Susquehanna Bancshares' (SUSQ) CEO Bill Reuter on Q2 2014 Results - Earnings Call Transcript

| About: Susquehanna Bancshares, (SUSQ)

Susquehanna Bancshares, Inc. (NASDAQ:SUSQ)

Q2 2014 Earnings Conference Call

July 24, 2014 11:00 AM ET

Executives

Jason H. Weber – Vice President and Director-Investor Relations

William J. Reuter – Chairman and Chief Executive Officer

Michael W. Harrington – Executive Vice President, Chief Financial Officer and Treasurer

Michael M. Quick – Executive Vice President and Chief Corporate Credit Officer

Analysts

Casey Haire – Jefferies & Company, Inc.

Frank Schiraldi – Sandler O'Neill & Partners

Robert H. Ramsey – FBR Capital Markets & Co.

Christopher McGratty – Keefe, Bruyette & Woods Inc.

Preeti S. Dixit – JPMorgan Securities LLC

Matthew Kelley – Sterne, Agee & Leach, Inc.

Blair Brantley – BB&T Capital Markets

Robert H. Ramsey – FBR Capital Markets & Co.

Operator

Good day and welcome to the Susquehanna Bancshares’ Second Quarter 2014 Earnings Conference Call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

Thank you. Mr. Weber, you may begin your conference call.

Jason H. Weber

Thanks, Angela. Thank you. 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 2014 second quarter financial results was made available yesterday after the market closed. You can find this and other financial releases in the 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 2014 performance, deposit and loan mix and growth, net interest margin, capital management and shareholder returns, off-balance sheet transactions, credit quality and reserves, interest rate risk and the impact of process and technology improvements and purchasing the accounting benefit on financial results.

Such statements are not guarantees of future performance and are subject to certain risk and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in the 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-Q and 10-K for a complete discussion on 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 those required by law.

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

William J. Reuter

Thank you, Jason, and good morning everyone and thank you for joining us. This morning, I would like to address two primary topics: a review of our second quarter business results and the company’s actions as they relate to capital management.

During the second quarter, we made solid progress on a number of the strategic priorities we established for 2014. We achieved strong deposit growth, continued to improve the mix of our loan portfolio, as well as asset quality and made targeted investments, designed to enhance the customer experience, employee engagement and enterprise risk management.

Increasing our relationship based deposits is a primary component of our strategy and is at the forefront of our efforts. In the second quarter, our rate of deposit growth continued to accelerate with total deposits up $235 million, or 1.8% from the first quarter and $551 million or 4.3% year-over-year.

This compares to a year-over-year growth rate of 3.1% from the first quarter. We’ve been supporting deposit growth with relationship-based CD promotions. To that end, in addition to the increase in CD balances, we opened 2,300 new net personal checking accounts during the quarter.

Looking at loans, we’re working to enhance the mix of our portfolio to optimize our balance sheet as part of our strategic plan. C&I loan growth was somewhat limited during the quarter, partly due to our decision to strategically exit a fairly large credit. In addition, some of the key markets where we operate are among the most competitive in the country right now, as noted in the Fed’s most recent Beige Book.

On a year-over-year basis, C&I lending did grow by 5.8%, while the second quarter started out slowly. we did see momentum build in June and our teams are working diligently to sustain that momentum in the third quarter. Construction lending was up, reversing a downward trend. Our construction portfolio has been running off for some time, consistent with our strategy to manage the relative size of this portfolio. The recent uptick contributed to the overall loan growth for the quarter as a good sign of what we can expect to continue in the future for this segment of our balance sheet.

As you may recall, we would like to see this portfolio, make up between 8% and 10% of total outstandings. while our residential loans appeared essentially flat quarter-to-quarter, this is another area where we’re adjusting the makeup of the portfolio. We’re running down our first lien residential mortgage loans, while increasing branch-based home equity lines of credit. Mike Harrington will provide additional details about these trends, as well as our plans to manage the size of our indirect auto portfolio. Consistent with previous quarters, we saw solid advances in consumer loans and leases. However, consistent with our strategic plan, the growth rate in consumer leases is decelerating.

Turning to credit quality, we continue to see positive migration trends. Net charge-offs did tick up this quarter. However, non-performing assets decreased on both a linked quarter and year-over basis. Given the ongoing improvement in credit quality, we are comfortable with the $3 million loan loss provision we made for the quarter and with our current reserve levels.

