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 March 31, 2014

¨ 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	x	Accelerated Filer	¨
Non-Accelerated Filer	¨ (Do not check if a smaller reporting company)	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 April 25, 2014, there were 187,626,109 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			3

	Item 1 Financial Statements (Unaudited)		3

		Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013	3

		Consolidated Statements of Income for the three months ended March 31, 2014 and 2013	4

		Consolidated Statements of Comprehensive Income for the three months ended March 31, 2014 and 2013	5

		Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013	6

		Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2014 and 2013	7

		Notes to Consolidated Financial Statements	8

	Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		49

	Item 3 Quantitative and Qualitative Disclosures About Market Risk		68

	Item 4 Controls and Procedures		71

PART II. OTHER INFORMATION			72

	Item 1 Legal Proceedings		72

	Item 1A Risk Factors		73

	Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		73

	Item 3 Defaults Upon Senior Securities		73

	Item 4 Mine Safety Disclosures		74

	Item 5 Other Information		74

	Item 6 Exhibits		75

SIGNATURES			76

EXHIBIT INDEX			77

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
					March 31,		December 31,
					2014		2013
					(in thousands, except share data)
Assets
	Cash and due from banks				$	389,793	$	305,357
	Unrestricted short-term investments					24,768		37,967
			Cash and cash equivalents			414,561		343,324
	Interest-bearing deposits held by consolidated variable interest entities that can be used only to
		settle obligations of the consolidated variable interest entities				1,689		2,347
	Restricted short-term investments					42,993		42,913
	Securities available for sale					2,299,235		2,375,224
	Restricted investment in bank stocks					146,087		158,232
	Loans and leases, net of deferred costs and fees					13,505,746		13,503,392
	Loans held by consolidated variable interest entities that can be used only to settle obligations of
		the consolidated variable interest entities				69,549		72,694
			Less: Allowance for loan and lease losses			154,150		157,608
				Net loans and leases		13,421,145		13,418,478
	Premises and equipment, net					170,349		173,542
	Other real estate and foreclosed assets					12,943		17,573
	Accrued interest receivable					41,594		41,690
	Bank-owned life insurance					449,778		449,320
	Goodwill					1,275,439		1,275,439
	Intangible assets with finite lives					30,303		32,262
	Deferred income tax assets					5,216		6,472
	Other assets					128,350		136,673
				Total Assets	$	18,439,682	$	18,473,489
Liabilities and Shareholders’ Equity
	Deposits:
		Noninterest-bearing			$	1,880,284	$	1,913,526
		Interest-bearing				11,199,239		10,955,846
				Total deposits		13,079,523		12,869,372
	Federal Home Loan Bank short-term borrowings					1,150,000		1,450,000
	Other short-term borrowings					584,664		555,740
	Federal Home Loan Bank long-term borrowings					79,296		81,282
	Other long-term debt					250,224		250,227
	Junior subordinated debentures					155,022		155,002
	Long-term debt of consolidated variable interest entities for which creditors do not have recourse to
		Susquehanna’s general credit				43,275		48,031
	Accrued interest, taxes, and expenses payable					69,404		82,150
	Deferred income tax liabilities					75,911		70,308
	Other liabilities					197,164		193,790
				Total Liabilities		15,684,483		15,755,902
	Shareholders’ equity:
		Common stock, $2.00 par value, 400,000,000 shares authorized; Issued: 187,922,762 at
			March 31, 2014, and 187,676,711 at December 31, 2013			375,845		375,353
		Treasury stock, at cost, 332,289 at March 31, 2014, and 313,568 at December 31, 2013				(2,735)		(2,531)
		Additional paid-in capital				1,654,357		1,652,116
		Retained earnings				766,381		744,215
		Accumulated other comprehensive loss, net of taxes of $21,734 and $25,039, respectively				(38,649)		(51,566)
				Total Shareholders’ Equity		2,755,199		2,717,587
				Total Liabilities and Shareholders’ Equity	$	18,439,682	$	18,473,489

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
			March 31,
			2014		2013
			(in thousands, except per share data)
Interest Income:
	Loans and leases, including fees		$	149,538	$	160,344
	Securities:
		Taxable		9,648		10,260
		Tax-exempt		3,501		3,594
		Dividends		1,765		1,166
	Short-term investments			19		36
		Total interest income		164,471		175,400

Interest Expense:
	Deposits:
		Interest-bearing demand and savings		3,962		4,901
		Time		9,628		11,232
	Federal Home Loan Bank short-term borrowings			4,621		3,371
	Other short-term borrowings			2,100		2,153
	Federal Home Loan Bank long-term borrowings			245		301
	Other long-term debt			3,851		4,236
		Total interest expense		24,407		26,194
Net interest income				140,064		149,206
Provision for loan and lease losses				6,000		12,000
Net interest income, after provision for loan and lease losses				134,064		137,206

Noninterest Income:
	Service charges on deposit accounts			9,000		8,672
	Vehicle origination and servicing fees			2,968		3,354
	Wealth management commissions and fees			12,719		12,390
	Commissions on property and casualty insurance sales			5,666		4,542
	Other commissions and fees			5,035		4,328
	Income from bank-owned life insurance			1,637		1,508
	Mortgage banking revenue			2,410		4,110
	Capital markets revenue			1,240		902
	Net realized gain (loss) on sales and impairment of securities			(8)		18
	Other			1,422		2,820
		Total noninterest income		42,089		42,644

Noninterest Expenses:
	Salaries and employee benefits			65,581		62,614
	Occupancy			13,847		11,215
	Furniture and equipment			3,944		3,578
	Professional and technology services			6,070		5,729
	Advertising and marketing			3,576		3,300
	FDIC insurance			5,121		3,798
	Legal fees			1,527		1,870
	Amortization of intangible assets			2,539		3,268
	Vehicle lease disposal			2,251		1,290
	Other			18,576		21,067
		Total noninterest expenses		123,032		117,729

Income before income taxes				53,121		62,121
Provision for income taxes				15,959		19,722
Net Income			$	37,162	$	42,399
Earnings per common share:
		Basic	$	0.20	$	0.23
		Diluted	$	0.20	$	0.23
Cash dividends per common share			$	0.08	$	0.00
Average common shares outstanding:
		Basic		187,455		186,607
		Diluted		188,378		187,442
The accompanying notes are an integral part of these consolidated financial statements.

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)

			Three Months Ended
			March 31,

			2014		2013
				(in thousands)

Net Income			$	37,162	$	42,399

Other comprehensive income (loss):

	Change in unrealized gain (loss) on securities available for sale			16,121		(6,171)
		Tax effect and reclassification adjustment		(5,807)		2,179
				10,314		(3,992)

	Non-credit related unrealized loss on other-than-temporarily impaired debt securities			0		(292)
		Tax effect		0		107
				0		(185)

	Change in unrealized gain on cash flow hedges			4,100		4,405
		Tax effect		(1,497)		(1,608)
				2,603		2,797

	Changes in postretirement benefit obligations			0		(26)
		Tax effect		0		9
				0		(17)

Total other comprehensive income (loss)				12,917		(1,397)
Total comprehensive income			$	50,079	$	41,002

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

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
			Three Months Ended
			March 31,
			2014		2013
				(in thousands)
Cash Flows from Operating Activities:
	Net income		$	37,162	$	42,399
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation, amortization, and accretion		19,540		13,376
		Provision for loan and lease losses		6,000		12,000
		Stock compensation expense		1,569		804
		Realized loss (gain) on available-for-sale securities, net		8		(18)
		Deferred income tax (benefit) expense		(445)		13,618
		Gain on sale of loans and leases		(1,933)		(4,878)
		(Gain) loss on sale of foreclosed assets		(29)		225
		(Gain) loss on sale of fixed assets		(53)		280
		Mortgage loans originated for sale		(87,790)		(132,464)
		Proceeds from sale of mortgage loans originated for sale		92,557		150,876
		Increase in cash surrender value of bank-owned life insurance		(1,445)		(1,296)
		Decrease (increase) in accrued interest receivable		96		(3,898)
		Decrease in accrued interest payable		(1,126)		(1,246)
		Decrease in accrued expenses and taxes payable		(11,620)		(19,297)
		Other, net		14,996		9,977
	Net cash provided by operating activities			67,487		80,458
Cash Flows from Investing Activities:
	Net decrease in restricted short-term investments			578		7,302
	Activity in available-for-sale securities:
		Sales		42		12,770
		Maturities, repayments, and calls		87,667		154,037
		Purchases		0		(24,139)
	Net decrease in restricted investment in bank stock			12,145		460
	Net increase in loans and leases			(23,403)		(139,389)
	Purchase of bank-owned life insurance			0		(2,694)
	Proceeds from bank-owned life insurance			987		3,909
	Proceeds from sale of foreclosed assets			6,727		5,733
	Additions to premises and equipment, net			(955)		(878)
	Net cash (used in) provided by investing activities			83,788		17,111
Cash Flows from Financing Activities:
	Net increase in deposits			211,355		111,386
	Net increase (decrease) in other short-term borrowings			28,924		(31,326)
	Net decrease in short-term FHLB borrowings			(300,000)		(150,000)
	Repayment of long-term FHLB borrowings			(1,522)		(4,038)
	Repayment of long-term debt			(4,759)		(11,861)
	Proceeds from issuance of common stock			1,164		1,795
	Purchase of treasury stock			(204)		(21)
	Cash dividends paid			(14,996)		0
	Net cash provided by (used in) financing activities			(80,038)		(84,065)
Net change in cash and cash equivalents				71,237		13,504
Cash and cash equivalents at January 1				343,324		316,592
Cash and cash equivalents at March 31			$	414,561	$	330,096
Supplemental Disclosure of Cash Flow Information
	Cash paid for interest on deposits and borrowings		$	25,532	$	27,441
	Income tax payments (refunds)			2,384		(24,441)
Supplemental Schedule of Noncash Activities
	Real estate acquired in settlement of loans		$	3,549	$	3,511
	Securities sold not settled			0		22,320
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)



												Accumulated
			Shares of					Additional				Other
			Common	Common		Treasury		Paid-in		Retained		Comprehensive
			Stock	Stock		Stock		Capital		Earnings		Loss		Total
Balance at January 1, 2013			186,811,642	$	373,623	$	(1,850)	$	1,645,958	$	615,436	$	(37,258)	$	2,595,909
	Total comprehensive income										42,399		(1,397)		41,002
	Issuance of common stock and share-based awards under employee
		benefit plans	247,379		495				2,104						2,599
	Treasury stock purchased						(21)								(21)
Balance at March 31, 2013			187,059,021	$	374,118	$	(1,871)	$	1,648,062	$	657,835	$	(38,655)	$	2,639,489

Balance at January 1, 2014			187,676,711	$	375,353	$	(2,531)	$	1,652,116	$	744,215	$	(51,566)	$	2,717,587
	Total comprehensive income										37,162		12,917		50,079
	Issuance of common stock and share-based awards under employee
		benefit plans	246,051		492				2,241						2,733
	Treasury stock purchased						(204)								(204)
	Cash dividends paid on common stock ($0.08 per share)										(14,996)				(14,996)
Balance at March 31, 2014			187,922,762	$	375,845	$	(2,735)	$	1,654,357	$	766,381	$	(38,649)	$	2,755,199

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)

NOTE 1. Summary of Significant Accounting Policies

The information contained in this report is unaudited.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information. Certain prior-year amounts have been reclassified to conform to current period. In the opinion of management, the information reflects all normal recurring adjustments necessary for a fair statement of results for the three months ended March 31, 2014 and 2013. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Operating results for the three-month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

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 78 through 85 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported and contingent amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses; the fair value of financial instruments, such as loans, investment securities, and derivatives; measurement and assessment of goodwill, intangible assets, and other purchase accounting related adjustments; and income tax assets, liabilities and expenses.

Recently Adopted Accounting Guidance

In February 2013, FASB issued ASU 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU requires entities to disclose information regarding reclassification adjustments from accumulated other comprehensive income in their financial statements in a single note or on the face of the financial statements. ASU 2013-02 is effective for interim and annual reporting periods beginning after December 15, 2012. The adoption of this guidance, in the first quarter of 2013, did not have a material impact on results of operations or financial condition, however did result in additional disclosures. For more information about these disclosures, refer to Note 8. Accumulated Other Comprehensive Income.

In July 2013, FASB issued ASU 2013-10, Derivatives and Hedging (Topic 815) – Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to U.S. Treasury interest rates and the London Interbank Offered Rate. The amendment also removes the restriction on using different benchmark rates for similar hedges. The adoption of this guidance, in the third quarter of 2013, did not have a material impact on results of operations, financial condition, or disclosures. For more information, refer to Note 14. Fair Value Disclosures.

In July 2013, FASB issued ASU 2013-11, Income Taxes (Topic 740) – Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU provides clarifying guidance on the presentation of unrecognized tax benefits to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. ASU 2013-11 is effective for interim and annual reporting periods beginning after December 15, 2013. The adoption of this amendment, in the first quarter of 2014, did not 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)

Recently Issued Accounting Guidance

In January 2014, FASB issued ASU 2014-01, Investments – Equity Method and Joint Ventures (Topic 323) – Accounting for Investments in Qualified Affordable Housing Projects. This ASU provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. ASU 2014-01 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of this amendment is not expected to have a material impact on the financial condition or results of operations.

In January 2014, FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) – Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized. ASU 2014-04 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of this amendment is not expected to have a material impact on the financial condition or results of operations.

NOTE 2. Investment Securities

The amortized cost and fair values of investment securities at March 31, 2014 and December 31, 2013 were as follows:

				Gross		Gross
		Amortized		Unrealized		Unrealized		Fair
At March 31, 2014		Cost		Gains		Losses		Value
Available-for-Sale:
	U.S. Government agencies	$	110,176	$	388	$	332	$	110,232
	Obligations of states and political subdivisions		385,404		17,158		2,536		400,026
	Agency residential mortgage-backed securities		1,700,182		15,086		13,671		1,701,597
	Non-agency residential mortgage-backed securities		567		1		3		565
	Commercial mortgage-backed securities		6,187		133		0		6,320
	Other structured financial products		25,038		0		13,619		11,419
	Other debt securities		43,176		2,219		569		44,826
			2,270,730		34,985		30,730		2,274,985
	Other equity securities		24,370		947		1,067		24,250
Total available-for-sale securities		$	2,295,100	$	35,932	$	31,797	$	2,299,235

				Gross		Gross
		Amortized		Unrealized		Unrealized		Fair
At December 31, 2013		Cost		Gains		Losses		Value
Available-for-Sale:
	U.S. Government agencies	$	110,227	$	343	$	422	$	110,148
	Obligations of states and political subdivisions		389,199		13,386		4,075		398,510
	Agency residential mortgage-backed securities		1,786,133		12,163		20,104		1,778,192
	Non-agency residential mortgage-backed securities		572		1		8		565
	Commercial mortgage-backed securities		8,568		166		0		8,734
	Other structured financial products		25,038		0		13,741		11,297
	Other debt securities		43,156		1,487		557		44,086
			2,362,893		27,546		38,907		2,351,532
	Other equity securities		24,318		557		1,183		23,692
Total available-for-sale securities		$	2,387,211	$	28,103	$	40,090	$	2,375,224

At March 31, 2014 and December 31, 2013, investment securities with carrying values of $1,420,413 and $1,512,824, 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, agency and non-agency residential mortgage-backed securities, commercial mortgage-backed securities, other structured financial products, other debt

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

securities, and residential and commercial mortgage-backed securities, at March 31, 2014 and December 31, 2013, 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.

			March 31, 2014				December 31, 2013
			Amortized		Fair		Amortized		Fair
			Cost		Value		Cost		Value
Securities available for sale:
	Within one year		$	26,301	$	26,701	$	8,870	$	9,005
	After one year but within five years			109,683		110,293		129,176		130,091
	After five years but within ten years			907,313		912,610		945,637		946,754
	After ten years			1,227,433		1,225,381		1,279,210		1,265,682
		Total	$	2,270,730	$	2,274,985	$	2,362,893	$	2,351,532

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.

