UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2008
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-133872
Susquehanna Bancshares, Inc.
(Exact Name of Registrant as Specified in Its Charter)
| | |
| Pennsylvania | | 23-2201716 |
(State or Other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification No.) |
| 26 North Cedar St., Lititz, Pennsylvania | | 17543 |
| (Address of Principal Executive Offices) | | (Zip Code) |
Registrant’s telephone number, including area code (717) 626-4721
Securities registered pursuant to Section 12(b) of the Act:
| | |
Title of Each Class | | Name of Each Exchange on Which Registered |
| common stock, par value $2.00 per share | | The Nasdaq Stock Market, LLC |
Susquehanna Capital I Capital Stock (and the Guarantee by Susquehanna Bancshares, Inc. with respect thereto) | | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act: (Check one):
Large Accelerated Filer x Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller Reporting Company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $1,008,206,306 as of June 30, 2008, based upon the closing price quoted on the Nasdaq Global Select Market for such date. Shares of common stock held by each executive officer and director and by each person who beneficially owns more than 5% of the outstanding common stock have been excluded in that such persons may under certain circumstances be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes. The number of shares issued and outstanding of the registrant’s common stock as of February 23, 2009, was 86,186,395.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 8, 2009 are incorporated by reference into Part III of this Annual Report.
SUSQUEHANNA BANCSHARES, INC.
TABLE OF CONTENTS
Unless the context otherwise requires, the terms “Susquehanna,” “we,” “us,” and “our” refer to Susquehanna Bancshares, Inc. and its subsidiaries.
PART I
Item 1. Business
General
Susquehanna Bancshares, Inc. is a financial holding company that provides a wide range of retail and commercial banking and financial services through our subsidiaries in the mid-Atlantic region. In addition to one commercial bank, we operate a trust and investment company, an asset management company (which provides investment advisory, asset management, brokerage and retirement planning services), a property and casualty insurance brokerage company and a vehicle leasing company. As of December 31, 2008, we had total assets of $13.7 billion, consolidated net loans and leases of $9.7 billion, deposits of $9.1 billion, and shareholders’ equity of $1.9 billion.
Susquehanna was incorporated in Pennsylvania in 1982. Our executive offices are located at 26 North Cedar Street, Lititz, Pennsylvania 17543. Our telephone number is (717) 626-4721, and our web site address iswww.susquehanna.net. Our stock is traded on the Nasdaq Global Select Market under the symbol SUSQ. We make available free of charge, through the Investor Relations section of our web site, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We include our web site address in this Annual Report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our web site.
As a financial holding company with operations in multiple states, we manage our bank subsidiary on a geographic market basis, which allows each division operating in different markets to retain flexibility with regard to loan approvals and product pricing. We believe that this approach differentiates us from other large competitors because it gives our bank greater flexibility to better serve its markets and increase responsiveness to the needs of local customers. We continue, however, to implement consolidations in selected lines of business, operations and support functions in order to achieve economies of scale and cost savings. We also provide our bank subsidiary guidance in the areas of credit policy and administration, risk assessment, investment advisory administration, strategic planning, investment portfolio management, asset liability management, liquidity management and other financial, administrative, and control services.
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The following table sets forth information, for the year ended December 31, 2008, regarding our bank subsidiary and our non-bank subsidiaries that had annual revenues in excess of $5.0 million:
| | | | | | | | | | | | | | | | | | | | |
Subsidiary | | Assets | | Percent
of Total | | | Revenues(1) | | | Percent
of Total | | | Pre-tax
Income | | | Percent
of Total | |
| | | (dollars in thousands) | |
Bank Subsidiary: | | | | | | | | | | | | | | | | | | | | |
Susquehanna Bank(2) | | $ | 13,318,298 | | 97.5 | % | | $ | 501,642 | | | 92.8 | % | | $ | 142,907 | | | 130.4 | % |
Non-Bank Subsidiaries: | | | | | | | | | | | | | | | | | | | | |
Susquehanna Trust & Investment Company | | | 9,659 | | 0.1 | | | | 15,593 | | | 2.9 | | | | 1,141 | | | 1.0 | |
Valley Forge Asset Management Corp. | | | 39,511 | | 0.3 | | | | 15,619 | | | 2.9 | | | | 1,940 | | | 1.8 | |
Stratton Management Company, LLC | | | 76,907 | | 0.6 | | | | 9,722 | | | 1.8 | | | | 4,324 | | | 3.9 | |
Boston Service Company, Inc. (t/a Hann Financial Service Corp.) | | | 138,414 | | 1.0 | | | | 16,495 | | | 3.1 | | | | (6,261 | )(3) | | (5.7 | ) |
The Addis Group, LLC | | | 42,566 | | 0.3 | | | | 12,351 | | | 2.3 | | | | 854 | | | 0.8 | |
Consolidation adjustments and other non-bank subsidiaries | | | 57,633 | | 0.2 | | | | (30,811 | ) | | (5.8 | ) | | | (35,326 | )(4) | | (32.2 | ) |
| | | | | | | | | | | | | | | | | | | | |
TOTAL | | $ | 13,682,988 | | 100.0 | % | | $ | 540,611 | | | 100.0 | % | | $ | 109,579 | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | |
(1) | Revenue equals net interest income and other income. |
(2) | Excludes Susquehanna Trust & Investment Company, a wholly owned subsidiary. |
(3) | Does not include incremental benefits to Susquehanna Bank for loans, leases and deposits originated by Hann. When these benefits, not recorded on Hann’s books, are taken into consideration, Hann’s pre-tax income for 2008 would have been $1.6 million. The corresponding reduction in pre-tax income in Susquehanna Bank would have been $7.8 million. |
(4) | Primarily the parent company’s unallocated expenses. |
As of December 31, 2008, non-interest income represented 26.3% of our total revenue. Susquehanna Bank (excluding Susquehanna Trust & Investment Company) contributed 54.6% of total non-interest income, and non-bank affiliates contributed 45.4% of total non-interest income.
We are managed from a long-term perspective with financial objectives that emphasize loan quality, balance sheet liquidity, and earnings stability. Consistent with this approach, we emphasize a low-risk loan portfolio derived from our local markets. In addition, we focus on not having any portion of our business dependent upon a single customer or limited group of customers or a substantial portion of our loans or investments concentrated within a single industry or a group of related industries. Our net charge-offs over the past five years have averaged 0.23% of total average loans and leases.
As of December 31, 2008, our total loans and leases (net of unearned income) in dollars and by percentage were as follows:
| | | | | | |
| | | (dollars in thousands) | |
Commercial, financial and agricultural | | $ | 2,169,262 | | 22.4 | % |
Real estate – construction | | | 1,313,647 | | 13.6 | |
Real estate secured – residential | | | 2,298,709 | | 23.8 | |
Real estate secured – commercial | | | 2,875,502 | | 29.8 | |
Consumer | | | 314,051 | | 3.3 | |
Leases | | | 682,702 | | 7.1 | |
| | | | | | |
Total loans and leases | | $ | 9,653,873 | | 100.0 | % |
| | | | | | |
As of December 31, 2008, core deposits funded 64.8% of our lending and investing activities.
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Products and Services
Our Bank Subsidiary. Our commercial bank subsidiary, Susquehanna Bank, operates an extensive branch network and maintains a strong market presence in our primary markets. It provides a wide-range of retail banking services, including checking, savings and club accounts, check cards, debit cards, money market accounts, certificates of deposit, individual retirement accounts, home equity lines of credit, residential mortgage loans, home improvement loans, automobile loans, personal loans, and internet banking services. It also provides a wide-range of commercial banking services, including business checking accounts, cash management services, money market accounts, land acquisition and development loans, commercial loans, floor plan, equipment and working capital lines of credit, small business loans, and internet banking services.
Our Non-bank Subsidiaries. Our non-bank subsidiaries offer a variety of financial services to complement our core banking operations, broaden our customer base, and diversify our revenue sources. The Addis Group, LLC provides commercial, property and casualty insurance, and risk management programs for medium and large sized companies. Susquehanna Trust & Investment Company, a subsidiary of Susquehanna Bank, provides traditional trust and custodial services, and acts as administrator, executor, guardian, and managing agent for individuals, businesses and non-profit entities. Valley Forge Asset Management Corp. offers investment advisory, asset management and brokerage services for institutional and high net worth individual clients, and directly and through a subsidiary, retirement planning services. Stratton Management Company provides equity management of assets for institutions, pensions, endowments and high net worth individuals. Boston Service Company, Inc. (t/a Hann Financial Service Corp.) provides comprehensive consumer vehicle financing services.
Market Areas
Our Bank Subsidiary. Susquehanna Bank is a Pennsylvania state-chartered bank that operates 236 banking offices. Its operations are divided into the following regional divisions:
| | • | | The PA Division includes 123 banking offices operating primarily in the central Pennsylvania market area, including Adams, Berks, Chester, Cumberland, Dauphin, Lancaster, Luzerne, Lycoming, Northumberland, Schuylkill, Snyder, Union, and York counties. |
| | • | | The MD Division includes 64 banking offices operating primarily in the market areas of Maryland and southwestern central Pennsylvania, including Allegany, Anne Arundel, Baltimore, Carroll, Garrett, Harford, Howard, Washington, and Worcester counties and the City of Baltimore in Maryland, Berkeley County in West Virginia and Bedford and Franklin counties in Pennsylvania. |
| | • | | The DV Division includes 49 banking offices operating primarily in the suburban Philadelphia, Pennsylvania and southern New Jersey market areas, including Berks, Chester, Delaware, Lehigh, Montgomery, and Northampton counties in Pennsylvania and Atlantic, Burlington, Camden, Cumberland, and Gloucester counties in New Jersey. |
Our Non-bank Subsidiaries. Susquehanna Trust & Investment Company and Valley Forge Asset Management Corp. operate primarily in the same market areas as Susquehanna Bank. The Addis Group, LLC operates primarily in southeastern Pennsylvania, southern New Jersey, and northern Delaware. Boston Service Company, Inc. (t/a Hann Financial Service Corp.) operates primarily in New Jersey, eastern Pennsylvania, and southeastern New York. Stratton Management Company operates throughout the continental United States.
Like the rest of the nation, the market areas that we serve are presently experiencing an economic slowdown. A variety of factors (e.g., any substantial rise in inflation or unemployment rates, decrease in consumer confidence, natural disasters, war, or political instability) may further affect both our markets and the national market. We will continue our emphasis on managing our funding costs and lending rates to effectively maintain profitability. In addition, we will continue to seek relationships that can generate fee income that is not directly tied to lending relationships. We anticipate that this approach will help mitigate profit fluctuations that are caused by movements in interest rates, business and consumer loan cycles, and local economic factors.
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Our Long-Term Strategy
We manage our business for sustained long-term growth and profitability. Our primary strategies are internal growth through expansion of our customer base in existing markets and external growth through acquisitions in selected markets. We focus on leveraging customer relationships through the cross-selling of a comprehensive range of financial services and products by a highly trained and motivated employee sales force. Our long-term strategic plan to enhance shareholder value has three main components: growing our business profitably through the specific methods mentioned above; building enduring relationships through sales and service; and focusing on risk management. Integrated into our strategic plan under these components are various company-wide initiatives we believe are important to achieving our plan, including technology, rewards, teamwork, training, communications, and organizational structure.
Mergers and Acquisitions
Stratton.In April 2008, we completed the acquisition of Stratton Holding Company, an investment management company based in Plymouth Meeting, Pennsylvania, with approximately $3.0 billion in assets under management. Stratton Holding Company was the parent of Stratton Management Company, a privately owned investment management firm founded in 1972 and based in Plymouth Meeting, Pennsylvania. Stratton Management Company provides equity 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, Stratton Multi-Cap Fund, and Stratton Monthly Dividend REIT Shares. Another subsidiary of Stratton, Semper Trust Company, is a Pennsylvania-chartered trust company.
After the acquisition, Stratton Holding Company was merged out of existence, and Stratton Management Company is now a wholly-owned subsidiary of Susquehanna and part of the Susquehanna wealth management companies. The addition of Stratton Management Company increased diversification in our investment expertise, including experience in mutual fund management.
Bank Merger. In October 2008, we merged our three bank subsidiaries together to improve efficiency, customer service and product delivery. Susquehanna Bank and Susquehanna Bank DV were merged into Susquehanna Bank PA, which subsequently changed its name to Susquehanna Bank.
We currently have no other formal commitments with respect to the acquisition of any entities, although discussions with prospects occur on a regular and continuing basis.
Future Acquisitions.We routinely evaluate possible future acquisitions of other banks, and may also seek to enter businesses closely related to banking or that are financial in nature, or to acquire existing companies already engaged in such activities, including investment advisory services and insurance brokerage services. Any acquisition by us may require notice to or approval of the Board of Governors of the Federal Reserve System, the Pennsylvania Department of Banking, other regulatory agencies and, in some instances, our shareholders. While any such acquisition may occur in any market area, the four major growth corridors that we are currently focused on are as follows:
| | • | | the Lancaster/York/Baltimore corridor, comprising Lancaster and York counties in Pennsylvania, the City of Baltimore, and Baltimore, Harford, Howard, Carroll, and Anne Arundel counties in Maryland; |
| | • | | the Greater Delaware Valley corridor, comprising Chester, Montgomery, Delaware, and Bucks counties in Pennsylvania, the City of Philadelphia, and Gloucester, Camden, Burlington, and Mercer counties in New Jersey; |
| | • | | the Interstate 81 corridor, comprising Franklin, Cumberland, and Adams counties in Pennsylvania, Washington and Frederick counties in Maryland, and Berkeley and Jefferson counties in West Virginia; and |
| | • | | the contiguous market area that would fill in between the market areas of our current bank subsidiary. |
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Employees
As of December 31, 2008, we had 2,959 full-time and 312 part-time employees.
Competition
Financial holding companies and their subsidiaries compete with many institutions for deposits, loans, trust services and other banking-related and financial services. We are subject to competition from less heavily regulated entities such as brokerage firms, money market funds, credit unions, consumer finance and credit card companies, and other financial services companies.
The Gramm-Leach-Bliley Act has liberalized many of the regulatory restrictions previously imposed on us, including our subsidiaries. Further legislative proposals are pending or may be introduced which could further affect the financial services industry. It is not possible to assess whether any of such proposals will be enacted, and if enacted, what effect such proposals would have on our competitive positions in our marketplace.
As a result of state and federal legislation enacted over the past 20 years, consolidation in the industry has continued at a rapid pace. Further, as a result of the relaxation of laws and regulations pertaining to branch banking in the state, and the opportunity to engage in interstate banking, consolidation within the banking industry has had a significant effect on us and our markets. At present, we compete with numerous super-regional institutions, with significantly greater resources and assets, that conduct banking business throughout the region.
Supervision and Regulation
General. We are a financial holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and are subject to regulation under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act requires prior approval of an acquisition of all or substantially all of the assets of a bank or of ownership or control of voting shares of any bank if the share acquisition would give us more than 5% of the voting shares of any bank or bank holding company. It also imposes restrictions, summarized below, on the assets or voting shares of non-banking companies that we may acquire.
Susquehanna Bank is also subject to regulation and supervision. It is a Pennsylvania state-chartered bank subject to regulation and periodic examination by the Pennsylvania Department of Banking and the Federal Reserve Board. Susquehanna Trust & Investment Company is a Pennsylvania non-depository trust company subject to regulation and periodic examination by the Pennsylvania Department of Banking and the Federal Reserve Board. All of our subsidiaries are subject to examination by the Federal Reserve Board even if not otherwise regulated by the Federal Reserve Board, subject to certain conditions in the case of “functionally regulated subsidiaries,” such as broker/dealers and registered investment advisers.
Consistent with the requirements of the Bank Holding Company Act, our only lines of business in 2008 consisted of providing our customers with banking, trust and other financial products and services. These included commercial banking through Susquehanna Bank, trust and related services through Susquehanna Trust & Investment Company, consumer vehicle financing through Boston Service Company, Inc. (t/a Hann Financial Service Corp.), investment advisory, asset management, retirement plan consulting and brokerage services through Valley Forge Asset Management Corp. and Stratton Management Company, and property and casualty insurance brokerage services through The Addis Group, LLC. Of these activities, banking activities accounted for 92% of our gross revenues in 2008 and 91% of our gross revenues in 2007.
Regulations governing our bank subsidiary restrict extensions of credit by the bank to Susquehanna and, with some exceptions, the other Susquehanna affiliates. For these purposes, extensions of credit include loans and advances to and guarantees and letters of credit on behalf of Susquehanna and such affiliates. These regulations also restrict investments by our bank subsidiary in the stock or other securities of Susquehanna and the covered affiliates, as well as the acceptance of such stock or other securities as collateral for loans to any borrower, whether or not related to Susquehanna.
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Our bank subsidiary is subject to comprehensive federal and state regulations dealing with a wide variety of subjects, including reserve requirements, loan limitations, restrictions as to interest rates on loans and deposits, restrictions as to dividend payments, requirements governing the establishment of branches, and numerous other aspects of its operations. These regulations generally have been adopted to protect depositors and creditors rather than shareholders.
Additional Activities. Susquehanna is a “financial holding company” (an “FHC”) under the Gramm-Leach-Bliley Act (the “GLB Act”). As an FHC, we are permitted to engage, directly or through subsidiaries, in a wide variety of activities which are financial in nature or are incidental or complementary to a financial activity, in addition to all of the activities otherwise allowed to us. The additional activities permitted to us as an FHC (if we so determine to conduct them) include, among others, insurance and securities underwriting, merchant banking activities, issuing and selling annuities and securitized interests in financial assets, and engaging domestically in activities that bank holding companies previously have been permitted to engage in only overseas. It is expected that in the future, other activities will be added to the permitted list. All of these listed activities can be conducted, through an acquisition or on a start-up basis, generally without prior Federal Reserve Board approval and with only notice to the Federal Reserve Board afterward.
The GLB Act also generally permits well-capitalized national banks and, if state law permits, well-capitalized state chartered banks, to form or acquire financial subsidiaries to engage in most of these same activities, with the exception of certain specified activities (insurance underwriting, for example) which must be conducted only at the level of the holding company or a non-bank subsidiary of the holding company. State chartered banks in Pennsylvania are generally allowed to engage (with proper regulatory authorization) in activities that are permitted to national banks.
As an FHC, Susquehanna is generally subject to the same regulation as other bank holding companies, including the reporting, examination, supervision and consolidated capital requirements of the Federal Reserve Board. However, in some respects the regulation is modified as a result of FHC status. For example, Susquehanna must continue to satisfy certain conditions (discussed below) to preserve our full flexibility as an FHC. However, as an FHC, Susquehanna (unlike traditional bank holding companies) is permitted to undertake several new types of activities, and to acquire companies engaged in several additional kinds of activities, without prior Federal Reserve Board approval and with only notice to the Federal Reserve Board afterward. To preserve our FHC status, we must ensure that Susquehanna Bank remains well-capitalized and well-managed for regulatory purposes and earns “satisfactory” or better ratings on its periodic Community Reinvestment Act (“CRA”) examinations.
An FHC ceasing to meet these standards is subject to a variety of restrictions, depending on the circumstances. If the Federal Reserve Board determines that any of the FHC’s subsidiary depository institutions are either not well-capitalized or not well-managed, it must notify the FHC. Until compliance is restored, the Federal Reserve Board has broad discretion to impose appropriate limitations on the FHC’s activities. If compliance is not restored within 180 days, the Board may ultimately require the FHC to divest its depository institutions or in the alternative, to discontinue or divest any activities that are permitted only to non-FHC bank holding companies.
The potential restrictions are different if the lapse pertains to the CRA requirement. In that case, until all the subsidiary institutions are restored to at least “satisfactory” CRA rating status, the FHC may not engage, directly or through a subsidiary, in any of the additional activities permissible under the GLB Act nor make additional acquisitions of companies engaged in the additional activities. However, completed acquisitions and additional activities and affiliations previously begun are left undisturbed, as the GLB Act does not require divestiture for this type of situation.
Capital Adequacy. Under the risk-based capital requirements applicable to them, bank holding companies must maintain a ratio of total capital to risk-weighted assets (including the asset equivalent of certain off-balance sheet activities such as acceptances and letters of credit) of not less than 8% (10% in order to be considered
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“well-capitalized”). At least 4% out of the total capital (6% to be well-capitalized) must be composed of common stock, related surplus, retained earnings, qualifying perpetual preferred stock and minority interests in the equity accounts of certain consolidated subsidiaries, after deducting goodwill and certain other intangibles (“tier 1 capital”). The remainder of total capital (“tier 2 capital”) may consist of certain perpetual debt securities, mandatory convertible debt securities, hybrid capital instruments and limited amounts of subordinated debt, qualifying preferred stock, allowance for loan and lease losses, allowance for credit losses on off-balance-sheet credit exposures, and unrealized gains on equity securities.
At December 31, 2008, our tier 1 capital and total capital (i.e., tier 1 plus tier 2) ratios were 11.17% and 13.52%, respectively.
The Federal Reserve Board has also established minimum leverage ratio guidelines for bank holding companies. These guidelines mandate a minimum leverage ratio of tier 1 capital to adjusted quarterly average total assets less certain amounts (“leverage amounts”) equal to 3% for bank holding companies meeting certain criteria (including those having the highest regulatory rating). All other banking organizations are generally required to maintain a leverage ratio of at least 3% plus an additional cushion of at least 100 basis points and in some cases more. The Federal Reserve Board’s guidelines also provide that bank holding companies experiencing internal growth or making acquisitions are expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a “tangible tier 1 leverage ratio” (i.e., after deducting all intangibles) in evaluating proposals for expansion or new activities. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us. At December 31, 2008, our leverage ratio was 9.92%.
Susquehanna Bank is subject to similar capital standards promulgated by the Federal Reserve Board. The Federal Reserve Board has not advised it of any specific minimum leverage ratios applicable to it.
The federal bank regulatory agencies’ risk-based capital guidelines for years have been based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision, a committee of central bankers and bank supervisors from the major industrialized countries. This body develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. In 2004, it proposed a new capital adequacy framework (“Basel II”) for large, internationally active banking organizations to replace Basel I. Basel II was designed to produce a more risk-sensitive result than its predecessor. However, certain portions of Basel II entail complexities and costs that were expected to preclude their practical application to the majority of U.S. banking organizations that lack the economies of scale needed to absorb the associated expenses.
Effective April 1, 2008, the U.S. federal bank regulatory agencies adopted Basel II for application to certain banking organizations in the United States. The new capital adequacy framework apply to organizations that: (i) have consolidated assets of at least $250 billion; or (ii) have consolidated total on-balance sheet foreign exposures of at least $10 billion; or (iii) are eligible to, and elect to, opt-in to the new framework even though not required to do so under clause (i) or (ii) above; or (iv) as a general matter, are subsidiaries of a bank or bank holding company that uses the new rule. During a two-year phase in period, organizations required or electing to apply Basel II will report their capital adequacy calculations separately under both Basel I and Basel II on a “parallel run” basis. Implementation of Basel II may be delayed, or Basel II may be modified to address issues related to the financial crisis of 2008.
Given the high thresholds noted above, Susquehanna is not required to apply Basel II and does not expect to apply it in the foreseeable future. No determination has been made as to whether we will be eligible, and if so will elect, to apply Basel II at the first opportunity or at some future point. The U.S. federal bank regulatory agencies issued a separate proposal in December 2006 that would modify the existing Basel I framework applicable to the vast majority of U.S. banking organizations not required or electing to use the new Basel II program. The goal of this separate proposal would be to provide a more risk-sensitive capital regime for those
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organizations and to address concerns that the new Basel II framework would otherwise present significant competitive advantages for the largest participants in the U.S. banking industry.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, requires the federal regulators to take prompt corrective action against any undercapitalized institution. FDICIA establishes five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Well-capitalized institutions significantly exceed the required minimum level for each relevant capital measure. Adequately capitalized institutions include depository institutions that meet but do not significantly exceed the required minimum level for each relevant capital measure. Undercapitalized institutions consist of those that fail to meet the required minimum level for one or more relevant capital measures. Significantly undercapitalized characterizes depository institutions with capital levels significantly below the minimum requirements for any relevant capital measure. Critically undercapitalized refers to depository institutions with minimal capital and at serious risk for government seizure.
Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category. A depository institution is generally prohibited from making capital distributions, including paying dividends, or paying management fees to a holding company if the institution would thereafter be undercapitalized. Institutions that are adequately capitalized but not well-capitalized cannot accept, renew or roll over brokered deposits except with a waiver from the Federal Deposit Insurance Corporation (“FDIC”) and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits.
The federal bank regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories. Depending on the level of an institution’s capital, the agency’s corrective powers include, among other things:
| | • | | prohibiting the payment of principal and interest on subordinated debt; |
| | • | | prohibiting the holding company from making distributions without prior regulatory approval; |
| | • | | placing limits on asset growth and restrictions on activities; |
| | • | | placing additional restrictions on transactions with affiliates; |
| | • | | restricting the interest rate the institution may pay on deposits; |
| | • | | prohibiting the institution from accepting deposits from correspondent banks; and |
| | • | | in the most severe cases, appointing a conservator or receiver for the institution. |
A banking institution that is undercapitalized is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. As of December 31, 2008, Susquehanna Bank exceeded the required capital ratios for classification as “well capitalized.”
Federal Deposit Insurance. Under the Federal Deposit Insurance Reform Act of 2005, the FDIC adopted a new risk-based premium system for FDIC deposit insurance, providing for quarterly assessments of FDIC insured institutions based on their respective rankings in one of four risk categories depending upon their examination ratings and capital ratios. Beginning in 2007, well-capitalized institutions with certain “CAMELS” ratings (under the Uniform Financial Institutions Examination System adopted by the Federal Financial Institutions Examination Council) were grouped in Risk Category I and were assessed for deposit insurance premiums at an annual rate, with the assessment rate for the particular institution to be determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either a set of financial ratios or the average ratings of its long-term debt. Institutions in Risk Categories II, III and IV are assessed premiums at progressively higher rates.
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On November 21, 2008, following a determination by the Secretary of the Treasury that systemic risk existed in the nation’s financial sector, the FDIC Board of Directors adopted a new program to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and by providing full coverage of noninterest-bearing deposit transaction accounts, regardless of dollar amount (the “Temporary Liquidity Guarantee Program” (“TLGP”)). Susquehanna Bank is eligible to participate in both facets of the TLGP. A 10 basis-point annual rate surcharge will be applied to noninterest-bearing transaction deposit amounts over $250,000 in an account. Banks will not be assessed on amounts that are otherwise insured.Susquehanna Bank currently does not plan to issue any senior unsecured debt under the TLGP.
After the passage of the Emergency Economic Stabilization Act of 2008 (the “EESA”), the FDIC also increased deposit insurance for all deposit accounts up to $250,000 per account as of October 3, 2008 and ending December 31, 2009. On December 16, 2008, the FDIC Board of Directors determined deposit insurance assessment rates for the first quarter of 2009. Risk Category I Institutions, such as Susquehanna Bank, were assessed at a rate of between 12 and 14 basis points, for every $100 of deposits, an increase from last year’s rate range of 5 to 7 basis points. Effective April 1, 2009, the FDIC will change the way its assessment system differentiates for risk, making corresponding changes to assessment rates beginning with the second quarter of 2009, and make certain technical and other changes to these rules. The increase in deposit insurance described above, as well as the recent increase and anticipated additional increase in the number of bank failures, is expected to result in an increase in deposit insurance assessments for all banks, including Susquehanna Bank. The FDIC is required by law to return the insurance reserve ratio to a 1.15 percent ratio no later than the end of 2013. Recent failures caused that ratio to fall to 0.76 percent as of September 30, 2008.
Source of Strength Doctrine. Under Federal Reserve Board policy and regulation, a bank holding company must serve as a source of financial and managerial strength to each of its subsidiary banks and is expected to stand prepared to commit resources to support each of them. Consistent with this, the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company should generally not maintain a given rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the organization’s capital needs, asset quality, and overall financial condition.
Interstate Banking and Branching. Under the Pennsylvania Banking Code of 1965, there is no limit on the number of banks that may be owned or controlled by a Pennsylvania-based bank holding company and Susquehanna Bank may branch freely throughout the Commonwealth and, with Department of Banking approval, elsewhere in the United States and abroad.
Substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies have been eliminated. In addition, the federal banking agencies are generally permitted to approve merger transactions resulting in the creation of branches by banks outside their home states if the host state into which they propose to branch has enacted authorizing legislation. Liberalizing of the branching laws has had the effect of increasing competition within the markets in which we now operate.
USA Patriot Act of 2001. A major focus of governmental policy applicable to financial institutions in recent years has been the effort to combat money laundering and terrorism financing. The USA Patriot Act of 2001 was enacted to strengthen the ability of the U.S. law enforcement and intelligence communities to achieve this goal. The Act requires financial institutions, including our banking and broker-dealer subsidiaries, to assist in the prevention, detection and prosecution of money laundering and the financing of terrorism. The Act established standards to be followed by institutions in verifying client identification when accounts are opened and provides rules to promote cooperation among financial institutions, regulators and law enforcement organizations in identifying parties that may be involved in terrorism or money laundering.
Regulation of Non-bank Subsidiaries. In addition to Susquehanna Trust & Investment Company, we have other primary non-bank subsidiaries whose activities subject them to licensing and regulation. Boston Service
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Company, Inc. (t/a Hann Financial Service Corp.) is organized under the laws of New Jersey. It is regulated by Connecticut as a motor vehicle leasing company, by Delaware as a finance or small loan agency and a motor vehicle lessor, and by New Jersey and Pennsylvania as a sales finance company. Valley Forge Asset Management Corp. is organized under the laws of Pennsylvania. It is registered with the Securities and Exchange Commission (the “SEC”) as an investment adviser under the Investment Advisers Act of 1940. It is also a registered broker-dealer and is a member of the Financial Industry Regulatory Authority (“FINRA”). It is also licensed with 25 states as an investment advisor, 24 states as a broker-dealer, and has a firm insurance license with three states. Stratton Management Company is licensed as an investment advisor with the SEC and 17 states. The Addis Group, LLC is organized under the laws of Pennsylvania. It is licensed with the Pennsylvania Insurance Commissioner and the insurance commissioners of 47 other states.
Privacy. Title V of the GLB Act is intended to increase the level of privacy protection afforded to customers of financial institutions, including customers of the securities and insurance affiliates of such institutions, partly in recognition of the increased cross-marketing opportunities created by the GLB Act’s elimination of many of the boundaries previously separating various segments of the financial services industry. Among other things, these provisions require institutions to have in place administrative, technical, and physical safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records, and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. The GLB Act also requires institutions to furnish consumers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.
EESA.Turmoil in the nation’s financial sector during 2008 resulted in the passage of the EESA and the adoption of several programs by the U.S. Department of the Treasury, as well as several actions by the Federal Reserve Board. One such program under the Treasury Department’s Troubled Asset Relief Program (“TARP”) was action by Treasury to make significant investments in U.S. financial institutions through the Capital Purchase Program (“CPP”). The Treasury’s stated purpose in implementing the CPP was to improve the capitalization of healthy institutions, which would improve the flow of credit to businesses and consumers, and boost the confidence of depositors, investors, and counterparties alike. All federal banking and thrift regulatory agencies encouraged eligible institutions to participate in the CPP.
We applied for, and the Department of the Treasury approved, a capital purchase in the amount of $300 million. We entered into a Letter Agreement with the Treasury, pursuant to which we issued and sold to the Treasury for an aggregate purchase price of $300 million in cash: (i) 300,000 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share, having a liquidation preference of $1,000 per share; and (ii) a ten-year warrant to purchase up to 3,028,264 shares of our common stock, at an initial exercise price of $14.86 per share, subject to certain anti-dilution and other adjustments. The TARP transaction closed on December 12, 2008.
The Federal Reserve has also developed an Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (“AMLF”) and the Commercial Paper Funding Facility (“CPFF”). The AMLF provides loans to depository institutions to purchase asset-backed commercial paper from money market mutual funds. The CPFF provides a liquidity backstop to U.S. issuers of commercial paper. These facilities are presently authorized through April 30, 2009. We have not made use of either of these facilities and presently have no intentions of using them in the future.
Future Legislation. From time to time, various legislation is introduced in Congress and state legislatures with respect to the regulation of financial institutions. It is anticipated that the 111th Congress will consider legislation affecting financial institutions in its upcoming session. Such legislation may change banking statutes and our operating environment or that of our subsidiaries in substantial and unpredictable ways. We cannot determine the ultimate effect that potential legislation, if enacted, or any regulations issued to implement it, would have upon our financial condition or results of operations.
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National Monetary Policy. In addition to being affected by general economic conditions, the earnings and growth of Susquehanna and our subsidiaries are affected by the policies of the Federal Reserve Board. An important function of the Federal Reserve Board is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve Board to implement these objectives are open market operations in U.S. Government securities, adjustments of the discount rate, and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments, and deposits. Their use also affects interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our future business, earnings, and growth cannot be predicted.
Executive Officers
As of December 31, 2008, the executive officers of Susquehanna, their ages and their positions with Susquehanna, are set forth in the following table:
| | | | |
Name | | Age | | Title |
William J. Reuter | | 59 | | Chairman of the Board and Chief Executive Officer |
Eddie L. Dunklebarger | | 54 | | President and Chief Operating Officer |
Drew K. Hostetter | | 54 | | Executive Vice President, Treasurer and Chief Financial Officer |
Edward Balderston, Jr. | | 61 | | Executive Vice President and Chief Administrative Officer |
Michael M. Quick | | 60 | | Executive Vice President and Chief Corporate Credit Officer |
James G. Pierné | | 57 | | Executive Vice President |
Jeffrey M. Seibert | | 49 | | Executive Vice President |
Peter J. Sahd | | 49 | | Senior Vice President and Group Executive |
Bernard A. Francis, Jr. | | 58 | | Senior Vice President and Group Executive |
Rodney A. Lefever | | 42 | | Senior Vice President and Chief Technology Officer |
Lisa M. Cavage | | 44 | | Senior Vice President, Secretary and Counsel |
Edward J. Wydock | | 52 | | Senior Vice President and Chief Risk Officer |
Joseph R. Lizza | | 50 | | Senior Vice President |
Michael M. Hough | | 44 | | Senior Vice President |
John H. Montgomery | | 46 | | Senior Vice President |
William J. Reuter has been a Director of Susquehanna since 1999 and became Chairman of the Board in May 2002. He has been Chief Executive Officer since May 2001. From January 2000 until June 2008, he was also President. From January 1998 until he was named President, he was Senior Vice President. He has also been Chairman of the Board of Susquehanna Bank (including its predecessors, Susquehanna Bank PA and Farmers First Bank) since March 2001, Boston Service Company, Inc. (t/a Hann Financial Service Corp.) since February 2000, Valley Forge Asset Management Corp. since March 2000, and The Addis Group, LLC since September 2002. He has been a Director of Stratton Management Company and Semper Trust Company since May 2008.
Eddie L. Dunklebarger has been a Director of Susquehanna since November 2007. He was named President and Chief Operating Officer in June 2008. From November 2007 until he was named President and Chief Operating Officer, he was Vice Chairman of the Board and an Executive Vice President. He has also been a Director of Susquehanna Bank (including its predecessor Susquehanna Bank PA) since November 2007 and has served as its President and Chief Executive Officer since April 2008. From 1998 to 2007, he served as a Director of Community Banks, Inc. and was elected Chairman of Community’s Board in 2002. From 1998 to 2007, he also served as President and Chief Executive Officer of Community, and from 1999 to 2007, he also served as President and Chief Executive Officer of Community’s subsidiary bank.
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Drew K. Hostetter was appointed Executive Vice President in May 2001 and has been Treasurer and Chief Financial Officer since 1998. From January 2000 until his appointment as Executive Vice President, he was Senior Vice President. He has also been Chairman of Hann Financial Service Corp. since February 2004.
Edward Balderston, Jr. was appointed Executive Vice President and Chief Administrative Officer in June 2004. From May 2001 until his appointment as Executive Vice President and Chief Administrative Officer, he was Senior Vice President and Group Executive. From May 1998 until his appointment as Senior Vice President and Group Executive, he was Vice President in Charge of Marketing and Human Resources.
Michael M. Quick was appointed Executive Vice President and Chief Corporate Credit Officer in July 2007. From May 2005 until his appointment as Executive Vice President and Chief Corporate Credit Officer, he was Executive Vice President and Group Executive. From June 2004 until his appointment as Executive Vice President and Group Executive, he was Senior Vice President and Group Executive. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive. From June 2006 until October 2008, he was Chairman of Susquehanna Bank DV (including its predecessor Susquehanna Patriot Bank). From November 2005 until he was appointed Chairman of Susquehanna Bank DV, he was Chairman and Chief Executive Officer of Susquehanna Patriot Bank. From June 2004 until his appointment as Chairman and Chief Executive Officer of Susquehanna Patriot Bank, he was Chairman of Susquehanna Patriot Bank. From March 1998 until his appointment as Chairman of Susquehanna Patriot Bank, he was President and Chief Executive Officer of Equity Bank, N.A.
James G. Pierné was appointed Executive Vice President and Group Executive in May 2007. From June 2004 until his appointment as Executive Vice President and Group Executive, he was Senior Vice President and Group Executive. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive. He was appointed Managing Director – Retail Banking Services/Marketing of Susquehanna Bank in October 2008. From March 2002 until October 2008, he was Chairman, President and Chief Executive Officer of Susquehanna Bank (including its predecessor, Farmers & Merchants Bank and Trust). From March 2000 to March 2002, he also served as President and Chief Executive Officer of Farmers & Merchants Bank and Trust. From March 1999 until his appointment as President and Chief Executive Officer, he was Executive Vice President of Farmers & Merchants Bank and Trust. From 1993 until his appointment as Executive Vice President, he was Senior Vice President of Farmers & Merchants Bank and Trust.
Jeffrey M. Seibert was appointed Executive Vice President in June 2008. He was appointed Managing Director – Commercial/Business Banking Services of Susquehanna Bank in October 2008. From November 2007 until his appointment as Managing Director, he was the Chief Operating Officer of Susquehanna Bank PA. From March 1994 until his appointment as Chief Operating Officer, he was Executive Vice President, Managing Director of Banking Services, Chief Credit Officer and Senior Lender of CommunityBanks.
Peter J. Sahd was appointed Senior Vice President and Group Executive in June 2004. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive. From April 1999 until his appointment as Vice President and Group Executive, he was Director — Alternative Delivery Services. Prior to joining Susquehanna, Mr. Sahd served as Senior Vice President, Operations, of Fulton Bank from August 1994 until April 1999.
Bernard A. Francis, Jr. was appointed Senior Vice President and Group Executive in May 2005. From June 2004 until his appointment as Senior Vice President and Group Executive, he was Vice President. He has also been President and Chief Executive Officer of Valley Forge Asset Management Corp. since March 2000, Chief Investment Officer of Susquehanna Trust & Investment Company since November 2001, Chairman of the Board of Stratton Management Company since April 2008, Chairman of the Board of Semper Trust Company since April 2008 and a Director of Stratton Funds, Inc. since April 2008.
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Rodney A. Lefever was appointed Senior Vice President and Chief Technology Officer in June 2004. From May 2002 until his appointment as Senior Vice President and Chief Technology Officer, he was Vice President and Chief Technology Officer. From April 2001 until his appointment as Vice President and Chief Technology Officer, he was Chief Technology Officer. Prior to joining Susquehanna, he served as Director, Earthlink Everywhere, Earthlink, Inc. from September 2000 until April 2001, as the President of New Business Development, OneMain.com Inc. from December 1999 until September 2000 and as the President of D&E Supernet (and its predecessors) from March 1995 until December 1999.
Lisa M. Cavage was appointed Senior Vice President in May 2005. From May 2001 until her appointment as Senior Vice President, she was Vice President. She has been Counsel to Susquehanna since March 1998.
Edward J. Wydock was appointed Senior Vice President and Chief Risk Officer in May 2007. From May 2002 until his appointment as Senior Vice President and Chief Risk Officer, he served as Vice President and Chief Audit Executive. Prior to joining Susquehanna, he served as Director of Internal Audit and Risk Consulting at PricewaterhouseCoopers LLP from March 1997 to May 2002.
Joseph R. Lizza was appointed Senior Vice President and Group Executive in April 2007. He was appointed Managing Director — DV Division of Susquehanna Bank in October 2008. From July 2006 until his appointment as Managing Director, he served as President and Chief Executive Officer of Susquehanna Bank DV (including its predecessor, Susquehanna Patriot Bank). From July 2006 until his appointment as Senior Vice President, he served as Vice President of Susquehanna. From April 2005 until his appointment as President and Chief Executive Officer of Susquehanna Patriot Bank, he was Senior Executive Vice President — Risk Management of Susquehanna Bank. From February 2000 until his appointment as Senior Executive Vice President — Risk Management of Susquehanna Bank, he was President and Chief Executive Officer of Susquehanna Bank.
Michael M. Hough was appointed Senior Vice President in June 2008. He was appointed Managing Director — Maryland Division of Susquehanna Bank in October 2008. From May 2007 until his appointment as Managing Director, he served as President and Chief Operating Officer of Susquehanna Bank. From 2005 until his appointment as President and Chief Operating Officer, he was Senior Executive Vice President of Susquehanna Bank. From 2003 until his appointment as Senior Executive Vice President, he was Executive Vice President of Farmers & Merchants Bank and Trust Company.
John H. Montgomery was appointed Senior Vice President in June 2008. He was appointed Managing Director – Pennsylvania Division of Susquehanna Bank in October 2008. From November 2007 until his appointment as Managing Director, he served as Senior Vice President and Regional Executive of Susquehanna Bank PA. From September 2005 until his appointment as Senior Vice President and Regional Executive, he was Senior Vice President of Susquehanna Bank PA’s Business Banking and Agricultural Banking division. From November 1996 until he joined Susquehanna, he served in various positions with CommunityBanks and its predecessors, most recently as Senior Vice President and Regional President.
There are no family relationships among the executive officers of Susquehanna. The executive officers are elected or appointed by the Board of Directors of Susquehanna and serve until the appointment or election and qualification of their successor or their earlier death, resignation or removal. There are no arrangements or understandings between any of them and any other person pursuant to which any of them was selected an officer of Susquehanna.
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Item 1A. Risk Factors
Recent Market, Legislative and Regulatory Events.
Difficult conditions in the capital markets and the economy generally may materially adversely affect our business and results of operations, and we do not expect these conditions to improve in the near future.
Our results of operations are materially affected by conditions in the capital markets and the economy generally. The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months at unprecedented levels. In many cases, these markets have produced downward pressure on stock prices of, and credit availability to, certain companies without regard to those companies’ underlying financial strength.
Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining U.S. real estate market have contributed to increased volatility and diminished expectations for the economy and the capital and credit markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and national recession. In addition, the fixed-income markets are experiencing a period of extreme volatility which has negatively impacted market liquidity conditions. Initially, the concerns on the part of market participants were focused on the subprime segment of the mortgage-backed securities market. However, these concerns have since expanded to include a broad range of mortgage-and asset-backed and other fixed income securities, including those rated investment grade, the U.S. and international credit and interbank money markets generally, and a wide range of financial institutions and markets, asset classes and sectors. As a result, the market for fixed income instruments has experienced decreased liquidity, increased price volatility, credit downgrade events, and increased probability of default. Securities that are less liquid are more difficult to value and may be hard to dispose of. Domestic and international equity markets have also been experiencing heightened volatility and turmoil, with issuers (such as our company) that have exposure to the real estate, mortgage, automobile and credit markets particularly affected. These events and the continuing market upheavals may have an adverse effect on us, in part because we have a large investment portfolio and also because we are dependent upon customer behavior. Our revenues are likely to decline in such circumstances, and our profit margins could erode. In addition, in the event of extreme and prolonged market events, such as the global credit crisis, we could incur significant losses. Even in the absence of a market downturn, we are exposed to substantial risk of loss due to market volatility.
Factors such as consumer spending, business investment, government spending, the volatility and strength of the capital markets, and inflation all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our financial products could be adversely affected. Adverse changes in the economy could affect earnings negatively and could have a material adverse effect on our business, results of operations and financial condition. The current mortgage crisis and economic slowdown has also raised the possibility of future legislative and regulatory actions in addition to the recent enactment of the EESA that could further impact our business. We cannot predict whether or when such actions may occur, or what impact, if any, such actions could have on our business, results of operations and financial condition.
There can be no assurance that actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets will achieve the intended effect.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, President Bush signed the EESA into law. Pursuant to the EESA, the Treasury has the authority to utilize up to $700 billion to purchase distressed assets from financial institutions or infuse capital into financial institutions for the purpose of stabilizing the financial markets. The Treasury announced the CPP under the EESA pursuant to which it has purchased and will continue to purchase senior preferred stock in participating financial institutions. There can be no assurance,
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however, as to the actual impact that the EESA, including the CPP and the Treasury’s Troubled Asset Repurchase Program, will have on the financial markets or on us. The failure of these programs to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
The federal government, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. There can be no assurance as to what impact such actions will have on the financial markets, including the extreme levels of volatility currently being experienced. Such continued volatility could materially and adversely affect our business, financial condition and results of operations, or the trading price of our common stock.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in funding transactions could be adversely affected by the actions and failure of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even questions or rumors about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. Losses related to these credit risks could materially and adversely affect our results of operations or earnings.
We may be required to pay significantly higher Federal Deposit Insurance Corporation (FDIC) premiums in the future.
Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The FDIC expects a higher rate of insured institution failures in the next few years compared to recent years; thus, the reserve ratio may continue to decline. In addition, the EESA temporarily increased the limit on FDIC coverage to $250,000 through December 31, 2009. These developments will cause the premiums assessed to us by the FDIC to increase.
On December 16, 2008, the FDIC Board of Directors determined deposit insurance assessment rates for the first quarter of 2009. Our assessment rate will increase from 5 to 7 basis points per $100 of deposits to approximately 12 to 14 basis points beginning in 2009, which will result in an increase in our expected premium of at least $12.0 million. Effective April 1, 2009, the FDIC will modify the way its assessment system differentiates risk, making corresponding changes to assessment rates beginning with the second quarter of 2009. Potentially higher FDIC assessment rates and special assessments could have an adverse impact on our results of operations.
Recent negative developments in the financial industry and the credit markets may subject us to additional regulation.
As a result of the recent global financial crisis, the potential exists for new federal or state laws and regulations regarding lending and funding practices and liquidity standards to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and may adversely impact our financial performance.
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Our future growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our current capital levels will satisfy our regulatory requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, your interest could be diluted.
A prolonged economic downturn, especially one affecting our geographic market areas, could reduce our customer base, our level of deposits and demand for financial products, such as loans.
We are in uncertain economic times, including uncertainty with respect to financial markets that have been volatile as a result of sub-prime mortgage related and other matters. Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our geographic markets. If the communities in which we operate do not grow, or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. A prolonged economic downturn would likely contribute to the deterioration of the credit quality of our loan portfolio and reduce our level of customer deposits, which in turn would hurt our business. If the current economic downturn in the economy as a whole, or in our geographic market areas, continues for a prolonged period, borrowers may be less likely to repay their loans as scheduled or at all. Moreover, the value of real estate or other collateral that may secure our loans could be adversely affected. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies and geographic locations. A prolonged economic downturn could, therefore, result in losses that could materially and adversely affect our business.
Business and Industry Risks
We may not be able to continue to grow our business, which may adversely impact our results of operations.
Our total assets have grown from approximately $7.5 billion at December 31, 2004, to $13.7 billion at December 31, 2008. Our business strategy calls for continued expansion. Our ability to continue to grow depends, in part, upon our ability to open new branch locations, successfully attract deposits, identify favorable loan and investment opportunities, and acquire other bank and non-bank entities. In the event that we do not continue to grow, our results of operations could be adversely impacted.
Our ability to grow successfully will depend on whether we can continue to fund this growth while maintaining cost controls and asset quality, as well as on factors beyond our control, such as national and regional economic conditions and interest rate trends. If we are not able to control costs and maintain asset quality, such growth could adversely impact our earnings and financial condition.