Other strategic priorities this year are enhancing the experience we offer to customers and elevating employee engagement. We need to be sure we’re investing our resources in the best way possible to deliver excellent service to customers, while making operations as efficient as possible for our teams.

With that in mind, we are in the midst of a comprehensive review of our business that is designed to identify process improvements, as well as areas of opportunity for cost management. When we operate more efficiently, it enables us to invest money back in the business to enhance our capabilities, expertise and ability to grow.

In the area of talent, over the last few months, we continued to enhance our leadership team with the addition of a new market CEO for our banking division in Southeastern Pennsylvania and Southern New Jersey, as well as a new Chief Internal Auditor. In addition, we continue to build out our teams focused on aspects of enterprise risk management, as well as information technology and finance. These investments are driven in part by the regulatory environment, but it goes well beyond that.

Expanding the expertise of our teams, implementing more efficient processes and upgrading technology will position us to compete even more effectively and build on our success. I’d like to turn now to two steps we’ve taken recently to illustrate our commitment to managing our excess capital while providing a strong return to the shareholders, both in the short and long-term.

Last week, our Board voted to increase the quarterly cash dividend to $0.09 per share, marking the seventh increase over the last three-and-a-half years. In addition, after a thorough consideration, our Board authorized a stock repurchase plan for a number of reasons. First, it complements the company’s current practice of distributing FX capital by dividends. second, it provides flexibility in managing our capital position. and finally, it can serve as an effective means of enhancing shareholder return. Looking forward, we will continue to evaluate repurchase opportunities as part of our ongoing capital management program.

Now I’ll turn the call over to Mike Harrington.

Michael W. Harrington

Thank you, Bill, and good morning, everyone. To build on what Bill has discussed this morning, I’d like to review some of our key financial results for the second quarter, 2014.

Net income for the second quarter was $43.5 million or 23% per diluted share, compared to $37.2 million or $0.20 per diluted share for the prior quarter. Return on average assets and average tangible equity for the quarter finished at 0.95% and 12.34% respectively, compared to 0.82% and 11.08% respectively for the prior quarter.

Net interest income increased $1.6 million, or 1.2% linked quarter. This increase was attributable to an extra day in the quarter. Average earning assets were down slightly, while net interest margin increased 2 basis points to 3.63% from 3.61% in the prior quarter.

Purchase accounting accretion increased 25 basis points this quarter, compared to 21 basis points prior quarter. This increase was due to $3.7 million pretax benefit we received from redeeming $5 million trust preferred security during the quarter. Excluding this benefit, purchase accounting accretion would have been 16 basis points, which is in line with prior guidance. The net interest margin excluding purchase accounting was down 2 basis points to 3.3%, in line with our prior guidance, compared to 3.40% in the prior quarter.

This compression in the margin is primarily a function of our existing loan book repricing, as well as the mix of new loan originations, including more variable rate assets such as HELOCs and construction loans. New loan originations and commitments increased linked quarter, while line utilization was down for commercial loans, but increased in the construction segment. Line utilization for commercial and construction was 41% and 45% respectively.

Consumer utilization was consistent with the prior quarter at 52%. The commercial pipeline was stable linked quarter, but showed good momentum in the Baltimore area. New loan origination, and commitment spreads, and yields were down slightly this quarter, illustrating the competitive pressures we face in the markets we serve.

We’re moving closer to the point where new yields match the existing loan book, but the specific timing of when we reach that point will be a function of the competitive market, interest rate environment and the origination mix for the remainder of the year. Loans and leases ended the quarter at $13.7 billion, increasing 0.7% from the prior quarter.

As Bill mentioned, we made the decision to strategically exit a fairly large commercial credit this quarter. Absent the exit of this credit, the increase in commercial loans would have been 2% or 8% annualized. Also, consistent with our strategic plan, we saw the first lien residential loan portfolio decreased by $35 million, offset by growth in our branch-based HELOC portfolio.

Finally, after eight quarters of declines, the construction portfolio increased linked quarter as activity in our markets picked up in the second quarter. Total deposits ended the quarter at $13.3 billion, an increase of 1.8%, or 7.2% annualized. Checking account balances increased 0.6% linked quarter, or 2.5% annualized, while time deposits were up 9.1% linked quarter, or 36% annualized. We are seeing strong growth in the relationship-based promotional CDs.