	Available-for-sale Securities
	Three Months Ended March 31,
	2014		2013
Gross gains	$	25	$	407
Gross losses		(33)		(1)
Other-than-temporary impairment		0		(388)
Net gains	$	(8)	$	18

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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 March 31, 2014 and December 31, 2013.

	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2014	Value		Losses		Value		Losses		Value		Losses
U.S. Government agencies	$	68,200	$	332	$	0	$	0	$	68,200	$	332
Obligations of states and political subdivisions		62,254		2,289		9,638		247		71,892		2,536
Agency residential mortgage-backed securities		825,040		13,335		8,439		336		833,479		13,671
Non-agency residential mortgage-backed securities		534		3		0		0		534		3
Other structured financial products		0		0		11,419		13,619		11,419		13,619
Other debt securities		0		0		6,477		569		6,477		569
Other equity securities		19,322		178		1,577		889		20,899		1,067
	$	975,350	$	16,137	$	37,550	$	15,660	$	1,012,900	$	31,797


	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2013	Value		Losses		Value		Losses		Value		Losses
U.S. Government agencies	$	68,111	$	422	$	0	$	0	$	68,111	$	422
Obligations of states and political subdivisions		73,895		3,910		7,025		165		80,920		4,075
Agency residential mortgage-backed securities		1,030,987		20,104		0		0		1,030,987		20,104
Non-agency residential mortgage-backed securities		530		8		0		0		530		8
Other structured financial products		0		0		11,297		13,741		11,297		13,741
Other debt securities		0		0		6,476		557		6,476		557
Other equity securities		19,111		286		1,619		897		20,730		1,183
	$	1,192,634	$	24,730	$	26,417	$	15,360	$	1,219,051	$	40,090

Non-agency residential mortgage-backed securities. At March 31, 2014, Susquehanna held one security that had unrealized losses, but was not rated below investment grade. None of Susquehanna’s non-agency residential mortgage-backed securities were backed by loans identified by the issuer as subprime or Alt-A collateral. Management has analyzed the collateral underlying these securities with respect to defaults, loan to collateral value ratios, current levels of subordination, and geographic concentrations and concluded that none of these securities are other-than-temporarily impaired.

Susquehanna recorded other-than-temporary impairment losses as presented in the following table:

Credit Losses on Non-agency Residential Mortgage-backed and Other Equity Securities for which a
Portion of an Other-than-temporary Impairment was Recognized in Other Comprehensive Income

				Three Months Ended
				March 31,
				2014		2013
	Balance - beginning of period			$	609	$	1,280
	Additions:
		Amount related to credit losses for which an other-than-temporary
			impairment was not previously recognized		0		325
		Additional amount related to credit losses for which an other-than-
			temporary impairment was previously recognized		0		63
	Deletions:
		Realized losses			0		34
	Balance - end of period			$	609	$	1,634

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The balance at March 31, 2014 and 2013 includes other-than-temporary impairment of $609 and $512, respectively, for Other Equity Securities.

Susquehanna estimated the portion of loss attributable to credit using a discounted cash flow model. Susquehanna, in conjunction with a third-party financial advisory firm, assisted with the development of critical assumptions including the expected cash flows of the underlying collateral of the non-agency residential mortgage-backed securities 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 terms. Expected principal and interest cash flows on an other-than-temporarily impaired debt security are discounted using the effective 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 ($0 and $745 at March 31, 2014 and 2013, respectively). Significant assumptions used in the valuation of these other-than-temporarily impaired securities were as follows:

			Weighted-average (%)
			March 31,
			2014 ⁽¹⁾	2013
		Conditional repayment rate ⁽²⁾	N/A	10.3%
		Loss severity ⁽³⁾	N/A	43.0%
		Conditional default rate ⁽⁴⁾	N/A	3.8%


⁽¹⁾	Not applicable as the related securities were sold during 2013.
⁽²⁾	Conditional repayment rate represents a rate equal to the proportion of principal balance paid off voluntarily over a certain period of time on an annualized basis.

⁽³⁾	Loss severity rates are projected by considering collateral characteristics such as current loan-to-value, original creditworthiness of borrowers (FICO score) and geographic concentration.

⁽⁴⁾	Conditional default rate is an annualized rate of default on a group of mortgages, and represents the percentage of outstanding principal balances in the pool that are in default, which typically equates to the borrower being past due 60 days, 90 days, or possibly already in the foreclosure process.

Management provides input and monitors the third party valuation process of the non-agency residential mortgage-backed securities. A detailed review of the critical assumptions and inputs is performed by Susquehanna’s Corporate Investment Committee (“CIC”). Key assumptions reviewed by the CIC include prepayment assumptions, default rates, loss severity, bond waterfall payments, and the discount rate. Additionally, available market indications of similar securities are provided by Susquehanna to the third party and are given a significant weighting by the third party.

Other structured financial products. Susquehanna’s structured financial product investments are comprised of four pooled trust preferred securities which have an aggregate unrealized loss of $13,619 and $15,072 at March 31, 2014 and 2013, respectively. All of these securities are below investment grade but are of a more senior tranche of the specific issue. Susquehanna has contracted with a third party financial advisory firm (“third party firm”) to assist in its valuation and other-than-temporary impairment analysis of its structured financial product investments. In addition to the valuation work performed by a third party firm which Susquehanna utilizes to support its valuation and other-than-temporary-impairment analysis, management of Susquehanna considered Section 619 of the Dodd-Frank Act (commonly referred to as the “Volcker Rule”). Specifically, Susquehanna considered the interim final rule published by federal regulatory agencies on January 14, 2014, which indicated Susquehanna’s trust preferred securities will remain permissible holdings under the Volcker Rule.

Management has assisted with the development of, and performed a detailed review of the critical assumptions. The review of the inputs for the valuation of the pooled trust preferred securities is performed by the CIC. Key aspects reviewed by CIC include the detail on non-performing financial institutions within the pools of trust preferred securities, the probability of default of the underlying institutions within the pools, the discount rate, trades of similar securities and indexes, and the weighting given to market indications. Susquehanna management believes that the valuation analysis and methodology reasonably supports the value and projected

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

performance of the specific trust preferred securities. Management believes this valuation methodology presents an appropriate approach in the determination of other-than-temporary impairment charges in accordance with GAAP.

Using publicly available financial information, the third party firm’s valuation analysis compares the present value of the expected base cash flows with the amortized cost basis of the trust preferred securities to determine whether Susquehanna expects to receive the entire amortized cost basis of such securities. To make this comparison, the third party firm evaluates 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 production of cash flows, application of the cash flows to the percent owned, and assessment of any other-than-temporary impairment.

To determine expected cash flows, the valuation analysis considers credit default rates, call options and deferrals, waterfall structure, and covenants relating to the trust preferred securities. The trust indenture documentation and the trustee reports for each specific trust preferred security issuance provides information regarding deferral rights, call options, various triggers, (including over-collateralization triggers), and waterfall structure, which management believes is essential in determining projected base cash flows. The third party firm determines short-term default risk using ratios, including the Texas ratio, that relate to the issuers, capitalization, asset quality, profitability, and liquidity. To determine longer term default probabilities, the third party firm uses an internal scoring approach that relies on key historical financial performance ratios. Management believes that future cash flows for these securities are reasonably developed and supported.

If a collateral security is in default at the assessment date, a recovery rate specific to the issuer of the collateral security is incorporated into the expected cash flows with a twenty-four month lag in timing of receipt of those expected cash flows. The third party firm calculates a terminal default rate based upon certain key financial ratios of the active issuers in the security to all FDIC insured bank institutions. The active issuers of the collateral securities are summarized as a weighted average based on issue size according to status of deferral and default assumption. To enhance the analysis, the third party firm calculates the standard deviation across the issuers for each ratio and removes any issuer that falls more than three standard deviations above or below the average for that ratio. No recovery is incorporated into the expected cash flows for any issuers that exceed the terminal default rate. For issuers currently making interest payments and for those currently deferring interest payments, Susquehanna makes an estimate using publicly available financial information as to the likelihood and timing of any default, after which the estimated cash flow reflects a recovery rate specific to the issuer. Issuers of collateral securities that are currently deferring interest payments and not expected to default are assumed to continue to defer interest payments for twenty quarters, the full contractually permitted deferral, from the period of initial deferral.

In considering the amount and timing of expected cash flows on the pooled trust preferred securities, management considers the right of the issuers of the securities underlying the pooled trust preferred securities to call those collateral securities. Management assesses any projected exercise of the call option, incorporating changes in economic and market conditions and the impact of any change in timing of expected cash flows in the measurement of fair value and other-than-temporary impairment.

The discount rate applied to the projected cash flows for the specific class is calculated using a spread to the current swap curve. The swap curve gives a market participant perspective of the term structure of interest rates and on credit spreads. The determination of the discount rate used in Susquehanna’s valuation is based upon the referenced swap curve plus an additional credit spread based upon the credit rating of the class. Lower rated classes would have a wider implied credit spread. These multiple discount rates are then applied to the estimated cash flows in determining the estimated present value.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The present value of the expected cash flows for Susquehanna’s specific class and subordinate classes, as well as additional
information about the pooled trust preferred securities, are included in the following tables.


As of March 31, 2014		Pooled Trust #1		Pooled Trust #2		Pooled Trust #3		Pooled Trust #4
Recorded investment		$	3,000	$	7,177	$	8,111	$	6,750
Fair value			1,104		3,793		4,142		2,380
Unrealized loss			(1,896)		(3,384)		(3,969)		(4,370)
Class		B		B		B		A2L
Class face value		$	35,000	$	59,724	$	89,652	$	45,500
Present value of expected cash flows
	for class noted above and all
	subordinated classes ⁽¹⁾	$	190,364	$	200,462	$	327,975	$	160,914
Lowest credit rating assigned		D		Ca		Caa2		Ca
Original collateral		$	623,984	$	501,470	$	700,535	$	487,680
Performing collateral			393,342		318,814		476,546		255,600
Actual defaults			47,400		51,580		44,000		73,500
Actual deferrals			28,500		79,430		77,650		93,080
Projected future defaults			24,970		42,179		41,438		34,065
Actual defaults as a % of original
	collateral		7.6%		10.3%		6.3%		15.1%
Actual deferrals as a % of original
	collateral ⁽²⁾		4.6%		15.8%		11.1%		19.1%
Actual defaults and deferrals as a % of
	original collateral		12.2%		26.1%		17.4%		34.2%
Projected future defaults as a % of
	original collateral ⁽³⁾		4.0%		8.4%		5.9%		7.0%
Actual institutions deferring and
	defaulted as a % of total institutions		16.9%		31.5%		21.9%		40.6%
Projected future defaults as a % of
	performing collateral plus
	deferrals		5.9%		10.6%		7.5%		9.8%

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

As of March 31, 2013		Pooled Trust #1		Pooled Trust #2		Pooled Trust #3		Pooled Trust #4
Recorded investment		$	3,000	$	7,183	$	8,116	$	6,750
Fair value			1,245		3,068		3,444		2,220
Unrealized loss			(1,755)		(4,115)		(4,672)		(4,530)
Class		B		B		B		A2L
Class face value		$	35,000	$	58,922	$	88,670	$	45,500
Present value of expected cash flows
	for class noted above and all
	subordinated classes ⁽¹⁾	$	150,775	$	178,443	$	308,449	$	147,139
Lowest credit rating assigned		D		Ca		Ca		Ca
Original collateral		$	623,984	$	501,470	$	700,535	$	487,680
Performing collateral			361,842		295,080		484,731		281,600
Actual defaults			30,000		51,580		44,000		77,100
Actual deferrals			77,400		125,810		96,150		93,080
Projected future defaults			61,045		53,910		47,105		42,053
Actual defaults as a % of original
	collateral		4.8%		10.3%		6.3%		15.8%
Actual deferrals as a % of original
	collateral ⁽²⁾		12.4%		25.1%		13.7%		19.1%
Actual defaults and deferrals as a % of
	original collateral		17.2%		35.4%		20.0%		34.9%
Projected future defaults as a % of
	original collateral ⁽³⁾		9.8%		10.8%		6.7%		8.6%
Actual institutions deferring and
	defaulted as a % of total institutions		18.5%		37.5%		25.4%		41.8%
Projected future defaults as a % of
	performing collateral plus
	deferrals		13.9%		12.8%		8.1%		11.2%

⁽¹⁾	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. As of March 31, 2014 and 2013, the present value of the current estimated cash flows is equal to or greater than the book value of the trust preferred securities held. Consequently, there is no credit-related other-than-temporary impairment required to be recognized.




⁽²⁾	Includes current interest deferrals for the quarter for those institutions deferring as of the date of the assessment of the other-than-temporary impairment. Current deferrals are assumed to continue for twenty quarters, the full contractually permitted deferral period, if the institutions are not projected to default prior to that time.



⁽³⁾	Includes those institutions that are performing but are not projected to continue to perform and includes those institutions that are currently deferring interest that are projected to default, based upon third-party proprietary valuation methodology used to determine future defaults. Creditworthiness of each underlying issue in the collateralized debt obligation is determined using publicly available data.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 3. Loans and Leases

Originated loans and leases is defined to exclude loans purchased in business combinations since September 30, 2011, and purchased loans and leases is defined to include those loans and leases excluded from the definition of originated loans.

Loans and Leases, Net of Deferred Costs and Fees
				March 31,		December 31,
				2014		2013
	Commercial, financial, and agricultural			$	2,411,851	$	2,394,847
	Real estate - construction				714,291		735,877
	Real estate secured - residential				4,178,505		4,204,430
	Real estate secured - commercial				4,041,989		4,068,816
	Consumer				955,577		953,000
	Leases				1,273,082		1,219,116
			Total loans and leases	$	13,575,295	$	13,576,086

	Originated loans and leases			$	11,994,018	$	11,930,946
	Purchased loans and leases				1,581,277		1,645,140
			Total loans and leases	$	13,575,295	$	13,576,086

	Nonaccrual loans and leases			$	108,408	$	100,815
	Loans and leases contractually past due 90 days
		and still accruing			9,328		9,757
	Troubled debt restructurings				39,555		72,133
	Deferred origination costs, net of fees				23,099		21,216
	All overdrawn deposit accounts, reclassified
		as loans and evaluated for collectability			2,992		2,918

	A summary of our net investment in direct lease financing is presented below.

Net Investment in Direct Financing Leases
				March 31,		December 31,
				2014		2013
		Minimum lease payments receivable		$	672,605	$	667,365
		Estimated residual value of leases			684,024		634,875
		Unearned income under lease contracts			(83,547)		(83,124)
			Total leases	$	1,273,082	$	1,219,116

Susquehanna monitors the credit quality of its commercial loan portfolio using internal risk ratings. These risk ratings are consistent with established regulatory guidance. Loans with a Pass rating represent those not considered a problem credit. Special mention loans are those that have a potential weakness deserving management’s careful attention. Substandard loans are those where a well-defined weakness has been identified that may put the complete receipt of contractual cash flows at risk. Substandard loans are placed in nonaccrual status when Susquehanna believes it is no longer probable it will collect all contractual cash flows.

Susquehanna reviews the loan gradings on an annual basis or at any time management becomes aware of the potential for not collecting all contractual cash flows. Significant credits with ratings of special mention or substandard, and associated with a relationship greater than $5.0 million, are reviewed quarterly by the Senior Credit Staff of Susquehanna Bank.

Susquehanna monitors the credit quality of its retail loan portfolio based primarily on delinquency status, which is the primary factor considered in determining whether a retail loan should be classified as nonaccrual.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following tables present Susquehanna's credit quality indicators by internally assigned grading and by payment activity at
March 31, 2014 and December 31, 2013.