Geographic concentration in one market may unfavorably impact our operations.
Substantially all of our business is with customers located within Pennsylvania, Maryland, and New Jersey and our operations are heavily concentrated in the Mid-Atlantic region. As a result of this geographic concentration, our results depend largely on economic conditions in these and surrounding areas. Deterioration in economic conditions in this market could:
| | • | | increase loan delinquencies; |
| | • | | increase problem assets and foreclosures; |
| | • | | increase claims and lawsuits; |
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| | • | | decrease the demand for our products and services; and |
| | • | | decrease the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with nonperforming loans and collateral coverage. |
Generally, we make loans to small to mid-sized businesses whose success depends on the regional economy. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. Adverse economic and business conditions in our market area could reduce our growth rate, affect our borrowers’ ability to repay their loans and, consequently, adversely affect our financial condition and performance. For example, we place substantial reliance on real estate as collateral for our loan portfolio. A sharp downturn in real estate values in our market area could leave many of our loans inadequately collateralized. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings could be adversely affected.
Our issuance of securities to the Treasury may limit our ability to return capital to our shareholders and is dilutive to the holders of our common stock and may result in other restrictions to our operations.
In connection with our sale of $300 million of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value per share (“Preferred Stock”) to the Treasury on December 12, 2008, we also issued to the Treasury a warrant to purchase approximately 3 million shares of our common stock. The terms of the transaction with the Treasury will result in limitations on our ability to pay dividends and repurchase our shares. Until December 12, 2011 or until the Treasury no longer hold any shares of the Preferred Stock, we will not be able to increase dividends above current level nor repurchase any of our shares without the approval of the Treasury, with limited exceptions, most significantly purchases in connection with benefit plans. In addition, we will not be able to pay any dividends at all on our common stock unless we are current on our dividend payments on the Preferred Stock. These restrictions, as well as the dilutive impact of the warrant, may have a negative effect on the market price of our common stock.
In addition, we are required to pay cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. Depending on our financial condition at the time, this increase in dividends on the Preferred Stock could have a negative effect on our liquidity.
The securities issued to the Treasury may also subject us to additional restrictions or modifications in the terms of the agreements. For instance, in February 2009, legislation was signed that may result in changes in those terms.
Loss of certain of our key officers would adversely affect our business.
Our future operating results are substantially dependent on the continued service of William J. Reuter, our Chairman and Chief Executive Officer; Eddie L. Dunklebarger, our President and Chief Operating Officer; Drew K. Hostetter, our Executive Vice President and Chief Financial Officer; Michael M. Quick, our Executive Vice President and Chief Corporate Credit Officer, and Bernard A. Francis, Jr., our Senior Vice President and Group Executive. The loss of the services of Messrs. Reuter, Dunklebarger, Hostetter, Quick and Francis would have a negative impact on our business because of their expertise and years of industry experience. In addition, the loss of the services of Mr. Reuter would have a negative impact on our business because of his leadership, business development skills and community involvement. We do not maintain key man life insurance on Messrs. Reuter, Dunklebarger, Hostetter, Quick or Francis.
Our exposure to credit risk, because we focus on commercial lending, could adversely affect our earnings and financial condition.
There are certain risks inherent in making loans. These risks include interest rate changes over the time period in which loans may be repaid, risks resulting from changes in the economy, risks inherent in dealing with borrowers and, in the case of a loan backed by collateral, risks resulting from uncertainties about the future value of the collateral.
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Commercial loans, including commercial real estate, are generally viewed as having a higher credit risk than residential real estate or consumer loans because they usually involve larger loan balances to a single borrower and are more susceptible to a risk of default during an economic downturn. Our consolidated commercial lending operations include commercial, financial and agricultural lending, real estate construction lending, and commercial mortgage lending, which comprised 22.4%, 13.6% and 29.8% of our total loan portfolio, respectively, as of December 31, 2008. Construction financing typically involves a higher degree of credit risk than commercial mortgage lending. Risk of loss on a construction loan depends largely on the accuracy of the initial estimate of the property’s value at completion of construction compared to the estimated cost (including interest) of construction. If the estimated property value proves to be inaccurate, the loan may be inadequately collateralized.
Because our loan portfolio contains a significant number of commercial real estate, commercial and industrial loans, and construction loans, the deterioration of these loans may cause a significant increase in nonperforming loans. An increase in nonperforming loans could cause an increase in loan charge-offs and a corresponding increase in the provision for loan losses, which could adversely impact our financial condition and results of operations.
If our allowance for loan and lease losses is not sufficient to cover actual loan and lease losses, our earnings would decrease.
In an attempt to mitigate any loan and lease losses that we may incur, we maintain an allowance for loan and lease losses based on, among other things, national and regional economic conditions, historical loss experience, and delinquency trends. However, we cannot predict loan and lease losses with certainty, and we cannot assure you that charge-offs in future periods will not exceed the allowance for loan and lease losses. If charge-offs exceed our allowance, our earnings would decrease. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan and lease losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination. Factors that require an increase in our allowance for loan and lease losses could reduce our earnings.
Changes in interest rates may adversely affect our earnings and financial condition.
Our net income depends primarily upon our net interest income. Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities and short-term investments. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates, and the levels of nonperforming loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of non-interest-bearing demand deposits and equity capital.
Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, recession, unemployment, money supply, domestic and international events, and changes in the United States and other financial markets.
We attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest- rate-sensitive assets and interest-rate-sensitive liabilities. However, interest-rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.
19
If we are not able to securitize assets, it could negatively affect our liquidity and capital ratios.
We use the securitization of financial assets as a source of funding and a means to manage capital. It is part of our core business. If we are not able to securitize these assets for any reason, including, without limitation, market conditions, a failure to maintain our investment-grade senior unsecured long-term debt ratings, or regulatory changes, it could negatively affect our capital ratios and require us to rely more heavily on other sources of funding such as repos, brokered deposits, the Federal Reserve Discount Window and Federal Home Loan Bank (“FHLB”) borrowings. As of December 31, 2008, the lack of securitization markets has not been detrimental to our liquidity or our capital ratios.
Adverse business conditions in our vehicle leasing subsidiary could adversely affect our financial performance.
Through our subsidiary, Boston Service Company, Inc. (t/a Hann Financial Service Corp.), we are involved in the vehicle leasing business. In 2007 and 2008, Hann suffered a decrease in its vehicle origination, servicing, and securitization fees, due primarily to decreased lease origination volumes. We believe that the reduction in volume principally resulted from the downturn in the economy and special financing offers provided by the major automobile manufacturers.
If the downturn in the economy and these special financing offers were to continue in 2009, our financial performance could be negatively impacted. Additionally, in 2005, vehicle residual value expense at Hann increased significantly based upon service agreements with Auto Lenders Liquidation Center, Inc., a third party residual value guarantor. Under the terms of these servicing agreements, vehicle residual value expense was substantially less in 2006, 2007 and 2008 and will have a moderate increase in 2009. For 2010 and 2011, vehicle residual value expense should remain the same as 2009. Beyond 2011, vehicle residual value expense could once again increase depending upon used vehicle market conditions. If this were to happen, it could have a negative impact on our financial performance after 2011.
A continued decline of the debt and equity markets could adversely affect our wealth management subsidiaries
As a result of recent changes in the economic environment, we have experienced significant market declines in our Assets Under Management (“AUM”). Due to the decline in AUM, combined with the near-term economic outlook, we have adjusted growth rate assumptions and increased discount rates used in the determination of implied fair values of intangible assets and goodwill of our wealth management reporting unit. These changes have resulted in lower projected cash flows and lower implied fair values for certain of our intangible assets and goodwill. However, at December 31, 2008 fair values were still greater than carrying values, and therefore, no impairment was recorded. The carrying values of these assets are sensitive to further decreases in projected cash flows, decreases in publically available market multiples, and/or increases in the discount rate. Consequently, further declines in fair values could trigger impairment in the future.
Competition from other financial institutions in originating loans, attracting deposits and providing various financial services may adversely affect our profitability.
Our banking subsidiary faces substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies, and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that our banking subsidiary originates and the interest rates it may charge on these loans.
20
In attracting business and consumer deposits, our bank subsidiary faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns and better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.
Our banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over our banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements, which could reduce our ability to effectively compete.
The financial services industry is undergoing rapid technological changes with frequent introduction of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial service institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services to enhance customer convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete.
Government regulation significantly affects our business.
The banking industry is heavily regulated, and such regulations are intended primarily for the protection of depositors and the federal deposit insurance funds, not shareholders. As a financial holding company, we are subject to regulation by the Federal Reserve Board. Our bank subsidiary, as of December 31, 2008, is also regulated by the Federal Reserve Board and is subject to regulation by the Pennsylvania Department of Banking. These regulations affect lending practices, capital structure, investment practices, dividend policy, and growth. In addition, we have non-bank operating subsidiaries from which we derive income. Several of these non-bank subsidiaries engage in providing investment management and insurance brokerage services, industries which are also heavily regulated on both a state and federal level. In addition, changes in laws, regulations, and regulatory practices affecting the financial service industry may limit the manner in which we may conduct our business. Such changes may adversely affect us, including our ability to offer new products and services, obtain financing, attract deposits, make loans and leases and achieve satisfactory spreads, and may also result in the imposition of additional costs on us. As a public company, we are also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of 2002, as well as any applicable rules or regulations promulgated by the SEC and The NASDAQ Stock Market, LLC. Complying with these standards, rules and regulations may impose administrative costs and burdens on us.
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The Pennsylvania business corporation law and various anti-takeover provisions under our articles of incorporation could impede the takeover of the company.
Various Pennsylvania laws affecting business corporations may have the effect of discouraging offers to acquire Susquehanna, even if the acquisition would be advantageous to shareholders. In addition, we have various anti-takeover measures in place under our articles of incorporation. Any one or more of these measures may impede the takeover of Susquehanna without the approval of our board of directors and may prevent our shareholders from taking part in a transaction in which they could realize a premium over the current market price of our common stock.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
We reimburse our subsidiaries for space and services utilized. In 2008, we also leased office space located at 13511 Label Lane, Hagerstown, Maryland, for our loan servicing center.
Our bank subsidiary operates 236 branches and 31 free-standing automated teller machines. It owns 116 of the branches and leases the remaining 120. Thirteen (13) additional locations are owned or leased by Susquehanna Bank to facilitate operations and expansion. We believe that the properties currently owned and leased by our subsidiaries are adequate for present levels of operation.
As of December 31, 2008, the offices (including executive offices) of our bank subsidiary were as follows:
| | | | | | |
Subsidiary | | Location of Executive Office | | Executive Office
Owned/Leased | | Location of Offices
(including executive office) |
| | | |
| Susquehanna Bank | | 1570 Manheim Pike Lancaster, Pennsylvania | | Owned | | 236 banking offices in Adams, Bedford, Berks, Chester, Cumberland, Dauphin, Delaware, Franklin, Lancaster, Lehigh, Luzerne, Lycoming, Montgomery, Northampton, Northumberland, Schuylkill, Snyder, Union and York counties, Pennsylvania; Baltimore City, Allegany, Anne Arundel, Baltimore, Carroll, Garrett, Harford, Howard, Washington and Worcester counties, Maryland; Atlantic, Burlington, Camden, Cumberland and Gloucester counties, New Jersey; and Berkeley County, West Virginia |
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As of December 31, 2008, the offices (including executive offices) of our non-bank subsidiaries were as follows:
| | | | | | |
Subsidiary | | Location of Executive Office | | Executive Office Owned/Leased | | Location of Offices (including executive office) |
| Susquehanna Trust & Investment Company | | 1570 Manheim Pike Lancaster, Pennsylvania | | Leased | | 10 offices in Franklin, Lancaster, Lycoming, Montgomery, Northumberland, Schuylkill and York counties, Pennsylvania; Camden County, New Jersey; and Washington and Baltimore counties, Maryland |
| | | |
| Boston Service Company, Inc., t/a Hann Financial Service Corp. | | One Centre Drive
Jamesburg, New Jersey | | Leased | | 2 offices located in Gloucester and Middlesex counties, New Jersey |
| | | |
| Valley Forge Asset Management Corp. | | 120 South Warner Road King of Prussia, Pennsylvania | | Leased | | 4 offices located in Chester, Lancaster and Montgomery counties, Pennsylvania, and New Castle County, Delaware |
| | | |
| The Addis Group, LLC | | 2500 Renaissance Boulevard King of Prussia, Pennsylvania | | Leased | | 1 office located in Montgomery County, Pennsylvania |
| | | |
| Susquehanna Commercial Finance, Inc. | | 1566 Medical Drive Suite 201 Pottstown, Pennsylvania | | Leased | | 1 office located in Montgomery County, Pennsylvania |
Item 3. Legal Proceedings.
There are no material proceedings to which Susquehanna or any of our subsidiaries are a party or by which, to Susquehanna’s knowledge, we, or any of our subsidiaries, are threatened. All legal proceedings presently pending or threatened against Susquehanna or our subsidiaries involve routine litigation incidental to our business or that of the subsidiary involved and are not material in respect to the amount in controversy.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
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PART II
Item 5. Market for Susquehanna’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information. Our common stock is listed for quotation on the Nasdaq Global Select Market. Set forth below are the quarterly high and low sales prices of our common stock as reported on the Nasdaq Global Select Market for the years 2008 and 2007, and cash dividends paid. The table represents prices between dealers and does not include retail markups, markdowns, or commissions, and does not necessarily represent actual transactions.
| | | | | | | | | | | |
Year | | Period | | Cash
Dividends
Paid | | Price Range Per
Share |
| | | | Low | | High |
2008 | | 1st Quarter | | $ | 0.26 | | $ | 15.78 | | $ | 22.40 |
| | 2nd Quarter | | | 0.26 | | | 13.69 | | | 22.86 |
| | 3rd Quarter | | | 0.26 | | | 10.50 | | | 27.70 |
| | 4th Quarter | | | 0.26 | | | 11.03 | | | 20.35 |
| | | | |
2007 | | 1st Quarter | | | 0.25 | | $ | 21.90 | | $ | 27.32 |
| | 2nd Quarter | | | 0.25 | | | 21.27 | | | 23.89 |
| | 3rd Quarter | | | 0.25 | | | 16.31 | | | 23.00 |
| | 4th Quarter | | | 0.26 | | | 17.03 | | | 21.49 |
As of February 23, 2009, there were 11,900 record holders of Susquehanna common stock.
Dividend Policy. Dividends paid to our shareholders are provided from dividends paid to us by our subsidiaries. Our ability to pay dividends is largely dependent upon the receipt of dividends from Susquehanna Bank. Both federal and state laws impose restrictions on the ability of Susquehanna Bank to pay dividends. These include the Pennsylvania Banking Code of 1965, the Federal Reserve Act, and the applicable regulations under such laws. The net capital rules of the SEC under the Securities Exchange Act of 1934 also limit the ability of Valley Forge Asset Management Corp. to pay dividends to us. In addition to the specific restrictions summarized below, the banking and securities regulatory agencies also have broad authority to prohibit otherwise permitted dividends proposed to be made by an institution regulated by them if the agency determines that their distribution would constitute an unsafe or unsound practice.
The Federal Reserve Board has issued policy statements which provide that, as a general matter, insured banks and bank holding companies should pay dividends only out of current operating earnings.
For state-chartered banks which are members of the Federal Reserve System, the approval of the Federal Reserve Board is required for the payment of dividends by the bank subsidiary in any calendar year if the total of all dividends declared by the bank in that calendar year, including the proposed dividend, exceeds the current year’s net income combined with the retained net income for the two preceding calendar years. “Retained net income” for any period means the net income for that period less any common or preferred stock dividends declared in that period. Moreover, no dividends may be paid by such bank in excess of its undivided profits account.
Dividends by a Pennsylvania state-chartered bank payable in cash or property other than shares may be paid only out of accumulated net earnings and are restricted by the requirement that the bank set aside to a surplus fund each year at least 10% of its net earnings until the bank’s surplus equals the amount of its capital (a requirement presently satisfied in the case of Susquehanna Bank). Furthermore, a Pennsylvania bank may not pay such a dividend if the payment would result in a reduction of the surplus account of the bank.
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Pursuant to the terms of the Letter Agreement entered into between Susquehanna and the Treasury as part of the Capital Purchase Program, prior to the earlier of the December 12, 2011 and the date on which the Preferred Stock has been redeemed in whole or has been transferred in whole to third parties that are not affiliates of the Treasury, Susquehanna is not permitted to declare or pay any dividend or make any distribution on the common stock other than: (i) regular quarterly cash dividends of not more than the amount of the last quarterly cash dividend per share declared or, if lower, publicly announced an intention to declare, on the common stock prior to October 14, 2008, as adjusted for any stock split, stock dividend, reverse stock split, reclassification or similar transaction; (ii) dividends payable solely in shares of common stock; and (iii) dividends or distributions of rights in connection with a stockholders’ rights plan.
Within the regulatory restrictions described above, Susquehanna Bank presently has the ability to pay dividends. At December 31, 2008, $26.9 million in the aggregate was available for dividend distributions during calendar 2009 to us from Susquehanna Bank without regulatory approval and with the bank remaining well capitalized. Also, our non-bank subsidiaries at December 31, 2008, had approximately $98.0 million which they could pay as dividends to us without regulatory approval. We presently expect that cash dividends will continue to be paid by our subsidiaries in the future at levels comparable with those of prior years.
25
Stock Performance Graph. The following graph compares for fiscal years 2003 through 2008 the yearly change in the cumulative total return to holders of our common stock with the cumulative total return of the Nasdaq Composite Index, a broad market in which we participate, and the SNL Mid-Atlantic Bank Index, an index comprised of banks and related holding companies operating in the Mid-Atlantic region. The graph depicts the total return on an investment of $100 based on both stock price appreciation and reinvestment of dividends for Susquehanna, the companies represented by the Nasdaq Index, and the SNL Mid-Atlantic Bank Index.
| | | | | | | | | | | | |
| | | Period Ending |
Index | | 12/31/03 | | 12/31/04 | | 12/31/05 | | 12/31/06 | | 12/31/07 | | 12/31/08 |
Susquehanna Bancshares, Inc. | | 100.00 | | 103.49 | | 102.20 | | 120.71 | | 86.86 | | 79.69 |
NASDAQ Composite | | 100.00 | | 108.59 | | 110.08 | | 120.56 | | 132.39 | | 78.72 |
SNL Mid-Atlantic Bank | | 100.00 | | 105.91 | | 107.79 | | 129.37 | | 97.83 | | 53.89 |
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Item 6. Selected Financial Data.
Susquehanna Bancshares, Inc. & Subsidiaries
| | | | | | | | | | | | | | | | | | | | |
Year ended December 31, | | 2008 | | | 2007(1) | | | 2006(2) | | | 2005 | | | 2004(3) | |
| | | (Amounts in thousands, except per share data) | |
Interest income | | $ | 697,070 | | | $ | 526,157 | | | $ | 462,791 | | | $ | 387,020 | | | $ | 321,759 | |
Interest expense | | | 298,768 | | | | 250,254 | | | | 206,021 | | | | 144,775 | | | | 107,741 | |
Net interest income | | | 398,302 | | | | 275,903 | | | | 256,770 | | | | 242,245 | | | | 214,018 | |
Provision for loan and lease losses | | | 63,831 | | | | 21,844 | | | | 8,680 | | | | 12,335 | | | | 10,020 | |
Noninterest income | | | 142,309 | | | | 120,659 | | | | 136,313 | | | | 125,078 | | | | 114,590 | |
Noninterest expenses | | | 367,201 | | | | 276,955 | | | | 262,836 | | | | 242,550 | | | | 219,042 | |
Income before taxes | | | 109,579 | | | | 97,763 | | | | 121,567 | | | | 112,438 | | | | 99,546 | |
Net income | | | 82,606 | | | | 69,093 | | | | 83,638 | | | | 79,563 | | | | 70,180 | |
Net income available to common shareholders | | | 81,814 | | | | 69,093 | | | | 83,638 | | | | 79,563 | | | | 70,180 | |
Cash dividends declared on common stock | | | 89,462 | | | | 52,686 | | | | 49,067 | | | | 43,432 | | | | 38,471 | |
| | | | | |
Per Common Share Amounts | | | | | | | | | | | | | | | | | | | | |
Net income: | | | | | | | | | | | | | | | | | | | | |
Basic | | $ | 0.95 | | | $ | 1.23 | | | $ | 1.66 | | | $ | 1.70 | | | $ | 1.61 | |
Diluted | | | 0.95 | | | | 1.23 | | | | 1.66 | | | | 1.70 | | | | 1.60 | |
Cash dividends declared on common stock | | $ | 1.04 | | | $ | 1.01 | | | $ | 0.97 | | | $ | 0.93 | | | $ | 0.89 | |
Dividend payout ratio | | | 109.3 | % | | | 76.3 | % | | | 58.7 | % | | | 54.6 | % | | | 54.8 | % |
| | | | | |
Financial Ratios | | | | | | | | | | | | | | | | | | | | |
Return on average total assets | | | 0.62 | % | | | 0.78 | % | | | 1.05 | % | | | 1.07 | % | | | 1.04 | % |
Return on average shareholders’ equity | | | 4.80 | | | | 6.66 | | | | 9.56 | | | | 10.52 | | | | 10.73 | |
Return on average tangible shareholders’ equity(4) | | | 13.35 | | | | 11.56 | | | | 15.42 | | | | 16.06 | | | | 14.36 | |
Average equity to average assets | | | 12.92 | | | | 11.66 | | | | 11.00 | | | | 10.18 | | | | 9.65 | |
Net interest margin | | | 3.62 | | | | 3.67 | | | | 3.77 | | | | 3.76 | | | | 3.60 | |
Efficiency ratio | | | 66.46 | | | | 69.10 | | | | 66.43 | | | | 65.58 | | | | 66.15 | |
| | | | | |
Capital Ratios | | | | | | | | | | | | | | | | | | | | |
Leverage | | | 9.92 | % | | | 10.24 | % | | | 8.68 | % | | | 7.77 | % | | | 7.30 | % |
Tier 1 risk-based capital | | | 11.17 | | | | 9.23 | | | | 9.48 | | | | 8.53 | | | | 8.13 | |
Total risk-based capital | | | 13.52 | | | | 11.31 | | | | 12.48 | | | | 11.61 | | | | 11.30 | |
| | | | | |
Credit Quality | | | | | | | | | | | | | | | | | | | | |
Net charge-offs/Average loans and leases | | | 0.42 | % | | | 0.25 | % | | | 0.10 | % | | | 0.24 | % | | | 0.16 | % |
Nonperforming assets/Loans and leases plus OREO | | | 1.22 | | | | 0.81 | | | | 0.67 | | | | 0.38 | | | | 0.41 | |
ALLL/Nonperforming loans and leases | | | 105 | | | | 149 | | | | 175 | | | | 309 | | | | 265 | |
ALLL/Total loans and leases | | | 1.18 | | | | 1.01 | | | | 1.13 | | | | 1.03 | | | | 1.03 | |
| | | | | |
Year-End Balances | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 13,682,988 | | | $ | 13,077,994 | | | $ | 8,225,134 | | | $ | 7,466,007 | | | $ | 7,475,073 | |
Investment securities | | | 1,879,891 | | | | 2,063,952 | | | | 1,403,566 | | | | 1,154,261 | | | | 1,245,414 | |
Loans and leases, net of unearned income | | | 9,653,873 | | | | 8,751,590 | | | | 5,560,997 | | | | 5,218,659 | | | | 5,253,008 | |
Deposits | | | 9,066,493 | | | | 8,945,119 | | | | 5,877,589 | | | | 5,309,187 | | | | 5,130,682 | |
Total borrowings | | | 2,428,085 | | | | 2,131,156 | | | | 1,152,932 | | | | 1,148,966 | | | | 1,395,365 | |
Shareholders’ equity | | | 1,945,918 | | | | 1,729,014 | | | | 936,286 | | | | 780,470 | | | | 751,694 | |
| | | | | |
Selected Share Data | | | | | | | | | | | | | | | | | | | | |
Common shares outstanding (period end) | | | 86,174 | | | | 85,935 | | | | 52,080 | | | | 46,853 | | | | 46,593 | |
Average common shares outstanding: | | | | | | | | | | | | | | | | | | | | |
Basic | | | 85,987 | | | | 56,297 | | | | 50,340 | | | | 46,711 | | | | 43,585 | |
Diluted | | | 86,037 | | | | 56,366 | | | | 50,507 | | | | 46,919 | | | | 43,872 | |
At December 31: | | | | | | | | | | | | | | | | | | | | |
Book value per common share | | $ | 19.21 | | | $ | 20.12 | | | $ | 17.98 | | | $ | 16.66 | | | $ | 16.13 | |
Tangible book value per common share | | $ | 6.77 | | | $ | 8.44 | | | $ | 11.18 | | | $ | 11.23 | | | $ | 10.71 | |
Market price per common share | | $ | 15.91 | | | $ | 18.44 | | | $ | 26.88 | | | $ | 23.68 | | | $ | 24.95 | |
Common shareholders of record | | | 12,035 | | | | 11,144 | | | | 6,694 | | | | 6,857 | | | | 6,981 | |
| (1) | On November 16, 2007, we completed our acquisition of Community Banks, Inc. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. |
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| (2) | On April 21, 2006, we completed our acquisition of Minotola National Bank. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. |
| (3) | On June 10, 2004, we completed our acquisition of Patriot Bank Corp. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. |
| (4) | Supplemental Reporting of Non-GAAP-based Financial Measures |
Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable measure is return on average equity, which is calculated using GAAP-based amounts. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average equity to return on average tangible equity is set forth below.
| | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
Return on average equity (GAAP basis) | | 4.80 | % | | 6.66 | % | | 9.56 | % | | 10.52 | % | | 10.73 | % |
Effect of excluding average intangible assets and related amortization | | 8.55 | % | | 4.90 | % | | 5.86 | % | | 5.54 | % | | 3.63 | % |
Return on average tangible equity | | 13.35 | % | | 11.56 | % | | 15.42 | % | | 16.06 | % | | 14.36 | % |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following pages of this report present management’s discussion and analysis of the consolidated financial condition and results of operations of Susquehanna Bancshares, Inc. and its subsidiaries.
Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited to, our expectations regarding the benefits associated with participating in the Capital Purchase Program; Susquehanna’s potential exposures to various types of market risks, such as interest rate risk and credit risk; whether Susquehanna’s allowance for loan and lease losses is adequate to meet probable loan and lease losses; our ability to maintain loan growth; our ability to maintain sufficient liquidity; our expectations regarding the amount of savings to be generated by the merger of our bank subsidiaries; our ability to manage credit quality; out ability to monitor the impact of the recession moving into the commercial and industrial, commercial real estate, and consumer segments; the impact of a breach by Auto Lenders, a third-party residual value guarantor of our auto leasing subsidiary, on residual loss exposure; the unlikelihood that more than 10% of the home equity line of credit loans in securitization transactions will convert from variable interest rates to fixed interest rates; our ability to collect all amounts due under our outstanding synthetic collateralized debt obligations; our expectation of the net asset value after liquidation of a mutual fund; further declines in the fair value of our wealth management subsidiaries could trigger future impairment; and our ability to achieve our 2009 financial goals. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:
| | • | | adverse changes in our loan and lease portfolios and the resulting credit-risk-related losses and expenses; |
28
| | • | | adverse changes in the automobile industry; |
| | • | | interest rate fluctuations which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income; |
| | • | | continued levels of our loan and lease quality and origination volume; |
| | • | | the adequacy of loss reserves; |
| | • | | the loss of certain key officers, which could adversely impact our business; |
| | • | | continued relationships with major customers; |
| | • | | the ability to continue to grow our business internally and through acquisition and successful integration of bank and non-bank entities while controlling our costs; |
| | • | | adverse national and regional economic and business conditions; |
| | • | | compliance with laws and regulatory requirements of federal and state agencies; |
| | • | | competition from other financial institutions in originating loans, attracting deposits, and providing various financial services that may affect our profitability; |
| | • | | the ability to hedge certain risks economically; |
| | • | | our ability to effectively implement technology driven products and services; |
| | • | | greater reliance on wholesale funding because our loan growth has outpaced our deposit growth, and we have no current access the securitization markets; |
| | • | | the pace of our loan growth compared to our deposit growth; |
| | • | | changes in consumer confidence, spending and savings habits relative to the bank and non-bank financial services we provide; and |
| | • | | our success in managing the risks involved in the foregoing. |
We encourage readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. Forward-looking statements speak only as of the date they are made. We do not intend to update publicly any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events except as required by law.
The following discussion and analysis, the purpose of which is to provide investors and others with information that we believe to be necessary for an understanding of Susquehanna’s financial condition, changes in financial condition, and results of operations, should be read in conjunction with the financial statements, notes, and other information contained in this document.
The following information refers to the parent company and its wholly owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) (“Hann”), Susquehanna Bank and subsidiaries, Valley Forge Asset Management Corp. and subsidiaries (“VFAM”), Stratton Management Company, LLC (“Stratton”), and The Addis Group, LLC (“Addis”).
Critical Accounting Estimates
Susquehanna’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Application of these principles involves significant judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are based
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on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations.
Our most critical accounting estimates are presented in Note 1 to the consolidated financial statements. Furthermore, we believe that the determination of the allowance for loan and lease losses, the valuation of recorded interests in securitized assets, the valuation of goodwill, and the determination of the fair value of certain financial instruments under the guidance of FAS No. 157, “Fair Value Measurements,” and FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” to be the accounting areas that require the most subjective and complex judgments.
The allowance for loan and lease losses represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan and lease losses.
Valuations for our investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, investment valuation is based on pricing models, quotes for similar investment securities, and observable yield curves and spreads. In addition to valuation, management must assess whether there are any declines in value below the carrying value of the investments that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of income. For additional information on management’s consideration of investment valuation and other then temporary impairment, refer to“Note 4. Investment Securities” and “Note 23. Fair Value Disclosures” to the consolidated financial statements appearing in Part II, Item 8.
Recorded interests in securitized assets are established and accounted for based on discounted cash flow modeling techniques which require management to make estimates regarding the amount and timing of expected future cash flows, including estimates of repayment rates, credit loss experience, and discount rates that consider the risk involved. Since the values of these assets are sensitive to changes in estimates, the valuation of recorded interests in securitized assets is considered a critical accounting estimate. Note 1 and Note 21 provide additional information regarding recorded interests.
Management evaluates the valuation of goodwill on an annual basis and more often if situations or the economic environment warrant it. In performing these evaluations, managements makes critical estimates to determine the fair value of its reporting units. Such estimates include assumptions used in determining cash flows and evaluation of appropriate market multiples.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. As defined in FAS No. 157, “Fair Value Measurements,” Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the
30
asset or liability. For additional information about our financial assets and financial liabilities carried at fair value, refer to“Note 23. Fair Value Disclosures” to the consolidated financial statements appearing in Part II, Item 8.
Any material effect on the consolidated financial statements related to these critical accounting areas is also discussed within the body of this document.
Executive Overview
Bank Merger
On October 10, 2008, we merged our three bank subsidiaries together. Susquehanna Bank and Susquehanna Bank DV were merged into Susquehanna Bank PA which subsequently changed its name to Susquehanna Bank. This initiative, planned and implemented over a six-month period, was designed to improve efficiency, customer service, and product delivery. Expenses related to the merger resulted in a $2.5 million pre-tax charge in the third quarter, but we expect that the merger will generate annual savings of approximately $20.0 million beginning in 2009.
Capital Purchase Program
Susquehanna was one of many banks to participate in the U.S. Treasury Department’s voluntary Capital Purchase Program (“CPP”). Under the program, we applied for and received $300.0 million in capital, with the transaction having been completed on December 12, 2008. In return, we issued to the Treasury $300.0 million in shares of Fixed Rate Cumulative Perpetual Preferred Stock with an initial annual dividend rate of 5.0% and warrants to purchase approximately 3.0 million shares of Susquehanna common stock at an exercise price of $14.86 per share.
Our intention is to use the $300 million received through the CPP for loan growth. As stated in Item 7, we currently project net loan growth of 8% in 2009. With a loan portfolio of $9.65 billion at year-end 2008, this projection would mean loan growth of approximately $750 million in the current year. This increase would follow the 10% net increase in loans (or approximately $900 million) that we achieved in 2008. Susquehanna has a history of sound asset quality, and we were able to generate this level of loan growth while maintaining credit quality ratios superior to the majority of our peer group. While these projections represent our present intentions, we must reserve the right to react to unforeseen regulatory, legislative or economic changes.
We believe that looking at overall lending provides the best insight into how a bank is operating as an engine of economic growth in local communities. As you can see from our projection above, we expect our overall loan growth in 2009 to more than double the amount of capital we received through the Capital Purchase Program.
We believe that participating in the Capital Purchase Program is in the best interests of our shareholders, customers, and the communities that we serve. This funding gives us a foundation to generate additional lending to our customers, and it also builds our capital reserves for additional security against the uncertain nature of the economy.
Allowance for Loan and Lease Losses
The deterioration in economic conditions has impacted our credit quality. Net charge-offs as a percentage of average loans and leases were 0.42% for 2008, compared to 0.25% for 2007. Non-performing assets as a percentage of loans, leases, and other real estate owned were 1.22% for 2008, compared to 0.81% for 2007. Given the pressures facing our customers and loan portfolio, we increased our provision for loan and lease losses
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to $63.8 million for 2008, compared to $21.8 million for 2007. See the discussion regarding loan and lease losses in “Results of Operations, Provision and Allowance for Loan and Lease Losses.”
The following table compares our 2008 financial goals to actual results:
| | | | | | |
| | | Goal | | | Actual | |
Net interest margin | | 3.70 | % | | 3.62 | % |
Loan growth | | 8.0 | % | | 10.3 | % |
Deposit growth | | 1.0 | % | | 1.4 | % |
Noninterest income growth | | 45.0 | % | | 17.9 | % |
Noninterest expense growth | | 26.0 | % | | 32.6 | % |
Tax rate | | 30.0 | % | | 24.6 | % |
Given the current economic climate and real estate trends, we recognize that the tightening credit market poses challenges for financial institutions. However, we believe that it creates opportunities as well. With that in mind, our financial goals for 2009 are as follows:
| | | | |
| | | Goal | |
Net interest margin | | | 3.70 | % |
Loan growth (adjusted for securitizations) | | | 8.0 | % |
Deposit growth | | | 1.0 | % |
Noninterest income growth | | | 6.0 | % |
Noninterest expense growth | | | (1.0 | %) |
Tax rate | | | 32.0 | % |
Preferred dividend and discount accretion | | $ | 16.7 | million |
These financial goals include no securitization activity in 2009.
Acquisitions
Stratton Holding Company
On April 30, 2008, we completed the acquisition of Stratton Holding Company, an investment management company based in Plymouth Meeting, Pennsylvania with approximately $3.0 billion in assets under management. Stratton became a wholly owned subsidiary of Susquehanna and part of the family of Susquehanna wealth management companies. The addition of Stratton brings increased diversification in our investment expertise, including experience in mutual fund management. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Stratton was considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
Community Banks, Inc.
On November 16, 2007, we completed the acquisition of Community Banks, Inc. (“Community”) in a stock and cash transaction valued at approximately $871.0 million. Under the terms of the merger agreement, shareholders of Community were entitled to elect to receive for each share of Community common stock that they owned, either $34.00 in cash or 1.48 shares of Susquehanna common stock. The acquisition expands our territory into the Harrisburg market and deepens our foundation in central Pennsylvania. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. See Note 2 to our consolidated financial statements for the disclosures required by FAS No. 141, “Business Combinations.”
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Widmann, Siff & Co., Inc.
On August 1, 2007, we acquired Widmann, Siff & Co., Inc., an investment advisory firm in Radnor, Pennsylvania. Widmann, Siff had more than $300.0 million in assets under management, including accounts serving individuals, pension and profit-sharing plans, corporations, and family trusts. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Widmann, Siff was considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
Minotola National Bank
On April 21, 2006, we acquired Minotola National Bank in a stock and cash transaction valued at approximately $172.0 million. The acquisition of Minotola, with total assets of $607.0 million and fourteen branch locations, significantly enhanced our presence in the high-growth markets in southern New Jersey. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Minotola was considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
Results of Operations
Summary of 2008 Compared to 2007
The acquisition of Community Banks, Inc. on November 16, 2007 has had a significant impact on our results of operations for the year ended December 31, 2008. Consequently, comparisons to the years ended December 31, 2007 and 2006 may not be particularly meaningful.
Furthermore, results of operations for the year ended December 31, 2008 include the following pre-tax charges:
| | • | | a $6.5 million loss related to an interest rate swap termination; |
| | • | | a $2.5 million merger charge composed of the following: |
| | | |
Employee termination benefits | | $ | 1.60 million |
Legal fees | | | 0.25 million |
Technology costs | | | 0.65 million |
| | • | | a $17.5 million securities impairment charge; and |
| | • | | a $2.1 million VFAM customer-loss contingency. |
Also, results of operations for the twelve months ending December 31, 2007 include a pre-tax loss of $11.8 million related to a restructuring of our investment portfolio.
Net income for the year ended December 31, 2008, was $82.6 million, an increase of $13.5 million, or 19.6%, over net income of $69.1 million in 2007. Net interest income increased 44.4%, to $398.3 million for 2008, from $275.9 million in 2007. Noninterest income increased 17.9%, to $142.3 million for 2008, from $120.7 million in 2007, and noninterest expenses increased 32.6%, to $367.2 million for 2008, from $277.0 million for 2007.
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Additional information is as follows:
| | | | | | | | |
| | | Twelve Months
Ended
December 31, | |
| | | 2008 | | | 2007 | |
Diluted Earnings per Common Share | | $ | 0.95 | | | $ | 1.23 | |
Return on Average Assets | | | 0.62 | % | | | 0.78 | % |
Return on Average Equity | | | 4.80 | % | | | 6.66 | % |
Return on Average Tangible Equity(1) | | | 13.35 | % | | | 11.56 | % |
Efficiency Ratio | | | 66.46 | % | | | 69.10 | % |
Net Interest Margin | | | 3.62 | % | | | 3.67 | % |
The following discussion details the factors that contributed to these results.
| (1) | Supplemental Reporting of Non-GAAP-based Financial Measures |
Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable measure is return on average equity, which is calculated using GAAP-based amounts. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average equity to return on average tangible equity is set forth below.
| | | | | | |
| | | 2008 | | | 2007 | |
Return on average equity (GAAP basis) | | 4.80 | % | | 6.66 | % |
Effect of excluding average intangible assets and related amortization | | 8.55 | % | | 4.90 | % |
Return on average tangible equity | | 13.35 | % | | 11.56 | % |
Net Interest Income — Taxable Equivalent Basis
Our major source of operating revenues is net interest income, which increased to $398.3 million in 2008, as compared to $275.9 million in 2007. Net interest income as a percentage of net interest income plus other income was 74% for the twelve months ended December 31, 2008, 70% for the twelve months ended December 31, 2007, and 65% for the twelve months ended December 31, 2006.
Net interest income is the income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities, and short-term investments. The amount of interest income is dependent upon many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates, and the levels of non-performing loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, the rates paid on borrowed funds, and the levels of noninterest-bearing demand deposits and equity capital.
Table 1 presents average balances, taxable equivalent interest income and expense and yields earned or paid on these assets and liabilities. For purposes of calculating taxable equivalent interest income, tax-exempt interest has been adjusted using a marginal tax rate of 35% in order to equate the yield to that of taxable interest rates. Table 2 illustrates the changes in net interest income caused by changes in average volume, rates, and yields.
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Table 1 - Distribution of Assets, Liabilities and Shareholders’ Equity
Interest Rates and Interest Differential - Tax Equivalent Basis
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
| | | Average
Balance | | | Interest | | Rate
(%) | | Average
Balance | | | Interest | | Rate
(%) | | Average
Balance | | | Interest | | Rate
(%) |
| | | | | | | | | |
| | | (Dollars in thousands) |
Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | 101,715 | | | $ | 2,411 | | 2.37 | | $ | 97,583 | | | $ | 4,782 | | 4.90 | | $ | 81,939 | | | $ | 3,669 | | 4.48 |
Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | | 1,759,424 | | | | 91,531 | | 5.20 | | | 1,485,561 | | | | 73,837 | | 4.97 | | | 1,261,515 | | | | 53,463 | | 4.24 |
Tax-advantaged | | | 296,211 | | | | 19,560 | | 6.60 | | | 69,389 | | | | 4,380 | | 6.31 | | | 20,506 | | | | 1,300 | | 6.34 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total investment securities | | | 2,055,635 | | | | 111,091 | | 5.40 | | | 1,554,950 | | | | 78,217 | | 5.03 | | | 1,282,021 | | | | 54,763 | | 4.27 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans and leases, (net): | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | | 8,972,747 | | | | 581,070 | | 6.48 | | | 5,876,948 | | | | 439,680 | | 7.48 | | | 5,434,490 | | | | 400,923 | | 7.38 |
Tax-advantaged | | | 197,249 | | | | 14,375 | | 7.29 | | | 102,930 | | | | 7,708 | | 7.49 | | | 83,322 | | | | 5,987 | | 7.19 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total loans and leases | | | 9,169,996 | | | | 595,445 | | 6.49 | | | 5,979,878 | | | | 447,388 | | 7.48 | | | 5,517,812 | | | | 406,910 | | 7.37 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | | 11,327,346 | | | $ | 708,947 | | 6.26 | | | 7,632,411 | | | $ | 530,387 | | 6.95 | | | 6,881,772 | | | $ | 465,342 | | 6.76 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Allowance for loan and lease losses | | | (98,321 | ) | | | | | | | | (64,993 | ) | | | | | | | | (59,465 | ) | | | | | |
Other noninterest-earning assets | | | 2,089,321 | | | | | | | | | 1,337,310 | | | | | | | | | 1,127,513 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 13,318,346 | | | | | | | | $ | 8,904,728 | | | | | | | | $ | 7,949,820 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand | | $ | 2,604,337 | | | $ | 33,667 | | 1.29 | | $ | 2,173,731 | | | $ | 61,572 | | 2.83 | | $ | 1,846,483 | | | $ | 51,424 | | 2.78 |
Savings | | | 723,612 | | | | 4,848 | | 0.67 | | | 480,065 | | | | 4,278 | | 0.89 | | | 496,056 | | | | 4,960 | | 1.00 |
Time | | | 4,402,956 | | | | 167,431 | | 3.80 | | | 2,720,688 | | | | 124,673 | | 4.58 | | | 2,408,684 | | | | 99,195 | | 4.12 |
Short-term borrowings | | | 654,149 | | | | 10,796 | | 1.65 | | | 423,827 | | | | 17,464 | | 4.12 | | | 324,326 | | | | 13,495 | | 4.16 |
FHLB borrowings | | | 1,337,505 | | | | 50,944 | | 3.81 | | | 653,605 | | | | 27,600 | | 4.22 | | | 615,841 | | | | 24,788 | | 4.03 |
Long-term debt | | | 421,795 | | | | 31,082 | | 7.37 | | | 237,910 | | | | 14,667 | | 6.16 | | | 207,765 | | | | 12,159 | | 5.85 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 10,144,354 | | | $ | 298,768 | | 2.95 | | | 6,689,826 | | | $ | 250,254 | | 3.74 | | | 5,899,155 | | | $ | 206,021 | | 3.49 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | | 1,205,381 | | | | | | | | | 935,018 | | | | | | | | | 946,369 | | | | | | |
Other liabilities | | | 247,529 | | | | | | | | | 241,697 | | | | | | | | | 229,540 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 11,597,264 | | | | | | | | | 7,866,541 | | | | | | | | | 7,075,064 | | | | | | |
Equity | | | 1,721,082 | | | | | | | | | 1,038,187 | | | | | | | | | 874,756 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities & shareholders’ equity | | $ | 13,318,346 | | | | | | | | $ | 8,904,728 | | | | | | | | $ | 7,949,820 | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income / yield on average earning assets | | | | | | $ | 410,179 | | 3.62 | | | | | | $ | 280,133 | | 3.67 | | | | | | $ | 259,321 | | 3.77 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Additional Information
Average loan balances include non accrual loans.
Tax-advantaged income has been adjusted to a tax-equivalent basis using a marginal rate of 35%.
For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.
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Table 2 - Changes in Net Interest Income - Tax Equivalent Basis
| | | | | | | | | | | | | | | | | | | | | | | |
| | | 2008 Versus 2007
Increase (Decrease)
Due to Change in | | | 2007 Versus 2006
Increase (Decrease)
Due to Change in | |
| | | Average
Volume | | Average
Rate | | | Total | | | Average
Volume | | | Average
Rate | | | Total | |
| | | (Dollars in thousands) | |
Interest Income | | | | | | | | | | | | | | | | | | | | | | | |
Other short-term investments | | $ | 194 | | ($ | 2,565 | ) | | ($ | 2,371 | ) | | $ | 746 | | | $ | 367 | | | $ | 1,113 | |
Investment securities: | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | | 14,119 | | | 3,575 | | | | 17,694 | | | | 10,343 | | | | 10,031 | | | | 20,374 | |
Tax-advantaged | | | 14,969 | | | 211 | | | | 15,180 | | | | 3,086 | | | | (6 | ) | | | 3,080 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total investment securities | | | 29,088 | | | 3,786 | | | | 32,874 | | | | 13,429 | | | | 10,025 | | | | 23,454 | |
Loans (net of unearned income): | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | | 206,809 | | | (65,419 | ) | | | 141,390 | | | | 33,160 | | | | 5,597 | | | | 38,757 | |
Tax-advantaged | | | 6,879 | | | (212 | ) | | | 6,667 | | | | 1,463 | | | | 258 | | | | 1,721 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total loans | | | 213,688 | | | (65,631 | ) | | | 148,057 | | | | 34,623 | | | | 5,855 | | | | 40,478 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | $ | 242,970 | | ($ | 64,410 | ) | | $ | 178,560 | | | $ | 48,798 | | | $ | 16,247 | | | $ | 65,045 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Interest Expense | | | | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand | | $ | 10,426 | | ($ | 38,331 | ) | | ($ | 27,905 | ) | | $ | 9,170 | | | $ | 978 | | | $ | 10,148 | |
Savings | | | 1,809 | | | (1,239 | ) | | | 570 | | | | (156 | ) | | | (526 | ) | | | (682 | ) |
Time | | | 66,803 | | | (24,045 | ) | | | 42,758 | | | | 13,652 | | | | 11,826 | | | | 25,478 | |
Short-term borrowings | | | 6,785 | | | (13,453 | ) | | | (6,668 | ) | | | 4,098 | | | | (129 | ) | | | 3,969 | |
FHLB borrowings | | | 26,291 | | | (2,947 | ) | | | 23,344 | | | | 1,580 | | | | 1,232 | | | | 2,812 | |
Long-term debt | | | 13,103 | | | 3,312 | | | | 16,415 | | | | 1,829 | | | | 679 | | | | 2,508 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 125,217 | | | (76,703 | ) | | | 48,514 | | | | 30,173 | | | | 14,060 | | | | 44,233 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Net Interest Income | | $ | 117,753 | | $ | 12,293 | | | $ | 130,046 | | | $ | 18,625 | | | $ | 2,187 | | | $ | 20,812 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Changes that are due in part to volume and in part to rate are allocated in proportion to their relationship to the amounts of changes attributed directly to volume and rate.
The $122.4 million increase in our net interest income in 2008, as compared to 2007, was primarily the result of the net contribution from interest-earning assets and interest-bearing liabilities acquired from Community on November 16, 2007. Our net interest margin, however, declined 5 basis points, from 3.67% for the year ended December 31, 2007, to 3.62% for the year ended December 31, 2008. This decrease in net interest margin was primarily due to a decrease in lower-cost transaction and savings deposits with an offsetting increase in higher-cost time deposits.
Variances do occur in the net interest margin, as an exact repricing of assets and liabilities is not possible. A further explanation of the impact of asset and liability repricing is found in the section entitled“Market Risks -Interest Rate Risk.”
