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Susquehanna Bancshares (NASDAQ:SUSQ)

Q4 2013 Earnings Call

January 23, 2014 11:00 AM ET

Executives

Jason Weber – Director, IR and Capital Management

Bill Reuter – Chairman and CEO

Mike Harrington – EVP, CFO and Treasurer

Mike Quick – EVP and Chief Corporate Credit Officer

Analysts

Casey Haire – Jefferies & Co

Frank Schiraldi – Sandler O’Neill

Chris McGratty – KBW

Bob Ramsey – FBR

Preeti Dixit – JP Morgan

Matthew Clark – Credit Suisse

David Darst – Guggenheim Securities

Michael Byrne – Macquarie Capital

Matthew Kelley – Sterne, Agee

Operator

Good day, and welcome to today’s Susquehanna Bancshares Fourth Quarter 2013 Earnings Conference Call. Today’s call is being recorded. At this time, participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) Thank you.

And Mr. Weber, you may please begin your conference call.

Jason Weber

Thank you, Casey. Good morning, and welcome everyone. I am Jason Weber and I serve as Vice President and Director of Investor Relations at Susquehanna Bancshares. Our press release containing fourth quarter and full year financial results for 2013 was made available yesterday after the market closed. You can find this and our other financial releases in Investor Relations section of our website at www.susquehanna.net.

Certain statements made during this conference call may be considered to be forward-looking statements. In particular, certain statements made on this call may include forward-looking statements relating to customer relationship strategies; 2014 performance; loan and deposit volume and growth; fee income activities and revenues; and the impact of purchase accounting benefit on financial results.

Such statements are not guarantees of future performance and are subject to certain risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in this press release and our SEC filings. We encourage you to refer to such filings including the Form 8-K filed yesterday containing our earnings release and our most recent Forms 10-K and 10-Q for a complete discussion of forward-looking statements.

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 may occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events, except as required by law.

Participants in today’s call will be Bill Reuter, Chairman and Chief Executive Officer; Mike Harrington, Executive Vice President and Chief Financial Officer and Treasurer, and Mike Quick, Executive Vice President and Chief Corporate Credit Officer.

Now I’ll turn the call over to Bill Reuter.

Bill Reuter

Thank you, Jason and good morning everyone. And thank you for joining us. 2013 marked a year of strong progress in the development of our relationship based strategy and this morning, I would like to share with you my thinking about our direction as well as some highlights from 2013.

We’re in the midst of a multi-year strategy to strengthen our focus on building enduring relationship with customers. This strategy is designed to enhance the earnings power of the bank, make the bank a more attractive franchise and position us to compete with other regional banks in our footprint while maintaining the service delivery of a community bank.

This strategy involves several key components. First, we are making the necessary investments to enhance our systems, processes and products to ensure we are providing value to customers while also increasing our wallet share and overall profitability. Additionally, we continue to improve our infrastructure around risk management and compliance that will support our continued growth.

Second, we continue to expand our talent in many areas. In fact, about 45% of our top 60 leaders having been [ph] with the company for less than two years and they have added valuable experience to our team.

Third, we are enhancing our incentive structure to award our team members for selling all of our products and services. For example, in 2013 we introduced a new relationship profitability model for our commercial accounts. This will assist relationship managers in cross-selling the appropriate products and services to build enduring relationships with our customers.

With this strategy in mind, I would like to review highlights of our performance of our business lines during 2013. Loan originations for 2013 totaled over $4 billion. We saw a continued strong growth in consumer and lease portfolio as well as a pickup in C&I lending in the fourth quarter. In keeping with our relationship focus, we did exit some loan participations during the year. Additionally our Susquehanna Commercial Finance portfolio grew 18% driven partly by increased internal referrals.

Deposit growth continues to be a top priority for us and overall deposit growth grew by 2.3% during 2013. We streamlined our checking account offerings going from 17 different accounts to 3. A highlight of the year was introduction of Stellar Checking with smart rewards, an account that provides tax rewards to customers for everyday activities like using a debit card for purchases or paying bills online.

Stellar Checking has generated 57,000 accounts, including 27,000 new accounts, and the new accounts being opened typically are carrying a higher average balance than converted accounts. The incentives that Stellar Checking offers has led to increased debit card usage among those customers which obviously contributes to fee income.

We also launched mobile deposit this year, adding another convenience service for customers. We have seen strong initial adoption rates and use of this service.

Growth in other online services is also strong with mobile banking users up 25% from over last year. Customers receiving e-statements up 107% and total online banking users up 27%. In light of the adoption rates for thee services, we will continue to evaluate all of our distribution channels to determine where to focus resources going forward.