Credit Quality Indicators, at March 31, 2014

	Commercial Credit Exposure
		Credit-risk Profile by Internally Assigned Grade

								Real Estate -		Total
						Real Estate -		Secured -		Commercial
				Commercial		Construction ⁽¹⁾		Commercial ⁽²⁾		Credit Exposure
Originated loans and leases
	Grade:
		Pass ⁽³⁾		$	2,135,322	$	487,431	$	3,611,171	$	6,233,924
		Special mention ⁽⁴⁾			76,982		20,625		162,210		259,817
		Substandard ⁽⁵⁾			79,490		37,585		208,667		325,742
			Total	$	2,291,794	$	545,641	$	3,982,048	$	6,819,483
Purchased loans and leases
	Grade:
		Pass ⁽³⁾		$	107,856	$	27,075	$	724,392	$	859,323
		Special mention ⁽⁴⁾			4,529		20,391		56,434		81,354
		Substandard ⁽⁵⁾			7,672		14,647		131,921		154,240
			Total	$	120,057	$	62,113	$	912,747	$	1,094,917
Total loans and leases
	Grade:
		Pass ⁽³⁾		$	2,243,178	$	514,506	$	4,335,563	$	7,093,247
		Special mention ⁽⁴⁾			81,511		41,016		218,644		341,171
		Substandard ⁽⁵⁾			87,162		52,232		340,588		479,982
			Total	$	2,411,851	$	607,754	$	4,894,795	$	7,914,400

	Other Credit Exposure
		Credit-risk Profile based on Payment Activity

				Real Estate -
				Secured -						Total Other
				Residential		Consumer		Leases		Credit Exposure
Originated loans and leases
	Performing			$	2,935,157	$	948,378	$	1,271,858	$	5,155,393
	Nonperforming ⁽⁶⁾				17,163		755		1,224		19,142
		Total		$	2,952,320	$	949,133	$	1,273,082	$	5,174,535

Purchased loans and leases
	Performing			$	471,387	$	6,444	$	0	$	477,831
	Nonperforming ⁽⁶⁾				8,529		0		0		8,529
		Total		$	479,916	$	6,444	$	0	$	486,360

Total loans and leases
	Performing			$	3,406,544	$	954,822	$	1,271,858	$	5,633,224
	Nonperforming ⁽⁶⁾				25,692		755		1,224		27,671
		Total		$	3,432,236	$	955,577	$	1,273,082	$	5,660,895

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Credit Quality Indicators, at December 31, 2013

	Commercial Credit Exposure
		Credit-risk Profile by Internally Assigned Grade
								Real Estate -		Total
						Real Estate -		Secured -		Commercial
				Commercial		Construction ⁽¹⁾		Commercial ⁽²⁾		Credit Exposure
Originated loans and leases
	Grade:
		Pass ⁽³⁾		$	2,133,884	$	478,097	$	3,658,875	$	6,270,856
		Special mention ⁽⁴⁾			75,162		33,907		168,464		277,533
		Substandard ⁽⁵⁾			60,168		30,583		194,799		285,550
			Total	$	2,269,214	$	542,587	$	4,022,138	$	6,833,939
Purchased loans and leases
	Grade:
		Pass ⁽³⁾		$	108,898	$	25,070	$	750,241	$	884,209
		Special mention ⁽⁴⁾			4,220		19,811		62,208		86,239
		Substandard ⁽⁵⁾			12,515		22,247		130,408		165,170
			Total	$	125,633	$	67,128	$	942,857	$	1,135,618
Total loans and leases
	Grade:
		Pass ⁽³⁾		$	2,242,782	$	503,167	$	4,409,116	$	7,155,065
		Special mention ⁽⁴⁾			79,382		53,718		230,672		363,772
		Substandard ⁽⁵⁾			72,683		52,830		325,207		450,720
			Total	$	2,394,847	$	609,715	$	4,964,995	$	7,969,557

	Other Credit Exposure
		Credit-risk Profile based on Payment Activity

				Real Estate -
				Secured -						Total Other
				Residential		Consumer		Leases		Credit Exposure
Originated loans and leases
	Performing			$	2,914,547	$	945,379	$	1,217,629	$	5,077,555
	Nonperforming ⁽⁶⁾				16,937		1,028		1,487		19,452
		Total		$	2,931,484	$	946,407	$	1,219,116	$	5,097,007

Purchased loans and leases
	Performing			$	491,922	$	6,591	$	0	$	498,513
	Nonperforming ⁽⁶⁾				11,007		2		0		11,009
		Total		$	502,929	$	6,593	$	0	$	509,522

Total loans and leases
	Performing			$	3,406,469	$	951,970	$	1,217,629	$	5,576,068
	Nonperforming ⁽⁶⁾				27,944		1,030		1,487		30,461
		Total		$	3,434,413	$	953,000	$	1,219,116	$	5,606,529

⁽¹⁾	Includes only construction loans granted to commercial customers. Construction loans for individuals are included in Real Estate – Secured – Residential, below.
⁽²⁾	Includes loans obtained for commercial purposes that are also secured by residential real estate.
⁽³⁾	Includes loans identified as having acceptable risk, which are loans for which the possibility of loss is considered unlikely.
⁽⁴⁾	Includes loans considered potentially weak; however, no loss of principal or interest is anticipated.
⁽⁵⁾	Includes loans that are inadequately protected by the current net-worth and paying capacity of the borrower or by the collateral pledged, if any. Loss of principal or interest is considered reasonably possible or likely.

⁽⁶⁾	Includes loans that are on non-accrual status or past due ninety days or more.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following tables detail the age analysis of Susquehanna's past due financing receivables as of March 31, 2014 and December 31, 2013.

Age Analysis of Past Due Financing Receivables, as of March 31, 2014

	Financing Receivables that are Accruing

												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	6,951	$	1,246	$	39	$	8,236	$	2,379,086	$	2,387,322
Real estate - construction			2,983		84		183		3,250		699,346		702,596
Real estate secured - residential			18,720		4,689		7,116		30,525		4,124,791		4,155,316
Real estate secured - commercial			3,982		4,007		1,055		9,044		3,984,995		3,994,039
Consumer			8,921		770		710		10,401		945,130		955,531
Leases			4,474		235		225		4,934		1,267,149		1,272,083
	Total	$	46,031	$	11,031	$	9,328	$	66,390	$	13,400,497	$	13,466,887

Originated loans and leases		$	40,442	$	10,823	$	6,566	$	57,831	$	11,847,446	$	11,905,277
Purchased loans and leases			5,589		208		2,762		8,559		1,553,051		1,561,610
	Total	$	46,031	$	11,031	$	9,328	$	66,390	$	13,400,497	$	13,466,887

	Financing Receivables that are Nonaccruing

												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	394	$	135	$	10,094	$	10,623	$	13,906	$	24,529
Real estate - construction			836		0		4,492		5,328		6,367		11,695
Real estate secured - residential			1,974		202		15,794		17,970		5,219		23,189
Real estate secured - commercial			1,176		5,777		23,649		30,602		17,348		47,950
Consumer			0		11		0		11		35		46
Leases			0		87		291		378		621		999
	Total	$	4,380	$	6,212	$	54,320	$	64,912	$	43,496	$	108,408

Originated loans and leases		$	4,209	$	2,023	$	43,875	$	50,107	$	38,634	$	88,741
Purchased loans and leases			171		4,189		10,445		14,805		4,862		19,667
	Total	$	4,380	$	6,212	$	54,320	$	64,912	$	43,496	$	108,408

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Age Analysis of Past Due Financing Receivables, as of December 31, 2013

	Financing Receivables that are Accruing

												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	3,640	$	518	$	127	$	4,285	$	2,373,735	$	2,378,020
Real estate - construction			1,631		903		418		2,952		719,695		722,647
Real estate secured - residential			27,441		6,223		7,274		40,938		4,140,127		4,181,065
Real estate secured - commercial			11,583		1,840		667		14,090		4,008,579		4,022,669
Consumer			8,664		1,537		983		11,184		941,769		952,953
Leases			4,275		368		288		4,931		1,212,986		1,217,917
	Total	$	57,234	$	11,389	$	9,757	$	78,380	$	13,396,891	$	13,475,271

Originated loans and leases		$	46,031	$	9,381	$	7,302	$	62,714	$	11,787,333	$	11,850,047
Purchased loans and leases			11,203		2,008		2,455		15,666		1,609,558		1,625,224
	Total	$	57,234	$	11,389	$	9,757	$	78,380	$	13,396,891	$	13,475,271

	Financing Receivables that are Nonaccruing

												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	4,832	$	855	$	4,850	$	10,537	$	6,290	$	16,827
Real estate - construction			2,176		788		5,320		8,284		4,946		13,230
Real estate secured - residential			609		497		16,518		17,624		5,741		23,365
Real estate secured - commercial			1,320		3,551		19,952		24,823		21,324		46,147
Consumer			0		0		0		0		47		47
Leases			0		199		148		347		852		1,199
	Total	$	8,937	$	5,890	$	46,788	$	61,615	$	39,200	$	100,815

Originated loans and leases		$	8,205	$	3,806	$	39,553	$	51,564	$	29,335	$	80,899
Purchased loans and leases			732		2,084		7,235		10,051		9,865		19,916
	Total	$	8,937	$	5,890	$	46,788	$	61,615	$	39,200	$	100,815

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following tables provide information about Susquehanna’s impaired loans, including principal balance, recorded investment, and related specific allowance amounts at the dates indicated. Loans with no specific allowance for loan losses have adequate collateral securing their carrying value and in some circumstances have been charged down to their current carrying value based on the fair value of the collateral less selling costs.

Impaired Loans at March 31, 2014

													Average
						Recorded							Recorded
				Unpaid		Investment							Investment		Interest
				Principal		in Impaired			Related		Related		in Impaired		Income
				Balance		Loans			Charge-offs		Allowance		Loans ⁽²⁾		Recognized
Impaired loans without a related reserve:
	Commercial, financial, and agricultural			$	24,237	$	21,076		$	3,161			$	24,653	$	331
	Real estate - construction				17,642		14,005			3,637				14,105		121
	Real estate secured - residential				25,256		24,593			663				26,881		284
	Real estate secured - commercial				124,145		105,620			18,525				117,643		1,898
	Consumer				0		0			0				0		0
		Total impaired loans without a
			related reserve		191,280		165,294	⁽¹⁾		25,986				183,282		2,634
Impaired loans with a related reserve:
	Commercial, financial, and agricultural				12,496		11,511			985	$	10,382		5,893		154
	Real estate - construction				11,031		3,117			7,914		875		5,831		228
	Real estate secured - residential				22,208		19,862			2,346		2,679		35,273		554
	Real estate secured - commercial				21,383		11,674			9,709		2,098		16,546		325
	Consumer				1,122		1,122			0		121		2,042		56
		Total impaired loans with a
			related reserve		68,240		47,286			20,954		16,155		65,585		1,317
Total impaired loans:
	Commercial, financial, and agricultural				36,733		32,587			4,146		10,382		30,546		485
	Real estate - construction				28,673		17,122			11,551		875		19,936		349
	Real estate secured - residential				47,464		44,455			3,009		2,679		62,154		838
	Real estate secured - commercial				145,528		117,294			28,234		2,098		134,189		2,223
	Consumer				1,122		1,122			0		121		2,042		56
			Total impaired loans	$	259,520	$	212,580		$	46,940	$	16,155	$	248,867	$	3,951

Impaired loans without a related reserve:
	Originated loans and leases			$	80,827	$	58,013		$	22,814			$	65,341	$	749
	Purchased loans and leases				110,453		107,281			3,172				117,941		1,885
		Total impaired loans without a
			related reserve		191,280		165,294			25,986				183,282		2,634
Impaired loans with a related reserve:
	Originated loans and leases				57,168		37,496			19,672	$	14,428		55,735		1,171
	Purchased loans and leases				11,072		9,790			1,282		1,727		9,850		146
		Total impaired loans with a
			related reserve		68,240		47,286			20,954		16,155		65,585		1,317
Total impaired loans:
	Originated loans and leases				137,995		95,509			42,486		14,428		121,076		1,920
	Purchased loans and leases ⁽³⁾				121,525		117,071			4,454		1,727		127,791		2,031
			Total impaired loans	$	259,520	$	212,580		$	46,940	$	16,155	$	248,867	$	3,951

⁽¹⁾	$64,606 of the $165,294 total impaired loans without a related reserve represents loans that had been written down to the fair value of the underlying collateral adjusted for selling costs through direct charge-offs of $25,986.

⁽²⁾	Average recorded investment in impaired loans is calculated on a quarterly basis using daily balances.
⁽³⁾	$9,790 of the $117,071 purchased impaired loans were subsequently impaired after being acquired.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Impaired Loans at December 31, 2013

													Average
						Recorded							Recorded
				Unpaid		Investment							Investment		Interest
				Principal		in Impaired			Related		Related		in Impaired		Income
				Balance		Loans			Charge-offs		Allowance		Loans ⁽²⁾		Recognized
Impaired loans without a related reserve:
	Commercial, financial, and agricultural			$	31,196	$	28,034		$	3,162			$	29,316	$	390
	Real estate - construction				17,851		14,215			3,636				14,715		140
	Real estate secured - residential				28,308		27,645			663				27,800		297
	Real estate secured - commercial				143,664		125,139			18,525				125,003		2,076
	Consumer				0		0			0				14		0
		Total impaired loans without a
			related reserve		221,019		195,033	⁽¹⁾		25,986				196,848		2,903
Impaired loans with a related reserve:
	Commercial, financial, and agricultural				6,864		5,879			985	$	3,008		5,893		154
	Real estate - construction				15,202		7,288			7,914		1,819		5,831		228
	Real estate secured - residential				37,499		35,153			2,346		4,753		35,273		554
	Real estate secured - commercial				27,238		17,529			9,709		3,827		16,546		325
	Consumer				1,992		1,992			0		218		2,042		56
		Total impaired loans with a
			related reserve		88,795		67,841			20,954		13,625		65,585		1,317
Total impaired loans:
	Commercial, financial, and agricultural				38,060		33,913			4,147		3,008		35,209		544
	Real estate - construction				33,053		21,503			11,550		1,819		20,546		368
	Real estate secured - residential				65,807		62,798			3,009		4,753		63,073		851
	Real estate secured - commercial				170,902		142,668			28,234		3,827		141,549		2,401
	Consumer				1,992		1,992			0		218		2,056		56
			Total impaired loans	$	309,814	$	262,874		$	46,940	$	13,625	$	262,433	$	4,220

Impaired loans without a related reserve:
	Originated loans and leases			$	88,900	$	66,086		$	22,814			$	65,341	$	749
	Purchased loans and leases				132,119		128,947			3,172				131,507		2,154
		Total impaired loans without a
			related reserve		221,019		195,033			25,986				196,848		2,903
Impaired loans with a related reserve:
	Originated loans and leases				78,015		58,343			19,672	$	11,612		55,881		1,172
	Purchased loans and leases				10,780		9,498			1,282		2,013		9,704		145
		Total impaired loans with a
			related reserve		88,795		67,841			20,954		13,625		65,585		1,317
Total impaired loans:
	Originated loans and leases				166,915		124,429			42,486		11,612		121,222		1,921
	Purchased loans and leases ⁽³⁾				142,899		138,445			4,454		2,013		141,211		2,299
			Total impaired loans	$	309,814	$	262,874		$	46,940	$	13,625	$	262,433	$	4,220

⁽¹⁾	$43,363 of the $195,033 total impaired loans without a related reserve represents loans that had been written down to the fair value of the underlying collateral adjusted for selling costs through direct charge-offs of $25,986.

⁽²⁾	Average recorded investment in impaired loans is calculated on a quarterly basis using daily balances.
⁽³⁾	$9,498 of the $138,445 purchased impaired loans were subsequently impaired after being acquired.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following table presents Troubled Debt Restructurings (TDR's), by class segment:

				March 31,		December 31,
				2014		2013
		Commercial, financial, and agricultural		$	5,264	$	6,885
		Real estate - construction			325		615
		Real estate secured - residential			16,168		31,623
		Real estate secured - commercial			16,681		31,295
		Consumer			1,117		1,715
			Total performing TDRs		39,555		72,133
		Non-performing TDRs ⁽¹⁾			20,884		22,676
			Total TDRs	$	60,439	$	94,809

		Performing TDRs			65%		76%
		Non-performing TDRs			35%		24%

⁽¹⁾	These loans are included in the 90 day past due and non-accrual categories.

