standpoint, although nobody likes any levels of delinquencies other than historical ranges. What we're seeing seems to be well-controlled and within reason.

John Boland – Maple Capital Management

Then, can you – or maybe did this earlier, I apologize if I missed it, but can you share any thoughts that you may have or what you're experiencing right now as far as work out efforts? What kind of recoveries are we seeing? What can we expect?

William J. Reuter

I'll let Mike Quick answer that, but I'll give you kind of a preamble on that. We've got a pretty aggressive loan work out department. I'll qualify that by saying that if you have the right loan grading system in place, and you're in constant contact with the customer, and you're managing your way through this economic environment, obviously, good loan workout department is worth its weight in gold to you. So, we are seeing a lot of progress there, but Mike, maybe you can answer it specifically.

Michael M. Quick

Well, we're doing a couple of different things in the loan work out. Number one, on the residential construction through our mortgage company, we are offering mortgages which is something of a scarce product, and that has been very successful in helping us move product in the residential area. We've done it in all our marketplaces. We've been very aggressive for the right type of deal to get projects moving and traffic coming in. That's step number one. Step number two is, we've continued to look to our sources out there people who may be interested in buying land, or may be interested in buying projects, or may be interested in doing joint ventures, and we are putting people together that maybe stressed to find a partner that can help them, get through this difficult time, and we've had some success in that particular area. Thirdly, just really working with the customer to make certain his cash flows are realistic to show him the need – that he may need to cut overhead, and show him his different ways that he can survive this downturn, which we think will last probably into 2009. So, we're having constant contact with all our major customers, and it's not just our work out team, it's also our loan officers who are involved in it as well as myself and any executive officer of the company are involved. We're out there in the field looking at the deals and meeting with customers and talking with them and trying to find solutions to their problems.

William J. Reuter

Perhaps the biggest – I guess I can say the biggest attribute we look for in working with a customer is total cooperation from the customer standpoint. When a customer is cooperative with us, when we can understand global cash flow, project cash flow, when they bring everything to the table, we'll work through those transactions with them usually every time. Customer is not going to be cooperative to us, we can veil the (inaudible) pretty quickly also. So, it's really an art that lot of us forgot about for a bunch of years, because credit quality was so good, but we're pretty happy with the way our work out department is operating, and their effect on this, they're doing a real good job for us.

John Boland – Maple Capital Management

Okay, thank you.

Operator

And we'll go next to Collyn Gilbert with Stifel Nicolaus.

Collyn Gilbert – Stifel Nicolaus

Thanks. Good morning, guys.

Michael M. Quick

Good morning, Collyn.

William J. Reuter

Good morning.

Collyn Gilbert – Stifel Nicolaus

First, a follow-up to the comment, Mike, that you made in terms of the improvement in moving some of the work outs that you're offering mortgages to get these projects moving. What types of rates are you offering, or structures of the mortgages that is enhancing these projects to move that they are not able to get elsewhere? Maybe you could just talk about the discrepancies there?

Michael M. Quick

I think that, from rates it could be anywhere from a seven year ARM to a 30-year mortgage. It's real – we're doing market rates primarily maybe a little bit below what the average market is out there. Lot of our customers are having difficulty in finding mortgage money especially for the more expensive type project. And we see a customer with a 700 FICA score or greater that is in our market, we would like to bank him for more than just a mortgage, and so we're looking at the total relationship. I think it's been a psychological plus, because now they know that we're in there providing the mortgage money for them. And secondly, it's to create traffic in the marketplace for them. I mean, in one particular case, on the Chesapeake Bay, we put together package and within the first week they got four contracts. So, we've had some success. We did that with a project down in Ocean City, Maryland that we're now down to 20 units and we just got four more contracts last weekend, so technically will be down to 16 from 35 in 18 months, so it's just a – it's not giving the store away, but we look at it as diversifying the risk away from one bar or too many bars.

William J. Reuter

Yeah, Collyn, some of this is just good old fashioned repackaging and marketing. I guess Mike indicated, there's a perception out there that mortgage money is impossible to get or very hard to get, and although that's true in lot of markets, we put our mortgage company in direct contact with the developer or borrower, and sometimes it's just a question of sitting down and kind of recreating a new marketing program, advertising program, a banner, direct mail marketing pieces, whatever the case might be, these are the type of things you have to do in this kind of environment to move – to make sure you're moving product.

Collyn Gilbert – Stifel Nicolaus

Okay, great. And then, just one to clarify in John's question. Bill, you had answered – I missed this question, but you had answered it was tough to predict.

William J. Reuter

He asked about a range of charge-offs.

Collyn Gilbert – Stifel Nicolaus

Okay.