We made a strategic decision to exit certain non-relationship deposits which were typically higher costs. The result put downward pressure on overall deposit growth but it also contributed to a significant improvement in deposit costs which improved from 66 basis points to 56 basis points at year end 2013.

Non-interest income was up 10% from 2012. One contributor to this increase was our expanding Capital Markets Group which gives our sales force additional capabilities to offer to business customers. This year it generated $7 million in non-interest income last year, a 66% increase over 2012.

We also saw an increase in cash management fee income that was up 15% to nearly $10 million. The cash management group generated more than $90 million in new demand deposit accounts for business customers and also introduced an industry leading Lockbox system.

The mortgage division had a record volume in originations. We were seeing good success in our originate-to-sell strategy with mortgage loans. The percent of loans originated and sold to investors was 56% last year and we expect to drive this rate higher in 2014.

The mortgage division also introduced a program to retain servicing of mortgages sold which gives us continued opportunities to communicate and cross-sell to these customers. In 2013, we retained servicing on 68% of mortgage loans. Additionally we continue to add new originators particularly in Baltimore and Philadelphia – areas where we believe there is a good potential to increase our market share in mortgage lending.

Our wealth management business had a strong year with an expanded sales team. We closed $233 million in new wealth management business from bank referrals and overall new wealth management business was up approximately $400 million for 2013.

On the expense side, we took steps in the fourth quarter to create greater efficiency in our branch network. As we discussed previously, we consolidated 14 of our branches into nearby offices during the quarter. This branch consolidation project resulted in a $16.6 million expensed but annualized ongoing savings from this move are projected at $5 million.

In December, we completed a sale leaseback transaction involving 30 of our branch facilities resulting in a $5 million gain in the quarter. The sale leaseback allows us to continue serving customers from the same locations while enabling us to reinvest the net proceeds of $54 million that was previously tied up in real estate.

We were also able to realize approximately $4 million of deferred tax assets as a result of this transaction, resulting in a reduction in the provision for income taxes in 2013.

As we mentioned on last quarter’s call, we are making continued investments in technology to enhance a customer experience as well as stress testing, enterprise risk management and other areas to create a foundation for future growth. For example, we recently hired a new executive vice president and chief risk officer Kevin Burns. He brings significant experience having worked for Deloitte’s national banking practice and in risk management capacities at several large leading financial institutions. Kevin will serve as a valuable resource both to our Board and to departments throughout the company in the area of enterprise risk management as we continue to more fully build out this program.

The expansion related to risk management is just one example of how we are investing to scale – to scale our capabilities in line with the growth that has propelled us into the ranks of the industry’s top 50 banks. Similar efforts are underway in other areas of our business from adding people and teams to the frontlines to enhancing back office service to create a better customer experience. These investments to achieve our long term relationship strategies may have some impact on earnings in the short term.

Another element of our long term strategy that may impact short term results is our focus on right-sizing our balance sheet for a more balanced loan to deposit ratio. Mike Harrington will provide further detail about this during his remarks.

So now I would like to turn the call over to him. Mike?

Mike Harrington

Thank you, Bill and good morning everyone. As Billed mentioned in his opening remarks, we continue to see positive momentum in our business.

Fourth quarter saw higher fee, revenue and continued improvement in our credit and capital markets. Expenses remained elevated as we continued to make investments in the areas Bill alluded to earlier in the call. With that in mind, I will review some of our key financial results for the fourth quarter and full year 2013.

Net income for the fourth quarter was $41.3 million or $0.22 per diluted share compared to $44.3 million or $0.24 per diluted share for the prior quarter. Return on average assets and average tangible equity for the quarter finished at 0.89% and 12.49% respectively compared to 0.96% and 13.67% respectively for the prior quarter.

We reported record net income for 2013 of $173.7 million or $0.92 per diluted share, compared with $141.2 million or $0.70 per diluted share for 2012. Return on average assets and average tangible equity for 2013 finished at 0.95% and 13.57% respectively compared to 0.81% and 12.03% respectively for 2012.

Net interest income decreased $3.3 million or 2.2% linked quarter. Loan growth of 1.5% was offset by a reduction in the net interest margin of 12 basis points. The net interest margin was 3.60% in the quarter versus 3.72% in the prior quarter. Net interest margin excluding purchase accounting was down 9 basis points. The margin decline is a function of existing loans repricing at lower rates, change in the mix of loans and less benefit from the repricing of higher rate CDs that we have noted in prior calls.

Net interest income decreased $5.3 million or 0.9% year-over-year . The net interest margin was 3.79% in 2013, one basis point below our most recent guidance, versus 4.01% in 2012. Net interest margin, excluding purchase accounting, declined 16 basis points to 3.53% in 2013 compared to 3.69% for 2012.

