Edgar Filing: SUSQUEHANNA BANCSHARES INC

Susquehanna Bancshares, Inc. Form 10-Q

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, 2010

¨	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 001-33872

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 has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer ¨	Accelerated Filer x	Non-Accelerated Filer ¨	Smaller Reporting Company ¨
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

As of October 29, 2010, there were 129,794,795 shares of the registrant’s common stock outstanding, par value $2.00 per share.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS


		Page

PART I.	FINANCIAL INFORMATION

Item 1	Financial Statements (Unaudited)

	Consolidated Balance Sheets as of September 30, 2010 and 2009, and December 31, 2009		3

	Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009		4

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009		5

	Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2010 and 2009		7

	Notes to the Consolidated Financial Statements		8

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		33

Item 3	Quantitative and Qualitative Disclosures About Market Risk		51

Item 4	Controls and Procedures		52

PART II.	OTHER INFORMATION

Item 1	Legal Proceedings		53

Item 1A	Risk Factors		53

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		53

Item 3	Defaults Upon Senior Securities		53

Item 4	Reserved		53

Item 5	Other Information		53

Item 6	Exhibits		53

SIGNATURES			55

EXHIBIT INDEX			56

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS (UNAUDITED)


	September 30, 2010			December 31, 2009			September 30, 2009
	(in thousands, except share data)
Assets
Cash and due from banks	$	201,353		$	203,240		$	199,626
Unrestricted short-term investments		66,497			87,966			100,099

Cash and cash equivalents		267,850			291,206			299,725
Interest-bearing deposits held by consolidated variable interest entities that can be used only to settle obligations of the consolidated variable interest entities		5,875			0			0
Restricted short-term investments		60,835			154			50
Securities available for sale		2,363,331			1,866,346			1,813,910
Securities held to maturity (fair values approximate $8,735; $8,921; and $8,985)		8,735			8,921			8,985
Loans and leases, net of unearned income		9,472,511			9,827,279			9,863,705
Loans held by consolidated variable interest entities that can be used only to settle obligations of the consolidated variable interest entities		224,289			0			0
Less: Allowance for loan and lease losses		191,115			172,368			168,570

Net loans and leases		9,505,685			9,654,911			9,695,135

Premises and equipment, net		163,205			165,529			165,764
Foreclosed assets (OREO)		18,856			24,292			22,510
Accrued income receivable		37,942			36,127			38,028
Bank-owned life insurance		353,036			355,373			357,325
Goodwill		1,018,031			1,018,031			1,018,031
Intangible assets with finite lives		36,424			43,513			46,116
Other assets		186,815			224,859			193,575

Total Assets	$	14,026,620		$	13,689,262		$	13,659,154

Liabilities and Shareholders’ Equity
Deposits:
Demand	$	1,362,116		$	1,261,208		$	1,210,770
Interest-bearing demand		3,527,064			3,262,812			2,962,307
Savings		758,672			743,687			724,487
Time		2,285,754			2,540,805			2,747,706
Time of $100 or more		1,268,572			1,165,851			1,255,043

Total deposits		9,202,178			8,974,363			8,900,313
Federal Home Loan Bank short-term borrowings		300,000			100,000			0
Other short-term borrowings		584,023			1,040,703			1,020,614
Federal Home Loan Bank long-term borrowings		817,116			923,817			1,049,383
Other long-term debt		176,040			176,050			176,055
Junior subordinated debentures		322,742			272,324			272,191
Long-term debt of consolidated variable interest entities for which creditors do not have recourse to Susquehanna’s general credit		215,959			0			0
Accrued interest, taxes, and expenses payable		57,099			47,688			71,708
Deferred taxes		38,329			87,981			74,391
Other liabilities		213,471			85,255			115,417

Total Liabilities		11,926,957			11,708,181			11,680,072

Shareholders’ equity:
Preferred stock, $1,000 liquidation value, 5,000,000 shares authorized. Issued: 100,000 at September 30, 2010; 300,000 at December 31, 2009 and September 30, 2009		97,891			292,359			291,944
Common stock, $2.00 par value, 200,000,000 shares authorized; Issued: 129,794,795 at September 30, 2010; 86,473,612 at December 31, 2009; and 86,394,320 at September 30, 2009		259,590			172,947			172,789
Additional paid-in capital		1,300,102			1,057,305			1,056,800
Retained earnings		474,161			478,167			475,591
Accumulated other comprehensive loss, net of taxes of $17,983; $10,606; and $9,715, respectively		(32,081	)		(19,697	)		(18,042	)

Total Shareholders’ Equity		2,099,663			1,981,081			1,979,082

Total Liabilities and Shareholders’ Equity	$	14,026,620		$	13,689,262		$	13,659,154

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(in thousands, except per share data)
Interest Income:
Loans and leases, including fees	$	134,047		$	139,591		$	406,529		$	415,341
Securities:
Taxable		13,468			16,758			40,955			54,329
Tax-exempt		3,891			3,755			10,951			11,174
Dividends		1,027			992			2,964			2,943
Short-term investments		56			54			129			529

Total interest income		152,489			161,150			461,528			484,316

Interest Expense:
Deposits:
Interest-bearing demand and savings		5,785			4,790			17,475			18,502
Time		19,196			33,166			62,990			109,103
Federal Home Loan Bank short-term borrowings		711			0			749			0
Other short-term borrowings		982			1,098			2,277			3,233
Federal Home Loan Bank long-term borrowings		11,148			10,122			31,844			30,275
Other long-term debt		9,256			7,172			26,260			23,027

Total interest expense		47,078			56,348			141,595			184,140

Net interest income		105,411			104,802			319,933			300,176
Provision for loan and lease losses		40,000			48,000			128,000			133,000

Net interest income, after provision for loan and lease losses		65,411			56,802			191,933			167,176

Noninterest Income:
Service charges on deposit accounts		8,923			9,326			25,878			28,277
Vehicle origination and servicing fees		1,717			1,210			5,202			4,996
Asset management fees		6,653			6,733			21,279			18,920
Income from fiduciary-related activities		1,784			1,803			5,375			5,270
Commissions on brokerage, life insurance, and annuity sales		1,866			2,291			5,527			5,850
Commissions on property and casualty insurance sales		2,589			2,661			8,871			9,446
Income from bank-owned life insurance		1,218			1,312			3,849			4,094
Net gain on sale of loans and leases		2,580			3,142			7,312			8,141
Net realized gain on sales of securities		393			4,727			11,285			5,079
Total other-than-temporary impairment, net of recoveries		119			0			(4,004	)		(937	)
Portion of (gain) loss recognized in other comprehensive income (before taxes)		(441	)		0			945			0

Net impairment losses recognized in earnings		(322	)		0			(3,059	)		(937	)
Other		8,006			7,500			20,841			28,586

Total noninterest income		35,407			40,705			112,360			117,722

Noninterest Expenses:
Salaries and employee benefits		48,850			47,771			146,243			144,849
Occupancy		8,610			7,633			26,961			26,696
Furniture and equipment		3,335			3,620			10,422			10,962
Advertising and marketing		2,980			1,802			8,875			6,392
FDIC insurance		4,500			4,245			13,284			20,236
Amortization of intangible assets		2,346			2,624			7,089			7,928
Vehicle lease disposal		3,923			3,858			11,095			10,384
Other		21,668			19,982			62,710			62,071

Total noninterest expenses		96,212			91,535			286,679			289,518

Income (loss) before income taxes		4,606			5,972			17,614			(4,620	)
Benefit from income taxes		(1,374	)		(850	)		(1,260	)		(9,690	)

Net Income		5,980			6,822			18,874			5,070
Preferred stock dividends and accretion		1,396			4,165			12,338			12,494

Net Income (Loss) Applicable to Common Shareholders	$	4,584		$	2,657		$	6,536		$	(7,424	)

Earnings per common share:
Basic	$	0.04		$	0.03		$	0.06		$	(0.09	)
Diluted	$	0.04		$	0.03		$	0.06		$	(0.09	)
Cash dividends per common share	$	0.01		$	0.05		$	0.03		$	0.36
Average common shares outstanding:
Basic		129,687			86,294			118,103			86,220
Diluted		129,718			86,294			118,135			86,220

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Nine Months Ended September 30,
	2010			2009
	(in thousands)
Cash Flows from Operating Activities:
Net income	$	18,874		$	5,070
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		22,086			17,669
Provision for loan and lease losses		128,000			133,000
Realized gain on available-for-sale securities, net		(8,226	)		(4,142	)
Deferred income taxes		(42,125	)		(49,526	)
Gain on sale of loans and leases		(7,312	)		(8,141	)
Loss (gain) on sale of foreclosed assets		1,403			(287	)
Gain on sale of branch		0			(402	)
Mortgage loans originated for sale		(263,553	)		(271,242	)
Proceeds from sale of mortgage loans originated for sale		260,156			275,996
Loans and leases originated/acquired for sale, net of payments received		0			(148,194	)
Payments received on loans and leases transferred from held for sale to held for investment, net of advances on home equity lines of credit		120,764			71,731
Increase in cash surrender value of bank-owned life insurance		(3,285	)		(3,554	)
(Increase) decrease in accrued interest receivable		(1,149	)		2,458
Increase (decrease) in accrued interest payable		2,158			(6,314	)
Increase in accrued expenses and taxes payable		7,217			22,896
Other, net		10,543			50,970