Provision and Allowance for Loan and Lease Losses
The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses at a level adequate to absorb management’s estimate of probable incurred losses in the loan and lease portfolio. Our provision for loan and lease losses is based upon management’s quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans and leases, analyze delinquencies, ascertain loan and lease growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets we serve.
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Commercial loans and commercial real estate loans of $0.5 million or greater are internally risk rated, using a standard rating system, by our loan officers and periodically reviewed by loan review personnel. Consumer loans, residential real estate loans, and leases are generally analyzed in the aggregate as they are of relatively small dollar size and homogeneous in nature.
Under our methodology for calculating the allowance for loan and lease losses, loss rates for the last three years on a rolling quarter-to-quarter basis, weighted towards the more recent periods, are determined for: (a) commercial credits (including agriculture, commercial, commercial real estate, land acquisition, development and construction; and (b) consumer credits (including residential real estate, consumer direct, consumer indirect, consumer revolving, and leases). After determining the loss rates, management adjusts these rates for certain considerations, such as trends in delinquency and other economic factors, and then applies the adjusted loss rates to loan balances of these portfolio segments.
In addition to using loss rates, secured commercial non-accrual loans of $0.5 million or greater are reviewed for impairment as required under Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (“FAS No. 114”). Those loans that have specific loss allocations are identified and included in the reserve allocation. Risk-rated loans that are not reviewed for impairment are segregated into homogeneous pools with loss allocation rates that reflect the severity of risk. Loss rates are adjusted by applying other factors to the calculations. These factors include adjustments for current economic trends, delinquency and risk trends, credit concentrations, credit administration, migration analysis, and other special allocations for unusual events or changes in products.
This methodology provides an in-depth analysis of the bank’s portfolio and reflects the estimated losses within it. Reserve allocations are then reviewed and consolidated. This process is performed on a quarterly basis, including a risk-rate review of commercial credit relationships.
With respect to the Community acquisition, we recorded an $11.1 million additional provision for loan and lease losses in the fourth quarter of 2007. The primary reason that we recognized this additional $11.1 million provision is that we evaluated more of the Community loan portfolio under FAS No. 5, “Accounting for Contingencies,” rather than under FAS No. 114, in accordance with our allowance for loan and lease loss methodology. FAS No. 114 states that a loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Using this guidance, Community defined an impaired loan as any loan rated special mention or worse, regardless of its accrual status, while we define an impaired loan as any non-consumer, non-accrual loan in an amount greater than $0.25 million (as previously discussed). We assess, and Community assessed, pools of homogenous loans not considered to be impaired under FAS No. 114 in accordance with the guidance in FAS No. 5 to determine if a probable loss has been incurred. This difference in determining impaired loans resulted in our evaluation of $70.0 million of loans in the Community portfolio under FAS No. 5, where Community had evaluated these same loans individually under FAS No. 114 with a $0 reserve, based on the net realizable value of the underlying collateral. As a result, we determined that is was necessary to record an additional provision of $8.1 million. The remaining $3.0 million addition to the provision resulted from our classification of Community’s loan portfolio into more risk categories than the number of risk categories used by Community. We classify loans into nine categories with different risk factors, while Community used five categories. These category differences resulted in loans being evaluated in FAS No. 5 pools with more severe risk factors than they had been evaluated by Community prior to the merger.
Throughout 2008, we continued to experience a challenging operating environment. Given the economic pressures that impact some of our borrowers, we increased our allowance for loan and lease losses in accordance with our assessment process, which took into consideration a $48.6 million increase in nonperforming loans and leases since December 31, 2007 and the rising charge-off level noted below. As presented in Table 3, the provision for loan and lease losses was $63.8 million for the year ended December 31, 2008, and $21.8 million for the year ended December 31, 2007. The allowance for loan and lease losses at December 31, 2008 was 1.18% of period-end loans and leases, or $113.7 million, and 1.01% of period-end loans and leases, or $88.6 million, at December 31, 2007.
37
Table 3 - Provision and Allowance for Loan and Lease Losses
| | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | (Dollars in thousands) | |
Allowance for loan and lease losses, January 1 | | $ | 88,569 | | | $ | 62,643 | | | $ | 53,714 | | | $ | 54,093 | | | $ | 42,672 | |
Allowance acquired in business combination | | | 0 | | | | 19,119 | | | | 5,514 | | | | 0 | | | | 9,149 | |
Additions to provision for loan and lease
losses charged to operations | | | 63,831 | | | | 21,844 | | | | 8,680 | | | | 12,335 | | | | 10,020 | |
Loans and leases charged-off during the year: | | | | | | | | | | | | | | | | | | | | |
Commercial, financial, and agricultural | | | 17,433 | | | | 4,758 | | | | 2,883 | | | | 8,827 | | | | 2,211 | |
Real estate - construction | | | 8,885 | | | | 1,949 | | | | 5 | | | | 45 | | | | 0 | |
Real estate secured - residential | | | 3,883 | | | | 1,829 | | | | 1,284 | | | | 1,407 | | | | 948 | |
Real estate secured - commercial | | | 2,154 | | | | 3,200 | | | | 454 | | | | 1,805 | | | | 1,845 | |
Consumer | | | 8,075 | | | | 3,790 | | | | 3,379 | | | | 3,455 | | | | 3,607 | |
Leases | | | 4,800 | | | | 3,659 | | | | 3,111 | | | | 2,816 | | | | 2,248 | |
| | | | | | | | | | | | | | | | | | | | |
Total charge-offs | | | 45,230 | | | | 19,185 | | | | 11,116 | | | | 18,355 | | | | 10,859 | |
| | | | | | | | | | | | | | | | | | | | |
Recoveries of loans and leases previously charged-off: | | | | | �� | | | | | | | | | | | | | | | |
Commercial, financial, and agricultural | | | 1,625 | | | | 536 | | | | 1,188 | | | | 1,694 | | | | 611 | |
Real estate - construction | | | 5 | | | | 10 | | | | 6 | | | | 0 | | | | 0 | |
Real estate secured - residential | | | 226 | | | | 406 | | | | 454 | | | | 370 | | | | 298 | |
Real estate secured - commercial | | | 145 | | | | 426 | | | | 1,360 | | | | 1,007 | | | | 96 | |
Consumer | | | 3,626 | | | | 1,792 | | | | 1,957 | | | | 1,649 | | | | 1,493 | |
Leases | | | 952 | | | | 978 | | | | 886 | | | | 921 | | | | 613 | |
| | | | | | | | | | | | | | | | | | | | |
Total recoveries | | | 6,579 | | | | 4,148 | | | | 5,851 | | | | 5,641 | | | | 3,111 | |
| | | | | | | | | | | | | | | | | | | | |
Net charge-offs | | | 38,651 | | | | 15,037 | | | | 5,265 | | | | 12,714 | | | | 7,748 | |
| | | | | | | | | | | | | | | | | | | | |
Allowance for loan and lease losses, December 31 | | $ | 113,749 | | | $ | 88,569 | | | $ | 62,643 | | | $ | 53,714 | | | $ | 54,093 | |
| | | | | | | | | | | | | | | | | | | | |
Average loans and leases outstanding | | $ | 9,169,996 | | | $ | 5,979,878 | | | $ | 5,517,812 | | | $ | 5,234,463 | | | $ | 4,743,864 | |
Period-end loans and leases | | | 9,653,873 | | | | 8,751,590 | | | | 5,560,997 | | | | 5,218,659 | | | | 5,253,008 | |
Net charge-offs as a percentage of average loans and leases | | | 0.42 | % | | | 0.25 | % | | | 0.10 | % | | | 0.24 | % | | | 0.16 | % |
Allowance as a percentage of period-end loans and leases | | | 1.18 | % | | | 1.01 | % | | | 1.13 | % | | | 1.03 | % | | | 1.03 | % |
Determining the level of the allowance for probable loan and lease losses at any given point in time is difficult, particularly during uncertain economic periods. We must make estimates using assumptions and information that is often subjective and changing rapidly. The review of the loan and lease portfolios is a continuing process in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and lease losses is adequate to meet probable incurred loan and lease losses at December 31, 2008. There can be no assurance, however, that we will not sustain losses in future periods that could be greater than the size of the allowance at December 31, 2008. The allowance for loan and lease losses as a percentage of non-performing loans and leases (coverage ratio) decreased to 105% at December 31, 2008, from 149% at December 31, 2007.
38
Should the economic climate deteriorate further, borrowers may experience increasing difficulty in meeting their payment obligations, and the level of non-performing loans and assets, charge-offs, and delinquencies could rise and require further increases in the provision. In addition, regulatory authorities, as an integral part of their examinations, periodically review the level of the allowance for loan and lease losses and may require additions to the allowance based upon their judgments about information available to them at the time of examination.
It is our policy not to renegotiate the terms of a commercial loan simply because of a delinquency status. Rather, a commercial loan is typically transferred to non-accrual status if it is not well secured and in the process of collection, and is considered delinquent in payment if either principal or interest is past due 90 days or more. Interest income received on impaired commercial loans in 2008 and 2007, was $0.5 million and $0.07 million, respectively. Interest income that would have been recorded on these loans under the original terms was $5.5 million and $1.8 million for 2008 and 2007, respectively. At December 31, 2008, we had no binding outstanding commitments to advance additional funds with respect to these impaired loans.
Consumer loans are typically charged-off when they are 120 days past due unless they are secured by real estate. Loans secured by real estate are evaluated on the basis of collateral value. Loans that are well secured may continue to accrue interest, while other loans are charged down to net realizable value or placed on non-accrual depending upon their loan-to-value ratio.
Net charge-offs as a percentage of average loans and leases for the year ended December 31, 2008, were 0.42%, compared to 0.25% for 2007.
Table 4 is a presentation of the five-year history of non-performing assets and loans and leases contractually past due 90 days and not placed on non-accrual. At December 31, 2008, non-performing assets totaled $118.2 million and included $10.3 million in other real estate acquired through foreclosure and $2.6 million in restructured loans. At December 31, 2007, non-performing assets totaled $71.3 million, and included $11.9 million in other real estate acquired through foreclosure and $2.6 million in restructured loans. The increase in non-performing assets primarily is the result of the impact on our borrowers of the deterioration in economic conditions.
Table 4 - Non-Performing Assets
| | | | | | | | | | | | | | | | | | | | |
At December 31, | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | (Dollars in thousands) | |
Loans contractually past due 90 days and still accruing | | $ | 22,316 | | | $ | 12,199 | | | $ | 9,364 | | | $ | 8,998 | | | $ | 10,217 | |
| | | | | | | | | | | | | | | | | | | | |
Non-performing assets: | | | | | | | | | | | | | | | | | | | | |
Nonaccrual loans: | | | | | | | | | | | | | | | | | | | | |
Commercial, financial, and agricultural | | $ | 13,882 | | | $ | 2,799 | | | $ | 1,264 | | | $ | 2,921 | | | $ | 1,866 | |
Real estate - construction | | | 49,774 | | | | 20,998 | | | | 9,631 | | | | 0 | | | | 0 | |
Real estate secured - residential | | | 18,271 | | | | 11,755 | | | | 5,900 | | | | 5,629 | | | | 5,801 | |
Real estate secured - commercial | | | 22,477 | | | | 18,261 | | | | 11,307 | | | | 5,872 | | | | 10,611 | |
Consumer | | | 844 | | | | 397 | | | | 2 | | | | 76 | | | | 146 | |
Leases | | | 65 | | | | 2,531 | | | | 2,221 | | | | 2,894 | | | | 1,983 | |
Restructured loans | | | 2,566 | | | | 2,582 | | | | 5,376 | | | | 0 | | | | 0 | |
Other real estate owned | | | 10,313 | | | | 11,927 | | | | 1,544 | | | | 2,620 | | | | 1,340 | |
| | | | | | | | | | | | | | | | | | | | |
Total non-performing assets | | $ | 118,192 | | | $ | 71,250 | | | $ | 37,245 | | | $ | 20,012 | | | $ | 21,747 | |
| | | | | | | | | | | | | | | | | | | | |
Total non-performing assets as a percentage of period-end loans and leases and other real estate owned | | | 1.22 | % | | | 0.81 | % | | | 0.67 | % | | | 0.38 | % | | | 0.41 | % |
Allowance for loan and lease losses as a percentage of
non-performing loans and leases | | | 105 | % | | | 149 | % | | | 175 | % | | | 309 | % | | | 265 | % |
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Of the $105.3 million of non-accrual loans and leases at December 31, 2008, $83.5 million, or 79.3%, represented non-consumer-loan relationships greater than $0.5 million that had been evaluated and considered impaired under FAS No. 114. Of the $83.5 million of impaired loans, $21.4 million, or 25.6%, had no related reserve. The determination that no related reserve for these collateral-dependent loans was required was based on the net realizable value of the underlying collateral.
Real estate acquired through foreclosure is recorded at the lower of its carrying value or the fair market value of the property at the transfer date, as determined by a current appraisal, less estimated costs to sell. Prior to foreclosure, the recorded amount of the loan is written-down, if necessary, to the fair value of the related real estate collateral by charging the allowance for loan and lease losses. Subsequent to foreclosure, gains or losses on the sale of real estate acquired through foreclosure are recorded in operating income, and any losses determined as a result of periodic valuations are charged to other operating expense. Real estate acquired through foreclosure decreased $1.6 million from December 31, 2007 to December 31, 2008.
Loans with principal and/or interest delinquent 90 days or more and still accruing interest totaled $22.3 million at December 31, 2008, an increase of $10.1 million, from $12.2 million at December 31, 2007. Additional deterioration in the economy may adversely affect certain borrowers and may cause additional loans to become past due beyond 90 days or be placed on non-accrual status because of the uncertainty of receiving full payment of either principal or interest on these loans.
Potential problem loans consist of loans that are performing under contract but for which potential credit problems have caused us to place them on our internally monitored loan list. These loans, which are not included in Table 4, totaled $185.0 million at December 31, 2008, and $133.8 million at December 31, 2007. The increase of $51.2 million can be attributed to the deterioration of economic conditions throughout 2008 and migrations to our internally monitored loan list that occur in the normal course of business.Further deterioration in the state of the economy and its concomitant impact on these borrowers, as well as future events, such as regulatory examination assessments, may result in these loans and others not currently so identified being classified as non-performing assets in the future.
In light of the current economic situation, we have undertaken the following additional measures to recognize and resolve troubled credits:
| | • | | we review all credit relationships in the categories of Commercial Real Estate, Commercial Construction – Real Estate, and Residential Real Estate with aggregate exposure of $5.0 million and loans of $2.5 million or greater during the third month of each quarter to determine the status of their global cash flows. This review includes a stress test for an increase of 1.0% in interest rates; |
| | • | | we hold credit quality meetings during the second month of each quarter to review all criticized and classified loans. This includes reviewing global cash flows and stress testing for an increase of 1.0% in interest rates; |
| | • | | we complete a fifteen-month rolling projection of potential non-accrual loans, charge-offs, foreclosed assets, loans ninety days past due and still accruing, total delinquencies, troubled debt restructurings, specific reserves, and recoveries over $0.5 million during the third month of every quarter. These projections are reviewed and discussed by executive management; |
| | • | | we hold monthly meetings with our work-out officers to review their portfolios and strategy to either upgrade or exit particular credit relationships; |
| | • | | we have instituted an ongoing review in our Consumer Lending area of all home equity line of credit loans to determine which property values and FICO scores have been negatively affected; and |
| | • | | we have established risk-based pricing to reflect the cost of classified and criticized loans. |
We believe that 2009 will be a challenging year, with the effects of the recession moving into the commercial and industrial, commercial real estate, and consumer credit segments. However, we also believe that
40
we have the proper monitoring systems in place to recognize issues in an appropriate time frame and to minimize the effect on our earnings.
Noninterest Income
Noninterest income, as a percentage of net interest income plus noninterest income, was 26%, 30%, and 35% for 2008, 2007, and 2006, respectively.
Noninterest income increased $21.7 million, or 17.9%, in 2008, over 2007. In general, increases in noninterest income are attributable to the effects of the Community acquisition on November 16, 2007. Non-Community related changes of note are as follows:
| | • | | Decreasedvehicle origination, servicing, and securitization fees of $4.5 million; |
| | • | | Increasedwealth management fee income (includes asset management fees, income from fiduciary-related activities,and commissions on brokerage, life insurance, and annuity sales) of $8.5 million; |
| | • | | Decreasedgains on sales of loans and leases of $1.9 million; |
| | • | | Increasednet realized loss on securities of $5.5 million; and |
| | • | | Increasedother income of $8.7 million. |
Vehicle origination, servicing, and securitization fees. The 31.5% decrease was the result of a decrease in vehicle lease managed balances due to significant competition from captive finance companies and a reduction in securitization fees due to the closing of the auto lease securitization market in 2008.
Wealth management fee income. The 26.5% increase primarily was the result of the contribution from Stratton Management Company, which was acquired on April 30, 2008.
Gains on sale of loans and leases. In 2007, we recognized a $2.7 million gain in an auto lease securitization transaction. In 2008, there were no securitization transactions.
Net realized loss on securities. During the third quarter of 2008, we recognized a $17.5 million other-than-temporary impairment of certain corporate synthetic collateralized debt obligations in our available-for-sale investment portfolio. For additional information, refer to the discussion under “Financial Condition,Investment Securities.” During the second quarter of 2007, we restructured our available-for-sale investment portfolio and recognized an $11.8 million loss on the sale of selected securities.
Other. During the third quarter of 2008, we reclassified the fair value of cash flow hedges related to a forecasted sale of vehicle leases from accumulated other comprehensive loss to earnings and recognized a reduction in other noninterest income of $6.5 million. This reduction was more than offset by the additional other revenue generated by the Community acquisition.
Noninterest Expenses
Noninterest expenses increased $90.2 million, or 32.6%, in 2008, over 2007. In general, increases in noninterest expenses are attributable to the effects of the Community acquisition on November 16, 2007. Non-Community-related changes of note are as follows:
Salaries and employee benefits. Included in salaries and employee benefits is a $1.6 million restructuring charge recorded in September 2008 related to the merger of our three bank subsidiaries.
Other. Included in other noninterest expenses is a $2.1 million charge recorded in September 2008 to mitigate losses of customers of VFAM who held positions in a money market mutual fund managed by an
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independent mutual fund company. In September 2008, the Securities and Exchange Commission granted an order, requested by the independent mutual fund manager, to suspend all redemption requests for the fund and to allow for the postponement of redemption payments, temporarily leaving retail investors without access to their short-term cash. Based upon information from the fund manager, we believe that the fund’s net asset value upon an orderly liquidation will be ninety-seven cents per share. Should customers receive less than one dollar per share, our $2.1 million commitment will be available to mitigate our customers’ losses in the fund, up to three cents per share.
Income Taxes
Our effective tax rates for 2008 and 2007 were 24.6% and 29.3%, respectively.
The decrease in our effective tax rate for 2008 was the result of an increase in tax-advantaged income relative to total income in 2008, as compared to tax-advantaged income relative to total income in 2007. The increase in tax-advantaged income is due, in part, to the large municipal bond portfolio acquired in the Community acquisition on November 16, 2007.
Financial Condition
Summary of 2008 Compared to 2007
Total assets at December 31, 2008, were $13.7 billion, an increase of 4.6%, as compared to total assets of $13.1 billion at December 31, 2007. Loans and leases, increased to $9.7 billion at December 31, 2008, from $8.8 billion at December 31, 2007. Total deposits increased to $9.1 billion in 2008, from $8.9 billion during the same time period in 2007.
Equity capital was $1.9 billion at December 31, 2008, or $19.21 per common share, compared to $1.7 billion, or $20.12 per common share, at December 31, 2007. The calculation of book value per common share excludes from Shareholders’ Equity the carrying value of the preferred stock issued to the U.S. Treasury as part of the Capital Purchase Program. For additional information concerning the changes in equity capital, refer to the“Consolidated Statements of Changes in Shareholders’ Equity” in Part II, Item 8.
Fair Value Measurements and The Fair Value Option for Financial Assets and Financial Liabilities
Effective January 1, 2008, we adopted FAS No. 157, “Fair Value Measurements” and FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” At December 31, 2008, Susquehanna had made no elections to use fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value. For additional information about our financial assets and financial liabilities carried at fair value, refer to“Note 23. Fair Value Disclosures” to the consolidated financial statements appearing in Part II, Item 8.
Investment Securities
Securities identified as “available for sale” are reported at their fair value, and the difference between that value and their amortized cost is recorded in the equity section, net of taxes, as a component of other comprehensive income. Accordingly, as a result of changes in the interest-rate environment and the economy in general, our total equity was negatively impacted by $69.3 million. Unrealized losses, net of taxes, on available-for-sale securities totaled $63.8 million at December 31, 2008, and unrealized gains, net of taxes, on available-for-sale securities totaled $5.4 million at December 31, 2008.
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Table 5 - Carrying Value of Investment Securities
| | | | | | | | | | | | | | | | | | |
Year ended December 31, | | 2008 | | 2007 | | 2006 |
| | | Available-
for-Sale | | Held-to-
Maturity | | Available-
for-Sale | | Held-to-
Maturity | | Available-
for-Sale | | Held-to-
Maturity |
| | | (Dollars in thousands) |
U.S. Government agencies | | $ | 444,022 | | $ | 0 | | $ | 533,019 | | $ | 0 | | $ | 509,872 | | $ | 0 |
State and municipal | | | 308,546 | | | 4,595 | | | 268,633 | | | 4,792 | | | 27,141 | | | 6,146 |
Other securities | | | 6,364 | | | 4,550 | | | 68,227 | | | 0 | | | 72,282 | | | 0 |
Mortgage-backed securities | | | 965,853 | | | 0 | | | 1,078,401 | | | 0 | | | 714,747 | | | 0 |
Equity securities | | | 145,961 | | | 0 | | | 110,880 | | | 0 | | | 73,378 | | | 0 |
| | | | | | | | | | | | | | | | | | |
Total investment securities | | $ | 1,870,746 | | $ | 9,145 | | $ | 2,059,160 | | $ | 4,792 | | $ | 1,397,420 | | $ | 6,146 |
| | | | | | | | | | | | | | | | | | |
In September 2008, we recorded a pre-tax impairment charge of $17.5 million related to two synthetic collateralized debt obligations held in our investment portfolio. Each security has a par value of $10.0 million and one hundred underlying reference companies. Through August 31, 2008, there were no credit events (i.e. bankruptcies, conservatorships, or receiverships) related to any of the reference companies. However, given the significant developments that have affected the market, a number of credit events reduced the fair value of one security to 12.5% of par as of September 30, 2008, and the fair value of the other security to 12.0% of par as of September 30, 2008. We believe that it is probable that we will be unable to collect all amounts due according to the contractual terms of these securities. Accordingly, we recognized an other-than-temporary impairment and established new cost bases for the securities reflecting the September 30, 2008 fair value. At December 31, 2008, one security was given a below-investment-grade rating by the rating agencies, while the other security was rated BBB-. These are the only two securities of this type that we currently hold in our $1.9 billion investment portfolio.
During May and June of 2007, while planning for the Community acquisition and the resulting growth and composition of the investment portfolio, our management performed a comprehensive review of our available-for-sale investments. Management determined that for administrative and operational purposes, small remaining portions in mortgage-backed securities (“odd lots,” or securities with remaining par amounts of less than $2.0 million) should be sold. These odd lots, totaling $182.0 million, resulted from previous mergers and bank mergers and from principal amortization over time. Additionally, we determined that all collateralized mortgage obligations, regardless of the remaining par amount, with an aggregate total of $51.0 million should be sold. Many of these mortgage obligations were acquired in the historic low-interest-rate environment of 2002 through 2004. The restructuring involved the sale of approximately 16.0% of our available-for-sale investment portfolio, and resulted in a pre-tax charge of approximately $11.8 million in June 2007.
Securities identified as “trading account securities” are to be marked to market with the change recorded in the income statement. Presently, we do not engage in trading activity, but we do engage in active portfolio management that requires the majority of our security portfolios to be identified as available for sale. While Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“FAS No. 115”) requires segregation into held-to-maturity and available-for-sale categories (see Table 5), it does not change our policy concerning the purchase of only high quality securities. Strategies employed address liquidity, capital adequacy, and net interest margin considerations, which then determine the assignment of purchases into these two categories. Table 6 illustrates the maturities of these security portfolios and the weighted-average yields based upon amortized costs. Yields are shown on a tax equivalent basis assuming a 35% federal income tax rate.
At December 31, 2008, we held no securities of any one issuer (other than securities of U.S. Government agencies and corporations, which, by regulation, may be excluded from this disclosure) where the aggregate book value exceeded 10% of shareholders’ equity.
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Table 6 - Maturities of Investment Securities
| | | | | | | | | | | | | | | | | | | | |
At December 31, 2008 | | Within 1
Year | | | After 1 Year
but Within
5 Years | | | After 5 Years
but Within
10 Years | | | After 10
Years | | | Total | |
| | | (Dollars in thousands) | |
Available-for-Sale | | | | | | | | | | | | | | | | | | | | |
U.S. Government agencies | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 21,954 | | | $ | 384,222 | | | $ | 37,846 | | | $ | 0 | | | $ | 444,022 | |
Amortized cost | | | 21,915 | | | | 368,959 | | | | 37,031 | | | | 0 | | | | 427,905 | |
Yield | | | 3.02 | % | | | 4.75 | % | | | 5.26 | % | | | 0.00 | % | | | 4.70 | % |
Corporate debt securities | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 0 | | | $ | 0 | | | $ | 1,200 | | | $ | 5,164 | | | $ | 6,364 | |
Amortized cost | | | 0 | | | | 0 | | | | 2,450 | | | | 26,334 | | | | 28,784 | |
Yield | | | 0.00 | % | | | 0.00 | % | | | 6.88 | % | | | 6.24 | % | | | 6.29 | % |
Mortgage-backed securities | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 0 | | | $ | 49,419 | | | $ | 95,445 | | | $ | 820,989 | | | $ | 965,853 | |
Amortized cost | | | 0 | | | | 53,232 | | | | 93,176 | | | | 901,379 | | | | 1,047,787 | |
Yield | | | 0.00 | % | | | 4.83 | % | | | 4.43 | % | | | 5.83 | % | | | 5.65 | % |
State and municipal securities | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 4,010 | | | $ | 4,513 | | | $ | 27,282 | | | $ | 272,741 | | | $ | 308,546 | |
Amortized cost | | | 3,993 | | | | 4,480 | | | | 27,119 | | | | 281,237 | | | | 316,829 | |
Yield (TE) | | | 4.75 | % | | | 6.27 | % | | | 5.96 | % | | | 6.07 | % | | | 6.05 | % |
Equity securities | | | | | | | | | | | | | | | | | | | | |
Fair value | | | | | | | | | | | | | | | | | | $ | 145,961 | |
Amortized cost | | | | | | | | | | | | | | | | | | | 147,681 | |
Yield | | | | | | | | | | | | | | | | | | | 3.74 | % |
| | | | | |
Held-to-Maturity | | | | | | | | | | | | | | | | | | | | |
State and municipal | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 4,595 | | | $ | 4,595 | |
Amortized cost | | | 0 | | | | 0 | | | | 0 | | | | 4,595 | | | | 4,595 | |
Yield | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | 5.36 | % | | | 5.36 | % |
Other | | | | | | | | | | | | | | | | | | | | |
Fair value | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 4,550 | | | $ | 4,550 | |
Amortized cost | | | 0 | | | | 0 | | | | 0 | | | | 4,550 | | | | 4,550 | |
Yield | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | 7.16 | % | | | 7.16 | % |
| | | | | |
Total Securities | | | | | | | | | | | | | | | | | | | | |
| | | | | |
Fair value | | $ | 25,964 | | | $ | 438,154 | | | $ | 161,773 | | | $ | 1,108,039 | | | $ | 1,879,891 | |
Amortized cost | | | 25,908 | | | | 426,671 | | | | 159,776 | | | | 1,218,095 | | | | 1,978,131 | |
Yield | | | 3.28 | % | | | 4.77 | % | | | 4.92 | % | | | 5.90 | % | | | 5.38 | % |
Weighted-average yields are based on amortized cost. For presentation in this table, yields on tax-exempt securities have been calculated on a tax-equivalent basis.
Information included in this table regarding mortgage-backed securities is based on final maturities.
For additional information about our investment securities portfolio, refer to“Note 4. Investment Securities” and “Note 23. Fair Value Disclosures” to the consolidated financial statements appearing in Part II, Item 8.
44
Loans and Leases
Loans and leases increased $902.3 million, from December 31, 2007 to December 31, 2008. The 10.3% increase was due to internal growth that was accomplished through our sales and marketing efforts and the fact that loan demand is still solid in our market area.
Our participation in the U.S. Treasury’s Capital Purchase Program brings with it a responsibility to make credit available to our local communities, and we have every intention of continuing our record of strong loan growth. We remain committed, however, to maintaining credit quality and doing business in our market area with customers we know.
In September 2008, we announced that, due to adverse market conditions, our previously disclosed plan to sell vehicle leases would not proceed. As a result, the $238.4 million in vehicle leases held for sale at December 31, 2007 and those subsequently originated are now classified as held for investment.
In January 2007, we exercised an early buyout option associated with Hann’s sale-leaseback transaction. As a result, Hann acquired approximately $78.4 million of beneficial interests in automobile leases and related vehicles. A significant portion of these automobile leases and related vehicles was sold to our banking subsidiaries and subsequently included in the February 2007 $300.4 million vehicle lease securitization transaction.
Table 7 presents loans outstanding, by type of loan, in our portfolio for the past five years. Our bank subsidiary has historically reported a significant amount of loans secured by real estate. Many of these loans have real estate collateral taken as additional security not related to the acquisition of the real estate pledged. Open-ended home equity loans totaled $353.1 million at December 31, 2008, and an additional $394.8 million was outstanding on loans with junior liens on residential properties at December 31, 2008. Senior liens on 1-4 family residential properties totaled $1.3 billion at December 31, 2008, and much of the $2.7 billion in loans secured by non-farm, non-residential properties represented collateralization of operating lines of credit, or term loans that finance equipment, inventory, or receivables. Loans secured by farmland totaled $178.2 million, while loans secured by multi-family residential properties totaled $203.5 million at December 31, 2008.
Table 8 represents the maturity of commercial, financial, and agricultural loans, as well as real estate construction loans. Table 9 presents the allocation of the allowance for loan and lease losses by type of loan.
Table 7 - Loan and Lease Portfolio
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | Amount | | Percentage
of Loans
to Total
Loans
and Leases | | | Amount | | Percentage
of Loans
to Total
Loans
and Leases | | | Amount | | Percentage
of Loans
to Total
Loans
and Leases | | | Amount | | Percentage
of Loans
to Total
Loans
and Leases | | | Amount | | Percentage
of Loans
to Total
Loans
and Leases | |
| | | | | | | | | | | | | (Dollars in thousands) | | | | | | | | | | | |
Commercial, financial, and agricultural | | $ | 2,169,262 | | 22.4 | % | | $ | 1,781,981 | | 20.4 | % | | $ | 978,522 | | 17.6 | % | | $ | 832,695 | | 16.0 | % | | $ | 760,106 | | 14.5 | % |
Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
construction | | | 1,313,647 | | 13.6 | | | | 1,292,953 | | 14.8 | | | | 1,064,452 | | 19.1 | | | | 934,601 | | 17.9 | | | | 741,660 | | 14.1 | |
residential | | | 2,298,709 | | 23.8 | | | | 2,151,923 | | 24.6 | | | | 1,147,741 | | 20.6 | | | | 1,355,513 | | 26.0 | | | | 1,611,999 | | 30.7 | |
commercial | | | 2,875,502 | | 29.8 | | | | 2,661,841 | | 30.3 | | | | 1,577,534 | | 28.5 | | | | 1,257,860 | | 24.1 | | | | 1,252,753 | | 23.8 | |
Consumer | | | 314,051 | | 3.3 | | | | 411,159 | | 4.7 | | | | 313,848 | | 5.6 | | | | 319,925 | | 6.1 | | | | 351,846 | | 6.7 | |
Leases | | | 682,702 | | 7.1 | | | | 451,733 | | 5.2 | | | | 478,900 | | 8.6 | | | | 518,065 | | 9.9 | | | | 534,644 | | 10.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 9,653,873 | | 100.0 | % | | $ | 8,751,590 | | 100.0 | % | | $ | 5,560,997 | | 100.0 | % | | $ | 5,218,659 | | 100.0 | % | | $ | 5,253,008 | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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Table 8 - Loan Maturity and Interest Sensitivity
| | | | | | | | | | | | |
At December 31, 2008 | | Under One
Year | | One to Five
Years | | Over Five
Years | | Total |
| | | (Dollars in thousands) |
Maturity | | | | | | | | | | | | |
Commercial, financial, and agricultural | | $ | 773,164 | | $ | 995,914 | | $ | 400,184 | | $ | 2,169,262 |
Real estate - construction | | | 816,409 | | | 342,055 | | | 155,183 | | | 1,313,647 |
| | | | | | | | | | | | |
| | $ | 1,589,573 | | $ | 1,337,969 | | $ | 555,367 | | $ | 3,482,909 |
| | | | | | | | | | | | |
Rate sensitivity of loans with maturities greater than 1 year | | | | | | | | |
Variable rate | | | | | $ | 447,459 | | $ | 298,121 | | $ | 745,580 |
Fixed rate | | | | | | 890,510 | | | 257,246 | | | 1,147,756 |
| | | | | | | | | | | | |
| | | | | $ | 1,337,969 | | $ | 555,367 | | $ | 1,893,336 |
| | | | | | | | | | | | |
Table 9 - Allocation of Allowance for Loan and Lease Losses
| | | | | | | | | | | | | | | | |
At December 31, | | 2008 | | 2007 | | | 2006 | | 2005 | | 2004 |
| | | (Dollars in thousands) |
Commercial, financial, and agricultural | | $ | 22,599 | | $ | 23,970 | | | $ | 16,637 | | $ | 16,205 | | $ | 14,775 |
Real estate - construction | | | 31,734 | | | 20,552 | | | | 12,419 | | | 5,833 | | | 3,507 |
Real estate secured - residential | | | 16,189 | | | 12,125 | | | | 6,891 | | | 7,967 | | | 9,743 |
Real estate secured - commercial | | | 33,765 | | | 23,320 | | | | 15,065 | | | 11,571 | | | 13,760 |
Consumer | | | 3,253 | | | 4,778 | | | | 4,568 | | | 5,475 | | | 5,779 |
Leases | | | 5,868 | | | 4,203 | | | | 6,589 | | | 6,645 | | | 6,050 |
Overdrafts | | | 34 | | | 57 | | | | 21 | | | 18 | | | 0 |
Loans in process | | | 285 | | | 0 | | | | 0 | | | 0 | | | 0 |
Unallocated | | | 22 | | | (436 | ) | | | 453 | | | 0 | | | 479 |
| | | | | | | | | | | | | | | | |
Total | | $ | 113,749 | | $ | 88,569 | | | $ | 62,643 | | $ | 53,714 | | $ | 54,093 |
| | | | | | | | | | | | | | | | |
Substantially all of our loans and leases are to enterprises and individuals in our market area. As shown in Table 10, there is no concentration of loans to borrowers in any one industry, or related industries, which exceeds 10% of total loans.
46
Table 10 - Loan Concentrations
At December 31, 2008, Susquehanna’s portfolio included the following industry concentrations:
| | | | | | | | | | | | | | | | |
| | | Permanent | | Construction | | All
Other | | Total
Amount | | % Nonperforming
in Each Category | | % of Total Loans
and Leases
Outstanding |
| | | (Dollars in thousands) |
Residential construction | | $ | 111,109 | | $ | 438,835 | | $ | 29,861 | | $ | 579,805 | | 4.53 | | 6.01 |
Real estate - residential | | | 477,317 | | | 46,740 | | | 22,973 | | | 547,030 | | 0.34 | | 5.67 |
Land development (site work) construction | | | 76,390 | | | 416,736 | | | 23,469 | | | 516,595 | | 4.30 | | 5.35 |
Motor vehicles | | | 380,293 | | | 215 | | | 56,931 | | | 437,439 | | 0.56 | | 4.53 |
Manufacturing | | | 101,833 | | | 10,729 | | | 205,333 | | | 317,895 | | 0.55 | | 3.29 |
Hotels/motels | | | 272,574 | | | 25,528 | | | 1,218 | | | 299,320 | | 0.30 | | 3.10 |
Retail consumer goods | | | 91,524 | | | 4,832 | | | 121,196 | | | 217,552 | | 1.41 | | 2.25 |
Agriculture | | | 175,102 | | | 2,342 | | | 38,761 | | | 216,205 | | 1.54 | | 2.24 |
Lessors of professional offices | | | 206,996 | | | 8,552 | | | 0 | | | 215,548 | | 0.69 | | 2.23 |
Public services | | | 53,432 | | | 4,430 | | | 121,427 | | | 179,289 | | 0.64 | | 1.86 |
Medical services | | | 69,746 | | | 3,674 | | | 98,711 | | | 172,131 | | 0.49 | | 1.78 |
Wholesalers | | | 50,645 | | | 1,739 | | | 101,650 | | | 154,034 | | 0.26 | | 1.60 |
Contractors | | | 61,947 | | | 12,002 | | | 79,553 | | | 153,502 | | 3.89 | | 1.59 |
Warehouses | | | 121,604 | | | 5,756 | | | 0 | | | 127,360 | | 0.41 | | 1.32 |
Elderly/child care services | | | 82,345 | | | 2,231 | | | 37,050 | | | 121,626 | | 2.13 | | 1.26 |
Recreation | | | 74,633 | | | 12,004 | | | 17,237 | | | 103,874 | | 1.84 | | 1.08 |
Real estate services | | | 56,369 | | | 31,084 | | | 13,448 | | | 100,901 | | 0.00 | | 1.05 |
Retail real estate, shopping malls | | | 96,330 | | | 0 | | | 0 | | | 96,330 | | 0.00 | | 1.00 |
Retail real estate, excluding malls | | | 92,889 | | | 2,946 | | | 0 | | | 95,835 | | 0.07 | | 0.99 |
Restaurants/bars | | | 69,922 | | | 1,918 | | | 23,252 | | | 95,092 | | 1.66 | | 0.99 |
Commercial construction | | | 48,047 | | | 24,420 | | | 9,743 | | | 82,210 | | 2.31 | | 0.85 |
Transportation | | | 11,283 | | | 134 | | | 69,931 | | | 81,348 | | 0.78 | | 0.84 |
Self storage units | | | 55,911 | | | 16,556 | | | 0 | | | 72,467 | | 0.00 | | 0.75 |
Medical office space | | | 51,368 | | | 13,990 | | | 0 | | | 65,358 | | 0.66 | | 0.68 |
Goodwill and Other Identifiable Intangible Assets
Goodwill recognized as a result of the Community acquisition was $615.5 million, and intangibles with finite lives were $40.5 million.
We test goodwill for impairment on an annual basis, or more often if events or circumstances indicate that there may be an impairment. We performed our annual goodwill impairment test as of May 31, 2008, and determined that there was no impairment. However, given the continuing downturn in the economy and overall market conditions since that time and the fact that our market capitalization has been below the book value of our equity, we decided an interim goodwill impairment test was required under FAS No. 142 as of December 31, 2008. This test requires significant judgment and analysis.
Susquehanna’s goodwill impairment test begins with a comparison between the fair value of the underlying reporting unit and its carrying amount (book value), including goodwill. If the estimated fair value is less than the carrying value, it is likely that an impairment has occurred.
47
Based upon our analyses at May 31 and December 31, 2008, fair value of each of Susquehanna’s reporting units exceeded their book value for the reporting units, and there was no goodwill impairment. However, due to the ongoing turmoil in market conditions, we will continue to monitor and evaluate the carrying value of goodwill for possible future impairment.
Deposits
Our deposit base is consumer-oriented, consisting of time deposits, primarily certificates of deposit with various terms, interest-bearing demand accounts, savings accounts, and demand deposits. Average deposit balances by type and the associated average rate paid are summarized in Table 11.
Table 11 - Average Deposit Balances
| | | | | | | | | | | | | | | | | | |
Year ended December 31, | | 2008 | | | 2007 | | | 2006 | |
| | | Average
Balance | | Average
Rate Paid | | | Average
Balance | | Average
Rate Paid | | | Average
Balance | | Average
Rate Paid | |
| | | (Dollars in thousands) | |
Demand deposits | | $ | 1,205,381 | | 0.00 | % | | $ | 935,018 | | 0.00 | % | | $ | 946,369 | | 0.00 | % |
Interest-bearing demand deposits | | | 2,604,337 | | 1.29 | | | | 2,173,731 | | 2.83 | | | | 1,846,483 | | 2.78 | |
Savings deposits | | | 723,612 | | 0.67 | | | | 480,065 | | 0.89 | | | | 496,056 | | 1.00 | |
Time deposits | | | 4,402,956 | | 3.80 | | | | 2,720,688 | | 4.58 | | | | 2,408,684 | | 4.12 | |
| | | | | | | | | | | | | | | | | | |
Total | | $ | 8,936,286 | | | | | $ | 6,309,502 | | | | | $ | 5,697,592 | | | |
| | | | | | | | | | | | | | | | | | |
Total deposits increased $121.4 million, or 1.4%, from December 31, 2007, to December 31, 2008. This relatively small increase reflects the intense competition within our marketplace to attract new deposits.
We do not rely upon time deposits of $0.1 million or more as a principal source of funds, as they represent only 17.6% of total deposits. Table 12 presents a breakdown by maturity of time deposits of $0.1 million or more as of December 31, 2008.
Table 12 - Deposit Maturity
The maturities of time deposits of $0.1 million or more at December 31, 2008, were as follows:
| | | |
(Dollars in thousands) | | |
Three months or less | | $ | 481,193 |
Over three months through six months | | | 195,646 |
Over six months through twelve months | | | 529,756 |
Over twelve months | | | 389,079 |
| | | |
Total | | $ | 1,595,674 |
| | | |
Short-term Borrowings
Short-term borrowings, which include securities sold under repurchase agreements, federal funds purchased, borrowings through the Federal Reserve’s Term Auction Facility, and Treasury tax and loan notes, increased by $341.8 million, or 60.1%, from December 31, 2007, to December 31, 2008.
Since our loan growth has been greater than our deposit growth, we have used short-term borrowings, primarily in the forms of federal funds purchased and the term auction facility, to fund loans.
Federal Home Loan Bank Borrowings and Long-term Debt
Federal Home Loan Bank borrowings decreased $76.0 million from December 31, 2007 to December 31, 2008. This decrease is the result of increasing our short-term borrowings at lower interest rates.
48
On December 31, 2008, we issued a $25.0 million subordinated note to another financial institution. The note bears interest at three-month LIBOR plus 4.50% and matures in December 2018.
Contractual Obligations and Commercial Commitments
Table 13 presents certain of our contractual obligations and commercial commitments and their expected year of payment or expiration.
Table 13 - Contractual Obligations and Commercial Commitments at December 31, 2008
| | | | | | | | | | | | | | | |
| | | Payments Due by Period |
Contractual Obligations | | Total | | Less than 1
Year | | 1 - 3 Years | | 4 - 5 Years | | Over 5
Years |
| | | (Dollars in thousands) |
Certificates of deposit | | $ | 4,641,327 | | $ | 3,076,919 | | $ | 1,037,664 | | $ | 521,701 | | $ | 5,043 |
FHLB borrowings | | | 1,069,784 | | | 139,996 | | | 236,921 | | | 291,133 | | | 401,734 |
Long-term debt | | | 448,082 | | | 0 | | | 0 | | | 75,000 | | | 373,082 |
Operating leases | | | 122,441 | | | 13,212 | | | 22,790 | | | 18,165 | | | 68,274 |
Residual value guaranty fees | | | 13,860 | | | 4,620 | | | 9,240 | | | 0 | | | 0 |
| | | | | | | | | | | | | | | |
| | | Commitment Expiration by Period |
Other Commercial Commitments | | Total | | Less than 1
Year | | 1 - 3 Years | | 4 - 5 Years | | Over 5
Years |
| | | (Dollars in thousands) |
Stand-by letters of credit | | $ | 442,725 | | $ | 318,236 | | $ | 124,489 | | $ | 0 | | $ | 0 |
Commercial commitments | | | 823,875 | | | 470,062 | | | 353,813 | | | 0 | | | 0 |
Real estate commitments | | | 699,435 | | | 235,584 | | | 463,851 | | | 0 | | | 0 |
Capital Adequacy
Risk-based capital ratios, based upon guidelines adopted by bank regulators in 1989, focus upon credit risk. Assets and certain off-balance-sheet items are segmented into one of four broad risk categories and weighted according to the relative percentage of credit risk assigned by the regulatory authorities. Off-balance-sheet instruments are converted into a balance sheet credit equivalent before being assigned to one of the four risk-weighted categories. To supplement the risk-based capital ratios, the regulators issued a minimum leverage ratio guideline (Tier 1 capital as a percentage of average assets less excludable intangibles).
Capital elements are segmented into two tiers. Tier 1 capital represents shareholders’ equity plus junior subordinated debentures reduced by excludable intangibles. Tier 2 capital represents certain allowable long-term debt, the portion of the allowance for loan and lease losses equal to 1.25% of risk-adjusted assets, and 45% of the unrealized gain on equity securities. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.”
The maintenance of a strong capital base at the parent company level as well as at the bank level is an important aspect of our philosophy. We and the bank have leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity is considered “well capitalized” under regulatory guidelines.
For additional information related to our risk-based capital ratios, see“Note 15. Capital Adequacy” to the consolidated financial statements appearing in Part II, Item 8.
Market Risks
The types of market risk exposures generally faced by banking entities include:
| | • | | equity market price risk; |
49
| | • | | foreign currency risk; and |
Due to the nature of our operations, foreign currency and commodity price risk are not significant to us. However, in addition to general banking risks, we have other risks that are related to vehicle leasing, asset securitizations, and off-balance-sheet financing that are also discussed below.
Equity Market Price Risk
Equity market price risk is the risk related to market fluctuations of equity prices in the securities markets. While we do not have significant risk in our investment portfolio, market price fluctuations may affect fee income generated through our asset management operations. Generally, our fee structure is based on the market value of assets being managed at specific time frames. If market values decline, our fee income may also decline.
Liquidity Risk
The maintenance of adequate liquidity — the ability to meet the cash requirements of our customers and other financial commitments — is a fundamental aspect of our asset/liability management strategy. Our policy of diversifying our funding sources — purchased funds, repurchase agreements, and deposit accounts — allows us to avoid undue concentration in any single financial market and also to avoid heavy funding requirements within short periods of time. At December 31, 2008, our bank subsidiary had approximately $1.1 billion available under a collateralized line of credit with the Federal Home Loan Bank of Pittsburgh; and $624.8 million more would have been available provided that additional collateral had been pledged.
Over the past few years, as an additional source of liquidity, we periodically entered into securitization transactions in which we sold the beneficial interests in loans and leases to qualified special purpose entities (QSPEs). Since our last securitization, which occurred in February 2007, adverse market conditions have made such transactions extremely difficult, as evidenced by our inability to complete the securitization forecasted for 2008. As an alternative source of funding, we have pledged the leases previously held for sale and certain auto loans to obtain collateralized borrowing availability at the Federal Reserve’s Discount Window and Term Auction Facility. At December 31, 2008, we had collateralized availability of $406.3 million.
Liquidity is not entirely dependent on increasing our liability balances. Liquidity is also evaluated by taking into consideration maturing or readily marketable assets. Unrestricted short-term investments amounted to $119.1 million for the year ended December 31, 2008, and represented additional sources of liquidity.
Management believes these sources of liquidity are sufficient to support our banking operations.
Interest Rate Risk
The management of interest rate risk focuses on controlling the risk to net interest income and the associated net interest margin as the result of changing market rates and spreads. Interest rate sensitivity is the matching or mismatching of the repricing and rate structure of the interest-bearing assets and liabilities. Our goal is to control risk exposure to changing rates within management’s accepted guidelines to maintain an acceptable level of risk exposure in support of consistent earnings.
