SUSQUEHANNA BANCSHARES INC - 10-Q Quarterly Report

Three Months ended
September 30,

Average balance of impaired loans

Interest income on impaired loans (cash-basis)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission file number 0-10674

Susquehanna Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania

23-2201716

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)


26 North Cedar St., Lititz, Pennsylvania		17543
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code (717) 626-4721

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

46,508,702 shares of common stock, par value $2.00 per share, as of October 28, 2004.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS


PART I.	FINANCIAL INFORMATION

Item 1	Financial Statements

	Consolidated Balance Sheets – as of September 30, 2004 and 2003 (unaudited), and December 31, 2003	3

	Consolidated Statements of Income – for the three and nine months ended September 30, 2004 and 2003 (unaudited)	4

	Consolidated Statements of Cash Flows - for the nine months ended September 30, 2004 and 2003 (unaudited)	5

	Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2004 and 2003 (unaudited)	7

	Notes to the Consolidated Financial Statements (unaudited)	8

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3	Quantitative and Qualitative Disclosures about Market Risk	30

Item 4	Controls and Procedures	38

PART II.	OTHER INFORMATION

Item 6	Exhibits and Reports on Form 8-K	39

SIGNATURES		40

EXHIBIT INDEX		41

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS


	September 30 2004		December 31 2003			September 30 2003
	(in thousands, except share data)
Assets
Cash and due from banks	$	182,857	$	176,240		$	164,444
Short-term investments:
Restricted		26,637		44,817			57,798
Unrestricted		26,952		34,145			38,641

Total short-term investments		53,589		78,962			96,439

Securities available for sale		1,289,222		983,882			1,018,747
Securities held to maturity (fair values approximate $4,602, $4,340 and $3,784)		4,602		4,340			3,784
Loans and leases, net of unearned income		5,166,137		4,263,272			4,147,957
Less: Allowance for loan and lease losses		52,468		42,672			41,513

Net loans and leases		5,113,669		4,220,600			4,106,444

Premises and equipment, net		80,399		62,961			59,959
Foreclosed assets		1,210		2,893			2,081
Accrued income receivable		21,711		17,494			17,192
Bank-owned life insurance		247,336		200,555			179,625
Goodwill		239,432		59,123			59,123
Intangible assets with finite lives		12,640		4,372			4,529
Investment in unconsolidated subsidiaries		62,541		42,717			41,168
Other assets		140,648		98,968			99,877

	$	7,449,856	$	5,953,107		$	5,853,412

Liabilities and Shareholders’ Equity
Deposits:
Demand	$	817,744	$	724,474		$	688,897
Interest-bearing demand		1,811,651		1,295,593			1,185,433
Savings		574,339		508,889			503,349
Time		1,375,371		1,251,058			1,250,593
Time of $100 or more		506,465		354,453			344,446

Total deposits		5,085,570		4,134,467			3,972,718
Short-term borrowings		460,820		355,553			427,032
FHLB borrowings		750,049		613,850			603,105
Long-term debt		200,000		130,000			130,000
Junior subordinated debentures		23,397		0			0
Accrued interest, taxes, and expenses payable		58,185		35,791			37,987
Deferred taxes		94,431		104,281			93,865
Other liabilities		30,991		31,783			47,496

Total liabilities		6,703,443		5,405,725			5,312,203

Shareholders’ equity:
Common stock, $2.00 par value, 100,000,000 shares authorized; Issued: 46,504,941 at Septembr 30, 2004; 39,861,317 at December 31, 2003; and 39,828,643 at September 30, 2003		93,010		79,723			79,657
Additional paid-in capital		225,021		66,264			65,714
Retained earnings		426,607		403,450			398,198
Accumulated other comprehensive income (loss), net of taxes of $956, ($1,107), and ($1,271)		1,775		(2,055	)		(2,360	)

Total shareholders’ equity		746,413		547,382			541,209

	$	7,449,856	$	5,953,107		$	5,853,412

The accompanying notes are an integral part of these consolidated financial statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME


	Three Months Ended September 30				Nine Months Ended September 30
(in thousands, except per share data)	2004		2003		2004		2003
Interest Income:
Loans and leases, including fees	$	74,255	$	61,165	$	198,790	$	184,000
Securities:
Taxable		11,761		6,526		29,174		28,380
Tax-exempt		508		322		1,067		1,156
Dividends		765		249		1,655		898
Short-term investments		159		180		543		542

Total interest income		87,448		68,442		231,229		214,976

Interest Expense:
Deposits:
Interest-bearing demand		5,092		2,115		11,452		7,258
Savings		655		399		1,487		1,608
Time		12,554		12,340		35,977		39,439
Short-term borrowings		1,228		950		2,646		2,718
FHLB borrowings		5,946		5,419		16,254		17,054
Long-term debt		3,561		2,398		8,965		7,780

Total interest expense		29,036		23,621		76,781		75,857

Net interest income		58,412		44,821		154,448		139,119
Provision for loan and lease losses		2,783		2,665		6,590		7,545

Net interest income, after provision for loan and lease losses		55,629		42,156		147,858		131,574

Noninterest Income:
Service charges on deposit accounts		5,955		5,283		16,270		14,573
Vehicle origination, servicing, and securitization fees		4,894		6,550		15,575		21,120
Asset management fees		3,784		2,570		10,478		7,369
Income from fiduciary-related activities		1,434		1,442		4,260		4,390
Commissions on brokerage, life insurance, and annuity sales		943		735		2,999		1,511
Commissions on property and casualty insurance sales		2,101		1,860		6,690		6,092
Income from bank-owned life insurance		2,430		1,864		6,694		4,939
Net gain on sale of loans and leases		977		3,888		7,625		8,828
Net gain on securities		3,770		1,926		4,338		2,110
Other		3,834		2,562		9,621		8,163

Total noninterest income		30,122		28,680		84,550		79,095

Noninterest Expenses:
Salaries and employee benefits		28,331		23,699		78,127		68,401
Occupancy		4,160		3,357		11,544		10,256
Furniture and equipment		2,388		1,985		6,675		6,454
Amortization of intangible assets		413		157		792		470
Vehicle residual value		1,663		1,758		4,053		4,833
Vehicle delivery and preparation		4,596		3,531		11,291		9,116
Other		17,951		13,862		47,685		42,055

Total noninterest expenses		59,502		48,349		160,167		141,585

Income before income taxes		26,249		22,487		72,241		69,084
Provision for income taxes		7,743		6,513		21,310		20,725

Net Income	$	18,506	$	15,974	$	50,931	$	48,359

Earnings per share:
Basic	$	0.40	$	0.40	$	1.20	$	1.22
Diluted	$	0.40	$	0.40	$	1.19	$	1.21
Cash dividends	$	0.22	$	0.22	$	0.66	$	0.64
Average shares outstanding:
Basic		46,478		39,789		42,596		39,712
Diluted		46,711		40,127		42,883		39,998

The accompanying notes are an integral part of these consolidated financial statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)


Nine months ended September 30,	2004			2003
Cash Flows from Operating Activities:
Net income	$	50,931		$	48,359
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		11,920			19,573
Provision for loan and lease losses		6,590			7,545
Realized gain on sales of available-for-sale securities, net		(4,338	)		(2,110	)
Deferred income taxes		(9,850	)		8,197
Gain on sale of loans and leases		(7,625	)		(8,828	)
Gain on sale of other real estate owned		(441	)		(254	)
Mortgage loans originated for sale		(100,547	)		(162,102	)
Proceeds from sale of mortgage loans originated for sale		102,772			168,620
Leases acquired/originated for sale		(194,852	)		(123,619	)
Proceeds from sale of leases acquired/originated for sale		179,971			115,584
Increase in cash surrender value of bank-owned life insurance		(6,694	)		(4,939	)
Net gain on sale of branch deposits		(1,068	)		0
(Increase) decrease in accrued interest receivable		(4,217	)		3,387
Increase (decrease) in accrued interest payable		2,768			(4,454	)
Increase in accrued expenses and taxes payable		21,681			6,200
Other, net		(7,646	)		33,700

Net cash provided by operating activities		39,355			104,859

Cash Flows from Investing Activities:
Net (increase) decrease in restricted short-term investments		18,180			(27,187	)
Activity in available-for-sale securities:
Sales		207,159			118,046
Maturities, repayments and calls		356,958			743,382
Purchases		(554,884	)		(789,785	)
Net increase in loans and leases		(266,442	)		(327,598	)
Purchase of bank-owned life insurance		(29,900	)		(50,000	)
Acquisition of Patriot, net of cash acquired		(28,709	)		0
Capitalized acquisition costs		(7,569	)		0
Sale of branch deposits, net of premium received		(8,949	)		0
Additions to premises and equipment		(11,229	)		(5,154	)

Net cash used for investing activities		(325,385	)		(338,296	)

Cash Flows from Financing Activities:
Net increase in deposits		312,323			141,403
Net increase in short-term borrowings		105,266			129,004
Net increase (decrease) in FHLB borrowings		(177,529	)		59,939
Repayment of long-term debt		(5,000	)		(50,000	)
Proceeds from issuance of long-term debt		74,356			0
Proceeds from issuance of common stock		3,812			3,236
Cash dividends paid		(27,774	)		(25,405	)

Net cash provided by financing activities		285,454			258,177

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)


Net change in cash and cash equivalents		(576	)		24,740
Cash and cash equivalents at January 1		210,385			178,345

Cash and cash equivalents at September 30	$	209,809		$	203,085

Cash and cash equivalents:
Cash and due from banks	$	182,857		$	164,444
Unrestricted short-term investments		26,952			38,641

Cash and cash equivalents at September 30	$	209,809		$	203,085

Supplemental Disclosure of Cash Flow Information

Cash paid for interest on deposits and borrowings	$	74,013		$	80,311
Income tax payments (refunds)	$	(3,151	)	$	(10,426	)