	The following table provides detail of TDR balance and activity for the periods presented:

		Three months ended
		March 31,
		2014		2013
Performing TDRs, beginning of period		$	72,133	$	67,775
	New restructurings as TDRs		870		17,882
	Repayments and payoffs		(439)		(2,237)
	Charge-offs after restructuring		(415)		(121)
	Transfer to nonaccrual, past due 90 days or greater, non-performing TDRs		(4,440)		(4,830)
	Transfer out of TDR status ⁽¹⁾		(28,155)		(12,341)
	Other, net ⁽²⁾		1		(355)
Performing TDRs, end of period		$	39,555	$	65,773

Non-performing TDRs ⁽³⁾, end of period		$	20,884	$	25,808

Performing TDRs			65%		72%
Non-performing TDRs			35%		28%

⁽¹⁾	Loans that have performed in accordance with the renegotiated terms for a minimum of six consecutive months with payments and at the time of renegotiation the loan's interest rate represented a then current market interest rate for a loan of similar risk.

⁽²⁾	Includes $203 transferred to OREO in 2013.
⁽³⁾	Included in Age Analysis of Past Due Financing Receivables.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following tables present Susquehanna’s loan modification activities that were considered troubled debt restructurings for the three month periods ended March 31, 2014 and 2013.

			Recorded Investment
						Post-		Financial Effect of
				Pre-Modification		Modification		Modification
			Number of	Recorded		Recorded		Recorded
Three months ended March 31, 2014			Loans	Investment		Investment		Investment⁽¹⁾		Interest ⁽²⁾
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	6	$	102	$	102	$	0	$	0
		Combination of modification types	0		0		0		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	6		450		450		0		0
		Combination of modification types	3		307		307		0		(16)
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	0		0		0		0		0
	Consumer
		Bankruptcies and maturity date extensions	2		11		11		0		0
		Combination of modification types	0		0		0		0		0
	Total		17	$	870	$	870	$	0	$	(16)

Originated loans and leases			16	$	804	$	804	$	0	$	(16)
Purchased loans and leases			1		66		66		0		0
	Total		17	$	870	$	870	$	0	$	(16)

⁽¹⁾	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
⁽²⁾	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.

					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			8	$	1,029
		Real estate - construction			0		0
		Real estate secured - residential			6		218
		Real estate secured - commercial			4		2,599
		Consumer			15		123
		Total			33	$	3,969

Originated loans and leases					30	$	1,443
Purchased loans and leases					3		2,526
		Total			33	$	3,969

			Recorded Investment
						Post-		Financial Effect of
				Pre-Modification		Modification		Modification
			Number of	Recorded		Recorded		Recorded
Three months ended March 31, 2013			Loans	Investment		Investment		Investment⁽¹⁾		Interest ⁽²⁾
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	16	$	7,493	$	7,493	$	0	$	0
		Combination of modification types	0		0		0		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	1		20		20		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	59		5,412		5,412		0		0
		Combination of modification types	7		1,316		1,316		0		(128)
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	7		1,549		1,549		0		0
		Combination of modification types	1		1,436		1,436		0		(196)
	Consumer
		Bankruptcies and maturity date extensions	87		656		656		0		0
		Combination of modification types	0		0		0		0		0
	Total		178	$	17,882	$	17,882	$	0	$	(324)

Originated loans and leases			170	$	16,149	$	16,149	$	0	$	(281)
Purchased loans and leases			8		1,733		1,733		0		(43)
	Total		178	$	17,882	$	17,882	$	0	$	(324)

⁽¹⁾	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
⁽²⁾	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.

					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			5	$	653
		Real estate - construction			1		20
		Real estate secured - residential			5		404
		Real estate secured - commercial			2		341
		Consumer			18		139
		Total			31	$	1,557

Originated loans and leases					28	$	1,357
Purchased loans and leases					3		200
		Total			31	$	1,557

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The unpaid principal balance and the related carrying amount of acquired loans are as follows:

				March 31,		December 31,
				2014		2013
	Credit impaired purchased loans evaluated individually for
		incurred credit losses
			Unpaid principal balance	$	146,884	$	176,351
			Carrying amount		117,071		138,445

	Other purchased loans evaluated collectively for incurred credit
		losses
			Unpaid principal balance		1,464,884		1,509,870
			Carrying amount		1,464,206		1,506,695

	Total purchased loans
			Unpaid principal balance		1,611,768		1,686,221
			Carrying amount		1,581,277		1,645,140

	The changes in the accretable discount related to the purchased credit impaired loans are as follows:

		Three Months Ended
		March 31,
		2014		2013
Balance - beginning of period		$	46,219	$	62,868
	Accretion recognized during the period		(3,161)		(6,570)
	Net reclassification from non-accretable to accretable		0		2,519
Balance - end of period		$	43,058	$	58,817

NOTE 4. Allowance for Loan and Lease Losses

In establishing the allowance for credit losses, Susquehanna estimates losses attributable to specific impaired credits identified through the credit review processes and also estimates losses inherent in other loans and leases on a collective basis. For purposes of determining the level of the allowance for credit losses, Susquehanna evaluates its loan and lease portfolio by loan type. The losses provisioned for in Susquehanna’s allowance for loan loss is determined through a loan by loan analysis of larger balance commercial and commercial real estate loans that show signs of credit deterioration and by applying loss factors to groups of loan balances based on loan type and management’s classification of such loans under the Susquehanna’s loan grading system, adjusted for qualitative considerations. In determining the allowance for credit losses, Susquehanna utilizes an internal loan grading system for its commercial portfolio. The internal loan gradings are monitored by Susquehanna’s loan review department. Additionally, loans that are part of a relationship of over $1.0 million and have a rating of substandard, special mention, and pass that are on the company’s watch list, are reviewed on a quarterly basis at Susquehanna’s Loan Quality Review Committee. Factors considered at the Loan Quality Review meetings include the financial statements of the borrower, the borrower’s global cash flow, guarantees, and underlying collateral valuations.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		An analysis of the allowance for loan and lease losses for the three months ended March 31, 2014 and 2013 are presented in the
following tables:

				Three Months Ended March 31, 2014
								Real Estate		Real Estate
						Real Estate -		Secured -		Secured -
				Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at January 1, 2014				$	40,590	$	26,189	$	24,076	$	48,261	$	2,266	$	15,259	$	967	$	157,608
	Charge-offs				(4,514)		(291)		(3,830)		(2,607)		(1,238)		(920)		0		(13,400)
	Recoveries				1,332		382		1,034		473		383		338		0		3,942
	Provision				10,608		(4,562)		798		(1,641)		686		111		0		6,000
Balance at March 31, 2014				$	48,016	$	21,718	$	22,078	$	44,486	$	2,097	$	14,788	$	967	$	154,150

Balance at March 31, 2014
	Individually evaluated for impairment:
		Originated loans and leases		$	10,356	$	875	$	2,284	$	793	$	120	$	0			$	14,428
		Purchased loans and leases			26		0		395		1,305		1		0				1,727
			Total	$	10,382	$	875	$	2,679	$	2,098	$	121	$	0			$	16,155

	Collectively evaluated for impairment:
		Originated loans and leases		$	37,634	$	20,843	$	19,399	$	42,388	$	1,976	$	14,788	$	967	$	137,995
		Purchased loans and leases			0		0		0		0		0		0		0		0
			Total	$	37,634	$	20,843	$	19,399	$	42,388	$	1,976	$	14,788	$	967	$	137,995

Financing receivables:
Balance at March 31, 2014				$	2,411,851	$	714,291	$	4,178,505	$	4,041,989	$	955,577	$	1,273,082			$	13,575,295

Balance at March 31, 2014
	Individually evaluated for impairment:
		Originated loans and leases		$	22,192	$	6,301	$	23,669	$	42,239	$	1,108	$	0			$	95,509
		Purchased loans and leases			10,395		10,821		20,786		75,055		14		0				117,071
			Total	$	32,587	$	17,122	$	44,455	$	117,294	$	1,122	$	0			$	212,580

	Collectively evaluated for impairment:
		Originated loans and leases		$	2,244,677	$	645,380	$	3,535,917	$	3,251,428	$	948,025	$	1,273,082			$	11,898,509
		Purchased loans and leases			134,587		51,789		598,133		673,267		6,430		0				1,464,206
			Total	$	2,379,264	$	697,169	$	4,134,050	$	3,924,695	$	954,455	$	1,273,082			$	13,362,715

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

				Three Months Ended March 31, 2013
								Real Estate		Real Estate
						Real Estate -		Secured -		Secured -
				Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at January 1, 2013				$	30,207	$	25,171	$	41,276	$	70,053	$	3,722	$	13,341	$	250	$	184,020
	Charge-offs				(10,037)		(4,763)		(3,013)		(4,603)		(558)		(1,119)		0		(24,093)
	Recoveries				1,996		462		651		722		322		297		0		4,450
	Provision				8,296		4,679		(2,372)		805		(489)		1,195		(114)		12,000
Balance at March 31, 2013				$	30,462	$	25,549	$	36,542	$	66,977	$	2,997	$	13,714	$	136	$	176,377

Balance at March 31, 2013
	Individually evaluated for impairment:
		Originated loans and leases		$	3,382	$	719	$	2,475	$	3,981	$	0	$	0			$	10,557
		Purchased loans and leases			47		13		1,214		79		0		0				1,353
			Total	$	3,429	$	732	$	3,689	$	4,060	$	0	$	0			$	11,910

	Collectively evaluated for impairment:
		Originated loans and leases		$	27,033	$	24,817	$	32,853	$	62,917	$	2,997	$	13,714	$	136	$	164,467
		Purchased loans and leases			0		0		0		0		0		0		0		0
			Total	$	27,033	$	24,817	$	32,853	$	62,917	$	2,997	$	13,714	$	136	$	164,467

Financing receivables:
Balance at March 31, 2013				$	2,312,660	$	779,344	$	4,077,810	$	3,971,438	$	859,664	$	998,787			$	12,999,703

Balance at March 31, 2013
	Individually evaluated for impairment:
		Originated loans and leases		$	18,015	$	17,275	$	29,108	$	57,183	$	0	$	0			$	121,581
		Purchased loans and leases			15,959		11,116		25,289		104,051		110		0				156,525
			Total	$	33,974	$	28,391	$	54,397	$	161,234	$	110	$	0			$	278,106

	Collectively evaluated for impairment:
		Originated loans and leases		$	2,113,397	$	637,787	$	3,150,965	$	3,125,247	$	850,534	$	998,787			$	10,876,717
		Purchased loans and leases			165,289		113,166		872,448		684,957		9,020		0				1,844,880
			Total	$	2,278,686	$	750,953	$	4,023,413	$	3,810,204	$	859,554	$	998,787			$	12,721,597

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 5. Goodwill

Goodwill is allocated to Susquehanna’s reporting units at the date the goodwill is initially recorded. Once goodwill has been allocated to the reporting units, it generally no longer retains its identification with a particular acquisition, but instead becomes identified with the reporting unit as a whole. As a result, all of the fair value of each reporting unit is available to support the value of goodwill allocated to the unit. Goodwill impairment testing is performed at the reporting unit level, one level below the business segment.

The goodwill impairment analysis is done in two steps. The first step requires a comparison of the fair value of the individual reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and no further analysis is necessary. If the carrying value of the reporting unit exceeds the fair value, there is an indication of potential impairment and a second step of testing is performed to measure the amount of impairment, if any, for the reporting unit.

Susquehanna assesses goodwill for impairment on an annual basis, or more often if events or circumstances indicate that goodwill may be impaired. This assessment requires significant judgment and analysis.

Susquehanna will perform its 2014 annual goodwill impairment assessments during the second quarter of 2014.

Bank Reporting Unit

Goodwill assigned to the bank reporting unit at the annual assessment date of May 31, 2013 was $1,165,200. Fair value of the bank reporting unit was determined using a market approach, which uses prices and other relevant information reported for market transactions involving recent non-distressed sales of comparable financial institutions in the United States, with particular consideration given to transactions within Susquehanna’s market, to value the bank reporting unit. In 2013, Susquehanna increased the number of key ratios in measuring the fair value of the bank reporting unit from two to three, adding a price to earnings ratio. The addition of the price to earnings ratio, and its corresponding use in valuations, is appropriate given the return to more normalized profitability of the banking industry, as a whole, from the economic downturn experienced during the past several years. The following table shows the ratios used at May 31, 2013.

		Annual
Ratio		May 31, 2013
Price to book		1.57x
Price to tangible book		1.80x
Price to earnings ⁽¹⁾		22.1x

⁽¹⁾	Last twelve months earnings.

Fair value of the bank reporting unit exceeded carrying value by 44.6% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is unnecessary.

Wealth Management Reporting Unit

Goodwill assigned to the wealth management reporting unit at the annual assessment date of May 31, 2013 was $82,746. Fair value of the wealth management reporting unit was determined utilizing the market approach and the income approach. The market approach measures the fair value of the reporting unit using transaction multiples reported for market transactions involving comparable wealth management business. The income approach measures the fair value of the reporting unit by converting the reporting unit’s future earnings over ten years, assuming a weighted increase in the reporting unit’s revenues and a weighted increase in the reporting unit’s expenses, to a single present (discounted) amount, based on a discount rate. In keeping with a market participant’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 May 31, 2013.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		Annual
	Factors	May 31, 2013
	Discount rate	18.4%
	Weighted-average increase in revenues	5.0%
	Weighted-average increase in expenses	3.0%

Fair value of the wealth management reporting unit exceeded carrying value by 45.9% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is unnecessary.

Property and Casualty Insurance Reporting Unit

Goodwill assigned to the property and casualty insurance reporting unit at the annual assessment date of May 31, 2013 was $17,177. Fair value of the property and casualty insurance reporting unit was determined using the market approach, which measures the fair value of the reporting unit using recent sales of comparable property and casualty insurance companies in Susquehanna’s market. Susquehanna uses two key ratios to measure the fair value of the property and casualty insurance reporting unit: average price to book and median price to earnings. The following table shows the ratios used at May 31, 2013.

		Annual
	Ratio	May 31, 2013
	Average price to book	1.15X
	Median price to earnings	18.1X

Fair value of the property and casualty insurance reporting unit exceeded carrying value by 21.7% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is not required.

NOTE 6. Deposits

	Deposits consisted of the following at March 31, 2014 and December 31, 2013:

		March 31,		December 31,
		2014		2013
Noninterest-bearing:
	Demand	$	1,880,284	$	1,913,526
Interest-bearing:
	Interest-bearing demand		2,908,507		2,909,376
	Money market		3,184,719		3,144,106
	Savings		1,132,850		1,077,923
	Time		2,166,207		2,113,209
	Time of $100 or more		1,806,956		1,711,232
Total deposits		$	13,079,523	$	12,869,372

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 7. Income Taxes

Our effective tax rate for the three months ended March 31, 2014 and 2013 was 30.0% and 31.7%, respectively. The decrease in tax rate was due to an increase in the proportion of the amount of tax-advantaged income relative to total income for the first three months of 2014, as compared to the first three months of 2013. Adjustments for tax expense (benefit) from discrete items recorded for the three months ended March 31, 2014 and 3013 impacted the effective tax rate by (0.4%) and 0.6%, respectively. The estimated annual effective rates for the reporting periods ended March 31, 2014 and 2013 were impacted by the level of permanent differences, including tax-advantaged income, Low Income Housing, and other credits, resulting in an effective rate below statutory rates for the interim reporting periods.