We employ a variety of methods to monitor interest rate risk. These methods include basic gap analysis, which points to directional exposure; routine rate shocks simulation; and evaluation of the change in economic value of equity. Board directed guidelines have been adopted for both the rate shock simulations and economic value of equity exposure limits. By dividing the assets and liabilities into three groups — fixed rate, floating rate, and those which reprice only at our discretion — strategies are developed to control the exposure to interest rate fluctuations.
50
Our interest rate risk using the static gap analysis is presented in Table 14. This method reports the difference between interest-rate sensitive assets and liabilities at a specific point in time. Management uses the static gap methodology to identify our directional interest-rate risk. Table 14 also illustrates our estimated interest-rate sensitivity (periodic and cumulative) gap positions as calculated as of December 31, 2008, and 2007. These estimates include anticipated prepayments on commercial and residential loans, and mortgage-backed securities, in addition to certain repricing assumptions relative to our core deposits. Traditionally, an institution with more assets repricing than liabilities over a given time frame is considered asset sensitive, and one with more liabilities repricing than assets is considered liability sensitive. An asset sensitive institution will generally benefit from rising rates, and a liability sensitive institution will generally benefit from declining rates. Static gap analysis is widely accepted because of its simplicity in identifying interest rate risk exposure; but it ignores market spread adjustments, the changing mix of the balance sheet, planned balance sheet management strategies, and the change in prepayment assumptions.
Table 14 - Balance Sheet Gap Analysis
| | | | | | | | | | | | | | | | | | | |
At December 31, 2008 | | 1-3
months | | | 3-12
months | | | 1-3
years | | | Over 3
years | | | Total |
| | | (Dollars in thousands) |
Assets | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | 119,357 | | | $ | 0 | | | $ | 0 | | | $ | 3 | | | $ | 119,360 |
Investments | | | 462,765 | | | | 579,848 | | | | 534,363 | | | | 302,914 | | | | 1,879,890 |
Loans and leases, net of unearned income | | | 3,725,781 | | | | 1,589,377 | | | | 2,435,705 | | | | 1,903,010 | | | | 9,653,873 |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 4,307,903 | | | $ | 2,169,225 | | | $ | 2,970,068 | | | $ | 2,205,927 | | | $ | 11,653,123 |
| | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand | | $ | 1,071,670 | | | $ | 257,505 | | | $ | 841,626 | | | $ | 357,674 | | | $ | 2,528,475 |
Savings | | | 43,454 | | | | 130,364 | | | | 382,402 | | | | 139,055 | | | | 695,275 |
Time | | | 901,119 | | | | 1,436,219 | | | | 648,362 | | | | 59,952 | | | | 3,045,652 |
Time in denominations of $100 or more | | | 663,036 | | | | 724,078 | | | | 191,048 | | | | 17,512 | | | | 1,595,674 |
Total borrowings | | | 1,084,887 | | | | 26,995 | | | | 301,856 | | | | 1,014,347 | | | | 2,428,085 |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 3,764,166 | | | $ | 2,575,161 | | | $ | 2,365,294 | | | $ | 1,588,540 | | | $ | 10,293,161 |
| | | | | | | | | | | | | | | | | | | |
Impact of other assets, other liabilities, capital, and noninterest-bearing deposits: | | ($ | 70,770 | ) | | ($ | 226,129 | ) | | ($ | 663,312 | ) | | ($ | 399,751 | ) | | | |
Interest Sensitivity Gap: | | | | | | | | | | | | | | | | | | | |
Periodic | | $ | 472,967 | | | ($ | 632,065 | ) | | ($ | 58,538 | ) | | $ | 217,636 | | | | |
Cumulative | | | | | | | (159,098 | ) | | | (217,636 | ) | | | 0 | | | | |
Cumulative gap as a percentage of total assets | | | 3 | % | | | -1 | % | | | -2 | % | | | 0 | % | | | |
| | | | | |
At December 31, 2007 | | 1-3
months | | | 3-12
months | | | 1-3
years | | | Over 3
years | | | Total |
| | | (Dollars in thousands) |
Assets | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | 140,854 | | | $ | 0 | | | $ | 0 | | | $ | 2,430 | | | $ | 143,284 |
Investments | | | 367,357 | | | | 409,721 | | | | 758,064 | | | | 528,810 | | | | 2,063,952 |
Loans and leases, net of unearned income | | | 3,090,669 | | | | 1,492,473 | | | | 2,349,564 | | | | 1,818,884 | | | | 8,751,590 |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 3,598,880 | | | $ | 1,902,194 | | | $ | 3,107,628 | | | $ | 2,350,124 | | | $ | 10,958,826 |
| | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand | | $ | 1,384,915 | | | $ | 314,564 | | | $ | 818,470 | | | $ | 312,076 | | | $ | 2,830,025 |
Savings | | | 35,016 | | | | 105,052 | | | | 423,156 | | | | 150,760 | | | | 713,984 |
Time | | | 507,609 | | | | 1,463,800 | | | | 717,663 | | | | 61,795 | | | | 2,750,867 |
Time in denominations of $100 or more | | | 439,059 | | | | 674,540 | | | | 219,812 | | | | 24,041 | | | | 1,357,452 |
Total borrowings | | | 1,143,804 | | | | 131,836 | | | | 405,509 | | | | 450,006 | | | | 2,131,155 |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 3,510,403 | | | $ | 2,689,792 | | | $ | 2,584,610 | | | $ | 998,678 | | | $ | 9,783,483 |
| | | | | | | | | | | | | | | | | | | |
Impact of other assets, other liabilities, capital, and noninterest-bearing deposits: | | ($ | 76,787 | ) | | ($ | 243,201 | ) | | ($ | 732,482 | ) | | ($ | 122,873 | ) | | | |
Interest Sensitivity Gap: | | | | | | | | | | | | | | | | | | | |
Periodic | | $ | 11,690 | | | ($ | 1,030,799 | ) | | ($ | 209,464 | ) | | $ | 1,228,573 | | | | |
Cumulative | | | | | | | (1,019,109 | ) | | | (1,228,573 | ) | | | 0 | | | | |
Cumulative gap as a percentage of total assets | | | 0 | % | | | -8 | % | | | -9 | % | | | 0 | % | | | |
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In addition to static gap reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, we also utilize simulation analysis that measures our exposure to interest rate risk. The financial simulation model calculates the income effect and the economic value of assets, liabilities and equity at current and forecasted interest rates, and at hypothetical higher and lower interest rates at one percent intervals. The income effect and economic value of defined categories of financial instruments is calculated by the model using estimated cash flows based on embedded options, prepayments, early withdrawals, and weighted average contractual rates and terms. For economic value calculations, the model also considers discount rates for similar financial instruments. The economic values of longer-term fixed-rate financial instruments are generally more sensitive to changes in interest rates. Adjustable-rate and variable-rate financial instruments largely reflect only a change in economic value representing the difference between the contractual and discounted rates until the next contractual interest rate repricing date, unless subject to rate caps and floors.
A portion of our loan portfolio consists of commercial and residential mortgage loans containing embedded options, which permit the borrower to repay the principal balance of the loan prior to maturity (“prepayments”) without penalty. A loan’s susceptibility for prepayment is dependent upon a number of factors, including the current interest rate versus the contractual interest rate of the loan, the financial ability of the borrower to refinance, the economic benefit and the availability of refinancing at attractive terms in addition to general changes in customers’ needs. Refinancing may also depend upon economic and other factors in specific geographic areas that affect the sales and price levels of residential property. In a changing interest rate environment, prepayments may increase or decrease depending on the current relative levels and expectations of future short-term and long-term interest rates.
Changes in market rates and general economic conditions will have an impact on an organization’s mortgage-backed security portfolio. This will have an associated change on our sensitivity position in changing economic times. Savings and checking deposits generally may be withdrawn upon the customer’s request without prior notice. A continuing relationship with customers resulting in future deposits and withdrawals is generally predictable, resulting in a dependable source of funds. Time deposits generally have early withdrawal penalties, while term FHLB borrowings and subordinated notes have prepayment penalties, which discourage customer withdrawal of time deposits and prepayment of FHLB borrowings and subordinated notes prior to maturity.
Our floating-rate loan portfolio is primarily indexed to national interest rate indices. The portfolio is funded by interest-bearing liabilities which are determined by other indices, primarily deposits and FHLB borrowings. A changing interest rate environment may result in different levels of changes to the different indices resulting in disproportionate changes in the value of, and the net earnings generated from, such financial instruments. Basis risk is the result of this inconsistent change in the indices, with historical relationships not always being a good indicator.
Tables 15 and 16 reflect the estimated income effect and economic value of assets, liabilities, and equity calculated using certain assumptions we determined as of December 31, 2008, and 2007, at then current interest rates and at hypothetical higher and lower interest rates in 1% and 2% increments. As noted in Table 15, the economic value of equity at risk as of December 31, 2008, is -1%, at an interest rate change of positive 2%, while Table 16 discloses that net interest income at risk as of December 31, 2008, is -7%, at an interest rate change of negative 1%.
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Table 15 - Balance Sheet Shock Analysis
| | | | | | | | | | | | | | | | |
At December 31, 2008 | | -1% | | | Base
Present
Value | | | 1% | | | 2% | |
Assets | | | | | | | | | | | | | | | | |
Cash and due from banks | | $ | 237,701 | | | $ | 237,701 | | | $ | 237,701 | | | $ | 237,701 | |
Short-term investments | | | 119,360 | | | | 119,360 | | | | 119,360 | | | | 119,360 | |
Investment securities: | | | | | | | | | | | | | | | | |
Held-to-maturity | | | 4,595 | | | | 4,595 | | | | 4,595 | | | | 4,595 | |
Available-for-sale | | | 2,043,042 | | | | 1,903,994 | | | | 1,955,460 | | | | 1,906,938 | |
Loans and leases, net of unearned income | | | 9,939,763 | | | | 9,798,658 | | | | 9,662,752 | | | | 9,534,731 | |
Other assets | | | 1,905,912 | | | | 1,905,912 | | | | 1,905,912 | | | | 1,905,912 | |
| | | | | | | | | | | | | | | | |
Total assets | | $ | 14,250,373 | | | $ | 13,970,220 | | | $ | 13,885,780 | | | $ | 13,709,237 | |
| | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | |
Non-interest bearing | | | 1,175,472 | | | | 1,156,090 | | | | 1,134,222 | | | | 1,112,961 | |
Interest-bearing | | | 7,928,187 | | | | 7,886,192 | | | | 7,833,551 | | | | 7,781,807 | |
Total borrowings | | | 2,369,715 | | | | 2,313,670 | | | | 2,261,996 | | | | 2,226,531 | |
Other liabilities | | | 242,492 | | | | 242,492 | | | | 242,492 | | | | 242,492 | |
| | | | | | | | | | | | | | | | |
Total liabilities | | | 11,715,866 | | | | 11,598,444 | | | | 11,472,261 | | | | 11,363,791 | |
Total economic equity | | | 2,534,507 | | | | 2,371,776 | | | | 2,413,519 | | | | 2,345,446 | |
Off balance sheet | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | | | | | |
Total liabilities and equity | | $ | 14,250,373 | | | $ | 13,970,220 | | | $ | 13,885,780 | | | $ | 13,709,237 | |
| | | | | | | | | | | | | | | | |
Economic equity ratio | | | 18 | % | | | 17 | % | | | 17 | % | | | 17 | % |
Value at risk | | $ | 162,731 | | | $ | 0 | | | $ | 41,743 | | | ($ | 26,330 | ) |
% Value at risk | | | 7 | % | | | 0 | % | | | 2 | % | | | -1 | % |
| | | | | | | | | | | | | | | | | | | | |
At December 31, 2007 | | -2% | | | -1% | | | Base
Present
Value | | | 1% | | | 2% | |
| | | (Dollars in thousands) | |
Assets | | | | | | | | | | | | | | | | | | | | |
Cash and due from banks | | $ | 326,965 | | | $ | 326,965 | | | $ | 326,965 | | | $ | 326,965 | | | $ | 326,965 | |
Short-term investments | | | 143,277 | | | | 143,274 | | | | 143,271 | | | | 143,269 | | | | 143,266 | |
Investment securities: | | | | | | | | | | | | | | | | | | | | |
Held-to-maturity | | | 4,792 | | | | 4,792 | | | | 4,792 | | | | 4,792 | | | | 4,792 | |
Available-for-sale | | | 2,140,691 | | | | 2,107,057 | | | | 2,079,271 | | | | 2,004,859 | | | | 1,919,878 | |
Loans and leases, net of unearned income | | | 9,023,671 | | | | 8,883,127 | | | | 8,754,378 | | | | 8,632,427 | | | | 8,508,007 | |
Other assets | | | 1,880,784 | | | | 1,880,784 | | | | 1,880,784 | | | | 1,180,784 | | | | 1,880,784 | |
| | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 13,520,180 | | | $ | 13,345,999 | | | $ | 13,189,461 | | | $ | 12,293,096 | | | $ | 12,783,692 | |
| | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | |
Non-interest bearing | | | 1,241,078 | | | | 1,218,113 | | | | 1,195,770 | | | | 1,174,026 | | | | 1,152,862 | |
Interest-bearing | | | 7,698,368 | | | | 7,637,179 | | | | 7,589,121 | | | | 7,535,290 | | | | 7,482,569 | |
Total borrowings | | | 2,140,037 | | | | 2,053,749 | | | | 2,002,628 | | | | 1,970,659 | | | | 1,943,299 | |
Other liabilities | | | 272,706 | | | | 272,706 | | | | 272,706 | | | | 272,706 | | | | 272,706 | |
| | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 11,352,189 | | | | 11,181,747 | | | | 11,060,225 | | | | 10,952,681 | | | | 10,851,436 | |
Total economic equity | | | 2,167,991 | | | | 2,164,252 | | | | 2,129,236 | | | | 2,040,415 | | | | 1,932,256 | |
Off balance sheet | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | | | | | | | | | |
Total liabilities and equity | | $ | 13,520,180 | | | $ | 13,345,999 | | | $ | 13,189,461 | | | $ | 12,993,096 | | | $ | 12,783,692 | |
| | | | | | | | | | | | | | | | | | | | |
Economic equity ratio | | | 16 | % | | | 16 | % | | | 16 | % | | | 16 | % | | | 15 | % |
Value at risk | | $ | 38,755 | | | $ | 35,016 | | | $ | 0 | | | ($ | 88,821 | ) | | ($ | 196,980 | ) |
% Value at risk | | | 2 | % | | | 2 | % | | | 0 | % | | | -4 | % | | | -9 | % |
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Table 16 - Net Interest Income Shock Analysis
| | | | | | | | | | | | | | | | | | | | |
At December 31, 2008 | | | | | -1% | | | Base
Scenario | | | 1% | | | 2% | |
Interest income: | | | | | | | | | | | | | | | | | | | | |
Short-term investments | | | | | | $ | 1,272 | | | $ | 1,399 | | | $ | 2,692 | | | $ | 4,097 | |
Investments | | | | | | | 91,409 | | | | 98,238 | | | | 104,826 | | | | 109,122 | |
Loans and leases | | | | | | | 500,779 | | | | 539,814 | | | | 580,126 | | | | 620,796 | |
| | | | | | | | | | | | | | | | | | | | |
Total interest income | | | | | | | 593,460 | | | | 639,451 | | | | 687,644 | | | | 734,015 | |
| | | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand and savings | | | | | | | 16,137 | | | | 26,194 | | | | 38,844 | | | | 55,670 | |
Time | | | | | | | 126,359 | | | | 134,170 | | | | 149,078 | | | | 164,031 | |
Total borrowings | | | | | | | 75,664 | | | | 77,694 | | | | 88,365 | | | | 99,029 | |
| | | | | | | | | | | | | | | | | | | | |
Total interest expense | | | | | | | 218,160 | | | | 238,058 | | | | 276,287 | | | | 318,730 | |
| | | | | | | | | | | | | | | | | | | | |
Net interest income | | | | | | $ | 375,300 | | | $ | 401,393 | | | $ | 411,357 | | | $ | 415,285 | |
| | | | | | | | | | | | | | | | | | | | |
Net interest income at risk | | | | | | ($ | 26,093 | ) | | $ | 0 | | | $ | 9,964 | | | $ | 13,892 | |
% Net interest income at risk | | | | | | | -7 | % | | | 0 | % | | | 2 | % | | | 3 | % |
| | | | | |
At December 31, 2007 | | -2% | | | -1% | | | Base
Scenario | | | 1% | | | 2% | |
| | | (Dollars in thousands) | |
Interest income: | | | | | | | | | | | | | | | | | | | | |
Short-term investments | | $ | 8,257 | | | $ | 11,878 | | | $ | 15,471 | | | $ | 19,168 | | | $ | 22,784 | |
Investments | | | 100,889 | | | | 106,812 | | | | 110,462 | | | | 112,746 | | | | 115,207 | |
Loans and leases | | | 547,358 | | | | 582,543 | | | | 617,404 | | | | 651,162 | | | | 683,508 | |
| | | | | | | | | | | | | | | | | | | | |
Total interest income | | | 656,504 | | | | 701,233 | | | | 743,337 | | | | 783,076 | | | | 821,499 | |
| | | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | | |
Interest-bearing demand and savings | | | 16,354 | | | | 36,997 | | | | 64,638 | | | | 88,202 | | | | 111,809 | |
Time | | | 122,195 | | | | 137,637 | | | | 154,263 | | | | 171,036 | | | | 187,857 | |
Total borrowings | | | 84,547 | | | | 93,052 | | | | 99,931 | | | | 112,177 | | | | 124,427 | |
| | | | | | | | | | | | | | | | | | | | |
Total interest expense | | | 223,096 | | | | 267,686 | | | | 318,832 | | | | 371,415 | | | | 424,093 | |
| | | | | | | | | | | | | | | | | | | | |
Net interest income | | $ | 433,408 | | | $ | 433,547 | | | $ | 424,505 | | | $ | 411,661 | | | $ | 397,406 | |
| | | | | | | | | | | | | | | | | | | | |
Net interest income at risk | | $ | 8,903 | | | $ | 9,042 | | | $ | 0 | | | ($ | 12,844 | ) | | ($ | 27,099 | ) |
% Net interest income at risk | | | 2 | % | | | 2 | % | | | 0 | % | | | -3 | % | | | -6 | % |
Derivative Financial Instruments and Hedging Activities
Our interest rate risk management strategy involves hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on our net interest margin and cash flows from changes in interest rates. While we do not participate in speculative derivatives trading, we consider it prudent to use certain derivative instruments to add stability to our interest income and expense, to modify the duration of specific assets and liabilities, and to manage our exposure to interest rate movements.
Additionally, we execute derivative instruments in the form of interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that we minimize our net risk exposure resulting from such transactions. We do not use credit default swaps in our investment or hedging operations.
At December 31, 2008, the aggregate amount of derivative assets recorded in other assets was $21.9 million, and the aggregate amount of derivative liabilities recorded in other liabilities was $22.4 million. Furthermore, net
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credit valuation adjustments reduced the settlement values of our derivative assets by $1.2 million and the settlement values of our derivative liabilities by $1.7 million. During 2008, we recognized noninterest income of $0.4 million related to credit valuation adjustments on nonhedge derivative instruments
In September 2008, we announced that, due to adverse market conditions, a forecasted sale of vehicle leases would not occur, and the associated interest rate swap agreements were terminated. In accordance with generally accepted accounting principles, we reclassified $2.1 million (net of taxes of $1.1 million) from accumulated comprehensive loss to earnings and recognized an additional reduction in pre-tax income of $3.3 million.
For additional information about our derivative financial instruments, refer to“Note 22. Derivative Financial Instruments” and “Note 23. Fair Value Disclosures” to the consolidated financial statements appearing in Part II, Item 8.
Vehicle Leasing Residual Value Risk
In an effort to manage the vehicle residual value risk arising from the auto leasing business of Hann and our affiliate banks, Hann and the banks have entered into arrangements with Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) pursuant to which Hann or a bank, as applicable, effectively transferred to Auto Lenders all residual value risk of its respective auto lease portfolio, and all residual value risk on any new leases originated over the term of the applicable agreement. Auto Lenders, which was formed in 1990, is a used-vehicle remarketer with four retail locations in New Jersey and has access to various wholesale facilities throughout the country. Under these arrangements, Auto Lenders agrees to purchase the beneficial interest in all vehicles returned by the obligors at the scheduled expiration of the related leases for a purchase price equal to the stated residual value of such vehicles. Stated residual values of new leases are set in accordance with the standards approved in advance by Auto Lenders. Under a servicing agreement with Auto Lenders, Hann also agrees to make monthly guaranty payments to Auto Lenders based upon a negotiated schedule covering a three-year period. At the end of each year, the servicing agreement may be renewed by the mutual agreement of the parties for an additional one-year term, beyond the current three-year term, subject to renegotiation of the payments for the additional year. During the renewal process, we periodically obtain competitive quotes from third parties to determine the best remarketing and/or residual guarantee alternatives for Hann and our bank affiliates.
Securitizations and Off-Balance-Sheet Financings
TABLE 17 - Components of Loans and Leases Serviced
| | | | | | |
| | | As of December 31, 2008 | | As of December 31, 2007 |
| | | (Dollars in thousands) |
Lease Securitization Transactions* | | $ | 123,608 | | $ | 463,517 |
Home Equity Loan Securitization Transactions* | | | 286,577 | | | 334,417 |
Agency Arrangements and Lease Sales* | | | 31,645 | | | 61,551 |
Leases and Loans Held in Portfolio | | | 9,653,873 | | | 8,751,590 |
| | | | | | |
Total Leases and Loans Serviced | | $ | 10,095,703 | | $ | 9,611,075 |
| | | | | | |
Securitization Transactions
We use the securitization of financial assets as a source of funding and a means to manage capital. Hann and our bank subsidiary sell beneficial interests in automobile leases and related vehicles and home equity loans to qualified special purpose entities. These transactions are accounted for as sales under the guidelines of Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125)” (“FAS No. 140”), and a net gain or loss is recognized at the time of the initial sale.
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The QSPEs then issue beneficial interests in the form of senior and subordinated asset-backed securities backed or collateralized by the assets sold to the QSPEs. The senior classes of the asset-basked securities typically receive investment grade credit ratings at the time of issuance. These ratings are generally achieved through the creation of lower-rated subordinated classes of asset-backed securities, as well as subordinated interests retained by Susquehanna.
Excess cash flows represent the cash flows from the underlying assets less distributions of cash flows to beneficial interest holders in accordance with the distribution priority requirements of the transaction. We, as servicer, distribute to third-party beneficial interest holders contracted returns. We retain the right to remaining cash flows after distributions to these third-party beneficial interest holders. The cash flows are discounted to present value and recorded as interest-only strips. The resulting interest-only strips are subordinate to the rights of each of the third-party beneficial interest holders. We estimate the fair value of these interest-only strips based on the present value of future expected cash flows, using management’s estimate of the key assumptions regarding credit losses, prepayment speeds, and discount rates commensurate with the risks involved at the time assets are sold to the applicable QSPE and adjusted quarterly based on changes in these key economic risk factors. Based upon the information found in the table in Note 21, “Securitization Activity,” we believe that any adverse change of 20% in the key economic assumptions would not have a significant effect on the fair value of our interest-only strips.
In order to facilitate lease securitizations and other off-balance-sheet financings, Hann formed Hann Auto Trust, a Delaware statutory trust (the “Origination Trust”), on September 30, 1997, pursuant to a trust agreement between Hann, as settlor and initial beneficiary, and a third-party trustee. The primary business purpose of the Origination Trust is to enter into lease contracts with respect to automobiles, sport utility vehicles, light-duty trucks, and other vehicles and to serve as record holder of title to such leased vehicles. Unlike ordinary accounts receivable or lease paper, a motor vehicle can only be transferred if the transferor signs the back of the certificate of title and certifies the odometer reading, and the transferee applies for a new certificate of title in its own name. With the use of an origination or “titling” trust like the Origination Trust, a party may hold a beneficial interest in a lease and the related vehicle (including the related cash flows), but because legal ownership of the vehicle remains with the trust, the vehicle need not be retitled. The Origination Trust was created to avoid the administrative difficulty and expense associated with retitling leased vehicles in a securitization, sale-leaseback, or other financing of automobile and truck leases and the related vehicles. Upon formation, the Origination Trust issued to Hann the undivided trust interest representing the entire beneficial interest in the unallocated assets of the Origination Trust.
Hann purchases vehicles and related leases directly from motor vehicle dealers. The motor vehicle dealers title these vehicles in the name of the Origination Trust at the time of the purchase. Hann initially owns the beneficial interest in all leases and related vehicles. Under the trust agreement for the Origination Trust, Hann may instruct the trustees of the trust: (i) to establish a special unit of beneficial interest in the Origination Trust (commonly referred to as a “SUBI”) and (ii) to allocate a separate portfolio of leases and the related vehicles leased under the leases to that SUBI. The SUBI will evidence an indirect beneficial interest, rather than a direct legal interest, in the assets allocated thereto. Under the terms of the trust agreement and the Delaware Statutory Trust Act, the holder of a SUBI will have no interest in the assets allocated to the undivided trust interest or to any other SUBI, and the holder of the undivided trust interest will have no interest in the assets allocated to any SUBI. Hann creates and transfers beneficial interests in the Origination Trust that represent the rights in pools of leases and related vehicles included in securitization, sale-leaseback, agency, and other transactions.
The beneficial interests in the Origination Trust represented by a SUBI have only been used for securitizations, sale-leasebacks, agency transactions, and as a method of permitting affiliates of Hann to hold the beneficial interest in a pool of leases and related vehicles. There are no other transactions using a SUBI in the Origination Trust.
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The leases, for accounting purposes, are treated as direct financing receivables as a result of a residual purchase agreement with Auto Lenders. Although we have not retained residual value risk in the automobile leases and related vehicles, in the event of a breach by Auto Lenders, a QSPE may suffer residual losses, which we expect would decrease the value of the interest-only strips recognized by us.
Summary of Securitization Transactions in Prior Reporting Periods
Home Equity Loans
In September 2006, one of our banking subsidiaries, Susquehanna Bank PA, entered into a term securitization transaction of fixed-rate home mortgage loans and adjustable-rate HELOCs (the “September 2006 transaction”). Some of the loans sold were originated by two of our other banking subsidiaries, Susquehanna Bank and Susquehanna Bank DV, and sold to Susquehanna Bank PA immediately prior to the closing of the securitization. In connection with the September 2006 transaction, Susquehanna Bank PA sold a portfolio of fixed-rate home equity loans with an aggregate principal balance of approximately $238.0 million and a portfolio of adjustable-rate HELOCs with an aggregate principal balance of approximately $111.4 million to a wholly owned special purpose subsidiary (the “Transferor”). In the transaction documents for the September 2006 transaction, Susquehanna Bank PA provides, among other things, representations and warranties with respect to the home equity loans transferred. In the event that any such representations and warranties were materially untrue with respect to any assets when transferred, the affected loans must be repurchased by Susquehanna Bank PA. We provide a guaranty of such repurchase obligation. The Transferor sold the portfolio acquired from Susquehanna Bank PA to a newly formed statutory trust (the “Issuer”). The equity interests of the Issuer (other than a non-economic interest representing tax ownership of the securitized fixed-rate home equity loan portfolio) are owned by the Transferor. The Transferor financed the purchase of the portfolio of home equity loans from Susquehanna Bank PA primarily through the issuance by the Issuer of $345.2 million of floating-rate asset-backed notes to third-party investors. In connection with the securitization, Susquehanna retained servicing responsibilities for the loans.
A portion of the HELOCs, which generally accrue interest at a variable rate, include a feature that permits the obligor to “convert” all or a portion of the loan from a variable interest rate to a fixed interest rate. The maximum dollar amount of the portfolio balances sold in the September 2006 transaction that is subject to this conversion feature was $72.0 million at the transaction cut-off date. During the draw period, the obligor may request that Susquehanna establish fixed-rate repayment terms for an amount not to exceed the then outstanding balance under the credit line. Requests must be for amounts which do not exceed the credit limit, and no event of default shall have occurred and be continuing at the time of the request. We complete all required underwriting at the time of origination, and no additional underwriting occurs at the time the obligor exercises the fixed-rate conversion feature. The credit limit will include credit advances under the credit line and outstanding balances under the previously requested fixed-rate repayments. The minimum fixed-rate repayment request is three thousand dollars. The obligor may elect to submit fixed-rate repayment requests at any time during the draw period. The obligor is limited to three fixed-rate repayment schedules at any time. The reason for permitting the conversion feature is to be competitive in our marketplace, as many other financial institutions offer this feature.
In the September 2006 transaction, one class of the Issuer’s floating-rate asset-backed notes was backed by variable-rate HELOCs. However, approximately 70.5% of the HELOCs as of the cut-off date for the transaction included a feature that permits the obligor to “convert” all or a portion of the outstanding balance from a variable interest rate to a fixed interest rate. If a significant portion of obligors elected to fix the rate of interest on their mortgage loans, then the Issuer might have insufficient funds to make payments on the floating-rate notes backed by the HELOCs as rates increase beyond the rate of the fixed-rate loans. To mitigate the effect of this remote risk, the external parties involved in structuring the September 2006 Transaction and Susquehanna worked together to formulate a solution acceptable to the parties. The parties determined that the Issuer’s ability to make interest payments on the class of floating-rate notes backed by the HELOCs was unlikely to be materially and adversely affected if the Issuer’s portfolio of HELOCs included up to 10% fixed-rate loans. After that threshold was exceeded, however, Susquehanna Bank PA would be required to repurchase loans with converted balances
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in an amount not to exceed 10% of the original principal balance of the HELOCs, which is approximately $11.1 million. Under the transaction agreements, Susquehanna Bank PA is neither required nor permitted to repurchase more than 10% of the original principal balance of the converted loans. However, because up to 50.5% of the HELOCs could be held by the Issuer as fixed-rate loans in excess of the 10% threshold acceptable to the parties, the Issuer entered into an interest rate protection agreement with Susquehanna, structured in accordance with FAS No. 140, paragraph 40, to protect the third-party beneficial interest holders above the 10% threshold. The interest rate protection agreement counterparty is Susquehanna, and the agreement provides the Issuer with an additional source of funds to make payments on the floating-rate notes if the floating rate exceeds the fixed rates of the loans for which the related obligors have exercised their fixed-rate conversion feature.
Based on our historical experience with HELOCs with the conversion feature, we determined that it was highly unlikely that more than 10% of the HELOCs held by the Issuer would be converted by the related obligors from variable-rate to fixed-rate obligations. This conclusion is based in part on our experience with HELOCs that have conversion features, which tend to be converted by obligors from variable rate to fixed rate within the first three-to-six months after origination. The securitized pool, at the time the loans were transferred to the Issuer, was generally seasoned more than six months. Further, we determined that it is highly unlikely that we will have any liability under the interest rate protection agreement provided for in the transaction agreements because we believe that, based upon historical experience and business understanding of obligor behavior, less than 10% of the HELOCs will be converted by the related obligors to fixed-rate loans. The estimated maximum cost and fair value to Susquehanna of complying with the interest rate protection discussed above is considered de minimis.
This transaction was accounted for as a sale under FAS No. 140. For additional information concerning the initial valuation of retained interests, please see Note 21 to the consolidated financial statements entitled “Securitization Activity.” The gain recognized in this transaction was $8.2 million. The initial interest-only strips recorded for this transaction were $18.5 million, and the fair value of these interest-only strips at December 31, 2008, was $11.4 million.
In December 2005, one of our banking subsidiaries, Susquehanna Bank PA, entered into a term securitization transaction of HELOCs (the “2005 HELOC transaction”). Some of the loans sold were originated by two of our other banking subsidiaries, Susquehanna Bank and Susquehanna Bank DV, and sold to Susquehanna Bank PA immediately prior to the closing of the securitization. In connection with the 2005 HELOC transaction, Susquehanna Bank PA sold a portfolio of loans with an aggregate total of approximately $239.8 million to a wholly owned special purpose subsidiary (the “Transferor”). In the transaction documents for the 2005 HELOC transaction Susquehanna Bank PA provides, among other things, representations and warranties with respect to the home equity loans transferred. In the event that any such representations and warranties were materially untrue with respect to any assets when transferred, the affected loans must be repurchased by Susquehanna Bank PA. We provide a guaranty of such repurchase obligation. The Transferor sold the portfolio acquired from Susquehanna Bank PA to a newly formed statutory trust (the “Issuer”). The equity interests of the Issuer are owned by the Transferor. The Transferor financed the purchase of the portfolio of HELOCs from Susquehanna Bank PA primarily through the issuance by the Issuer of $239.8 million of floating-rate asset-backed notes to third-party investors. In connection with the securitization, Susquehanna retained servicing responsibilities for the loans.
Some of the HELOCs, which generally accrue interest at a variable rate, include a feature that permits the obligor to “convert” all or a portion of the loan from a variable interest rate to a fixed interest rate. Specifically, during the draw period, the obligor may request that Susquehanna establish fixed-rate repayment terms for an amount not to exceed the then outstanding balance under the credit line. Requests must be for amounts which do not exceed the credit limit, and no event of default shall have occurred and be continuing at the time of the request. We complete all required underwriting at the time of origination, and no additional underwriting occurs at the time the obligor exercises the fixed-rate conversion feature. The credit limit will include credit advances under the credit line and outstanding balances under the previously requested fixed-rate repayments. The minimum fixed-rate repayment request is three thousand dollars. The obligor may elect to submit fixed-rate
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repayment requests at any time during the draw period. The obligor is limited to three fixed-rate repayment schedules at any time. The reason for permitting the conversion feature is to be competitive in our marketplace as many other financial institutions offer this feature, and the maximum dollar amount of the portfolio balances sold which is subject to this conversion feature was $84.7 million at the transaction cut-off date.
Under the transaction documents for the 2005 HELOC transaction, if the aggregate principal balance of loans converted to fixed-rate loans exceeds 10% of the outstanding aggregate principal balance of the portfolio, then Susquehanna Bank PA is required to repurchase converted loans in excess of this 10% threshold until the aggregate principal balance of loans repurchased by Susquehanna Bank PA for this reason is equal to 10% of the original principal balance of the loans. If, after giving effect to any repurchase by Susquehanna Bank PA of loans with converted balances, the aggregate principal balance of fixed-interest-rate loans exceeds 10% of the aggregate principal balance of the portfolio, then an interest rate protection agreement between the Issuer and Susquehanna becomes operative. Under the interest rate protection agreement, the Issuer will be obligated to make fixed payments, which will be based on the fixed rates of the converted mortgage loans, and we will be obligated to make floating payments, which will be based on the indices of the variable-rate mortgage loans. We do not expect to repurchase any converted loans nor enter into any interest rate protection agreements.
In this transaction, the Issuer issued floating-rate asset-backed notes to third-party investors, which were backed by variable-rate HELOCs. However, approximately 35.35% of the loans as of the cut-off date for the transaction included a feature that permits the obligor to “convert” all or a portion of the outstanding balance from a variable interest rate to a fixed interest rate. If a significant portion of obligors elected to fix the rate of interest on their mortgage loans, then the Issuer might have insufficient funds to make payments on the floating-rate notes as rates increase beyond the rate of the fixed-rate loans. To mitigate the effect of this remote risk, the external parties involved in structuring the 2005 HELOC Transaction and Susquehanna worked together to formulate a solution acceptable to the parties. The parties determined that the Issuer’s ability to make interest payments on the floating-rate notes was unlikely to be materially and adversely affected if the Issuer’s assets included up to 10% fixed-rate loans. After that threshold was exceeded, however, Susquehanna Bank PA would be required to repurchase loans with converted balances in an amount not to exceed 10% of the original principal balance of the HELOCs, which is approximately $24.0 million. Under the transaction agreements, Susquehanna Bank PA is neither required nor permitted to repurchase more than 10% of the original principal balance of the converted loans. However, because up to 15.35% of loans could be held by the Issuer as fixed-rate loans in excess of the 10% threshold acceptable to the parties, the Issuer entered into an interest rate protection agreement with us, structured in accordance with FAS No. 140, paragraph 40, to protect the third-party beneficial interest holders, above the 10% threshold. The interest rate protection agreement counterparty is Susquehanna, and the agreement provides the issuer with an additional source of funds to make payments on the floating-rate notes if the floating-rate exceeds the fixed-rates of the loans for which the related obligors have exercised their fixed-rate conversion feature. Our estimated maximum cost of complying with the interest rate protection is considered de minimis.
Based on our historical experience with HELOCs with the conversion feature, we determined that it was highly unlikely that more than 10% of the HELOCs held by the Issuer would be converted by the related obligors from variable-rate to fixed-rate obligations. This conclusion is based in part on our experience with HELOCs that have conversion features, which tend to be converted by obligors from variable-rate to fixed-rate within the first three-to-six months after origination. The securitized pool, at the time the loans were transferred to the Issuer, was generally seasoned more than six months.
This transaction was accounted for as a sale under FAS No. 140. For additional information concerning the initial valuation of retained interests, please see footnote 21 to the consolidated financial statements entitled “Securitization Activity.” The gain recognized in this transaction was $6.6 million. The initial recorded interest-only strips for this transaction were $8.0 million, and the fair value of these interest-only strips at December 31, 2008, was $5.3 million.
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Leases
In February 2007, each of our wholly owned commercial and retail banking subsidiaries (each, a “Sponsor Subsidiary”) entered into a term securitization transaction (the “2007 transaction”). In connection with the 2007 transaction, each Sponsor Subsidiary sold and contributed the beneficial interest in a portfolio of automobile leases and related vehicles to a separate wholly owned QSPE (each QSPE, a “Transferor” and collectively, the “Transferors”). Collectively, the Sponsor Subsidiaries sold and contributed the beneficial interest in $300.4 million in automobile leases and the related vehicles to the Transferors. However, the transaction documents for the 2007 transaction provide, among other things, that any assets that failed to meet the eligibility requirements when transferred by the applicable Sponsor Subsidiary must be repurchased by such Sponsor Subsidiary. Each Transferor sold and contributed the portfolio acquired from the related Sponsor Subsidiary to a newly formed statutory trust (the “Issuer”). The equity interests of the Issuer are owned pro rata by the Transferors (based on the value of the portfolio conveyed by each Transferor to the Issuer). The Transferors financed the purchases of the beneficial interests from the Sponsor Subsidiaries primarily through the issuance by the Issuer of $260.3 million of fixed-rate asset-backed notes to third-party investors. The Issuer also issued an additional $7.8 million of notes, which have been retained pro rata by the Transferors in the same ratio as the Transferors retain the equity interests of the Issuer.
This transaction was accounted for as a sale under FAS No. 140. For additional information concerning the initial valuation of retained interests, please see Note 21 to the consolidated financial statements entitled “Securitization Activity.” The gain recognized in this transaction was $2.7 million. The initial interest-only strip recorded for this transaction was $4.0 million, and the fair value of this interest-only strip at December 31, 2008, was $0.9 million.
In March 2006, each of our wholly owned commercial and retail banking subsidiaries (each, a “Sponsor Subsidiary”) entered into a term securitization transaction (the “2006 transaction”). In connection with the 2006 transaction, each Sponsor Subsidiary sold and contributed the beneficial interest in a portfolio of automobile leases and related vehicles to a separate wholly owned QSPE (each QSPE a “Transferor” and, collectively the “Transferors”). Collectively, the Sponsor Subsidiaries sold and contributed the beneficial interest in $356.1 million in automobile leases and related vehicles to the Transferors. In the third quarter of 2008, Hann, as servicer, issued a clean-up call for this transaction and recorded $31.8 million in lease receivables.
In March 2005, each of our wholly owned commercial and retail banking subsidiaries entered into a term securitization transaction (the “2005 transaction”). In connection with the 2005 transaction, each Sponsor Subsidiary sold and contributed the beneficial interest in a portfolio of automobile leases and related vehicles to a separate wholly owned QSPE. Collectively, the Sponsor Subsidiaries sold and contributed the beneficial interest in $366.8 million in automobile leases and related vehicles to the Transferors. In the first quarter of 2008, Hann, as servicer, issued a clean-up call for this transaction and recorded $32.1 million in lease receivables.
During the third quarter of 2002, Hann entered into a revolving securitization transaction and sold and contributed beneficial interests in automobile leases and related vehicles to a wholly owned QSPE. The QSPE financed the purchases by borrowing funds in an amount up to $250.0 million from a non-related, asset-backed commercial paper issuer (a “lender”). In the third quarter of 2007, Hann, as servicer, issued a clean-up call for this transaction and recorded $22.7 million in lease receivables.
Agency Agreements and Lease Sales
Agency arrangements and lease sales generally occur on economic terms similar to vehicle lease terms and generally result in no accounting gains or losses to Hann and no retention of credit, residual value, or interest rate risk with respect to the sold assets. Agency arrangements involve the origination and servicing by Hann of automobile leases for other financial institutions, and lease sales involve the sale of previously originated leases (with servicing retained) to other financial institutions. Hann generally is entitled to receive all of the administrative fees collected from obligors, a servicing fee, and in the case of agency arrangements, an origination fee per lease. Lease sales are generally accounted for as sales under FAS No. 140.
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Sale-Leaseback Transaction
In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that had an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor was treated as a sale and an operating lease and qualified as a sale and leaseback under FAS No. 13.
During the third quarter of 2006, we notified the Lessor of our intention to exercise the early buyout option, and the transaction was terminated January 12, 2007. The early buyout option price was $93.7 million and was comprised of $78.4 million of beneficial interests in automobile leases and related vehicles and payment of $15.3 million in cash, which had been recognized in other operating expense in prior years. A significant portion of the automobile leases and related vehicles that Hann acquired in conjunction with the early buyout option was sold to our banking subsidiaries and included in the vehicle lease securitization transaction that closed February 14, 2007.
Servicing Fees under the Securitization Transactions, Agency Agreements, and Lease Sales
In accordance with FAS No. 156, “Accounting for Servicing of Financial Assets,” a servicing asset or servicing liability is recognized each time Susquehanna undertakes an obligation to service a financial asset by entering into a servicing contract in a transfer of financial assets that meets the requirements for sale accounting.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of servicing rights is netted against loan servicing fee income.
Overall, however, Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its loan and lease portfolio and to manage capital, and not primarily to maximize its ongoing servicing fee revenue.
Leases
The servicing fees paid to Hann under the lease securitization transactions, agency agreements, and lease sales approximate current market value and are set by contract at the time of sale. Hann has not recorded servicing assets or liabilities with regard to those transactions because its expected servicing costs are approximately equal to its expected servicing income. Based upon Susquehanna’s on-going experience with vehicle-lease sales, this rate has been, and continues to be, the prevailing market rate when compared to similar transactions. However, if these circumstances were to change, Susquehanna would adjust its evaluation as to whether a servicing asset or liability should be recorded. In addition, if servicing costs were to exceed servicing income, Hann would record the present value of that liability as an expense.
Home Equity Loans
The parent company acts as servicer for securitized home equity loans and has recorded servicing assets based on the present value of estimated future net servicing income. The initial carrying values of retained interests, including servicing rights, were determined by allocating the carrying value among the assets sold and retained based on their relative fair values. At December 31, 2008, these servicing assets totaled $1,357 and were reported in other assets. In accordance with FAS No. 156, Susquehanna’s servicing rights are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Furthermore, Susquehanna assesses servicing assets for impairment or increased obligation based on fair value at each reporting date.
Susquehanna considers its servicing assets to be immaterial items and therefore has not applied the disclosure provisions of FAS No. 156.
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Recently Adopted Accounting Pronouncements
In December 2008, the Financial Accounting Standards Board issuedFASB Staff Position FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” FASB Staff Position FAS 140-4 and FIN 46(R)-8 amends FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require public entities to provide additional disclosures about transfers of financial assets. It also amends FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” to require public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. Additionally, this FSP requires certain disclosures to be provided by a public enterprise that is (a) a sponsor of a qualifying special purpose entity (SPE) that holds a variable interest in the qualifying SPE but was not the transferor of financial assets to the qualifying SPE and (b) a servicer of a qualifying SPE that holds a significant variable interest in the qualifying SPE but was not the transferor of financial assets to the qualifying SPE. The disclosures required by this FSP are intended to provide greater transparency to financial statement users about the transferor’s continuing involvement with transferred financial assets and an enterprise’s involvement with variable interest entities and qualifying SPEs. This FSP was effective for the first reporting period ending after December 15, 2008. See Note 21 for the disclosures required by this FSP.
In October 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.”FSP No. FAS 157-3 clarifies the application of FAS No. 157, “Fair Value Measurements,” in a market that is not active and was effective upon issuance. Adoption of this FSP has had no material impact on results of operations and financial condition.
In September 2008, the Financial Account Standards Board issued FASB Staff Position FSP No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” This FSP is intended to improve disclosures about credit derivatives by requiring more information about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives. It amends FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. The FSP also amends FAS Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” to require additional disclosure about the current status of the payment/performance risk of a guarantee. The provisions of the FSP than amend FAS No. 133 and Fin 45 are effective for reporting periods (annual or interim) that ended after November 15, 2008. Finally, the FSP clarifies that the disclosures required by FAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” should be provided for any reporting period (annual or interim) beginning after November 5, 2008. This clarification was effective upon issuance of the FSP. Adoption of this FSP has had no material impact on results of operations and financial condition.
In May 2008, the Financial Accounting Standards Board issued Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” Statement No. 162 improves financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. Statement No. 162 was effective in November 2008. Adoption of this Statement has had no material impact on results of operations and financial condition.
In March 2008, the Financial Accounting Standards Board issuedStatement No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” Statement No. 161 requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also requires disclosure of derivative features that are credit risk-related and cross-referencing within footnotes to enable financial statement users to
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locate important information about derivative instruments. Statement No. 161 is effective for financial statements issued for fiscal year and interim periods beginning after November 15, 2008, with early application encouraged. See Note 22 to the consolidated financial statements for the disclosures required by this Statement.
In February 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting PronouncementsThat Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13.” FSP No. FAS 157-1 amends Statement No. 157, “Fair Value Measurements,” to exclude Statement No. 13, “Accounting for Leases,” and other pronouncements that address fair value measurements for purposes of lease classification or measurement under Statement No. 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under Statement No. 141, “Business Combinations,” or Statement No. 141(R), “Business Combinations,” regardless of whether those assets and liabilities are related to leases. Adoption of this FSP has had no material impact on results of operations and financial condition.
In February 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157.”FSP No. FAS 157-2 delays the effective date of FAS No. 157, “Fair Value Measurements,” for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. This FSP was effective upon issuance. Adoption of this FSP has had no material impact on results of operations and financial condition.
In February 2007, the Financial Accounting Standards Board issuedStatement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Statement No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. Statement No. 159 was effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Adoption of this Statement has had no material impact on results of operations and financial condition. Since the adoption date, Susquehanna has made no elections to use fair value as an alternative measurement for selected financial assets and liabilities not previously carried at fair value.
In September 2006, the Financial Accounting Standards Board issuedStatement No. 157, “Fair Value Measurements.” Statement No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. While Statement No. 157 does not require any new fair value measurements, the application of this Statement will change current practice for some entities. Statement No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. See Note 23 to the consolidated financial statements for the disclosures required by this Statement. Adoption of this Statement has had no material impact on results of operation and financial condition.
In December 2007, The Securities and Exchange Commission issuedStaff Accounting Bulletin 110. SAB 110 allows companies to continue using the simplified method of estimating the expected-term assumption for “plain vanilla” stock options in certain circumstances. Susquehanna uses historical employee exercise patterns to provide a reasonable basis for estimating its expected-term assumption; and therefore, this SAB has no impact on its results of operations and financial condition.
In September 2006, the Financial Accounting Standards Board reached a consensus onEmerging Issues Task Force Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” Issue 06-4 requires an employer to recognize a liability for future benefits in accordance with FAS No. 106, if, in substance, a postretirement benefit plan exists. The consensus on this Issue was effective for fiscal years beginning after December 15, 2007. Entities were to
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recognize the effects of applying the consensus in this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. Susquehanna is a party to split-dollar life insurance arrangements and has elected to recognize the effects of applying this consensus through a cumulative-effect adjustment to retained earnings of $2,488.