Deposit growth continues to be a top priority for us in 2014 and beyond. As we have mentioned in the past, our goal is to drive a loan-to-deposit ratio to just below 100% in 2014. We have been working to improve the liquidity profile of the company to better position us for future growth.

This effort comes at a time when deposit acquisition costs are low, given the available liquidity in the marketplace. We are confident that the achievement of this objective will increase the value of our franchise, while improving the interest rate risk profile of the bank.

To help achieve that goal, we reclassified approximately $265 million of indirect auto loans from held-for-investment to held-for-sale. We expect to close the securitization, or other off-balance transactions with substantially, all of these loans during 2014. We believe this transaction, along with our deposit momentum, will allow us to achieve our loan-to-deposit target by year-end.

Turning to credit quality, the loan loss provision was $3 million for the quarter while net charge-offs were $11.4 million. As a result, the allowance for loan losses declined to 1.46% of loans from 1.14% in the prior quarter, while the coverage ratio was 137% of non-accrual loans and leases. We are pleased with the positive credit migration that we saw during the quarter, which is reflected in the strong asset quality metrics that we reported.

Non-interest income increased to $45.3 million, compared to $42.1 million for the prior quarter. The second quarter included a net realized gain on sale securities of $3.3 million. This gain was the result of an opportunity, provided by a single name trust-preferred issuer to tender $20 million of a security they issued, which generated a gain of $3.3 million.

Absent the gain, non-interest income was essentially flat linked quarter. More specifically, mortgage banking revenue increased 25% to $3 million from the prior quarter, while capital markets revenue is slightly down. Insurance revenue was down as expected due to seasonality in the business. The first quarter typically has the highest policy renewal rates.

Wealth management had a solid quarter with assets under management and administration of 3.8% to $8 billion with approximately 60% of that increase in new money. Non-interest expense increased to $125.2 million, compared to $123 million in the prior quarter. Annual merit increases and higher commission expense were the primary drivers of the increase linked quarter. Occupancy expenses were down $2 million on a reduction of snow removal costs of $1.8 million offset by increases in other expense categories, notably professional fees. The effective tax rate for the quarter was 26% compared to 30% linked quarter. The tax rate was lower in the quarter due to a discreet benefit related to recently enacted state tax legislation that will allow the Company to realize approximately $2.4 million of deferred tax assets, which were previously subject to evaluation allowance.

The release of the allowance was recorded as a reduction and a provision for income taxes for the second quarter of 2014. Turning to capital, our capital ratios continue to build and exceed our internal targets and those required to be well capitalized under current regulatory requirements.

During the quarter, we had approximately $75 million of subordinated debt that matured and as I previously mentioned, $5 million of trust preferred that we redeemed. As Bill noted, our Board approved two actions related to capital management – a dividend increase and share repurchase plan. Assuming the full repurchase of 3.5% of our current shares outstanding and the share price at quarter end, the combination of these two actions would return approximately 78% of our trailing four quarter of net income to our shareholders. We believe this is the appropriate step in managing our excess capital to our desired long-term capital targets.

I will conclude my remarks with a few comments about our expectations for the next quarter. Earning asset growth will continue to be muted as we reposition our liquidity profile. We will see our net interest margin, excluding purchase accounting, decline slightly as we continue to experience similar competitive pressures in our existing loan book.

We expect a net interest margin excluding purchase accounting to be in the 3.2% to 3.6% range. Credit quality continues to improve. We expect the provision to be in a range consistent with our recent quarters. Excluding the net realized gain on sale securities in the second quarter, we expect non-interest income to increase from the prior quarter as mortgage banking builds momentum from the spring selling season and we see lift in other areas such as SBA loan sales and capital markets. We expect non-interest expenses to increase slightly. And finally, we expect the effective tax rate to return to a normalized rate of 30% to 31%.

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

William J. Reuter

Thank you, Mike. We're pleased with the progress we're making on our strategic objectives and we're excited by the potential we see for this momentum to continue. We've been making investments in key areas that will empower us to compete even more effectively in the future. Team members throughout our Company are focused on priorities we’ve been discussing, namely growing deposits and optimizing the composition of our loan portfolio, pursuing opportunities to enhance efficiencies while making strategic investments for future growth, creating a differentiating experience for customers and managing capital and enhancing the return we offer to shareholders. We've made significant strides so far, but there's still much work to be done. Looking forward to sharing the results of our team's efforts in future calls.