NOTE 8. Accumulated Other Comprehensive Loss

		The balances and changes in balances by component of accumulated other comprehensive income (loss) are shown in the
following tables:

										Unrealized				Accumulated
						Unrealized Gains (Losses) on				Gains (Losses)		Post-		Other
						Investment securities				on Cash Flow		retirement		Comprehensive
						With OTTI		All other		Hedges		Benefits		Loss
Balance, January 1, 2014						$	(279)	$	(7,195)	$	(21,683)	$	(22,409)	$	(51,566)
	AOCI before reclassifications, net of tax						0		10,309		(903)		0		9,406
	Amounts reclassified from AOCI:
			Interest expense				0		0		5,394		0		5,394
			Net realized loss (gain) on sales of securities				0		8		0		0		8
				Total before income taxes			0		8		5,394		0		5,402
				Less: Income taxes			0		(3)		(1,888)		0		(1,891)
					Net of income taxes		0		5		3,506		0		3,511
	Net change in AOCI						0		10,314		2,603		0		12,917
Balance, March 31, 2014						$	(279)	$	3,119	$	(19,080)	$	(22,409)	$	(38,649)

Balance, January 1, 2013						$	(839)	$	37,521	$	(34,636)	$	(39,304)	$	(37,258)
	AOCI before reclassifications, net of tax						(437)		(3,728)		(150)		(17)		(4,332)
	Amounts reclassified from AOCI:
			Interest expense				0		0		4,534		0		4,534
			Net realized loss (gain) on sales of securities				388		(406)		0		0		(18)
				Total before income taxes			388		(406)		4,534		0		4,516
				Less: Income taxes			(136)		142		(1,587)		0		(1,581)
					Net of income taxes		252		(264)		2,947		0		2,935
	Net change in AOCI						(185)		(3,992)		2,797		(17)		(1,397)
Balance, March 31, 2013						$	(1,024)	$	33,529	$	(31,839)	$	(39,321)	$	(38,655)

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 9. Share-based Compensation

During the three month period ended March 31, 2014, Susquehanna’s Board of Directors approved a Performance Stock Unit (“PSU”) grant. The PSU grant provides key executives with long-term incentives based on Susquehanna’s performance relative to peers, service, and market conditions, as a motivation for future performance and as a retention tool for continued employment. The PSU’s are based on a plan which is a multi-year performance plan, with stock-based incentive award opportunities if certain performance targets are met. At March 31, 2014, approximately 434 shares have been allocated for this grant.

NOTE 10. Pension and Other Postretirement Benefits

Components of Net Periodic Benefit Cost

		Three Months Ended March 31,
										Other Postretirement
		Pension Benefits				SERP				Benefits
		2014		2013		2014		2013		2014		2013
Service cost		$	0	$	1,333	$	72	$	313	$	317	$	337
Interest cost			1,923		1,794		123		102		246		217
Expected return on plan assets			(2,336)		(2,412)		0		0		0		0
Amortization of prior service cost			0		6		36		55		29		29
Amortization of transition obligation			0		0		0		0		0		2
Amortization of net actuarial loss			120		757		28		56		0		42
	Net periodic postretirement benefit cost	$	(293)	$	1,478	$	259	$	526	$	592	$	627

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2013, that it expected to contribute $559 to its pension plans and $782 to its other postretirement benefit plan in 2014. As of March 31, 2014, $140 of contributions had been made to its pension plans, and $196 of contributions had been made to its other postretirement benefit plan. Susquehanna anticipates contributing an additional $419 to fund its pension plans in 2014, for a total of $559, and an additional $586 to it other postretirement benefit plan, for a total of $782.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 11. Earnings per Common Share ("EPS")

	The following tables set forth the calculation of basic and diluted EPS for the three-month periods ended March 31, 2014
and 2013.

Basic earnings per common share
		Three Months Ended March 31,
		2014		2013
Net income applicable to common shareholders		$	37,162	$	42,399
Average common shares outstanding			187,455		186,607
Basic earnings per common share		$	0.20	$	0.23

Diluted earnings per common share
		Three Months Ended March 31,
		2014		2013
Net income available to common shareholders		$	37,162	$	42,399
Average common shares outstanding			187,455		186,607
Dilutive potential common shares			923		835
Total diluted average common shares outstanding			188,378		187,442
Diluted earnings per common share		$	0.20	$	0.23

For the three months ended March 31, 2014 and 2013, average options to purchase 1,233 and 1,586 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents were antidilutive.

NOTE 12. Derivative Financial Instruments

Risk Management Objective of Using Derivatives

Susquehanna is exposed to certain risks arising from both its business operations and economic conditions. Susquehanna manages economic risk exposures, 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. 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 impacted by changes in 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 those related to certain variable-rate liabilities. Susquehanna also has derivatives that are a result of a service it provides to certain qualifying customers. 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 interest rate risk resulting from such transactions. All derivatives are recorded at fair value.

Derivatives may expose Susquehanna to market, credit or liquidity risks in excess of the amounts recorded on the consolidated balance sheets. Market risk of a derivative is the exposure created by potential fluctuations in interest rates and other factors and is a function of the type of derivative, the tenor and terms of the agreement, and the underlying volatility. Credit risk is the exposure to loss in the event of nonperformance by the other party to the transaction where the value of any collateral held is not adequate to cover such losses. Liquidity risk is the potential exposure that arises when the size of the derivative position may not be able to be rapidly adjusted in periods of high volatility and financial stress at a reasonable cost.

All freestanding derivatives are recorded on the balance sheet at fair value.

Cash Flow Hedges of Interest Rate Risk

Susquehanna uses interest rate derivatives to manage its exposure to interest rate movements and add stability to interest income and expense. Susquehanna primarily uses interest rate swaps as part of its interest rate risk management strategy. For example, Susquehanna may issue variable-rate debt and then enter into a receive-variable pay-fixed-rate interest rate swap with the same payment timing and notional amount to convert the interest payments to a net fixed-rate basis for all or a portion of the term of the long-term debt. As of March 31, 2014, December 31, 2013, and March 31, 2013, Susquehanna had 13, 14, and 14 interest rate swaps, respectively for each period, with an aggregate notional amount of $1,119,613, $1,146,437, and $1,152,298, respectively that were designated as cash flow hedges of interest-rate risk.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Susquehanna applies hedge accounting to certain interest rate derivatives entered into for risk management purposes. To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, key aspects of achieving hedge accounting are documentation of hedging strategy and hedge effectiveness at the hedge inception and substantiating hedge effectiveness on an ongoing basis. A derivative must be highly effective in accomplishing the hedge objective of offsetting either changes in the fair value or cash flows of the hedged item for the risk being hedged. Any ineffectiveness in the hedge relationship is recognized in current earnings. The assessment of effectiveness excludes changes in the value of the hedged item that are unrelated to the risks being hedged. The effective portion of changes in the fair value of derivatives designated in a hedge relationship 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.

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 the next 12 months, Susquehanna estimates that $21,884 will be reclassified as an expense to net interest income.

Non-designated Derivatives

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.

Susquehanna does not seek to apply hedge accounting to all of the derivatives involved in Susquehanna’s risk management activities, such as the interest rate derivatives entered into to offset the derivatives offered to qualifying borrowers. Susquehanna offers qualifying commercial banking customers derivatives to enable such customers to transfer, modify or reduce their interest rate risks. The credit risk associated with derivatives entered into 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. Susquehanna actively manages the market risks from its exposure to these derivatives by entering into offsetting derivative transactions, controls focused on pricing, and reporting of positions to senior managers to minimize its exposure resulting from such transactions.

At March 31, 2014 and 2013, Susquehanna had 276 and 231 derivative transactions, respectively, related to these risk management activities with an aggregate notional amount of $1,783,804 and $1,392,430, respectively. For the three-month periods ended March 31, 2014 and 2013, Susquehanna recognized a net loss of $803 and $233, respectively, 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;

At March 31, 2014 and December 31, 2013, the fair value of derivatives in a net liability position, which includes accrued interest and any credit valuation adjustments related to these agreements, was $45,472 and $50,247, respectively. At March 31, 2014 and December 31, 2013, Susquehanna had minimum collateral posting thresholds with certain of its derivative counterparties and had posted cash collateral of $42,893 and $42,813, respectively. If Susquehanna had breached any of the above provisions at March 31, 2014, 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)

Fair Value of Derivative Instruments

		Fair Values of Derivative Instruments
		March 31, 2014
		Asset Derivatives			Liability Derivatives
		Balance Sheet			Balance Sheet
		Location	Fair Value		Location	Fair Value

Derivatives designated as hedging instruments
	Interest rate contracts	Other assets	$	1,175	Other liabilities	$	27,435
Derivatives not designated as hedging instruments
	Interest rate contracts	Other assets		22,083	Other liabilities		18,037
Total derivatives			$	23,258		$	45,472


		Fair Values of Derivative Instruments
		December 31, 2013
		Asset Derivatives			Liability Derivatives
		Balance Sheet			Balance Sheet
		Location	Fair Value		Location	Fair Value

Derivatives designated as hedging instruments
	Interest rate contracts	Other assets	$	1,419	Other liabilities	$	31,662
Derivatives not designated as hedging instruments
	Interest rate contracts	Other assets		22,897	Other liabilities		18,585
Total derivatives			$	24,316		$	50,247

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The Effect of Derivative Instruments on Comprehensive Income

Three Months Ended March 31, 2014

Location of Loss

Amount of Loss

Location of Loss

Amount of Loss

Recognized in

Amount of Gain

Reclassified from

Income

Derivatives in Cash Flow

Recognized

Accumulated OCI

(Ineffective

Hedging Relationships

in OCI

into Income

Portion)

Interest rate contracts:

2,604

Interest expense

(5,394)

Other expense

Location of Loss

Amount of Loss

Recognized

Derivatives Not Designated

in Income

as Hedging Instruments

on Derivatives

Interest rate contracts:

Other income

(803)

Other expense

Three Months Ended March 31, 2013

Location of Loss

Amount of Loss

Location of Loss

Amount of Loss

Recognized in

Amount of Gain

Reclassified from

Income

Derivatives in Cash Flow

Recognized

Accumulated OCI

(Ineffective

Hedging Relationships

in OCI

into Income

Portion)

Interest rate contracts:

2,796

Interest expense

(4,534)

Other expense

Location of Loss

Amount of Loss

Recognized

Derivatives Not Designated

in Income

as Hedging Instruments

on Derivatives

Interest rate contracts:

Other income

(232)

Other expense

(1)

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 13. Balance Sheet Offsetting

Assets and liabilities relating to certain financial instruments, including derivatives and securities sold under agreements to repurchase, may be eligible for offset in the consolidated balance sheet as permitted under accounting guidance. Susquehanna is party to transactions involving derivative instruments that are subject to master netting arrangements or similar agreements. Under these agreements, Susquehanna may have the right to net settle multiple contracts with the same counterparty. Certain derivative transactions may require Susquehanna to receive or pledge cash collateral based on the contract provisions.

Susquehanna also enters into agreements in which it sells securities subject to an obligation to repurchase the same or similar securities. Under these agreements, Susquehanna may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates Susquehanna to repurchase the assets. The obligation to repurchase the securities is reflected as a liability in Susquehanna’s consolidated balance sheet, while the securities underlying the repurchase agreements remain in the respective investment securities account, therefore there is no offsetting or netting of the investment securities assets with the repurchase agreement liability.

Susquehanna also offers derivative products to qualifying customers and enters into offsetting derivative transactions in due course. Susquehanna manages a matched book with respect to its derivative instruments offered as part of this service to its customers in order to minimize its interest rate risk resulting from such transactions. These instruments are free-standing derivatives and are recorded at fair value on the consolidated balance sheet. Collateral is posted by the counterparty with net liability positions in accordance with the contract provisions.

Susquehanna is subject to the regulations of the Commodity Futures Trading Commission that require financial institutions to clear all eligible contracts beginning June 2013. Susquehanna fulfills this obligation by clearing its eligible contracts through a clearing member that faces a designated clearing house on Susquehanna’s behalf. Susquehanna reports amounts for interest rate contracts in a single clearing member account as of period end on a net basis in the Consolidated Balance Sheet, including the related unrealized contract gains and losses, accrued interest receivable/payable, and cash collateral posted as initial and variation margin. Derivatives originated prior to June 2013 continue to be presented on a gross basis in the Consolidated Balance Sheet.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following table provides information about financial instruments that are eligible for offset at March 31, 2014 and December
31, 2013.

Balance Sheet Netting Disclosure about Offsetting Assets and Liabilities

							Net Amounts
							Presented in
							the		Gross Amounts Not Offset in the
			Gross				Consolidated		Consolidated Balance Sheet
			Amounts		Gross Amounts		Balance		Financial		Cash
			Recognized		Offset		Sheet		Instruments		Collateral		Net Amount

March 31, 2014

Financial assets:
	Derivatives		$	23,434	$	(176)	$	23,258	$	0	$	(3,390)	$	19,868

Financial liabilities:
	Derivatives		$	45,472	$	0	$	45,472	$	0	$	(42,893)	$	2,579
	Repurchase agreements			274,274		0		274,274		(274,274)		0		0
		Total	$	319,746	$	0	$	319,746	$	(274,274)	$	(42,893)	$	2,579

December 31, 2013

Financial assets:
	Derivatives		$	24,316	$	0	$	24,316	$	0	$	(3,940)	$	20,376

Financial liabilities:
	Derivatives		$	50,247	$	0	$	50,247	$	0	$	(42,813)	$	7,434
	Repurchase agreements			295,800		0		295,800		(295,800)		0		0
		Total	$	346,047	$	0	$	346,047	$	(295,800)	$	(42,813)	$	7,434

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		The table below presents the offsetting of derivative assets and derivative liabilities as of March 31, 2014 and December 31,
2013.

				Derivative Assets and Collateral								Derivative Liabilities and Collateral
				Held by Counterparty								Pledged by Counterparty
				Net Amounts		Gross Amounts						Net Amounts		Gross Amounts
				Presented in		Not Offset						Presented in		Not Offset
				the		in the Consolidated						the		in the Consolidated
				Consolidated		Balance Sheet						Consolidated		Balance Sheet
				Balance		Financial		Cash		Net		Balance		Financial		Cash		Net
March 31, 2014				Sheet		Instruments		Collateral		Amount		Sheet		Instruments		Collateral		Amount

Cleared Agreements:
	Clearing member A			$	0	$	0	$	0	$	0	$	3,563	$	0	$	(7,209)	$	(3,646)
					0		0		0		0		3,563		0		(7,209)		(3,646)
Bilateral Agreements:
	Counterparty:
		Dealer A			1,836		0		0		1,836		3,808		0		(2,220)		1,588
		Dealer B			1,874		0		0		1,874		3,062		0		(1,230)		1,832
		Dealer C			207		0		0		207		904		0		(950)		(46)
		Dealer D			4,068		0		(3,390)		678		826		0		0		826
		Dealer E			0		0		0		0		18,657		0		(21,300)		(2,643)
		Dealer F			0		0		0		0		4,135		0		(5,100)		(965)
		Dealer G			0		0		0		0		3,329		0		(3,570)		(241)
		Dealer H			0		0		0		0		791		0		(1,060)		(269)
		Dealer I			0		0		0		0		207		0		0		207
		Dealer J			0		0		0		0		0		0		0		0
		End User			15,273		0		0		15,273		6,190		0		(254)		5,936
					23,258		0		(3,390)		19,868		41,909		0		(35,684)		6,225
			Total	$	23,258	$	0	$	(3,390)	$	19,868	$	45,472	$	0	$	(42,893)	$	2,579

December 31, 2013

Cleared Agreements:
	Clearing member A			$	19	$	0	$	0	$	19	$	1,077	$	0	$	(3,993)	$	(2,916)
					19		0		0		19		1,077		0		(3,993)		(2,916)
Bilateral Agreements:
	Counterparty:
		Dealer A			2,836		0		0		2,836		3,840		0		(1,290)		2,550
		Dealer B			2,412		0		0		2,412		3,306		0		(1,400)		1,906
		Dealer C			359		0		0		359		684		0		(550)		134
		Dealer D			5,571		0		(3,940)		1,631		688		0		0		688
		Dealer E			0		0		0		0		21,251		0		(24,100)		(2,849)
		Dealer F			0		0		0		0		5,081		0		(6,100)		(1,019)
		Dealer G			0		0		0		0		3,966		0		(4,260)		(294)
		Dealer H			0		0		0		0		770		0		(1,120)		(350)
		Dealer I			0		0		0		0		121		0		0		121
		Dealer J			0		0		0		0		18		0		0		18
		End User			13,119		0		0		13,119		9,445		0		0		9,445
					24,297		0		(3,940)		20,357		49,170		0		(38,820)		10,350
			Total	$	24,316	$	0	$	(3,940)	$	20,376	$	50,247	$	0	$	(42,813)	$	7,434

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 14. Fair Value Disclosures

The accounting guidance for fair value measurements and disclosures defines fair value, establishes a framework for measuring fair value, and sets forth disclosure requirements regarding fair value measurements. This guidance applies whenever other accounting guidance requires or permits assets or liabilities to be measured at fair value. Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market for the asset or liability, or, in the absence of a principal market, in the most advantageous market for the asset or liability.