In September 2006, the Financial Accounting Standards Board issuedStatement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” Statement No. 158 requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes are reported in comprehensive income. The requirement to recognize the funded status of a benefit plan and the related disclosure requirements were effective for the fiscal year ending after December 15, 2006. For information regarding the impact of FAS No. 158 on Susquehanna’s financial position, see Note 17 to the consolidated financial statements. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of position was effective for fiscal years ending after December 15, 2008. Susquehanna has measured plan assets and benefit obligations as of the end of its fiscal year.
Recently Issued Accounting Pronouncements
In June 2008, the Financial Accounting Standards Board issuedFASB Staff Position FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities.” FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. Susquehanna has granted share-based payment awards that contain nonforfeitable rights to dividends; however, Susquehanna has determined that their effect on the computation of EPS is immaterial.
In April 2008, the Financial Accounting Standards Board issuedFASB Staff Position FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets.”FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FAS No. 142, Goodwill and Other Intangible Assets.” FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Susquehanna is evaluating the impact of FSP No. FAS 142-3.
In February 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.”FSP No. FAS 140-3 provides guidance on a repurchase financing, which is a repurchase agreement that relates to a previously transferred financial asset between the same counterparties, that is entered into contemporaneously with, or in contemplation of, the initial transfer. FSP No. FAS 140-3 is effective for financial statements issued for fiscal years beginning after November 15, 2009, and interim periods within those fiscal years. Earlier application is not permitted. Susquehanna is evaluating the impact of this FSP.
In December 2007, the Financial Accounting Standards Board issuedStatement No. 141(R), “Business Combinations.” Statement No. 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial
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effect of the business combination. Statement No. 141(R) is effective for fiscal years beginning after December 15, 2008. Susquehanna is evaluating the impact of Statement No. 141(R).
In December 2007, the Financial Accounting Standards Board issuedStatement No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” Statement No. 160 requires that a reporting entity provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. Statement No. 160 is effective for fiscal years beginning after December 15, 2008. Susquehanna is evaluating the impact of Statement No. 160.
Summary of 2007 Compared to 2006
Results of Operations
Net income for the year ended December 31, 2007, was $69.1 million, a decrease of $14.5 million, or 17.4%, over net income of $83.6 million in 2006. Net interest income increased 7.5%, to $275.9 million for 2007, from $256.8 million in 2006. Noninterest income decreased 11.5%, to $120.7 million for 2007, from $136.3 million in 2006, and noninterest expenses increased 5.4%, to $277.0 million for 2007, from $262.8 million for 2006.
Additional information is as follows:
| | | | | | | | |
| | | Twelve Months Ended
December 31, | |
| | | 2007 | | | 2006 | |
Diluted Earnings per Share | | $ | 1.23 | | | $ | 1.66 | |
Return on Average Assets | | | 0.78 | % | | | 1.05 | % |
Return on Average Equity | | | 6.66 | % | | | 9.56 | % |
Return on Average Tangible Equity(1) | | | 11.56 | % | | | 15.42 | % |
Efficiency Ratio | | | 69.10 | % | | | 66.43 | % |
Net Interest Margin | | | 3.67 | % | | | 3.77 | % |
(1) Supplemental Reporting of Non-GAAP-based Financial Measures
Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable measure is return on average equity, which is calculated using GAAP-based amounts. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average equity to return on average tangible equity is set forth below.
| | | | | | |
| | | 2007 | | | 2006 | |
Return on average equity (GAAP basis) | | 6.66 | % | | 9.56 | % |
Effect of excluding average intangible assets and related amortization | | 4.90 | % | | 5.86 | % |
Return on average tangible equity | | 11.56 | % | | 15.42 | % |
Net Interest Income — Taxable Equivalent Basis
Net interest income increased to $275.9 million in 2007, as compared to $256.8 million in 2006. Net interest income as a percentage of net interest income plus other income was 70% for the twelve months ended December 31, 2007, 65% for the twelve months ended December 31, 2006, and 66% for the twelve months ended December 31, 2005.
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The $20.8 million increase in our net interest income in 2007, as compared to 2006, was primarily the result of increased volume in interest-earning assets (most notably in loans and leases), partially attributable to the Community acquisition. Our net interest margin, however, declined 10 basis points, from 3.77% for the year ended December 31, 2006, to 3.67% for the year ended December 31, 2007. This decrease in net interest margin was primarily due to a 25 basis point increase in rates paid on average interest-bearing liabilities and an $11.4 million decrease in average noninterest-bearing demand deposits. The 25 basis point increase in rates paid on average interest-bearing liabilities was partially offset by a 19 basis point increase in yields on average interest-earning assets.
Provision and Allowance for Loan and Lease Losses
The allowance for loan and lease losses at December 31, 2007 was 1.01% of period-end loans and leases, or $88.6 million, and 1.13% of period-end loans and leases, or $62.6 million, at December 31, 2006.
Interest income received on impaired commercial loans in 2007 and 2006, was $0.07 million and $0.16 million, respectively. Interest income that would have been recorded on these loans under the original terms was $1.8 million and $1.6 million for 2007 and 2006, respectively. At December 31, 2007, we had no binding outstanding commitments to advance additional funds with respect to these impaired loans.
Net charge-offs, as a percentage of average loans and leases for the year ended December 31, 2007, were 0.25%, compared to 0.10% for 2006. The charge-off ratio for 2007 is within historical norms of 15 to 25 basis points.
At December 31, 2007, non-performing assets totaled $71.3 million and included $11.9 million in other real estate acquired through foreclosure and $2.6 million in restructured loans. At December 31, 2006, non-performing assets totaled $37.2 million, and included $1.5 million in other real estate acquired through foreclosure and $5.4 million in restructured loans. The increase in non-performing assets primarily is the result of $26.4 million in nonaccrual loans and $3.4 million in other real estate acquired through foreclosure that we acquired in the Community transaction.
The allowance for loan and lease losses as a percentage of non-performing loans and leases (coverage ratio) decreased to 149% at December 31, 2007, from 175% at December 31, 2006. However, when the $7.4 million valuation allowance discussed above is added to the allowance for loan and lease losses at December 31, 2007, the coverage ratio becomes 162%.
Loans with principal and/or interest delinquent 90 days or more and still accruing interest totaled $12.2 million at December 31, 2007, an increase of $2.8 million, from $9.4 million at December 31, 2006.
Potential problem loans totaled $133.8 million at December 31, 2007, and $56.5 million at December 31, 2006. The increase of $77.3 million was attributed to $46.8 million in potential problem loans acquired in the Community transaction and migrations to our internally monitored loan list that occur in the normal course of business.
Noninterest Income
Noninterest income, as a percentage of net interest income plus noninterest income, was 30%, 35%, and 34% for 2007, 2006, and 2005, respectively.
Noninterest income decreased $15.7 million, or 11.5%, in 2007, over 2006. This net decrease primarily was composed of the following:
| | • | | Increasedservice charges on deposit accounts of $5.0 million; |
| | • | | Decreasedvehicle origination, servicing, and securitization fees of $4.2 million; |
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| | • | | Increasedwealth management fee income (includes asset management fees, income from fiduciary-related activities,and commissions on brokerage, life insurance, and annuity sales) of $3.1 million; |
| | • | | Decreasedgains on sales of loans and leases of $8.4 million; |
| | • | | Increasedlosses on securities of $10.9 million; |
| | • | | Decreasedgains on the sales of bank branches of $4.2 million; and |
| | • | | Increasedother income of $2.4 million. |
Service charges on deposit accounts. The 18.8% increase was the result of improvements initiated in the second quarter of 2006 relating to the processing of customer overdrafts; the inclusion of Minotola operations for the entire twelve months of 2007, as opposed to approximately eight months in 2006 (Minotola was acquired on April 21, 2006); and the inclusion of Community operations since November 16, 2007.
Vehicle origination, servicing, and securitization fees. The 22.7% decrease was the result of a decrease in vehicle lease originations and managed balances due to significant competition from captive finance companies.
Wealth management fee income. The 10.9% increase was attributed to an increase in assets under management and administration, from $5.1 billion at December 31, 2006 to $6.0 billion at December 31, 2007.
Gains on sale of loans and leases. In 2006, we recognized gains totaling $10.2 million on the sales of loans and leases in two securitization transactions. During 2007, we completed only one securitization transaction in which we recognized a gain of $2.7 million.
Net realized losses on securities. The increase was a direct result of our investment portfolio restructuring that occurred in June 2007. The restructuring involved the sale of $233.0 million in available-for-sale securities, or approximately 16.0% of our total investment portfolio.
Other income. The 12.4% increase primarily was the result of the inclusion of Minotola operations for the entire twelve months of 2007, as opposed to approximately eight months in 2006 (Minotola was acquired on April 21, 2006), and the inclusion of Community operations since November 16, 2007.
Noninterest Expenses
Noninterest expenses increased $14.1 million, or 5.4%, in 2007, over 2006. This net increase primarily was composed of the following:
| | • | | Increasedsalaries and employee benefits of $16.0 million; |
| | • | | Increasedoccupancyand furniture and equipmentexpense of $4.7 million; |
| | • | | Increasedamortization of intangible assets of $1.3 million; |
| | • | | Decreasedvehicle lease disposalexpense of $1.6 million; and |
| | • | | Decreasedother expenses of $6.9 million. |
Salaries and employee benefits. Salaries and employee benefits increased by 12.5% in 2007. This increase was primarily the result of the inclusion of Minotola operations for the entire twelve months of 2007, as opposed to approximately eight months in 2006, the inclusion of Community operations since November 16, 2007, normal annual salary increases, and higher benefit costs.
Occupancy and furniture and equipment. The 14.8% increase was attributable to the inclusion of Minotola operations for the entire twelve months of 2007, as opposed to approximately eight months in 2006 and the inclusion of Community operations since November 16, 2007.
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Amortization of intangible assets. The 58.0% increase was the result of the amortization of intangibles with finite lives that were recognized in the Minotola, Community and Widmann Siff acquisitions.
Vehicle lease disposal. The 11.0% decrease primarily was the result of lower residual guarantee expense.
Other expense. The 9.1% net decrease primarily was due to the elimination of monthly rental expense as a result of the termination of the sale-leaseback transaction on January 12, 2007. This decrease was partially offset by increases in most other expense categories as a result of the inclusion of Minotola operations for the entire twelve months of 2007, as opposed to approximately eight months in 2006, and the inclusion of Community operations since November 16, 2007.
Income Taxes
Our effective tax rates for 2007 and 2006 were 29.3% and 31.2%, respectively.
The decrease in our effective tax rate for 2007 was the result of an increase in the percentage of tax-advantaged income relative to total income in 2007 compared to the percentage of tax-advantaged income relative to total income in 2006.
Financial Condition
Total assets at December 31, 2007, were $13.1 billion, an increase of 59.0%, as compared to total assets of $8.2 billion at December 31, 2006. The fair value of assets acquired in the Community transaction was $4.3 billion. Loans and leases, increased to $8.8 billion at December 31, 2007, from $5.6 billion at December 31, 2006. The fair value of loans and leases acquired in the Community transaction was $2.6 billion. Total deposits increased to $8.9 billion in 2007, from $5.9 billion during the same time period in 2006. The fair value of deposits assumed in the Community transaction was $2.8 billion. Equity capital was $1.7 billion at December 31, 2007, or $20.12 per share, compared to $936.3 million, or $17.98 per share, at December 31, 2006.
Investment Securities
As a result of changes in the interest-rate environment and the portfolio restructurings discussed in the following paragraphs, our total equity was positively impacted by $17.6 million. Unrealized losses, net of taxes, on available-for-sale securities totaled $12.2 million at December 31, 2006, and unrealized gains, net of taxes, on available-for-sale securities totaled $5.4 million at December 31, 2007.
Investment securities available for sale increased $661.7 million, from December 31, 2006, to December 31, 2007. The fair value of securities acquired in the Community transaction was $664.5 million.
During May and June of 2007, while planning for the Community acquisition and the resulting growth and composition of the investment portfolio, our management performed a comprehensive review of our available-for-sale investments. Management determined that for administrative and operational purposes, small remaining portions in mortgage-backed securities (“odd lots,” or securities with remaining par amounts of less than $2.0 million) should be sold. These odd lots, totaling $182.0 million, resulted from previous mergers and bank mergers and from principal amortization over time. Additionally, we determined that all collateralized mortgage obligations, regardless of the remaining par amount, with an aggregate total of $51.0 million should be sold. Many of these mortgage obligations were acquired in the historic low-interest-rate environment of 2002 through 2004.
The restructuring involved the sale of approximately 16.0% of our available-for-sale investment portfolio, and resulted in a pre-tax charge of approximately $11.8 million in June 2007. There was minimal impact on shareholders’ equity, as the decline in value of the investments had been reflected previously in accumulated other comprehensive income.
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The proceeds from the sales of these securities were reinvested in a diversified mix of Federal Agency bullet debentures and commercial and residential mortgage-backed securities with higher yields, longer duration, and positive convexity attributes. The sold securities had a weighted-average yield of 3.76%, while the proceeds were reinvested in securities with an expected yield of 5.75%.
In December 2006, we recognized an other-than-temporary impairment of $1.0 million, related to our Corporate Investment Committee’s decision to implement a modest restructuring program of our Federal Agency debenture portfolio in 2007. This restructuring program included the January 2007 sale of Federal Agency debentures classified as available for sale with an aggregate book value of $79.0 million and unrealized losses of $1.0 million at December 31, 2006.
Unrealized losses recorded for U.S. Government agencies and mortgage-backed securities were attributable to changes in interest rates. Unrealized losses in other debt securities were attributable to market factors other than interest rates and credit risk.
At December 31, 2007, we held no securities of any one issuer (other than securities of U.S. Government agencies and corporations, which, by regulation, may be excluded from this disclosure) where the aggregate book value exceeded ten percent of shareholders’ equity. Furthermore, at December 31, 2007 and December 31, 2006, our holdings of investment securities that were rated below investment grade were insignificant.
Loans and Leases
Loans and leases increased $3.2 billion, from December 31, 2006 to December 31, 2007. The fair value of loans and leases acquired in the Community transaction was $2.6 billion. The additional increase was due to internal growth that was accomplished through our sales and marketing efforts and the fact that loan demand was still solid in our market area.
In January 2007, we exercised an early buyout option associated with Hann’s sale-leaseback transaction. As a result, Hann acquired approximately $78.4 million of beneficial interests in automobile leases and related vehicles. A significant portion of these automobile leases and related vehicles was sold to our banking subsidiaries and subsequently included in the February 2007 $300.4 million vehicle lease securitization transaction.
In September 2006, our banking subsidiaries entered into a term securitization transaction in which they collectively sold fixed-rate home mortgage loans and variable-rate home equity lines of credit (“HELOCs”) with an aggregate total of $351.2 million. In March 2006, our banking subsidiaries entered into a term securitization transaction in which they collectively sold and contributed beneficial interests in a portfolio of automobile leases and related vehicles with an aggregate total of $356.1 million.
Our bank subsidiaries have historically reported a significant amount of loans secured by real estate. Many of these loans have real estate collateral taken as additional security not related to the acquisition of the real estate pledged. Open-end home equity loans totaled $255.8 million at December 31, 2007, and an additional $405.2 million was lent against junior liens on residential properties at December 31, 2007. Senior liens on 1-4 family residential properties totaled $1.3 billion at December 31, 2007, and much of the $2.5 billion in loans secured by non-farm, non-residential properties represented collateralization of operating lines of credit, or term loans that finance equipment, inventory, or receivables. Loans secured by farmland totaled $165.7 million, while loans secured by multi-family residential properties totaled $175.3 million at December 31, 2007.
Substantially all of our loans and leases were to enterprises and individuals in our market area. There was no concentration of loans to borrowers in any one industry, or related industries, which exceeded 10% of total loans.
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Goodwill and Other Identifiable Intangible Assets
Goodwill recognized in the Community acquisition in 2007 was $606.1 million, and intangibles with finite lives totaled $40.3 million.
Goodwill recognized in the Minotola acquisition was $91.2 million, and an intangible with a finite life was $10.1 million.
Investment in and Receivables from Unconsolidated Entities
Concurrent with the lease securitization transaction in February 2007, our banking subsidiaries recorded investments in and receivables from unconsolidated entities of $47.9 million, representing notes and equity certificates of the issuer. In addition, in the third quarter of 2007, Hann, as servicer, issued a clean-up call relating to the 2002 securitization. As a result, Hann recorded $33.4 million in lease receivables, thereby reducing investment in and receivables from unconsolidated entities.
Concurrent with the lease securitization transaction in March 2006, our banking subsidiaries recorded investments in and receivables from unconsolidated entities of $53.3 million, representing notes and equity certificates of the issuer. In addition, in the third quarter of 2006, Hann, as servicer, issued a clean-up call relating to the 2003 securitization. As a result, Hann received $2.3 million in cash and recorded $12.3 million in lease receivables, thereby reducing investment in and receivables from unconsolidated entities.
Deposits
Total deposits increased $3.1 billion, or 52.2%, from December 31, 2006, to December 31, 2007. The fair value of deposit liabilities assumed in the Community acquisition totaled $2.8 billion.
Deposit growth of 2.4% for 2007, excluding the impact of the Community acquisition, fell short of our expectations due to intense competition within our marketplace to attract new deposits.
Short-term Borrowings
Short-term borrowings, which included securities sold under repurchase agreements, federal funds purchased, and Treasury tax and loan notes, increased by $166.4 million, or 41.4%, from December 31, 2006, to December 31, 2007. The fair value of short-term borrowings assumed in the Community transaction was $102.4 million.
Federal Home Loan Bank Borrowings and Long-term Debt
Federal Home Loan Bank borrowings increased $617.1 million from December 31, 2006 to December 31, 2007. The fair value of FHLB borrowings assumed in the Community transaction was $402.7 million. This increase was due to the fact that the increase in total deposits had been insufficient to support the growth in our loan and lease portfolio.
Junior subordinated debentures increased $194.4 million, from December 31, 2006, to December 31, 2007. The fair value of junior subordinated debentures assumed in the Community transactions was $69.7 million. In addition, on December 12, 2007, we issued $125.0 million of retail hybrid trust preferred notes through a newly formed Delaware statutory trust, Susquehanna Capital I. The only assets of the issuer are Capital Efficient Notes issued by us. The notes mature in December 2057, are redeemable at our option beginning after five years, and bear interest initially at a rate of 9.375% per annum through the interest payment date in December 2037 and, after the interest payment date in December 2037, at a rate per annum equal to the three-month LIBOR plus 5.455%. The proceeds from the sale of the CENts were used to replenish cash reserves used to pay for the cash portion of the Community acquisition and for general corporate purposes.
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Capital Adequacy
We, and each of our bank subsidiaries, had leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity was considered “well capitalized” under regulatory guidelines.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
The discussion concerning the effects of liquidity risk and interest rate risk on us is set forth under“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risks” in Item 7 hereof under the section entitled “Market Risk.”
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Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements of Susquehanna are submitted herewith:
| | |
| | | Page Reference |
Consolidated Balance Sheets at December 31, 2008 and 2007 | | 73 |
| |
Consolidated Statements of Income for the years ended December 31, 2008, 2007, and 2006 | | 74 |
| |
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007, and 2006 | | 75 |
| |
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2008, 2007, and 2006 | | 76 |
| |
Notes to Consolidated Financial Statements | | 77 |
| |
Management’s Responsibility for Financial Statements and Report on Internal Control over Financial Reporting | | 125 |
| |
Report of Independent Registered Public Accounting Firm | | 126 |
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SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
| | | | | | | | |
Year ended December 31, | | 2008 | | | 2007 | |
| | | (in thousands, except share data) | |
Assets | | | | | | | | |
Cash and due from banks | | $ | 237,701 | | | $ | 326,965 | |
Unrestricted short-term investments | | | 119,146 | | | | 143,042 | |
| | | | | | | | |
Cash and cash equivalents | | | 356,847 | | | | 470,007 | |
Restricted short-term investments | | | 214 | | | | 242 | |
Securities available for sale | | | 1,870,746 | | | | 2,059,160 | |
Securities held to maturity (fair values approximate$9,145 and $4,792) | | | 9,145 | | | | 4,792 | |
Loans and leases, net of unearned income | | | 9,653,873 | | | | 8,751,590 | |
Less: Allowance for loan and lease losses | | | 113,749 | | | | 88,569 | |
| | | | | | | | |
Net loans and leases | | | 9,540,124 | | | | 8,663,021 | |
| | | | | | | | |
Premises and equipment, net | | | 173,269 | | | | 179,740 | |
Foreclosed assets | | | 10,313 | | | | 11,927 | |
Accrued income receivable | | | 40,486 | | | | 46,765 | |
Bank-owned life insurance | | | 353,771 | | | | 344,578 | |
Goodwill | | | 1,017,551 | | | | 945,081 | |
Intangible assets with finite lives | | | 54,044 | | | | 58,274 | |
Investment in and receivables from unconsolidated entities | | | 36,767 | | | | 123,586 | |
Other assets | | | 219,711 | | | | 170,821 | |
| | | | | | | | |
Total Assets | | $ | 13,682,988 | | | $ | 13,077,994 | |
| | | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | | |
Deposits: | | | | | | | | |
Noninterest-bearing | | $ | 1,201,416 | | | $ | 1,292,791 | |
Interest-bearing | | | 7,865,077 | | | | 7,652,328 | |
| | | | | | | | |
Total deposits | | | 9,066,493 | | | | 8,945,119 | |
Short-term borrowings | | | 910,219 | | | | 568,412 | |
Federal Home Loan Bank borrowings | | | 1,069,784 | | | | 1,145,759 | |
Long-term debt | | | 176,284 | | | | 150,303 | |
Junior subordinated debentures | | | 271,798 | | | | 266,682 | |
Accrued interest, taxes, and expenses payable | | | 55,126 | | | | 60,869 | |
Deferred taxes | | | 87,695 | | | | 136,076 | |
Other liabilities | | | 99,671 | | | | 75,760 | |
| | | | | | | | |
Total liabilities | | | 11,737,070 | | | | 11,348,980 | |
| | | | | | | | |
Commitments and contingencies (Notes 13 and 14) | | | | | | | | |
Shareholders’ equity: | | | | | | | | |
Preferred stock, $1,000 liquidation value, 5,000,000 shares authorized; Issued:300,000 at December 31, 2008 and 0 at December 31, 2007 | | | 290,700 | | | | 0 | |
Common stock, $2.00 par value, 200,000,000 shares authorized; Issued:86,174,285 at December 31, 2008 and 85,935,315 at December 31, 2007 | | | 172,349 | | | | 171,810 | |
Additional paid-in capital | | | 1,055,255 | | | | 1,038,894 | |
Retained earnings | | | 512,924 | | | | 522,268 | |
Accumulated other comprehensive loss, net of taxes of$45,936 and $2,131 | | | (85,310 | ) | | | (3,958 | ) |
| | | | | | | | |
Total shareholders’ equity | | | 1,945,918 | | | | 1,729,014 | |
| | | | | | | | |
Total Liabilities and Shareholders’ Equity | | $ | 13,682,988 | | | $ | 13,077,994 | |
| | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
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SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
| | | | | | | | | | | | |
Years ended December 31, | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands, except per share data) | |
Interest Income: | | | | | | | | | | | | |
Loans and leases, including fees | | $ | 590,414 | | | $ | 444,690 | | | $ | 404,814 | |
Securities: | | | | | | | | | | | | |
Taxable | | | 86,289 | | | | 69,265 | | | | 49,810 | |
Tax-exempt | | | 12,714 | | | | 2,848 | | | | 845 | |
Dividends | | | 5,242 | | | | 4,572 | | | | 3,653 | |
Short-term investments | | | 2,411 | | | | 4,782 | | | | 3,669 | |
| | | | | | | | | | | | |
Total interest income | | | 697,070 | | | | 526,157 | | | | 462,791 | |
| | | | | | | | | | | | |
Interest Expense: | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | |
Interest-bearing demand | | | 33,667 | | | | 61,572 | | | | 51,424 | |
Savings | | | 4,848 | | | | 4,278 | | | | 4,960 | |
Time | | | 167,431 | | | | 124,673 | | | | 99,195 | |
Short-term borrowings | | | 10,796 | | | | 17,464 | | | | 13,495 | |
Federal Home Loan Bank borrowings | | | 50,944 | | | | 27,600 | | | | 24,788 | |
Long-term debt | | | 31,082 | | | | 14,667 | | | | 12,159 | |
| | | | | | | | | | | | |
Total interest expense | | | 298,768 | | | | 250,254 | | | | 206,021 | |
| | | | | | | | | | | | |
Net interest income | | | 398,302 | | | | 275,903 | | | | 256,770 | |
Provision for loan and lease losses | | | 63,831 | | | | 21,844 | | | | 8,680 | |
| | | | | | | | | | | | |
Net interest income, after provision for loan and lease losses | | | 334,471 | | | | 254,059 | | | | 248,090 | |
| | | | | | | | | | | | |
Noninterest Income: | | | | | | | | | | | | |
Service charges on deposit accounts | | | 46,294 | | | | 31,413 | | | | 26,446 | |
Vehicle origination, servicing, and securitization fees | | | 9,808 | | | | 14,323 | | | | 18,524 | |
Asset management fees | | | 25,552 | | | | 19,843 | | | | 18,439 | |
Income from fiduciary-related activities | | | 8,285 | | | | 7,479 | | | | 6,160 | |
Commissions on brokerage, life insurance, and annuity sales | | | 6,764 | | | | 4,767 | | | | 4,350 | |
Commissions on property and casualty insurance sales | | | 12,684 | | | | 12,751 | | | | 12,660 | |
Income from bank-owned life insurance | | | 12,900 | | | | 11,405 | | | | 10,000 | |
Net gain on sale of loans and leases | | | 6,510 | | | | 8,427 | | | | 16,816 | |
Net gain on sale of bank branches | | | 0 | | | | 0 | | | | 4,189 | |
Net realized loss on securities | | | (17,314 | ) | | | (11,857 | ) | | | (949 | ) |
Other | | | 30,826 | | | | 22,108 | | | | 19,678 | |
| | | | | | | | | | | | |
Total noninterest income | | | 142,309 | | | | 120,659 | | | | 136,313 | |
| | | | | | | | | | | | |
Noninterest Expenses: | | | | | | | | | | | | |
Salaries and employee benefits | | | 188,855 | | | | 144,508 | | | | 128,465 | |
Occupancy | | | 35,949 | | | | 24,371 | | | | 20,905 | |
Furniture and equipment | | | 16,212 | | | | 12,181 | | | | 10,948 | |
Advertising and marketing | | | 12,356 | | | | 10,216 | | | | 9,627 | |
Amortization of intangible assets | | | 11,062 | | | | 3,525 | | | | 2,231 | |
Vehicle lease disposal | | | 12,576 | | | | 12,651 | | | | 14,220 | |
Other | | | 90,191 | | | | 69,503 | | | | 76,440 | |
| | | | | | | | | | | | |
Total noninterest expenses | | | 367,201 | | | | 276,955 | | | | 262,836 | |
| | | | | | | | | | | | |
Income before income taxes | | | 109,579 | | | | 97,763 | | | | 121,567 | |
Provision for income taxes | | | 26,973 | | | | 28,670 | | | | 37,929 | |
| | | | | | | | | | | | |
Net Income | | | 82,606 | | | | 69,093 | | | | 83,638 | |
Accumulated preferred stock dividends | | | 792 | | | | 0 | | | | 0 | |
| | | | | | | | | | | | |
Net Income Available to Common Shareholders | | $ | 81,814 | | | $ | 69,093 | | | $ | 83,638 | |
| | | | | | | | | | | | |
Earnings per common share: | | | | | | | | | | | | |
Basic | | $ | 0.95 | | | $ | 1.23 | | | $ | 1.66 | |
Diluted | | $ | 0.95 | | | $ | 1.23 | | | $ | 1.66 | |
Cash dividends per common share | | $ | 1.04 | | | $ | 1.01 | | | $ | 0.97 | |
Average common shares outstanding: | | | | | | | | | | | | |
Basic | | | 85,987 | | | | 56,297 | | | | 50,340 | |
Diluted | | | 86,037 | | | | 56,366 | | | | 50,507 | |
The accompanying notes are an integral part of these consolidated financial statements.
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SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
| | | | | | | | | | | | |
Years ended December 31, | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Cash Flows from Operating Activities: | | | | | | | | | | | | |
Net income | | $ | 82,606 | | | $ | 69,093 | | | $ | 83,638 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
Depreciation, amortization, and accretion | | | 27,428 | | | | 17,177 | | | | 15,919 | |
Provision for loan and lease losses | | | 63,831 | | | | 21,844 | | | | 8,680 | |
Realized loss on available-for-sale securities, net | | | 17,314 | | | | 11,857 | | | | 949 | |
Deferred income taxes | | | (4,577 | ) | | | 1,070 | | | | 21,955 | |
Gain on sale of loans and leases | | | (6,510 | ) | | | (8,427 | ) | | | (16,816 | ) |
Gain on sale of foreclosed assets | | | (425 | ) | | | (196 | ) | | | (176 | ) |
Mortgage loans originated for sale | | | (182,698 | ) | | | (102,507 | ) | | | (94,640 | ) |
Proceeds from sale of mortgage loans originated for sale | | | 173,782 | | | | 105,478 | | | | 96,526 | |
Loans and leases originated/acquired for sale, net of payments received | | | (118,370 | ) | | | (391,975 | ) | | | (296,211 | ) |
Payments received on leases transferred from held for sale to held for investment | | | 56,732 | | | | 0 | | | | 0 | |
Net proceeds from sale of loans and leases originated/acquired for sale | | | 0 | | | | 252,493 | | | | 339,420 | |
Increase in cash surrender value of bank-owned life insurance | | | (12,203 | ) | | | (11,630 | ) | | | (10,000 | ) |
Net gain on sale of branch offices | | | 0 | | | | 0 | | | | (4,189 | ) |
Contribution to defined benefit pension plan | | | (15,000 | ) | | | 0 | | | | (3,000 | ) |
Decrease (increase) in accrued interest receivable | | | 6,279 | | | | (440 | ) | | | (4,620 | ) |
(Decrease) increase in accrued interest payable | | | (5,697 | ) | | | 3,721 | | | | 3,138 | |
Decrease in accrued expenses and taxes payable | | | (46 | ) | | | (3,240 | ) | | | (2,820 | ) |
Other, net | | | (50,172 | ) | | | (28,190 | ) | | | (31,828 | ) |
| | | | | | | | | | | | |
Net cash (used in) provided by operating activities | | | 32,274 | | | | (63,872 | ) | | | 105,925 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities: | | | | | | | | | | | | |
Net decrease (increase) in restricted short-term investments | | | 28 | | | | 33,291 | | | | (7,197 | ) |
Activity in available-for-sale securities: | | | | | | | | | | | | |
Sales | | | 60,279 | | | | 436,716 | | | | 151,184 | |
Maturities, repayments, and calls | | | 610,808 | | | | 485,730 | | | | 215,859 | |
Purchases | | | (603,998 | ) | | | (903,203 | ) | | | (542,914 | ) |
Net proceeds from sale of loans and leases in banks’ portfolios | | | 0 | | | | 0 | | | | 312,870 | |
Net increase in loans and leases | | | (808,544 | ) | | | (503,114 | ) | | | (253,962 | ) |
Cash flows received from retained interests | | | 32,736 | | | | 37,715 | | | | 25,806 | |
Proceeds from bank-owned life insurance | | | 3,010 | | | | 4,471 | | | | 2,891 | |
Proceeds from sale of foreclosed assets | | | 10,626 | | | | 4,370 | | | | 3,997 | |
Acquisitions, net of subsequent divestitures | | | (68,146 | ) | | | 114,749 | | | | (15,379 | ) |
Additions to premises and equipment, net | | | (10,155 | ) | | | (19,356 | ) | | | (12,718 | ) |
| | | | | | | | | | | | |
Net cash used in investing activities | | | (773,356 | ) | | | (308,631 | ) | | | (119,563 | ) |
| | | | | | | | | | | | |
Cash Flows from Financing Activities: | | | | | | | | | | | | |
Net increase in deposits | | | 121,374 | | | | 238,605 | | | | 76,364 | |
Sale of branch deposits, net of premium received | | | 0 | | | | 0 | | | | (28,900 | ) |
Net increase in short-term borrowings | | | 341,807 | | | | 64,067 | | | | 94,441 | |
Net (decrease) increase in short-term FHLB borrowings | | | (50,000 | ) | | | 50,000 | | | | (15,000 | ) |
Proceeds from long-term FHLB borrowings | | | 220,000 | | | | 400,000 | | | | 106,035 | |
Repayment of long-term FHLB borrowings | | | (245,975 | ) | | | (248,974 | ) | | | (231,013 | ) |
Proceeds from issuance of long-term debt | | | 25,000 | | | | 0 | | | | 0 | |
Repayment of long-term debt | | | (19 | ) | | | (11 | ) | | | (7 | ) |
Proceeds from issuance of junior subordinated debentures | | | 0 | | | | 121,062 | | | | 50,000 | |
Proceeds from issuance of preferred stock | | | 299,885 | | | | 0 | | | | 0 | |
Proceeds from issuance of common stock | | | 5,141 | | | | 4,512 | | | | 9,155 | |
Tax benefit from exercise of stock options | | | 171 | | | | 154 | | | | 906 | |
Cash dividends paid | | | (89,462 | ) | | | (52,686 | ) | | | (49,067 | ) |
| | | | | | | | | | | | |
Net cash provided by financing activities | | | 627,922 | | | | 576,729 | | | | 12,914 | |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | (113,160 | ) | | | 204,226 | | | | (724 | ) |
Cash and cash equivalents at January 1 | | | 470,007 | | | | 265,781 | | | | 266,505 | |
| | | | | | | | | | | | |
Cash and cash equivalents at December 31 | | $ | 356,847 | | | $ | 470,007 | | | $ | 265,781 | |
| | | | | | | | | | | | |
Supplemental Disclosure of Cash Flow Information | | | | | | | | | | | | |
Cash paid for interest on deposits and borrowings | | $ | 304,465 | | | $ | 239,953 | | | $ | 202,883 | |
Income tax payments | | $ | 40,250 | | | $ | 31,452 | | | $ | 20,406 | |
Supplemental Schedule of Noncash Activities | | | | | | | | | | | | |
Real estate acquired in settlement of loans | | $ | 9,981 | | | $ | 14,057 | | | $ | 2,721 | |
Interests retained in securitizations | | $ | 0 | | | $ | 47,921 | | | $ | 54,970 | |
Securities purchased, not settled | | $ | 0 | | | $ | 0 | | | $ | 10,113 | |
Leases acquired in clean-up calls | | $ | 63,913 | | | $ | 22,682 | | | $ | 12,284 | |
Leases transferred from held for sale to held for investment | | $ | 238,351 | | | $ | 0 | | | $ | 0 | |
Acquisitions: | | | | | | | | | | | | |
| | | | | | Community | | | Minotola | |
Common stock issued | | | | | | $ | 756,037 | | | $ | 115,149 | |
Fair value of assets acquired (noncash) | | | | | | $ | 4,070,693 | | | $ | 653,339 | |
Fair value of liabilities assumed | | | | | | $ | 3,432,519 | | | $ | 522,811 | |
The accompanying notes are an integral part of these consolidated financial statements.
75
SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
| | | | | | | | | | | | | | | | | | | | | | | |
Years Ended December 31, 2008, 2007, and 2006 | | Preferred
Stock | | Shares of
Common
Stock | | Common
Stock | | Additional
Paid-in
Capital | | Retained
Earnings | | | Accumulated
Other
Comprehensive
Income (Loss) | | | Total | |
| | | (in thousands, except share data) | |
Balance, January 1, 2006 | | $ | 0 | | 46,853,193 | | $ | 93,706 | | $ | 231,085 | | $ | 471,290 | | | ($ | 15,611 | ) | | $ | 780,470 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | | | | | | | | | | | | 83,638 | | | | | | | | 83,638 | |
Change in unrealized loss on securities available for sale, net of taxes of $2,874 and reclassification adjustment of $617 | | | | | | | | | | | | | | | | | | 5,337 | | | | 5,337 | |
Change in unrealized gain on recorded interests in securitized assets, net of taxes of $633 | | | | | | | | | | | | | | | | | | 1,232 | | | | 1,232 | |
Change in unrealized gain on cash flow hedges, net of taxes of $940 | | | | | | | | | | | | | | | | | | (1,161 | ) | | | (1,161 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | 89,046 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Common stock issued in acquisition | | | | | 4,797,870 | | | 9,596 | | | 105,553 | | | | | | | | | | | 115,149 | |
Common stock issued under employee benefit plans (including related tax benefit of $906) | | | | | 429,356 | | | 859 | | | 9,202 | | | | | | | | | | | 10,061 | |
Cash dividends declared ($0.97 per share) | | | | | | | | | | | | | | (49,067 | ) | | | | | | | (49,067 | ) |
Adjustment to initially apply FAS No. 158, net of taxes of $(5,047) | | | | | | | | | | | | | | | | | | (9,373 | ) | | | (9,373 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2006 | | | 0 | | 52,080,419 | | | 104,161 | | | 345,840 | | | 505,861 | | | | (19,576 | ) | | | 936,286 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | | | | | | | | | | | | 69,093 | | | | | | | | 69,093 | |
Change in unrealized loss on securities available for sale, net of taxes of $9,475 and reclassification adjustment of $7,707 | | | | | | | | | | | | | | | | | | 17,708 | | | | 17,708 | |
Change in unrealized gain on recorded interests in securitized assets, net of taxes of $195 | | | | | | | | | | | | | | | | | | 363 | | | | 363 | |
Change in unrealized gain on cash flow hedges, net of taxes of $1,440 and reclassification adjustment of $202 | | | | | | | | | | | | | | | | | | (2,675 | ) | | | (2,675 | ) |
Net postretirement benefit loss arising during the year, net of taxes of $(52) | | | | | | | | | | | | | | | | | | (96 | ) | | | (96 | ) |
Reclassification of postretirement benefit costs recognized in net income, net of taxes of $171 | | | | | | | | | | | | | | | | | | 318 | | | | 318 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | 84,711 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Common stock issued in acquisition | | | | | 33,685,947 | | | 67,372 | | | 688,665 | | | | | | | | | | | 756,037 | |
Common stock issued under employee benefit plans (including related tax benefit of $154) | | | | | 168,949 | | | 277 | | | 4,389 | | | | | | | | | | | 4,666 | |
Cash dividends declared ($1.01 per share) | | | | | | | | | | | | | | (52,686 | ) | | | | | | | (52,686 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2007 | | | 0 | | 85,935,315 | | | 171,810 | | | 1,038,894 | | | 522,268 | | | | (3,958 | ) | | | 1,729,014 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Cumulative-effect adjustment relating to adoption of EITF 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” | | | | | | | | | | | | | | (2,488 | ) | | | | | | | (2,488 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | | | | | | | | | | | | 82,606 | | | | | | | | 82,606 | |
Change in unrealized loss on securities available for sale, net of taxes of $37,288 and reclassification adjustment of $11,254 | | | | | | | | | | | | | | | | | | (69,250 | ) | | | (69,250 | ) |
Change in unrealized gain on recorded interests in securitized assets, net of taxes of $1,347 | | | | | | | | | | | | | | | | | | 2,502 | | | | 2,502 | |
Change in unrealized gain on cash flow hedges, net of taxes of $821 and reclassification adjustments of $2,031 | | | | | | | | | | | | | | | | | | 1,524 | | | | 1,524 | |
Net postretirement benefit loss arising during the year, net of taxes of $8,964 | | | | | | | | | | | | | | | | | | (16,648 | ) | | | (16,648 | ) |
Reclassification of postretirement benefit costs recognized in net income, net of taxes of $281 | | | | | | | | | | | | | | | | | | 520 | | | | 520 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | 1,254 | |
| | | | | | | | | | | | | | | | | | | | | | | |
Preferred stock issued, net of issuance costs | | | 290,700 | | | | | | | | 9,185 | | | | | | | | | | | 299,885 | |
Common stock issued under employee benefit plans (including related tax benefit of $171) | | | | | 238,970 | | | 539 | | | 4,773 | | | | | | | | | | | 5,312 | |
Adjustments relating to the Community acquisition | | | | | | | | | | | 2,403 | | | | | | | | | | | 2,403 | |
Cash dividends declared ($1.04 per share) | | | | | | | | | | | | | | (89,462 | ) | | | | | | | (89,462 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2008 | | $ | 290,700 | | 86,174,285 | | $ | 172,349 | | $ | 1,055,255 | | $ | 512,924 | | | ($ | 85,310 | ) | | $ | 1,945,918 | |
| | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
76
Notes to Consolidated Financial Statements
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
1. Summary of Significant Accounting Policies
The accounting and reporting policies of Susquehanna Bancshares, Inc. and subsidiaries (collectively “Susquehanna”) conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry. The more significant policies follow:
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the parent company and its wholly owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) (“Hann”), Susquehanna Bank and subsidiaries, Valley Forge Asset Management Corp. and subsidiaries (“VFAM”), The Addis Group, LLC (“Addis”), and Stratton Management Company, LLC (“Stratton”) as of and for the years ended December 31, 2008, 2007, and 2006. All significant intercompany balances and transactions have been eliminated in consolidation.
Reclassifications. Certain prior year amounts have been reclassified to conform with current period classifications. The reclassifications had no effect on gross revenues, gross expenses, net income, or the net change in cash and cash equivalents and are not material to previously issued financial statements.
Nature of Operations. Susquehanna is a financial holding company that operates a commercial bank with 236 branches and non-bank subsidiaries that provide leasing; trust and related services; consumer vehicle financing; investment advisory, asset management, and brokerage services; and property and casualty insurance brokerage services. Susquehanna’s primary source of revenue is derived from loans to customers, who are predominately small and middle-market businesses and middle-income individuals.
Use of Estimates.The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses and recorded interests in securitized assets.
Significant Concentrations of Credit Risk.Substantially all of Susquehanna’s loans and leases are to enterprises and individuals in its market area. There is no concentration of loans to borrowers in any one industry, or related industries, that exceeds 10% of total loans.
Cash and Cash Equivalents. For purposes of reporting cash flows, cash and cash equivalents include cash, balances due from banks, and unrestricted short-term investments. Unrestricted short-term investments consist of interest-bearing deposits in other banks, federal funds sold, commercial paper, and money market funds with an original maturity of three months or less.
Securities Sold Under Agreements to Repurchase.Securities sold under agreements to repurchase are treated as debt and are reflected as a liability in the consolidated statements of financial condition. The fair value of securities pledged to secure the repurchase agreements remains in the securities portfolio.
Securities. Susquehanna classifies debt and equity securities as either held to maturity or available for sale. Susquehanna does not have any securities classified as trading at December 31, 2008 or 2007. Investments for which management has the intent, and Susquehanna has the ability to hold to maturity, are carried at the lower of cost or market adjusted for amortization of premium and accretion of discount. Amortization and accretion are calculated principally using the effective interest method over the term of the securities. All other securities are classified as available for sale and reported at fair value. Changes in unrealized gains and losses, net of related
77
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
deferred taxes, for available-for-sale securities are recorded in accumulated other comprehensive income. Other-than-temporary impairments are recorded in noninterest income in the period in which they are recognized.
Securities classified as available for sale include investments management intends to use as part of its asset/liability management strategy. Those securities that have long-term unrealized gains, in which fair value is greater than cost, may be sold in response to changes in interest rates, resultant prepayment risk, and other factors. Management has the ability and intent to hold those securities that have unrealized losses due to changes in interest rates and other market factors for a time necessary to recover the amortized cost. Realized gains and losses on securities are recognized using the specific identification method and are included in noninterest income.
Loans and Leases. Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are stated at their outstanding unpaid principal balances, net of any deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. Direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property, less unearned income.
Interest income on loans and leases is computed using the effective interest method. Loan and lease origination fees and certain direct loan and lease origination costs are deferred, and the net amount is recognized as an adjustment to the yield on the related loans over the contractual life of the loans.
Nonaccrual loans are those loans on which the accrual of interest has ceased and where all previously accrued-but-not-collected interest is reversed. Loans other than consumer loans are placed on nonaccrual status when principal or interest is past due 90 days or more and the loan is not well-collateralized and in the process of collection or immediately, if, in the opinion of management, full collection is doubtful. Interest accrued but not collected as of the date of placement on nonaccrual status is reversed and charged against current income. Susquehanna does not accrue interest on impaired loans. While a loan is considered impaired or on nonaccrual status, subsequent cash interest payments received either are applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of the ultimate collectibility of principal and interest. In any case, the deferral or non-recognition of interest does not constitute forgiveness of the borrower’s obligation. Consumer loans are recorded in accordance with the Uniform Retail Classification regulation adopted by the FDIC. Generally, the regulation requires that consumer loans be charged off to the allowance for loan losses when they become 120 days or more past due.
Allowance for Loan and Lease Losses. The allowance for loan and lease losses is established, as losses are estimated to have occurred, through a provision for loan and lease losses charged to earnings. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Recoveries on previously charged-off loans and leases are credited to the allowance.
The allowance for loan and lease losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectibility of the loans and leases in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is subjective, as it requires estimates that are susceptible to revision as more information becomes available.
Susquehanna considers a loan to be impaired, based upon current information and events, if it is probable that Susquehanna will be unable to collect payments of principal or interest according to the contractual terms of the loan agreement. Adversely risk-rated loans that are not evaluated for impairment on an individual basis are
78
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
grouped in homogeneous pools based on severity of risk. Larger homogeneous groups of small-balance loans, such as residential mortgages and installment loans, are collectively evaluated for impairment. Non-accrual commercial loans greater than $500 are evaluated for impairment on an individual basis. An insignificant delay or shortfall in the amounts of payments, when considered independently of other factors, would not cause a loan to be rendered impaired. Insignificant delays or shortfalls may include, depending on specific facts and circumstances, those that are associated with temporary operational downturns or seasonal delays.
Management performs quarterly reviews of Susquehanna’s loan portfolio to identify impaired loans. The measurement of impaired loans is based upon the present value of expected future cash flows discounted at the historical effective interest rate, except where collateral-dependent loans can be reasonably measured for impairment based on the net realizable value of the collateral.
Loans continue to be classified as impaired until they are brought fully current, and the continued collection of scheduled interest and principal is considered probable. When an impaired loan or portion of an impaired loan is determined to be uncollectible, the portion deemed uncollectible is charged against the related allowance. Subsequent recoveries, if any, are credited to the allowance.
Off-Balance-Sheet Credit-Related Financial Instruments.In the ordinary course of business, Susquehanna enters into commitments to extend credit, including commitments under commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the Statement of Condition when they are funded.
Derivative Financial Instruments.Susquehanna’s interest rate risk management strategy involves hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on our net interest margin and cash flows from changes in interest rates. While we do not participate in speculative derivatives trading, we consider it prudent to use certain derivative instruments to add stability to our interest income and expense, to modify the duration of specific assets and liabilities, and to manage our exposure to interest rate movements.
Additionally, we execute derivative instruments in the form of interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that we minimize our net risk exposure resulting from such transactions. We do not use credit default swaps in our investment or hedging operations.
Foreclosed Assets. Other real estate property acquired through foreclosure or other means is recorded at the lower of its carrying value or the fair market value of the of the related real estate collateral at the transfer date less estimated selling costs. Costs to maintain other real estate are expensed as incurred.
Premises and Equipment. Land is carried at cost. Buildings, land improvements, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or ten to twenty years. Maintenance and normal repairs are charged to operations as incurred, while additions and improvements to buildings and furniture and equipment are capitalized. Gains or losses on disposition of assets are reflected in operations.
In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” long-lived assets are evaluated for impairment by management on an on-going basis. Impairment may occur whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
79
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Goodwill and Other Intangible Assets. Susquehanna follows Statement of Financial Accounting Standards No. 141, “Business Combinations,” and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” Net assets of companies acquired in purchase transactions are recorded at their fair value at the date of acquisition. Core deposit and other intangible assets acquired in acquisitions are identified and amortized over their useful lives. The excess of the purchase price over the fair value of net assets acquired, or goodwill, is not amortized in accordance with FAS No. 142, rather an impairment evaluation is performed on an annual basis. In addition, Susquehanna evaluates potential impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit (as defined in FAS No. 142, paragraph 30) below its carrying amount. There was no impairment noted as of and for the year ended December 31, 2008.