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 & Company, Inc.

Hey, good morning, guys.

William J. Reuter

Morning.

Casey Haire – Jefferies & Company, Inc.

Mike, question for you on the earning assets and NIM guide. I was wondering if that contemplates the sale of the indirect auto. Obviously, it would hurt you on the earning asset front, but I would think would help you on the NIM guide.

Michael W. Harrington

Well, our guidance factors in the potential for that sale, Casey we’re not we said second half; we said the rest of the year just because we're not exactly sure what the timing of that's going to be. So, what we're thinking about is for the next quarter, which is the guidance we just provided, to be flat-ish for that quarter and the [NIM] (ph) guidance we provided considers the potential of the sale and the timing of that sale.

Casey Haire – Jefferies & Company, Inc.

Okay, so as it stands today, you think you can hold earning assets flat even while probably selling some of, if not all – selling some of the indirect auto?

Michael W. Harrington

On an average basis, yes.

Casey Haire – Jefferies & Company, Inc.

And the indirect auto, I would think that the disposition of that would be accretive to NIM dynamics, correct?

Michael W. Harrington

No.

Casey Haire – Jefferies & Company, Inc.

Oh, okay.

Michael W. Harrington

At a minimum, what we'd be doing is taking the proceeds with that coupon and reinvesting it in securities; that's clearly a lower yield than what we're selling.

Casey Haire – Jefferies & Company, Inc.

Okay, got you. All right, and then switching to expenses, sounds like you guys are looking at efficiency initiatives. Just curious what kind of efficiency ratio you might be targeting or looking to improve towards, and then how you balance that with – expenses were up this quarter on the merit increase and commissions; no mention of regulatory spend; how you balance a tougher regulatory spend environment versus finding incremental efficiencies?

Michael W. Harrington

Well, I don't think we're in a position to talk about what our longer-term efficiency ratio target is, what’s baked into our run-rate expenses right now is the incremental dollars we're spending to upgrade some of the areas that we've talked about previously. And as Bill, just to pick up on – the comment Bill made is we're doing a very comprehensive analysis of the organization and we're obviously looking for ways to run the Company more efficiently. And that's about as much as we're going to say I think on the call at this point.

William J. Reuter

Yes, this is Bill Reuter speaking. I think in the past we had said publicly that we were targeting an efficiency ratio over the long term of about 60%. And I would suspect that that position has not changed.

Casey Haire – Jefferies & Company, Inc.

Okay, thank you.

Operator

And we will now go to Frank Schiraldi with Sandler O'Neill.

Frank Schiraldi – Sandler O'Neill & Partners

Morning.

William J. Reuter

Morning, Frank.

Frank Schiraldi – Sandler O'Neill & Partners

Just a few questions, if I could. I wondered first if you could talk a little bit about specifically deposit growth. Given what you've seen in the last couple of quarters, what are your thoughts on the level of deposit growth going forward? And it seemed like you got some good traction in checking in the quarter. Could we see some more growth there or do you think it'll be more on the CD side?

William J. Reuter

It’s our anticipation to see more on just core deposit growth and we define core deposit growth as CD saving, I mean money markets, CD and checking. So, as part and parcel of all that, the relationship-based products that we offer periodically will include a CD promotion with people with checking accounts, as an example, or people that will open a checking account with us. So, we're really focused more on core deposits. And I would think, Frank, part of our strategic plan, part of our expectations would be for core deposit growth to continue.

Frank Schiraldi – Sandler O'Neill & Partners

Okay. Do you have any I mean – is it sort of low single digits or you're not comfortable sort of getting into that sort of range guidance?

William J. Reuter

I think internally we're comfortable with saying what we're going to do. But externally, I think you just rest assured that we're going to – that component of core deposit growth we believe is the most important to establishing long-term franchise value. It also help us bring that loan deposit ratio down so it's very much in focus. So, you could assume that we're going to continue to do a better job of that in the future.

Frank Schiraldi – Sandler O'Neill & Partners

Okay, great. And then just wanted to talk a little bit about long-term or longer term capital return. I'm trying to get a sense – we still have the dividend increase and then obviously the buyback plan. And is it a specific payout ratio you're looking at on the dividend side or is there a specific level of earnings you're looking to target as a return going forward? How should we think about maybe out beyond 2014 about capital return?