As we noted in prior quarters, we expect the purchase accounting benefit to continue well into 2014 and 2015 but caution that the timing of the recognition of this benefit is difficult to predict.

Loans and leases ended the quarter at $13.6 billion, up 1.5% from the prior quarter and 5.3% year over year. In spite of the competitive market, we were able to generate loan growth that exceeded our original 5% projection while remaining disciplined from a risk and return perspective.

On a positive note, collectively spreads appear to be stabilizing. While it’s too early to tell if this represents a trend, we are encouraged by the early signs.

Consistent with our strategic plan, we saw a strong pick up in C&I lending in the fourth quarter, which was up 5.3% both from last quarter and year over year. Consumer loans totaled $953 million, up 1.9% over the prior quarter and 13.1% year over year.

And our lease portfolio continued a strong growth ending the quarter at $1.2 billion, up 6.2% from the prior quarter and 35.4% year over year. Total deposits ended the quarter at $12.9 billion, an increase of 1.2% from the prior quarter and 2.3% year over year. Time deposits were down slightly from the prior quarter but increased 2.1% year over year.

In keeping with our strategic plan, we increased core deposits which were up 1.7% from the prior quarter and up 2.4% on a year-over-year basis. Deposit growth continues to be a top priority for us in 2014. Additionally we feel now is the time to begin the process of strengthening our liquidity profile before interest rates rise. Our goal is to drive that ratio below 100% -- drive the loan to deposit ratio below 100% in 2014. Achieving this goal will increase the value of our deposit franchise and improve the liquidity profile of the bank but may limit asset growth in 2014.

Turning to credit quality. The loan loss provision was $2 million for the quarter while net charge-offs were $11.1 million. As a result, the allowance for loan losses declined to 1.16% of loans from 1.25% in the prior quarter and the coverage ratio remained strong at 156% of non-accrual loans and leases.

Non-interest income increased to $50.7 million compared to $41.3 million for the prior quarter. The fourth quarter included a gain on sale of branch properties of $5 million. Solid performance in our fee income initiatives, especially capital markets also contributed to the linked quarter increase. Non-interest income increased to $183.7 million in 2013 compared to $166.8 million in 2012.

Looking at a few selected line items in this category, other commissions and fees increased to $7.6 million, a 43.6% increase from the prior quarter driven by an increase of $2.1million in our capital markets group. This is an area that we’re actively building and one we believe will continue to grow in 2014.

Wealth management commissions and fees increased to $13 million, a 3.5% increase from the prior quarter. Other commission and fee income was driven by better retail trading activity and better market conditions. Our mortgage division rebounded nicely this quarter with revenues increasing to $2.5 million, an 11% increase from the prior quarter.

Non-interest expense increased to $135.7 million compared to $117.7 million in the prior quarter. Our fourth quarter included branch consolidation costs of $6.6 million. The primary driver of the remaining increase was stronger than anticipated fourth quarter results, particularly in the commercial loan growth which resulted in additional incentive compensation expense.

Additionally, in the third quarter, there was an adjustment in our benefit accruals which reduced expenses by approximately $4 million. Non-interest expense was $490.8 million in 2013 compared to $490 million in 2012.

Effective tax rate for the quarter was 26% compared to 31% on a linked quarter basis. The tax rate was lower in the fourth quarter primarily due to a reduction in expense of approximately $4 million as a sale leaseback transaction enabled Susquehanna to realized a deferred tax asset which was previously subject to valuation allowance. Going forward, we expect our effective tax rate to return to its recent average of approximately 31%.

Turning to capital. Our capital ratio has continued to exceed internal capital targets and those required to be well capitalized under the current regulatory requirements with the tier 1 common ratio of 10.58%., a tier 1 risk weighted capital ratio of 11.68%, total risk weighted capital ratio of 13.01% and the leverage ratio of 9.54% each as of December 31, 2013.

I will conclude my remarks with a few comments about 2014. Historically, we have provided detailed financial targets for the full year but after careful consideration we have decided to change our process. We will no longer provide annual financial targets; instead we’ll discuss current trends and provide guidance in general terms for the next quarter. We believe this change is prudent and it brings us in mind with peer disclosure practices.

First, net interest income and net interest margin. We expect our recent margin level in the fourth quarter to serve us an inflection point. Stated another way, we expect the margin to remain relatively stable in the near term and over the longer term if interest rates do not change. In the first quarter, we’ll also be impacted by two fewer days, so actual net interest income may be down.

As I noted earlier, the trend in average earning asset growth for the year will likely be lower than past years given our desire to lower our loan-to-deposit ratio. We’re pleased with the general direction of credit quality. We expect the provision to trend in-line with recent annual amounts as many of you providing for loan and lease losses is a modeling exercise that is dependent on numerous variables.