On February 1, 2000, Susquehanna completed the acquisition of Boston Service Company, Inc. (t/a Hann Financial Service Corporation) under the pooling-of-interests method of accounting for business combinations. Consequently, under the prevailing generally accepted accounting principles, no goodwill was recorded.
Segment Reporting. Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that public business enterprises report financial and descriptive information about their reportable operating segments. Based on the guidance provided by the statement, Susquehanna has determined that its only reportable segment is Community Banking, and all services offered by Susquehanna relate to Community Banking.
Comprehensive Income. Susquehanna reports comprehensive income in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income.” Components of comprehensive income, as detailed in the Consolidated Statements of Changes in Shareholders’ Equity, are net of tax. Comprehensive income includes reclassification adjustments for net realized gains/(losses) included in net income of $13,805; $8,227; and $323 for the years ended December 31, 2008, 2007, and 2006, respectively.
Asset Securitizations.Susquehanna uses the securitization of financial assets as a source of funding and for capital management. Hann and the bank subsidiary sell beneficial interests in automobile leases and related vehicles and home equity loans to qualified special purpose entities. These transactions are accounted for as sales under the guidelines of FAS No. 140, and a net gain or loss is recognized at the time of the initial sale. Retained interests in securitized assets, including debt securities, equity certificates of the securitization trusts, and interest-only strips, are initially recorded at their allocated carrying amounts based on the relative fair value of assets sold and retained or liabilities assumed.
The QSPEs issue beneficial interests in the form of senior and subordinated asset-backed securities backed or collateralized by the assets sold to the QSPEs. The senior classes of the asset-backed securities typically receive investment grade credit ratings at the time of issuance. These ratings are generally achieved through the creation of lower-rated subordinated classes of asset-backed securities, as well as subordinated interests retained by Susquehanna.
Excess cash flows represent the cash flows from the underlying assets less distributions of cash flows to beneficial interest holders in accordance with the distribution priority requirements of the transaction. Susquehanna, as servicer, distributes to third-party beneficial interest holders contracted returns. Susquehanna retains the right to remaining cash flows after distributions to these third-party beneficial interest holders. The cash flows are discounted to present value and recorded as interest-only strips. The resulting interest-only strips
80
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
are subordinate to the rights of each of the third-party beneficial interest holders. Susquehanna initially estimates the fair value of these interest-only strips based on the present value of future expected cash flows, using management’s estimate of the key assumptions regarding credit losses, prepayment speeds, and discount rates commensurate with the risks involved at the time assets are sold to the applicable QSPE. The fair value of the interest-only strips is adjusted quarterly based on changes in these key economic risk factors. If the fair value of an interest-only strip were to fall below the unamortized portion of the original retained interest, other than for temporary circumstances, then an impairment would be recognized.
Subordinated notes and equity certificates retained in the securitization transactions are recorded on the balance sheet under the caption “Investment in and receivables from unconsolidated entities,” and other retained interests are recorded on the balance sheet under the caption “Other assets.”
For more information about Susquehanna’s securitization activities, see Note 21 to the consolidated financial statements.
Servicing Fees under Securitization Transactions, Agency Agreements, and Lease Sales.In accordance with FAS No. 156, “Accounting for Servicing of Financial Assets,” a servicing asset or servicing liability is recognized each time Susquehanna undertakes an obligation to service a financial asset by entering into a servicing contract in a transfer of financial assets that meets the requirements for sale accounting.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of servicing rights is netted against loan servicing fee income.
Overall, however, Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its loan and lease portfolio and to manage capital, and not primarily to maximize its ongoing servicing fee revenue.
Leases
The servicing fees paid to Hann under the lease securitization transactions, agency agreements, and lease sales approximate current market value and are set by contract at the time of sale. Hann has not recorded servicing assets or liabilities with regard to those transactions because its expected servicing costs are approximately equal to its expected servicing income. Based upon Susquehanna’s on-going experience with vehicle-lease sales, this rate has been, and continues to be, the prevailing market rate when compared to similar transactions. However, if these circumstances were to change, Susquehanna would adjust its evaluation as to whether a servicing asset or liability should be recorded. In addition, if servicing costs were to exceed servicing income, Hann would record the present value of that liability as an expense.
Home Equity Loans
The parent company acts as servicer for securitized home equity loans and has recorded servicing assets based on the present value of estimated future net servicing income. The initial carrying values of retained interests, including servicing rights, were determined by allocating the carrying value among the assets sold and retained based on their relative fair values. At December 31, 2008, these servicing assets totaled $1,357 and were reported in other assets. In accordance with FAS No. 156, Susquehanna’s servicing rights are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the
81
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
underlying financial assets and adjusts the values, if required, as a result of market value being lower than amortized cost. Furthermore, Susquehanna assesses servicing assets for impairment or increased obligation based on fair value at each reporting date.
Susquehanna considers its servicing assets to be immaterial items and therefore has not applied the disclosure provisions of FAS No. 156.
Income Taxes. Deferred income taxes reflect the temporary tax consequences on future years of differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.
Earnings per Common Share.Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares relate to outstanding stock options, restricted stock, and stock warrants and are determined using the treasury stock method.
Recently Adopted Accounting Pronouncements.
In December 2008, the Financial Accounting Standards Board issuedFASB Staff Position FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” FASB Staff Position FAS 140-4 and FIN 46(R)-8 amends FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require public entities to provide additional disclosures about transfers of financial assets. It also amends FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities,” to require public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. Additionally, this FSP requires certain disclosures to be provided by a public enterprise that is (a) a sponsor of a qualifying special purpose entity (SPE) that holds a variable interest in the qualifying SPE but was not the transferor of financial assets to the qualifying SPE and (b) a servicer of a qualifying SPE that holds a significant variable interest in the qualifying SPE but was not the transferor of financial assets to the qualifying SPE. The disclosures required by this FSP are intended to provide greater transparency to financial statement users about the transferor’s continuing involvement with transferred financial assets and an enterprise’s involvement with variable interest entities and qualifying SPEs. This FSP was effective for the first reporting period ending after December 15, 2008. See Note 21 for the disclosures required by this FSP.
In October 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.”FSP No. FAS 157-3 clarifies the application of FAS No. 157, “Fair Value Measurements,” in a market that is not active and was effective upon issuance. Adoption of this FSP has had no material impact on results of operations and financial condition.
In September 2008, the Financial Account Standards Board issuedFASB Staff Position FSP No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.”This FSP is intended to improve disclosures about credit derivatives by requiring more
82
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
information about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives. It amends FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. The FSP also amends FAS Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others,” to require additional disclosure about the current status of the payment/performance risk of a guarantee. The provisions of the FSP than amend FAS No. 133 and Fin 45 are effective for reporting periods (annual or interim) that ended after November 15, 2008. Finally, the FSP clarifies that the disclosures required by FAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” should be provided for any reporting period (annual or interim) beginning after November 5, 2008. This clarification was effective upon issuance of the FSP. Adoption of this FSP has had no material impact on results of operations and financial condition.
In May 2008, the Financial Accounting Standards Board issuedStatement No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” Statement No. 162 improves financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. Statement No. 162 was effective in November 2008. Adoption of this Statement has had no material impact on results of operations and financial condition.
In March 2008, the Financial Accounting Standards Board issuedStatement No. 161, “Disclosures about Derivative Instruments and Hedging Activities.” Statement No. 161 requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also requires disclosure of derivative features that are credit risk-related and cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. Statement No. 161 is effective for financial statements issued for fiscal year and interim periods beginning after November 15, 2008, with early application encouraged. See Note 22, for the disclosures required by this Statement.
In February 2008, the Financial Accounting Standards Board issued FASB Staff Position No. FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13.”FSP No. FAS 157-1 amends Statement No. 157, “Fair Value Measurements,” to exclude Statement No. 13, “Accounting for Leases,” and other pronouncements that address fair value measurements for purposes of lease classification or measurement under Statement No. 13. However, this scope exception does not apply to assets acquired and liabilities assumed in a business combination that are required to be measured at fair value under Statement No. 141, “Business Combinations,” or Statement No. 141(R), “Business Combinations,” regardless of whether those assets and liabilities are related to leases. Adoption of this FSP has had no material impact on results of operations and financial condition.
In February 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157.”FSP No. FAS 157-2 delays the effective date of FAS No. 157, “Fair Value Measurements,” for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. This FSP was effective upon issuance. Adoption of this FSP has had no material impact on results of operations and financial condition.
83
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
In February 2007, the Financial Accounting Standards Board issuedStatement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Statement No. 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. Statement No. 159 was effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Adoption of this Statement has had no material impact on results of operations and financial condition. Since the adoption date, Susquehanna has made no elections to use fair value as an alternative measurement for selected financial assets and liabilities not previously carried at fair value.
In September 2006, the Financial Accounting Standards Board issuedStatement No. 157, “Fair Value Measurements.” Statement No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. While Statement No. 157 does not require any new fair value measurements, the application of this Statement will change current practice for some entities. Statement No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. See Note 23 for the disclosures required by this Statement. Adoption of this Statement has had no material impact on results of operation and financial condition.
In December 2007, The Securities and Exchange Commission issuedStaff Accounting Bulletin 110.SAB 110 allows companies to continue using the simplified method of estimating the expected-term assumption for “plain vanilla” stock options in certain circumstances. Susquehanna uses historical employee exercise patterns to provide a reasonable basis for estimating its expected-term assumption; and therefore, this SAB has no impact on its results of operations and financial condition.
In September 2006, the Financial Accounting Standards Board reached a consensus onEmerging Issues Task Force Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” Issue 06-4 requires an employer to recognize a liability for future benefits in accordance with FAS No. 106, if, in substance, a postretirement benefit plan exists. The consensus on this Issue was effective for fiscal years beginning after December 15, 2007. Entities were to recognize the effects of applying the consensus in this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. Susquehanna is a party to split-dollar life insurance arrangements and has elected to recognize the effects of applying this consensus through a cumulative-effect adjustment to retained earnings of $2,488.
In September 2006, the Financial Accounting Standards Board issuedStatement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” Statement No. 158 requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes are reported in comprehensive income. The requirement to recognize the funded status of a benefit plan and the related disclosure requirements were effective for the fiscal year ending after December 15, 2006. For information regarding the impact of FAS No. 158 on Susquehanna’s financial position, see Footnote 17. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of position was effective for fiscal years ending after December 15, 2008. Susquehanna has measured plan assets and benefit obligations as of the end of its fiscal year.
84
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Recently Issued Accounting Pronouncements.
In June 2008, the Financial Accounting Standards Board issuedFASB Staff Position FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-based Payment Transactions are Participating Securities.” FSP EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. All prior-period EPS data presented shall be adjusted retrospectively (including interim financial statements, summaries of earnings, and selected financial data) to conform with the provisions of this FSP. Early application is not permitted. Susquehanna has granted share-based payment awards that contain nonforfeitable rights to dividends; however, Susquehanna has determined that their effect on the computation of EPS is immaterial.
In April 2008, the Financial Accounting Standards Board issuedFASB Staff Position FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets.”FSP No. FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FAS No. 142, Goodwill and Other Intangible Assets.” FSP No. FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Susquehanna is evaluating the impact of FSP No. FAS 142-3.
In February 2008, the Financial Accounting Standards Board issuedFASB Staff Position No. FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.”FSP No. FAS 140-3 provides guidance on arepurchase financing,which is a repurchase agreement that relates to a previously transferred financial asset between the same counterparties, that is entered into contemporaneously with, or in contemplation of, the initial transfer. FSP No. FAS 140-3 is effective for financial statements issued for fiscal years beginning after November 15, 2009, and interim periods within those fiscal years. Earlier application is not permitted. Susquehanna is evaluating the impact of this FSP.
In December 2007, the Financial Accounting Standards Board issued Statement No. 141(R), “Business Combinations.” Statement No. 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Statement No. 141(R) is effective for fiscal years beginning after December 15, 2008. Susquehanna is evaluating the impact of Statement No. 141(R).
In December 2007, the Financial Accounting Standards Board issuedStatement No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” Statement No. 160 requires that a reporting entity provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. Statement No. 160 is effective for fiscal years beginning after December 15, 2008. Susquehanna is evaluating the impact of Statement No. 160.
2. Acquisitions
Stratton Holding Company
On April 30, 2008, Susquehanna completed the acquisition of Stratton Holding Company, an investment management company based in Plymouth Meeting, Pennsylvania with approximately $3,000,000 in assets under management. Stratton became a wholly owned subsidiary of Susquehanna Bancshares and part of the family of Susquehanna wealth management companies. The addition of Stratton brings increased diversification in
85
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Susquehanna’s investment expertise, including experience in mutual fund management. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in Susquehanna’s consolidated financial statements.
The acquisition of Stratton was considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
Community Banks, Inc.
On November 16, 2007, Susquehanna completed the acquisition of Community Banks, Inc. in a stock and cash transaction valued at $873,205. Under the terms of the merger agreement, shareholders of Community were entitled to elect to receive for each share of Community common stock that they owned, either $34.00 in cash or 1.48 shares of Susquehanna common stock. The acquisition expanded Susquehanna’s territory into the Harrisburg market and deepened its foundation in central Pennsylvania. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in Susquehanna’s consolidated financial statements.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. However, since the acquisition occurred in the fourth quarter of 2007, net adjustments increasing goodwill totaling $9,382 were made in 2008, as additional information became available.
| | | |
| | | Unaudited |
Assets | | | |
Cash and cash equivalents | | $ | 232,628 |
Securities | | | 664,334 |
Loans and leases, net of allowance of $19,119 | | | 2,574,830 |
Premises and other equipment | | | 63,586 |
Goodwill and other intangibles | | | 655,987 |
Deferred taxes | | | 20,816 |
Other assets | | | 99,800 |
| | | |
Total assets acquired | | $ | 4,311,981 |
| | | |
Liabilities | | | |
Deposits | | $ | 2,830,408 |
Borrowings | | | 588,376 |
Other liabilities | | | 19,992 |
| | | |
Total liabilities assumed | | | 3,438,776 |
| | | |
Net assets acquired | | $ | 873,205 |
| | | |
Presented below is certain unaudited pro forma information for the years ended December 31, 2007 and 2006, as if Community had been acquired on January 1, 2007 and 2006. These results combine the historical results of Community, including the termination of certain employee benefit programs and costs incurred in connection with the merger, with Susquehanna’s consolidated statements of income and, while certain adjustments were made for the estimated impact of purchase accounting adjustments, they are not necessarily indicative of what would have occurred had the acquisition taken place on the indicated dates.
86
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
| | | | | | | | | |
| | | For the Year Ended
December 31, |
| | | 2008
Actual | | 2007
Pro Forma | | 2006
Pro Forma |
Net income available to common shareholders | | $ | 81,814 | | $ | 89,921 | | $ | 130,029 |
Basic EPS | | $ | 0.95 | | $ | 1.05 | | $ | 1.55 |
Diluted EPS | | $ | 0.95 | | $ | 1.05 | | $ | 1.54 |
Widmann, Siff & Co., Inc.
On August 1, 2007, Susquehanna acquired Widmann, Siff & Co. Inc., an investment advisory firm in Radnor, Pennsylvania. Widman, Siff had more that $300,000 in assets under management, including accounts serving individuals, pension and profit-sharing plans, corporations, and family trusts. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in Susquehanna’s consolidated financial statements.
The acquisition of Widmann, Siff was considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
Minotola National Bank
On April 21, 2006, Susquehanna acquired Minotola National Bank in a stock and cash transaction valued at approximately $172,000. The acquisition of Minotola, with total assets of $607,000 and fourteen branch locations, provided Susquehanna with an opportunity to expand its franchise into high-growth markets in southern New Jersey. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in Susquehanna’s consolidated financial statements.
The acquisition of Minotola is considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”
3. Short-term Investments
The book values of short-term investments and weighted-average interest rates on December 31, 2008 and 2007, were as follows:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | Book
Value | | Rates | | | Book
Value | | Rates | |
Interest-bearing deposits in other banks | | $ | 53,149 | | 1.59 | % | | $ | 71,890 | | 4.54 | % |
Money market funds | | | 64,214 | | 0.50 | | | | 66,660 | | 3.70 | |
Commercial paper purchased | | | 1,997 | | 0.20 | | | | 4,734 | | 4.06 | |
| | | | | | | | | | | | |
Total | | $ | 119,360 | | | | | $ | 143,284 | | | |
| | | | | | | | | | | | |
87
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
4. Investment Securities
The amortized cost and fair values of investment securities at December 31, 2008 and 2007, were as follows:
| | | | | | | | | | | | |
| | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair Value |
At December 31, 2008 | | | | | | | | | | | | |
Available-for-Sale: | | | | | | | | | | | | |
U.S. Government agencies | | $ | 427,905 | | $ | 16,117 | | $ | 0 | | $ | 444,022 |
Obligations of states and political subdivisions | | | 316,829 | | | 1,787 | | | 10,070 | | | 308,546 |
Mortgage-backed securities | | | 1,047,787 | | | 20,973 | | | 102,907 | | | 965,853 |
Other debt securities | | | 28,784 | | | 0 | | | 22,420 | | | 6,364 |
Equity securities | | | 147,681 | | | 306 | | | 2,026 | | | 145,961 |
| | | | | | | | | | | | |
| | | 1,968,986 | | | 39,183 | | | 137,423 | | | 1,870,746 |
| | | | | | | | | | | | |
Held-to-Maturity: | | | | | | | | | | | | |
Other | | | 4,550 | | | 0 | | | 0 | | | 4,550 |
State and municipal | | | 4,595 | | | 0 | | | 0 | | | 4,595 |
| | | | | | | | | | | | |
| | | 9,145 | | | 0 | | | 0 | | | 9,145 |
| | | | | | | | | | | | |
Total investment securities | | $ | 1,978,131 | | $ | 39,183 | | $ | 137,423 | | $ | 1,879,891 |
| | | | | | | | | | | | |
At December 31, 2007 | | | | | | | | | | | | |
Available-for-Sale: | | | | | | | | | | | | |
U.S. Government agencies | | $ | 523,258 | | $ | 9,807 | | $ | 46 | | $ | 533,019 |
Obligations of states and political subdivisions | | | 266,982 | | | 2,250 | | | 599 | | | 268,633 |
Mortgage-backed securities | | | 1,071,001 | | | 11,150 | | | 3,750 | | | 1,078,401 |
Other debt securities | | | 78,333 | | | 158 | | | 10,264 | | | 68,227 |
Equity securities | | | 111,289 | | | 463 | | | 871 | | | 110,880 |
| | | | | | | | | | | | |
| | | 2,050,863 | | | 23,828 | | | 15,530 | | | 2,059,160 |
Held-to-Maturity: | | | | | | | | | | | | |
State and municipal | | | 4,792 | | | 0 | | | 0 | | | 4,792 |
| | | | | | | | | | | | |
Total investment securities | | $ | 2,055,655 | | $ | 23,828 | | $ | 15,530 | | $ | 2,063,952 |
| | | | | | | | | | | | |
At December 31, 2008 and 2007, investment securities with carrying values of $1,318,894 and $1,424,965, respectively, were pledged to secure public funds and for other purposes as required by law.
At December 31, 2008, Susquehanna’s portfolio included two investment securities that were rated below investment grade. The aggregate book value and aggregate fair value of these securities was $7,950 and $1,711, respectively. At December 31, 2007, Susquehanna’s holdings of investment securities that were rated below investment grade were considered insignificant.
88
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The amortized cost and fair value of U.S. Government agencies, obligations of states and political subdivisions, other debt securities, and mortgage-backed securities, at December 31, 2008, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | |
| | | Amortized
Cost | | Fair
Value |
Securities available-for-sale: | | | | | | |
Within one year | | $ | 25,908 | | $ | 25,964 |
After one year but within five years | | | 426,671 | | | 438,154 |
After five years but within ten years | | | 159,776 | | | 161,773 |
After ten years | | | 1,208,950 | | | 1,098,894 |
| | | | | | |
| | | 1,821,305 | | | 1,724,785 |
| | | | | | |
Securities held-to-maturity: | | | | | | |
Within one year | | | 0 | | | 0 |
After one year but within five years | | | 0 | | | 0 |
After five years but within ten years | | | 0 | | | 0 |
After ten years | | | 9,145 | | | 9,145 |
| | | | | | |
| | | 9,145 | | | 9,145 |
| | | | | | |
Total debt securities | | $ | 1,830,450 | | $ | 1,733,930 |
| | | | | | |
The gross realized gains and gross realized losses on investment securities transactions are summarized below.
| | | | | | | |
| | | Available-
for-Sale | | | Held-to-
Maturity |
For the year ended December 31, 2008 | | | | | | | |
Gross gains | | $ | 240 | | | $ | 0 |
Gross losses | | | 17,554 | | | | 0 |
| | | | | | | |
Net losses | | ($ | 17,314 | ) | | $ | 0 |
| | | | | | | |
For the year ended December 31, 2007 | | | | | | | |
Gross gains | | $ | 218 | | | $ | 0 |
Gross losses | | | 12,075 | | | | 0 |
| | | | | | | |
Net losses | | ($ | 11,857 | ) | | $ | 0 |
| | | | | | | |
For the year ended December 31, 2006 | | | | | | | |
Gross gains | | $ | 1,095 | | | $ | 0 |
Gross losses | | | 2,044 | | | | 0 |
| | | | | | | |
Net losses | | ($ | 949 | ) | | $ | 0 |
| | | | | | | |
89
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The following table presents Susquehanna’s investments’ gross unrealized losses and the corresponding fair values by investment category and length of time that the securities have been in a continuous unrealized loss position, at December 31, 2008 and 2007.
| | | | | | | | | | | | | | | | | | |
| | | Less than 12 Months | | 12 Months or More | | Total |
December 31, 2008 | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
U.S. Government Agencies | | $ | 0 | | $ | 0 | | $ | 0 | | $ | 0 | | $ | 0 | | $ | 0 |
States and political subdivisions | | | 218,184 | | | 9,842 | | | 1,586 | | | 228 | | | 219,770 | | | 10,070 |
Mortgage-backed securities | | | 316,874 | | | 102,907 | | | 0 | | | 0 | | | 316,874 | | | 102,907 |
Other debt securities | | | 2,396 | | | 1,812 | | | 3,968 | | | 20,608 | | | 6,364 | | | 22,420 |
Equity securities | | | 1,111 | | | 443 | | | 19,462 | | | 1,583 | | | 20,573 | | | 2,026 |
| | | | | | | | | | | | | | | | | | |
| | $ | 538,565 | | $ | 115,004 | | $ | 25,016 | | $ | 22,419 | | $ | 563,581 | | $ | 137,423 |
| | | | | | | | | | | | | | | | | | |
| | | |
| | | Less than 12 Months | | 12 Months or More | | Total |
December 31, 2007 | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses | | Fair
Value | | Unrealized
Losses |
U.S. Government Agencies | | $ | 550 | | $ | 1 | | $ | 31,136 | | $ | 45 | | $ | 31,686 | | $ | 46 |
States and political subdivisions | | | 51,144 | | | 397 | | | 18,440 | | | 202 | | | 69,584 | | | 599 |
Mortgage-backed securities | | | 1,121 | | | 1,643 | | | 184,182 | | | 2,107 | | | 185,303 | | | 3,750 |
Other debt securities | | | 47,961 | | | 10,217 | | | 17,438 | | | 47 | | | 65,399 | | | 10,264 |
Equity securities | | | 2,589 | | | 502 | | | 16,710 | | | 369 | | | 19,299 | | | 871 |
| | | | | | | | | | | | | | | | | | |
| | $ | 103,365 | | $ | 12,760 | | $ | 267,906 | | $ | 2,770 | | $ | 371,271 | | $ | 15,530 |
| | | | | | | | | | | | | | | | | | |
In September 2008, Susquehanna recorded a pre-tax impairment charge of $17,550 related to two synthetic collateralized debt obligations held in its investment portfolio. Each security has a par value of $10,000 and one hundred underlying reference companies. Through August 31, 2008, there were no credit events (i.e. bankruptcies, conservatorships, or receiverships) related to any of the reference companies. However, given the significant developments that have affected the market, a number of credit events reduced the fair value of one security to 12.5% of par at September 30, 2008, and the fair value of the other security to 12.0% of par at September 30, 2008. Susquehanna believes that it is probable that it will be unable to collect all amounts due according to the contractual terms of these securities. At December 31, 2008, one security was given a below-investment-grade rating by the rating agencies, while the other security was rated BBB-. These are the only two securities of this type that Susquehanna currently holds in its investment portfolio.
In May and June of 2007, while planning for the Community acquisition and the resulting growth and composition of the investment portfolio, management performed a comprehensive review of the available-for-sale investments. Management determined that for administrative and operational purposes, small remaining portions in mortgage-backed securities (“odd lots,” or securities with remaining par amounts of less than $2,000) should be sold. These odd lots, totaling $182,000, resulted from previous mergers and bank consolidations and from principal amortization over time. Additionally, Susquehanna determined that all collateralized mortgage obligations, regardless of the remaining par amount, with an aggregate total of $51,000 should be sold. Many of these mortgage obligations were acquired in the historic low-interest-rate environment of 2002 through 2004. The restructuring involved the sale of approximately 16.0% of our available-for-sale investment portfolio, and resulted in a pre-tax charge of approximately $11,800.
90
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
In December 2006, Susquehanna recognized an other-than-temporary impairment of $954 related to Susquehanna’s Corporate Investment Committee’s decision to implement a modest restructuring program of its Federal Agency debenture portfolio in 2007. This restructuring program included the January 2007 sale of Federal Agency debentures classified as available for sale with an aggregate book value of $78,992 and unrealized losses of $954 at December 31, 2006.
At December 31, 2008, gross unrealized losses in Susquehanna’s available-for-sale investment portfolio totaled $137,423. Included in this total are gross unrealized losses of $102,907 related to mortgage-backed securities that have been in a continuous unrealized loss position for less than twelve months and gross unrealized losses of $20,608 related to other debt securities that have been in a continuous unrealized loss position for more than twelve months.
Mortgage-backed securities include issues of the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association, and $396,303 of other non-agency issuers. Of the non-agency issues, $321,231 were rated Triple A with the remainder being at least investment grade. None of Susquehanna’s mortgage-backed securities include subprime or Alt-A components, and management’s analysis of the underlying assets found that the unrealized losses in this category were caused principally by decreased liquidity and larger risk premiums in the marketplace.
Other debt securities are comprised of corporate synthetic collateralized debt obligations (discussed above) and pooled trust preferred securities. The bulk of the unrealized losses in this category were related to the pooled trust preferred securities, since the corporate synthetic collateralized debt obligations have been written down. Management believes that the unrealized losses on the pooled trust preferred securities were principally a result of decreased liquidity and larger risk premiums in the marketplace, and not deterioration in the creditworthiness of the underlying issuers.
While it is possible that, under certain conditions, defaults on these securities (excluding the two synthetic collateralized debt obligations previously discussed) could result in a loss of principal, Susquehanna presently does not believe that those conditions are probable. Therefore, based on Susquehanna’s ability and intent to hold its available-for-sale securities for a sufficient time to recover all amortized costs and the fact that Susquehanna has not identified any issues related to the ultimate repayment of contractual principal as a result of credit concerns, management has concluded that the reduction in the fair value of these securities, as well as any other individual security is temporary at this time.
5. Loans and Leases
Loans and leases, net of unearned income of $189,252 and $159,766 at December 31, 2008 and December 31, 2007, respectively, and net of deferred origination costs of $8,728 and $9,099 at December 31, 2008 and 2007, respectively, were as follows:
| | | | | | |
| | | 2008 | | 2007 |
Commercial, financial and agricultural | | $ | 2,169,262 | | $ | 1,781,981 |
Real estate—construction | | | 1,313,647 | | | 1,292,953 |
Real estate secured—residential | | | 2,298,709 | | | 2,151,923 |
Real estate secured—commercial | | | 2,875,502 | | | 2,661,841 |
Consumer | | | 314,051 | | | 411,159 |
Leases | | | 682,702 | | | 451,733 |
| | | | | | |
Total loans and leases | | $ | 9,653,873 | | $ | 8,751,590 |
| | | | | | |
Leases held for sale (included in “Leases,” above) | | $ | 0 | | $ | 238,351 |
Home equity loans held for sale (included in “Real estate secured—residential,” above) | | | 215,690 | | | 97,320 |
91
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
In September 2008, Susquehanna announced that, due to adverse market conditions, its previously disclosed plan to sell vehicle leases would not proceed. As a result, the vehicle leases held for sale at December 31, 2007 and those subsequently originated are now classified as held for investment.
Included in loans and leases are the aggregate balances of all overdrawn deposit accounts. These “loans” are evaluated under management’s current model for collectibility. At December 31, 2008 and 2007, the aggregate balances of overdrawn deposit accounts reclassified as loans were $3,415 and $5,655, respectively.
Net investment in direct financing leases was as follows:
| | | | | | | | |
| | | 2008 | | | 2007 | |
Minimum lease payments receivable | | $ | 443,703 | | | $ | 337,875 | |
Estimated residual value of leases | | | 318,850 | | | | 176,400 | |
Unearned income under lease contracts | | | (79,851 | ) | | | (62,542 | ) |
| | | | | | | | |
Total leases | | $ | 682,702 | | | $ | 451,733 | |
| | | | | | | | |
Substantially all of Susquehanna’s loans and leases are to enterprises and individuals in its market area. There is no concentration of loans to borrowers in any one industry, or related industries, that exceeds 10% of total loans.
Impaired Loans
Management performs quarterly reviews of Susquehanna’s commercial loans greater than $500 to identify impaired loans. The measurement of impaired loans is based upon the present value of expected future cash flows discounted at the historical effective interest rate, except where collateral-dependent loans can be reasonably measured for impairment based on the net realizable value of the collateral.
An analysis of impaired loans at December 31, 2008, 2007, and 2006, follows:
| | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
Impaired loans without a related reserve | | $ | 21,388 | | $ | 27,716 | | $ | 11,468 |
Impaired loans with a reserve | | | 62,092 | | | 13,033 | | | 8,620 |
| | | | | | | | | |
Total impaired loans | | $ | 83,480 | | $ | 40,749 | | $ | 20,088 |
| | | | | | | | | |
Reserve for impaired loans | | $ | 14,454 | | $ | 4,146 | | $ | 1,877 |
Average balance of impaired loans | | | 66,409 | | | 20,921 | | | 8,987 |
Interest income on impaired loans (cash basis) | | | 467 | | | 66 | | | 156 |
Interest income that would have been recorded under original terms | | | 5,462 | | | 1,811 | | | 1,641 |
Sale-leaseback Transaction
On January 12, 2007, Susquehanna exercised an early buyout option associated with Hann’s sale-leaseback transaction. As a result, Hann acquired approximately $78,400 of beneficial interests in automobile leases and related vehicles. A significant portion of these automobile leases and related vehicles was sold to Susquehanna’s banking subsidiaries and subsequently included in the February 2007 vehicle lease securitization transaction.
92
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
6. Allowance for Loan and Lease Losses
Changes in the allowance for loan and lease losses were as follows:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Balance - January 1, | | $ | 88,569 | | | $ | 62,643 | | | $ | 53,714 | |
Additions through acquisition | | | 0 | | | | 19,119 | (1) | | | 5,514 | (2) |
Provision charged to operating expense | | | 63,831 | | | | 21,844 | | | | 8,680 | |
Charge-offs | | | (45,230 | ) | | | (19,185 | ) | | | (11,116 | ) |
Recoveries | | | 6,579 | | | | 4,148 | | | | 5,851 | |
| | | | | | | | | | | | |
Net charge-offs | | | (38,651 | ) | | | (15,037 | ) | | | (5,265 | ) |
| | | | | | | | | | | | |
Balance - December 31, | | $ | 113,749 | | | $ | 88,569 | | | $ | 62,643 | |
| | | | | | | | | | | | |
| (1) | As part of the Community acquisition, Susquehanna recorded a $19,119 addition to the allowance for loan and lease losses in accordance with management’s evaluation of FAS No. 5. In addition, Susquehanna evaluated Community’s loan portfolio at the time of acquisition and identified loans for which there was evidence of deterioration of credit quality since origination, and for which it was probable that all contractually required payments would not be collected, in accordance with Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” and FAS No. 114, “Accounting by Creditors for Impairment of a Loan.” The contractually required payments receivable related to these loans totaled $16,350, and cash flows expected to be collected at acquisition totaled $8,985. Prepayments were not considered in the determination of cash flows expected to be collected. Susquehanna considers the current amount of loans accounted for under SOP 03-3 as immaterial and therefore has not presented the disclosures otherwise required by this guidance. |
| (2) | As part of the Minotola acquisition, Susquehanna recorded a $5,514 addition to the allowance for loan and lease losses. Susquehanna evaluated Minotola’s loan portfolio at the time of acquisition and did not identify any impaired loans as defined in SOP 03-3 and FAS No. 114. Therefore, as required by FAS No. 141, “Business Combinations,” Susquehanna recorded Minotola’s loan portfolio at present value, determined at the then current interest rates, net of the allowance for loan and lease losses in accordance with management’s evaluation of FAS No. 5. |
7. Premises and Equipment
Property, buildings, and equipment at December 31, were as follows:
| | | | | | |
| | | 2008 | | 2007 |
Land | | $ | 30,709 | | $ | 30,986 |
Buildings | | | 120,260 | | | 125,646 |
Furniture and equipment | | | 100,253 | | | 95,008 |
Leasehold improvements | | | 30,876 | | | 25,145 |
Land improvements | | | 3,335 | | | 3,257 |
| | | | | | |
| | | 285,433 | | | 280,042 |
Less: accumulated depreciation and amortization | | | 112,164 | | | 100,302 |
| | | | | | |
| | $ | 173,269 | | $ | 179,740 |
| | | | | | |
Depreciation and amortization expense charged to operations totaled $15,874 in 2008, $11,541 in 2007, and $9,803 in 2006.
93
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
All subsidiaries lease certain banking branches and equipment under operating leases that expire on various dates through 2030. Renewal options generally are available for periods up to 10 years. Minimum future rental commitments under non-cancelable leases, as of December 31, 2008, were as follows:
| | | |
| | | Operating
Leases |
2009 | | $ | 13,212 |
2010 | | | 12,213 |
2011 | | | 10,578 |
2012 | | | 9,489 |
2013 | | | 8,675 |
Subsequent years | | | 68,274 |
| | | |
| | $ | 122,441 |
| | | |
Rent expense charged to operations totaled $12,139 in 2008, $8,944 in 2007, and $7,953 in 2006.
8. Goodwill and Other Intangible Assets
The gross carrying amounts and accumulated amortization of amortizing identifiable intangible assets as of December 31, 2008 and 2007 were as follows:
| | | | | | | | | | | | | | |
| | | December 31, 2008 | | | December 31, 2007 | |
| | | Gross Carrying
Amount | | Accumulated
Amortization | | | Gross Carrying
Amount | | Accumulated
Amortization | |
Amortizing intangible assets: | | | | | | | | | | | | | | |
Core deposit intangibles | | $ | 59,199 | | ($ | 18,399 | ) | | $ | 59,199 | | ($ | 9,744 | ) |
Customer lists | | | 15,900 | | | (2,874 | ) | | | 9,467 | | | (702 | ) |
Favorable lease adjustments | | | 393 | | | (342 | ) | | | 393 | | | (339 | ) |
Non-compete agreements | | | 400 | | | (233 | ) | | | 0 | | | 0 | |
| | | | | | | | | | | | | | |
Total | | $ | 75,892 | | ($ | 21,848 | ) | | $ | 69,059 | | ($ | 10,785 | ) |
| | | | | | | | | | | | | | |
In 2008, as a result of the Stratton acquisition, $7,330 was recognized as a customer list intangible that is being amortized over 10 years.
In 2007, as a result of the Community acquisition, $35,154 was recognized as a core deposit intangible that is being amortized over 10 years, and $5,099 was recognized as customer list intangibles that are being amortized over 10 years. In addition, as a result of the Widmann Siff acquisition, $2,452 was recognized as a customer list intangible that is being amortized over 15 years.
In 2006, as a result of the Minotola acquisition, $10,053 was recognized as a core deposit intangible that is being amortized over 10 years.
94
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The following is the activity in the goodwill account during the periods presented:
| | | | |
Goodwill at January 1, 2007 | | $ | 335,005 | |
Goodwill acquired through the Community acquisition | | | 606,071 | (1) |
Goodwill acquired through the Widmann Siff acquisition | | | 736 | |
Additional goodwill related to contingent earn-out agreement associated with the Addis acquisition | | | 2,000 | |
Additional goodwill related to contingent earn-out agreement associated with the Brandywine acquisition | | | 1,172 | |
Other | | | 97 | |
| | | | |
Goodwill at December 31, 2007 | | | 945,081 | |
Goodwill acquired through the Stratton acquisition | | $ | 63,088 | |
Adjustments to goodwill acquired through the Community acquisition | | | 9,382 | |
| | | | |
Goodwill at December 31, 2008 | | $ | 1,017,551 | |
| | | | |
| (1) | Nondeductible for income tax purposes. |
Susquehanna tests goodwill for impairment on an annual basis, or more often if events or circumstances indicate that there may be an impairment. Susquehanna performed its annual goodwill impairment test as of May 31, 2008 and determined that there was no impairment. However, given the continuing downturn in the economy and overall market conditions since that time and the fact that Susquehanna’s market capitalization has been below the book value of its equity, Susquehanna decided an interim goodwill impairment test was required under FAS No. 142 as of December 31, 2008. This test requires significant judgment and analysis.
Susquehanna’s goodwill impairment test begins with a comparison between the fair value of the underlying reporting unit and its carrying amount (book value), including goodwill. If the estimated fair value is less than the carrying value, it is likely that an impairment has occurred.
Based upon our analyses at May 31 and December 31, 2008, fair value of each of Susquehanna’s reporting units exceeded their book value, and there was no goodwill impairment. However, due to the ongoing turmoil in market conditions, Susquehanna will continue to monitor and evaluate the carrying value of goodwill for possible future impairment.
The following table sets forth the actual and estimated pre-tax amortization expense for amortizing intangible assets.
| | | |
Aggregate Amortization Expense for the Year Ended December 31: | | | |
2008 | | $ | 11,062 |
Estimated Amortization Expense for the Year Ended December 31: | | | |
2009 | | $ | 10,390 |
2010 | | | 9,310 |
2011 | | | 8,403 |
2012 | | | 7,152 |
2013 | | | 6,243 |
95
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
9. Deposits
Deposits at December 31 were as follows:
| | | | | | |
| | | 2008 | | 2007 |
Noninterest-bearing: | | | | | | |
Demand | | $ | 1,201,416 | | $ | 1,292,791 |
Interest-bearing: | | | | | | |
Interest-bearing demand | | | 2,528,475 | | | 2,830,025 |
Savings | | | 695,275 | | | 713,984 |
Time | | | 3,045,653 | | | 2,750,867 |
Time of $100 or more | | | 1,595,674 | | | 1,357,452 |
| | | | | | |
Total deposits | | $ | 9,066,493 | | $ | 8,945,119 |
| | | | | | |
10. Borrowings
Short-Term Borrowings
Short-term borrowings and weighted-average interest rates, at December 31, were as follows:
| | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | Amount | | Rate | | | Amount | | Rate | | | Amount | | Rate | |
Securities sold under repurchase agreements | | $ | 375,317 | | 0.88 | % | | $ | 387,158 | | 2.79 | % | | $ | 249,728 | | 4.04 | % |
Federal funds purchased | | | 480,000 | | 0.30 | | | | 178,000 | | 3.74 | | | | 150,000 | | 5.30 | |
Treasury tax and loan notes | | | 4,902 | | 0.00 | | | | 3,254 | | 4.00 | | | | 2,236 | | 5.00 | |
Term auction facility | | | 50,000 | | 0.28 | | | | 0 | | | | | | 0 | | | |
| | | | | | | | | | | | | | | | | | |
| | $ | 910,219 | | | | | $ | 568,412 | | | | | $ | 401,964 | | | |
| | | | | | | | | | | | | | | | | | |
Securities sold under agreements to repurchase are classified as secured short-term borrowings. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The securities underlying the repurchase agreements remain in available-for-sale investment securities.
Additional information pertaining to securities sold under repurchase agreements follows:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Average amounts outstanding | | $ | 391,898 | | | $ | 275,135 | | | $ | 219,327 | |
Average interest rate | | | 1.46 | % | | | 3.58 | % | | | 3.73 | % |
Maximum amount outstanding at any month end | | $ | 487,386 | | | $ | 442,958 | | | $ | 295,757 | |
96
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Federal Home Loan Bank Borrowings
| | | | | | |
December 31, | | 2008 | | 2007 |
Due 2008, 2.70% to 5.50% | | $ | 0 | | $ | 187,720 |
Due 2009, 1.942% to 5.50% | | | 139,996 | | | 195,107 |
Due 2010, 2.273% to 6.06% | | | 121,544 | | | 96,113 |
Due 2011, 2.84% to 4.98% | | | 115,377 | | | 40,465 |
Due 2012, 3.25% to 4.60% | | | 221,048 | | | 221,043 |
Due 2013 through 2014, 3.50% to 6.51% | | | 233,185 | | | 164,557 |
Due 2015, 3.75% to 5.22% | | | 149,078 | | | 149,525 |
Due 2016 through 2026, 4.14% to 6.0% | | | 89,556 | | | 91,229 |
| | | | | | |
| | $ | 1,069,784 | | $ | 1,145,759 |
| | | | | | |
Susquehanna Bank is a member of the Federal Home Loan Bank of Pittsburgh and, as such, can take advantage of FHLB programs for overnight and term advances at published daily rates. Under the terms of a blanket collateral agreement, advances from the FHLB are collateralized by qualifying first mortgages. In addition, all of the bank’s stock in the FHLB is pledged as collateral for such debt. Advances available under this agreement are limited by available and qualifying collateral and the amount of FHLB stock held by the borrower.
Under this program, Susquehanna’s banking subsidiary had line-of-credit availability of $2,772,422 and $3,344,009 at December 31, 2008 and 2007, respectively. Excluding purchase-accounting adjustments, $1,068,472 and $1,144,378 was outstanding at December 31, 2008 and 2007, respectively. At December 31, 2008, Susquehanna Bank could have borrowed an additional $1,079,200 based on qualifying collateral, and $624,750 more could have been borrowed provided that additional collateral would have been pledged. Such additional borrowings would have required the bank to increase its investment in FHLB stock by approximately $27,440.
Long-Term Debt and Junior Subordinated Debentures(1)
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | |
| | | Amount | | Rate | | | Amount | | Rate | |
Subordinated notes due 2012 | | $ | 75,000 | | 6.05 | % | | $ | 75,000 | | 6.05 | % |
Subordinated notes due 2014 | | | 75,000 | | 4.75 | | | | 75,000 | | 4.75 | |
Subordinated note due 2018 | | | 25,000 | | 5.93 | (6) | | | 0 | | 0.00 | |
Other | | | 1,284 | | 3.75 | | | | 303 | | 4.31 | |
Junior subordinated notes due 2027 | | | 16,760 | | 9.80 | (2) | | | 16,252 | | 8.55 | (2) |
Junior subordinated notes due 2032 | | | 5,842 | | 7.10 | (2) | | | 5,704 | | 8.76 | (2) |
Junior subordinated notes due 2036 | | | 51,547 | | 6.39 | (3) | | | 50,000 | | 6.39 | (3) |
Junior subordinated notes due 2057 | | | 125,000 | | 9.38 | (4) | | | 125,000 | | 9.38 | (4) |
Junior subordinated notes due 2033 | | | 15,464 | | 7.08 | (2) | | | 15,001 | | 8.59 | (5) |
Junior subordinated notes due 2033 | | | 15,464 | | 6.90 | (2) | | | 14,940 | | 8.07 | (5) |
Junior subordinated notes due 2036 | | | 9,909 | | 7.99 | (2) | | | 9,430 | | 6.35 | (5) |
Junior subordinated notes due 2036 | | | 9,116 | | 7.84 | (2) | | | 8,663 | | 6.44 | (5) |
Junior subordinated notes due 2037 | | | 19,603 | | 7.95 | (2) | | | 18,692 | | 6.53 | (5) |
Junior subordinated notes due 2033 | | | 3,093 | | 6.95 | (2) | | | 3,000 | | 6.65 | (5) |
| | | | | | | | | | | | |
| | $ | 448,082 | | | | | $ | 416,985 | | | |
| | | | | | | | | | | | |
97
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
| (1) | The notes, except “Other,” require interest-only payments throughout their term with the entire principal balance paid at maturity. |
| (2) | Reflects the effect of purchase accounting adjustments. |
| (3) | On April 19, 2006, Susquehanna completed a private placement to an institutional investor of $50,000 of fixed/floating rate trust preferred securities through a newly formed Delaware trust affiliate, Susquehanna TP Trust 2006-1. The trust preferred securities mature in June 2036, are redeemable at Susquehanna’s option beginning after five years, and bear interest initially at a rate of 6.392% per annum through the interest payment date in June 2011 and, after the interest payment date in June 2011, at a rate per annum equal to the three-month LIBOR plus 1.33%. The proceeds from the sale of the trust preferred securities were used by the Trust to purchase Susquehanna’s fixed/floating rate junior subordinated notes. The net proceeds from the sale of the notes were used to finance the acquisition of Minotola National Bank. |
| (4) | On December 12, 2007, Susquehanna issued $125,000 of retail hybrid trust preferred notes through a newly formed Delaware statutory trust, Susquehanna Capital I. The only assets of the issuer are Capital Efficient Notes (“CENts”) issued by Susquehanna. The notes mature in December 2057, are redeemable at Susquehanna’s option beginning after five years, and bear interest initially at a rate of 9.375% per annum through the interest payment date in December 2037 and, after the interest payment date in December 2037, at a rate per annum equal to the three-month LIBOR plus 5.455%. The proceeds from the sale of the CENts were used to replenish cash reserves used to pay for the cash portion of the Community Banks acquisition and for general corporate purposes. |
| (5) | As a result of the Community acquisition, Susquehanna assumed subordinated debentures with a fair value of $69,726 issued by Community to five statutory trusts. The trust preferred securities issued by the trusts are callable on dates specified in the individual indentures. The notes are presented in this table at their fair values. |
| (6) | On December 31, 2008, Susquehanna issued a $25,000 subordinated note to another financial institution. The note bears interest at ninety-day LIBOR plus 4.5% and matures on December 31, 2018. |
11. Income Taxes
The components of the provision for income taxes are as follows:
| | | | | | | | | | | |
| | | 2008 | | | 2007 | | 2006 | |
Current: | | | | | | | | | | | |
Federal | | $ | 23,636 | | | $ | 24,131 | | $ | 13,342 | |
State | | | 3,460 | | | | 3,196 | | | 2,832 | |
| | | | | | | | | | | |
Total current | | | 27,096 | | | | 27,327 | | | 16,174 | |
| | | | | | | | | | | |
Deferred: | | | | | | | | | | | |
Federal | | | 1,632 | | | | 1,133 | | | 21,961 | |
State | | | (1,755 | ) | | | 211 | | | (206 | ) |
| | | | | | | | | | | |
Total deferred | | | (123 | ) | | | 1,344 | | | 21,755 | |
| | | | | | | | | | | |
Total income tax expense | | $ | 26,973 | | | $ | 28,671 | | $ | 37,929 | |
| | | | | | | | | | | |
98
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The provision for income taxes differs from the amount derived from applying the statutory income tax rate to income before income taxes as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | |
Provision at statutory rates | | $ | 38,352 | | | 35.00 | % | | $ | 34,217 | | | 35.00 | % | | $ | 42,548 | | | 35.00 | % |
Tax-advantaged income | | | (10,336 | ) | | (9.43 | ) | | | (6,313 | ) | | (6.42 | ) | | | (5,087 | ) | | (4.07 | ) |
Other, net | | | (1,043 | ) | | (0.96 | ) | | | 767 | | | 0.75 | | | | 468 | | | 0.27 | |
| | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 26,973 | | | 24.61 | % | | $ | 28,671 | | | 29.33 | % | | $ | 37,929 | | | 31.20 | % |
| | | | | | | | | | | | | | | | | | | | | |
As of December 31, 2008, Susquehanna has state net operating losses of $308,432, which begin to expire in 2012.
