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SUSQ > SEC Filings for SUSQ > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for SUSQUEHANNA BANCSHARES INC

Form 10-K for SUSQUEHANNA BANCSHARES INC


3-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following pages of this report present management's discussion and analysis of the consolidated financial condition and results of operations of Susquehanna Bancshares, Inc.

The following discussion and analysis, the purpose of which is to provide investors and others with information that we believe to be necessary for an understanding of our financial condition, changes in financial condition, and results of operations, should be read in conjunction with the financial statements, notes, and other information contained in this document.

Critical Accounting Estimates

Susquehanna's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and conform to general practices within the banking industry. Application of these principles involves complex judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are based on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations.

Our most significant accounting estimates are presented in "Note 1. Summary of Significant Accounting Policies" to the consolidated financial statements appearing in Part II, Item 8. Furthermore, we believe that the determination of the allowance for loan and lease losses, the evaluation of goodwill, the analysis of certain debt securities to measure other-than-temporary impairment exists, and the determination of the fair value of certain financial instruments to be the accounting areas that require the most subjective and complex judgments.

The allowance for loan and lease losses represents management's estimate of probable incurred credit losses in the loan and lease portfolio as of the balance sheet date. Determining the amount of the allowance for loan and lease losses is considered a complex accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. For additional information about our process for determining the allowance for loan and lease losses, refer to "Results of Operations-Provision and Allowance for Loan and Lease Losses" below, and "Note 6. Allowance for Loan and Lease Losses" to the consolidated financial statements appearing in Part II, Item 8.

Goodwill is evaluated for impairment on an annual basis and more often if situations or the economic environment warrant it. In performing these evaluations, management makes estimates to determine the fair value of its reporting units. Such estimates include assumptions used in determining cash flows and evaluation of appropriate market multiples. For additional information about goodwill, refer to "Note 8. Goodwill and Other Intangibles" to the consolidated financial statements appearing in Part II, Item 8.

Certain debt securities that are in unrealized loss positions are analyzed to determine if they are other-than- temporarily impaired. This analysis consists of calculating expected cash flows, taking into consideration credit default and severity rates, prepayments, deferrals, waterfall structure, covenants relating to the securities, and appropriate discount rates. Furthermore, if a security is found to be other-than-temporarily impaired, additional analysis is required to determine the portion of the loss attributable to credit quality. For additional information about other-than-temporary impairment of debt securities, refer to "Note 4. Investment Securities" to the consolidated financial statements appearing in Part II, Item 8.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. As defined in U.S. GAAP, Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. For additional information about our financial assets and financial liabilities carried at fair value, refer to "Note 22. Fair Value Disclosures" to the consolidated financial statements appearing in Part II, Item 8.

Any material effect on the consolidated financial statements related to these complex accounting areas is also discussed in this Annual Report on Form 10-K.


Table of Contents

Recent Regulatory Developments

In July 2013, the Federal Reserve Board, Office of the Comptroller of the Currency, and FDIC approved final rules to implement the Basel III capital framework. The rules will be effective on January 1, 2014 and phased-in over a multiple year period becoming fully effective on January 1, 2019. The new capital rules call for higher quality capital with higher minimum capital level requirements. Consistent with the international Basel framework, the rules include a new minimum ratio of common equity tier I capital to risk-weighted assets of 4.5 percent, and a common equity tier I capital conservation buffer of 2.5 percent of risk-weighted assets. The rules also raise the minimum ratio of tier I capital to risk-weighted assets from 4.0 percent to 6.0 percent, and include a minimum leverage ratio of 4.0 percent. Management has evaluated these new rules and believes that Susquehanna, and Susquehanna Bank, would have had sufficient capital to meet the increased requirement at December 31, 2013.

Other Recent Developments

During the fourth quarter of 2013, Susquehanna completed a branch consolidation plan in which 14 branch locations were merged into other Susquehanna branches. The total expense incurred, and recognized in the fourth quarter, in connection with the consolidation process was $6.6 million, with $2.7 million incurred to shorten the useful life of premises and equipment, and $3.9 million incurred for contract termination and other related costs.

On December 23, 2013, Susquehanna sold a portfolio of 30 of its owned branch bank properties, and simultaneously entered into lease agreements of either 15 years or 26 years, for each property sold with the buyer of the properties. The sale of the properties resulted in an aggregate pretax gain of approximately $38.2 million, net of transaction expenses of $2.8 million. Of the total gain, approximately $33.3 million was recorded as deferred revenue and will be recognized over the terms of the leases. The remaining pretax gain of $4.9 million was recognized in Susquehanna's consolidated financial statements for the period ended December 31, 2013. The monthly base rents in the lease agreements will be recognized as expense evenly over the lease terms at an annual average rate of $1.8 million for the 15 year leases and $2.5 million for the 26 year leases. Susquehanna anticipates that these monthly base rents, as noted, will be substantially offset by the deferred gain on the sale of the properties and the elimination of depreciation on the properties. Additionally, the transaction allowed Susquehanna to realize $4.0 million of deferred tax assets, which were previously subject to a valuation allowance. The proceeds from the transaction will be used for general corporate purposes, including supporting lending and investing activities, and repayment of short-term borrowings.