Susquehanna uses fair value measurements for the initial recording of certain assets and liabilities and periodic subsequent measurement of certain assets and liabilities on a recurring or non-recurring basis.

Fair Value Hierarchy

The accounting guidance for fair value measurements and disclosures establishes a three-level fair value hierarchy that prioritizes the inputs into the valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority, Level 1, to measurements based on quoted prices in active markets for identical assets or liabilities. The next highest priority, Level 2, is given to measurements based on observable inputs other than quoted prices in active markets for identical assets and liabilities. The lowest priority, Level 3, is given to measurements based on unobservable inputs. Assets and liabilities are classified in their entirety within the fair value hierarchy based on the lowest level input that is significant to the fair value measurement.

The accounting guidance requires the measurement of fair value to maximize the use of observable inputs and minimize the use of unobservable inputs. 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 Susquehanna’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.

Valuation Processes and Controls over Fair Value Measurement

As part of Susquehanna’s overall valuation process, management employs processes to evaluate and validate the methodologies, techniques and inputs, including review and approval of valuation judgments, methods, models, process controls, and results. These processes are designed to help ensure that the fair value measurements and disclosures are appropriate, consistently applied, and reliable.

Valuation Methodologies and Inputs

The following is a description of Susquehanna’s valuation methodologies and more significant inputs for assets and liabilities measured at fair value. These methods may produce a fair value measurement that may not be indicative 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 uses a third-party pricing service and third-party financial advisory firms in determining the fair value of its securities. Certain fair value measurements are derived from market-based pricing matrices that were developed using observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads and broker quotes. For certain other fair value measurements, when market observable data is not available due to the lack of an active market for a given security, the valuation of the security involves assistance of a third-party financial advisory firm and substantial judgment by management.

Specific valuation methodologies and inputs used in determining the fair value of each significant class of assets and liabilities follows:

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

U.S. Government agencies: These are debt securities issued by U.S. government-sponsored entities (“GSE”). These securities are valued using market-based pricing matrices that are based on observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads and broker quotes. The investor base is broad, resulting in moderate trading volumes and are classified as Level 2 in the fair value hierarchy. These valuations are sensitive to interest rates. As interest rates increase (decrease), the fair value of the securities will generally decrease (increase).

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Obligations of states and political subdivisions: These securities are valued using market-based pricing matrices that are based on observable inputs including the structure of the bond, including call terms, cross-collateralization features, and tax-exempt features, together with MSRB reported trades, issuer spreads, material event notices and benchmark yield curves. The investor base for most issues of municipal securities is fairly broad, resulting in moderate trading volumes and are classified as Level 2 in the fair value hierarchy. These valuations are sensitive to trends in the broader municipal securities market, which includes credit risk. As market concerns associated with credit risk increase (decrease), the fair value of the securities will generally decrease (increase).

Agency residential mortgage-backed securities: These securities are valued using market-based pricing matrices that are based on observable inputs, including benchmark TBA security pricing and yield curves that were estimated based on U.S. Treasury yields and certain floating rate indices. The pricing matrices for these securities may also give consideration to pool-specific data supplied directly by the GSE. GSE collateralized mortgage obligations (“CMOs”) are valued using market-based pricing matrices that are based on observable inputs including offers, bids, reported trades, dealer quotes and market research reports, the characteristics of a specific tranche, market convention prepayment speeds and benchmark yield curves as described above. Because agency residential mortgage-backed securities are generally liquid and are valued using observable pricing in the market, they generally are classified as Level 2. As interest rates increase (decrease), the fair value of the securities will generally decrease (increase).

Non-agency mortgage-backed securities: Refer to the description in “Note 2-Investment Securities”.

Commercial mortgage-backed securities: Commercial mortgage-backed securities are valued primarily based on the median prices from multiple pricing services. Some of the important valuation assumptions used by the pricing services include the collateral type, collateral performance, capital structure, issuer, credit enhancement, coupon, weighted average life, and interest rates, coupled with the observed spread levels on trades of similar securities. Many of these securities have significant prepayment lockout periods or penalty periods that limit the window of potential prepayment to a relatively narrow band. These securities are primarily classified as Level 2.

These valuations are sensitive to market changes, specifically changes in interest rates and credit spreads. As interest rates increase (decrease) and/or credit spreads widens (tightens), fair values will typically decrease (increase).

Other structured financial products: The significant unobservable inputs used in the fair value measurement of Susquehanna’s other structured financial products are conditional repayment rate, loss severity, and conditional default rate. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and directionally opposite change in the assumption used for repayment rate. In addition, refer to the description in “Note 2-Investment Securities.”

Other debt securities: These securities consist primarily of government and corporate bonds. These securities are valued using market-based pricing matrices that are based on observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads and broker quotes. The investor base is broad, resulting in moderate trading volumes and are classified as Level 2 in the fair value hierarchy. These valuations are sensitive to interest rates. As interest rates increase (decrease), the fair value of the securities will generally decrease (increase).

Other equity securities; These securities include liquid, exchange-traded equity securities as well as thinly-traded bank stocks and trust preferred securities. The exchange-traded equities are classified in Level 1 because they are valued using quoted market prices. The thinly traded and trust preferred securities are classified in Level 2 or 3 based on the significance of market observable inputs to the overall measurement.

Restricted investments in bank stocks

Restricted investments in bank stocks consists of FRB stock, FHLB stock, and Atlantic Central Bankers Bank stock. Federal law requires a member institution of the district FRB and FHLB to hold stock according to predetermined formulas. Atlantic Central Bankers Bank requires its correspondent banking institutions to hold stock as a condition of membership.

Loans and leases

The fair values for loans are estimated using discounted cash flow analyses, applying interest rates currently being offered for loans with similar terms and credit quality, which are indicative of orderly transactions in the current market. For commercial loans and leases, internal risk grades are used to adjust discount rates for risk migration and expected losses. For residential mortgage and other consumer loans, internal prepayment risk models are used to adjust contractual cash flows. Loans are aggregated into pools of similar terms and credit quality and discounted using benchmark-based rates. The carrying amounts of accrued interest receivable approximate fair values.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Deposits

The fair values of demand, interest-bearing demand, and savings deposits are the amounts payable on demand at the balance sheet date; recognition of the inherent funding value of these instruments is not permitted. The carrying value of variable-rate time deposits approximates 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, using the U.S. Treasury yield curve.

Short-term borrowings

For those short-term instruments, the carrying amount approximates 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. The carrying amounts of accrued interest payable approximate fair values.

Derivatives

The fair values of interest rate swaps are determined using models that use readily observable market inputs and a market standard methodology applied to the contractual terms of the derivatives, including the period to maturity and interest rate indices.

The methodology nets 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 and thresholds, mutual settlements, and guarantees.

In the first quarter of 2013 Susquehanna changed its valuation methodology for over-the-counter (“OTC”) derivatives to discount cash flows based on Overnight Index Swap (“OIS”) rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially-collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs, such as a spread between LIBOR and OIS to approximate an uncollateralized cost of funds, and credit risk. Susquehanna made the changes to reflect inputs, assumptions, and pricing methodologies that are used in its principal market by market participants.

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 use Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2014 and 2013, 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.

The fair values of commitments to originate mortgage loans to be held for sale and their corresponding forward-sales agreements are estimated using the fees charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The valuation of fixed-rate loan commitments also considers the difference between current levels of interest rates and the committed rates. These respective fair value measurements would be categorized within Level 3 of the fair value hierarchy.

For additional information regarding derivatives, refer to “Note 12 – Derivative Financial Instruments” above.

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.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Assets and Liabilities Measured at Fair Value on a Recurring Basis

		The following tables present the financial instruments carried at fair value at March 31, 2014 and December 31, 2013, on the
consolidated balance sheets and by levels within the valuation hierarchy.

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in		Significant
						Active Markets for		Other		Significant
						Identical		Observable		Unobservable
						Instruments		Inputs		Inputs
Description				March 31, 2014		(Level 1)		(Level 2)		(Level 3)
Assets
Available-for-sale securities:
	U.S. Government Agencies			$	110,232	$	0	$	110,232	$	0
	Obligations of states and political
		subdivisions			400,026		0		400,026		0
	Agency residential mortgage-backed
		securities			1,701,597		0		1,701,597		0
	Non-agency residential mortgage-
		backed securities			565		0		565		0
	Commercial mortgage-backed
		securities			6,320		0		6,320		0
	Other structured financial products				11,419		0		0		11,419
	Other debt securities				44,826		0		44,826		0
	Other equity securities				24,250		21,434		0		2,816
Derivatives: ⁽¹⁾
	Designated as hedging instruments				1,175		0		1,175		0
	Not designated as hedging
		instruments			22,083		0		22,083		0
			Total	$	2,322,493	$	21,434	$	2,286,824	$	14,235
Liabilities
Derivatives: ⁽²⁾
	Designated as hedging instruments			$	27,435	$	0	$	27,435	$	0
	Not designated as hedging
		instruments			18,037		0		18,037		0
			Total	$	45,472	$	0	$	45,472	$	0

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in		Significant
						Active Markets for		Other		Significant
						Identical		Observable		Unobservable
						Instruments		Inputs		Inputs
Description				December 31, 2013		(Level 1)		(Level 2)		(Level 3)
Assets
Available-for-sale securities:
	U.S. Government Agencies			$	110,148	$	0	$	110,148	$	0
	Obligations of states and political
		subdivisions			398,510		0		398,510		0
	Agency residential mortgage-
		backed securities			1,778,192		0		1,778,192		0
	Non-agency residential mortgage-
		backed securities			565		0		565		0
	Commercial mortgage-backed
		securities			8,734		0		8,734		0
	Other structured financial products				11,297		0		0		11,297
	Other debt securities				44,086		0		44,086		0
	Other equity securities				23,692		20,895		0		2,797
Derivatives: ⁽¹⁾
	Designated as hedging instruments				1,419		0		1,419		0
	Not designated as hedging
		instruments			22,897		0		22,897		0
			Total	$	2,399,540	$	20,895	$	2,364,551	$	14,094
Liabilities
Derivatives: ⁽²⁾
	Designated as hedging instruments			$	31,662	$	0	$	31,662	$	0
	Not designated as hedging
		instruments			18,585		0		18,585		0
			Total	$	50,247	$	0	$	50,247	$	0

⁽¹⁾	Included in Other assets
⁽²⁾	Included in Other liabilities

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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

		The following tables present roll-forwards of the balance sheet amounts for the three months ended March 31, 2014 and 2013,
for financial instruments classified by Susquehanna within Level 3 of the valuation hierarchy.

					Available-for-sale Securities
								Non-
								agency
						Other		Residential
						Structured		Mortgage-
				Equity		Financial		backed
				Securities		Products		Securities		Total
Balance at January 1, 2014				$	2,797	$	11,297	$	0	$	14,094
	Total gains or losses (realized/unrealized):
		Included in other comprehensive income (before taxes)			19		122		0		141
Balance at March 31, 2014				$	2,816	$	11,419	$	0	$	14,235

Balance at January 1, 2013				$	3,156	$	9,550	$	26,800	$	39,506
	Total gains or losses (realized/unrealized):
		Included in earnings:
			Other-than-temporary impairment ⁽¹⁾		0		0		(388)		(388)
		Included in other comprehensive income (before taxes)			1		427		(820)		(392)
Balance at March 31, 2013				$	3,157	$	9,977	$	25,592	$	38,726

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

Susquehanna’s policy is to recognize transfers in and transfers out of Levels 1, 2, and 3 as of the end of a reporting period.

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Impaired collateral dependent loans and other loans where the carrying value is based on the fair value of the underlying collateral minus selling costs, such as residential mortgage loans charged off in accordance with regulatory guidance, are measured at fair value on a nonrecurring basis. The fair value of the underlying collateral is incorporated into the estimate of the impairment of a loan. Most of Susquehanna’s impaired collateral dependent loans are secured by real estate. The value of the real estate collateral is determined through appraisals performed by third-party, 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. When the value of the real estate, less estimated selling costs, is less than the principal balance of the loan, a specific reserve is established. 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 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 third party 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)

	The following tables present assets measured at fair value on a nonrecurring basis at March 31, 2014 and December 31, 2013,
on the consolidated balance sheets and by the valuation hierarchy.

				Quoted
				Prices
				in Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
				Instruments		Inputs		Inputs
	Description	March 31, 2014		(Level 1)		(Level 2)		(Level 3)
	Impaired loans	$	31,131	$	0	$	0	$	31,131
	Foreclosed assets		11,980		0		0		11,980
		$	43,111	$	0	$	0	$	43,111

				Quoted
				Prices
				in Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
				Instruments		Inputs		Inputs
	Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
	Impaired loans	$	54,216	$	0	$	0	$	54,216
	Foreclosed assets		16,555		0		0		16,555
		$	70,771	$	0	$	0	$	70,771

	The following table details the quantitative information about Level 3 fair value measurements:


		Fair Value at		Valuation		Range
Asset		March 31, 2014		Technique(s)	Unobservable Input	(Weighted Average)

Other structured financial products ⁽¹⁾		$	11,419	Discounted Cash Flow	Credit default rates, call options and deferrals, waterfall structure, and covenants.	Varies by individual security, refer to Note 2
				Discounted Cash Flow



Other equity securities			2,816	Discounted Cash Flow	Cash flows from dividends and terminal value	0.2x - 1.5x
				Discounted Cash Flow	Cash flows from dividends and terminal value	(.8x)

Impaired loans			31,131	Discounted Cash Flow	Cash flows based upon current discount rates and terminal value	0.8% - 8.0%
				Discounted Cash Flow		(4.1%)


Foreclosed assets			11,980	Discounted Cash Flow	Third party appraisals less estimated selling costs	0.0% - 100.0%
				Discounted Cash Flow	Third party appraisals less estimated selling costs	(31.7%)

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		Fair Value at		Valuation		Range
Asset		December 31, 2013		Technique(s)	Unobservable Input	(Weighted Average)

Other structured financial products ⁽¹⁾		$	11,297	Discounted Cash Flow	Credit default rates, call options and deferrals, waterfall structure, and covenants.	Varies by individual security, refer to Note 2
				Discounted Cash Flow



Other equity securities			2,797	Discounted Cash Flow	Cash flows from dividends and terminal value	0.2x - 1.5x
				Discounted Cash Flow	Cash flows from dividends and terminal value	(0.8x)

Impaired loans			54,216	Discounted Cash Flow	Cash flows based upon current discount rates and terminal value	0.8% - 8.0%
				Discounted Cash Flow		(3.9%)


Foreclosed assets			16,555	Discounted Cash Flow	Third party appraisals less estimated selling costs	0.0% - 100.0%
				Discounted Cash Flow	Third party appraisals less estimated selling costs	(29.6%)

⁽¹⁾	The significant unobservable inputs used in the fair value measurement of Susquehanna's other structured financial products are conditional repayment rate, loss severity, and conditional default rate. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and directionally opposite change in the assumption used for repayment rate.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Additional Disclosures about Fair Value of Financial Instruments

	The following table represents the carrying amounts and estimated fair values of Susquehanna's financial instruments. The
methods and assumptions used to estimate the fair value of each class of financial instruments are described above.

			March 31, 2014
			Carrying
			Amount		Fair Value		Level 1		Level 2		Level 3
	Financial assets:
		Cash and due from banks	$	389,793	$	389,793	$	389,793	$	0	$	0
		Short-term investments		69,450		69,450		0		69,450		0
		Investment securities		2,299,235		2,299,235		21,434		2,263,566		14,235
		Restricted investment in bank stocks		146,087		146,087		0		146,087		0
		Loans and leases		13,575,295		13,473,666		0		0		13,473,666
		Derivatives		23,258		23,258		0		23,258		0
	Financial liabilities:
		Deposits		13,079,523		12,164,191		0		12,164,191		0
		Short-term borrowings		584,664		584,664		0		584,664		0
		FHLB borrowings		1,229,296		1,229,549		0		1,229,549		0
		Long-term debt		448,521		447,063		0		447,063		0
		Derivatives		45,472		45,472		0		45,472		0

			December 31, 2013
			Carrying
			Amount		Fair Value		Level 1		Level 2		Level 3
	Financial assets:
		Cash and due from banks	$	305,357	$	305,357	$	305,357	$	0	$	0
		Short-term investments		83,227		83,227		0		83,227		0
		Investment securities		2,375,224		2,375,224		20,895		2,340,235		14,094
		Restricted investment in bank stocks		158,232		158,232		0		158,232		0
		Loans and leases		13,576,086		13,463,676		0		0		13,463,676
		Derivatives		24,316		24,316		0		24,316		0
	Financial liabilities:
		Deposits		12,869,372		11,901,099		0		11,901,099		0
		Short-term borrowings		555,740		555,740		0		555,740		0
		FHLB borrowings		1,531,282		1,531,606		0		1,531,606		0
		Long-term debt		453,260		461,247		0		461,247		0
		Derivatives		50,247		50,247		0		50,247		0

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

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

Forward-Looking Statements.