Accounting for income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax return. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
The components of the net deferred tax asset/(liability) as of December 31 were as follows:
| | | | | | | | |
| | | 2008 | | | 2007 | |
Deferred tax assets: | | | | | | | | |
Reserve for loan losses | | $ | 52,443 | | | $ | 36,162 | |
Deferred directors fees | | | 158 | | | | 190 | |
Deferred compensation | | | 6,378 | | | | 4,883 | |
Nonaccrual loan interest | | | 3,008 | | | | 1,633 | |
State net operating losses | | | 18,186 | | | | 8,709 | |
State alternative minimum tax credit carryover | | | 884 | | | | 884 | |
Post-retirement benefits | | | 3,986 | | | | 2,604 | |
Unrealized gains and losses | | | 32,325 | | | | (2,795 | ) |
Underfunded status of defined benefit pension or other postretirement benefit plans | | | 13,611 | | | | 4,927 | |
Other assets | | | 1,598 | | | | 1,250 | |
| | | | | | | | |
Total deferred tax assets | | | 132,577 | | | | 58,447 | |
| | | | | | | | |
Deferred tax liabilities: | | | | | | | | |
Prepaid pension expense | | | (9,565 | ) | | | (5,689 | ) |
Amortization of market value purchase adjustments | | | (10,720 | ) | | | (4,958 | ) |
Deferred loan costs | | | (4,201 | ) | | | (3,814 | ) |
Premises and equipment | | | (9,996 | ) | | | (2,440 | ) |
Lease transaction adjustments, net | | | (180,265 | ) | | | (174,192 | ) |
Deferred gain on sale of loans | | | (1,409 | ) | | | (2,479 | ) |
Other liabilities | | | (3,545 | ) | | | (951 | ) |
| | | | | | | | |
Total deferred tax liabilities | | | (219,701 | ) | | | (194,523 | ) |
| | | | | | | | |
Net deferred liability before valuation allowance | | | (87,124 | ) | | | (136,076 | ) |
Valuation allowance | | | (571 | ) | | | 0 | |
| | | | | | | | |
Net deferred tax liabilities | | ($ | 87,695 | ) | | ($ | 136,076 | ) |
| | | | | | | | |
99
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Uncertainty in Income Taxes
Susquehanna adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. There was no impact on Susquehanna’s financial position or results of operations as a result of the implementation of Interpretation No. 48. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
| | | | |
Balance at January 1, 2007 | | $ | 1,321 | |
Increase based on tax positions related to the current year | | | 915 | |
Increase for tax positions of prior years | | | 204 | |
Decrease for tax positions of prior years | | | (182 | ) |
Decrease related to settlements with taxing authorities | | | (231 | ) |
Decrease related to expiration of statute of limitations | | | (91 | ) |
| | | | |
Balance at December 31, 2007 | | | 1,936 | |
Increase based on tax positions related to the current year | | | 379 | |
Increase for tax positions of prior years | | | 658 | |
Decrease for tax positions of prior years | | | (565 | ) |
Decrease related to settlements with taxing authorities | | | 0 | |
Decrease related to expiration of statute of limitations | | | (168 | ) |
| | | | |
Balance at December 31, 2008 | | $ | 2,240 | |
| | | | |
Susquehanna had $2,240 of unrecognized tax benefits, of which $2,198, if recognized, would affect the effective tax rate.
Susquehanna does not anticipate a significant change to the total amount of unrecognized tax benefits within the next twelve months.
Susquehanna recognizes interest accrued and penalties related to unrecognized tax benefits in income tax expense. During the twelve months ended December 31, 2008 and 2007, Susquehanna recognized approximately $86 and $66 in interest and penalties and had accrued approximately $257 and $154 for the payment of interest and penalties, respectively.
Susquehanna and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, Susquehanna is no longer subject to U.S. federal, state, and local examinations by tax authorities before 2004. As of December 31, 2008, there are no federal or state examinations of Susquehanna’s tax returns in progress.
100
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
12. Accumulated Other Comprehensive Income
| | | | | | | | | | | | | | | | | | | |
| | | Unrealized
Gains (Losses)
on Securities | | | Unrealized
Gains on
Recorded
Interests in
Securitized
Assets | | Unrealized
Gains (Losses)
on Cash Flow
Hedges | | | Post-retirement
Benefits | | | Accumulated
Other
Comprehensive
Loss | |
Balance at January 1, 2007 | | ($ | 12,282 | ) | | $ | 1,541 | | $ | 538 | | | ($ | 9,373 | ) | | ($ | 19,576 | ) |
Current-period change | | | 17,708 | | | | 363 | | | (2,675 | ) | | | 222 | | | | 15,618 | |
| | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2007 | | $ | 5,426 | | | $ | 1,904 | | ($ | 2,137 | ) | | ($ | 9,151 | ) | | ($ | 3,958 | ) |
Current-period change | | | (69,250 | ) | | | 2,502 | | | 1,524 | | | | (16,128 | ) | | | (81,352 | ) |
| | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2008 | | ($ | 63,824 | ) | | $ | 4,406 | | ($ | 613 | ) | | ($ | 25,279 | ) | | ($ | 85,310 | ) |
| | | | | | | | | | | | | | | | | | | |
The information presented above is net of taxes at 35%.
13. Financial Instruments with Off-balance-sheet Credit Risk
Credit-Related Financial Instruments.Susquehanna is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to originate loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of condition. The contract or notional amount of those instruments reflects the extent of involvement Susquehanna has in particular classes of financial instruments.
Susquehanna’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the contractual amount of these instruments. Susquehanna uses the same credit policies for these instruments as it does for on-balance-sheet instruments.
Standby letters of credit are conditional commitments issued by Susquehanna to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment does not necessarily represent future cash requirements. Susquehanna evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Susquehanna upon extension of credit, is based upon management’s credit evaluation of the borrower.
Financial instruments whose contractual amounts represent off-balance-sheet credit risk at December 31, 2008 and 2007, were as follows:
| | | | | | |
| | | 2008 | | 2007 |
Standby letters of credit | | $ | 442,725 | | $ | 244,577 |
Real estate commitments | | | 699,435 | | | 780,025 |
Unused portion of home equity lines | | | 581,900 | | | 585,409 |
Commercial commitments | | | 823,875 | | | 861,991 |
Credit card lines | | | 3,975 | | | 4,485 |
101
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
14. Contingent Liabilities
There are no material proceedings to which Susquehanna or any of its subsidiaries are a party or by which, to Susquehanna’s knowledge, it, or any of its subsidiaries, are threatened. All legal proceedings presently pending or threatened against Susquehanna or its subsidiaries involve routine litigation incidental to the business of Susquehanna or the subsidiary involved and are not material in respect to the amount in controversy.
Susquehanna, from time-to-time and in the ordinary course of business, enters into guarantees of certain financial obligations. The total amounts outstanding at December 31, 2008 and 2007, respectively, on those guarantees were $0 and $29.
15. Capital Adequacy
Risk-based capital ratios, based upon guidelines adopted by bank regulators in 1989, focus upon credit risk. Assets and certain off-balance-sheet items are segmented into one of four broad risk categories and weighted according to the relative percentage of credit risk assigned by the regulatory authorities. Off-balance-sheet instruments are converted into a balance sheet credit equivalent before being assigned to one of the four risk-weight categories. To supplement the risk-based capital ratios, the regulators issued a minimum leverage ratio guideline (Tier 1 capital as a percentage of average assets less excludable intangibles).
Capital elements are segmented into two tiers. Tier 1 capital represents shareholders’ equity plus junior subordinated debentures, reduced by excludable intangibles. Tier 2 capital represents certain allowable long-term subordinated debt, the portion of the allowance for loan and lease losses and the allowance for credit losses on off-balance-sheet credit exposures equal to 1.25% of risk-adjusted assets, and 45% of the unrealized gain on equity securities. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.”
The following table illustrates these capital ratios for Susquehanna’s banking subsidiary and Susquehanna on a consolidated basis. Susquehanna and its banking subsidiary each have leverage and risk-weighted ratios in excess of regulatory minimums, and each entity is considered “well capitalized” under regulatory guidelines.
On October 10, 2008, Susquehanna merged Susquehanna Bank DV and Susquehanna Bank into Susquehanna Bank PA, which subsequently changed its name to Susquehanna Bank.
| | | | | | | | | |
At December 31, 2008 | | Tier I Capital
Ratio(1) | | | Total Capital
Ratio(2) | | | Leverage
Ratio(3) | |
Minimum Required Ratio | | 4.00 | % | | 8.00 | % | | 4.00 | % |
Susquehanna Bank | | 8.94 | | | 10.20 | | | 7.93 | |
Susquehanna Bancshares (consolidated) | | 11.17 | | | 13.52 | | | 9.92 | % |
| | | |
At December 31, 2007 | | Tier I Capital
Ratio(1) | | | Total Capital
Ratio(2) | | | Leverage
Ratio(3) | |
Minimum Required Ratio | | 4.00 | % | | 8.00 | % | | 4.00 | % |
Susquehanna Bank PA | | 9.36 | | | 10.33 | | | 12.93 | |
Susquehanna Bank DV | | 8.44 | | | 11.23 | | | 7.70 | |
Susquehanna Bank | | 8.46 | | | 10.71 | | | 7.94 | |
Susquehanna Bancshares (consolidated) | | 9.23 | % | | 11.31 | % | | 10.24 | % |
| (1) | Tier I capital divided by year-end risk-adjusted assets, as defined by the risk-based capital guidelines. |
| (2) | Total capital divided by year-end risk-adjusted assets. |
| (3) | Tier I capital divided by average total assets less disallowed intangible assets. |
102
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
16. Share-based Compensation
Susquehanna implemented an Equity Compensation Plan (“Compensation Plan”) in 1996 under which Susquehanna may have granted options to its employees and directors for up to 2,463 shares of common stock. Under the Compensation Plan, the exercise price of each nonqualified option equaled the market price of Susquehanna’s stock on the date of grant, and an option’s maximum term was ten years. Options were granted upon approval of the Board of Directors and typically vested one-third at the end of years three, four and five. The option prices ranged from a low of $13.00 to a high of $25.47. This Compensation Plan expired in 2006.
In May 2005, Susquehanna’s shareholders approved the 2005 Equity Compensation Plan (“the 2005 Plan”). Subject to adjustment in certain circumstances, the 2005 Plan authorizes up to 2,000 shares of common stock for issuance. Incentives under the 2005 Plan consist of incentive stock options, non-qualified stock options, restricted stock options, restricted stock grants, restricted stock unit grants, and stock appreciation rights. The exercise price of any stock option granted under the 2005 Plan is the fair market value of such stock on the date that option is granted, and the exercise period may not exceed ten years. Options typically vest one-third at the end of years three, four and five.
In November 2007, as part of the Community acquisition, Susquehanna assumed all Community option plans. Susquehanna will not grant any new options or awards under the Comminity option plans. All Community options became fully vested immediately prior to the effective date of the merger. At December 31, 2008, there were 21 unexercised options under the Community plans with exercise prices ranging from $16.57 to $19.56.
For the twelve months ended December 31, 2008, 2007, and 2006, share-based compensation expense totaling $1,873, $1,439, and $968, respectively, was included in salaries and employee benefits expense in the Consolidate Statements of Income.
The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton model. Expected volatilities are based on the historical volatility of Susquehanna stock, based on the monthly high stock price over the past ten years. The expected term of options granted is based upon historical exercise behavior of all employees and directors. The risk-free rate is based on zero coupon treasury rates in effect on the grant-date of the options. The following table presents the assumptions used to estimate the fair value of options granted in 2008, 2007, and 2006.
| | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Volatility | | 19.70 | % | | 20.59 | % | | 21.44 | % |
Expected dividend yield | | 4.50 | % | | 4.00 | % | | 3.80 | % |
Expected term (in years) | | 7.0 | | | 6.5 | | | 6.0 | |
Risk-free rate | | 3.33 | % | | 4.44 | % | | 4.30 | % |
103
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
A summary of option activity under the Plans as of December 31, 2008, and changes during the year then ended is presented below:
| | | | | | | | | | | |
| | | Options | | | Weighted-
average
Exercise
Price | | Weighted-
average
Remaining
Contractual
Term | | Aggregate
Intrinsic
Value |
Outstanding at January 1, 2008 | | 2,056 | | | $ | 22.54 | | | | | |
Granted | | 703 | | | | 21.82 | | | | | |
Forfeited | | (321 | ) | | | 23.69 | | | | | |
Exercised | | (78 | ) | | | 16.30 | | | | | |
| | | | | | | | | | | |
Outstanding at December 31, 2008 | | 2,360 | | | $ | 22.37 | | 6.5 | | $ | 234 |
| | | | | | | | | | | |
Exercisable at December 31, 2008 | | 989 | | | $ | 21.33 | | 3.8 | | $ | 234 |
The weighted-average grant-date fair value of options granted during the years 2008, 2007, and 2006 was $2.78, $4.08, and $4.24, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007, and 2006, was $491, $450, and $2,613, respectively.
A summary of the status of Susquehanna’s nonvested shares as of December 31, 2008, and changes during the year ended December 31, 2008, is presented below:
| | | | | | |
| | | Shares | | | Weighted-
average
Grant-date
Fair Value |
Nonvested at January 1, 2008 | | 900 | | | $ | 4.11 |
Granted | | 703 | | | | 2.78 |
Vested | | (95 | ) | | | 3.87 |
Forfeited | | (137 | ) | | | 4.56 |
| | | | | | |
Nonvested at December 31, 2008 | | 1,371 | | | | 3.50 |
| | | | | | |
As of December 31, 2008, there was $2,278 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized through 2013.
Cash received, net of withholding taxes paid on behalf of optionees electing cashless exercises, from option exercises under share-based-payment arrangements for the years ended December 31, 2008, 2007, and 2006, was $1,274, $1,026, and $6,811, respectively.
17. Benefit Plans
Pension Plan and Other Postretirement Benefits
Susquehanna maintains a single non-contributory defined benefit pension plan that covers substantially all full-time employees. The plan provides defined benefits based on years of service and final average salary. In addition, Susquehanna offers life insurance and certain medical benefits to its retirees. Susquehanna acquired Minotola National Bank on April 21, 2006, including its pension plan and other postretirement benefit obligations.
104
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Community Banks, Inc. maintained a defined benefit pension plan for employees of a predecessor bank that covered less than 20% of Community’s aggregate employee base prior to its acquisition by Susquehanna. During the third quarter of 2003, the board of directors of Community approved the curtailment of this pension plan. On January 1, 2008, the plan was merged into the Susquehanna plan.
Susquehanna also maintains a supplemental executive retirement plan (“SERP”) for selected participants. This plan provides for benefits lost under the defined benefit pension plan due to provisions in the Internal Revenue Code that limit the compensation and benefits under a qualified retirement plan.
A summary of the obligations and funded status of the plans at December 31, is as follows:
Obligations and Funded Status
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | | SERP | | | Other Postretirement
Benefits | |
At December 31 | | 2008 | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Change in Benefit Obligation | | | | | | | | | | | | | | | | | | | | | | | | |
Benefit obligation at beginning of year | | $ | 81,893 | | | $ | 77,745 | | | $ | 3,999 | | | $ | 3,667 | | | $ | 7,531 | | | $ | 9,220 | |
Service cost | | | 5,905 | | | | 3,706 | | | | 111 | | | | 103 | | | | 490 | | | | 383 | |
Interest cost | | | 5,329 | | | | 4,550 | | | | 243 | | | | 224 | | | | 632 | | | | 415 | |
Plan participants’ contributions | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 392 | | | | 205 | |
Change in plan provisions | | | 0 | | | | 60 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Actuarial (gain) loss | | | 3,759 | | | | (634 | ) | | | 191 | | | | 126 | | | | 603 | | | | (2,219 | ) |
Acquisition | | | 8,219 | | | | 0 | | | | 0 | | | | 0 | | | | 2,599 | | | | 0 | |
Benefits paid | | | (3,799 | ) | | | (3,534 | ) | | | (116 | ) | | | (121 | ) | | | (656 | ) | | | (473 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Benefit obligation at end of year | | $ | 101,306 | | | $ | 81,893 | | | $ | 4,428 | | | $ | 3,999 | | | $ | 11,591 | | | $ | 7,531 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Change in Plan Assets | | | | | | | | | | | | | | | | | | | | | | | | |
Fair value of plan assets at beginning of year | | $ | 84,907 | | | $ | 84,209 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | |
Actual return on plan assets | | | (12,344 | ) | | | 4,330 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Acquisition | | | 7,238 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Employer contributions | | | 15,000 | | | | 0 | | | | 116 | * | | | 120 | * | | | 264 | * | | | 267 | * |
Expenses | | | (42 | ) | | | (99 | ) | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Plan participants’ contributions | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 392 | | | | 205 | |
Benefits paid | | | (3,799 | ) | | | (3,533 | ) | | | (116 | ) | | | (120 | ) | | | (656 | ) | | | (472 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Fair value of plan assets at end of year | | $ | 90,960 | | | $ | 84,907 | | | $ | 0 | | | $ | 0 | | | $ | 0 | | | $ | 0 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Funded status at end of year | | ($ | 10,346 | ) | | $ | 3,014 | | | ($ | 4,428 | ) | | ($ | 3,999 | ) | | ($ | 11,591 | ) | | ($ | 7,531 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
| * | Cash contributions made to providers, insurers, trusts, or participants for payment of claims. |
Amounts recognized in the statement of financial position consist of:
| | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | SERP | | Other Postretirement
Benefits |
| | | 2008 | | 2007 | | 2008 | | 2007 | | 2008 | | 2007 |
Assets | | $ | 0 | | $ | 3,014 | | $ | 0 | | $ | 0 | | $ | 0 | | $ | 0 |
Liabilities | | | 10,346 | | | 0 | | | 4,428 | | | 3,999 | | | 11,591 | | | 7,531 |
| | | | | | | | | | | | | | | | | | |
Net asset/liability recognized | | $ | 10,346 | | $ | 3,014 | | $ | 4,428 | | $ | 3,999 | | $ | 11,591 | | $ | 7,531 |
| | | | | | | | | | | | | | | | | | |
105
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Amounts recognized in accumulated other comprehensive income (net of taxes at 35%) consist of:
| | | | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | SERP | | Other Postretirement
Benefits | |
| | | 2008 | | 2007 | | 2008 | | 2007 | | 2008 | | | 2007 | |
Net loss (gain) | | $ | 23,486 | | $ | 7,579 | | $ | 619 | | $ | 536 | | ($ | 14 | ) | | ($ | 376 | ) |
Transition obligation | | | 0 | | | 0 | | | 0 | | | 0 | | | 299 | | | | 372 | |
Prior service cost | | | 208 | | | 236 | | | 349 | | | 429 | | | 301 | | | | 374 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 23,694 | | $ | 7,815 | | $ | 968 | | $ | 965 | | $ | 586 | | | $ | 370 | |
| | | | | | | | | | | | | | | | | | | | |
The accumulated benefit obligation for the defined benefit pension plan was $95,476 and $77,439 at December 31, 2008 and 2007, respectively. The accumulated benefit obligation for the SERP was $3,839 and $3,297 at December 31, 2008, and 2007, respectively.
Components of Net Periodic Benefit Cost and Other Amounts Recognized in Other Comprehensive Income
| | | | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | | SERP | | Other Postretirement
Benefits |
Net Periodic Benefit Cost | | 2008 | | | 2007 | | | 2008 | | 2007 | | 2008 | | 2007 |
Service cost | | $ | 5,905 | | | $ | 3,706 | | | $ | 111 | | $ | 103 | | $ | 490 | | $ | 383 |
Interest cost | | | 5,329 | | | | 4,550 | | | | 243 | | | 224 | | | 632 | | | 414 |
Expected return on plan assets | | | (7,693 | ) | | | (7,046 | ) | | | 0 | | | 0 | | | 0 | | | 0 |
Amortization of prior service cost | | | 42 | | | | 36 | | | | 124 | | | 124 | | | 113 | | | 113 |
Amortization of transition obligation (asset) | | | 0 | | | | (7 | ) | | | 0 | | | 0 | | | 113 | | | 113 |
Amortization of net actuarial (gain) or loss | | | 347 | | | | 51 | | | | 63 | | | 59 | | | 0 | | | 0 |
| | | | | | | | | | | | | | | | | | | | |
Net periodic postretirement benefit cost | | $ | 3,930 | | | $ | 1,290 | | | $ | 541 | | $ | 510 | | $ | 1,348 | | $ | 1,023 |
| | | | | | | | | | | | | | | | | | | | |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | | SERP | | | Other Postretirement
Benefits | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Net loss (gain) for the period | | $ | 24,818 | | | $ | 2,181 | | | $ | 191 | | | $ | 126 | | | $ | 558 | | | ($ | 2,219 | ) |
Amortization of net (loss) gain | | | (346 | ) | | | (51 | ) | | | (63 | ) | | | (59 | ) | | | 0 | | | | 0 | |
Prior service cost | | | 0 | | | | 60 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
Amortization of prior service cost | | | (42 | ) | | | (36 | ) | | | (124 | ) | | | (124 | ) | | | (113 | ) | | | (113 | ) |
Amortization of transition obligation | | | 0 | | | | 7 | | | | 0 | | | | 0 | | | | (113 | ) | | | (113 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total recognized in other comprehensive income | | $ | 24,430 | | | $ | 2,161 | | | $ | 4 | | | ($ | 57 | ) | | $ | 332 | | | ($ | 2,445 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total recognized in net periodic cost and other comprehensive income | | $ | 28,360 | | | $ | 3,451 | | | $ | 545 | | | $ | 453 | | | $ | 1,681 | | | $ | 1,422 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
106
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Expected Amortizations
The estimated net loss, prior service cost, and transition obligation (asset) for the plans that are expected to be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is as follows:
| | | | | | | | | |
| | | Pension
Benefits | | SERP | | Other Postretirement
Benefits |
Expected amortization of net loss | | $ | 2,564 | | $ | 62 | | $ | 0 |
Expected amortization of prior service cost | | | 42 | | | 118 | | | 93 |
Expected amortization of transition obligation | | | 0 | | | 0 | | | 113 |
Additional Information
The weighted-average assumptions used in the actuarial computation of the plans’ benefit obligations were as follows:
| | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | | SERP | | | Other Postretirement
Benefits | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Discount rate | | 5.75 | % | | 6.00 | % | | 5.75 | % | | 6.00 | % | | 5.75 | % | | 6.00 | % |
Rate of compensation increase | | 3.00 | % | | 3.25 | % | | 3.00 | % | | 3.25 | % | | 3.00 | % | | 3.25 | % |
Assumed health care trend rates: | | | | | | | | | | | | | | | | | | |
Health care cost trend rate assumed for next year | | | | | | | | | | | | | | 9.00 | % | | 10.00 | % |
Ultimate rate | | | | | | | | | | | | | | 5.00 | % | | 5.00 | % |
Year that ultimate rate is reached | | | | | | | | | | | | | | 2013 | | | 2013 | |
The weighted average assumptions used in the actuarial computation of the plans’ net periodic cost were as follows:
| | | | | | | | | | | | | | | | | | |
| | | Pension Benefits | | | SERP | | | Other Postretirement
Benefits | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Discount rate | | 6.00 | % | | 6.00 | % | | 6.00 | % | | 6.00 | % | | 6.00 | % | | 6.00 | % |
Expected return on plan assets | | 8.50 | % | | 8.50 | % | | N/A | | | N/A | | | N/A | | | N/A | |
Rate of compensation increase | | 3.25 | % | | 3.25 | % | | 3.25 | % | | 3.25 | % | | 3.25 | % | | 3.25 | % |
Assumed health care trend rates: | | | | | | | | | | | | | | | | | | |
Health care cost trend rate assumed for current year | | | | | | | | | | | | | | 10.00 | % | | 11.00 | % |
Ultimate rate | | | | | | | | | | | | | | 5.00 | % | | 5.00 | % |
Year that ultimate rate is reached | | | | | | | | | | | | | | 2013 | | | 2013 | |
The impact of one-percentage-point change in assumed health care cost trend rates is as follows:
| | | | | | | | |
| | | Increase | | | Decrease | |
Effect on service cost plus interest cost components of net periodic postretirement benefit cost | | $ | 44 | | | ($ | 38 | ) |
| | | 3.93 | % | | | -3.41 | % |
Effect on benefit obligation as of December 31, 2008 | | $ | 528 | | | ($ | 461 | ) |
| | | 4.56 | % | | | -3.98 | % |
107
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The expected long-term rate of return was estimated using market benchmarks for equities and bonds applied to the defined pension benefit plan’s target asset allocation. The expected return on equities was computed using a valuation methodology, which projected future returns based on current equity valuations while looking at historical returns, as well. Due to active management of the plan’s assets, the return on the equity investments of the plan historically has exceeded general market returns. Management estimated the rate by which the plan’s assets would perform to the market in the future looking at historical performance and adjusting for changes in the asset allocations.
For the plan year ending December 31, 2009, expected employer contributions to the pension plan, SERP, and other benefit plans are $0, $124, and $594, respectively; and, for the same year, expected employee contributions are $0, $0, and $392, respectively. The 2009 plan assumptions used to determine net periodic cost will be a discount rate of 5.75% and an expected long-term return on plan assets of 8.0%. The assumed discount rate was determined by matching Susquehanna’s projected pension payments to high quality Double-A bonds of similar duration. The payment projections used a seventy-five year payout projection.
The investment objective of the pension plan is to maximize total return by emphasizing growth at a reasonable price. The plan’s equity portfolio consists primarily of large-cap stocks. Equity investments are diversified and sector weighted. Industry growth prospects and economic sentiment are major considerations in the investment process, but risk reduction is achieved through diversification and active portfolio management. In June 2005, the plan sold all of its holdings of Susquehanna common stock.
The pension plan’s debt securities portfolio consists of bonds rated A or higher at the time of purchase. The current portfolio consists primarily of U.S. Treasuries and agency securities, high quality corporates, and money market investments. A credit analysis is conducted to ensure that the appropriate liquidity, industry diversification, safety, maximum yield, and minimum risk are achieved. A laddered approach to maturity distribution is taken depending on market conditions, but is primarily limited to ten years or less.
The target and actual allocations expressed as a percentage of the defined benefit pension plan’s assets are presented as follows:
| | | | | | | | | |
For the year ended | | Target
2009 | | | 2008 | | | 2007 | |
Equity securities | | 40-60 | % | | 43 | % | | 59 | % |
Debt securities | | 20-40 | % | | 41 | % | | 34 | % |
Temporary cash investments | | 0-20 | % | | 16 | % | | 7 | % |
| | | | | | | | | |
Total | | | | | 100 | % | | 100 | % |
| | | | | | | | | |
Estimated aggregate future benefit payments for pension, the SERP, and other benefits, which reflect expected future services, as appropriate, are as follows:
| | | | | | | | | |
| | | Pension | | SERP | | Other
Benefits |
2009 | | $ | 3,597 | | $ | 124 | | $ | 594 |
2010 | | | 3,741 | | | 124 | | | 633 |
2011 | | | 3,997 | | | 131 | | | 671 |
2012 | | | 4,467 | | | 131 | | | 693 |
2013 | | | 4,774 | | | 188 | | | 721 |
Year 2014-2018 | | | 21,374 | | | 2,099 | | | 4,063 |
108
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
401(k) Plan
Susquehanna maintains a 401(k) savings plan which allows employees to invest a percentage of their earnings, matched up to a certain amount specified by Susquehanna. Contributions to the savings plan, which are included in salaries and benefits expense, totaled $3,517 in 2008, $2,749 in 2007, and $2,258 in 2006.
18. Earnings per Common Share
The following table sets forth the calculation of basic and diluted earnings per common share:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2008 | | 2007 | | 2006 |
For the Year Ended December 31, | | Income | | Average
Shares | | Per
Share
Amount | | Income | | Average
Shares | | Per
Share
Amount | | Income | | Average
Shares | | Per
Share
Amount |
Basic Earnings per Share: | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 82,606 | | | | | | | $ | 69,093 | | | | | | | $ | 83,638 | | | | | |
Accumulated preferred stock dividends | | | 792 | | | | | | | | 0 | | | | | | | | 0 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Income available to common shareholders | | | 81,814 | | 85,987 | | $ | 0.95 | | | 69,093 | | 56,297 | | $ | 1.23 | | | 83,638 | | 50,340 | | $ | 1.66 |
Effect of Diluted Securities: | | | | | | | | | | | | | | | | | | | | | | | | |
Stock options and warrants outstanding | | | | | 50 | | | 0.00 | | | | | 69 | | | 0.00 | | | | | 167 | | | 0.00 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Diluted Earnings per Share: | | | | | | | | | | | | | | | | | | | | | | | | |
Income available to common shareholders and assuming conversion | | $ | 81,814 | | 86,037 | | $ | 0.95 | | $ | 69,093 | | 56,366 | | $ | 1.23 | | $ | 83,638 | | 50,507 | | $ | 1.66 |
| | | | | | | | | | | | | | | | | | | | | | | | |
For the years ended December 31, 2008, 2007, and 2006, options to purchase 2,229, 1,631 and 911 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents under FAS No. 123(R) were antidilutive. For the year ended December 31, 2008, warrants to purchase 3,028 shares of common stock were outstanding and were included in the computation of diluted earnings per share.
Note 19. Related Party Transactions
Certain directors and named executive officers of Susquehanna and its affiliates, including their immediate families and companies in which they are principal owners (more than 10%), were indebted to banking subsidiaries. In the opinion of management, such loans are consistent with sound banking practices and are within applicable regulatory bank lending limitations and in compliance with applicable rules and regulations of the Securities and Exchange Commission. Susquehanna relies on the directors and named executive officers for the identification of their associates.
109
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The activity of loans to such persons whose balances exceeded $120 follows:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Balance - January 1 | | $ | 19,643 | | | $ | 17,831 | | | $ | 19,010 | |
Additions | | | 50,483 | | | | 11,655 | | | | 23,683 | |
Deductions: | | | | | | | | | | | | |
Amounts collected | | | (31,846 | ) | | | (10,189 | ) | | | (15,680 | ) |
Other changes | | | (5,078 | ) | | | 346 | | | | (9,182 | ) |
| | | | | | | | | | | | |
Balance - December 31 | | $ | 33,202 | | | $ | 19,643 | | | $ | 17,831 | |
| | �� | | | | | | | | | | |
20. Regulatory Restrictions of Subsidiaries
Susquehanna is limited by regulatory provisions in the amount it can receive in dividends from its banking subsidiary. Accordingly, at December 31, 2008, $26,928 was available for dividend distribution to Susquehanna in 2009, from its banking subsidiary.
Included in cash and due from banks are balances required to be maintained by Susquehanna Bank on deposit with the Federal Reserve. The amounts of such reserves are based on percentages of certain deposit types and totaled $11,210 at December 31, 2008, and $48,994 at December 31, 2007.
Under current Federal Reserve regulations, Susquehanna Bank is limited in the amount it may lend to the parent company and its nonbank subsidiaries. Loans to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20% of the bank’s capital stock, surplus, and undivided profits, plus the allowance for loan and lease losses. Loans from Susquehanna Bank to nonbank affiliates, including the parent company, are also required to be collateralized according to regulatory guidelines. At December 31, 2008, there were no loans from the bank to any nonbank affiliate, including the parent company.
Note 21. Securitization Activity
Since 2001, Susquehanna has sold the beneficial interests in automobile leases in securitization transactions. Beginning in 2005, Susquehanna entered into term securitization transactions in which it sold portfolios of home equity loans. All of these transactions were accounted for as sales under FAS No. 140, and Susquehanna retained servicing responsibilities and subordinated interests. Susquehanna receives annual servicing fees and rights to future cash flows remaining after the investors have received the return for which they contracted. Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its loan and lease portfolios and to manage capital. The investors and the securitization trusts have no recourse to Susquehanna’s other assets, except retained interests, for failure of debtors to pay when due. Susquehanna’s retained interests are subordinate to investors’ interests. Their value is subject to credit, prepayment, and interest-rate risks on the transferred assets.
Automobile Leases
2007 Transaction
In February 2007, Susquehanna securitized $300,414 of closed-end motor vehicle leases and recorded a pre-tax net gain of $2,709 (which included a loss recognized on the associated cash-flow hedge) in noninterest income. Retained interests in the securitization totaled $51,930 and included $7,774 in subordinated notes, $40,147 in equity certificates of the securitization trust, and a $4,009 interest-only strip. The initial carrying
110
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
values of these retained interests were determined by allocating the carrying value among the assets sold and retained based on their relative fair values at the date of sale. The initial carrying value of the interest-only strip was estimated at the date of sale by discounting projected future cash flows. Susquehanna has retained the right to service the leases; however, no servicing asset or liability was recognized because expected servicing costs were approximately equal to expected servicing fee income, which approximates market value. Transaction costs associated with this securitization were included as a component of gain on sale. The subordinated notes retained in the transaction, which do not bear interest, have been rated by independent rating agencies. Their final maturity date is January 14, 2013.
2006 Transaction
In the third quarter of 2008, Susquehanna, as servicer, issued a clean-up call for this securitization and acquired $31,773 in lease receivables.
2005 Transaction
In the first quarter of 2008, Susquehanna, as servicer, issued a clean-up call for this securitization and acquired $32,140 in lease receivables.
2002 Revolving Transaction
In the third quarter of 2007, Susquehanna, as servicer, issued a clean-up call for this securitization and acquired $22,682 in lease receivables.
Home Equity Loans
2006 Transaction
In September 2006, Susquehanna securitized $349,403 of fixed-rate home mortgage loans and variable-rate line of credit loans and recorded a pre-tax gain of $8,225 in noninterest income. Retained interests in the securitization totaled $21,244 and included $2,745 in subordinated notes, and $18,499 in interest-only strips. The initial carrying values of the interest-only strips were estimated at the date of sale by discounting projected future cash flows. Susquehanna has retained the right to service the loans and recorded a servicing asset of $2,334. Transaction costs associated with this securitization were included as a component of gain on sale. The subordinated notes retained in the transaction, which bear interest at one-month LIBOR + .75%, were rated by independent rating agencies and have a final maturity date of August 2036.
In this securitization, approximately 70.5% of the variable-rate loans as of the cut-off date included a feature that permits the obligor to convert all or a portion of the loan from a variable interest rate to a fixed interest rate. If the total principal balance of the converted loans is greater than 10% of the total outstanding balance of the portfolio, Susquehanna is required to repurchase the converted loans in excess of the 10% threshold until the total principal balance of the loans repurchased by Susquehanna is equal to 10% of the original principal balance of the loans. Based upon Susquehanna’s experience with this product, Susquehanna has concluded that the event requiring the repurchase of converted loans would be remote. The maximum dollar amount of this repurchase obligation at the cut-off date was $11,140, and its related fair value was considered to be de minimis.
111
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
2005 Transaction
In December 2005, Susquehanna securitized $239,766 of home equity line of credit loans and recorded a pre-tax gain of $6,648 in noninterest income. The interest-only strips retained in the securitization totaled $7,298. The initial carrying values of the interest-only strips were estimated at the date of sale by discounting projected future cash flows. Susquehanna retained the right to service the loans and recorded a servicing asset of $1,289. Transaction costs associated with this securitization were included as a component of gain on sale.
In this securitization, approximately 35.4% of the loans as of the cut-off date included a feature that permits the obligor to convert all or a portion of the loan from a variable interest rate to a fixed interest rate. If the total principal balance of the converted loans is greater than 10% of the total outstanding balance of the portfolio. Susquehanna is required to repurchase the converted loans in excess of the 10% threshold until the total principal balance of the loans repurchased by Susquehanna is equal to 10% of the original principal balance of the loans. Based upon Susquehanna’s experience with this product, Susquehanna has concluded that the event requiring the repurchase of converted loans would be remote. The maximum dollar amount of this repurchase obligation at the cut-off date was $23,980, and its related fair value was considered to be de minimis.
Key economic assumptions used in measuring certain retained interests at the date of securitization were as follows:
| | | | | | | | | | | | | | | |
| | | Gain
Recognized | | Weighted-
average Life
(in months) | | Prepayment
Speed | | Expected
Credit
Losses | | | Annual
Discount
Rate | | | Annual Coupon
Rate to Investors |
Automobile Leases | | | | | | | | | | | | | | | |
2007 transaction | | $ | 2,709 | | 19 | | 2.00%-4.00% | | 0.05 | % | | 5.18 | % | | 5.25%-5.61% |
| | | | | | |
Home Equity Loans | | | | | | | | | | | | | | | |
2006 transaction | | $ | 8,225 | | | | | | | | | | | | |
Fixed-rate portion | | | | | 56 | | 10.00* | | 0.10 | % | | 6.60 | % | | 30-day LIBOR+ |
| | | | | | | | | | | | | | | 0.17% - 1.25% |
Variable-rate portion | | | | | 20 | | 45.00* | | 0.06 | | | 6.60 | | | 30-day LIBOR+ |
| | | | | | | | | | | | | | | 0.15% |
2005 transaction | | | 6,648 | | 20 | | 45.00* | | 0.15 | | | 6.50 | | | 30-day LIBOR+ |
| | | | | | | | | | | | | | | 0.19% |
| * | Constant Prepayment Rate |
The following table presents quantitative information about delinquencies, net credit losses, and components of loan and lease sales serviced by Susquehanna, including securitization transactions.
| | | | | | | | | | | | | | | | | | | | |
| | | As of December 31 | | For the Year Ended
December 31 | |
| | | Principal Balance | | Loans and Leases Past
Due 30 Days or More | | Net Credit Losses
(Recoveries) | |
| | | 2008 | | 2007 | | 2008 | | 2007 | | 2008 | | | 2007 | |
Loans and leases held in portfolio | | $ | 9,653,873 | | $ | 8,751,590 | | $ | 261,504 | | $ | 187,703 | | $ | 38,651 | | | $ | 15,037 | |
Leases securitized | | | 123,608 | | | 463,517 | | | 185 | | | 769 | | | 196 | | | | 398 | |
Home equity loans securitized | | | 286,577 | | | 334,417 | | | 5,637 | | | 2,979 | | | 196 | | | | 65 | |
Leases serviced for others | | | 31,645 | | | 61,551 | | | 1,060 | | | 1,300 | | | (30 | ) | | | (91 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total loans and leases serviced | | $ | 10,095,703 | | $ | 9,611,075 | | $ | 268,386 | | $ | 192,751 | | $ | 39,013 | | | $ | 15,409 | |
| | | | | | | | | | | | | | | | | | | | |
112
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Certain cash flows received from the structured entities associated with the securitizations described above are as follows:
| | | | | | | | | |
Automobile Leases | | Year Ended December 31 |
| | | 2008 | | 2007 | | 2006 |
Proceeds from securitizations | | $ | 0 | | $ | 252,493 | | $ | 302,887 |
Amounts derecognized | | | 0 | | | 300,414 | | | 356,140 |
Servicing fees received (included in Vehicle origination, servicing, and securitization fees) | | | 2,835 | | | 6,984 | | | 8,519 |
Other cash flows received from retained interests | | | 24,518 | | | 29,756 | | | 25,806 |
| |
Home Equity Loans | | Year Ended December 31 |
| | | 2008 | | 2007 | | 2006 |
Proceeds from securitizations | | $ | 0 | | $ | 0 | | $ | 338,597 |
Amounts derecognized | | | 0 | | | 0 | | | 351,150 |
Additional draws conveyed to the trusts | | | 53,752 | | | 59,688 | | | 61,285 |
Servicing fees received (included in Noninterest Income, Other) | | | 1,268 | | | 1,631 | | | 1,365 |
Other cash flows received from retained interests | | | 8,217 | | | 7,959 | | | 955 |
Excess cash flows represent the cash flows from the underlying assets less distributions of cash flows to beneficial interest holders in accordance with the distribution priority requirements of the transaction. Susquehanna, as servicer, distributes to third-party beneficial interest holders contracted returns and retains the right to remaining cash flows. The expected cash flows are discounted to present value and recorded as interest-only strips. Susquehanna estimates the fair value of these interest-only strips using assumptions regarding credit losses, prepayment speeds, and discount rates commensurate with the risks involved at the time the underlying assets are sold. The fair values are adjusted quarterly based on changes in these key economic risk factors.
The following table sets forth a summary of the fair values of the interest-only strips, key economic assumptions used to arrive at the fair values, and the sensitivity of the December 31, 2008 fair values to immediate 10% and 20% adverse changes in those assumptions. The sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest in calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in low prepayments and increased credit losses), which might magnify or counteract the sensitivities.
Susquehanna’s analysis of the information presented below indicates that any adverse change of 20% in the key economic assumptions would not have a significant effect on the fair value of the Company’s interest-only strips.
113
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
As of December 31, 2008
| | | | | | | | | | | | | | | | | |
Automobile Leases | | Fair
Value | | Weighted-
average
Life (in
months) | | Monthly
Prepayment
Speed | | | Expected
Cumulative
Credit
Losses | | | Annual
Discount
Rate(1) | |
2007 transaction - Interest-Only Strip | | $ | 898 | | 8.4 | | | 4.00 | % | | | 0.05 | % | | | 9.66 | % |
Decline in fair value of 10% adverse change | | | | | | | $ | 2 | | | $ | 4 | | | $ | 4 | |
Decline in fair value of 20% adverse change | | | | | | | | 4 | | | | 8 | | | | 8 | |
| | | | | | | | | | | | | | | | |
Home Equity Loans | | Fair
Value | | Weighted-
average
Life (in
months) | | Constant
Prepayment
Rate | | Expected
Cumulative
Credit
Losses | | | Annual
Discount
Rate(1) | |
2006 transaction - Interest-Only Strips | | | | | | | | | | | | | | | | |
Fixed-rate portion | | $ | 8,507 | | 37.8 | | | 15.00 | | | 0.15 | % | | | 10.38 | % |
Decline in fair value of 10% adverse change | | | | | | | $ | 397 | | $ | 51 | | | $ | 236 | |
Decline in fair value of 20% adverse change | | | | | | | | 769 | | | 102 | | | | 456 | |
Variable-rate portion | | $ | 2,844 | | 32 | | | 30.00 | | | 0.15 | % | | | 10.24 | % |
Decline in fair value of 10% adverse change | | | | | | | $ | 165 | | $ | 19 | | | $ | 70 | |
Decline in fair value of 20% adverse change | | | | | | | | 311 | | | 38 | | | | 135 | |
2005 transaction - Interest-Only Strips | | $ | 5,316 | | 31.1 | | | 30.00 | | | 0.15 | % | | | 10.23 | % |
Decline in fair value of 10% adverse change | | | | | | | $ | 186 | | $ | 26 | | | $ | 128 | |
Decline in fair value of 20% adverse change | | | | | | | | 361 | | | 53 | | | | 248 | |
| (1) | The annual discount rate is based on fair-value estimates of similar instruments. |
22. Derivative Financial Instruments
Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS No. 133), as amended and interpreted, established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In addition, FAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (effective for reporting periods beginning after November 15, 2008, with early application encouraged) requires disclosures of the fair values of derivative instruments and their gains and losses in a tabular format.
Susquehanna’s interest rate risk management strategy involves hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on its net interest margin and cash flows from changes in interest rates. While Susquehanna does not participate in speculative derivatives trading, it considers it prudent to use certain derivative instruments to add stability to its interest income and expense, to modify the duration of specific assets and liabilities, and to manage its exposure to interest rate movements.
Additionally, Susquehanna executes derivative instruments in the form of interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that Susquehanna minimizes its net risk exposure resulting from such transactions. Susquehanna does not use credit default swaps in its investment or hedging operations.
At December 31, 2008, the aggregate amount of derivative assets recorded in other assets was $21,895, and the aggregate amount of derivative liabilities recorded in other liabilities was $22,412. When quoted market prices are not available, the valuation of derivative instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis
114
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
reflects the contractual terms of the derivatives, including interest rate curves and implied volatilities. The estimates of fair value are made by an independent third-party valuation service using a standardized methodology that nets the discounted expected future cash receipts and cash payments (based on observable market inputs). As part of Susquehanna’s overall valuation process, management evaluates this third-party methodology to ensure that it is representative of exit prices in Susquehanna’s principal markets. These future net cash flows, however, are susceptible to change primarily due to fluctuations in interest rates. As a result, the estimated values of these derivatives will change over time as cash is received and paid and also as market conditions change. As these changes take place, they may have a positive or negative impact on estimated valuations. Based on the nature and limited purposes of the derivatives that Susquehanna employs, fluctuation in interest rates have had only a modest effect on its results of operations. As such, fluctuations are generally expected to be countered by offsetting changes in income, expense, and/or values of assets and liabilities.
In addition to making valuation estimates, Susquehanna also faces the risk that certain derivative instruments that have been designated as hedges and currently meet the hedge accounting requirements of FAS No. 133 may not qualify in the future. Further, new interpretations and guidance related to FAS No. 133 may be issued in the future, and Susquehanna cannot predict the possible impact that such guidance may have on its use of derivative instruments.
The majority of Susquehanna’s hedging relationships have been designated as cash flow hedges, for which hedge effectiveness is assessed and measured using a “long haul” approach. During 2008, an immaterial amount of hedge ineffectiveness was required to be reported in earnings on Susquehanna’s outstanding cash flow hedging relationships. In September 2008, Susquehanna announced that, due to adverse market conditions, a forecasted sale of vehicle leases would not occur, and the associated interest rate swap agreements were terminated. In accordance with generally accepted accounting principles, Susquehanna reclassified $2,098 (net of taxes of $1,130) from accumulated comprehensive loss to earnings and recognized an additional reduction in pre-tax income of $3,363.
During 2009, Susquehanna estimates that an additional $675 of deferred losses will be reclassified out of accumulated other comprehensive loss and into interest expense for hedges of variable-rate FHLB advances based on interest rate projections derived from the LIBOR swap curve (increasing interest expense).
Derivative contracts can be exchange-traded or over-the-counter (“OTC”). Susquehanna’s OTC derivatives consist of interest rate swaps. Susquehanna has classified its OTC derivatives in Level 2 of the fair value hierarchy, as the significant inputs to the overall valuations are based on market-observable data or information derived from or corroborated by market-observable date, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. Susquehanna generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generics swaps, model inputs can generally be verified, and model selection does not involve significant management judgment.
To comply with the provisions of FAS No. 157, “Fair Value Measurements,” Susquehanna incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements of its OTC derivatives. The credit valuation adjustments are calculated by determining the total expected exposure of the derivatives (which incorporates both
115
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
the current and potential future exposure) and then applying each counterparty’s credit spread to the applicable exposure. For derivatives with two-way exposure, such as interest rate swaps, the counterparty’s credit spread is applied to Susquehanna’s exposure to the counterparty, and Susquehanna’s own credit spread is applied to the counterparty’s exposure to Susquehanna, and the net credit valuation adjustment is reflected in Susquehanna’s derivative valuations. The total expected exposure of a derivative is derived using market-observable inputs, such as yield curves and volatilities. For Susquehanna’s own credit spread and for counterparties having publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third-party credit data provider. For counterparties without publicly available credit information, who are primarily commercial banking customers, the credit spreads over LIBOR used in the calculations are estimated by Susquehanna based on current market conditions, including consideration of current borrowing spreads for similar customers and transactions, review of existing collateralization or other credit enhancements, and changes in credit sector and entity-specific credit information. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Susquehanna has considered the impact of netting and any applicable credit enhancements, such as collateral postings, current threshold amounts, mutual puts, and guarantees. Additionally, Susquehanna actively monitors counterparty credit ratings for significant changes.