As our allowance methodology becomes increasingly quantitative, we anticipate our provision for loan losses may increasingly vary from quarter to quarter. Absent the gain on sale of branch properties, we expect non-interest income to be slightly up from the prior quarter driven by seasonal factors and continued growth. Absent the branch optimisation costs, we expect non-interest expenses to be slightly down for the quarter as the year end incentive expenses are normalized.

Trends for the year will be influenced by normal inflation factors such as merit increases and the investments we have been discussing. As for capital management, we expect things to be status quo until after the stress test results are submitted and we receive feedback on our submission from the regulators, which we don’t expect until the second half of 2014.

Now I would like to turn the call back over to Bill for his closing remarks.

Bill Reuter

Thank you, Mike. As the New Year began we rolled out ads in our branches and online that promote our recognition as one of Money Magazine’s Best Banks in America. In this selection process, Money looked at the 40 biggest retail banks in the country as well as large online banks and credit unions. The strategies and investments we’ve outlined on our call today are driven by the fact that we have achieved the size and scale that demand expanded capabilities for our customers, greater efficiency of operation and greater proficiency in enterprise risk management. Our team is focused on achieving these objectives and building on our success.

Thank you for your attention. We’ll now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll take our first question from Casey Haire with Jefferies.

Casey Haire – Jefferies & Co

Mike, could you help out with the NIM outlook and it sounds -- your commentary sounds pretty stable. But that said, I would think loan pricing would still be under pressure and your initiatives around improving the loan to deposit ratio might actually push deposit costs higher and we also have purchase accounting fading, so can you just give us some color on how you get to a stable NIM outlook?

Mike Harrington

I mean the loan growth we’re originating loans right now is getting, the activity we’re seeing on the asset side, we think that’s going to – our asset yield is held [ph] up pretty well. Purchase accounting, we don’t expect to – we expect to be about [indiscernible] were in this quarter at least for the foreseeable future. And the activity around expanding the loan-to- deposit ratio is just switching deposits for borrowings and we don’t – there is not a large change in terms of cost there. So the guidance we’re providing as we think the margin and NIM is going to stabilize.

Bill Reuter

[indiscernible] I also want to mention to you that one of areas of focus for 2014 will continue to be grow -- although we’ll probably be emphasizing certain segments of our loan portfolio. Clearly, the C&I side is where we’re getting the biggest bang for the buck. We’re getting relatively attractive rates, we’re getting opportunities to collect swap fees, we’re getting solid demand deposit balances with those transactions. So we think a kind of shift in the mix of deposits will also help that NIM at the same time.

Mike Harrington

Casey, just follow on the Bill’s comments -- and that mix of assets we’re going to be focused more on C&I growth. So the yield or the weighted average yield that we’re bringing on should be higher than what we’ve been experiencing as well. And we’ve had a lot of growth in the consumer line especially on the lease line and that growth rate is not going to be maintained.

Casey Haire – Jefferies & Co

Okay, got you. And then just clarification question on the purchase accounting, it seems like in the table in the release, it seems like the benefit from last quarter was a little bit stronger than what you guys originally disclosed. Are we getting – I mean what’s driving that change?

Mike Harrington

The benefit from last quarter was changed.

Casey Haire – Jefferies & Co

Yes. I remember it’s about 14 basis points, so that looks around to be about 17 basis points in the release.

Mike Harrington

If you’re looking at the table it’s got every – the table has all categories in it including deposits. As far as I know we didn’t change the table from last quarter, so that dropped this quarter. We expected a drop a little bit more than we thought but again this gets to the challenge of trying to predict what actual purchase accounting is going be on the quarter-to-quarter basis.

Casey Haire – Jefferies & Co

Got you. Okay and just last one from me. The credit migration, obviously you guys continued to get good news there. With the loan loss reserve coverage ratio kind of in-line where you guys were in ‘07/’08. Is it fair to say that the provision is going to track charge-offs from here?

Mike Quick

I would say that would be a good assumption that it will track charge-offs.

Casey Haire – Jefferies & Co

Okay. Thank you.

Operator

Thank you. We’ll take our next question from Frank Schiraldi with Sandler O’Neill.

Frank Schiraldi – Sandler O’Neill

Just on the loan-to-deposit ratio you talked about getting to 100%, I’m just wondering, is that a goal that you say by the end of 2014?

Bill Reuter

That’s correct, Frank.

Frank Schiraldi – Sandler O’Neill

Okay, and so do you foresee getting more aggressive on – obviously there is two sides to that. Growing deposits is one side and so do you see yourself getting more aggressive or significantly more aggressive on bringing deposits in the door?