William J. Reuter

What I said was that obviously you saw we charged off in the first quarter, and the second quarter, but, I really don't know how to predict the third and fourth quarter. I mean if I think things were going to stay the way they are right now, it would be much easier to predict, but I just don't know what the economy is going to continue to do. I will tell you, as I said earlier, and you probably know this that although nobody is in love with any markets anywhere, any place, Mid-Atlantic and Northeast has held up better than most, and we continue to see that. Mike?

Collyn Gilbert – Stifel Nicolaus

Okay.

Michael M. Quick

Collyn, let me give a little more color to Bill's answer. We have developed a model and it's not perfect yet, but we are predicting out. I think we're through the first quarter of next year and we hope to be through all of next year by the end of – next time we talk to you. We're taking a worse case situation, middle case situation, and a best case situation, and predicting where we will be with these credits and where we will be with our loan loss reserve, et cetera. So, it's not finalized, so that's another reason why we're hesitant to say anything, but we are looking at that, and that is being updated every other month in the quarter. We're going back out into the field to validate our expectations and adjust, et cetera.

William J. Reuter

Yeah, make sure you understand what I'm really – there are still lots of challenges out there, I'm not trying to paint a real rosy picture, because when you do a historical charge-off as we have done from 15 to 25 basis points, you have a higher quarter than we have ever had, we're not happy with that, but we still believe based on what we see, and how we're managing the portfolio, and the interaction of our account officers with the customers that things appear to be very well contained at this point in time.

Collyn Gilbert – Stifel Nicolaus

Okay. Because that was going to be – just in terms of I would understand if it would be tough to predict the direction, well not the direction, that's pretty obvious, but the magnitude of the MPLs, but I would think that maybe charge-offs would be a little bit easier to predict simply because of the timing. I mean, I don't know, maybe you could give some clarity as to the timeline of when you generally would see loans that go on non-accrual status and then charge-offs, because if you – if there are loans kind of in the work out mode, I would think that it would take a three to six month period or whatever that you might have a better sense of where the potential charge-offs would be at least under the loans that are currently now non-performing or no?

Michael M. Quick

I'll answer your question. When a loan hits 90 days, it has to have a reasonable opportunity to be – that we will collect, and it will stay current or else we'll put it on non-accrual. At that point we will order a current appraisal on the property, and we will then determine what the effect of the economy has had on the value of that particular property. If, in fact, the loan is impaired, we will take the necessary write-down at that point in time based upon the appraisal. So, right now, we're – on many of our workouts we're in the process of getting updated appraisals.

Collyn Gilbert – Stifel Nicolaus

Okay.

William J. Reuter

So, Collyn, to put it another way, when you see a non-accrual that we report to you quarterly, a number, the provision – the charge-offs already – most times the charge-offs is already been written down, the charge-offs already occurred.

Collyn Gilbert – Stifel Nicolaus

Yeah. Okay. That's helpful. And then just one housekeeping item on, the increase in vehicle expense from the first to second quarter, Drew, what was driving that?

Drew K. Hostetter

That is – it relates to the fact that the best time for our third-party guarantor to sell those cars is second and third quarter, so it's cyclical. He designs the – his lease term, so he get these cars back in the second and third quarters, that's his best time to sell a car.

Collyn Gilbert – Stifel Nicolaus

Okay.

Drew K. Hostetter

So you'll see historically that the first and fourth are typically our lower quarters, and the second and third are our higher quarters.

Collyn Gilbert – Stifel Nicolaus

Okay, so then the corresponding sales related to those will be in the third and fourth quarter.

Drew K. Hostetter

Right. That's when he sells most of his cars out of his resale facilities in New Jersey.

Collyn Gilbert – Stifel Nicolaus

Okay. Okay, great, that was all I had. Thank you.

William J. Reuter

Thank you.

Operator

(Operator instructions) We'll go next to David Darst with FTN Midwest.

David Darst – FTN Midwest Securities

Good morning.

William J. Reuter

Hi, David.

Michael M. Quick

Good morning, David.

David Darst – FTN Midwest Securities

I was just following up on the leasing. Is the reason that the leasing vehicle registration certainties were lower related to the securitization or is that related to the cycle of the sale?

Michael M. Quick

No, it's actually related to the – typically, we have three securitizations outstanding in any one time. Okay? And typically, that the differential that you get you amortize the gain that you – or the highest strip that you set up, and then you have cash coming in. Well, in the first year, that cash coming in is historically a fair amount greater than the amortization amount. And as you get down through the rest of the deal through the next two years of the deal, that becomes a much smaller number. So, the fact that we haven't done a securitization yet this year has caused that securitization fee line to decline.

David Darst – FTN Midwest Securities

Okay. Got it. And then, are there any circumstances that would cause you to have to bring any of the securitizations or realize any losses either back to balance sheet or through your income statement?