Net cash provided by operating activities		245,551			87,988

Cash Flows from Investing Activities:
Net (increase) decrease in restricted short-term investments		(59,019	)		164
Activity in available-for-sale securities:
Sales		280,683			72,746
Maturities, repayments, and calls		515,775			343,170
Purchases		(1,175,706	)		(242,587	)
Net decrease (increase) in loans and leases		142,642			(233,519	)
Cash flows received from retained interests		0			18,960
Proceeds from bank-owned life insurance		5,622			0
Proceeds from sale of foreclosed assets		21,569			13,448
Additions to premises and equipment, net		(8,124	)		(3,828	)

Net cash used in investing activities		(276,558	)		(31,446	)

Cash Flows from Financing Activities:
Net increase (decrease) in deposits		227,815			(152,368	)
Sale of branch deposits		0			(13,410	)
Net (decrease) increase in other short-term borrowings		(456,680	)		110,395
Net increase in short-term FHLB borrowings		200,000			0
Proceeds from long-term FHLB borrowings		150,000			0
Repayment of long-term FHLB borrowings		(255,143	)		(18,878	)
Proceeds from issuance of long-term debt		47,749			0
Repayment of long-term debt		(23,987	)		(229	)
Proceeds from issuance of common stock		329,440			1,985
Redemption of preferred stock		(200,000	)		0
Cash dividends paid		(11,543	)		(41,159	)

Net cash provided by (used in) financing activities		7,651			(113,664	)

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)


Net change in cash and cash equivalents		(23,356	)		(57,122	)
Cash and cash equivalents at January 1		291,206			356,847

Cash and cash equivalents at September 30	$	267,850		$	299,725

Supplemental Disclosure of Cash Flow Information
Cash paid for interest on deposits and borrowings	$	139,400		$	190,454
Income tax payments		38,492			1,358
Supplemental Schedule of Noncash Activities
Interest-bearing deposits held by consolidated variable interest entities that can be used only to settle obligations of the consolidated variable interest entities at January 1, 2010	$	7,537		$	0
Loans held by consolidated variable interest entities that can be used only to settle obligations of the consolidated variable interest entities at January 1, 2010		248,333			0
Real estate acquired in settlement of loans		18,006			32,820
Long-term debt of consolidated variable interest entities for which creditors do not have recourse to Susquehanna’s general credit at January 1, 2010		239,936			0
Securities purchased not settled		70,013			15,000
Accretion of preferred stock discount		5,532			1,244
Home equity line of credit loans transferred from held for sale to held for investment		434,897			0
Cumulative-effect adjustment to retained earnings relating to the consolidation of variable interest entities		(5,805	)		0
Adjustment to accumulated other comprehensive income relating to the consolidation of variable interest entities		(6,922	)		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 (UNAUDITED)

(In thousands, except share data)


	Preferred Stock			Shares of Common Stock		Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balance at January 1, 2009	$	290,700			86,174,285	$	172,349	$	1,055,255	$	512,924		$	(85,310	)	$	1,945,918

Comprehensive income:
Net income											5,070						5,070
Change in unrealized loss on securities available for sale, net of taxes and reclassification adjustment of $3,301														61,796			61,796
Change in unrealized gain on recorded interests in securitized assets, net of taxes														2,960			2,960
Change in unrealized loss on cash flow hedges, net of taxes														2,512			2,512

Total comprehensive income																	72,338

Issuance of common stock and options under employee benefit plans					220,035		440		1,545								1,985
Accretion of discount on preferred stock		1,244									(1,244	)					0
Cash dividends paid on preferred stock											(10,125	)					(10,125	)
Cash dividends paid on common stock ($0.36 per share)											(31,034	)					(31,034	)

Balance at September 30, 2009	$	291,944			86,394,320	$	172,789	$	1,056,800	$	475,591		$	(18,042	)	$	1,979,082

Balance at January 1, 2010	$	292,359			86,473,612	$	172,947	$	1,057,305	$	478,167		$	(19,697	)	$	1,981,081

Cumulative-effect adjustment resulting from the consolidation of variable interest entities											(5,805	)		(6,922	)		(12,727	)

Comprehensive income:
Net income											18,874						18,874
Change in unrealized gain on securities available for sale, net of taxes and reclassification adjustment of $4,137														29,893			29,893
Non-credit related unrealized loss on other-than-temporarily impaired debt securities, net of taxes of $346														(599	)		(599	)
Change in unrealized loss on cash flow hedges, net of taxes														(34,756	)		(34,756	)

Total comprehensive income																	13,412

Issuance of common stock					43,125,000		86,250		241,090								327,340
Issuance of common stock and options under employee benefit plans					196,183		393		1,707								2,100
Redemption of preferred stock		(200,000	)														(200,000	)
Accretion of discount on preferred stock		5,532									(5,532	)					0
Cash dividends paid on preferred stock											(8,083	)					(8,083	)
Cash dividends paid on common stock ($0.03 per share)											(3,460	)					(3,460	)

Balance at September 30, 2010	$	97,891			129,794,795	$	259,590	$	1,300,102	$	474,161		$	(32,081	)	$	2,099,663

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

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 1. Accounting Policies

The information contained in this report is unaudited. Certain prior year amounts have been reclassified to conform to current period classifications. In the opinion of management, the information reflects all normal recurring adjustments necessary for a fair statement of results for the periods ended September 30, 2010 and 2009. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). Operating results for the three and nine-month periods ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

The accounting policies of Susquehanna Bancshares, Inc. and Subsidiaries (“Susquehanna”), 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 76 through 83 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Recently Adopted Accounting Guidance

In April 2010, FASB issued ASU 2010-18, Receivables (Topic 310) – Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force. As a result of the amendments in this ASU, modifications of loans that are accounted for within a pool do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. This ASU was effective for modifications occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. In addition, upon initial adoption of the guidance in this ASU, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. Adoption of this guidance has not had a material impact on results of operations or financial condition.

In March 2010, FASB issued ASU 2010-11, Derivatives and Hedging (Topic 815) Scope Exception Related to Embedded Credit Derivatives. This ASU provides amendments that clarify the scope exception for embedded credit derivative features related to the transfer of credit risk in the form of subordination of one financial instrument to another. This ASU was effective for each reporting entity at the beginning of its first fiscal quarter beginning after June 15, 2010. Adoption of this guidance has not had a material impact on results of operations or financial condition.

In February 2010, FASB issued ASU 2010-08, Technical Corrections to Various Topics. While none of the provisions in the amendments in this ASU fundamentally change U.S. GAAP, certain clarifications to the guidance on embedded derivatives and hedging (FASC Subtopic 815-15) may cause a change in the application of that Subtopic. This ASU was effective for Susquehanna on April 1, 2010. Adoption of this guidance has not had a material impact on results of operations or financial condition.

In February 2010, FASB issued ASU 2010-10, Consolidation (Topic 810) - Amendments for Certain Investment Funds. These amendments defer the consolidation requirements for a reporting entity’s interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The deferral does not apply in situations in which a reporting entity has the explicit or implicit obligation to fund losses of an entity that could potentially be significant to the entity. This ASU was effective January 1, 2010. Adoption of this guidance has not had a material impact on result of operations or financial condition.

In February 2010, FASB issued ASU 2010-09, Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09, among other things, removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. Adoption of this guidance has not had a material impact on results of operations or financial condition.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

In January 2010, FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements. This ASU provides amendments to Subtopic 820-10 that require new disclosures as follows: a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. This ASU also provides amendments that clarify existing disclosures relating to the level of disaggregation and inputs and valuation techniques. This ASU was effective for interim and annual reporting periods that began after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Adoption of this ASU has not had and will not have a material impact on results of operations or financial condition.

In June 2009, FASB issued ASU 2009-17, Consolidations (Topic 810) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities and ASU 2009-16, Transfers and Servicing (Topic 860) - Accounting for Transfers of Financial Assets. ASU 2009-16 requires more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. ASU 2009-17 changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. Both ASUs were effective January 1, 2010. As a result of adopting this guidance, Susquehanna, as primary beneficiary, consolidated two securitization trusts. For additional information, refer to “Note 10. Securitization and Variable Interest Entities.”