Bill Reuter

The answer, this is Bill Reuter, the answer is yes. We have some fairly lofty deposit goals this year that are not necessarily just price driven. I want to make sure you understand that. We don’t want to erode the margin at the same time. But we believe we have the structure in place now with some of the things we’ve perfected over a period of time, the consolidated branch system that we now have, the investments we’ve made in technology on the mobile side. With our workplace – where our workplace banking model that we’ve put in place to not only attract corporate business but to attract the retail accounts of everybody who works at that business. And we believe Stellar Checking will continue to do very, very well for us and as I said earlier, with our real emphasis on small business lending and C&I lending, that’s all deposit-rich opportunities as well as what we’re targeting just basically deposit-rich companies. So I think the deposit side of the equation for loans and deposits is going to be a pretty significant force.

Mike Harrington

And then as I mentioned earlier, Frank, the other side of that, solving that equation is on the asset side of where we’re going to limit growth in certain categories. We’re still going to support our C&I growth rates in particular and support that activity but limit growth to other categories.

Bill Reuter

So Frank, as an example, again Bill Reuter speaking. So as an example, one of our goals is to significantly increase the amount of residential mortgages we place in the secondary market and not to put much in our own portfolio. We also think that’s a judicious move when you -- especially if you look at potential interest rates down the road at some point in time. We’re probably going to scale back the level of activity we have in our indirect portfolio; again, not customer driven. If you believe our concept of developing relationship banking and developing deep relationships, indirect portfolio certainly would have room to wind down, for lack of a better word.

Frank Schiraldi Sandler O'Neill

Okay. And as you mentioned, you want to support your C&I growth, so how does 4Q stack up in terms of just specifically looking at C&I now? How does 4Q results stack up in terms of a potential run rate growth – growth run rate going forward?

Bill Reuter

I think that’s a pretty good indicator of what we expect to do next year -- this year ’14. And I’d also say the thing that was encouraging in the fourth quarter. Of course, the fourth quarter is also is a result of what we’re working on the third quarter. We’re pleased with the distribution of that C&I growth. It wasn’t one particular market, although the Central Pennsylvania market did very well in the fourth quarter on the C&I side. But Baltimore, Philadelphia, all, the Northern tier, we’re all starting to see some pretty solid pickup on the C&I side and some opportunities there that are as a result of us not making calls, as a result of us getting referrals and I think maybe just a general little bit of pickup in the economy. I’m not going to bank on that yet, but we’d like to think we’re getting more market share.

Frank Schiraldi Sandler O'Neill

Okay. And then just I guess finally on the loan growth. I guess perhaps you’re not prepared to do so, but is there any color you can give in terms of just year-over-year growth, net loan growth in 2014. Are we talking low single digits? Would you consider mid-single digits? What are you guys thinking?

Bill Reuter

Well, we’re thinking more, not a number as much as we’re changing the mix. So mix is working on. Where that ends up being we’ll just have to see, but we’re working hard on just changing the mix in general. Overall asset 2013 was 2.4% and we don’t expect on our overall balance sheet standpoint, we expect our number this year to be lower than that.

Frank Schiraldi Sandler O'Neill

Okay. Okay. And then just on expenses, Mike, I think you said slightly down in terms of the expense base in 1Q rather off of 4Q and I’m just wondering if you could share, how much of the incentive, the uptick in incentive comp was there in 4Q and what is sort of one-time true up?

Mike Harrington

I’d say the easiest way to think about is probably an extra 3 million in the quarter. So when that gets normalized in Q1, that line item by itself would drop by 3. And what offsets that a little bit is we’re going to start to have, merit increase will start to hit, just some normal things that happen once you turn the calendar, so.

Frank Schiraldi Sandler O'Neill

Got you. Okay. So the primary – so the increase you’re talking about in the 4Q release in terms of incentive comp was basically 3 million bucks and we should consider one time really in terms of run rate?

Mike Harrington

Right. And then hopefully, I explained the Q3 to Q4 dynamic wherein Q3 we actually had a reversal of expense and I think we mentioned that on the call last time that the run rate, the 2Q ’13 run rate for salaries and benefits was probably – was a better indicator of what our normal run rate is.

Frank Schiraldi Sandler O'Neill

Right. Okay. And just finally, on expenses, just when we think about the stress test that’s ongoing, should we expect that there is a decent amount of front loaded expenses that could be consulting that would be considered – I don’t know if you’d call it one time – but would flow off the income statement in 2Q, 3Q and the rest of the year?

Mike Harrington

Well if we looked at stress testing in isolation, then the answer to that would be yes. I just think there is other things that are coming down the pipe, other initiatives that we have ongoing where those costs might be reallocated to some other area.