Executive Overview

Consolidated net income available to common shareholders was $173.7 million for 2013, or $0.93 basic earnings per share and diluted earnings per share of $0.92. Return on average assets was 0.95% compared to 0.81% in 2012. The non-GAAP ratio of return on average tangible equity was 13.57% compared to 12.03% in 2012. For additional information on non-GAAP ratios, refer to"Table 4, Reconciliation of Non-GAAP Measures".

The following table compares our 2013 financial targets to actual results.

Table 5

Key Susquehanna Financial Targets and Results

                                                      2013
                                              Target        Actual
                 Net interest margin (FTE)       3.90 %        3.79 %
                 Loan growth                      5.0 %         5.3 %
                 Deposit growth                   6.0 %         2.3 %
                 Noninterest income growth        8.0 %        10.2 %
                 Noninterest expense growth      (2.0 )%        0.2 %
                 Effective tax rate              32.0 %        29.9 %

During 2013, we continued to execute a strategy to strengthen our focus on building enduring relationships with customers. This strategy is designed to enhance our earnings power make us a more attractive franchise, and position us to more effectively compete with other regional financial holding companies in our footprint.

Loan originations during 2013 totaled over $4 billion, with strong growth in the consumer and leasing portfolios, as well as increases in commercial and real estate secured lending. This loan growth was complemented by better credit metrics. Our net charge-offs to average loans and leases ratio improved from 0.55% in 2012 to 0.44% in 2013. Additionally, our non-performing assets ratio declined from 0.96% in 2012 to 0.86% in 2013. The improvement of our credit quality allowed us to reduce our provision for loan and lease losses from $64 million in 2012 to $31 million in 2013.


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Deposits grew by 2.3% during 2013, with core deposits increasing 2.4%. We introduced the Stellar Checking with Smart Rewards product, which generated approximately 28,000 new accounts, and provides cash rewards to customers for everyday activities like using a debit card or paying bills online. We also strategically exited relationships with certain higher-priced non-relationship accounts. We expect to continue to focus on increased deposit growth.

Noninterest income increased by 10.2%. In addition to the $4.9 million gain from the sale leaseback transaction in December 2013, the major contributors to this increase were our capital markets and wealth management groups, whose revenues increased by 8% or greater. In addition, our mortgage division had a record origination year, and is selling more than 50% of the originations to investors. We also elected to retain the servicing on the sold loans, thus providing us the opportunity to communicate with and cross-sell to these customers.

Noninterest expenses, excluding certain non-recurring items, increased 3.7%. As noted earlier, we executed a branch consolidation plan to create greater efficiency in our branch network and to reduce overall occupancy costs in the future. In addition, we continue to make investments in technology to enhance the experience of our customers, develop regulatory mandated stress testing, and enhance enterprise risk management to create a foundation for future growth.

At December 31, 2013, all of Susquehanna's risk-based capital ratios exceeded the regulatory requirements for well-capitalized institutions.

Results of Operations

                                    Table 6

                        Summary of 2013 Compared to 2012



                                                            Years Ended December 31,
                                                     2013            2012           % Change
                                                             (Dollars in thousands)

Net income                                         $ 173,679       $ 141,172             23.0 %
Net interest income                                  585,940         591,238             (0.9 )
Provision for loan and lease losses                   31,000          64,000            (51.6 )
Non-interest income                                  183,729         166,759             10.2
Non-interest expense                                 490,840         490,017              0.2
Non-interest expense excluding merger-related
expenses, branch consolidation costs, and loss
on extinguishment of debt                            484,237         466,806              3.7

                                    Table 7

                       Key Susquehanna Financial Measures



                                                           Twelve Months Ended
                                                               December 31,
                                                            2013           2012

   Diluted Earnings per Common Share                     $     0.92       $  0.77
   Return on Average Assets                                    0.95 %        0.81 %
   Return on Average Shareholders' Equity                      6.56 %        5.62 %
   Return on Average Tangible Shareholders' Equity (1)        13.57 %       12.03 %
   Efficiency Ratio (1)                                       62.55 %       60.37 %
   Net Interest Margin                                         3.79 %        4.01 %

(1) For information regarding Supplemental Reporting of Non-GAAP-based Financial Measurements, refer to Table 4 - Reconciliation of Non-GAAP Measures.