Recently Issued Accounting Guidance

In July 2010, FASB issued ASU 2010-20, Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This update requires companies to provide more information in their disclosures about the credit quality of their financing receivables and the credit reserves held against them. The additional disclosures required for financing receivables include: aging of past due receivables, credit quality indicators, and modifications of financing receivables. Under the update, a company will need to disaggregate new and existing disclosures based on how it develops its allowance for credit losses and how it manages credit exposures. The amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. Adoption of this guidance is not expected to have a material impact on results of operations or financial condition.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

2. Investment Securities

The amortized cost and fair values of investment securities at September 30, 2010 and December 31, 2009, were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
At September 30, 2010
Available-for-Sale:
U.S. Government agencies	$	411,839	$	3,870	$	0	$	415,709
Obligations of states and political subdivisions		397,983		21,705		447		419,241
Agency residential mortgage-backed securities		1,053,410		30,222		108		1,083,524
Non-agency residential mortgage-backed securities		139,503		144		13,425		126,222
Commercial mortgage-backed securities		99,363		6,178		0		105,541
Synthetic collateralized debt obligations		744		479		0		1,223
Other structured financial products		24,643		0		12,930		11,713
Other debt securities		51,684		906		482		52,108
Equity securities of the Federal Home Loan Bank		72,658		0		0		72,658
Equity securities of the Federal Reserve Bank		50,225		0		0		50,225
Other equity securities		26,002		684		1,519		25,167

		2,328,054		64,188		28,911		2,363,331

Held-to-Maturity:
Other		4,560		0		0		4,560
State and municipal		4,175		0		0		4,175

		8,735		0		0		8,735

Total investment securities	$	2,336,789	$	64,188	$	28,911	$	2,372,066


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
At December 31, 2009
Available-for-Sale:
U.S. Government agencies	$	366,065	$	5,142	$	188	$	371,019
Obligations of states and political subdivisions		343,254		12,043		1,878		353,419
Agency residential mortgage-backed securities		661,755		19,813		1,386		680,182
Non-agency residential mortgage-backed securities		168,476		18		33,029		135,465
Commercial mortgage-backed securities		162,835		2,625		435		165,025
Synthetic collateralized debt obligations		1,301		30		0		1,331
Other structured financial products		26,294		0		10,975		15,319
Equity securities of the Federal Home Loan Bank		74,342		0		0		74,342
Equity securities of the Federal Reserve Bank		45,725		0		0		45,725
Other equity securities		26,597		302		2,380		24,519

		1,876,644		39,973		50,271		1,866,346

Held-to-Maturity:
Other		4,550		0		0		4,550
State and municipal		4,371		0		0		4,371

		8,921		0		0		8,921

Total investment securities	$	1,885,565	$	39,973	$	50,271	$	1,875,267

At September 30, 2010 and December 31, 2009, investment securities with carrying values of $1,539,696 and $1,344,858, respectively, were pledged to secure public funds and for other purposes as required by law.

The amortized cost and fair value of U.S. Government agencies, obligations of states and political subdivisions, synthetic collateralized debt obligations, other structured financial products, other debt securities, and residential and commercial mortgage-backed securities, at September 30, 2010, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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


	Amortized Cost		Fair Value
Securities available for sale:
Within one year	$	44,777	$	45,245
After one year but within five years		204,091		208,881
After five years but within ten years		465,772		473,368
After ten years		1,464,529		1,487,787

		2,179,169		2,215,281

Securities held to maturity:
Within one year		0		0
After one year but within five years		0		0
After five years but within ten years		0		0
After ten years		8,735		8,735

		8,735		8,735

Total debt securities	$	2,187,904	$	2,224,016

Gross realized gains and gross realized losses on investment securities transactions are summarized below. These gains and losses were recognized using the specific identification method and were included in noninterest income.


	For the Three Months Ended September 30,
	2010					2009
	Available-			Held-to-		Available-			Held-to-
	for-Sale			Maturity		for-Sale			Maturity
Gross gains	$	394		$	0	$	4,962		$	0
Gross losses		(1	)		0		(235	)		0
Other-than-temporary impairment		(322	)		0		0			0

Net gains	$	71		$	0	$	4,727		$	0


	For the Nine Months Ended September 30,
	2010					2009
	Available- for-Sale			Held-to- Maturity		Available- for-Sale			Held-to- Maturity
Gross gains	$	11,409		$	0	$	5,314		$	0
Gross losses		(124	)		0		(235	)		0
Other-than-temporary impairment		(3,059	)		0		(937	)		0

Net gains	$	8,226		$	0	$	4,142		$	0

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following table presents Susquehanna’s investments’ gross unrealized losses and the corresponding fair values by investment category and length of time that the securities have been in a continuous unrealized loss position, at September 30, 2010 and December 31, 2009.


September 30, 2010	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of states and political subdivisions	$	13,496	$	175	$	7,236	$	272	$	20,732	$	447
Agency residential mortgage-backed securities		72,466		108		0		0		72,466		108
Non-agency residential mortgage-backed securities		0		0		122,128		13,425		122,128		13,425
Other structured financial products		0		0		11,713		12,930		11,713		12,930
Other debt securities		18,895		167		1,463		315		20,358		482
Other equity securities		184		66		2,977		1,453		3,161		1,519

	$	105,041	$	516	$	145,517	$	28,395	$	250,558	$	28,911


December 31, 2009	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U. S. Government agencies	$	14,813	$	188	$	0	$	0	$	14,813	$	188
Obligations of states and political subdivisions		45,348		554		31,637		1,324		76,985		1,878
Agency residential mortgage-backed securities		157,762		1,386		0		0		157,762		1,386
Non-agency residential mortgage-backed securities		89		7		130,579		33,022		130,668		33,029
Commercial mortgage-backed securities		0		0		43,498		435		43,498		435
Other structured financial products		0		0		15,319		10,975		15,319		10,975
Other equity securities		24		29		2,727		2,351		2,751		2,380

	$	218,036	$	2,164	$	223,760	$	48,107	$	441,796	$	50,271

Non-agency residential mortgage-backed securities (16 of the 18 securities are in a loss position, and 7 of the 16 securities in a loss position are rated below investment grade). None of Susquehanna’s non-agency residential mortgage-backed securities include subprime or Alt-A components. Management has analyzed the assets underlying these issues with respect to defaults, loan to collateral value ratios, current levels of subordination, and geographic concentrations and concluded that the unrealized losses were caused principally by decreased liquidity and larger risk premiums in the marketplace and not credit quality.

During the second quarter of 2010, however, Susquehanna’s analysis determined that one of these securities was other-than-temporarily impaired, and Susquehanna recorded an other-than-temporary impairment loss as presented in the following table.

Credit Losses on Non-agency Residential Mortgage-backed Securities for which a Portion of an Other-than-temporary

Impairment was Recognized in Other Comprehensive Income


	Three months ended September 30,				Nine months ended September 30,
	2010		2009		2010		2009
Balance - beginning of period	$	1,737	$	0	$	0	$	0
Additions - amount related to the credit loss for which an other-than-temporary impairment was not previously recognized		0		0		1,737		0

Balance - end of period	$	1,737	$	0	$	1,737	$	0

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Susquehanna estimated the portion of loss attributable to credit using a discounted cash flow model. Susquehanna, in conjunction with an independent third-party, estimated the expected cash flows of the underlying collateral using internal credit risk, interest rate risk, and prepayment risk models that incorporated management’s best estimate of current key assumptions, such as default rates, loss severity, and prepayment rates. Assumptions used can vary widely from loan to loan and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics, and collateral type. The distribution of underlying cash flows is determined in accordance with the security’s indenture. Expected principal and interest cash flows on an other-than-temporarily impaired debt security are discounted using the book yield of that debt security.

Based on the expected cash flows derived from the model, Susquehanna expects to recover the unrealized loss in accumulated other comprehensive income ($599 at September 30, 2010). Significant assumptions used in the valuation of this other-than-temporarily impaired security were as follows:


As of June 30, 2010	Weighted- average (%)
Annual constant prepayment speed		1.6
Loss severity (1)		29.0
Life default rate, net of recoveries (2)		12.2

(1)	Loss severity rates are projected considering collateral characteristics such as loan-to-value, creditworthiness of borrowers (FICO score) and geographic concentration.

(2)	Default rates, net of expected recoveries, are projected by considering collateral characteristics including, but not limited to, loan-to-value, FICO score, and geographic concentration.

Other structured financial products. Other structured financial products are comprised of pooled trust preferred securities. All four of these securities are in unrealized loss positions and rated below investment grade. Management has analyzed the assets underlying these securities with respect to interest deferrals and defaults, collateral coverage, and current levels of subordination and concluded that the unrealized losses were caused principally by decreased liquidity and larger risk premiums in the marketplace and not credit quality.

Susquehanna determines whether it expects to recover the entire amortized cost basis by comparing the present value of the expected cash flows to be collected with the amortized cost basis. To make this comparison, Susquehanna works with a third-party financial advisory firm to evaluate two scenarios consisting of three phases each. The two scenarios are: (1) the first dollar loss scenario and (2) the expected or forecasted scenario. The three phases associated with each scenario are (a) production of cash flows, (b) application of the cash flows to the percent owned and (c) assessment of other-than-temporary impairment.