Bill Reuter

And Frank, there are some expenses we’re incurring that the revenue comes later on. A great example is despite the great year capital markets had for us, we’ve invested in a lot of – we’ve invested a lot of new people, hired a lot of new people for that area. And they’re not nearly where they’re going to be two and three years from now. So my point in my presentation was some of the increased run rate expenses right now will have benefits later on. Just may not be the next quarter. So but your specific question is exactly on the mark. The stress testing expenses we would expect to subside at some point in time. And there will be some consulting fees in there that would go away at some point in time also. But clearly, I’ll make it clear that areas like regulatory change requirements in the area of things like internal audit, stress testing, enterprise risk management, are all adding pressure to the expense side.

Now where we’re watching expenses very carefully, I would just remind you that we did the branch consolidation move in the third quarter and we’ll continue to look at our expense levels and manage them for – both for the good long-term benefit of the company.

Frank Schiraldi Sandler O'Neill

Okay, great. That’s all I had. Thank you.

Operator

Thank you. We’ll take our next question from Chris McGratty with KBW.

Chris McGratty – KBW

Hey, good morning guys. Mike, on the size of the investment portfolio, it’s about 2.6 billion today. Can you help us in where that size should ultimately trough based on your comments on the balance sheet strategy?

Mike Harrington

We don’t expect it to move.

Chris McGratty – KBW

Okay. And then –

Mike Harrington

We’ve talked about – that’s why we’re giving just kind of directional guidance on our overall balance sheet size. So loan growth, asset growth – asset growth in general is not going to move a lot this year.

Chris McGratty – KBW

Okay. And the decision on the loan to deposit, that was you guys internal based on projected balance sheet growth and profitability. That wasn’t anything regulatory driven, correct?

Bill Reuter

You want to answer that?

Mike Harrington

You know, we’ve also looked at our peers. If you look at our peers, we’re actually pretty good from a loan to deposit ratio side.

Bill Reuter

Yeah, I mean it’s just the right -- it’s the right thing to do. We feel the time’s right now is to start to get that ratio where we’re looking to get it to, which is down. Actually our longer term objective is to get it into the mid-90s. We think that’s appropriate, that’s where we want to run the business and we think now is the time to start moving in that direction.

Chris McGratty – KBW

Great. Just a technical on the FDIC insurance. Is that $6 million, that run rate, is that a good level for next year?

Bill Reuter

I think it is, yeah. I mean something in that, it’s going to be – again, that’s a function of our asset size as well but I think that number is in the ballpark of where we’d expect it to be going forward.

Chris McGratty – KBW

Okay. And then last one Bill on maybe the back half of the year post-stress test. Can you talk about capital deployments via dividends and potentially maybe doing a deal later in the year?

Bill Reuter

I would say, I think as Mike had in his presentation, we’re already looking at capital planning. We obviously, we’re going to be submitting some stress testing in the first quarter. We have been told that the residents will look at – most of those stress tests by the June-ish, July timeframe. And hopefully as we get closer to that timeframe, we’ll be able to make some decisions about things like capital planning, dividends, buybacks, whatever the case might be.

Chris McGratty – KBW

Understood.

Bill Reuter

On the M&A side, we’re pretty much just – I mean most of the M&A transactions that are occurring right now are currently on the very small side. We’re not that interested in small. So we have plenty to do just making sure we get the most out of the investments we’re making in 2013 and ’14 beyond. If something unique were to come up, we certainly would look at it, but it would have to be unique.

Chris McGratty – KBW

Understood. Thanks.

Operator

Thank you. We’ll take our next question from Bob Ramsey with FBR.

Bob Ramsey – FBR

Hey good morning. Just a little bit of clarity on the expense guidance. Was the guidance for lower expenses next year relative to the fourth quarter number without the one-time charges or relative to the full year?

Bill Reuter

I don’t think – I wasn’t trying to guide expenses down. I just wanted to make sure that the number in the fourth quarter that we printed, the headline number that you all adjust that, which I think you have just based on the commentary we’ve seen early on and take the $6.6 million out of that, that leaves you with $129 million of quarterly expense. Some of that had some incentive in it. So depending on how much you subtract there, which I think I went over earlier, you’re in the 125-126 zone. We don’t expect expenses to drop. If anything, what I said in my prepared remarks was that that run rate, it has some inflation associated with it, just because of normal things that happened when the calendar changes to a new year. And these continued investments we’re making won’t -- really aren’t going to allow us to squeeze any more out of that expense line in the near term.

Bob Ramsey – FBR

Okay, I think that helps clarify. Thank you. And then on net interest margin, I know you talked a little bit about that and you expect the purchase accounting benefits to stay flattish in the near term. But if I think about it correctly, you’ve got 15 basis points benefit that should disappear over the next couple of years. I mean that’s fair, isn’t it?

Bill Reuter

Yeah, and hopefully the mix of business win will offset that as we alluded to earlier. So as we change the mix profile of the loan portfolio, what’s rolling off will be replaced by something that’s closer to what rolled off.