Supplemental Schedule of Noncash Investing Activities

Real estate acquired in settlement of loans	$	1,154		$	1,963

Acquisition of Patriot Bank Corp.
Common stock issued	$	166,454		$	0
Fair value of assets acquired (noncash)	$	1,138,122		$	0
Liabilities assumed	$	985,922		$	0

The accompanying notes are an integral part of these consolidated financial statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands, except share data)


Nine months ended September 30	Shares of Common Stock	Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balance at January 1, 2003	39,638,447	$	79,277	$	62,858	$	375,244		$	16,476		$	533,855

Comprehensive income:
Net income							48,359						48,359
Change in unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effect										(14,887	)		(14,887	)
Change in unrealized gain on recorded interest in securitized assets, net of taxes										(3,949	)		(3,949	)

Total comprehensive income													29,523

Common stock issued under employee benefit plans (includes related tax benefit of $659)	190,196		380		2,856								3,236
Cash dividends declared ($0.64 per share)							(25,405	)					(25,405	)

Balance at September 30, 2003	39,828,643	$	79,657	$	65,714	$	398,198		$	(2,360	)	$	541,209

Balance at January 1, 2004	39,861,317	$	79,723	$	66,264	$	403,450		$	(2,055	)	$	547,382

Comprehensive income:
Net income							50,931						50,931
Change in unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effect										4,554			4,554
Change in unrealized gain on recorded interest in securitized assets, net of tax effect										(724	)		(724	)

Total comprehensive income													54,761

Common stock issued in acquisition	6,402,074		12,804		155,428								168,232
Common stock issued under employee benefit plans (includes related tax benefit of $786)	241,550		483		3,329								3,812
Cash dividends declared ($0.66 per share)							(27,774	)					(27,774	)

Balance at September 30, 2004	46,504,941	$	93,010	$	225,021	$	426,607		$	1,775		$	746,413

The accompanying notes are an integral part of these consolidated financial statements.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except as noted and per share data)

NOTE 1. Accounting Policies

The information contained in this report is unaudited and is subject to year-end adjustments. Certain prior year amounts have been reclassified to conform with current period classifications. The adjustments had no effect on gross revenues, gross expenses or net income. In the opinion of management, the information reflects all adjustments necessary for a fair statement of results for the periods ended September 30, 2004 and 2003.

The accounting policies of Susquehanna Bancshares, Inc. and Subsidiaries, as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 58 through 66 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

Recent Accounting Pronouncements.

In May 2004, the Financial Accounting Standards Board staff issued FSP No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” This FSP provides guidance on the accounting for the effect of the Medicare Prescription Act of 2003 for employers that sponsor post- retirement health care plans that provide prescription drug benefits. The FSP also requires those employers to provide certain disclosure regarding the effect of the federal subsidy provided by the Act. This FSP is effective for the first interim or annual period beginning after June 14, 2004. Adoption of this FSP had no material effect on financial condition or results of operations.

In December 2003, the Financial Accounting Standards Board issued FAS No. 132 (revised 2003), “Employers’ Disclosure about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88, and 106.” This statement improves financial statement disclosures for defined benefit plans by requiring additional disclosures to those in the original Statement No. 132 about assets, investment strategy, measurement dates, plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods. With certain exceptions, this statement was effective for fiscal years ending after December 15, 2003. Susquehanna adopted this statement as of December 31, 2003, and the additional interim pension and other postretirement benefit disclosures are included in Note 8 to these financial statements.

In addition, in December 2003, the Financial Accounting Standards Board reissued FIN 46 (FIN 46R) with certain modifications and clarifications. Application of this guidance was effective for interests in certain Variable Interest Entities (VIEs), commonly referred to as special-purpose entities (SPEs) as of December 31, 2003. Application for all other types of

entities was required for periods ending after March 15, 2004, unless previously applied. Considering these modifications and clarifications, management has determined that consolidation of Susquehanna’s VIE was still not required.

NOTE 2. Acquisitions

Patriot Bank Corp.

On June 10, 2004, Susquehanna acquired 100% of the outstanding voting shares of Patriot Bank Corp., a financial services company with total assets in excess of $1.0 billion, and the holding company for Patriot Bank. The results of Patriot’s operations have been included in the consolidated financial statements since that date. Concurrent with the closing, Susquehanna merged Patriot Bank into Equity Bank, a wholly owned Susquehanna subsidiary. The combined bank, with assets of approximately $2.1 billion, is now known as Susquehanna Patriot Bank, headquartered in Marlton, New Jersey, and operates 36 banking centers in eastern Pennsylvania

and southern New Jersey. The transaction enhances Susquehanna’s strong presence in Pennsylvania, particularly in the high-growth counties of Berks, Chester, Lehigh, Montgomery, and Northampton.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)

Under the terms of the merger, each share of Patriot common stock was exchanged for 1.143 shares of Susquehanna common stock, $30.00 in cash, or a combination thereof, resulting in the issuance of 6,402 shares of Susquehanna common stock and a cash payment of $40,739, net of tax benefit. The total purchase price was $208,517. The value of the common shares issued was determined based on the market price of Susquehanna common shares at the close of business immediately prior to the announcement.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.


Assets
Cash and cash equivalents	$	13,804
Securities		303,584
Loans and leases, net of allowance of $9,149		642,322
Premises and other equipment		11,728
Goodwill and other intangibles		188,285
Other assets		43,106

Total assets acquired	$	1,202,829

Liabilities
Deposits	$	648,797
Borrowings		337,125
Other Liabilities		8,390

Total liabilities assumed		994,312

Net assets acquired	$	208,517

Of the $188,285 of acquired intangible assets, $7,976 was assigned to core deposit intangibles that will be amortized over 10 years.

Presented below is certain unaudited pro forma information for the three and nine month periods ended September 30, 2004 and 2003 as if Patriot had been acquired on January 1, 2004 and 2003 with respect to the nine-month periods ended September 30, 2004

and 2003, and as if Patriot had been acquired at the beginning of each interim period presented with respect to the three-month period ended September 30, 2003. These results combine the historical results of Patriot, including the termination of certain employee

benefit programs and costs incurred in connection with the merger, with Susquehanna’s consolidated statements of income and, while certain adjustments were made for the estimated impact of purchase accounting adjustments, they are not necessarily indicative of

what would have occurred had the acquisition taken place on the indicated dates.


	Three Months Ended September 30				Nine Months Ended September 30
	2004 Actual		2003		2004		2003
Net income	$	18,506	$	18,593	$	44,627	$	57,078
Basic EPS	$	0.40	$	0.40	$	0.96	$	1.24
Diluted EPS	$	0.40	$	0.40	$	0.96	$	1.23

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)

NOTE 3. Investment Securities

The amortized costs and fair values of securities were as follows:


	September 30, 2004				December 31, 2003
	Amortized cost		Fair value		Amortized cost		Fair value
Available-for-sale:
U.S. Treasury	$	0	$	0	$	200	$	202
U.S. Government agencies		240,757		240,942		84,352		84,679
State & municipal		39,476		40,899		18,123		18,793
Mortgage-backed		939,981		941,650		836,962		832,248
Other debt securities		7,368		7,439		7,342		7,409
Equities		57,882		58,292		40,151		40,551

		1,285,464		1,289,222		987,130		983,882
Held-to-maturity:
State & municipal		4,602		4,602		4,340		4,340

Total investment securities	$	1,290,066	$	1,293,824	$	991,470	$	988,222

NOTE 4. Loans and Leases

Loans and leases, net of unearned income, were as follows:


	September 30, 2004			December 31, 2003
Commercial, financial, and agricultural	$	724,719		$	621,438
Real estate - construction		654,702			549,672
Real estate secured - residential		1,611,456			1,306,371
Real estate secured - commercial		1,246,638			1,016,360
Consumer		356,620			337,989
Leases		572,002			431,442

Total loans and leases	$	5,166,137		$	4,263,272


The net investment in direct financing leases was as follows:
Minimum lease payments receivable	$	344,155		$	236,423
Estimated residual value of leases		291,128			235,828
Unearned income under lease contracts		(63,281	)		(40,809	)

Total leases	$	572,002		$	431,442


An analysis of impaired loans, as of September 30, 2004 and December 31, 2003, is as follows:

Impaired loans without a related reserve	$	2,903		$	2,232
Impaired loans with a reserve		3,309			7,423

Total impaired loans	$	6,212		$	9,655

Reserve for impaired loans	$	844		$	1,657

An analysis of impaired loans, for the three and nine month periods ended September 30, 2004 and 2003, is as follows:

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)

NOTE 5. Borrowings

Short-term borrowings were as follows:


	September 30, 2004		December 31, 2003
Securities sold under repurchase agreements	$	344,773	$	295,512
Federal funds purchased		113,500		55,250
Treasury tax and loan notes		2,547		4,791

Total short-term borrowings	$	460,820	$	355,553

Long-term debt was as follows:
Subsidiaries:
Term notes due July, 2004	$	0	$	5,000
Parent:

Subordinated notes due February, 2005		50,000		50,000
Subordinated notes due November, 2012		75,000		75,000
Subordinated notes due May, 2014		75,000		0
Junior subordinated notes callable 2007		23,397		0

Total long-term debt	$	223,397	$	130,000

On May 3, 2004, Susquehanna completed the private placement of $75,000 aggregate principal amount of 4.75% fixed rate/floating rate subordinated notes due May 1, 2014. Susquehanna used the net proceeds from the offering to fund the cash portion of the Patriot acquisition and the remaining balance to increase its liquidity and capital position in anticipation of future growth and for general corporate purposes. The notes qualify as Tier 2 Capital under the capital guidelines established by the Federal Reserve Board and were offered and sold by Susquehanna to several initial purchasers, who then resold the notes only to “qualified institutional buyers” in accordance with Rule 144A of the Securities Act of 1933, as amended, and Regulation S.