To determine expected cash flows, the valuation analysis considers credit default rates, prepayments and deferrals, waterfall structure and covenants relating to the trust preferred securities. The third-party firm focuses on the Texas ratio and the second ratio to determine short term default risk. To determine longer term default probabilities, the third-party firm uses an internal scoring approach that relies on key financial performance ratios. Since using financial ratios to determine short and long term default probabilities is a data driven approach, management believes that realistic conclusions can be made on the likelihood of future cash flows for these securities. In addition, the trust indenture documentation and the trustee reports for each specific trust preferred security issuance provide information regarding prepayments, deferral rights, call options, various triggers, including over-collateralization triggers, and waterfall structure, which management believes is essential in determining projected base cash flows.

Management has assisted with the development of, and reviews and comments on the results of, this proprietary valuation methodology, and believes that the valuation analysis and methodology reasonably supports the value and projected performance of the specific trust preferred securities.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The present value of the expected cash flows for Susquehanna’s specific class and all subordinate classes, as well as additional information about the pooled trust preferred securities, is included in the following table. At September 30, 2010, the present values of the current estimated cash flows is equal to or greater than the face amount of the specific class for all trust preferred securities, and therefore, there is no other-than-temporary impairment.


As of September 30, 2010	Pooled Trust #1			Pooled Trust #2			Pooled Trust #3			Pooled Trust #4
Class	B			B			B			A2L
Book value	$	3,000		$	6,974		$	7,919		$	6,750
Fair value		1,457			3,448			3,642			3,166
Unrealized loss		(1,543	)		(3,526	)		(4,277	)		(3,584	)
Present value of expected cash flows for class noted above and all subordinated classes		109,285			109,523			139,652			103,153
Class face value		35,000			57,360			86,715			45,500
Lowest credit rating assigned		CCC-			Caa3			B3			Caa3
Original collateral	$	624,000		$	474,000	⁽¹⁾	$	701,000		$	488,000
Performing collateral		445,300			304,400			528,500			373,000
Actual defaults		106,700			24,600			90,500			59,000
Actual deferrals		72,000			145,000			82,000			56,000
Projected future defaults		133,300			168,400			224,500			132,000
Actual defaults as a % of original collateral		17.1	%		5.2	%		12.9	%		12.1	%
Actual deferrals as a % of original collateral		11.5			30.6			11.7			11.5
Projected future defaults as a % of performing collateral plus deferrals		25.8			37.5			36.8			30.8

(1)	Original collateral is reduced by purchases and calls totalling $27,000. The purchase transaction of $20,000 resulted in a loss of $18,400 and is not included in actual defaults.

Other equity securities. During the third quarter of 2010, Susquehanna recognized an aggregate other-than-temporary impairment of $322 relating to two financial institution equity securities. During the second quarter of 2010, Susquehanna recognized an aggregate other-than-temporary impairment of $443 relating to five financial institution equity securities. The determination that an other-than-temporary impairment had occurred was the result of management’s assessment of the near-term prospects of each specific issuer, dilution to shareholders as a result of issuances of common stock, and the severity and duration of the decline in fair value of those equity securities.

Susquehanna does not have the intent to sell any of its available-for-sale securities that are in an unrealized loss position, and it is more likely than not that Susquehanna will not be required to sell these securities before recovery of its amortized cost basis.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 3. Loans and Leases

Loans and Leases, net of unearned income


	September 30, 2010			December 31, 2009
Commercial, financial, and agricultural	$	1,829,217		$	2,050,110
Real estate - construction		914,761			1,114,709
Real estate secured - residential		2,664,042			2,369,380
Real estate secured - commercial		3,021,525			3,060,331
Consumer		576,912			482,266
Leases		690,343			750,483

Total loans and leases	$	9,696,800		$	9,827,279

Nonaccrual loans and leases	$	227,418		$	219,554
Loans and leases contractually past due 90 days and still accruing		18,005			14,820
Troubled debt restructurings		119,398			58,244
Home equity line of credit loans held for sale (included in “Real estate secured - residential,” above)		0	(1)		403,574

(1)

During the first quarter of 2010, Susquehanna concluded that, due to recent changes in U.S. GAAP and market conditions, it was highly unlikely that the home equity line of credit loans held for sale would be securitized and sold. Therefore, on March 31, 2010, Susquehanna transferred $434,897 of home equity line of credit loans held for sale to held for investment.

Net investment in direct financing leases was as follows:


	September 30, 2010			December 31, 2009
Minimum lease payments receivable	$	477,240		$	492,664
Estimated residual value of leases		283,639			335,003
Unearned income under lease contracts		(70,536	)		(77,184	)

Total leases	$	690,343		$	750,483

Allowance for Loan and Lease Losses


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Balance - Beginning of period	$	185,795		$	157,517		$	172,368		$	113,749
Additions		40,000			48,000			128,000			133,000

		225,795			205,517			300,368			246,749

Charge-offs		(37,109	)		(39,848	)		(120,719	)		(85,715	)
Recoveries		2,429			2,901			11,466			7,536

Net charge-offs		(34,680	)		(36,947	)		(109,253	)		(78,179	)

Balance - Period end	$	191,115		$	168,570		$	191,115		$	168,570

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Impaired Loans

An analysis of impaired loans, as of September 30, 2010 and December 31, 2009, is as follows:


	September 30,			December 31,
	2010			2009
Impaired loans without a related reserve:
Commercial, financial, and agricultural	$	10,937		$	21,814
Real estate - construction		49,678			54,788
Real estate secured - residential		20,249			892
Real estate secured - commercial		53,027			41,393
Consumer		136			0

Total impaired loans without a related reserve		134,027	(1)		118,887

Impaired loans with a related reserve:
Commercial, financial, and agricultural		13,609			3,241
Real estate - construction		33,609			66,236
Real estate secured - residential		15,785			6,370
Real estate secured - commercial		86,287			54,613
Consumer		691			0

Total impaired loans with a related reserve		149,981	(2)		130,460

Total impaired loans	$	284,008		$	249,347

Reserve for impaired loans:
Commercial, financial, and agricultural	$	4,507		$	672
Real estate - construction		6,756			18,705
Real estate secured - residential		3,823			1,561
Real estate secured - commercial		16,286			14,092
Consumer		197			0

Total reserve for impaired loans	$	31,569		$	35,030

(1)	$100,381 of the $134,027 total impaired loans without a related reserve represents loans which had been written down to the fair value of the collateral through direct charge-offs of $71,623.

(2)	Charge-offs related to these loans totaled $42,477.

Additional information relating to impaired loans for the three months and nine months ended September 30, 2010 and 2009 is as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Average balance of impaired loans	$	292,731	$	245,895	$	286,520	$	194,723
Interest income on impaired loans (cash-basis)		1,874		1,715		5,514		4,666

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 4. Goodwill

Susquehanna tests goodwill for impairment on an annual basis, or more often if events or circumstances indicate that there may be an impairment. This test, which requires significant judgment and analysis, involves discounted cash flows and market-price multiples of non-distressed financial institutions.

Susquehanna performed its annual goodwill impairment tests in the second quarter of 2010 and determined that the fair value of each of its reporting units exceeded its book value, and there was no goodwill impairment. However, taking into consideration current market conditions, Susquehanna decided that it would be prudent to perform an interim goodwill impairment test for its bank reporting unit and wealth management report unit at September 30, 2010. There was no interim goodwill impairment test performed for the property and casualty insurance reporting unit as its fair value substantially exceeded its carrying value at June 30, 2010, and the amount of goodwill assigned to this unit is relatively insignificant.

Bank Reporting Unit

Goodwill assigned to the bank reporting unit at both September 30, 2010 and May 31, 2010 was $915,421. Fair value of the bank reporting unit was determined utilizing the market multiples approach, which measures the value of the reporting unit using recent non-distressed sales of financial institutions in Susquehanna’s market. Susquehanna considered two key ratios to measure goodwill of the bank reporting unit for impairment: price to book and price to tangible book. In keeping with the investment community’s current valuations of financial institutions, Susquehanna gave no consideration to the price to earnings ratio. The following table shows the ratios used at September 30, 2010 and May 31, 2010.


	Interim		Annual
Ratio	September 30, 2010		May 31, 2010
Price to book		1.37X		1.41X
Price to tangible book		1.58X		1.60X

Fair value of the bank reporting unit exceeded carrying value by 12.0% at September 30, 2010 and by 14.2% at June 30, 2010.

Wealth Management Reporting Unit

Goodwill assigned to the wealth management reporting unit at both September 30, 2010 and May 31, 2010 was $82,746. Fair value of the wealth management reporting unit was determined utilizing the “market multiples” approach and the “income” approach. The income approach measures the value of the reporting unit based on a discount rate to determine the present value of the reporting unit’s future economic benefit over ten years, assuming a weighted increase in the reporting unit’s revenues and a weighted increase in the reporting unit’s expenses. In keeping with the investment community’s current valuations of wealth management institutions, Susquehanna predominantly uses the income approach. The following table shows the factors used in the income approach at September 30, 2010 and May 31, 2010.