Bob Ramsey – FBR

Okay. And I know you mentioned the C&I yields in the quarter were attractive. Could you tell us where you’re putting these C&I loans on your books and similarly I guess where you’re putting auto leases on your books?

Mike Harrington

We’re putting them on – we’re using LIBOR base and we’re usually somewhere between 250 to 375 over LIBOR depending on the total profitability of the relationship. Our hurdle is a 15% return on equity on every deal.

Bill Reuter

And the lease portfolio is coming on again, just like it did last quarter in the low 3s, so the average yield on that’s 320-ish, somewhere around there. Our overall yield that we booked quarter to quarter is actually stable, which was good news from our perspective. Now it’s in the high 3s, 380 range.

Bob Ramsey – FBR

Great. Thank you very much.

Bill Reuter

Yeah.

Operator

Thank you. We’ll go next to Preeti Dixit with JP Morgan.

Preeti Dixit – JP Morgan

Hi, good morning everyone. Most of my questions have been asked, but just a follow up to the expense commentary. You have the investments slated for this year, how much of it do you view as discretionary? In other words, would you be willing to let operating leverage slip here in order to make the investments or could you pull back if revenues remain pressured? I’m just trying to get a sense of operating leverage for the full year.

Bill Reuter

Well, letting it – so I think it has the potential to slip, just when I think when you do the financials and run your model. What we’re messaging is what we feel is important for the long term. So there is always discretion involved in some of these investments, but what we’re messaging is look, this is what we really think we need to do in 2014. So I wouldn’t – there’s not levers we can throw to say, well, we’re not going to do X, Y or Z, or there is not a lot of levers we’re going to want to throw because we want to make those investments. Does that answer your question?

Preeti Dixit – JP Morgan

Yeah, no, that’s definitely helpful. And then just as a follow up to the commercial loan growth question. Do you have what your pipeline looked like at the end of the quarter and how that compared to the prior quarter?

Bill Reuter

I don’t, but I think it’s similar to what we carried over into third quarter, into the fourth quarter.

Mike Harrington

It is similar to what we carried over into first couple of meetings this month have been very positive in the C&I pipeline.

Bill Reuter

We’re seeing – we’ve been seeing a fair amount of activity in the loan committee level too, so that’s good.

Preeti Dixit – JP Morgan

Okay, great. Thanks for taking my questions.

Operator

Thank you. We’ll take our next question from Matthew Clark with Credit Suisse.

Matthew Clark – Credit Suisse

Hey, good morning guys.

Bill Reuter

Hey Matthew.

Matthew Clark – Credit Suisse

I guess as a follow up to one of those prior questions. On operating leverage and I guess longer term, have you guys thought about where you want to be from an efficiency standpoint, understanding that we’ve got some investments to make here? Just trying to think longer term what you think the right –

Bill Reuter

We’re still pondering 60% or slightly under 60%.

Matthew Clark – Credit Suisse

Okay. And I guess I assume that’s a long-term target. I wouldn’t expect you guys to be there maybe this year or next, but is that fair?

Bill Reuter

Yeah I would agree with that.

Matthew Clark – Credit Suisse

Okay. Okay, the rest of my questions have been answered. Thanks

Bill Reuter

Thank you.

Operator

Thank you. We’ll take our next question from David Darst with Guggenheim Securities.

David Darst – Guggenheim Securities

Hi.

Bill Reuter

Hi David.

David Darst – Guggenheim Securities

Good morning. Mike, just – are you expecting your charge offs to kind of tick down this year pretty dramatically? I mean you didn’t get that much improvement year-over-year in ’12 and ’13.

Mike Quick

I’ll just tell you in the fourth quarter, if you take out one charge off which our models indicated the value of that collateral would go down dramatically over the next two years, we would have been equal to what our charge offs were. So we made a strategic decision on that, but we have seen our charge offs come down and we’ve had an excellent year in recoveries also. And our models are predicting, our model for all – will drive the provision, but at this point in time with the improvement we’ve seen in credit, the positive migration in loans that were classified for the first time in some time, we feel very good about the trend.

Mike Harrington

Yeah, and that’s about – this is Mike Harrington. That’s about all we can say is we feel good about the trends. As you’ll see when we file our K, we had really good activity in our past rated loans, we’ve got good migration out of classifieds and we’re very focused on that and we’re going to continue to stay focused on it in 2014. And if we’re successful, then we’ll continue to see positive trends in credit.

David Darst – Guggenheim Securities

Okay. And then just Bill, you’re using a lot of -- lowered investment a lot, but this feels like a dramatic kind of repositioning, almost internal restructuring of who you are relative to what you need to be to be a larger company. The ROA improvement, ROEs are going to be significantly lower. You’re building capital through this phase. How do you think about where you should be relative to your peers as you come on the backside of those, because it seems like you’re a long way from where you might want to be?

