Is Susquehanna Bancshares Fairly Valued? What Investors Need To Know

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 |  About: Susquehanna Bancshares, Inc. (SUSQ)
by: Harvard Winters

Susquehanna Bancshares, Inc. (NASDAQ:SUSQ) likes to acquire other banks.

It has announced and completed 15 acquisitions since 1989, three of these since April 2007, the latter period being notable for depressed/volatile bank earnings and low bank M&A activity overall. The three recent deals are the largest SUSQ has done, and were large relative to SUSQ, comprising $1.47 billion in total announced deal value. SUSQ's current market cap is $1.90 billion.

SUSQ closed the $274 million Abington Bancorp deal in Oct 2011 and the $342 million Tower Bancorp deal on February 17, 2012, so SUSQ's Q1 2012 results don't contain three months of revenues and expenses for Tower. We'll have to wait until Q2 to see a real post-merger quarter. However, since SUSQ has no more pending acquisitions, investors can start to see what the pro forma bank looks like.

What do we see? First, SUSQ's Q2 2012 tangible book value per share (TBV-PS) was $6.46. TBV-PS has fallen in each of the last two quarters. It was $7.61 at the end of Q3 2011. Furthermore, it was $10.52 back at the end of Q1 2005, remaining essentially stagnant until the closing of the $852 million Community Banks deal drove TBV-PS from $11.18 in Q3 2007 down to $8.44 in Q4 2007. And TBV-PS has drifted downward since that point because of subsequent acquisitions, not because of dilution associated with a giant share issuance, a la Citigroup.

Falling TBV-PS is a disturbing trend for a bank. For SUSQ's share price to rise over time, either its TBV-PS must grow or its price/tangible book value (P/TBV) multiple must increase. SUSQ's TBV-PS has fallen by 39% since Q1 2005. Only three things can cause a bank's P/TBV multiple to increase: (1) a lowering of the discount rate investors require, (2) an increase in return on equity and (3) a takeover offer. Which were investors supposed to be hoping for?

What about earnings? SUSQ reported Q2 2012 EPS of $0.14. I estimate that "clean" (excluding non-recurring income and expense and normalizing loan loss provision) EPS was $0.22. That gives us a "clean" return on assets (RoAA) and return on average tangible common equity (RoATCE) of 0.95% and 15.70%, respectively; both figures are higher than they've been in some time. I wouldn't expect these figures to increase much, if at all, in future quarters. SUSQ's Q1 2012 net interest margin was 3.92%, materially higher than the 3.62% of Q4 2011. Tower's net interest margin was higher than SUSQ's, and the Tower acquisition therefore drove the big increase. Few banks saw even a modest net interest margin improvement in Q1 2012.

Here's a bigger issue. SUSQ has promised big cost savings. In an investor presentation last October, SUSQ reiterated a goal of $20 million in annual cost savings from SUSQ itself, plus $8 million from the Abington deal and $30 million from the Tower deal. $58 million of pre-tax savings translates into $35 million of after-tax earnings, or $0.185 of EPS based on SUSQ's Q1 2012 188 million shares outstanding. To hit the target cost savings, SUSQ must bring its overhead expense/average assets ((OH/AA)) ratio below where it's ever been before, to a level lower than that of many similarly-sized banks.

The mean sell-side EPS estimate for SUSQ is $0.82 for 2012 and $0.95 for 2013. I don't know whether SUSQ investors believe these numbers or expect something different. I believe that for SUSQ to hit the mean 2012 EPS estimate, SUSQ's quarterly loan loss provision must fall meaningfully, and soon. And for SUSQ to hit the materially higher 2013 EPS estimate, it will need to realize most or all of the targeted cost savings. Because asset growth won't help SUSQ hit its EPS target. Here's why.

In the investor presentation mentioned above, SUSQ touts compound annual organic and total loan growth of 6.1% and 12.2% respectively, from 1998 to 2011. What this arithmetic ignores is the fact that, when you grow via acquisition, you "buy" loan growth with shares. Even if you grow organically after you do a big acquisition, you share this subsequent organic growth with the shareholders of banks you've acquired. Therefore, it's smarter to look at assets per share (A-PS) growth rather than total asset growth. SUSQ has a meaningful securities portfolio in addition to its loan portfolio, so let's look at total assets.

At the end of 1998, SUSQ's total assets and A-PS were $4.1 billion and $113, respectively. At the end of 2009 (I use this date because an equity issuance in Q1 2010 meaningfully lowered A-PS), total assets and A-PS were $13.7 BN and $158, respectively. That means A-PS grew at a 3.1% CAGR during this 11-year period; in contrast, total assets grew at an 11.7% CAGR. Big difference, isn't it? The following quarter, A-PS fell to $106; total assets remained essentially unchanged. By the end of Q1 2012, total assets were $17.8 billion and $95, respectively. So since Q1 2010, total assets grew at a CAGR of 13.7% and A-PS at a CAGR of -5.5%.

There are only two ways a bank can increase EPS: (1) increase A-PS and (2) increase RoAA. The former can happen on an ongoing basis, the latter cannot. SUSQ hasn't grown A-PS rapidly in the past, despite all the acquisitions, and I don't think it will in the future.

Is SUSQ out of the M&A game for awhile? That's unclear. Recently, SUSQ said "yes", and shortly thereafter, the rumor was "no". SUSQ's current Chairman and CEO William Reuter has been CEO since May 2001 and Chairman since May 2002, so the last five acquisitions, comprising $1.8 billion in aggregate value, have occurred on his watch. I think holding off on M&A for awhile will help clarify whether the recent acquisitions were worthwhile. Of course, clarity on this point may be bad for Reuter, and for SUSQ's share price.

I should mention that SUSQ has long been a favorite of short sellers. Its short interest as a percentage of shares outstanding has been above a nosebleed 15% at three different month ends, September 2008, Dec 2009 and September 2011. Short interest reached a month-end high of 20.5 million shares in September 2011, at which point SUSQ's share price had dipped to $5.46 from a near-term closing high of $9.77 on April 7. Short interest has fallen meaningfully since then, to 7.2 million shares in April 2012, which now translates into 3.8% of current shares outstanding. That 3.8% is much lower than the peak short interest percentage, and SUSQ is no longer an outlier among banks on this basis, but the number is still high in absolute terms. Do the shorts think SUSQ will hit the mean EPS estimates?

On Tuesday, May 15th, SUSQ closed at $9.97, implying a P/TBVPS multiple of 1.57x. I believe SUSQ's "clean" RoATCE is 15.7%. So today's share price makes sense assuming a 10% discount rate, justifiable in today's low interest rate environment, but definitely too low in a more normal rate environment. I think SUSQ's share price will fall as rates rise, unless SUSQ finally starts to grow TBV-PS. SUSQ needs to retain the next 1-2 years of EPS, even though this will probably reduce RoATCE, rather than chase another deal. I'm not sure that building up TBV-PS will drive SUSQ's share price higher, but I'm pretty sure that another TBV-PS dilutive deal will push share price lower.

Contact me if you'd like to discuss this in detail.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.