	Interim			Annual
Factors	September 30, 2010			May 31, 2010
Discount rate		17.5	%		17.5	%
Weighted-average increase in revenues		6.0	%		6.0	%
Weighted-average increase in expenses		5.0	%		5.0	%

Fair value of the wealth management reporting unit exceeded carrying value by 40.0% at September 30, 2010 and by 53.6% at June 30, 2010.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Property and Casualty Insurance Reporting Unit

Goodwill assigned to the property and casualty insurance reporting unit at May 31, 2010 was $17,177. Fair value of the property and casualty insurance reporting unit was determined utilizing the market multiples approach, which measures the value of the reporting unit using recent sales of property and casualty insurance companies in Susquehanna’s market. Susquehanna uses two key ratios to measure goodwill of the property and casualty insurance reporting unit for impairment: average price to book and median price to earnings. The following table shows the ratios used at May 31, 2010. There was no interim impairment test performed at September 30, 2010.


	Annual
Ratio	May 31, 2010
Average price to book		1.06X
Median price to earnings		8.5X

Fair value of the property and casualty insurance reporting unit exceeded carrying value by 33.9% at June 30, 2010.

NOTE 5. Borrowings


Short-term borrowings	September 30, 2010		December 31, 2009
Securities sold under repurchase agreements	$	326,923	$	333,803
Federal funds purchased		250,000		200,000
Treasury tax and loan notes		7,100		6,900
Federal Reserve term auction facility (1)		0		500,000

Total short-term borrowings	$	584,023	$	1,040,703

(1)

The final auction was held on March 8, 2010.

11% Junior Subordinated Deferrable Interest Debentures, Series II

On March 16, 2010, Susquehanna Capital II, a Delaware statutory trust, sold to the public $50,000 aggregate principal amount of 11% Cumulative Trust Preferred Securities, Series II and used the proceeds from those sales to fund its purchase of $50,010 of 11% Junior Subordinated Deferrable Interest Debentures, Series II issued by Susquehanna. The subordinated debentures are unsecured and rank equally in right of payment with Susquehanna’s existing series of junior subordinated debt securities. Interest on the subordinated debentures is payable semi-annually in arrears on each March 23 and September 23, beginning September 23, 2010, unless Susquehanna defers payment. Susquehanna may elect to redeem any or all of the subordinated debentures at any time on or after March 23, 2015. The maturity date of the subordinated debentures is March 23, 2040.

NOTE 6. Shareholders’ Equity

Preferred Stock

On April 21, 2010, Susquehanna redeemed $200,000 of the outstanding $300,000 of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued to the U.S. Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program in December 2008. The redemption price included $200,000 of the original investment amount plus approximately $1,800 of accrued and unpaid dividends. The preferred stock that Susquehanna redeemed in the second quarter of 2010 for $200,000 had a carrying value of $195,198 (net of a $4,802 unaccreted discount.) As a result of the redemption, Susquehanna accelerated the accretion of the discount, which reduced net income applicable to common shareholders by $4,802 in the second quarter of 2010.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The U.S. Treasury continues to own $100,000 of Susquehanna’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, as well as a warrant giving the U. S. Treasury the right to purchase up to 3,028 shares of Susquehanna’s common stock at a price of $14.86 per share.

Common Stock

On March 15, 2010, Susquehanna completed an offering of 43,125 shares of its common stock, par value $2.00 per share, at a public offering price of $8.00 per share. Proceeds from the offering, net of underwriting discounts and commissions of $17,250 and expenses of $409, totaled $327,341.

NOTE 7. Earnings per Share (EPS)

The following tables set forth the calculation of basic and diluted EPS for the three-month and nine-month periods ended September 30, 2010 and 2009.


	For the Three Months Ended September 30,
	2010						2009
	Income		Average Common Shares		Per Share Amount		Income		Average Common Shares		Per Share Amount
Basic Earnings per Share:
Income applicable to common shareholders	$	4,584		129,687	$	0.04	$	2,657		86,294	$	0.03
Effect of Diluted Securities:
Stock options and restricted shares outstanding				31						0

Diluted Earnings per Share:
Income applicable to common shareholders and assuming conversion	$	4,584		129,718	$	0.04	$	2,657		86,294	$	0.03

For the three months ended September 30, 2010 and 2009, average options to purchase 2,327 shares and 2,490 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents were antidilutive. For the three months ended September 30, 2010 and 2009, warrants to purchase 3,028 shares of common stock were outstanding but were not included in the computation of diluted EPS because the warrants’ common stock equivalents were antidilutive.


	For the Nine Months Ended September 30,
	2010						2009
	Income		Average Common Shares		Per Share Amount		Loss			Average Common Shares		Per Share Amount
Basic Earnings per Share:
Income (loss) applicable to common shareholders	$	6,536		118,103	$	0.06	$	(7,424	)		86,220	$	(0.09	)
Effect of Diluted Securities:
Stock options and restricted shares outstanding				32							0

Diluted Earnings per Share:
Income (loss) applicable to common shareholders and assuming conversion	$	6,536		118,135	$	0.06	$	(7,424	)		86,220	$	(0.09	)

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

For the nine months ended September 30, 2010 and 2009, average options to purchase 2,327 shares and 2,490 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents were antidilutive. For the nine months ended September 30, 2010 and 2009, warrants to purchase 3,028 shares of common stock were outstanding but were not included in the computation of diluted EPS because the warrants’ common stock equivalents were antidilutive.

NOTE 8. Pension and Other Postretirement Benefits

Components of Net Periodic Benefit Cost


	Three Months Ended September 30,
	Pension Benefits						Supplemental Executive Retirement Plan				Other Postretirement Benefits
	2010			2009			2010		2009		2010		2009
Service cost	$	640		$	954		$	18	$	30	$	137	$	128
Interest cost		1,613			1,468			67		70		186		162
Expected return on plan assets		(2,445	)		(1,899	)		0		0		0		0
Amortization of prior service cost		6			9			30		30		16		23
Amortization of transition obligation (asset)		0			0			0		0		28		28
Amortization of net actuarial loss		757			714			18		31		0		0
Curtailments/settlements		0			(80	)		0		0		0		0

Net periodic benefit cost	$	571		$	1,166		$	133	$	161	$	367	$	341


	Nine Months Ended September 30,
	Pension Benefits						Supplemental Executive Retirement Plan				Other Postretirement Benefits
	2010			2009			2010		2009		2010		2009
Service cost	$	3,442		$	4,386		$	84	$	90	$	519	$	384
Interest cost		4,791			4,304			213		196		572		486
Expected return on plan assets		(7,319	)		(5,683	)		0		0		0		0
Amortization of prior service cost		18			17			88		88		48		69
Amortization of transition obligation (asset)		0			0			0		0		84		84
Amortization of net actuarial loss		1,947			1,966			68		63		0		0
Curtailments/settlements		0			124			0		0		0		0

Net periodic benefit cost	$	2,879		$	5,114		$	453	$	437	$	1,223	$	1,023

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2009, that it expected to contribute $124 to its pension plans and $290 to its other postretirement benefit plan in 2010. As of September 30, 2010, $93 of contributions have been made to its pension plans, and $218 of contributions have been made to its other postretirement benefit plan. Susquehanna anticipates contributing an additional $31 to fund its pension plan in 2010, for a total of $124, and an additional $72 to its other postretirement benefit plan, for a total of $290.

Changes to Susquehanna’s Retirement Program

On February 24, 2009, Susquehanna notified its employees that changes were going to be made to the retirement program, effective July 1, 2009. The changes affected three groups of Susquehanna employees differently - employees for whom there were no retirement program changes, employees for whom the cash balance plan was “frozen,” and employees who were not yet eligible to participate in the plan and will not be eligible in the future.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 9. Derivative Financial Instruments

Risk Management Objective of Using Derivatives

Susquehanna is exposed to certain risks arising from both its business operations and economic conditions, and principally manages its exposures through management of its core business activities. Susquehanna manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments. Specifically, Susquehanna enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Susquehanna’s derivative financial instruments are used to manage differences in the amount, timing, and duration of its known or expected cash payments principally related to certain variable-rate liabilities. Susquehanna also has derivatives that are a result of a service it provides to certain qualifying customers, and therefore, are not used to manage interest-rate risk in its assets or liabilities. Susquehanna manages a matched book with respect to its derivative instruments offered as a part of this service to its customers in order to minimize its net exposure resulting from such transactions.

Cash Flow Hedges of Interest Rate Risk

Susquehanna’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, Susquehanna primarily uses interest rate swaps as part of its interest rate risk management strategy. For hedges of its variable-rate borrowings, Susquehanna uses interest rate swaps designated as cash flow hedges that involve the receipt of variable amounts from a counterparty in exchange for fixed-rate payments from Susquehanna. As of September 30, 2010, Susquehanna had nine interest rate swaps with an aggregate notional amount of $753,330 that were designated as cash flow hedges of interest-rate risk. Two of these interest rate swaps, with notional amounts of $48,124 and $30,206 and fair values of $100 and ($1,917), respectively, relate to consolidated variable interest entities.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transaction affects earnings. During the first nine months of 2010, such derivatives were used to hedge the variable cash outflows associated with Federal Home Loan Bank borrowings, federal funds borrowings, and long-term debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. For the first nine months of 2010, Susquehanna recognized $413 in other expenses as a result of the ineffectiveness of cash flow hedges, all of which was related to consolidated variable interest entities.