Bill Reuter

Well, some of it depends on the size of the company. So I think we’re doing the things right now, and investing in the things right now to be a larger company. And I think it’d be difficult for us to be a larger company than do those things later. So I think we’re making the right investments at the right time and that’s all I can really say at about this point in time.

David Darst – Guggenheim Securities

Are higher…

Bill Reuter

Obviously, the issue of capital is one that we’ll be addressing as the year progresses. Obviously we have excess capital, we have it right now, we’ll continue to build capital. But I think all options will be on the table for us. I know historically we have said we’re a dividend paying company, but I think we’ll put all things back on the table and just take a good hard look at what our options are with capital as we get to the mid part of the year.

David Darst – Guggenheim Securities

Are higher capital ratios an expected outcome of the things you’re doing today?

Mike Harrington

No, I don’t, this is Mike, I don’t believe so. The two aren’t linked. The capital, the constraints around capital distribution I think are just the obvious, which is we’re in the middle of a process that will give us more information around where our capital level should be. And we have to finish that process before we can definitively decide okay, here’s where our capital level should be and then that will let us know whether we have excess capital or we don’t. Once we know we have excess capital, then we can take the steps that Bill’s discussing which is decide what we do with it. Whether we store it and hold on to it for something strategic or we return it, we’ll make that decision as soon as we’re in a position to do that.

David Darst – Guggenheim Securities

Okay, got it. Thank you.

Operator

We will go to John Moran with Macquarie Capital.

Michael Byrne – Macquarie Capital

This is Michael Byrne for John. Just a question on the C&I growth. Do you guys have the line utilization from sort of 3Q to 4Q? Just give us a sense of whether the growth is driven by existing customers drawing down on lines or are you guys expanding into new customers?

Bill Reuter

This would have been opportunity for new customers, [indiscernible] opportunity to new customers.

Michael Byrne – Macquarie Capital

Okay, sure. And then just -- you also said you'd evaluate your distribution channels as the positive usage trends in mobile and online have sort of continued. Would that be more on the closing branches side or investing more in your additional mobile and online capabilities?

Bill Reuter

Could be all the above.

Operator

We’ll go to Matthew Kelley with Sterne, Agee.

Matthew Kelley – Sterne, Agee

I was wondering if you can just give a little bit more context in terms of why you're making the decision or communicating the decision on changing your liquidity profile and the loan-to-deposit ratio focus? I mean, if you look at the loan-to-deposit ratio over the last several years, it's consistently been above 100. So I guess the question is, why now? And what has changed over the last 90 days for this to become a big area of focus for management?

Bill Reuter

Well we believe that new appropriate operating models to run at something below 100. I know in the past we were indifferent to wholesale borrowings but I think if you just look at what’s happening at the large banks and the emphasis is being placed on liquidity with those banks and not relying on wholesale funding sources that we think that’s appropriate, that a bank should predominantly rely on deposits to fund its activity. And so that’s the conclusion we have reached in our internal conversations and with our board. We feel the timing is right now because I think we all agree that at some point rates will be higher than they are today and we feel that would require deposits now than do that in a future time period. That’s why we are acting now, we’ve been talking about this for the last two quarters but we want to be very exclusive about this strategy for ’14 just to make sure that we are setting appropriate tone. So hope you all can do your job and come up with accurate estimates around what we are going to look like this year.

Matthew Kelley – Sterne, Agee

And then not much of a conversation here today on just commercial real estate and what you have been seeing. I know that's a longer duration type of product, and maybe some concern about that. But what's changed or what are you observing in the commercial real estate markets? Some of your peers have put up decent growth. What are you seeing? And what's your strategy around that asset class? I know you're focused on C&I primarily, but what have you been seeing in commercial real estate for risk-adjusted pricing? And what's your view there?

Mike Harrington

We have been seeing opportunities but we have seen a pickup in our construction loans for CRE and within our marketplace, it’s not so much in residential book. We do or we are doing some selective CRE loans.

Matthew Kelley – Sterne, Agee

And how has the pricing changed, migrated?

Mike Harrington

It’s been about the same as it’s been the last several quarters.

Operator

It appears at this time we have no further questions. I will turn the conference back over to Bill Reuter for any additional or closing remarks.

Bill Reuter

Okay. Well thank you for your questions s and discussions this morning. We hope you can join us for our next quarterly conference call on Thursday, April 24, 2014 at 11:00 AM Eastern Time. It will be available via webcast on our website www.susquehanna.net. Thank you for your interest in Susquehanna Bancshares.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect.

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