Michael W. Harrington

Well, what we're doing now is a function of we're not growing our balance sheet; we're accumulating capital. And the best thing we can do with that is give it back to our shareholders. Longer term, we're going to have some payout ratio that from a dividend perspective it's probably in the zone that we're looking at now. And we'll take the opportunities when the timing's right to continue to give it back to shareholders depending on the situation at the time whether or not we need it, we have a better use for it. But I think the big event that took place this quarter that you're seeing is we're open to share repurchases – first time the Company's done a share repurchase and recognized the fact that if we don't have a good use for it, we need to be returning it to shareholders. And that's going to just be part of our thinking on a go-forward basis.

William J. Reuter

Frank, we have – this is Bill Reuter. We had anticipated earlier on this year that this event would happen later on this year. But we thought it was a great opportunity to accelerate it into this quarter. As Mike indicated, we're looking at something around the 75% payout ratio if you look at the last four trailing quarters. We wanted to keep a little buffer on that initially so that as Basel III becomes more clear to us, we can better focus on what that payout ratio should be in the future. But I guess the real signal from us is simply we're very open-minded toward dividend and toward capital management in general, including forms of stock buyback.

Frank Schiraldi – Sandler O'Neill & Partners

Okay, great. And then finally, just on the margin, I thought in the past that 15 basis points has been a decent expectation of purchase accounting amortization per quarter. And I'm wondering if that's sort of a decent estimate to have, first of all, and then if you could remind us that will eventually roll off and sort of the timing on that?

Michael W. Harrington

That is still – that's what we said last quarter. That's what we're using. That's what's factored into the range that I provided earlier. And then I think just from purchase accounting generally, as most – and I think we've said this before – is that if rates stay where they're at, the purchase accounting is going to burn off and our margin is going to track and trend towards our core margin. So, that's how we think about it here and we're going to do what we can to maybe not have it track as fast. But there's a lot of pressure on asset yields right now. So, that's a part of what we factored into our short-term guidance. So, that's how we think about a longer-term, Frank, it just tracks towards our core margin.

Frank Schiraldi – Sandler O'Neill & Partners

Got you. Okay, all right. Thank you very much.

Michael W. Harrington

Thank you.

Operator

And we will now go to Bob Ramsey with FBR Capital Markets.

Robert H. Ramsey – FBR Capital Markets & Co.

Hey, good morning. Wanted to ask about the auto securitization plan, first off, and sort of what prompted this decision. Was it more about managing the concentration limits or was it about improving the loan-to-deposit ratio or is it a reflection of how you all view the auto securitization market today?

Michael W. Harrington

Well, I'd say it’s the primary driver is what we're trying to do from just position the balance sheet and improving the liquidity profile of the balance sheet and loan-to-deposit ratio. And then we said over the last few quarters that we've talked about this – it was going to be a combo strategy. So, part of it’s going to be maybe not growing our assets as quickly or limiting the growth in certain categories and then also potentially selling portfolios as well as deposit growth. I mean, the primary method we're using to get where we want to get to is to increase our deposit growth rate above and beyond our loan growth rate. But this is just part of that overall plan that we had laid out for 2014.

Back to your point or your question around the auto loan market and the securitization market's very strong, as you would expect. I mean, given the environment generally around and the need for earning assets in the banking sector, the auto loan securitization market's very strong. So, we felt pretty good about using that as an alternative to reach our objective here on the loan-to-deposit side.

William J. Reuter

And Bob, this is Bill Reuter. So, as we've done investor conferences this year, as we put investor decks out, we've been pretty specific in terms of what our major strategy is here, including a change in the mix of the loan portfolio and a rundown of first lien residential mortgages on our books. We still want to be big in the residential market, but most of that we're selling in the secondary market. As a matter of fact, I think this past quarter, well over 80% of what we originated was sold in the secondary market. So, if we can at the same time we're letting the residential mortgages run off on our books, we've continued do a pretty good job on the home equity line of credit – branch-originated home equity lines of credit. So again, just a change on the mix of the portfolio. Indirect lending to us, in terms of car loan, has no relationship attached to it; doesn't have a checking account, doesn't have a core deposit or core deposit capability with it. So, we had basically said earlier in the year that we would look at a number of different things – a whole loan sale of that portfolio, a securitization of that portfolio – so, it's pretty consistent with what we've talked about all year long.