Amounts recorded in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on Susquehanna’s variable-rate liabilities. During 2010, Susquehanna estimates that $7,580 will be reclassified as an increase to interest expense.

Non-designated Hedges

Susquehanna does not use derivatives for trading or speculative purposes. Derivatives not designated as hedges are used to manage Susquehanna’s exposure to interest rate movements and other identified risks but do not meet the strict requirements of hedge accounting. Changes in the fair value of derivatives not designated in hedging relationships are recognized directly in earnings. Additionally, Susquehanna has interest rate derivatives, including interest rate swaps and option products, resulting from a service it provides to certain customers with high-quality credit ratings. Susquehanna executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. The credit risk associated with derivatives executed with these customers is essentially the same as that involved in extending loans and is subject to our normal credit policies. Susquehanna obtains collateral based upon its assessment of the customers’ credit quality. Those derivatives are simultaneously hedged by offsetting derivatives that Susquehanna executes with a third party to minimize Susquehanna’s net risk exposure resulting from those transactions.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

At September 30, 2010, Susquehanna had ninety-two derivative transactions related to this program with an aggregate notional amount of $649,096. For the first nine months of 2010, Susquehanna recognized a net loss of $19 related to changes in fair value of the derivatives in this program. For the first nine months of 2009, Susquehanna recognized a net loss of $582 related to changes in fair value of the derivatives in this program.

Credit-risk-related Contingent Features

Susquehanna has agreements with certain of its derivative counterparties that contain the following provisions:

•

if Susquehanna defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Susquehanna could also be declared in default on its derivative obligations;

•

if Susquehanna fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions, and Susquehanna would be required to settle its obligations under the agreements;

•

if Susquehanna fails to maintain a specified minimum leverage ratio, then Susquehanna could be declared in default on its derivative obligations;

•

if a specified event or condition occurs that materially changes Susquehanna’s creditworthiness in an adverse manner, it may be required to fully collateralize its obligations under the derivative instrument; and

•

if Susquehanna’s credit rating is reduced below investment grade, then a termination event shall be deemed to have occurred and the non-affected counterparty shall have the right, but not the obligation, to terminate all transactions under the agreement.

At September 30, 2010, the fair value of derivatives in a net liability position, which includes accrued interest and any credit valuation adjustments related to these agreements, was $24,210. At September 30, 2010, Susquehanna had minimum collateral posting thresholds with certain of its derivative counterparties and had posted cash collateral of $60,735. If Susquehanna had breached any of the above provisions at September 30, 2010, it would have been required to settle its obligations under the agreements at termination value and would have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the respective counterparty.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Fair Values of Derivative Instruments
September 30, 2010

Asset Derivatives

Liability Derivatives

Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair Value

Derivatives designated as hedging instruments

Interest rate contracts

Other assets

100

Other liabilities

49,305

Derivatives not designated as hedging instruments

Interest rate contracts

Other assets

24,197

Other liabilities

23,718

Total derivatives

24,297

73,023

December 31, 2009

Asset Derivatives

Liability Derivatives

Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair Value

Derivatives designated as hedging instruments

Interest rate contracts

Other assets

6,956

Other liabilities

408

Derivatives not designated as hedging instruments

Interest rate contracts

Other assets

13,781

Other liabilities

13,282

Total derivatives

20,737

13,690

The Effect of Derivative Instruments on the Statement of Income

Three months ended September 30, 2010


Derivatives in cash flow hedging relationships	Amount of Loss Recognized in OCI			Location of Loss Reclassified from Accumulated OCI into Income			Amount of Loss Reclassified from Accumulated OCI into Income			Location of Gain Recognized in Income (Ineffective Portion)		Amount of Gain Recognized in Income (Ineffective Portion)
Interest rate contracts:	$	(11,368	)		Interest expense		$	(2,295	)		Other expense	$	48

Derivatives not designated as hedging instruments	Location of Loss Recognized in Income on Derivatives			Amount of Loss Recognized in Income on Derivatives
Interest rate contracts:		Other income		$	(91	)

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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



Three months ended September 30, 2009
Derivatives in cash flow hedging relationships	Amount of Loss Recognized in OCI			Location of Loss Reclassified from Accumulated OCI into Income			Amount of Loss Reclasified from Accumulated OCI into Income
Interest rate contracts:	$	(7,280	)		Interest expense		$	(226	)

Derivatives not designated as hedging instruments	Location of Loss Recognized in Income on Derivatives			Amount of Loss Recognized in Income on Derivatives
Interest rate contracts:		Other income		$	(455	)

Nine months ended September 30, 2010
Derivatives in cash flow hedging relationships	Amount of Loss Recognized in OCI			Location of Loss Reclassified from Accumulated OCI into Income			Amount of Loss Reclassified from Accumulated OCI into Income			Location of Loss Recognized in Income (Ineffective Portion)		Amount of Loss Recognized in Income (Ineffective Portion)
Interest rate contracts:	$	(34,756)			Interest expense		$	(4,761	)		Other expense	$	(413	)

Derivatives not designated as hedging instruments	Location of Loss Recognized in Income on Derivatives			Amount of Loss Recognized in Income on Derivatives
Interest rate contracts:		Other income		$	(19	)

Nine months ended September 30, 2009
Derivatives in cash flow hedging relationships	Amount of Gain Recognized in OCI			Location of Loss Reclassified from Accumulated OCI into Income			Amount of Loss Reclassified from Accumulated OCI into Income
Interest rate contracts:	$	2,512			Interest expense		$	(548	)

Derivatives not designated as hedging instruments	Location of Loss Recognized in Income on Derivatives			Amount of Loss Recognized in Income on Derivatives
Interest rate contracts:		Other income		$	(582	)

NOTE 10. Securitizations and Variable Interest Entities (“VIEs”)

In 2005 and 2006, Susquehanna entered into term securitization transactions in which it sold portfolios of home equity loans to securitization trusts. Both of the securitization trusts are, by definition, variable interest entities. Susquehanna performed an analysis to determine whether it has a controlling financial interest in these entities, and

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

thus, as the primary beneficiary, would be required to consolidate the entities. An enterprise is deemed to have a controlling financial interest in a VIE if it has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Susquehanna retained servicing responsibilities and interests in the VIEs. Susquehanna receives servicing fees and rights to cash flows remaining after the investors have received the return for which they contracted. Susquehanna, as servicer, has the ability to manage the entities’ assets that become delinquent to improve the economic performance of the entities. Therefore, Susquehanna meets the “power criterion.” In addition, through its ownership of the entities’ equity certificates, Susquehanna has the right to receive potentially significant benefits. Therefore, Susquehanna meets the “losses/benefits criterion.” Since Susquehanna meets both criteria, it is the primary beneficiary of the VIEs and is required to consolidate them. Upon consolidation, Susquehanna removed retained interests of $23,705 and recorded interest-bearing deposits of $7,537, aggregate loans balances of $248,333, and long term-debt of $239,936 on January 1, 2010. In addition, Susquehanna recognized a cumulative-effect adjustment that reduced retained earnings by $5,805 and an adjustment that reduced accumulated other comprehensive income by $6,922. Susquehanna entered into these securitization transactions primarily to achieve low-cost funding for the growth of its loan and lease portfolios and to manage capital. The investors and the VIEs have no recourse to Susquehanna’s general credit for failure of debtors to pay when due.

2006 Transaction

In September 2006, Susquehanna securitized $349,403 of fixed-rate home mortgage loans and variable-rate line of credit loans. Susquehanna retained the right to service the loans and recorded a servicing asset of $2,334.

In this securitization, approximately 70.5% of the variable-rate loans as of the cut-off date included a feature that permits the obligor to convert all or a portion of the loan from a variable interest rate to a fixed interest rate. If the total principal balance of the converted loans is greater than 10% of the total outstanding balance of the portfolio, Susquehanna is required to purchase the converted loans in excess of the 10% threshold until the total principal balance of the loans purchased by Susquehanna is equal to 10% of the original principal balance of the loans. Based upon Susquehanna’s experience with this product, Susquehanna has concluded that the event requiring the purchase of converted loans of the VIE would be remote. The maximum dollar amount of this purchase obligation at the cut-off date was $11,140, and its related fair value was considered to be de minimis.

2005 Transaction

In December 2005, Susquehanna securitized $239,766 of home equity line of credit loans. Susquehanna retained the right to service the loans and recorded a servicing asset of $1,289.