The notes bear interest at a fixed rate of 4.75% per annum through and including May 1, 2009 and convert to a floating rate thereafter until maturity, based on the US dollar three-month LIBOR plus 1.82%. Beginning May 1, 2009, Susquehanna, upon consultation with the Federal Reserve Board, has the right to redeem the notes at a redemption price of 100% of the principal amount of the notes plus any accrued interest.

In addition, as part of the Patriot acquisition, Susquehanna assumed $20,500 in junior subordinated debt issued to Patriot Capital Trust I and Patriot Capital Trust II. The aggregate fair value of this debt at the date of acquisition was $23,554. The $15,500 in debentures issued to Patriot Capital Trust I bear interest at 10.30% and are callable on or after July 1, 2007. If these debentures are not called, they must be redeemed upon maturity in 2027. The $5,000 in debentures issued to Patriot Capital Trust II bear interest at the 180-day LIBOR plus 3.70%, and the rate at September 30, 2004 was 5.31%. The debentures are callable on

any April 22 or October 22 after April 22, 2007. If these debentures are not called, they must be redeemed upon maturity in 2032.

NOTE 6. Earnings per Share (shares in thousands)

The following tables set forth the calculation of basic and diluted earnings per share for the three months and nine months ended September 30, 2004 and 2003.


	For the three months ended September 30
	2004					2003
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	18,506	46,478	$	0.40	$	15,974	39,789	$	0.40

Effect of Diluted Securities:
Stock options outstanding			233					338

Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	18,506	46,711	$	0.40	$	15,974	40,127	$	0.40

For the three months ended September 30, 2004 and 2003, average options to purchase 362 and 0 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares; and the options were, therefore, antidilutive.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)


	For the nine months ended September 30
	2004					2003
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	50,931	42,596	$	1.20	$	48,359	39,712	$	1.22

Effect of Diluted Securities:
Stock options outstanding			287					286

Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	50,931	42,883	$	1.19	$	48,359	39,998	$	1.21

For the nine months ended September 30, 2004 and 2003, average options to purchase 362 and 460 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares; and the options were, therefore, antidilutive.

NOTE 7. Stock-Based Compensation

Susquehanna’s stock-based compensation plan is accounted for using the intrinsic value method set forth in Accounting Principles Board (APB) Opinion 25, “Accounting for Stock Issued to Employees” and related Interpretations. Under APB 25, no compensation expense is recognized, as the exercise price of Susquehanna’s stock options is equal to the fair market value of its common stock on the date of grant.

Pursuant to FAS No. 123, “Accounting for Stock-Based Compensation,” as amended by FAS No. 148, “Accounting for Stock-Based Compensation - Transitions and Disclosure,” disclosure requirements, pro forma net income, and earnings per share are presented in the following table as if compensation cost for stock options was determined under the fair value method and amortized to expense over the options’ vesting periods. On January 21, 2004, options to purchase 136 shares of common stock were granted to employees and directors, with an exercise price of $25.14 per share on the date of grant; and, on June 10, 2004, options to purchase 7 shares of common stock were granted to directors, with an exercise price of $25.47. In addition, on June 30, 2004, 20 shares of common stock were purchased under Susquehanna’s Employee Stock Purchase Plan at a price of $22.51 per share.


	For the three months ended September 30				For the nine months ended September 30
	2004		2003		2004		2003
Net income, as reported	$	18,506	$	15,974	$	50,931	$	48,359
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		238		212		718		576

Pro forma net income	$	18,268	$	15,762	$	50,213	$	47,783

Earnings per share:
Basic - as reported	$	0.40	$	0.40	$	1.20	$	1.22
Basic - pro forma	$	0.39	$	0.40	$	1.18	$	1.20

Diluted - as reported	$	0.40	$	0.40	$	1.19	$	1.21
Diluted - pro forma	$	0.39	$	0.39	$	1.17	$	1.19

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)

NOTE 8. Benefit Plans

Components of Net Periodic Benefit Cost


	Three months ended September 30
	Pension Benefits						Other Benefits
	2004			2003			2004		2003
Service cost	$	739		$	560		$	121	$	48
Interest cost		755			837			102		64
Expected return on plan assets		(1,104	)		(978	)		0		0
Amortization of prior service cost		(20	)		(59	)		12		12
Amortization of transition obligation (asset)		(51	)		(17	)		29		28
Amortization of net actuarial (gain) or loss		42			135			16		(12	)

Net periodic benefit cost	$	361		$	478		$	280	$	140


	Nine months ended September 30
	Pension Benefits						Other Benefits
	2004			2003			2004		2003
Service cost	$	2,079		$	1,680		$	229	$	144
Interest cost		2,667			2,511			242		192
Expected return on plan assets		(3,310	)		(2,934	)		0		0
Amortization of prior service cost		(44	)		(177	)		36		36
Amortization of transition obligation (asset)		(51	)		(51	)		85		84
Amortization of net actuarial (gain) or loss		268			405			0		(36	)

Net periodic benefit cost	$	1,609		$	1,434		$	592	$	420

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $0 to its pension plans and $277 to its other postretirement benefit plan in 2004. As of September 30, 2004, $0 of contributions have been made to its pension plans, and $177 of contributions have been made to its other postretirement benefit plan. Susquehanna does not anticipate any changes to its 2004 projections.

NOTE 9. Goodwill and Other Intangible Assets

The change in the carrying amount of goodwill for the nine months ended September 30, 2004, is as follows:


Balance as of January 1, 2004	$	59,123

Goodwill acquired through the Patriot acquisition, deemed to be non-tax deductible		180,759
Subsequent adjustments relating to the Patriot acquisition, net		(450	)

Balance as of September 30, 2004	$	239,432

In addition, $7,976 was assigned to core deposit intangibles and will be amortized over 10 years. The estimated amortization expense for 2004 for this intangible is $465. The estimated amortization expense for the next five years is as follows:


For the year ended 12/31/05	$	798
For the year ended 12/31/06	$	798
For the year ended 12/31/07	$	798
For the year ended 12/31/08	$	798
For the year ended 12/31/09	$	798

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(in thousands, except as noted and per share data)

Note 10. Securitization Activity

Since 2001, Susquehanna has sold the beneficial interests in automobile leases in securitization transactions. In all those securitizations, Susquehanna retained servicing responsibilities and subordinated interests. Susquehanna receives annual servicing fees approximating 1.0% of the outstanding balance and rights to future cash flows arising after the investors have received the return for which they contracted. Susquehanna recognizes no servicing asset, as servicing income approximates servicing costs. Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its auto portfolio, and not primarily to maximize its ongoing servicing fee revenue. Susquehanna monitors its servicing costs to ensure that future costs do not exceed servicing income. If servicing costs were to exceed servicing income, Susquehanna would record the present value of that liability as an expense.

The investors and the securitization trusts have no recourse to Susquehanna’s other assets, except retained interests, for failure of debtors to pay when due. Susquehanna’s retained interests are subordinate to investors’ interests. Their value is subject to credit, prepayment, and interest rate risks on the transferred financial assets.

As a result of a June 2004 clean-up call, the reimbursement obligations under the 2001 transaction to a lender under a letter of credit facility have terminated. At June 30, 2004, Susquehanna was no longer obligated to make payments in an amount up to $20,500 under this letter of credit.

The following table presents quantitative information about delinquencies, net credit losses, and components of lease sales serviced by Susquehanna, including securitization transactions.


	As of September 30								For the Nine Months Ended September 30
	Principal Balance				Past Due 30 Days or More				Net Credit Losses
	2004		2003		2004		2003		2004		2003
Total leases and loans serviced	$	1,612,452	$	1,518,266	$	3,768	$	3,814	$	260	$	433
Less:
Leases securitized		399,748		324,774		406		176		114		77
Leases serviced for others (1)		751,933		886,949		2,795		3,160		100		253

Leases and loans held in portfolio	$	460,771	$	306,543	$	567	$	478	$	46	$	103

(1)	Amounts include the sale-leaseback transaction and agency arrangements.

Certain cash flows received from the structured entities associated with the lease securitizations described above are as follows:


	Three Months Ended September 30				Nine Months Ended September 30
	2004		2003		2004		2003
Proceeds from lease securitizations	$	0	$	0	$	179,971	$	115,584
Amounts derecognized		0		0		194,852		123,619
Servicing fees received		1,421		1,231		2,846		2,164
Other cash flows received on retained interests		2,176		51		3,411		4,081

Set forth below is a summary of the fair values of the interest-only strips, key economic assumptions used to arrive at the fair values, and the sensitivity of the September 30, 2004 fair values to immediate 10% and 20% adverse changes in those assumptions. The sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption: in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

As of September 30, 2004


	Fair Value		Weighted- average Life (in months)	Monthly Prepayment Speed		Expected Cumulative Credit Losses		Annual Discount Rate (1)
Automobile Leases

2003 Revolving transaction - Interest-Only Strip	$	4,287	31	0.40	%	0.10	%	3.14	%
Decline in fair value of 10% adverse change				0		0		34
Decline in fair value of 20% adverse change				17		0		68
2003 transaction - Interest-Only Strip		4,827	16	0.25	%	0.10	%	2.65	%
Decline in fair value of 10% adverse change				0		0		17
Decline in fair value of 20% adverse change				0		0		34

(1)	The annual discount rate used is derived from the interpolated Treasury swap rate as of the reporting date.

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of the significant changes in the consolidated results of operations, financial condition, and cash flows of Susquehanna Bancshares, Inc. and its subsidiaries is set forth below for the periods indicated. Susquehanna Bancshares, Inc. and its subsidiaries are collectively referred to as “Susquehanna,” “we,” “us,” and “our.”

Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective,” and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited, to Susquehanna’s potential exposures to various types of market risks, such as interest rate risk; credit risk; whether Susquehanna’s allowance for loan and lease losses is adequate to meet probable loan and leases losses; the impact of a breach by Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) on residual loss exposure; the likelihood of an occurrence of an Early Amortization Event; expectations regarding our branding strategy and internal realignment plans and their potential impact on our efficiency ratios and earnings; and the impact on Susquehanna of its ability to maintain contingent vehicle liability insurance coverage in vicarious liability states. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:

•

adverse changes in our loan and lease portfolios and the resulting credit risk-related losses and expenses;

•

interest rate fluctuations that could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

•

continued levels of our loan and lease quality and origination volume;

•

the adequacy of the allowance for loan and lease losses;

•

the loss of certain key officers which could adversely impact our business;

•

continued relationships with major customers;

•

the inability to continue to grow our business internally and through acquisition and successful integration of bank and non-bank entities while controlling our costs;

•

adverse national and regional economic and business conditions;

•

compliance with laws and regulatory requirements of federal and state agencies;

•

competition from other financial institutions in originating loans, attracting deposits, and providing various financial services that may affect our profitability;

•

the inability to hedge certain risks economically;

•

our ability to effectively implement technology driven products and services;

•

changes in consumer confidence, spending and savings habits relative to the bank and non-bank financial services we provide; and

•

our success in managing the risks involved in the foregoing.

We encourage readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. 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 occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events except as required by law.

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 Susquehanna’s 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.

The following information refers to the parent company and its wholly owned subsidiaries: Boston Service Company, Inc., (t/a Hann Financial Service Corporation) (“Hann”), Conestoga Management Company, Farmers First Bank and subsidiaries (“Farmers”), Farmers & Merchants Bank and Trust and subsidiaries (“F&M”), First American Bank of Pennsylvania (“FAB”), First Susquehanna Bank & Trust (“First Susquehanna”), WNB Bank (“WNB”), Citizens Bank of Southern Pennsylvania (“Citizens”), Susquehanna Patriot Bank and subsidiaries (“Susquehanna Patriot”), Susquehanna Bank and subsidiaries (“SB”), Susque-Bancshares Life Insurance Co. (“SBLIC”), Valley Forge Asset Management Corporation (“VFAM”), and The Addis Group, LLC (“Addis”).

Availability of Information

Our website address is www.susqbanc.com. We make available free of charge, through the Investor Relations section of our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We include our website address in this Quarterly Report on Form 10-Q only as an inactive textual reference and do not intend it to be an active link to our website.

Subsequent Events

On October 1, 2004, we announced our decision to unify our financial services affiliates under a common master brand. Each affiliate will adopt the master brand “Susquehanna” and will incorporate Susquehanna into its legal and market name. Along with a name and brand identity change, we will combine our eight banking subsidiaries into three. The branding and realignment will provide customers access to more banking offices and will create banks of greater size, allowing us to increase our presence in target markets. In addition, our realignment also should help to streamline the application of increasingly complex regulatory requirements and should provide operational and administrative efficiencies by reducing redundancies. We anticipate limited staff reductions as a result of operational and administrative consolidations.

On October 28, 2004, we completed an exchange offer relating to our outstanding $75.0 million 4.75% fixed rate/floating rate subordinated notes due 2014 (the “Outstanding 2014 Notes”), pursuant to which we exchanged all of such Outstanding 2014 Notes, which notes were originally issued under a supplemental indenture dated as of May 3, 2004 to an indenture dated as of November 4, 2002, between us and J.P. Morgan Trust Company, National Association, for an identical form of notes that were registered under the Securities Exchange Act of 1934, as amended. See “Financial Condition-Borrowings.”

Results of Operations

Acquisition of Patriot Bank Corp.

On June 10, 2004, we completed our acquisition of Patriot Bank Corp (“Patriot”). The acquisition was accounted for under the purchase method, and all transactions since that date are included in our consolidated financial statements.

Summary of 2004 Compared to 2003

Net income for the third quarter of 2004 was $18.5 million, a 15.9% increase from net income of $16.0 million in the third quarter of 2003. For the first nine months of 2004, net income was $50.9 million, a 5.3% increase over net income of $48.4 million for the first nine months of 2003.

During the third quarter of 2004, our net interest income increased by 30.3% from net income during the third quarter of 2003. Noninterest income continued to improve and increased by 5.0% for the third quarter of 2004 from the third quarter of 2003. Noninterest income represented 34.0% of total revenues for the third quarter of 2004 and 39.0% for the third quarter of 2003. Noninterest expenses increased 23.1% from the comparable period in 2003.

During the first nine months of 2004, our net interest income increased by 11.0%, and noninterest income increased by 6.9% from the comparable period in 2003. Noninterest income represented 35.4% of total revenues for the first nine months of 2004 and 36.2% for the first nine months of 2003. Noninterest expenses increased 13.1% from the comparable period in 2003.

Additional information is as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Diluted Earnings per Share	$	0.40		$	0.40		$	1.19		$	1.21
Return on Average Assets		1.00	%		1.09	%		1.04	%		1.14	%
Return on Average Equity		10.07	%		11.77	%		10.91	%		12.03	%
Return on Average Tangible Equity (1)		15.60	%		13.39	%		13.91	%		13.65	%
Efficiency Ratio		66.67	%		65.32	%		66.52	%		64.38	%
Efficiency Ratio Excluding Hann (1)		59.07	%		63.17	%		62.31	%		62.70	%

(1) Supplemental Reporting of Non-GAAP Financial Measures

Susquehanna has presented a return on average tangible equity, which is a non-GAAP financial measure and is most directly comparable to the GAAP measurement of return on average equity. For purposes of computing return on average tangible equity, we have excluded the balance of intangible assets and their related amortization expense from our calculation of return on average tangible equity to allow us to review the core operating results of our company. This is consistent with the treatment by bank regulatory agencies which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average tangible equity to return on average equity is set forth below.


Return on average equity (GAAP basis)	10.07	%	11.77	%	10.91	%	12.03	%
Effect of excluding average intangible assets and related amortization	5.53	%	1.62	%	3.00	%	1.62	%
Return on average tangible equity	15.60	%	13.39	%	13.91	%	13.65	%

Susquehanna has presented an efficiency ratio excluding Hann, which is a non-GAAP financial measure and is most directly comparable to the GAAP presentation of efficiency ratio. We measure our efficiency ratio by dividing noninterest expenses by the sum of net interest income, on a FTE basis, and noninterest income. The presentation of an efficiency ratio excluding Hann is computed as the efficiency ratio excluding the effects of our auto leasing subsidiary, Hann. Management believes this to be a preferred measurement because it excludes the volatility of full-term ratios, securitization gains, and residual values of Hann and provides more focused visibility into our core business activities. A reconciliation of efficiency ratio excluding Hann to efficiency ratio is set forth below.


Efficiency ratio (GAAP basis)	66.67	%	65.32	%	66.52	%	64.38	%
Effect of excluding Hann	7.60	%	2.15	%	4.21	%	1.68	%
Efficiency ratio excluding Hann	59.07	%	63.17	%	62.31	%	62.70	%

The following discussion details the factors that contributed to these results.

Net Interest Income – Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which increased to $58.4 million in the third quarter of 2004, from $44.8 million for the same period in 2003. For the nine months ended September 30, 2004, net interest income was $154.4 million compared with $139.1 million for the same period in 2003.

Net interest income as a percentage of net interest income plus other income was 66.0% for the quarter ended September 30, 2004 and 61.0% for the quarter ended September 30, 2003. Net interest income as a percentage of net interest income plus other income was 64.6% for the nine months ended September 30, 2004 and 63.8% for the nine months ended September 30, 2003.

Net interest income 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. Income from earning assets includes income from loans and leases, income from investment securities, and income from 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 levels of non-performing assets. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds, and the levels of non-interest bearing demand deposits and equity capital.

Table 1 presents average balances, taxable equivalent interest income, interest expenses, 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.

Net interest income for the third quarter of 2004 increased $13.6 million over the third quarter of 2003. Average earning assets in the third quarter of 2004 increased $1.2 billion over the same period in 2003, with average loans and leases increasing $1.1 billion, average investment securities increasing $202.4 million, and lower yielding, short-term investments decreasing $32.4 million. Average interest-bearing liabilities increased $1.2 billion, with average interest-bearing deposits increasing $934.4 million, and average borrowings increasing $220.3 million. In addition, average non-interest bearing demand deposits increased $160.3 million in the third quarter of 2004 over the third quarter of 2003.

The increase in net interest income for the third quarter of 2004 was primarily the result of the net contribution from interest-earning assets and interest-bearing liabilities acquired from Patriot. In addition, since we are an asset-sensitive institution, where assets reprice more quickly than liabilities, we have benefited from the recent increases in interest rates; and our net interest margin increased to 3.63% in the third quarter of 2004, from 3.43% in the third quarter of 2003. Yields on average earning assets increased while the average cost of funds continued to decline, improving our spread. The yield on average earning assets increased 20 basis points, while the average cost of funds declined 6 basis points. The improvement in the yield on average earning assets can be mainly attributed to lower prepayments in our mortgage-backed securities portfolio and the accompanying slowdown in premium amortization.

Net interest income for the nine months ended September 30, 2004 increased $16.3 million compared to the same period in 2003. Average earning assets for the first nine months of 2004 increased $693.8 million over the same period in 2003, with average loans and leases increasing $704.7 million, average investment securities decreasing $12.7 million, and lower yielding, short-term investments increasing $1.8 million. Average interest-bearing liabilities increased

$649.1 million, with average interest-bearing deposits increasing $575.6 million, and average borrowings increasing $73.5 million. In addition, average noninterest bearing demand deposits increased $131.4 million for the first nine months of 2004 compared with the first nine months of 2003.