The reason we're being a little hesitant on the timing of this is because obviously we want to sell it at the proper time when market conditions are best. So, whether that's August or September or November, we'll just have to see when market conditions are best. We have it queued up; we're ready and we want to maximize the sale at the proper time – sometime before the year is out.

Robert H. Ramsey – FBR Capital Markets & Co.

Okay. And I know you mentioned markets are strong. What are down sale margins look like in all the securitizations today?

Michael W. Harrington

We're not prepared to talk about that being a function of the coupon that we're selling. So we can't provide that information to you, Bob.

Robert H. Ramsey – FBR Capital Markets & Co.

I'm curious, too, how you all think about the decisions – I know you said that you would most likely replace those assets with mortgage-backed securities. And I hear other banks evaluating that decision and they view auto as better because the yields are higher and the duration extension risk is lower. And I’m just curious how you guys are thinking about that.

Michael W. Harrington

Well, think my response to previous question is just some of those proceeds could end up in securities. I didn't think I mentioned what type of securities they were, there might be shorter duration. Just trying to respond to the question around the – it's definitely a lower yield because we're going from loans to securities.

So we’re very focused on managing the asset duration of our portfolio given just the uncertainty all of us have in the industry about deposit repricing and deposit reactivity if and when rates rise. So, we've been very focused on our asset duration. That's why you see some of the growth that we're focused on in our own portfolios and HELOCs and construction loans, a lot of variable rate type of product; that's putting a little bit of pressure on our reported core margin, but we want to position the balance sheet for the eventual rise in rates. And all these things we're doing are a function of getting in that position.

William J. Reuter

Yes, from a more global standpoint, we also want to manage to a concentration risk in autos in general. So, getting rid of that portfolio helps us be within the kind of limits we want and where we want to be.

Robert H. Ramsey – FBR Capital Markets & Co.

Okay. And then maybe last question with the improvement in your loan-to-deposit ratio that the securitization will provide, does that free you guys up to grow the loan portfolio a little bit faster or are you going to continue to sort of show restraint until you get that loan-to-deposit ratio closer to your longer term goals?

Michael W. Harrington

Well, I don't think we ever said we were going to have any restraint on the C&I, CRE and on the consumer side. I think where the restraint is, is on what we bought residentially and what we bought – car leases have pretty much peaked at this point in time and clearly we're not going to go back out and book a bunch of indirect auto loans at this point in time. So, we've never said we're out of loan market. As a matter of fact, that repositioning of loan portfolio for us is pretty critical in the future.

Robert H. Ramsey – FBR Capital Markets & Co.

Okay. And will you continue to originate for sale on the auto side or I mean that made it sound as if you've got less appetite to originate period?

William J. Reuter

Are we talking about car leases or are we talking about auto loans.

Robert H. Ramsey – FBR Capital Markets & Co.

Yes. On indirect auto.

Michael W. Harrington

That's a to-be-determined. So, right now, we're doing this loan securitization, auto loan securitization and we'll determine that strategy on a go-forward basis. We haven't done that at this point in time.

Robert H. Ramsey – FBR Capital Markets & Co.

Thank you guys.

Operator

And we will now go to Chris McGratty with KBW.

Christopher McGratty – Keefe, Bruyette & Woods Inc.

Hey, good morning, guys. On your buyback comments, Bill, do you have enough liquidity in your stock to presumably get through the 6 million shares or so in the next two quarters? If we look to next year, how should we be thinking about estimated payout ratios? Is this kind of a one-time, get it done in the next six months, or is this, Mike, your comment on 75%, 85% payout ratio total, is that a fair assumption for next year? I'm just trying to manage expectations here on the buyback.

William J. Reuter

Yes, I think the fair assumption is we're going to take a look at it. And I don't think you should think that it's going to be at that level. We're going to consider it on a case-by-case basis. We'll get through this stock buyback hopefully successfully and then kind of revisit it as we get into the end of the year.

Christopher McGratty – Keefe, Bruyette & Woods Inc.

Okay, and then do you have the terms of the CDs, both in duration and in cost that you put out in the quarter?