In this securitization, approximately 35.4% of the loans as of the cut-off date included a feature that permits the obligor to convert all or a portion of the loan from a variable interest rate to a fixed interest rate. If the total principal balance of the converted loans is greater than 10% of the total outstanding balance of the portfolio, Susquehanna is required to purchase the converted loans in excess of the 10% threshold until the total principal balance of the loans purchased by Susquehanna is equal to 10% of the original principal balance of the loans. Based upon Susquehanna’s experience with this product, Susquehanna has concluded that the event requiring the purchase of converted loans of the VIE would be remote. The maximum dollar amount of this purchase obligation at the cut-off date was $23,980, and its related fair value was considered to be de minimis.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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


									For the Nine Months Ended Sept 30,
	Principal Balance				Risk Assets (1)				Net Credit Losses (Recoveries)
	Sept 30, 2010		December 31, 2009		Sept 30, 2010		December 31, 2009		2010			2009
Loans and leases held in portfolio	$	9,472,511	$	9,827,279	$	258,915	$	258,666	$	109,253		$	78,179
Leases held by VIEs		0		0		0		0		0			101
Home equity loans held by VIEs		224,289		248,554		5,364		4,797		636			85
Leases serviced for others		4,605		13,551		12		7		(3	)		(15	)

Total loans and leases serviced	$	9,701,405	$	10,089,384	$	264,291	$	263,470	$	109,886		$	78,350

(1)	Includes nonaccrual loans and leases, other real estate owned, and loans and leases past due 90 days and still accruing.

Certain cash flows received from or conveyed to the VIEs associated with the securitizations are as follows:


Automobile Leases	Three Months Ended Sept 30,				Nine Months Ended Sept 30,
	2010		2009		2010		2009
Servicing fees received	$	0	$	170	$	0	$	701
Other cash flows received		0		4,856		0		11,885

Home Equity Loans	Three Months Ended Sept 30,				Nine Months Ended Sept 30,
	2010		2009		2010		2009
Additional draws conveyed	$	8,057	$	11,487	$	25,570	$	35,494
Servicing fees received		250		281		765		857
Other cash flows received		2,117		2,626		4,751		7,075

There were no proceeds from securitizations or amounts derecognized for the nine-month periods ended September 30, 2010 and 2009 relating to home equity loans and automobile leases.

NOTE 11. Fair Value Disclosures

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The level in the hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety.

At September 30, 2010, Susquehanna had made no elections to use fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value.

The following is a description of Susquehanna’s valuation methodologies for assets and liabilities carried at fair value. These methods may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while Susquehanna believes that its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Securities

Where quoted prices are available in an active market, securities are classified in Level 1 of the valuation hierarchy. Securities in Level 1 are exchange-traded equities. If quoted market prices are not available for the specific security, then fair values are provided by independent third-party valuations services. These valuations services estimate fair values using pricing models and other accepted valuation methodologies, such as quotes for similar securities and observable yield curves and spreads. As part of Susquehanna’s overall valuation process, management evaluates these third-party methodologies to ensure that they are representative of exit prices in Susquehanna’s principal markets. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, state and municipal securities, Federal Home Loan Bank stock, and Federal Reserve Bank stock. Securities in Level 3 include thinly traded bank stocks, collateralized debt obligations, trust preferred securities, and indexed-amortizing notes.

Derivatives

Currently, Susquehanna uses interest rate swaps to manage its interest rate risk and to assist its borrowers in managing their interest rate risk. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates derived from observable market interest rate curves. Susquehanna incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Susquehanna has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although Susquehanna has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives may utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2010, Susquehanna has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Susquehanna has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Certain Retained Interests in Securitizations—Prior to January 1, 2010

For interest-only strips, there was a lack of similar observable transactions for similar assets in the marketplace. Therefore, Susquehanna used the present-value approach to determine the initial and ongoing fair values of the cash flows associated with securitizations. Assumptions used, which incorporate certain market information obtained from third parties, included an estimation of an appropriate discount rate, net credit losses, and prepayment rates. Changes in the assumptions used may have had a significant impact on Susquehanna’s valuation of retained interests, and accordingly, such interests were classified within Level 3 of the valuation hierarchy.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the financial instruments carried at fair value at September 30, 2010 and December 31, 2009, on the consolidated balance sheets and by levels within the valuation hierarchy.


			Fair Value Measurements at Reporting Date Using
Description	September 30, 2010		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Available-for-sale securities:
U.S. Government Agencies	$	415,709	$	0	$	415,709	$	0
Obligations of states and political subdivisions		419,241				419,241
Agency residential mortgage-backed securities		1,083,524				1,083,524
Non-agency residential mortgage-backed securities		126,222				126,222
Commercial mortgage-backed securities		105,541				105,541
Synthetic collateralized debt obligations		1,223				0		1,223
Other structured financial products		11,713				0		11,713
Other debt securities		52,108				52,108
Equity securities of the FHLB		72,658				72,658
Equity securities of the FRB		50,225				50,225
Other equity securities		25,167		3,076		18,535		3,556
Derivatives: (1)
Designated as hedging instruments		100				100
Not designated as hedging instruments		24,197				24,197

Total	$	2,387,628	$	3,076	$	2,368,060	$	16,492

Liabilities
Derivatives: (2)
Designated as hedging instruments	$	49,305	$	0	$	49,305	$	0
Not designated as hedging instruments		23,718				23,718

Total	$	73,023	$	0	$	73,023	$	0

(1)	Included in Other assets

(2)	Included in Other liabilities


			Fair Value Measurements at Reporting Date Using
Description	December 31, 2009		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Available-for-sale securities:
U.S. Government Agencies	$	371,019	$	0	$	371,019	$	0
Obligations of states and political subdivisions		353,419				353,419
Agency residential mortgage-backed securities		680,182				680,182
Non-agency residential mortgage-backed securities		135,465				133,354		2,111
Commercial mortgage-backed securities		165,025				165,025
Synthetic collateralized debt obligations		1,331						1,331
Other structured financial products		15,319				1,206		14,113
Equity securities of the FHLB		74,342				74,342
Equity securities of the FRB		45,725				45,725
Other equity securities		24,519		2,907		17,531		4,081
Derivatives: (1)
Designated as hedging instruments		6,956				6,956
Not designated as hedging instruments		13,781				13,781
Interest-only strips (1)(3)		17,840						17,840

Total	$	1,904,923	$	2,907	$	1,862,540	$	39,476

Liabilities
Derivatives: (2)
Designated as hedging instruments	$	408	$	0	$	408	$	0
Not designated as hedging instruments		13,282				13,282

Total	$	13,690	$	0	$	13,690	$	0

(1)	Included in Other assets

(2)	Included in Other liabilities

(3)	On January 1, 2010, interest-only strips were eliminated as a result of the consolidation of the variable interest entities.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs

The following tables present rollforwards of the balance sheet amounts for the three months ended September 30, 2010 and 2009, for financial instruments classified by Susquehanna within Level 3 of the valuation hierarchy.


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Available-for-sale Securities
	Equity Securities			Synthetic Collateralized Debt Obligations			Other Structured Financial Products							Total
Balance at July 1, 2010	$	3,556		$	1,576		$	10,953						$	16,085
Total gains or losses (realized/unrealized):
Other-than-temporary impairment (1)		(240	)		0			0							(240	)
Included in other comprehensive income (before taxes)		240			(353	)		760							647

Balance at September 30, 2010	$	3,556		$	1,223		$	11,713						$	16,492


	Available-for-sale Securities
	Equity Securities			Synthetic Collateralized Debt Obligations			Other Structured Financial Products		Non-agency Residential Mortgage- backed Securities		Interest- only Strips			Total
Balance at July 1, 2009	$	4,081		$	1,513		$	12,071	$	2,795	$	18,020		$	38,480
Total gains or losses (realized/unrealized):
Included in other comprehensive income (before taxes)		0			(370	)		671		5		1,759			2,065
Purchases, issuances, and settlements		0			0			0		0		(749	)		(749	)

Balance at September 30, 2009	$	4,081		$	1,143		$	12,742	$	2,800	$	19,030		$	39,796

(1)	Included in noninterest income, net impairment losses recognized in earnings.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following tables present rollforwards of the balance sheet amounts for the nine months ended September 30, 2010 and 2009, for financial instruments classified by Susquehanna within Level 3 of the valuation hierarchy.


	Available-for-sale Securities
	Equity Securities			Synthetic Collateralized Debt Obligations			Other Structured Financial Products			Non-agency Residential Mortgage- backed Securities			Interest- only Strips			Total
Balance at January 1, 2010	$	4,081		$	1,331		$	14,113		$	2,111		$	17,840		$	39,476
Adjustments relating to the consolidation of variable interest entities											(2,111	)		(17,840	)		(19,951	)
Total gains or losses (realized/unrealized):
Other-than-temporary impairment (1)		(240	)		(557	)		0			0			0			(797	)
Included in other comprehensive income (before taxes)		(285	)		449			(2,400	)		0			0			(2,236	)

Balance at September 30, 2010	$	3,556		$	1,223		$	11,713		$	0		$	0		$	16,492


	Available-for-sale Securities
	Equity Securities			Synthetic Collateralized Debt Obligations			Other Structured Financial Products		Non- agency Residential Mortgage- backed Securities		Obligations of State and Political Subdivisions			U.S. Government Agencies			Interest-only Strips			Total
Balance at January 1, 2009	$	5,169		$	1,200		$	3,968	$	2,787	$	440		$	31,751		$	17,565		$	62,880
Total gains or losses (realized/unrealized)
Other-than-temporary impairment (1)					(937	)															(937	)
Included in other comprehensive income (before taxes)		4			880			8,774		13								4,553			14,224
Purchases, issuances, and settlements		(1,092	)															(3,088	)		(4,180	)
Transfers in and/or out of Level 3												(440	)(2)		(31,751	)(2)		0			(32,191	)

Balance at September 30, 2009	$	4,081		$	1,143		$	12,742	$	2,800	$	0		$	0		$	19,030		$	39,796

(1)	Included in noninterest income, net impairment losses recognized in earnings.