The increase in net interest income for the nine months ended September 30, 2004, was primarily the result of the net contribution from interest-earning assets and interest-bearing liabilities acquired from Patriot. However, despite the increase in yields on average earning assets for the third quarter of 2004, year-to-date yields on average earning assets declined slightly more than the average cost of funds. The yield on average earning assets declined 31 basis points, while the average cost of funds declined only 28 basis points. As a result, our net interest margin decreased to 3.58% for the first nine months of 2004, from 3.66% for the first nine months of 2003.

Variances do occur in the net interest margin, as an exact repricing of assets and liabilities is not possible. A further explanation of the impact of asset and liability repricing is found in Item 3, “Quantitative and Qualitative Disclosures about Market Risk.”

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 1 - Distribution of Assets, Liabilities and Shareholders’ Equity

(dollars in thousands)

Interest rates and interest differential - taxable equivalent basis


	For the Three Month Period Ended September 30, 2004						For the Three Month Period Ended September 30, 2003
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short - term investments	$	56,212		$	160	1.13	$	88,651		$	180	0.81
Investment securities:
Taxable		1,306,170			12,525	3.81		1,120,148			6,775	2.40
Tax - advantaged		43,971			781	7.07		27,580			497	7.15

Total investment securities		1,350,141			13,306	3.92		1,147,728			7,272	2.51

Loans and leases, (net):
Taxable		4,996,775			73,448	5.85		3,954,132			60,529	6.07
Tax - advantaged		80,350			1,242	6.15		57,458			978	6.76

Total loans and leases		5,077,125			74,690	5.85		4,011,590			61,507	6.08

Total interest - earning assets		6,483,478		$	88,156	5.41		5,247,969		$	68,959	5.21

Allowance for loan and lease losses		(53,562	)					(40,954	)
Other non - earning assets		930,719						598,986

Total assets	$	7,360,635					$	5,806,001

Liabilities
Deposits:
Interest - bearing demand	$	1,822,372		$	5,092	1.11	$	1,204,135		$	2,115	0.70
Savings		589,745			655	0.44		505,371			399	0.31
Time		1,843,671			12,554	2.71		1,581,929			12,340	3.09
Short - term borrowings		417,090			1,229	1.17		409,120			950	0.92
FHLB borrowings		732,242			5,946	3.23		611,116			5,419	3.52
Long - term debt		224,451			3,560	6.31		133,261			2,398	7.14

Total interest - bearing liabilities		5,629,571		$	29,036	2.05		4,444,932		$	23,621	2.11

Demand deposits		824,583						664,312
Other liabilities		175,075						158,500

Total liabilities		6,629,229						5,267,744

Equity		731,406						538,257

Total liabilities and shareholders’ equity	$	7,360,635					$	5,806,001

Net interest income / yield on average earning assets				$	59,120	3.63				$	45,338	3.43

Additional Information

Average loan balances include non-accrual loans.

Tax-exempt income has been adjusted to a tax-equivalent basis using a marginal rate of 35%.

For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 1 - Distribution of Assets, Liabilities and Shareholders’ Equity (continued)

(dollars in thousands)

Interest rates and interest differential - taxable equivalent basis


	For the Nine Month Period Ended September 30, 2004						For the Nine Month Period Ended September 30, 2003
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short - term investments	$	75,565		$	543	0.96	$	73,741		$	542	0.98
Investment securities:
Taxable		1,136,607			30,829	3.62		1,145,737			29,278	3.42
Tax - advantaged		29,703			1,642	7.38		33,260			1,780	7.16

Total investment securities		1,166,310			32,471	3.72		1,178,997			31,058	3.52

Loans and leases, (net):
Taxable		4,518,955			196,548	5.81		3,831,914			181,976	6.35
Tax - advantaged		73,417			3,449	6.28		55,750			3,114	7.47

Total loans and leases		4,592,372			199,997	5.82		3,887,664			185,090	6.37

Total interest - earning assets		5,834,247		$	233,011	5.33		5,140,402		$	216,690	5.64

Allowance for loan and lease losses		(47,545	)					(40,511	)
Other non - earning assets		766,334						568,308

Total assets	$	6,553,036					$	5,668,199

Liabilities
Deposits:
Interest - bearing demand	$	1,589,569		$	11,452	0.96	$	1,176,731		$	7,258	0.82
Savings		547,022			1,487	0.36		494,588			1,608	0.43
Time		1,721,819			35,977	2.79		1,600,991			39,439	3.29
Short - term borrowings		343,166			2,646	1.03		342,440			2,718	1.06
FHLB borrowings		611,950			16,255	3.55		584,119			17,054	3.90
Long - term debt		179,669			8,964	6.66		145,275			7,780	7.16

Total interest - bearing liabilities		4,993,195		$	76,781	2.05		4,344,144		$	75,857	2.33

Demand deposits		759,997						628,619
Other liabilities		176,115						158,016

Total liabilities		5,929,307						5,130,779

Equity		623,729						537,420

Total liabilities and shareholders’ equity	$	6,553,036					$	5,668,199

Net interest income / yield on average earning assets				$	156,230	3.58				$	140,833	3.66

Additional Information

Average loan balances include non-accrual loans.

Tax-exempt income has been adjusted to a tax-equivalent basis using a marginal rate of 35%.

Provision and Allowance for Loan and Lease Losses

The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses at a level adequate to absorb management’s estimate of probable losses in the loan and lease portfolio. Our provision for loan and lease losses is based upon management’s quarterly review of the loan and lease portfolio. The purpose of the review is to assess loan quality, identify impaired loans and leases, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets we serve.

As illustrated in Table 2, the provision was $2.8 million in the third quarter of 2004, an increase of $0.1 million from the same period in 2003. Net charge-offs increased from $1.5 million for the quarter ended September 30, 2003, to $3.1 million for the quarter ended September 30, 2004.

For the nine months ended September 30, 2004, the provision was $6.6 million, a decrease of $0.9 million over the $7.5 million provision for the first nine months of 2003. Net charge-offs increased slightly, from $5.7 million in 2003 to $5.9 million in 2004.

The allowance for loan and lease losses as a percentage of period-end loans and leases was 1.02% at September 30, 2004 and 1.00% at September 30, 2003.

Determining the level of the allowance for probable loan and lease losses at any given period is difficult, particularly during uncertain economic periods. We must make estimates using information and assumptions that are often subjective and changing rapidly. The review of the loan and lease portfolios is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and lease losses is adequate to meet probable loan and lease losses at September 30, 2004. There can be no assurance, however, that we will not sustain losses in future periods, which could be greater than the size of the allowance at September 30, 2004.

Susquehanna Bancshares, Inc. and Subsidiaries

(dollars in thousands)

TABLE 2 - Allowance for Loan and Lease Losses


	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
Balance - Beginning of period	$	52,811		$	40,329		$	42,672		$	39,671
Additions through acquisition		0			0			9,149			0
Additions charged to operating expenses		2,783			2,665			6,590			7,545

		55,594			42,994			58,411			47,216

Charge-offs		(3,904	)		(2,139	)		(8,245	)		(7,873	)
Recoveries		778			658			2,302			2,170

Net charge-offs		(3,126	)		(1,481	)		(5,943	)		(5,703	)

Balance - Period end	$	52,468		$	41,513		$	52,468		$	41,513

Net charge-offs as a percent of average loans and leases (annualized)		0.24	%		0.15	%		0.17	%		0.20	%
Allowance as a percent of period-end loans and leases		1.02	%		1.00	%		1.02	%		1.00	%

Average loans and leases	$	5,077,125		$	4,011,590		$	4,592,372		$	3,887,664
Period-end loans and leases		5,166,137			4,147,957			5,166,137			4,147,957

TABLE 3 - Risk Assets


	September 30, 2004			December 31, 2003			September 30, 2003
Nonperforming assets:
Nonaccrual loans and leases	$	18,204		$	19,037		$	19,689
Restructured accrual loans		0			5,823			5,855
Other real estate owned		1,210			2,893			2,081

Total nonperforming assets	$	19,414		$	27,753		$	27,625

As a percent of period-end loans and leases plus other real estate owned		0.38	%		0.65	%		0.67	%
Coverage ratio		288.22	%		172.00	%		162.52	%
Loans and leases contractually past due 90 days and still accruing	$	10,126		$	6,538		$	8,410

Noninterest Income

Noninterest income as a percentage of net interest income plus noninterest income was 34.0% for the quarter ended September 30, 2004, compared with 39.0% for the same period in 2003. Noninterest income as a percentage of net interest income plus noninterest income was 35.4% for the nine months ended September 30, 2004, compared with 36.2% for the same period in 2003.

For the third quarter of 2004, noninterest income increased $1.4 million, or 5.0%, from $28.7 million in the third quarter of 2003, to $30.1 million. This net increase is primarily the result of:

•

increased asset management fees of $1.2 million;

•

increased income from bank-owned life insurance of $0.6 million;

•

increased service charges on deposit accounts of $0.7 million;

•

increased net gains on securities sales of $1.8 million;

•

net gain on the sale of branch deposits of $1.1 million;

•

decreased net gains on the sale of loans and leases of $2.9 million; and

•

decreased vehicle origination, servicing, and securitization fees of $1.7 million.