Michael W. Harrington

We're running promotional campaigns. One of those is a five-year campaign, so we have been trying out some duration of the portfolio as a 2%. And then we had something shorter term in that 18month, that 120. Both those require a checking account to be opened and that's why Bill mentioned in his prepared remarks about the net new checking gross. We're leveraging that activity and our branches have also opened up other accounts and continue to build our checking base. So, those are the two promos we're running. The good news this quarter was we were able to hold the cost; CD costs held flat because we had some other higher cost stuff coming off that was maturing this quarter.

Operator

And we will now go to Preeti Dixit with JPMorgan.

Preeti S. Dixit – JPMorgan Securities LLC

Hi, good morning, everyone. Just turning to the fee items, could you give us some color on the outlook for the capital markets line? And then I know other income has been fairly volatile so how should we think about a good run-rate there?

William J. Reuter

Well, I'll let Mike to answer maybe the run-rate question. But we do expect to see better fee income performance this quarter as a result of the spring home sale season for our residential mortgage area. We expect to see pickup in fee income from SBA lending and we expect capital markets to pick up this quarter. I don't know that I'm positioned to tell you exactly how much, but we expect those three to contribute a nice increase in fee income for the quarter.

Michael W. Harrington

Yes, so I mean that’s about, Bill hit all the high points. We expect all three of those areas to bounce back in the quarter. Don't want to be more specific than that, but expect the number to be a few million more than it was this quarter.

William J. Reuter

That’s combination of all three.

Michael W. Harrington

Yes, as I mentioned earlier in the call, we did start to see a pickup of business activity in June. And hopefully that carries forward through the quarter and through the rest of the year.

Preeti S. Dixit – JPMorgan Securities LLC

Okay, that's really helpful. And then just turning to the provision real quick, the MPA seemed a little stickier this quarter. Charge-offs picked up a little. So, can you talk a little more specifically about why this was general reserve that drove the provision lower? And then how much lower are you comfortable taking the reserve ratio here?

William J. Reuter

Yes, I’m going to let Mike quick answer that. But before he does, let me just mention to you on the last conference call, we had mentioned in terms – I know this provisioning is the most problematic thing for you all to predict. We had mentioned in the last conference call that you should look at provisioning for this past quarter to be the average of the last four quarters. The average for the last four quarters was a little over $6 million, we came in at $3 million, so that was about a penny better than what we had guided. So, Mike, why don't you kind of take it from there?

Michael W. Harrington

Okay. When we began this year, one of the focuses we had was on the overall quality of the portfolio. And our goal was to drive to a 90% tax ratio. This second quarter, we had net upgrades of $144 million and that really drove all our metrics and created the opportunity for us to release some reserves based upon that credit improvement.

Again, we look at it on a quarter-to-quarter basis. We're tracking that upgrade process and we hope that it continues. But – and we are highly – we hope it will continue, but we also know that it is a metric that the lenders are being measured on and it's part of their incentive program. So, we think it is a focus they will have. But it will depend on how we do over the next quarter, next couple of quarters with increasing our quality of our portfolio and moving closer to our 90% goal in tax rated credit.

William J. Reuter

Yes, and we alluded to the fact earlier that we had exited a relatively large credit on the C&I side for the quarter. That was all initiated by us. It was a company that was borrowing a fair amount of money from us, but it was underperforming for a long period of time. And our thought process there – it was going to continue to underperform, certainly for a next period of time. So we decided that if there was a taker for the credit, it was better for them to go elsewhere. So, they're the kind of decision we're making that affect things like loan loss reserves, affect asset quality ratios, affect loan grades. And so, we think these are prudent decisions to make.

Michael W. Harrington

This is Mike Harrington. I think the last part of your question was a target coverage ratio. We really don’t have a target coverage ratio; it's a function of the portfolio and how it performs and all the analysis that goes into that that dictates what our allowance is. So, we don't have anything to provide there, in terms of a target percentage that we might be shooting for.

William J. Reuter

But I want to emphasize one more thing that Mike Quick said, and that is that the biggest single factor in the provision for the quarter was the significant upgrades we had in credit quality for the quarter; that's certainly a good thing.

Preeti S. Dixit – JPMorgan Securities LLC

Okay, that's great. Thank you so much.

Operator

And we will now go to Matthew Kelley with Sterne Agee.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Yes, hi. First question on the portfolio of auto loans now held for sale, 265, what is the coupon on that 265?