(2)	Represents four securities transferred from Level 3 to Level 2 as a result of enhanced valuation methodologies.

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Certain loans are evaluated for impairment in accordance with U.S. GAAP. To estimate the impairment of a loan, Susquehanna uses the practical expedient method, which is based upon the fair value of the underlying collateral for collateral-dependent loans. Currently, most of Susquehanna’s impaired loans are secured by real estate. The value of the real estate collateral is determined through appraisals performed by independent licensed appraisers. As part of Susquehanna’s overall valuation process, management evaluates these third-party appraisals to ensure that they are representative of the exit prices in Susquehanna’s principal markets. When the value of the real estate, less estimated costs to sell, is less than the principal balance of the loan, a specific reserve is established. Susquehanna considers the appraisals used in its impairment analysis to be Level 3 inputs. Impaired loans are reviewed at least quarterly for additional impairment, and reserves are adjusted accordingly.

Foreclosed Assets

Other real estate property acquired through foreclosure is recorded at the lower of its carrying value or the fair market value of the related real estate collateral at the transfer date, less estimated selling costs. The value of the real estate collateral is determined through appraisals performed by independent licensed appraisers. As part of Susquehanna’s overall valuation process, management evaluates these third-party appraisals to ensure that they are representative of the exit prices in Susquehanna’s principal markets. Susquehanna considers the appraisals used in its impairment analysis to be Level 3 inputs.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following tables present assets measured at fair value on a nonrecurring basis at September 30, 2010 and December 31, 2009, on the consolidated balance sheets and by the valuation hierarchy.


Description	September 30, 2010		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	118,412	$	0	$	0	$	118,412
Foreclosed assets		18,856		0		0		18,856

	$	137,268	$	0	$	0	$	137,268

Specific reserves for the first nine months of 2010 were reduced by $3,461. These specific reserves were taken into consideration when the required level of the allowance for loan and lease losses was determined at September 30, 2010.


Description	December 31, 2009		Quoted Prices in Active Markets for Identical Instruments (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	95,430	$	0	$	0	$	95,430
Foreclosed assets		24,292		0		0		24,292

	$	119,722	$	0	$	0	$	119,722

Specific reserves identified during 2009 totaled $35,030. These specific reserves were taken into consideration when the required level of the allowance for loan and lease losses was determined at December 31, 2009.

Additional Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and due from banks and short-term investments

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities

Refer to the above discussion on securities.

Loans and leases

Variable-rate loans, which do not expose Susquehanna to interest-rate risk, have a fair value that equals their carrying value, discounted for estimated future credit losses. The fair value of fixed-rate loans and leases was based upon the present value of projected cash flows. The discount rate was based upon the U.S. Treasury yield curve.

Deposits

The fair values of demand, interest-bearing demand, and savings deposits are the amounts payable on demand at the balance sheet date. The carrying value of variable-rate time deposits represents a reasonable estimate of fair value. The fair value of fixed-rate time deposits is based upon the discounted value of future cash flows expected to be paid at maturity. Discount rates were based upon the U.S. Treasury yield curve.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Short-term borrowings

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

FHLB borrowings and long-term debt

Fair values were based upon quoted rates of similar instruments issued by banking institutions with similar credit ratings.

Derivatives

Refer to the above discussion on derivatives.

Off-balance-sheet items

The fair values of unused commitments to lend and standby letters of credit are considered to be the same as their contractual amounts. The fair values of commitments to originate mortgage loans to be held for sale and their corresponding forward-sales agreements are calculated as the reasonable amounts that Susquehanna would agree to pay or receive, after considering the likelihood of the commitments expiring.

The following table represents the carrying amounts and estimated fair values of Susquehanna’s financial instruments:

September 30, 2010

December 31, 2009

Carrying
Amount

Fair Value

Carrying
Amount

Fair Value

Financial assets:

Cash and due from banks

201,353

203,240

Short-term investments

133,207

88,120

Investment securities

2,372,066

1,875,267

Loans and leases

9,505,685

9,764,067

9,654,911

9,808,728

Derivatives

24,297

20,737

Financial liabilities:

Deposits

9,202,178

9,293,755

8,974,363

8,838,190

Short-term borrowings

584,023

1,040,703

FHLB borrowings

1,117,116

1,191,343

1,023,817

1,091,796

Long-term debt

714,741

681,470

448,374

381,618

Derivatives

73,023

13,690

Note 12. Income Taxes

Susquehanna’s provision for income taxes during interim reporting periods historically has been calculated by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pre-tax income or loss excluding significant, unusual or infrequently occurring items) for the reporting period. For the reporting period ended September 30, 2010, Susquehanna has computed its provision for income taxes based on the actual effective tax rate for the year-to-date by applying the discrete method. Susquehanna determined that, as small changes in estimated “ordinary” income result in significant changes in the estimated annual effective tax rate, the historical method would not provide a reliable estimate for the reporting period ended September 30, 2010. The actual effective rate for the reporting period ended September 30, 2010 was impacted by the level of permanent differences, including tax-advantaged investment and loan income, resulting in an effective rate below statutory rates for the interim reporting periods.

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. Unless the context requires otherwise, the terms “Susquehanna,” “we,” “us,” and “our” refer to Susquehanna Bancshares, Inc. and its subsidiaries.

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, expectations regarding Susquehanna’s future operating results or financial condition; expectations regarding a redemption of the remaining securities issued to the U. S. Treasury; Susquehanna’s potential exposures to various types of market risks, such as interest rate risk and credit risk; whether Susquehanna’s allowance for loan and lease losses is adequate to meet probable loan and lease losses; our ability to maintain loan growth; our ability to maintain sufficient liquidity; our ability to manage credit quality; our ability to monitor the impact of the recession moving into the commercial and industrial, commercial real estate, and consumer segments; the impact of a breach by Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) on residual loss exposure; our ability to collect all amounts due under our outstanding synthetic collateralized debt obligations; and our ability to achieve our 2010 financial goals. 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;

•

adverse changes in the automobile industry;

•

adverse changes in regional real estate values;

•

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

•

decreases in our loan and lease quality and origination volume;

•

the adequacy of loss reserves;

•

impairment of goodwill or other assets;

•

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

•

continued relationships with major customers;

•

the ability 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 ability to hedge certain risks effectively and 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;

•

greater reliance on wholesale funding because our loan growth has outpaced our deposit growth, and we have no current access to securitization markets;

•

changes in legal or regulatory requirements or the results of regulatory examinations that could adversely impact our business and financial condition and restrict growth;

•

the impact of federal laws and related rules and regulations on our business operations and competitiveness, including the impact of executive compensation restrictions, which may affect our ability to retain and recruit executives in competition with other firms that do not operate under those restrictions;

•

future legislative or administrative changes to the TARP Capital Purchase Program;

•

the effects of and changes in trade, monetary and fiscal policies, and laws, including interest rate policies of the Federal Reserve Board;

•

the effects of and changes in the rate of Federal Deposit Insurance Corporation premiums; 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 Susquehanna and its wholly owned subsidiaries: Boston Service Company, Inc., (t/a Hann Financial Service Corporation) (“Hann”), Susquehanna Bank and subsidiaries, Valley Forge Asset Management Corp. and subsidiary (“VFAM”), Stratton Management Company, LLC and subsidiary (“Stratton”), and The Addis Group, LLC.

Availability of Information

Our web-site address is www.susquehanna.net. We make available free of charge, through the Investor Relations section of our web site, 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 web-site address in this Quarterly Report on Form 10-Q as an inactive textual reference only.

Executive Overview

The prolonged economic downturn continues to impact customers in our markets, as well as our own financial performance. Our results for the first nine months of 2010 have been impacted by a number of issues related to the recession, including an elevated provision for loan and lease losses and related credit costs, as a result of deterioration in credit quality. We have, however, strong liquidity, and our capital ratios are well in excess of regulatory minimums to be considered “well-capitalized.” With these factors in mind, we have updated our 2010 financial goals as follows:

Updated Financial Goals for 2010

Our updated financial goals for 2010 are as follows:


	Original Targets			Updated Targets
Net interest margin		3.75	%		3.65	%
Loan growth		6.0	%		-2.0	%
Deposit growth		4.0	%		1.0	%
Noninterest income growth		-14.0	%		-11.0	%
Noninterest expense growth		-1.0	%		0.0	%
Tax rate		25.0	%		Not meaningful
Preferred dividend and discount accretion	$	16.8 million

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