We regularly communicate information concerning our business activities to investors, the news media, securities analysts, and others as part of our normal operations. Some of these communications, including this Quarterly Report on Form 10-Q, contain “forward-looking statements,” for which we claim the protection of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These include statements pertaining to our future business plans; regulatory capital and capital resources generally; management; general economic conditions; the impact of new regulations on our business; accounting policies and estimates; our potential exposures to various types of market risks, such as interest rate risk and credit risk; expectations regarding future acquisitions; whether our allowance for loan and lease losses is appropriate to meet probable loan and lease losses; our ability to evaluate loan collateral and guarantors; our ability to achieve loan growth; our ability to maintain sufficient liquidity; our ability to manage credit quality; and our ability to achieve our 2014 operating and financial goals. Forward-looking statements are often accompanied by, and identified with, terms such as “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. Actual results may differ significantly from those described in or implied by such forward-looking statements due to various factors 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 estimates. 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:

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

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

· decreases in our loan and lease origination volume;

· our ability to make accurate assumptions and judgments about the collectability of our loan and lease portfolio, including the creditworthiness of our borrowers, guarantors, and lessees, and the value of the assets securing the loans;

· adverse changes in regional real estate values;

· adverse international, national, and regional economic and business conditions;

· changes in consumer confidence, spending and savings habits impacting our bank and non-bank financial products and services;

· impairment of our goodwill or other assets;

· our ability to recruit and retain executive officers and other key employees;

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

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

· our ability to effectively fund our growth in earning assets with a managed blend of funding sources that provide an appropriate level of liquidity;

· our ability to hedge certain market risks effectively and economically;

· our ability to effectively implement technology-driven products and services;

· costs of compliance with and impact of laws and regulatory requirements of federal and state agencies;

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

· cyber-security risks impacting us or our vendors, including “denial of service,” “hacking” and “identity theft,” that could adversely affect our business and financial performance, or our reputation;

· operational risks, such as the risk of loss resulting from human error, inadequate or failed internal processes and systems, outsourcing arrangements, compliance and legal risk, and external events;

· 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 FDIC 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. A more detailed description of the factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this filing is included in Item 1A of Annual Report on Form 10-K for the year ended December 31, 2013, available at www.sec.gov.

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

The following information refers to Susquehanna Bancshares, Inc. 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. (“VFAM”), Stratton Management Company and subsidiary (“Stratton”), and The Addis Group, LLC (“Addis”).

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 report as an inactive textual reference only. Information contained on our website is not incorporated into and does not constitute part of this report.

Critical Accounting Policies

Susquehanna’s significant accounting policies are defined in Note 1 to the Consolidated Financial Statements included in its 2013 Form 10-K, and in Note 1 to the Consolidated Financial Statements included in this report. The preparation of the Consolidated Financial Statements is in accordance with accounting principles generally accepted in the United States (“GAAP”). Management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for: (i) the allowance for loan and lease losses; (ii) fair value measurements for valuation of financial instruments; (iii) valuation of goodwill; and, (iv) income taxes, as Susquehanna’s most critical accounting policies and estimates in that they are important to the portrayal of Susquehanna’s financial condition and results. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout the Consolidated Financial Statements, accompanying footnotes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Recent Legislation

In July 2013, the Federal Reserve Board, Office of the Comptroller of the Currency and FDIC approved final rules to implement the Basel III capital framework. The rules were effective on January 1, 2014 and will be phased-in over a multiple year period, becoming fully effective on January 1, 2019. The new capital rules call for higher quality capital with higher minimum capital level requirements. Consistent with the international Basel framework, the rules include a new minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 4.5 percent, and a Common Equity Tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets. The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0 percent to 6.0 percent, establish a minimum leverage ratio of 4.0 percent, and a minimum total capital (Tier 1 plus Tier 2) to risk-weighted assets ratio of 8.0 percent The rules also revise the definition of capital by expanding the conditions for the inclusion of equity capital instruments and minority interests in Tier 1 capital, and will impose limitations on capital distributions and certain discretionary bonus payments if additional specified amounts or “buffers” of Common Equity Tier 1 capital are not met. Management has evaluated these new rules and believes that Susquehanna, and Susquehanna Bank would have had sufficient capital at March 31, 2014 to meet the fully phased in increased requirements had they been in effect on that date.

Recent Developments

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

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

Executive Overview

Consolidated net income available to common shareholders was $37.2 million, or $0.20 per diluted share, for the three months ended March 31, 2014, a decrease of $5.2 million when compared to $42.4 million, or $0.23 per diluted share, for the three months ended March 31, 2013. Return on average assets for the three months ended March 31, 2014 was 0.82% compared to 0.95% for the same period in 2013. The non-GAAP ratio of return on average tangible equity was 11.08% compared to 13.87% in 2013. For additional information on non-GAAP ratios, refer to “Table 3, Reconciliation of Non-GAAP Measures”.

The following tables present a summary of our results of operations and key financial measures for the periods ended March 31, 2014 and 2013.

Table 1
Summary of First Quarter 2014 Compared to First Quarter 2013

		Three Months Ended
		March 31,
		2014		2013		% Change
	Net income	$	37,162	$	42,399	-12.35	%
	Net interest income		140,064		149,206	-6.13
	Provision for loan and lease losses		6,000		12,000	-50.00
	Non-interest income		42,089		42,644	-1.30
	Non-interest expense		123,032		117,729	4.50


Table 2
Key Susquehanna Financial Measures

			Three Months Ended
			March 31,
			2014			2013
		Diluted Earnings per Common Share	$	0.20		$	0.23
		Return on Average Assets		0.82	%		0.95	%
		Return on Average Shareholders' Equity		5.53	%		6.58	%
		Return on Average Tangible Shareholders' Equity ⁽¹⁾		11.08	%		13.87	%
		Efficiency Ratio ⁽¹⁾		66.18	%		60.17	%
		Net Interest Margin		3.61	%		3.97	%

⁽¹⁾	For information regarding Supplemental Reporting of Non-GAAP-based Financial Measurements, refer to Table 3 - Reconciliation of Non-GAAP Measures.

Table 3
Reconciliation of Non-GAAP Measures
(Dollars in thousands, except per share)

			Three Months Ended
			March 31,
			2014		2013
Tangible Book Value per Common Share
End of period balance sheet data
	Shareholders' equity		$	2,755,199	$	2,639,489
	Goodwill and other intangible assets			(1,305,742)		(1,313,648)
		Tangible common equity (numerator)	$	1,449,457	$	1,325,841

Common shares outstanding (denominator)				187,590		186,800
	Tangible book value per common share		$	7.73	$	7.10

	Tangible book value per share is a non-GAAP based financial measure calculated using non-GAAP based amounts. The most
directly comparable GAAP based measure is book value per share. In order to calculate tangible book value per share, we divide tangible common equity, which is a non-GAAP based measure calculated as common shareholders' equity less intangible assets, by the number of shares of common stock outstanding. In contrast, book value per share is calculated by dividing total common shareholders' equity by the number of shares of common stock outstanding. Management uses tangible book value per share to assess our capital position and ratios.

		Three Months Ended
		March 31,
		2014			2013
Return on Average Tangible Shareholders; Equity
Return on average shareholders' equity (GAAP basis)			5.53	%		6.58	%
Effect of excluding average intangible assets and related amortization			5.55	%		7.29	%
	Return on average tangible shareholders' equity		11.08	%		13.87	%

	Return on average tangible equity is a non-GAAP based financial measure calculated using non-GAAP based amounts. The
most directly comparable GAAP-based measure is return on average equity. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios.





Efficiency Ratio
Noninterest operating expense (numerator)		$	123,032		$	117,729

Taxable-equivalent net interest income			143,813			153,021
Other income			42,089			42,644
	Denominator		185,902			195,665
	Efficiency Ratio		66.18	%		60.17	%

	The efficiency ratio is a non-GAAP based financial measure. Management excludes merger-related expenses and certain other
selected items when calculating this ratio, which is used to measure the relationship of operating expenses to revenues.

Net Interest Margin (excluding purchase accounting)
Reported net interest margin (GAAP basis)			3.61	%		3.97	%
Adjustments for purchase accounting:
	Loans and leases		(0.17)	%		(0.27)	%
	Deposits		(0.03)	%		(0.07)	%
	Borrowings		(0.01)	%		(0.01)	%
	Net Interest Margin (excluding purchase accounting)		3.40	%		3.62	%

	Net interest margin (excluding purchase accounting) is a non-GAAP based financial measure using non-GAAP based amounts.
The most directly comparable GAAP based measure is net interest margin. In order to calculate net interest margin (excluding purchase accounting) we subtract the effects of amortizing/accreting purchase accounting valuation amounts from net interest income, and divide the remainder by average earning assets. Our management uses net interest margin (excluding purchase accounting) to measure and monitor the impact of the current economic environment on our net interest income and believes that this measure is more representative of our ongoing earnings power because it excludes the effect of valuation variables used to arrive at the acquisition fair value recorded on the acquisition date. We believe this non-GAAP measure, when taken together with the corresponding GAAP measure, provides meaningful supplemental information to investors regarding our performance. However, this non-GAAP measure should be considered in addition to, and not as a substitute for or preferable to, net interest margin prepared in accordance with GAAP.

Table 4
Distribution of Assets, Liabilities and Shareholders' Equity

Interest Rates and Interest Differential - Tax Equivalent Basis

			For the Three Month Period Ended						For the Three Month Period Ended
			March 31, 2014						March 31, 2013
			Average					Average
			Balance		Interest		Rate (%)	Balance		Interest		Rate (%)
			(Dollars in thousands)
Assets
Short-term investments			$	81,747	$	19	0.09	$	109,349	$	36	0.13
Investment securities:
		Taxable		2,117,969		11,413	2.19		2,202,136		11,426	2.10
		Tax-advantaged		387,968		5,388	5.63		401,459		5,529	5.59
	Total investment securities			2,505,937		16,801	2.72		2,603,595		16,955	2.64
Loans and leases, (net):
		Taxable		13,136,268		146,080	4.51		12,501,991		156,853	5.09
		Tax-advantaged		438,258		5,320	4.92		427,374		5,371	5.10
	Total loans and leases			13,574,526		151,400	4.52		12,929,365		162,224	5.09
Total interest-earning assets				16,162,210		168,220	4.22		15,642,309		179,215	4.65
Allowance for loan and lease losses				(157,444)					(184,909)
Other noninterest-earning assets				2,407,107					2,573,727
Total assets			$	18,411,873				$	18,031,127

Liabilities
Deposits:
Interest-bearing demand
		Interest-bearing demand	$	6,032,537	$	3,674	0.25	$	5,895,120	$	4,622	0.32
		Savings		1,099,944		287	0.11		1,048,881		279	0.11
		Time		3,910,698		9,630	1.00		3,778,086		11,232	1.21
Short-term borrowings				671,653		2,101	1.27		817,816		2,153	1.07
FHLB borrowings				1,387,124		4,866	1.42		1,155,637		3,672	1.29
Long-term debt				451,267		3,849	3.46		508,541		4,236	3.38
Total interest-bearing liabilities				13,553,223		24,407	0.73		13,204,081		26,194	0.80
Demand deposits				1,830,861					1,918,463
Other liabilities				301,324					294,264
Total liabilities				15,685,408					15,416,808
Equity				2,726,465					2,614,319
Total liabilities & shareholders' equity			$	18,411,873				$	18,031,127
Net interest income / yield on
		average earning assets				143,813	3.61				153,021	3.97
Taxable equivalent adjustment						(3,749)					(3,815)
Net interest income - as reported					$	140,064				$	149,206

Table 5
Changes in Net Interest Income - Tax Equivalent Basis

		Three months ended March 31, 2014
		versus March 31, 2013
		Increase (Decrease)
		Due to Change in ⁽¹⁾
		Average		Average
		Volume		Rate			Total
		(Dollars in thousands)
Interest Income
Other short-term investments		$	(8)	$	(9)		$	(17)
Investment securities:
	Taxable		(445)		432			(13)
	Tax-advantaged		(187)		46			(141)
Total investment securities			(632)		478			(154)
Loans (net of unearned income):
	Taxable		7,679		(18,452)			(10,773)
	Tax-advantaged		135		(186)			(51)
Total loans			7,814		(18,638)			(10,824)
Total interest-earning assets		$	7,174	$	(18,169)		$	(10,995)
Interest Expense
Deposits:
	Interest-bearing demand	$	106	$	(1,054)		$	(948)
	Savings		13		(5)			8
	Time		384		(2,016)	��		(1,632)
Short-term borrowings			(420)		368			(52)
FHLB borrowings			786		408			1,194
Long-term debt			(487)		100			(387)
Total interest-bearing liabilities			382		(2,199)			(1,817)
Net Interest Income		$	6,792	$	(15,970)		$	(9,178)

⁽¹⁾	Changes that are due in part to volume and in part to rate are allocated in proportion to their relationship to the amounts of changes directly to volume and rate.

Net Interest Income-Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which is the income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the cost of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities, and short-term investments. The amount of interest income is dependent upon many factors, including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates, the levels of non-performing loans, and accretion of fair value adjustments on purchased loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, the rates paid on borrowed funds, amortization of core deposit intangibles, accretion of fair value adjustments on acquired deposits, and the levels of noninterest-bearing demand deposits, and equity capital.

Table 4 presents average balances, taxable equivalent interest income and expense, and yields earned or paid on these assets and liabilities. For purposes of calculating taxable equivalent interest income, tax-exempt interest has been adjusted using a marginal tax rate of 35% in order to equate the yield to that of taxable interest rates.

Net interest income on a fully taxable-equivalent basis totaled $143.8 million for the three-month period ended March 31, 2014 compared to $153.0 million for the same period in 2013. The decrease of $9.2 million in our taxable equivalent net interest income was the result of the decline in interest earned on earning assets exceeding the decline in interest paid on rate related liabilities.

The net interest margin for the three month period ended March 31, 2014 was 3.61%, a 36 basis point decline from 3.97% for the same period in 2013. The decline in the net interest margin results primarily from the runoff of higher yielding earning assets, replaced by lower yields on loans, and partially offset by lower funding costs of deposits and borrowings. The net interest margin is also positively affected by the recognition of purchase accounting benefit from the loan portfolio, which decreased by 10 basis points, from 27 basis points in the first quarter of 2013 to 17 basis points in the same period in 2014. Net interest margin (excluding purchase accounting), which eliminates the effect of purchase accounting amounts, declined 22 basis points from 3.62% in the first quarter of 2013 to 3.40% for the same period in 2014. For additional information related to our net interest margin (excluding purchase accounting), refer to “Table 3, Reconciliation of Non-GAAP Measures”.

We expect the purchase accounting benefit from the loan portfolio to continue in 2014, but would note that the timing of this benefit is not certain due to the behavior of customers in the current interest rate environment.

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

Provision and Allowance for Loan and Lease Losses

The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses as of the balance sheet date at a level appropriate to absorb management’s estimate of probable incurred losses in the loan and lease portfolio. A quarterly review of the allowance for loan and lease losses is performed for the purpose of assessing loan quality, identifying impaired loans and leases, analyzing delinquencies, ascertaining loan and lease growth, evaluating potential charge-offs and recoveries, and assessing general economic conditions in the markets we serve.