Michael W. Harrington

I’m not going to take my NIM guidance. I can't get into the details of the portfolio at this point in time. We have active process in place right now.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Okay. With the changes in the balance sheet, can you give us an update on your plus 200 basis point sensitivity from an NII perspective and just talk about your assumed deposit runoff that goes into that, just how that's changing?

Michael W. Harrington

I mean, deposit reactivity I think generally the way we model in a base case is, say, our standard case; it up couple percent over one-year time period up 200, it’s probably 3% to 4%. But what's really important around all that is the assumptions we make around deposit basis are the key driver of that. And that's where we're doing a lot of sensitivity analysis around those. We use a fairly conservative set of assumptions in what we would call our standard case and then we're stressing that up to what I think is fairly extreme levels to get a feel for what that could look like. So I mean if active conservation gets back to what we're trying to do on the asset side and on the liability side, as well, and it's all part of the dialogue we're having here around managing interest rate risk as we think about the future and where interest rates might head.

Matthew Kelley – Sterne, Agee & Leach, Inc.

So, in the first quarter, your plus 200 basis points on sensitivity was 4.9%. Is that going to retire over the course of the year?

Michael W. Harrington

I don’t think it’s materially different than it was in the first quarter.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Okay. And then can you just give us a recap of your last expense savings initiative – headcount reduction, branch closures, how that went on the branch closure side in particular; what was your experience with lessons and what could you do going forward on that front?

Michael W. Harrington

Yes, all the expenses that we talked about getting I'm confident we’ve all that, that’s baked into our current run-rate right now. Probably the best piece of information we got out of that whole process are deposit attrition was very low, which indicates that and we had modeled something that was even more than what we ended up experiencing. So, it gets to the value of the branch. And when you do consolidations if people are willing to stick with you for other reasons and locations. So, that was probably the best takeaway we had.

Michael W. Harrington

And I should also mention to you, too, to add to my comments earlier, as we're looking at efficiency initiatives and operating process and work flow, there is also some opportunity on the revenue side that we're identifying. So, it's not – it’s just on efficiency from a cost standpoint, but we've been able to identify I think some reasonable good revenue opportunities at the same time. We'll talk more about that later.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Okay, so we’ll get an update on kind of the round two expense cutting in Q3 or Q4 I mean second half of the year is a fair timeline to get an update on that?

Michael W. Harrington

We’ll just talk about it later.

Matthew Kelley – Sterne, Agee & Leach, Inc.

Okay. Thank you.

Operator

(Operator Instructions) And we will now go to Blair Brantley with BB&T Capital Markets.

Blair Brantley – BB&T Capital Markets

Good morning.

Michael W. Harrington

Good morning.

Blair Brantley – BB&T Capital Markets

Had a question on the construction portfolio, kind of where you're seeing strength, what type of project that you're seeing.

Michael M. Quick

This is Mike Quick. We are seeing strength in commercial development and also in multi-family homes. And basically in the I-95 Corridor, in that particular area. In residential construction, we have seen a pickup in the Baltimore area with some very nice projects that are coming out of the ground. And we continue to see a steady growth in our central Pennsylvania construction portfolio as they continue to see the uptick in home sales in this particular area.

Blair Brantley – BB&T Capital Markets

Okay, thank you very much.

Operator

And we will take a follow-up question from Bob Ramsey with FBR Capital Markets.

Robert H. Ramsey – FBR Capital Markets & Co.

Hey, thanks for the follow-up. Just real quickly, was curious if you had the balance of accretable yield at the end of the second quarter.

Michael W. Harrington

$26 million I think.

William J. Reuter

That’s everything.

Robert H. Ramsey – FBR Capital Markets & Co.

Okay.

Michael W. Harrington

I mean, the majority of the mark is on the impaired loans; that's the credit mark. That's the one that kind of flows through and has a volatility related to it. The non-impaired mark is a combination of discounts and premiums. That's fairly steady just because of the way those loans are prepaying, okay?

Robert H. Ramsey – FBR Capital Markets & Co.

Thank you.

Operator

There are no further questions Mr. Reuter I’ll now turn the conference back to you for closing remarks.

William J. Reuter

Thank you for your questions this morning. We hope you can join us for our next quarterly conference call on Thursday, October 23, 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

Ladies and gentlemen this does conclude today’s conference. We do thank you for your participation.

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