Net Interest Income - Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which is the income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets.


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Income from earning assets includes income from loans, investment securities, and short-term investments. The amount of interest income is dependent upon many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates, and the levels of non-performing loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, the rates paid on borrowed funds, and the levels of noninterest-bearing demand deposits and equity capital.

Table 8 presents average balances, taxable equivalent interest income and expense, and yields earned or paid on these assets and liabilities. For purposes of calculating taxable equivalent interest income, tax-exempt interest has been adjusted using a marginal tax rate of 35% in order to equate the yield to that of taxable interest rates. Table 9 illustrates the changes in net interest income caused by changes in average volume, rates, and yields.

2013 compared to 2012

Net interest income on a fully taxable-equivalent basis totaled $600.9 million in 2013 compared to $606.5 million in 2012, a 0.9%, or $5.6 million decline. The decline in net interest income was driven by the decrease in interest earned on earning assets exceeding the decrease in interest paid on rate related liabilities.

The net interest margin for 2013 was 3.79%, a 22 basis point decline from 4.01% in 2012. The decline in the net interest margin results primarily from the runoff of higher yielding earning assets, replaced by lower yields on loans, and partially offset by lower funding costs of deposits and borrowings. Net interest margin (excluding purchase accounting), which eliminates the effect of purchase accounting amounts, declined 16 basis points from 3.69% in 2012 to 3.53% in 2013. For additional information related to our net interest margin (excluding purchase accounting), refer to "Table 4, Reconciliation of Non-GAAP Measures".

Interest income on a fully-taxable basis declined by $22.5 million, or 3.1%. Interest earned on the investment portfolio decreased $8.1 million, or 10.6%, as management strategically elected to reinvest cash flows from the investment portfolio into higher yielding loans and leases. The average balance of the investment portfolio declined $130.3 million, or 4.8%. The fully taxable-equivalent yield on the investment securities portfolio declined 17 basis points from 2.81% in 2012 to 2.64% in 2013 as higher yielding investments were either called or paid down. Interest earned, on a fully taxable-equivalent basis, on loans and leases declined $14.4 million, or 2.2%. Average loans and leases totaled $13.2 billion in 2013, compared to $12.3 billion in 2012; however the growth in loans and leases balances were offset by the decline in yield earned, which decreased 45 basis points from 5.27% in 2012 to 4.82% in 2013, as the primary driver of the balance growth was in lower yielding consumer lending and leases.

Interest expense declined by $17.0 million, or 14.2%. Interest paid on deposits declined $8.5 million, or 12.3%, even as the average balance increased by $0.5 billion. The average rate paid on deposits declined 9 basis points from 0.56% to 0.47% in 2013. This improvement is the result of a 9 basis point decrease in rates paid on interest-bearing demand and savings deposits, and a 9 basis point reduction in rates paid on time deposits. Interest paid on short-term borrowings and Federal Home Loan Bank borrowings (primarily short-term) increased $2.6 million due primarily to the 2013 average balance increasing $181.8 million. The average rate paid on these borrowings increased 2 basis points to 1.26% from 1.24% in 2012. Long-term debt interest declined $11.1 million resulting from the net redemption of $137.1 million of long-term debt with interest rates ranging from 6.05% to 11.00%, in 2012.

2012 compared to 2011

Net interest income on a fully taxable-equivalent basis totaled $606.5 million in 2012 compared to $447.8 million in 2011, a 33.5% increase. The increase in net interest income was driven by the higher volumes of earning assets and rate-related liabilities resulting from the Tower and Abington acquisitions in February 2012 and October 2011, respectively.

The net interest margin for 2012 was 4.01%, a 41 basis point increase from 2011's 3.60%. The increase in the net interest margin results primarily from the 2012 $2.7 billion increase in average interest-earning assets compared to 2011, having a greater impact than the $2.2 billion increase in average interest-bearing liabilities. Net interest margin (excluding purchase accounting), which eliminates the effect of purchase accounting amounts, increased 15 basis points to 3.69% in 2012 from 3.54% in 2011. For additional information related to our net interest margin (excluding purchase accounting), refer to "Table 4, Reconciliation of Non-GAAP Measures".

Interest income on a fully-taxable basis increased by $116.5 million, or 19.1%. Interest earned on the investment portfolio decreased $10.0 million, or 11.6%, resulting from lower rates earned on the reinvestment of cash flows from securities that were called or paid down during 2012. The average balance of the investment portfolio increased $178.0 million, or 7.0% due to the Abington and Tower acquisitions. The fully taxable-equivalent yield on the investment securities portfolio declined 60 basis points from 3.41% in 2011 to 2.81% in 2012. Interest earned, on a fully taxable-equivalent basis, on loans and leases increased $126.5 million, or 24.2%. Average loans and leases average balances totaled $12.3 billion in 2012, compared to $9.8 billion in 2011, however the growth in loans and leases balances were offset by the decline in yield earned which decreased 7 basis points from 5.34% in 2011 to 5.27% in 2012, as the primary driver of the balance growth was in lower yielding consumer lending and leases.