For the nine months ended September 30, 2004, noninterest income increased $5.5 million, or 6.9%, from $79.1 million for the nine months ended September 30, 2003 to $84.6 million. This net increase is primarily the result of:

•

increased asset management fees of $3.1 million;

•

increased commissions on brokerage, life insurance, and annuity sales of $1.5 million;

•

increased income from bank-owned life insurance of $1.8 million;

•

increased service charges on deposit accounts of $1.7 million;

•

increased net gains on securities sales of $2.2 million;

•

net gain on the sale of branch deposits of $1.1 million;

•

decreased net gains on the sale of loans and leases of $1.2 million; and

•

decreased vehicle origination, servicing, and securitization fees of $5.5 million.

Asset Management Fees and Commissions on Brokerage, Life Insurance and Annuity Sales

As part of our strategy to increase other fee-based income, we continued to focus on enhancing the wealth management part of our business. As a result, asset management fees increased to $3.8 million for the second quarter of 2004, from $2.6 million for the same period in 2003. For the nine months ended September 30, 2004, asset management fees increased to $10.5 million from $7.4 million for the nine months ended September 2003, and commissions on brokerage, life insurance, and annuity sales increased from $1.5 million to $3.0 million. The increase in asset management fees is the result of a 41.7% increase in assets under management at VFAM, from $2.3 billion at September 30, 2003, to $3.5 billion at September 30, 2004.

Income from Bank-owned Life Insurance

The increase in income from bank-owned life insurance for the quarter and nine months ended September 30, 2004 primarily can be attributed to the purchase of $50.0 million of life insurance during the third quarter of 2003, $4.9 million during the first quarter of 2004, and $25.0 million in the third quarter of 2004. In addition, we acquired $19.0 million of bank-owned life insurance through the Patriot acquisition.

Service Charges on Deposit Accounts

The increase in service charges on deposit accounts is directly related to the acquisition of Patriot and to the increase in demand deposit accounts from $688.9 million at September 30, 2003, to $817.7 million at September 30, 2004.

Net Gains on Sales of Securities

In July and August of 2004, as part of a restructuring of our investment portfolio in response to the Patriot acquisition and EITF 03-01, we sold approximately $107.0 million in securities and realized a net, pre-tax gain of approximately $3.8 million.

Net Gain on the Sale of Branch Deposits

In July 2004, we closed the Hancock branch of our subsidiary, F & M, and realized a net, pre-tax gain on the sale of its deposits to another financial institution of $1.1 million. This sale is part of our effort to enhance the efficiency of our branch network through our previously announced plan to consolidate and/or sell several locations.

Net Gains on Sales of Loans and Leases

During the third quarter of 2004, Hann’s originations went to our affiliate banks and, therefore, Hann did not enter into any securitization transactions. Consequently, no gains or losses were realized. During the third quarter of 2003, however, Hann entered into a term securitization transaction and recognized a net, pre-tax gain of $2.7 million. In addition, gains realized through the sale of mortgage loans decreased $0.2 million, from $1.2 million for the third quarter of 2003, to $1.0 million for the third quarter of 2004. This decrease is attributable to higher mortgage interest rates and the resultant slowdown in the refinance market.

For the nine months ended September 30, gains realized through the sale of mortgage loans decreased from $3.6 million in 2003 to $2.4 million in 2004 due to higher mortgage interest rates and the resultant slowdown in the refinance market.

Vehicle Origination, Servicing, and Securitization Fees

The quarterly and year-to-date decreases in vehicle origination, servicing, and securitization fees were primarily due to a reduction in securitization fees as a result of the roll-off of earlier securitizations and lower vehicle origination volumes.

Noninterest Expenses

Total noninterest expenses increased $11.2 million, or 23.1%, from $48.3 million in the third quarter of 2003, to $59.5 million in the third quarter of 2004. For the nine months ended September 30, 2004, total noninterest expenses increased $18.6 million, or 13.1%, to $160.2 million from $141.6 million during the same period in 2003.

The quarter-to-quarter increase was primarily due to increases in salaries and benefits expense of 19.6%, or $4.6 million, as a result of the Patriot acquisition, normal annual salary increases, filling open positions, and higher benefit costs. Vehicle delivery and preparation expense increased by 30.2%, or $1.1 million, due to higher volumes of vehicles being returned upon the expiration of the related leases and higher costs associated with the retail dispositions, which should benefit future periods with lower residual value insurance expense. In addition, the inclusion of Patriot for the entire third quarter of 2004 has contributed to a general increase in all expense categories.

The $18.6 million increase in noninterest expenses between the nine-month periods ended September 30, 2003 and September 30, 2004 is attributable to the same factors described above. Salaries and benefits expense increased $9.7 million, or 14.2%, and vehicle delivery and preparation expenses increased $2.2 million, or 23.79%. Also contributing to the overall increase in noninterest expenses were increases in occupancy expense of $1.3 million, increases in consulting, advertising and marketing expenses of $1.6 million, which primarily relate to the Patriot acquisition and our branding initiatives.

Income Taxes

Susquehanna’s effective tax rate for the third quarter of 2004 was 29.5%, compared with 29.0% for the third quarter of 2003.

For the nine months ended September 30, 2004, our effective tax rate was 29.5%, compared with 30.0% for the nine months ended September 30, 2003. The reduction in the year-to-date effective tax rate was primarily due to the Patriot acquisition.

Financial Condition

Summary of 2004 compared to 2003

Total assets at September 30, 2004 were $7.4 billion, compared with $6.0 billion at December 31, 2003. Equity capital was $746.4 million at September 30, 2004, or $16.05 per share, compared with $547.4 million, or $13.73 per share, at December 31, 2003. The following discussion details the factors that contributed to these changes.

Acquisition of Patriot Bank Corp on June 10, 2004

The following is a summary of the fair value of assets acquired and liabilities assumed through the purchase of Patriot (in thousands):


Assets
Cash and cash equivalents	$	13,804
Securities		303,584
Loans and leases, net of allowance of 9,149		642,322
Premises and other equipment		11,728
Goodwill and other intangibles		188,285
Other assets		43,106

Total assets acquired	$	1,202,829

Liabilities
Deposits	$	648,797
Borrowings		337,125
Other liabilities		8,390

Total liabilities assumed		994,312

Net assets acquired	$	208,517

Investment Securities Available for Sale

Investment securities available for sale increased $305.3 million from December 31, 2003 to September 30, 2004. As part of the Patriot acquisition, we acquired $303.6 million in available-for-sale securities; however, in July and August of 2004, as part of a restructuring of our investment portfolio in anticipation of the ramifications of EITF 03-01, we sold approximately $107.0 million of these securities.

Loans and Leases

Loans and leases increased $902.9 million from December 31, 2003 to September 30, 2004. Of this increase, Patriot accounted for $651.5 million, resulting in internal core growth of $251.4 million.

Risk Assets

Table 3 shows a decrease in non-accrual loans and leases, from $19.7 million at September 30, 2003, to $18.2 million at September 30, 2004. Loans and leases past due 90 days or more and still accruing interest increased from $8.4 million at September 30, 2003 to $10.1 million at September 30, 2004. The percentage of non-performing assets to period-end loans and leases plus other real estate owned, however, decreased from 0.67% at September 30, 2003 to 0.38% at

September 30, 2004. The percentage of loan and lease loss reserves to non-performing loans and leases (coverage ratio) was 288.2% at September 30, 2004 compared with 162.5% at September 30, 2003.

At December 31, 2003, Susquehanna had a restructured loan totaling $5.8 million with a long-time borrower. However, in accordance with FAS No. 114, information about a restructured loan involving a modification of terms need not be included in disclosures in years after the restructuring if the restructuring agreement has market terms, including a market rate of interest, and the restructured loan is current and is expected to perform in accordance with the modified terms. The removal of this restructured loan from nonperforming assets in January 2004 was the primary reason for the ratio changes noted in the above paragraph.

Goodwill and Other Identifiable Intangible Assets

As a result of the Patriot acquisition, we recognized goodwill of $180.3 million and a core deposit intangible of $8.0 million. The core deposit intangible will be amortized over ten years.

Deposits

Total deposits increased $951.1 million from December 31, 2003 to September 30, 2004. Of this increase, Patriot accounted for $648.8 million, resulting in a net increase of $302.3 million. Of this net increase, approximately $115.0 million has been in brokered certificates of deposit, which are being utilized as an alternative funding source to support the increase in our loan portfolio. We believe that the remainder of the net increase is a direct result of the continuing success of our bank subsidiaries in carrying out our retail and corporate sales initiatives.

Borrowings

Total borrowings increased $334.9 million from December 31, 2003 to September 30, 2004. Of this increase, Patriot accounted for $337.1 million, resulting in a net decrease of $2.2 million. While the net change in borrowings has been minimal, we have decreased our borrowings from Federal Home Loan Banks and are using the purchase of Federal Funds and brokered certificates of deposits as alternative sources of funds.

On May 3, 2004, we completed the private placement of $75 million aggregate principal amount of 4.75% fixed rate/floating rate subordinated notes due May 1, 2014. We used the net proceeds from the offering to fund the cash portion of the Patriot acquisition and the remaining balance to increase our liquidity and capital position in anticipation of future growth and for general corporate purposes. The notes qualify as Tier 2 Capital under the capital guidelines established by the Federal Reserve Board.

The notes bear interest at a fixed rate of 4.75% per annum through and including May 1, 2009 and convert to a floating rate thereafter until maturity, based on the US dollar three-month LIBOR plus 1.82%. Beginning May 1, 2009, we, upon consultation with the Federal Reserve Board, have the right to redeem the notes at a redemption price of 100% of the principal amount of the notes plus any accrued interest. We issued and sold the notes to Keefe, Bruyette & Woods,

Inc., Sandler O’Neill & Partners, L.P., Legg Mason Wood Walker, Incorporated and Ferris, Baker Watts, Incorporated, the initial purchasers, in transactions exempt from the registration requirements of the Securities Act of 1933, as amended, because the sale did not involve a public offering. The initial purchasers resold the notes to persons they reasonably believed to be “qualified institutional buyers” as defined in Rule 144A of the Securities Act of 1933 or pursuant to Regulation S. Under the registration rights agreement relating to the notes, we filed a registration statement with the Securities and Exchange Commission to register an identical form of notes which could be exchanged for the privately placed notes that were not registered for sale; and on October 28, 2004, we completed the exchange offer pursuant to which we exchanged all of the outstanding $75 million notes for the form of notes registered for resale.