Michael M. Quick

We evaluate every quarter the pre-payments and the losses on those lease securitizations, and if those numbers whenever get greater than our estimate, then we would have to adjust the original gain we took, and that would come through the income statement. Right now, our losses are less than what we predicted, and our pre-pays are less than what we predicted. So, both those are still moving in the right direction.

David Darst – FTN Midwest Securities

Okay. And then could you give us an update on your regulatory capital levels?

Michael M. Quick

We don't have the total risk-based capital numbers yet, but I do have some pro forma estimates. For leverage ratio, we estimated June 30th will be 7.8%. For tier-one risk based, it'll be 8.6 and for total risk-based capital, it'll be 10.8.

David Darst – FTN Midwest Securities

Okay. Then you get a benefit after you do the securitization?

Michael M. Quick

A little bit.

David Darst – FTN Midwest Securities

Okay. All right. Thanks.

Operator

And we'll go next to Avi Barak with Sandler O'Neill.

Avi Barak – Sandler O’Neill

Good morning, guys.

William J. Reuter

Hi, Avi.

Avi Barak – Sandler O’Neill

Just sort of a follow-up to the previous question, with your tangible capital just under 5% now, how do you reconcile that with dividend yield that is now approaching 7.5% and the pay-out ratio up near 80? How comfortable are you letting that go and kind of what alternative do you have?

Michael M. Quick

Still pretty comfortable. The thing we focus on, Avi, is tier-one capital for leverage and risk-based, because we believe that – you look at these hybrid trust preferreds, you don't count that in your tangible common equity calculation, but the bottom line is, you can defer for ten years on that thing and still not be in default. So that's as close to common equity you're going to get. So we focus on the tier-one leverage, on the tier-one risk-based capital ratio, and we're still pretty – consider ourselves pretty strong in those two ratios.

Avi Barak – Sandler O’Neill

Okay. Thank you.

Operator

(Operator instructions) We'll go next to Steve Moss of Janney.

Steve Moss – Janney Montgomery Scott

Good morning, guys.

William J. Reuter

Hi, Steve.

Michael M. Quick

Good morning, Steve.

Steve Moss – Janney Montgomery Scott

I apologize for hopping late on the call here in case this question has been asked, but just a little color with regard to the loan growth this quarter looked quite strong on the C&I side.

William J. Reuter

Yeah, let me try to give that to you if I can. Let me give you a number of sense, the loan growth numbers since year-end. Since year-end, we've grown 476 million. Of that 476 million, 45% has been increase in the car lease portfolio, 31% has been owner occupied or non owner occupied commercial real estate, 17% of numbers been C&I, 5% has been residential mortgage, and that pretty much makes up all the gains of the quarter, $76 million for the first six months of the year. Even if you look quarter-to-quarter, the numbers are about the same, about 36% of our increases were commercial real estate, only 2% was construction LAD, leasing was 35%. So, we're basically seeing C&I was about another 10% quarter-to-quarter. So we're seeing C&I, we're seeing still strong opportunities in commercial real estate, obviously, less opportunities in construction. Car leasing is driving anywhere from 35% to 45% of that increase.

Steve Moss – Janney Montgomery Scott

Are you seeing that from less competition or are you seeing better pricing?

William J. Reuter

Let me answer the question kind of both ways. We're seeing some select opportunities to grow the portfolio with what we think are some pretty good customers. And some of those opportunities are directed to us, because some traditional avenues are not available to the customer. I mean, the conduit market is pretty much non-existent. So, we have some real select opportunities to do some fully strong deals that we might carry for the next two, three, four, five years until the conduit market comes back or when the conduit market comes back. So, that's one answer to your question. Now, what we've tried to impart to our loan officers – and I'm not totally confident it sunk in 100% at this point in time, but we're beating on them pretty good, is we have a commodity that's not readily available right now and that's money to lend. And so to do that we want to see our pricing driven upwards. And we're making good strides on that although we're not nearly where I think we ought to be. So, we're working hard on both fronts. We're turning a lot of transactions down. Let me make sure we understand that. We're being selective of what we're doing. We're saying no to a lot of new deals where they're just not worth it from a price standpoint, and there's no relationship we had. And we're locking in deposits or demanding deposits come to us as part of the deal. So, we're happy with what we're seeing from a growth standpoint, could be even higher, but again we've (inaudible) back even the good levels that it is, but it's all relationship driven.

Steve Moss – Janney Montgomery Scott

Okay, thank you very much.

Operator

And that does conclude today's question-and-answer session. At this time, I'd like to turn the conference back over to Mr. Reuter for any additional or closing remarks.

William J. Reuter

Okay. Thank you. I'd like to remind you that our next quarterly conference call will be held on Thursday, October 23^rd at 11 am Eastern Time. Thank you for your time today, and your questions, and your continued interest in Susquehanna Bancshares.

Operator

And this does conclude today's conference. We thank you for your participation. You may now disconnect.

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