Interest expense declined by $42.2 million, or 26.1%. Interest paid on deposits dropped $7.8 million, or 10.2%, even as the average interest-bearing balances increased by $0.5 billion. The average rate paid on deposits declined 24 basis points from 0.80% to 0.56% in 2012. This improvement is the result of changes in deposit mix. Interest paid on short-term borrowings and Federal Home Loan Bank borrowings (primarily short-term) decreased $27.7 million due to the restructuring in 2011 of the FHLB borrowings.


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Average balances in this category increase $26.9 million in 2012, while the average rate paid declined 157 basis points from 2.81% in 2011, to 1.24% in 2012. Long-term debt interest declined $6.7 million resulting from the net redemption of $137.1 million of long-term debt with interest rates ranging from 6.05% to 11.00% in the later part of 2012.

Variances do occur in the net interest margin, as an exact repricing of assets and liabilities is not feasible. A further explanation of the impact of asset and liability repricing is found in the section entitled "Market Risks-Interest Rate Risk."

                                    Table 8

          Distribution of Assets, Liabilities and Shareholders' Equity



                                                                          2013                                          2012                                          2011
                                                                            Taxable Equivalent                            Taxable Equivalent                            Taxable Equivalent
                                                          Average                           Rate        Average                           Rate        Average                           Rate
                                                          Balance          Interest         (%)         Balance          Interest         (%)         Balance          Interest         (%)
                                                                                                               (Dollars in thousands)
Assets
Short-term investments                                  $     96,825      $       108        0.11     $    108,408      $       144        0.13     $     98,424      $       108        0.11
Investment securities:
Taxable                                                    2,182,121           46,248        2.12        2,320,582           53,659        2.31        2,129,908           61,845        2.90
Tax-advantaged                                               395,086           21,835        5.53          386,926           22,518        5.82          399,554           24,355        6.10

Total investment securities                                2,577,207           68,083        2.64        2,707,508           76,177        2.81        2,529,462           86,200        3.41

Loans and leases, (net):
Taxable                                                   12,772,845          614,158        4.81       11,934,701          628,426        5.27        9,492,521          505,607        5.33
Tax-advantaged                                               416,654           21,038        5.05          386,627           21,175        5.48          311,342           17,503        5.62

Total loans and leases                                    13,189,499          635,196        4.82       12,321,328          649,601        5.27        9,803,863          523,110        5.34

Total interest-earning assets                             15,863,531          703,387        4.43       15,137,244          725,922        4.80       12,431,749          609,418        4.90

Allowance for loan and lease losses                         (176,782 )                                    (189,368 )                                    (194,746 )
Other noninterest-earning assets                           2,514,410                                     2,583,421                                     2,125,775

Total assets                                            $ 18,201,159                                  $ 17,531,297                                  $ 14,362,778


Liabilities
Deposits:
Interest-bearing demand                                 $  5,968,726      $    16,661        0.28     $  5,453,701      $    20,603        0.38     $  3,884,182      $    21,323        0.55
Savings                                                    1,070,248            1,144        0.11          989,123            1,208        0.12          815,066            1,161        0.14
Time                                                       3,833,262           42,713        1.11        3,939,528           47,168        1.20        3,482,801           54,294        1.56
Short-term borrowings                                        743,718            8,695        1.17          732,209            8,711        1.19          658,477            8,133        1.24
FHLB borrowings                                            1,247,209           16,329        1.31        1,076,962           13,723        1.27        1,123,801           42,024        3.74
Long-term debt                                               483,888           16,900        3.49          662,027           27,979        4.23          684,065           34,683        5.07

Total interest-bearing liabilities                        13,347,051          102,442        0.77       12,853,550          119,392        0.93       10,648,392          161,618        1.52

Demand deposits                                            1,905,502                                     1,873,755                                     1,413,077
Other liabilities                                            302,267                                       292,388                                       245,592

Total liabilities                                         15,554,820                                    15,019,693                                    12,307,061
Equity                                                     2,646,339                                     2,511,604                                     2,055,717

Total liabilities & shareholders' equity                $ 18,201,159                                  $ 17,531,297                                  $ 14,362,778

Net interest income / yield on average earning assets                         600,945        3.79                           606,530        4.01                           447,800        3.60
Taxable equivalent adjustment                                                 (15,005 )                                     (15,292 )                                     (14,650 )

Net interest income - as reported                                         $   585,940                                   $   591,238                                   $   433,150

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