Late Wednesday afternoon, **Susquehanna Bancshares, Inc.** (NASDAQ:SUSQ) announced its third quarter results, the second complete quarter of financial results since its acquisition of Tower Bancorp closed in February. Here are the highlights, followed by my thoughts:

Asset growth - total assets grew by 0.37%, which translates into an anemic annualized growth rate of 1.5%. Assets had grown at a 5.3% annualized rate in the prior quarter.

Net interest margin ("NIM") - 3.92%, versus 4.10% in the prior quarter. On the Q2 earnings conference call, SUSQ management had estimated that Q3 NIM would be about 3.90% (the 4.10% had been driven mainly by purchase accounting adjustments for Tower Bancorp), so the 3.92% is a modestly favorable outcome.

Loan losses - the loan loss provision was the same as in the prior quarter, $16 million. Non-performing assets ("NPAs") continued to fall; NPAs/assets fell to 1.13%, from 1.25% in the prior quarter. Reserves/NPAs rose to 91.7% from 84.6% in the prior quarter, another positive.

Non-interest income - non-interest income rose considerably, to $43.6 million versus $38.5 million in the prior quarter. SUSQ booked a $5.9 million net gain from the sale of loans and leases in the quarter, versus $4.4 million in the prior quarter.

Non-interest expense - non-interest expense rose to $122.9 million, versus $121.5 million in the prior quarter. SUSQ booked a $5.5 million loss on the extinguishment of debt and $1.5 million of merger-related expenses. On the Q2 earnings conference call, SUSQ had estimated that Q3 and Q4 non-interest expense would average $116 million per quarter, a figure that included realization of the last $2 million of deal-related and other synergies. SUSQ's Q3 figure is $115.9 million if the two charges above are excluded.

Net income to common - net income to common was $36.7 million, versus $37.8 in the prior quarter.

EPS - EPS was $0.20, the same as the prior quarter. Shares outstanding did not change materially from the prior quarter.

What's on the horizon? In my August 2nd article on SUSQ, I mentioned that the mean 2012 and 2013 sell-side EPS estimates for SUSQ were $0.81 and $0.93, respectively, down from $0.82 and $0.95 in May. At SUSQ's current shares outstanding of 186 million, $0.93 of EPS implies $173 million of net income to common. Removing the non-recurring expenses from the Q3 results and then annualizing this result gives $165 million. So SUSQ needs to grow net income by $8 million to hit the $0.93. Analysts are in the process of reviewing their 2013 estimates, but when this article was submitted, the mean estimate remained at $0.93.

What things might enable SUSQ to hit the $0.93? There are two big potential tailwinds. First, on September 18th, SUSQ announced that it had completed the redemption of $175 million of trust preferred and capital securities. The retired securities had a blended cost of 9.84%. SUSQ raised $150 million of senior debt yielding 5.375% to fund most of the retirement. The pre-tax yield differential is 4.46%. That differential, if applied to the $175 million and tax-effected at 35%, yields $5 million of after-tax earnings. In net interest margin ("NIM") terms, the refinancing adds about 5 basis points of NIM, which means that the Q3 NIM would have been 3.97% rather than 3.92% if the refinancing happened at the beginning of the quarter. And there are more refinancings to come, most importantly of $417 million of CDs with an average yield of 4.34% in the second half of 2013, which should save SUSQ more money than the trust preferred/capital securities refinancing did.

Second, SUSQ's asset quality is improving. The Q3 annualized provision/gross loans ratio was 0.50%. A reduction of this ratio to 0.20%, its average from 2004 to 2006, would generate an additional $25 million of after-tax earnings per year. Will this reduction come in 2013? It appears that SUSQ had net loan charge-offs of $19.7 million in Q3, only slightly lower than the $20.0 million of Q2. The drop in SUSQ's NPAs from Q2 to Q3 was $20.9 million. The two figures are roughly the same. And Q3 reserves were $7.8 million lower than where they were in Q1. I do not think that SUSQ is under-reserved. But nor do I think charge-offs are poised for a dramatic reduction in the next several quarters, which is what needs to happen for the loan loss provision to fall dramatically. SUSQ's NPAs still stand at $205 million. But even a relatively modest decrease in provisions, to 0.35%, would provide a $13 million earnings benefit, or $0.07 per share.

And now for the headwinds. Growth was anemic this quarter, and that's been an ongoing problem for SUSQ. I don't expect growth to add much benefit between now and the end of 2013. Second, I'm hesitant to believe SUSQ's sizable gains from loan sales are permanent. SUSQ booked $5.9 million of gains in Q3 and $4.4 million in Q2, which had been the highest quarterly gain from loan sales SUSQ had ever posted. These gains could easily fall by one-third, and if they did, SUSQ would have to plug an annual $5 million after-tax earnings hole, or $0.028 per share.

Third, let's return to NIM for a minute. Last quarter, SUSQ projected a 3.90% NIM for Q3 and Q4. Neither number anticipated a trust preferred/capital securities refinancing; these were expected to occur in 2013. So the actual Q3 NIM result of 3.92% beat this projection by 2 basis points. SUSQ now expects Q4 NIM to be 3.96%, and that's with full benefit from the trust preferred refinancing. SUSQ is sticking with a 3.85% NIM forecast for 2013, which includes the benefit of retiring those high-cost CDs. So what does a drop from the Q3 NIM of 3.92% to 3.85% cost from an earnings standpoint?

I estimate that each basis point of NIM decrease translates into a $1.0 million annual after-tax loss for SUSQ, or $0.0054 per share. So a 7 basis point reduction in NIM costs $0.038 of EPS in a year, assuming 0% earning asset growth. SUSQ reported Q3 EPS of $0.20; reversing out the non-recurring expenses and annualizing gives $0.88 of EPS. NIM compression would reduce this by $0.038. 3% earning asset growth, if it came at a 3.85% NIM, would recapture about 90% of the lost net interest income.

So if SUSQ beats the 2013 EPS estimate of $0.93, it will most likely be because loan loss provisions decline and non-interest income holds steady.

SUSQ mentioned a target dividend payout ratio of 30% of core earnings. If SUSQ hits the mean sell-side EPS estimates through 2013, its tangible book value per share ("TBV-PS") should grow to $7.71 by Q4 2013, versus $6.82 at Q3 2012, assuming no share buybacks or M&A activity. Q4 2013 return on average tangible common equity ("RoTCE") would be slightly over 13%.

SUSQ closed yesterday at $10.44, equating to 1.53x TBV-PS and 0.75x stated book value per share. That latter multiple makes the stock look cheap, until you realize that return on stated book value is just over 6%. High intangible assets can pound returns on stated book value. I prefer to use RoTCE for valuation purposes, given that different institutions have differing levels of intangible assets.

I'm hesitant to use a discount rate lower than 10%, so given SUSQ's 13% RoTCE, I believe its fair value is 1.3x TBV-PS, or $8.87, so SUSQ looks a bit expensive to me at the moment. SUSQ needs to beat the $0.93 estimate to support its current valuation.

I'm hoping that SUSQ management focuses on beating the $0.93 organically, rather than turning its attention to financial engineering, exciting and familiar though this engineering may be. Buybacks don't make sense right now, and as SUSQ management itself mentioned on the earnings conference call yesterday, there aren't that many properly-sized targets in SUSQ's footprint anyway.

If SUSQ management wants to prove that its acquisition strategy was a winning one, beating the $0.93 by a healthy margin is the clearest way to do so.

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.