In addition, as part of the Patriot acquisition, we assumed $20.5 million in junior subordinated debt issued to Patriot Capital Trust I and Patriot Capital Trust II. The aggregate fair value of this debt at the date of acquisition was $23.6 million. The $15.5 million in debentures issued to Patriot Capital Trust I bear interest at 10.30% and are callable on or after July 1, 2007. If these debentures are not called, they must be redeemed upon maturity in 2027. The $5.0 million in debentures issued to Patriot Capital Trust II bear interest at the 180-day LIBOR plus 3.70%; the rate at September 30, 2004 was 5.31%. The debentures are callable on any April 22 or October 22 after April 22, 2007. If these debentures are not called, they must be redeemed upon maturity in 2032.

Capital Resources

Capital elements for Susquehanna are segmented into two tiers. Tier 1 capital represents shareholders’ equity plus the junior subordinated debentures, reduced by most intangible assets. Tier 2 capital represents certain allowable long-term debt, the portion of the allowance for loan and lease losses limited to 1.25% of risk-adjusted assets, and 45% of the unrealized gain on equity securities. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.”

The minimum Tier 1 capital ratio is 4%; our ratio at September 30, 2004 was 8.08%. The minimum total capital (Tier 1 and 2) ratio is 8%; our ratio at September 30, 2004 was 11.25%. The minimum leverage ratio is 4%; our leverage ratio at September 30, 2004 was 7.24%. Susquehanna and each of its banking subsidiaries have leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity is considered “well-capitalized” under regulatory guidelines.

Item 3

Quantitative and Qualitative Disclosures about Market Risk

The types of market risk exposures generally faced by banking entities include interest rate risk, liquidity risk, equity market price risk, foreign currency risk, and commodity price risk. Due to the nature of our operations, foreign currency and commodity price risk are not significant to us.

In addition to general banking risks, we have other risks that are related to vehicle leasing, asset securitizations, and off-balance sheet financing that are discussed below.

Equity Market Price Risk

Equity market price risk is the risk related to market fluctuations of equity prices in the securities markets. While we do not have significant risk in our investment portfolio, market price fluctuations may affect fee income generated through our asset management operations. Generally, our fee structure is based on the market value of assets being managed at specific time frames. If market values decline, our fee income may also decline.

Liquidity Risk

The maintenance of adequate liquidity — the ability to meet the cash requirements of our customers and other financial commitments — is a fundamental aspect of our asset/liability management strategy. Our policy of diversifying our funding sources — purchased funds, repurchase agreements, and deposit accounts — enables us to avoid undue concentration in any single financial market and also to avoid heavy funding requirements within short periods of time. At September 30, 2004, our bank subsidiaries had approximately $361.0 million available to them under collateralized lines of credit with various Federal Home Loan Banks; and approximately $220.2 million more was available provided that additional collateral would have been pledged.

Liquidity, however, is not entirely dependent on increasing our liability balances. Liquidity also can be generated from maturing or readily marketable assets. Unrestricted short-term investments amounted to $27.0 million and represented additional sources of liquidity. Consequently, our exposure to liquidity risk is not considered significant.

Interest Rate Risk

The management of interest rate risk focuses on controlling the risk to net interest income and the associated net interest margin as the result of changing market rates and spreads. Interest rate sensitivity is the matching or mismatching of the repricing and rate structure of the interest-bearing assets and liabilities. Our goal is to control risk exposure to changing rates within management’s accepted guidelines to maintain an acceptable level of risk exposure in support of consistent earnings.

We employ a variety of methods to monitor interest rate risk. These methods include basic gap analysis, which points to directional exposure; routine rate shocks simulation; and evaluation of the change in economic value of equity. By dividing the assets and liabilities into three groups - fixed rate, floating rate, and those that reprice at our discretion - we develop strategies to control the exposure to interest rate fluctuations.

Our policy, as approved by our Board of Directors, is designed so that we experience no more than a 15% decline in net interest income and no more than a 30% decline in the economic value of equity for a 300 basis point shock (immediate change) in interest rates. The assumptions used for the interest rate shock analysis are reviewed and updated at least quarterly. Based upon the

most recent interest rate shock analysis, we were within the Board’s approved guidelines at a down 100 basis point shock and an up 300 basis point shock. Any down rate shock scenario greater than 100 basis points is considered remote, as the current federal funds target rate is only 1.75%.

At September 30, 2004, we continue to be an asset-sensitive institution and should benefit from additional increases in interest rates in the future, if they should occur. If rates should fall, we likely will experience compression in our net interest margin.

Vehicle Leasing Residual Value Risk

Our exposure to vehicle residual value risk results primarily from Hann, our vehicle-leasing subsidiary. In an effort to manage this risk, in the third quarter of 2000, Hann entered into a Servicing Agreement with Auto Lenders pursuant to which Hann effectively transferred to Auto Lenders all residual value risk of the managed auto lease portfolio originated by Hann, and all residual value risk on any new leases originated over the term of the agreement. Auto Lenders, which was formed in 1990, is a used vehicle remarketer with three retail locations in New Jersey and has access to various wholesale facilities throughout the country. Under this Servicing Agreement, Auto Lenders agrees to purchase the beneficial interest in all vehicles returned by the obligors at the scheduled expiration of the related leases for a purchase price equal to the stated residual value of such vehicles. Further, Hann agrees to set its stated residual values of new leases in accordance with the standards approved in advance by Auto Lenders. Hann also agrees to make monthly guaranty payments to Auto Lenders based upon a negotiated schedule covering a three-year period. At the end of each year, the Servicing Agreement may be renewed by the mutual agreement of the parties for an additional one-year term, beyond the current three-year term, subject to negotiation of the payments for the additional year. During the renewal process, Hann periodically obtains competitive quotes from third parties to determine the best remarketing alternative for Hann.

Securitizations and Off-Balance Sheet Vehicle Lease Financings

As of September 30, 2004 and December 31, 2003, Hann’s off-balance sheet, managed portfolio was funded in the following manner:


	As of September 30, 2004		As of December 31, 2003
Securitization Transactions	$	399.7 million	$	313.5 million
Agency Arrangements and Lease Sales	$	635.1 million	$	730.6 million
Sale-Leaseback Transaction	$	116.9 million	$	125.6 million

In comparison, as of September 30, 2004 and December 31, 2003, our on-balance sheet, managed portfolio totaled $460.8 million and $397.7 million, respectively. All of Hann’s securitizations and off-balance sheet financings primarily are done to fund the assets originated by the Origination Trust and in some cases, to enable Susquehanna to utilize more efficiently its required regulatory capital.

Securitization Transactions

As of September 30, 2004, the aggregate fair value of all recorded PV Receivables in connection with Hann securitizations was $9.1 million. For a description of the accounting policies for measuring the PV Receivables, the characteristics of the securitization transactions, including the gain or loss from sale, and the key assumptions used in measuring the fair value of the PV Receivables, see “Note 1 - Summary of Significant Accounting Policies” under the captions “Asset Securitizations” and “Recorded Interests in Securitized Assets” to the financial statements appearing in our Annual Report on Form 10-K for the year ended December 31, 2003 and “Note 10 - Securitization Activity” to the financial statements appearing in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Summary of Recent Securitization Transactions

Early in the fourth quarter of 2004, Hann entered into a revolving securitization transaction (the “2004 transaction”). In connection with this transaction, Hann sells and contributes beneficial interests in automobile leases and related vehicles to a wholly owned qualifying special purpose entity (the “QSPE”). From time to time, the QSPE may purchase the beneficial interests in additional automobile leases and related vehicles from Hann. Transfers to the QSPE are accounted for as sales under the guidelines of FAS No. 140. The QSPE finances the purchases by borrowing funds in an amount up to $200.0 million from a non-related, asset-backed commercial paper issuer (the “lender”). Neither Hann nor Susquehanna provides recourse for credit losses. However, the QSPE’s obligation to pay Hann the servicing fee each month is subordinate to the QSPE’s obligation to pay interest, principal and fees due on the loans. Therefore, if the QSPE suffers credit losses on its assets, it may have insufficient funds to pay the servicing fee to Hann. Additionally, if an early amortization event were to occur under the QSPE’s loan agreement, Hann, as servicer, would not receive payments of the servicing fee until all interest, principal and fees due on the loans have been paid (although the servicing fee will continue to accrue).

In connection with the transaction, Susquehanna has entered into a back-up servicing agreement pursuant to which it has agreed to service the automobile leases and related vehicles beneficially owned by the QSPE if Hann is terminated as servicer. If Susquehanna were appointed servicer, it would receive a servicing fee each month.

The debt issued in the revolving securitization transaction will bear a floating rate of interest. In this transaction, the QSPE is required to obtain an interest rate hedge agreement if the weighted average fixed interest rate of its assets is less than a targeted portfolio yield calculated monthly and if the funds on deposit in a yield supplement account established by the QSPE are less than a targeted amount. Neither Hann nor Susquehanna has any obligation to obtain such a hedge agreement for the QSPE, but the failure of the QSPE to obtain a required hedge agreement would be an event of default under its loan documents.

The transaction documents for the revolving transaction contain several requirements, obligations, liabilities, provisions and consequences, including events of default, which become applicable upon, among other conditions, the failure of the sold portfolio to meet certain performance tests. That transaction also provides that any assets that fail to meet the eligibility requirements set forth in that transaction must be repurchased by Hann and reallocated to Hann’s beneficial interest in the Origination Trust.