At December 31, 2008, net credit valuation adjustments reduced the settlement values of Susquehanna’s derivative assets by $1,234 and its derivative liabilities by $1,668. During 2008, Susquehanna recognized income of $419 related to credit valuation adjustments on nonhedge derivative instruments, which is included in noninterest income. Various factors impact changes in the credit valuation adjustments over time, including changes in the credit spreads of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments.
Although Susquehanna has determined that the majority of the inputs used to values its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31,2008, Susquehanna has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Susquehanna has classified its OTC derivative valuations in Level 2 of the fair value hierarchy.
When appropriate, valuations are also adjusted for various factors, such as liquidity and bid/offer spreads, which factors were deemed immaterial by Susquehanna as of December 31, 2008.
| | | | | | | | | | |
| | | Fair Values of Derivative Instruments |
| | | Asset Derivatives | | Liability Derivatives |
| | | 2008 | | 2008 |
As of December 31 | | Balance Sheet Location | | Fair Value | | Balance Sheet Location | | Fair Value |
Derivatives designated as hedging instruments under Statement 133 | | | | | | | | | | |
Interest rate contracts | | | | | | | Other liabilities | | $ | 939 |
Derivatives not designated as hedging instruments under Statement 133 | | | | | | | | | | |
Interest rate contracts | | Other assets | | | 21,895 | | Other liabilities | | | 21,473 |
| | | | | | | | | | |
Total derivatives | | | | $ | 21,895 | | | | $ | 22,412 |
| | | | | | | | | | |
116
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
The Effect of Derivative Instruments on the Statement of Income for the Year Ended December 31, 2008
| | | | | | | | | | | | | | |
Derivatives in Statement 133 Cash Flow Hedging Relationships | | Amount of Loss
Recognized in
OCI | | | Location of Loss Reclassified
from Accumulated
OCI into Income | | Amount of Loss
Reclassified
from Accumulated
OCI into Income | | | Amount of Loss
Recognized in
Current Year
Income(2) | |
| | 2008 | | | | 2008 | | | 2008 | |
Interest rate contracts: | | | | | | | | | | | | | | |
| | ($ | 507 | ) | | Other noninterest income | | ($ | 2,031 | )(1) | | ($ | 6,488 | ) |
| (1) | Net of taxes of $1,094 |
| (2) | Includes amounts reclassified from accumulated other comprehensive income plus deferred taxes |
| | | | | |
Derivatives not Designated as Hedging
Instruments under Statement 133 | | Location of Gain Recognized in Income on
Derivatives | | Amount of Gain
Recognized
in Income on
Derivatives |
| | | 2008 |
Interest rate contracts: | | | | | |
| | Other income | | $ | 419 |
Note 23. Fair Value Disclosures
Effective January 1, 2008, Susquehanna adopted FAS No. 157, “Fair Value Measurements” and FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” At December 31, 2008, Susquehanna had made no elections to use fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The level in the hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety.
The following is a description of Susquehanna’s valuation methodologies for assets and liabilities carried at fair value. These methods may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while Susquehanna believes that its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at reporting date.
Securities
Where quoted prices are available in an active market, securities are classified in Level 1 of the valuation hierarchy. Securities in Level 1 are exchange-traded equities. If quoted market prices are not available for the
117
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
specific security, then fair values are provided by independent third-party valuations services. These valuations services estimate fair values using pricing models and other accepted valuation methodologies, such as quotes for similar securities and observable yield curves and spreads. As part of Susquehanna’s overall valuation process, management evaluates these third-party methodologies to ensure that they are representative of exit prices in Susquehanna’s principal markets. This evaluation involves understanding the various sources and assumptions used to determine that the valuations received are reasonable, as well as performing independent monitoring of the underlying assets comprising these investment securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, state and municipal securities, and Federal Home Loan Bank stock. Securities in Level 3 include thinly traded bank stocks, collateralized debt obligations, trust preferred securities, indexed-amortizing notes, and private-issue mortgage-backed securities.
Derivatives
Currently, Susquehanna uses interest rate swaps to manage its interest rate risk and to assist its borrowers in managing their interest rate risk. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates derived from observable market interest rate curves. To comply with the provisions of FAS No. 157, Susquehanna incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Susquehanna has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Although Susquehanna has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives may utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2008, Susquehanna has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Susquehanna has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Certain Retained Interests in Securitizations
For our interest-only strips, there is a lack of similar observable transactions for similar assets in the marketplace. Therefore, Susquehanna uses the present-value approach to determine the initial and ongoing fair values of the cash flows associated with securitizations. Assumptions used, which incorporate certain market information obtained from third parties, include an estimation of an appropriate discount rate, net credit losses, and prepayment rates. Changes in the assumptions used may have a significant impact on Susquehanna’s valuation of retained interests, and accordingly, such interests are classified within Level 3 of the valuation hierarchy. For further discussion of the most significant assumptions used to value interest-only strips, as well as the applicable stress tests for those assumptions, refer to Note 21. Securitization Activity.
118
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Assets Measured at Fair Value on a Recurring Basis
The following table presents the financial instruments carried at fair value at December 31, 2008, on the consolidated balance sheet and by FAS No. 157 valuation hierarchy.
| | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using |
Description | | December 31, 2008 | | Quoted Prices in
Active Markets for
Identical Instruments
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable Inputs
(Level 3) |
Assets | | | | | | | | | | | | |
Available-for-sale securities | | $ | 1,870,746 | | $ | 3,877 | | $ | 1,821,554 | | $ | 45,315 |
Derivatives(1) | | | 21,895 | | | 0 | | | 21,895 | | | 0 |
Interest-only strips(1) | | | 17,565 | | | 0 | | | 0 | | | 17,565 |
| | | | | | | | | | | | |
Total | | $ | 1,910,206 | | $ | 3,877 | | $ | 1,843,449 | | $ | 62,880 |
| | | | | | | | | | | | |
| (1) | Included in Other assets |
| | | | | | | | | | | | |
| | | | | Fair Value Measurements at Reporting Date Using |
Description | | December 31, 2008 | | Quoted Prices in
Active Markets for
Identical Instruments
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable Inputs
(Level 3) |
Liabilities | | | | | | | | | | | | |
Derivatives(2) | | $ | 21,473 | | $ | 0 | | $ | 21,473 | | $ | 0 |
| | | | | | | | | | | | |
Total | | $ | 21,473 | | $ | 0 | | $ | 21,473 | | $ | 0 |
| | | | | | | | | | | | |
| (2) | Included in Other liabilities |
Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs
The following table presents a rollforward of the balance sheet amounts for the twelve months ended December 31, 2008, for financial instruments classified by Susquehanna within Level 3 of the valuation hierarchy.
| | | | | | | | | | | | |
| | | Fair Value Measurements
Using Significant Unobservable Inputs (Level 3) | |
| | | Available-for-
sale Securities | | | Interest-only Strips | | | Total | |
Balance at January 1, 2008 | | $ | 81,285 | | | $ | 21,138 | | | $ | 102,423 | |
Total gains or losses (realized/unrealized)
Included in earnings | | | (17,548 | )(1) | | | 0 | | | | (17,548 | ) |
Reclassified from other comprehensive income
(Presented here gross of taxes) | | | 5,175 | | | | 0 | | | | 5,175 | |
Included in other comprehensive income
(Presented here gross of taxes) | | | (12,864 | ) | | | 3,849 | | | | (9,015 | ) |
Purchases, issuances, and settlements | | | (3,173 | ) | | | (7,422 | ) | | | (10,595 | ) |
Transfers in and/or out of Level 3 | | | (7,560 | ) | | | 0 | | | | (7,560 | ) |
| | | | | | | | | | | | |
Balance at December 31, 2008 | | $ | 45,315 | | | $ | 17,565 | | | $ | 62,880 | |
| | | | | | | | | | | | |
| (1) | Included in net realized loss on securities |
119
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Assets Measured at Fair Value on a Nonrecurring Basis
Impaired loans
Certain loans are evaluated for impairment under FAS No. 114, “Accounting by Creditors for Impairment of a Loan — an amendment of FASB Statements No. 5 and 15.” To estimate the impairment of a loan, Susquehanna uses the practical expedient method which is based upon the fair value of the underlying collateral for collateral-dependent loans. Currently, all of Susquehanna’s impaired loans are secured by real estate. The value of the real estate collateral is determined through appraisals performed by independent licensed appraisers. As part of Susquehanna’s overall valuation process, management evaluates these third-party appraisals to ensure that they are representative of the exit prices in Susquehanna’s principal markets. When the value of the real estate, less estimated costs to sell, is less than the principal balance of the loan, a specific reserve is established. Susquehanna considers the appraisals used in its impairment analysis to be Level 3 inputs. Impaired loans are reviewed at least quarterly for additional impairment, and reserves are adjusted accordingly.
The following table presents the financial instruments carried at fair value at December 31, 2008, on the consolidated balance sheet and by FAS No. 157 valuation hierarchy.
| | | | | | | | | | | | |
| | | | | Fair Value Measurements Using |
Description | | December 31, 2008 | | Quoted Prices in
Active Markets for
Identical Instruments
(Level 1) | | Significant Other
Observable Inputs
(Level 2) | | Significant
Unobservable Inputs
(Level 3) |
Impaired loans | | $ | 47,638 | | $ | 0 | | $ | 0 | | $ | 47,638 |
| | | | | | | | | | | | |
| | $ | 47,638 | | $ | 0 | | $ | 0 | | $ | 47,638 |
| | | | | | | | | | | | |
Specific reserves identified under FAS No. 114 during the twelve months of 2008 totaled $10,308. These specific reserves were taken into consideration when the required level of the allowance for loan and lease losses was determined at December 31, 2008.
FAS No. 107, “Disclosures about Fair Value of Financial Instruments”
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and due from banks and short-term investments. For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Investment securities. Refer to the above discussion on securities.
Loans and leases. Variable-rate loans, which do not expose Susquehanna to interest-rate risk, have a fair value that equals their carrying value, discounted for estimated future credit losses. The fair value of fixed-rate loans and leases was based upon the present value of projected cash flows. The discount rate was based upon the U.S. Treasury yield curve.
Certain retained interests in securitizations. Refer to the above discussion on certain retained interests in securitizations.
Deposits. The fair values of demand, interest-bearing demand, and savings deposits are the amounts payable on demand at the balance sheet date. The carrying value of variable-rate time deposits represents a reasonable estimate of fair value. The fair value of fixed-rate time deposits is based upon the discounted
120
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
value of future cash flows expected to be paid at maturity. Discount rates were based upon the U.S.Treasury yield curve.
Short-term borrowings. For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
FHLB borrowings and long-term debt. Fair values were based upon quoted rates of similar instruments issued by banking institutions with similar credit ratings.
Derivatives. Refer to the above discussion on derivatives.
Off-balance-sheet items. The fair values of unused commitments to lend and standby letters of credit are considered to be the same as their contractual amounts. The fair values of commitments to originate mortgage loans to be held for sale and their corresponding forward-sales agreements are calculated as the reasonable amounts that Susquehanna would agree to pay or receive, after considering the likelihood of the commitments expiring.
The following table represents the carrying amounts and estimated fair values of Susquehanna’s financial instruments at December 31:
| | | | | | | | | | | | |
| | | 2008 | | 2007 |
| | | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
Financial assets: | | | | | | | | | | | | |
Cash and due from banks | | $ | 237,701 | | $ | 237,701 | | $ | 326,965 | | $ | 326,965 |
Short-term investments | | | 119,360 | | | 119,360 | | | 143,284 | | | 143,284 |
Investment securities | | | 1,879,891 | | | 1,879,891 | | | 2,063,952 | | | 2,063,952 |
Loans and leases | | | 9,653,879 | | | 9,798,658 | | | 8,751,590 | | | 8,754,378 |
Financial liabilities: | | | | | | | | | | | | |
Deposits | | | 9,066,493 | | | 9,042,282 | | | 8,945,119 | | | 8,784,891 |
Short-term borrowings | | | 910,219 | | | 910,219 | | | 568,412 | | | 568,412 |
FHLB borrowings | | | 1,069,784 | | | 1,158,477 | | | 1,145,759 | | | 1,164,779 |
Long-term debt | | | 448,082 | | | 366,380 | | | 416,985 | | | 396,566 |
Unrecognized financial instruments: | | | | | | | | | | | | |
Commitments to extend credit | | | 2,109,185 | | | 2,109,185 | | | 2,231,910 | | | 2,231,910 |
Standby letters of credit | | | 442,725 | | | 442,725 | | | 244,577 | | | 244,577 |
121
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
24. Condensed Financial Statements of Parent Company
Financial information pertaining only to Susquehanna Bancshares, Inc. is as follows:
Balance Sheets
| | | | | | |
| | | December 31, |
| | | 2008 | | 2007 |
Assets | | | | | | |
Cash in subsidiary banks | | $ | 95 | | $ | 142 |
Investments in and receivables from consolidated subsidiaries | | | 2,367,544 | | | 2,124,345 |
Other investment securities | | | 7,398 | | | 4,327 |
Premises and equipment, net | | | 3,497 | | | 8,584 |
Other assets | | | 42,759 | | | 51,989 |
| | | | | | |
Total assets | | $ | 2,421,293 | | $ | 2,189,387 |
| | | | | | |
Liabilities and Shareholders’ Equity | | | | | | |
Long-term debt | | $ | 150,000 | | $ | 150,000 |
Junior subordinated debentures | | | 272,342 | | | 267,229 |
Other liabilities | | | 53,033 | | | 43,144 |
| | | | | | |
Total liabilities | | | 475,375 | | | 460,373 |
Shareholders’ equity | | | 1,945,918 | | | 1,729,014 |
| | | | | | |
Total liabilities and shareholders’ equity | | $ | 2,421,293 | | $ | 2,189,387 |
| | | | | | |
Statements of Income
| | | | | | | | | | |
| | | Years Ended December 31, |
| | | 2008 | | 2007 | | | 2006 |
Income: | | | | | | | | | | |
Dividends from bank subsidiaries | | $ | 104,000 | | $ | 72,000 | | | $ | 72,000 |
Dividends from nonbank subsidiaries | | | 2,500 | | | 10,500 | | | | 2,300 |
Interest, dividends, and gains on sales of investment securities | | | 102 | | | (240 | ) | | | 140 |
Interest and management fees from bank subsidiaries | | | 68,388 | | | 53,861 | | | | 44,085 |
Interest and management fees from nonbank subsidiaries | | | 2,709 | | | 2,320 | | | | 2,237 |
Miscellaneous | | | 986 | | | 1,969 | | | | 6,584 |
| | | | | | | | | | |
Total income | | | 178,685 | | | 140,410 | | | | 127,346 |
| | | | | | | | | | |
Expenses: | | | | | | | | | | |
Interest | | | 31,066 | | | 14,664 | | | | 12,157 |
Other | | | 80,511 | | | 63,538 | | | | 59,370 |
| | | | | | | | | | |
Total expenses | | | 111,577 | | | 78,202 | | | | 71,527 |
| | | | | | | | | | |
Income before taxes and equity in undistributed income of subsidiaries | | | 67,108 | | | 62,208 | | | | 55,819 |
Income tax provision | | | 4,309 | | | 3,293 | | | | 2,464 |
Equity in undistributed net income of subsidiaries | | | 19,807 | | | 10,178 | | | | 30,283 |
| | | | | | | | | | |
Net Income | | $ | 82,606 | | $ | 69,093 | | | $ | 83,638 |
| | | | | | | | | | |
122
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Statements of Cash Flows
| | | | | | | | | | | | |
| | | Years Ended December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash Flows from Operating Activities: | | | | | | | | | | | | |
Net income | | $ | 82,606 | | | $ | 69,093 | | | $ | 83,638 | |
Adjustment to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Depreciation and amortization | | | 5,834 | | | | 3,121 | | | | 2,889 | |
Realized (gain) loss on sale of available-for-sale securities | | | (120 | ) | | | 212 | | | | 0 | |
Equity in undistributed net income of subsidiaries | | | (19,807 | ) | | | (10,178 | ) | | | (30,283 | ) |
Other, net | | | (9,883 | ) | | | 7,180 | | | | 2,477 | |
| | | | | | | | | | | | |
Net cash provided by operating activities | | | 58,630 | | | | 69,428 | | | | 58,721 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities: | | | | | | | | | | | | |
Purchase of investment securities | | | (4,586 | ) | | | 0 | | | | 0 | |
Proceeds from the sale/maturities of investment securities | | | 1,007 | | | | 499 | | | | 0 | |
Capital expenditures | | | (747 | ) | | | (4,935 | ) | | | (2,708 | ) |
Net investment in subsidiaries | | | (200,087 | ) | | | (46,950 | ) | | | (16,700 | ) |
Acquisitions | | | (69,999 | ) | | | (91,141 | ) | | | (51,455 | ) |
| | | | | | | | | | | | |
Net cash (used in) provided by investing activities | | | (274,412 | ) | | | (142,527 | ) | | | (70,863 | ) |
| | | | | | | | | | | | |
Cash Flows from Financing Activities: | | | | | | | | | | | | |
Proceeds from issuance of common stock | | | 5,312 | | | | 4,666 | | | | 10,061 | |
Proceeds from issuance of preferred stock | | | 299,885 | | | | 0 | | | | 0 | |
Proceeds from issuance of long-term debt | | | 0 | | | | 121,062 | | | | 50,000 | |
Repayment of long-term debt | | | 0 | | | | 0 | | | | 0 | |
Dividends paid | | | (89,462 | ) | | | (52,686 | ) | | | (49,067 | ) |
| | | | | | | | | | | | |
Net cash provided by (used in) financing activities | | | 215,735 | | | | 73,042 | | | | 10,994 | |
| | | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | (47 | ) | | | (57 | ) | | | (1,148 | ) |
Cash and cash equivalents at January 1, | | | 142 | | | | 199 | | | | 1,347 | |
| | | | | | | | | | | | |
Cash and cash equivalents at December 31, | | $ | 95 | | | $ | 142 | | | $ | 199 | |
| | | | | | | | | | | | |
123
Notes to Consolidated Financial Statements—(Continued)
Years Ended December 31, 2008, 2007, and 2006
(Amounts in thousands, except as noted and per share data)
Note 25. Summary of Quarterly Financial Data (Unaudited)
The unaudited quarterly results of consolidated operations for the years ended December 31, 2008 and 2007, are as follows:
| | | | | | | | | | | | | |
| | | 2008 |
Quarter Ended | | March 31 | | June 30 | | September 30 | | | December 31 |
Interest income | | $ | 178,493 | | $ | 171,975 | | $ | 175,063 | | | $ | 171,539 |
Interest expense | | | 80,312 | | | 72,917 | | | 73,801 | | | | 71,738 |
| | | | | | | | | | | | | |
Net interest income | | | 98,181 | | | 99,058 | | | 101,262 | | | | 99,801 |
Provision for loan and lease losses | | | 9,837 | | | 13,765 | | | 17,704 | | | | 22,525 |
| | | | | | | | | | | | | |
Net interest income after provision for loan and lease losses | | | 88,344 | | | 85,293 | | | 83,558 | | | | 77,276 |
Noninterest income | | | 42,902 | | | 44,685 | | | 17,919 | | | | 36,804 |
Noninterest expense | | | 91,961 | | | 90,304 | | | 95,790 | | | | 89,148 |
| | | | | | | | | | | | | |
Income before income taxes | | | 39,285 | | | 39,674 | | | 5,687 | | | | 24,932 |
Applicable income taxes | | | 11,265 | | | 10,473 | | | (673 | ) | | | 5,908 |
| | | | | | | | | | | | | |
Net income | | | 28,020 | | | 29,201 | | | 6,360 | | | | 19,024 |
Accumulated preferred stock dividends | | | 0 | | | 0 | | | 0 | | | | 792 |
| | | | | | | | | | | | | |
Net income available to common shareholders | | $ | 28,020 | | $ | 29,201 | | $ | 6,360 | | | $ | 18,232 |
| | | | | | | | | | | | | |
Earnings per common share: | | | | | | | | | | | | | |
Basic | | $ | 0.33 | | $ | 0.34 | | $ | 0.07 | | | $ | 0.21 |
Diluted | | | 0.33 | | | 0.34 | | | 0.07 | | | | 0.21 |
| | | | | | | | | | | | |
| | | 2007 |
Quarter Ended | | March 31 | | June 30 | | September 30 | | December 31 |
Interest income | | $ | 120,527 | | $ | 121,045 | | $ | 127,701 | | $ | 156,883 |
Interest expense | | | 57,479 | | | 57,608 | | | 61,627 | | | 73,539 |
| | | | | | | | | | | | |
Net interest income | | | 63,048 | | | 63,437 | | | 66,074 | | | 83,344 |
Provision for loan and lease losses | | | 2,000 | | | 1,933 | | | 2,414 | | | 15,497 |
| | | | | | | | | | | | |
Net interest income after provision for loan and lease losses | | | 61,048 | | | 61,504 | | | 63,660 | | | 67,847 |
Noninterest income | | | 34,280 | | | 19,151 | | | 30,290 | | | 36,938 |
Noninterest expense | | | 64,847 | | | 67,342 | | | 66,063 | | | 78,703 |
| | | | | | | | | | | | |
Income before income taxes | | | 30,481 | | | 13,313 | | | 27,887 | | | 26,082 |
Applicable income taxes | | | 9,754 | | | 3,495 | | | 7,994 | | | 7,427 |
| | | | | | | | | | | | |
Net income | | $ | 20,727 | | $ | 9,818 | | $ | 19,893 | | $ | 18,655 |
| | | | | | | | | | | | |
Earnings per common share: | | | | | | | | | | | | |
Basic | | $ | 0.40 | | $ | 0.19 | | $ | 0.38 | | $ | 0.27 |
Diluted | | | 0.40 | | | 0.19 | | | 0.38 | | | 0.27 |
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MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS and REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Susquehanna Bancshares, Inc. (the Company) is responsible for the preparation of the Company’s consolidated financial statements and related information as they appear in this report. Management believes that the consolidated financial statements of Susquehanna Bancshares, Inc. fairly reflect the form and substance of transactions and that the financial statements present the Company’s financial position and results of operations in conformity with generally accepted accounting principles. Management also has included in the Company’s financial statements amounts that are based on estimates and judgments which it believes are reasonable under the circumstances.
The independent registered public accounting firm of PricewaterhouseCoopers LLP audits the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).
The Board of Directors of the Company has an Audit Committee composed of five non-management Directors. The Committee meets periodically with financial management, the internal auditors and the independent registered public accounting firm to review accounting, control, auditing, corporate governance and financial reporting matters.
Management of Susquehanna Bancshares, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework inInternal Control – Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2008. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.
125
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of Susquehanna Bancshares, Inc.
In our opinion, the accompanying consolidated balance sheets and the related statements of income, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Susquehanna Bancshares, Inc. (the “Company”) and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
February 27, 2009
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There has been no change in our principal accountants in over two years. There have been no disagreements with such principal accountants on any matters of accounting principles, practices, financial statement disclosure, auditing scope, or procedures.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We have established disclosure controls and procedures to ensure that material information relating to us, including our consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the Board of Directors.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the design and operating effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2008, our disclosure controls and procedures are effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms.
Management’s Annual Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control – Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2008. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.
Management’s Responsibility for Financial Statements and Report on Internal Control over Financial Reporting is included herein in Part II, Item 8, “Financial Statements and Supplementary Data.”
Changes in Internal Controls. There were no significant changes in our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation, including any significant deficiencies or material weaknesses in internal controls that would require corrective action.
Item 9B. Other Information
Not applicable.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Certain portions of the information required by this Item will be included in the 2009 Proxy Statement in the Election of Directors section, the Corporate Governance section, the Director and Executive Officer Compensation section, and the Compliance with Section 16(a) of the Exchange Act section, each of which sections is incorporated herein by reference. The information concerning our executive officers required by this item is provided under the caption “Executive Officers” in Item 1, Part I of this Annual Report on Form 10-K.
Item 11. Executive Compensation
The information required by this Item will be included in the 2009 Proxy Statement in the Director and Executive Officer Compensation section, and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by this Item will be included in the 2009 Proxy Statement in the Security Ownership of Certain Beneficial Owners and Holdings of Management section and the Director and Executive Officer Compensation — Equity Compensation Plan Information section, and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item will be included in the 2009 Proxy Statement in the Certain Relationships and Related Transactions section and the Corporate Governance — Board Independence section, each of which sections is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information required by this Item will be included in the 2009 Proxy Statement in the Annual Audit Information—Fees Billed by Independent Accountant to Susquehanna section, and is incorporated herein by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
| (a) | The following documents are filed as part of this report: |
| | (1) | Financial Statements. See Item 8 of this report for the consolidated financial statements of Susquehanna and its subsidiaries (including the index to financial statements). |
| | | Financial Statement Schedules. Not Applicable. |
| | | Exhibits. A list of the Exhibits to this Form 10-K is set forth in (b) below. |
| | (3) 3.1 | Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 17, 2007. |
| | 3.1.a | Statement with Respect to Shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A of Susquehanna, is incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
| | 3.2 | By-laws. Incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008. |
| | (4) | Instruments defining the rights of security holders including indentures. The rights of the holders of Susquehanna’s Common Stock and the rights of Susquehanna’s note holders are contained in the following documents or instruments, which are incorporated herein by reference. |
| | 4.1 | Indenture, dated as of November 4, 2002, by and between Susquehanna and JP Morgan Trust Company, National Association, relating to the 6.05% subordinated notes due 2012, incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-4, Registration No. 333-102265. |
| | 4.2 | Global Note relating to the 6.05% subordinated notes due 2012, dated February 27, 2003 is incorporated by reference to Exhibit 4.3 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. |
| | 4.3 | Registration Rights Agreement, dated as of November 4, 2002, by and among Susquehanna, Keefe Bruyette & Woods Inc. and the other initial purchasers referred to therein is incorporated by reference to Exhibit 4.3 to Susquehanna’s Registration Statement on Form S-4, Registration Statement No. 333-102265. |
| | 4.4 | First Supplemental Indenture, dated May 3, 2004, to Indenture dated November 4, 2002, by and between Susquehanna and J.P. Morgan Trust Company, National Association, relating to the 4.75% fixed rate/floating rate subordinated notes due 2014 is incorporated by reference to Exhibit 4.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | 4.5 | Global Note to the 4.75% fixed rate/floating rate subordinated notes due 2014, dated May 3, 2004, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | 4.6 | Registration Rights Agreement, dated as of May 3, 2004, by and among Susquehanna, Keefe Bruyette & Woods Inc. and the other initial purchasers referred to therein is incorporated by reference to Exhibit 4.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | 4.7 | Amended and Restated Trust Agreement, dated as of December 12, 2007, among Susquehanna, The Bank of New York, The Bank of New York (Delaware), the Administrative Trustees named therein and the Holders is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
129
| | 4.8 | Guarantee Agreement between Susquehanna and The Bank of New York, as Trustee, dated December 12, 2007, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
| | 4.9 | Supplemental Indenture between Susquehanna and The Bank of New York, as Trustee, dated December 12, 2007, is incorporated by reference to Exhibit 4.3 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
| | 4.10 | 9.375% Capital Efficient Note is incorporated by reference to Exhibit 4.4 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
| | 4.11 | 9.375% Capital Securities Note is incorporated by reference to Exhibit 4.11 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. |
| | 4.12 | Form of Certificate for the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
| | 4.13 | Warrant to Purchase Shares of Common Stock of Susquehanna, dated December 12, 2008, issued to the United States Department of the Treasury, is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
| | 4.14 | Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt are not filed. Susquehanna agrees to furnish a copy thereof to the Securities and Exchange Commission upon request. |
| | 10.1 | Letter Agreement dated December 12, 2008 by and between Susquehanna and the United States Department of the Treasury, is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
| | 10.2 | Form of Waiver of Senior Executive Officers is attached hereto as Exhibit 10.2.* |
| | 10.3 | Form of Letter Agreement by and between the Senior Executive Officers and Susquehanna is attached hereto as Exhibit 10.3.* |
| | 10.4 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and William J. Reuter is attached hereto as Exhibit 10.4.* |
| | 10.5 | Employment Agreement, dated November 16, 2007, between Susquehanna and Eddie L. Dunklebarger is incorporated by reference to Exhibit 10.3* of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* First Amendment to Employment Agreement, dated February 27, 2009, between Susquehanna and Eddie L. Dunklebarger is attached hereto as Exhibit 10.5.* |
| | 10.6 | Employment Agreement, as amended and restated effective dated January 1, 2009, between Susquehanna and Drew K. Hostetter is attached hereto as Exhibit 10.6.* |
| | 10.7 | Employment Agreement dated November 4, 2003, but effective as of January 1, 2004, between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr. is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. First Amendment to Employment Agreement dated January 18, 2005 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K filed January 21, 2005. Second Amendment to Employment Agreement dated February 26, 2007 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007. Letter Agreement between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr., dated December 1, 2008, is attached hereto as Exhibit 10.7.* |
130
| | 10.8 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Michael M. Quick is attached hereto as Exhibit 10.8.* |
| | 10.9 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and James G. Pierné is attached hereto as Exhibit 10.9.* |
| | 10.10 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Edward Balderston, Jr. is attached hereto as Exhibit 10.10.* |
| | 10.11 | Employment Agreement, dated November 16, 2007, between Susquehanna, Susquehanna Bank PA and Jeffrey M. Seibert is attached hereto as Exhibit 10.11.* First Amendment to Employment Agreement, dated February 27, 2009, between Susquehanna and Jeffrey M. Seibert is attached hereto as Exhibit 10.11.* |
| | 10.12 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Peter J. Sahd is attached hereto as Exhibit 10.12.* |
| | 10.13 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Rodney A. Lefever is attached hereto as Exhibit 10.13.* |
| | 10.14 | Employment Agreement, effective January 1, 2009, between Susquehanna and Lisa M. Cavage is attached hereto as Exhibit 10.14.* |
| | 10.15 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and John H. Montgomery is attached hereto as Exhibit 10.15.* |
| | 10.16 | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Michael E. Hough is attached hereto as Exhibit 10.16.* |
| | 10.17 | Employment Agreement, effective January 1, 2009, between Susquehanna and Joseph R. Lizza is attached hereto as Exhibit 10.17.* |
| | 10.18 | Description of cash bonus paid to Bernard A. Francis, Jr. is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed October 15, 2008.* |
| | 10.19 | Description of 2008 Susquehanna Incentive Plan is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008. Description of termination of the cash incentive component of the 2008 Susquehanna Incentive Plan is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed September 29, 2008.* |
| | 10.20 | Description of base salaries and discretionary grants of equity compensation in the form of nonqualified stock options and restricted stock for the year ended December 31, 2008 to Susquehanna’s named executive officers is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008.* |
| | 10.21 | Susquehanna’s Executive Deferred Income Plan, effective January 1, 2009, is attached hereto as Exhibit 10.21.* |
| | 10.22 | Susquehanna’s Supplemental Executive Retirement Plan as amended and restated effective January 1, 2009, is attached hereto as Exhibit 10.22.* |
| | 10.23 | Forms of The Insurance Trust for Susquehanna Bancshares Banks and Affiliates Split Dollar Agreement and Split Dollar Policy Endorsement are incorporated by reference to Exhibit 10(v) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.* |
| | 10.24 | Community Banks, Inc. Survivor Income Agreement, including Split Dollar Addendum to Community Banks, Inc. Survivor Income Agreement, is incorporated by reference to Exhibit 10.18 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ending December 31, 2007.* |
131
| | 10.25 | Amended and Restated Salary Continuation Agreement between Community Banks, Inc. and Eddie L. Dunklebarger, dated January 1, 2004, as amended November 16, 2007, is attached incorporated by reference to Exhibit 10.19 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* |
| | 10.26 | Susquehanna’s Key Employee Severance Pay Plan, amended and restated as of January 1, 2009, is attached hereto as Exhibit 10.26.* |
| | 10.27 | Descriptions of Executive Life Insurance Program, Executive Supplemental Long Term Disability Plan, Francis Life Insurance Policy and the bonus programs offered by Valley Forge Asset Management Corp. are incorporated by reference to Exhibit 10.15 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
| | 10.28 | Susquehanna’s 2005 Equity Compensation Plan is incorporated by reference to Exhibit 10.16 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
| | 10.29 | Susquehanna’s Equity Compensation Plan is incorporated by reference to Exhibit 10.17 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
| | 10.30 | Community Banks, Inc. 1998 Long-Term Incentive Plan is incorporated by reference to Exhibit 99.1 of Susquehanna’s Post-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 (File No. 333-144397).* |
| | 10.31 | Director Compensation Schedule, effective January 1, 2009, is attached hereto as Exhibit 10.31.* |
| | 10.32 | Description of grants of nonqualified stock options to Susquehanna’s non-employee directors is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008.* |
| | 10.33 | Community Banks, Inc. Directors Stock Option Plan is incorporated by reference to Exhibit 99.2 of Susquehanna’s Post-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 (File No. 333-144397).* |
| | 10.34 | The Farmers and Merchants National Bank of Hagerstown Executive Supplemental Income Plan, dated March 6, 1984, is incorporated by reference to Exhibit 10.28 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* |
| | 10.35 | Description of Eddie L. Dunklebarger term life insurance policy is attached hereto as Exhibit 10.35.* |
| | 10.36 | 2002 Amended Servicing Agreement dated January 1, 2002 between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. First Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. Second Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.6 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Third Amendment to the 2002 Amended Servicing Agreement and Fourth Amendment to the 2002 Amended Servicing Agreement are incorporated by reference to Exhibit 10.6 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. Fifth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.8 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005. Sixth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.25 of |
132
| | Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005. Seventh Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.2 of Susquehanna’s Quarterly Report on Form 10-Q for quarterly period ended June 30, 2006. Eighth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.23 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Ninth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.30 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. Tenth Amendment to the 2002 Amended Servicing Agreement is attached hereto as Exhibit 10.36. |
| | 14.1 | A copy of Susquehanna’s Code of Ethics is available on Susquehanna’s website at www.susquehanna.net. Click on “Investor Relations,” then “Governance Documents,” then “Code of Ethics of Susquehanna Bancshares, Inc.” |
| | (21) | Subsidiaries of the registrant. Filed herewith. |
| | (23) | Consent of PricewaterhouseCoopers LLP. Filed herewith. |
| | (31) | Rule 13a-14(a)/15d-14(a) Certifications |
| | 31.1 | Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1. |
| | 31.2 | Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2. |
| | (32) | Section 1350 Certifications. Filed herewith. |
| * | Management contract or compensation plan or arrangement required to be filed or incorporated as an exhibit. |
| (c) | Financial Statement Schedule. None Required. |
133
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | |
| SUSQUEHANNA BANCSHARES, INC. |
| |
| By: | | /s/ WILLIAM J. REUTER |
| | William J. Reuter, Chairman of the Board and Chief Executive Officer |
Dated: February 27, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | | | |
Signature | | Title | | Date |
| | |
/S/ WILLIAM J. REUTER (William J. Reuter) | | Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) | | February 27, 2009 |
| | |
/S/ DREW K. HOSTETTER (Drew K. Hostetter) | | Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) | | February 27, 2009 |
| | |
/S/ ANTHONY J. AGNONE, SR. (Anthony J. Agnone, Sr.) | | Director | | February 27, 2009 |
| | |
/S/ WAYNE E. ALTER, JR. (Wayne E. Alter, Jr.) | | Director | | February 27, 2009 |
| | |
/S/ PETER DESOTO (Peter DeSoto) | | Director | | February 27, 2009 |
| | |
/S/ EDDIE L. DUNKLEBARGER (Eddie L. Dunklebarger) | | Director | | February 27, 2009 |
| | |
/S/ BRUCE A. HEPBURN (Bruce A. Hepburn) | | Director | | February 27, 2009 |
| | |
/S/ DONALD L. HOFFMAN (Donald L. Hoffman) | | Director | | February 27, 2009 |
134
SECURITIES AND EXCHANGE COMMISSION
SUSQUEHANNA BANCSHARES, INC.
Form 10-K, December 31, 2008
[SIGNATURES CONTINUED]
| | | | |
Signature | | Title | | Date |
| | |
/S/ GUY W. MILLER, JR. (Guy W. Miller, Jr.) | | Director | | February 27, 2009 |
| | |
/S/ MICHAEL A. MORELLO (Michael A. Morello) | | Director | | February 27, 2009 |
| | |
/S/ SCOTT J. NEWKAM (Scott J. Newkam) | | Director | | February 27, 2009 |
| | |
/S/ E. SUSAN PIERSOL (E. Susan Piersol) | | Director | | February 27, 2009 |
| | |
/S/ M. ZEV ROSE (M. Zev Rose) | | Director | | February 27, 2009 |
| | |
/S/ CHRISTINE SEARS (Christine Sears) | | Director | | February 27, 2009 |
| | |
/S/ JAMES A. ULSH (James A. Ulsh) | | Director | | February 27, 2009 |
| | |
/S/ DALE M. WEAVER (Dale M. Weaver) | | Director | | February 27, 2009 |
| | |
/S/ ROGER V. WIEST (Roger V. Wiest) | | Director | | February 27, 2009 |
| | |
/S/ WILLIAM B. ZIMMERMAN (William B. Zimmerman) | | Director | | February 27, 2009 |
[END OF SIGNATURE PAGES]
135
EXHIBIT INDEX
| | | | |
Exhibit Numbers | | | | Description and Method of Filing |
| (3) | | 3.1 | | Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 17, 2007. |
| | |
| | 3.1.a | | Statement with Respect to Shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A of Susquehanna, is incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
| | |
| | 3.2 | | By-laws. Incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008. |
| |
| (4) | | Instruments defining the rights of security holders including indentures. The rights of the holders of Susquehanna’s Common Stock and the rights of Susquehanna’s note holders are contained in the following documents or instruments, which are incorporated herein by reference. |
| | |
| | 4.1 | | Indenture, dated as of November 4, 2002, by and between Susquehanna and JP Morgan Trust Company, National Association, relating to the 6.05% subordinated notes due 2012, incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-4, Registration No. 333-102265. |
| | |
| | 4.2 | | Global Note relating to the 6.05% subordinated notes due 2012, dated February 27, 2003 is incorporated by reference to Exhibit 4.3 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. |
| | |
| | 4.3 | | Registration Rights Agreement, dated as of November 4, 2002, by and among Susquehanna, Keefe Bruyette & Woods Inc. and the other initial purchasers referred to therein is incorporated by reference to Exhibit 4.3 to Susquehanna’s Registration Statement on Form S-4, Registration Statement No. 333-102265. |
| | |
| | 4.4 | | First Supplemental Indenture, dated May 3, 2004, to Indenture dated November 4, 2002, by and between Susquehanna and J.P. Morgan Trust Company, National Association, relating to the 4.75% fixed rate/floating rate subordinated notes due 2014 is incorporated by reference to Exhibit 4.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | |
| | 4.5 | | Global Note to the 4.75% fixed rate/floating rate subordinated notes due 2014, dated May 3, 2004, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | |
| | 4.6 | | Registration Rights Agreement, dated as of May 3, 2004, by and among Susquehanna, Keefe Bruyette & Woods Inc. and the other initial purchasers referred to therein is incorporated by reference to Exhibit 4.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004. |
| | |
| | 4.7 | | Amended and Restated Trust Agreement, dated as of December 12, 2007, among Susquehanna, The Bank of New York, The Bank of New York (Delaware), the Administrative Trustees named therein and the Holders is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
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| | 4.8 | | Guarantee Agreement between Susquehanna and The Bank of New York, as Trustee, dated December 12, 2007, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
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| | 4.9 | | Supplemental Indenture between Susquehanna and The Bank of New York, as Trustee, dated December 12, 2007, is incorporated by reference to Exhibit 4.3 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
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Exhibit Numbers | | | | Description and Method of Filing |
| | 4.10 | | 9.375% Capital Efficient Note is incorporated by reference to Exhibit 4.4 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2007. |
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| | 4.11 | | 9.375% Capital Securities Note is incorporated by reference to Exhibit 4.11 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. |
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| | 4.12 | | Form of Certificate for the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
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| | 4.13 | | Warrant to Purchase Shares of Common Stock of Susquehanna, dated December 12, 2008, issued to the United States Department of the Treasury, is incorporated by reference to Exhibit 4.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
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| | 4.14 | | Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, copies of instruments defining the rights of holders of long-term debt are not filed. Susquehanna agrees to furnish a copy thereof to the Securities and Exchange Commission upon request. |
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| (10) | | Material Contracts. |
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| | 10.1 | | Letter Agreement dated December 12, 2008 by and between Susquehanna and the United States Department of the Treasury, is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed December 12, 2008. |
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| | 10.2 | | Form of Waiver of Senior Executive Officers is attached hereto as Exhibit 10.2.* |
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| | 10.3 | | Form of Letter Agreement by and between the Senior Executive Officers and Susquehanna is attached hereto as Exhibit 10.3.* |
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| | 10.4 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and William J. Reuter is attached hereto as Exhibit 10.4.* |
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| | 10.5 | | Employment Agreement, dated November 16, 2007, between Susquehanna and Eddie L. Dunklebarger is incorporated by reference to Exhibit 10.3* of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* First Amendment to Employment Agreement, dated February 27, 2009, between Susquehanna and Eddie L. Dunklebarger is attached hereto as Exhibit 10.5* |
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| | 10.6 | | Employment Agreement, as amended and restated effective dated January 1, 2009, between Susquehanna and Drew K. Hostetter is attached hereto as Exhibit 10.6.* |
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| | 10.7 | | Employment Agreement dated November 4, 2003, but effective as of January 1, 2004, between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr. is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. First Amendment to Employment Agreement dated January 18, 2005 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K filed January 21, 2005. Second Amendment to Employment Agreement dated February 26, 2007 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007. Letter Agreement between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr., dated December 1, 2008, is attached hereto as Exhibit 10.7.* |
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| | 10.8 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Michael M. Quick is attached hereto as Exhibit 10.8.* |
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| | 10.9 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and James G. Pierné is attached hereto as Exhibit 10.9.* |
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Exhibit Numbers | | | | Description and Method of Filing |
| | 10.10 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Edward Balderston, Jr. is attached hereto as Exhibit 10.10.* |
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| | 10.11 | | Employment Agreement, dated November 16, 2007, between Susquehanna, Susquehanna Bank PA and Jeffrey M. Seibert is attached hereto as Exhibit 10.11.* First Amendment to Employment Agreement, dated February 27, 2009, between Susquehanna and Jeffrey M. Seibert is attached hereto as Exhibit 10.11* |
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| | 10.12 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Peter J. Sahd is attached hereto as Exhibit 10.12.* |
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| | 10.13 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Rodney A. Lefever is attached hereto as Exhibit 10.13.* |
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| | 10.14 | | Employment Agreement, effective January 1, 2009, between Susquehanna and Lisa M. Cavage is attached hereto as Exhibit 10.14.* |
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| | 10.15 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and John H. Montgomery is attached hereto as Exhibit 10.15.* |
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| | 10.16 | | Employment Agreement, as amended and restated effective January 1, 2009, between Susquehanna and Michael E. Hough is attached hereto as Exhibit 10.16.* |
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| | 10.17 | | Employment Agreement, effective January 1, 2009, between Susquehanna and Joseph R. Lizza is attached hereto as Exhibit 10.17.* |
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| | 10.18 | | Description of cash bonus paid to Bernard A. Francis, Jr. is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed October 15, 2008.* |
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| | 10.19 | | Description of 2008 Susquehanna Incentive Plan is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008. Description of termination of the cash incentive component of the 2008 Susquehanna Incentive Plan is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed September 29, 2008.* |
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| | 10.20 | | Description of base salaries and discretionary grants of equity compensation in the form of nonqualified stock options and restricted stock for the year ended December 31, 2008 to Susquehanna’s named executive officers is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008.* |
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| | 10.21 | | Susquehanna’s Executive Deferred Income Plan, effective January 1, 2009, is attached hereto as Exhibit 10.21.* |
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| | 10.22 | | Susquehanna’s Supplemental Executive Retirement Plan as amended and restated effective January 1, 2009, is attached hereto as Exhibit 10.22.* |
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| | 10.23 | | Forms of The Insurance Trust for Susquehanna Bancshares Banks and Affiliates Split Dollar Agreement and Split Dollar Policy Endorsement are incorporated by reference to Exhibit 10(v) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.* |
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| | 10.24 | | Community Banks, Inc. Survivor Income Agreement, including Split Dollar Addendum to Community Banks, Inc. Survivor Income Agreement, is incorporated by reference to Exhibit 10.18 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ending December 31, 2007.* |
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| | 10.25 | | Amended and Restated Salary Continuation Agreement between Community Banks, Inc. and Eddie L. Dunklebarger, dated January 1, 2004, as amended November 16, 2007, is attached incorporated by reference to Exhibit 10.19 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* |
138
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Exhibit Numbers | | | | Description and Method of Filing |
| | 10.26 | | Susquehanna’s Key Employee Severance Pay Plan, amended and restated as of January 1, 2009, is attached hereto as Exhibit 10.26.* |
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| | 10.27 | | Descriptions of Executive Life Insurance Program, Executive Supplemental Long Term Disability Plan, Francis Life Insurance Policy and the bonus programs offered by Valley Forge Asset Management Corp. are incorporated by reference to Exhibit 10.15 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
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| | 10.28 | | Susquehanna’s 2005 Equity Compensation Plan is incorporated by reference to Exhibit 10.16 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
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| | 10.29 | | Susquehanna’s Equity Compensation Plan is incorporated by reference to Exhibit 10.17 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.* |
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| | 10.30 | | Community Banks, Inc. 1998 Long-Term Incentive Plan is incorporated by reference to Exhibit 99.1 of Susquehanna’s Post-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 (File No. 333-144397).* |
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| | 10.31 | | Director Compensation Schedule, effective January 1, 2009, is attached hereto as Exhibit 10.31.* |
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| | 10.32 | | Description of grants of nonqualified stock options to Susquehanna’s non-employee directors is incorporated by reference to Item 5.02 of Susquehanna’s Current Report on Form 8-K, filed March 4, 2008.* |
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| | 10.33 | | Community Banks, Inc. Directors Stock Option Plan is incorporated by reference to Exhibit 99.2 of Susquehanna’s Post-Effective Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 (File No. 333-144397).* |
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| | 10.34 | | The Farmers and Merchants National Bank of Hagerstown Executive Supplemental Income Plan, dated March 6, 1984, is incorporated by reference to Exhibit 10.28 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.* |
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| | 10.35 | | Description of Eddie L. Dunklebarger term life insurance policy is attached hereto as Exhibit 10.35.* |
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| | 10.36 | | 2002 Amended Servicing Agreement dated January 1, 2002 between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. First Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. Second Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.6 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Third Amendment to the 2002 Amended Servicing Agreement and Fourth Amendment to the 2002 Amended Servicing Agreement are incorporated by reference to Exhibit 10.6 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. Fifth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.8 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005. Sixth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.25 of Susquehanna’s Annual |
139
| | | | |
Exhibit Numbers | | | | Description and Method of Filing |
| | | | Report on Form 10-K for the fiscal year ended December 31, 2005. Seventh Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.2 of Susquehanna’s Quarterly Report on Form 10-Q for quarterly period ended June 30, 2006. Eighth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.23 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Ninth Amendment to the 2002 Amended Servicing Agreement is incorporated by reference to Exhibit 10.30 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. Tenth Amendment to the 2002 Amended Servicing Agreement is attached hereto as Exhibit 10.36. |
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| (14) | | Code of Ethics |
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| | 14.1 | | A copy of Susquehanna’s Code of Ethics is available on Susquehanna’s website at www.susquehanna.net. Click on “Investor Relations,” then “Governance Documents,” then “Code of Ethics of Susquehanna Bancshares, Inc.” |
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| (21) | | Subsidiariesof the registrant. Filed herewith. |
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| (23) | | Consent of PricewaterhouseCoopers LLP. Filed herewith. |
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| (31) | | Rule 13a-14(a)/15d-14(a) Certifications |
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| | 31.1 | | Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1. |
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| | 31.2 | | Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2. |
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| (32) | | Section1350 Certifications. Filed herewith. |
| * | Management contract or compensation plan or arrangement required to be filed or incorporated as an exhibit. |
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