Summary of Prior Years’ Securitization Transactions

In July 2003, Hann entered into a term securitization transaction (the “2003 transaction”). In this transaction, Hann sold and contributed the beneficial interest in $239.5 million in automobile leases and related leased vehicles to a wholly owned “QSPE” (the “Issuer”). The Issuer financed the purchase of the beneficial interest primarily by issuing $233.0 million of asset backed notes. The initial recorded PV Receivable for the 2003 transaction was $12.0 million, and the fair value of this PV Receivable at September 30, 2004 was $4.8 million.

During the third quarter of 2002, Hann entered into a revolving securitization transaction. In connection with this transaction, Hann sells and contributes beneficial interests in automobile leases and related vehicles to a wholly owned QSPE. From time to time, the QSPE may purchase the beneficial interests in additional automobile leases and related vehicles from Hann. Transfers to the QSPE are accounted for as sales under the guidelines of FAS No. 140. The QSPE finances the purchases by borrowing funds in an amount up to $250.0 million from a non-related, asset-backed commercial paper issuer (the “lender”); however, the lender is not committed to make loans to the QSPE. During the third quarter of 2004, Hann made no transfers to the QSPE of beneficial interests in automobile leases and related vehicles. For the nine months ended September 30, 2004, Hann transferred to the QSPE the beneficial interest in $194.9 million in automobile leases and related vehicles. Neither Hann nor Susquehanna provides recourse for credit losses. However, the QSPE’s obligation to pay Hann the servicing fee each month is subordinate to the QSPE’s obligation to pay interest, principal and fees due on the loans. Therefore, if the QSPE suffers credit losses on its assets, it may have insufficient funds to pay the servicing fee to Hann. Additionally, if an early amortization event were to occur under the QSPE’s loan agreement, Hann, as servicer, would not receive payments of the servicing fee until all interest, principal and fees due on the loans have been paid (although the servicing fee will continue to accrue).

The debt issued in the revolving securitization transaction bears a floating rate of interest. In this transaction, the QSPE is required to obtain an interest rate hedge agreement if the weighted average fixed interest rate of its assets is less than a targeted portfolio yield calculated monthly. Neither Hann nor Susquehanna has any obligation to obtain such a hedge agreement for the QSPE, but the failure of the QSPE to obtain a required hedge agreement would be an event of default under its loan documents.

In June 2004, Hann issued a cleanup call to purchase the remaining balance of the 2001 transaction. A cleanup call is issued when the amount of outstanding assets falls to a specified level at which the cost of servicing those assets becomes burdensome. As a result, Hann acquired $4.5 million in auto leases.

Agency Agreements and Lease Sales

Agency arrangements and lease sales generally occur on economic terms similar to vehicle lease terms and generally result in no accounting gains or losses to Hann and no retention of credit, residual value, or interest rate risk with respect to the sold assets. Agency arrangements involve the origination and servicing by Hann of automobile leases for other financial institutions, and lease sales involve the sale of previously originated leases (with servicing retained) to other financial institutions. Hann generally is entitled to receive all of the administrative fees collected from obligors, a servicing fee and, in the case of agency arrangements, an origination fee per lease. Lease sales are generally accounted for as sales under FAS 140.

During the second quarter of 2002, Hann entered into an agency arrangement. In connection with that arrangement, we entered into an agreement under which we guarantee Auto Lenders’ performance of its obligations to the new agency client (the “Residual Interest Agreement”). Auto Lenders has agreed to purchase leased vehicles in the agency client’s portfolio at the termination of the leases for the full residual value of those vehicles. In the event the agency client incurs any losses, costs or expenses as a result of any failure of Auto Lenders to perform this purchase obligation, we will compensate the agency client for any final liquidation losses with respect to such leased vehicle. However, our liability is limited to 12% of the maximum aggregate residual value of all leases purchased by the agency client. At September 30, 2004, the total residual value of the vehicles in the portfolio for this transaction was $56.3 million, and our maximum obligation under the Residual Interest Agreement at September 30, 2004, was $6.8 million.

Sale-leaseback Transaction

In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that has an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor is treated as a sale and an operating lease and qualifies as a sale and leaseback under FAS No. 13. The Lessor held the beneficial interest in vehicles and auto leases with a remaining balance of approximately

$116.9 million at September 30, 2004. To support its obligations under the Master Lease Agreement, at closing the Lessee pledged the beneficial interest in an additional $43.0 million of automobile leases and related vehicles, which were also sold or contributed to the Lessee. At September 30, 2004, the beneficial interest in additional automobile leases and related vehicles pledged by the Lessee was $49.9 million.

Servicing Fees under the Securitization Transactions, the Sale-Leaseback Transaction, Agency Agreements, and Lease Sales

Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. The servicing fees paid to Hann under the securitization transactions, the sale-leaseback transaction, agency agreements, and lease sales approximate current market value and Hann’s servicing costs. Consequently, Hann records no servicing asset or liability with regard to those transactions because its expected servicing costs are approximately equal to its expected servicing income. We enter into securitization transactions primarily to achieve low-cost funding for the growth of our auto lease portfolio, and not primarily to maximize our ongoing servicing fee revenue. In the future, if servicing costs were to exceed servicing income, Hann would record the present value of that liability as an expense; if servicing income were to exceed servicing costs, Hann would record the present value of that asset as income.

Our policy regarding the impairment of servicing assets is to evaluate the assets based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics which affect their current value, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum. For the reasons discussed above, we presently have no recorded servicing rights, and therefore, no associated impairment allowance.

Summary of Susquehanna’s Potential Exposure under Off-Balance Sheet Vehicle Lease Financings as of September 30, 2004.

Securitization Transactions

As a result of the June 2004 clean-up call, the reimbursement obligations under the 2001 transaction to a lender under a letter of credit facility have terminated. At June 30, 2004, we were no longer obligated to make payments in an amount up to $20.5 million under this letter of credit upon a contractual breach by Auto Lenders.

Sale-Leaseback Transaction

Under the existing sale-leaseback transaction, we guarantee certain obligations of the Lessee, which is a wholly owned special purpose subsidiary of Hann. If we fail to maintain our investment-grade senior unsecured long-term debt ratings, then we must obtain a $35.1 million letter of credit from an eligible financial institution for the benefit of the equity participants in the transaction to secure our obligations under the guarantee. We also have obtained from a third party an $8.0 million letter of credit for the benefit of an equity participant if we fail to make payments under the guarantee.

Additionally, the transaction documents contain several requirements, obligations, liabilities, provisions, and consequences that become applicable upon the occurrence of an Early Amortization Event. The precise amount of any termination and other related payments is subject to a great deal of variability and depends significantly on future interest rates, the sales proceeds for the respective vehicles, the termination dates at which consumer leases terminate, and the length of the remaining term of the Master Lease Agreement at the time of the Early Amortization Event. It is virtually impossible to calculate the amount of any termination payments. Even if an Early Amortization Event were to occur, we would expect that the present value of these payments would not exceed the present value of the rent avoided and tax benefits gained by a material amount. We believe that the occurrence of any Early Amortization Event is remote.

At the end of the lease term under the Master Lease Agreement, the Lessee has agreed to act as a remarketing agent for the Lessor if the Lessor decides to sell the beneficial interest in the leases and related vehicles. The Lessee has agreed that if the aggregate net proceeds of such sale are less then the Lease End Value of the beneficial interest in the leases and related vehicles at that time, the Lessee will pay to the Lessor the excess, if any, of the Lease End Value over the aggregate net proceeds of such sale. If the leases and related vehicles were to be worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38 million.

Agency Agreement and Lease Sales

With regard to the agency arrangement, our maximum obligation under the Residual Interest Agreement at September 30, 2004 was $6.8 million.

Miscellaneous

Additionally, we are required to maintain contingent vehicle liability insurance coverage with regard to most of these transactions. This same coverage is also maintained on vehicles within our own portfolio. Because vehicles are leased in the State of New York, a vicarious liability state, the ability to maintain our coverage or the premium cost could potentially have a negative impact on us. The basic coverage policy is renewable annually and expires in the first quarter of 2005.

Item 4

Controls and Procedures

(a)	Evaluation of Disclosure Controls and Procedures

Susquehanna’s management, with the participation of Susquehanna’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of Susquehanna’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Susquehanna believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b)	Change in Internal Control over Financial Reporting

No change in Susquehanna’s internal control over financial reporting occurred during Susquehanna’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Susquehanna’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 6

Exhibits and Reports on Form 8-K

(a)

Exhibits. The Exhibits filed as part of this report are as follows:


10.1		Employment Agreement dated August 26, 2004 between the registrant and Michael M. Quick is incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K, filed August 31, 2004.

31.1		Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer

32.		Section 1350 Certifications

(b)

Reports on Form 8-K.

(i)

On July 27, 2004, the registrant furnished a report on Form 8-K regarding its issuance of a press release announcing financial results for its second quarter ended June 30, 2004.

(ii)

On August 31, 2004, the registrant filed a report on Form 8-K regarding the execution of an Employment Agreement between the registrant and Michael M. Quick on August 26, 2004.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		SUSQUEHANNA BANCSHARES, INC.

November 9, 2004		/s/ William J. Reuter
		William J. Reuter
		Chairman, President and Chief Executive Officer

November 9, 2004		/s/ Drew K. Hostetter
		Drew K. Hostetter
		Executive Vice President and Chief Financial Officer

EXHIBIT INDEX


Exhibit Numbers		Description and Method of Filing
10.1		Employment Agreement dated August 26, 2004 between the registrant and Michael M. Quick is incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K, filed August 31, 2004.

31.1		Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer

32		Section 1350 Certifications