Net charge-offs for the first quarter of 2014 decreased to $9.5 million, or 0.28% of average loans and leases, when compared to net charge-offs for the first quarter of 2013 of $19.6 million, or 0.62% of average loans and leases. Nonaccrual loans increased during this period, from $103.4 million at March 31, 2013 to $108.4 million at March 31, 2014. However, non-performing assets comprised of non-accrual loans plus foreclosed real estate, declined from $125.9 million, or 0.97% of total loans and leases at March 31, 2013, to $120.4 million, or 0.89% of total loans and leases at March 31, 2014. Table 6 – Provision and Allowance for Loan and Lease Losses provides detail of charge-offs and recoveries by loan category.

The allowance for loan and lease losses was 1.14% of period-end loans and leases, or $154.2 million, at March 31, 2014; 1.16% of period-end loans and leases, or $157.6 million, at December 31, 2013; and 1.36% of period-end loans and leases, or $176.4 million, at March 31, 2013. The allowance for loan and lease losses for Originated loans was 1.12% of period-end loans and leases, or $152.4 million, at March 31, 2014; 1.15% of period-end loans and leases, or $155.6 million, at December 31, 2013; and 1.35% of period-end loans and leases, or $175.0 million, at March 31, 2013.

The most significant driver of the allowance for loan and lease loss model is charge-off history, with the most recent periods receiving a more significant weighting. Our charge-offs have declined during recent quarters which results in the need for a lower allowance for loan loss. Also contributing to the need for a lower allowance for loan loss in the first quarter of 2014 was the loan portfolio remained relatively flat with a shift in composition to categories with historically lower loss factors. The need for a smaller allowance for loan loss resulted in a lower provision expense compared to the first quarter of 2013.

Determining the level of the allowance for probable loan and lease losses at any given point in time is difficult, particularly during uncertain economic periods. We must make estimates using assumptions and information that is often subjective and changing rapidly. The review of the loan and lease portfolios is a continuing process in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and lease losses is appropriate to meet probable incurred loan and lease losses at March 31, 2014. There can be no assurance, however, that we will not sustain loan and lease losses in future periods greater than the size of the allowance at March 31, 2014.

Table 6
Provision and Allowance for Loan and Lease Losses

				Three Months Ended
				March 31
				2014		2013
					(Dollars in thousands)
	Balance - beginning of period			$	157,608	$	184,020
		Additions			6,000		12,000
		Charge-offs:
			Commercial, financial, and agricultural		(4,514)		(10,037)
			Real estate - construction		(291)		(4,763)
			Real estate secured - residential		(3,830)		(3,013)
			Real estate secured - commercial		(2,607)		(4,603)
			Consumer		(1,238)		(558)
			Leases		(920)		(1,119)
		Total charge-offs			(13,400)		(24,093)
		Recoveries:
			Commercial, financial, and agricultural		1,332		1,996
			Real estate - construction		382		462
			Real estate secured - residential		1,034		651
			Real estate secured - commercial		473		722
			Consumer		383		322
			Leases		338		297
		Total recoveries			3,942		4,450
		Net charge-offs			(9,458)		(19,643)
	Balance - end of period			$	154,150	$	176,377

	Average loans and leases outstanding			$	13,574,526	$	12,929,365
	Period-end loans and leases				13,575,295		12,999,703
	Net charge-offs as a percentage of average loans
		and leases (annualized)			0.28%		0.62%
	Allowance as a percentage of period-end loans
		and leases			1.14%		1.36%

Noninterest Income

Noninterest income represents a significant portion of our revenue. Noninterest income includes service charges on deposit accounts, vehicle origination and servicing fees, wealth management commissions and fees, insurance income, mortgage banking income, capital markets income, gains and losses on securities transactions, and commissions and fees from other business activities. The following table presents a breakdown of our noninterest income.

Table 7
Noninterest Income

						% Change
		Three Months				2014
		Ended March 31,				vs.
		2014		2013		2013
		Dollars in thousands
Service charges on deposit accounts		$	9,000	$	8,672	3.8	%
Vehicle origination and servicing fees			2,968		3,354	(11.5)
Wealth management commissions and fees			12,719		12,390	2.7
Commissions on property and casualty insurance sales			5,666		4,542	24.7
Other commissions and fees			5,035		4,328	16.3
Income from bank-owned life insurance			1,637		1,508	8.6
Mortgage banking revenue			2,410		4,110	(41.4)
Capital markets revenue			1,240		902	37.5
Net realized gain (loss) on sales of securities			(8)		18	(144.4)
Other			1,422		2,820	(49.6)
	Total noninterest income	$	42,089	$	42,644	(1.3)

First Quarter 2014 Compared to First Quarter 2013

Noninterest income totaled $42.1 million for the three month period ended March 31, 2014 compared to $42.6 million for the same period in 2013. Noninterest income as a percentage of total revenue (net interest income plus noninterest income) was 23% in 2014 compared to 22% in 2013.

Vehicle origination and servicing fees totaled $3.0 million, a decrease of $0.4 million, or 11.5% compared to 2013. The decline is primarily due to lower vehicle leasing originations at our Hann subsidiary resulting from the inclement winter weather experienced by the Mid-Atlantic region in 2014, plus pricing adjustments made to balance origination volume with profitability.

Commissions on property and casualty insurance sales increased $1.1 million, or 24.7%, to $5.7 million in 2014, compared to $4.5 million in 2013. The main contributor to this increase is an additional $0.9 million of insurance carrier incentives paid in the first quarter of 2014.

Other commissions and fees totaled $5.0 million, an increase of $0.7 million, or 16.3%, compared to $4.3 million in 2013. The increase is primarily due to increased commissions and fees associated with debit/credit card activity.

Mortgage banking revenue declined $1.7 million, or 41.4%, to $2.4 million for the first quarter of 2014, compared to $4.1 million during the same period in 2013. The volume of mortgages sold declined 49.2% from the first quarter of 2013 due to the inclement weather the Mid-Atlantic region experienced in 2014, combined with an increase in mortgage interest rates during the first quarter of 2014.

Capital markets revenue totaled $1.2 million, an increase of $0.3 million, or 37.5%, compared to 2013. The increase is due to the growth of trade letters of credit and foreign currency-related contracts that begun in mid-2013.

Other income decreased $1.4 million, or 49.6%, to $1.4 million in 2014, compared to $2.8 million in 2013. Primary contributors to the 2014 decrease were: $0.7 million decline in insurance proceeds; $0.6 million decline in gain on sale of Small Business Loans; $0.1 million decline in rental income; and, $0.2 million decline in miscellaneous income. Partially offsetting these decreases are increased gains on sales of Other Real Estate Owned and other assets of $0.2 million.

The remaining noninterest income increased $0.8 million, or 3.4%, compared to 2013. Refer to Table 7 for detail of fluctuations in other categories of noninterest income.

*Noninterest Expense*

	The following table presents a breakdown of Susquehanna's noninterest expense.

Table 8
Noninterest Expense

						% Change
						2014
		Three Months Ended March 31,				vs.
		2014		2013		2013
		Dollars in thousands
Salaries and employee benefits		$	65,581	$	62,614	4.7	%
Occupancy			13,847		11,215	23.5
Furniture and equipment			3,944		3,578	10.2
Professional and technology services			6,070		5,729	6.0
Advertising and marketing			3,576		3,300	8.4
FDIC insurance			5,121		3,798	34.8
Legal fees			1,527		1,870	(18.3)
Amortization of intangible assets			2,539		3,268	(22.3)
Vehicle lease disposal			2,251		1,290	74.5
Other			18,576		21,067	(11.8)
	Total noninterest expenses	$	123,032	$	117,729	4.5

First Quarter 2014 Compared to First Quarter 2013

Noninterest expenses totaled $123.0 million for the three month period ended March 31, 2014 compared to $117.7 million for the same period in 2013.

Salaries and benefits are our largest single noninterest expense and include salaries, wages, commissions, stock-based compensation, incentives, pension, and other employee benefit costs. Total salaries and benefits expenses increased $3.0 million, or 4.7%, in 2014 compared to 2013. This increase is due to normal salary increases, and additional personnel to ensure our compliance with the increased governmental regulations issued as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act and strategic corporate initiatives. Partially offsetting this increase are decreases in statutory and non-statutory benefits.

Occupancy expense increased 23.5%, or $2.6 million, to $13.8 million in 2014 compared to $11.2 million in 2013. The primary drivers were increased grounds maintenance of $1.2 million due to winter weather, and additional rent expense of $0.8 million, resulting from the sale / leaseback transaction executed in the fourth quarter of 2013.

FDIC insurance costs increased $1.3 million, or 34.8%, to $5.1 million in 2014, due to the FDIC’s change in methodology for reporting various quantitative factors included in the assessment calculation.

Vehicle lease disposal expenses increased $1.0 million, or 74.5%, as a result of a 23% increase in the value of terminated leases, and a new quarterly contract amount with Auto Lenders Liquidation Center, Inc. to effectively transfer substantially all residual value risk.

Other expenses in 2014 totaled $18.6 million, a decrease of $2.5 million, or 11.8% from 2013’s amount of $21.1 million. This decrease is the result of lower operating risk losses partially offset by increased insurance expenses.

The remaining noninterest expenses decreased $89 thousand compared to 2013. Refer to Table 8 for detail of fluctuations in other categories of noninterest expense.

Income Taxes

Our effective tax rate for the three months ended March 31, 2014 and 2013 was 30.0% and 31.7%, respectively. The decrease in tax rate was due to an increase in the proportion of the amount of tax-advantaged income relative to total income for the first three months of 2014, as compared to the first three months of 2013. Adjustments for tax expense (benefit) from discrete items recorded for the three months ended March 31, 2014 and 2013 impacted the effective tax rate by (0.4%) and 0.6%, respectively. The estimated annual effective rates for the reporting periods ended March 31, 2014 and 2013 were impacted by the level of permanent differences, including tax-advantaged income, Low Income Housing, and other credits, resulting in an effective rate below statutory rates for the interim reporting periods.

Financial Condition
Table 9
Summary of March 31, 2014 Compared to December 31, 2013

		March 31,		December 31,
		2014		2013		% Change
	Total assets	$	18,439,682	$	18,473,489	(0.2)	%
	Investment securities available for sale		2,299,235		2,375,224	(3.2)
	Loans and leases		13,575,295		13,576,086	(0.0)
	Deposits		13,079,523		12,869,372	1.6
	Shareholders' equity		2,755,199		2,717,587	1.4
	Book value per common share		14.69		14.50	1.3
	Tangible book value per common share		7.73		7.52	2.8

Fair Value Measurements and the Fair Value Option for Financial Assets and Financial Liabilities

At March 31, 2014, we 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. In addition, non-financial assets and non-financial liabilities have not been measured at fair value because we have made the determination that the impact on our financial statements would be minimal. For additional information about our financial assets and financial liabilities carried at fair value, refer to “Note 14. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Securities Available for Sale

Securities available for sale decreased 3.2%, or $76.0 million from December 31, 2013 resulting from a strategic decision, in early 2014, not to purchase securities due to the current low interest rate environment. For additional information about our investment securities portfolio, refer to “Note 2. Investment Securities” and “Note 14. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Loans and Leases

Loans and leases totaled $13.6 billion at each of March 31, 2014 and December 31, 2013. For additional information about our loan portfolio, refer to “Note 3. Loans and Leases” to the financial statements appearing in Part I, Item 1, of this report.

*Risk Assets*

Table 10
Risk Assets

			March 31,		December 31,
			2014		2013		% Change
			(Dollars in thousands)
Non-performing assets:
	Nonaccrual loans and leases:
		Commercial, financial, and agricultural	$	24,529	$	16,827	45.8	%
		Real estate - construction		11,695		13,230	(11.6)
		Real estate secured - residential		23,189		23,365	(0.8)
		Real estate secured - commercial		47,950		46,147	3.9
		Consumer		46		47	(2.1)
		Leases		999		1,199	(16.7)
	Total nonaccrual loans and leases			108,408		100,815	7.5
	Foreclosed real estate			11,980		16,555	(27.6)
Total non-performing assets			$	120,388	$	117,370	2.6

Total non-performing assets as a percentage of period-end
	loans and leases and foreclosed real estate			0.89%		0.86%	3.5
Allowance for loan and lease losses as a percentage of
	nonaccrual loans and leases			142%		156%	(9.0)

Loans contractually past due 90 days and still accruing			$	9,328	$	9,757	(4.4)
Troubled debt restructurings				39,555		72,133	(45.2)

Nonperforming assets increased from $117.4 million at December 31, 2013, to $120.4 million at March 31, 2014. Consequently, total nonperforming assets as a percentage of period-end loans and leases plus foreclosed real estate increased from 0.86% at December 31, 2013 to 0.89% at March 31, 2014. Troubled debt restructurings decreased $32.5 million, from $72.1 million at December 31, 2013 to $39.6 million at March 31, 2014, resulting from our curing evaluation process.

Of the $212.6 million of impaired loans (nonaccrual, non-consumer loan relationships greater than $1.0 million plus accruing restructured loans) at March 31, 2014, $165.3 million, or 77.8%, had no related reserve (refer to “Note 3. Loans and Leases – Impaired Loans” to the financial statements appearing in Part I, Item 1, of this report.) The determination that no related reserve for collateral-dependent loans was required was based on the net realizable value of the underlying collateral less costs to sell.

At March 31, 2014, real estate – construction loans comprised only 5.3% of our total loan and lease portfolio, but accounted for 10.8% of nonaccrual loans and leases and 14.1% of our allowance for loan and lease losses. As a result, we consider real estate - construction loans to be higher-risk loans. Additional information about our real estate – construction loan portfolio is presented in Tables 11, 12, and 13. Categories within these tables are defined as follows:

· Construction loans – loans used to fund vertical construction for residential and non-residential structures;

· Land development loans – loans secured by land for which the approvals for site improvements have been obtained, the site improvements are in progress, or the site improvements have been completed; and

· Raw land – loans secured by land for which there are neither approvals nor site improvements.

Table 11
Construction, Land Development, and Other Land Loans - Portfolio Status

			Balance at				Past Due		Past Due				Other		Net
			March 31,		% of Total		30-89		90 Days and		Non		Internally		Charge-
Category			2014		Construction		Days		Still Accruing		Accrual		Monitored	⁽¹⁾	Offs	⁽²⁾	Reserve	⁽³⁾
			(Dollars in thousands)
1-4 Family:
	Construction		$	139,906	19.6	%	0.7	%	0.0	%	3.0	%	4.4	%	(1.5)	%	3.3	%
	Land development			163,798	22.9		0.5		0.1		0.5		12.4		(1.1)		3.2
	Raw land			1,221	0.2		0.0		0.0		0.0		2.6		33.8		3.9
				304,925	42.7		0.6		0.1		1.7		8.7		(1.0)		3.3
All Other:
	Construction:
		Investor		260,132	36.4		0.0		0.0		1.5		5.3		0.9		2.8
		Owner-occupied		22,235	3.1		0.0		0.0		0.8		0.0		0.0		1.9
	Land development:
		Investor		102,424	14.3		1.0		0.0		1.6		26.2		3.3		3.4
		Owner-occupied		4,762	0.7		0.0		0.0		17.5		7.3		5.7		2.2
	Raw land:
		Investor		19,313	2.7		1.8		0.0		0.0		4.7		(2.9)		1.9
		Owner-occupied		500	0.1		0.0		0.0		0.0		0.0		0.0		2.9
				409,366	57.3		0.3		0.0		1.6		10.2		1.4		2.9
Total			$	714,291	100.0		0.4		0.0		1.6		9.6		0.4		3.0


⁽¹⁾	Represents loans with initial signs of some financial weakness and potential problem loans that are on our internally monitored loan list, excluding non-accrual and past-due loans reflected in the prior three columns.

⁽²⁾	Represents the amount of net charge-offs in each category for the last nine months divided by the category loan balance at March 31, 2014 plus the net charge-offs.

⁽³⁾	Represents the amount of the allowance for loan and lease losses allocated to this category divided by the category loan balance at March 31, 2014.

Table 12
Construction, Land Development, and Other Land Loans - Collateral Locations

			Balance at		Geographical Location by %
Category			March 31, 2014		Maryland		New Jersey		Pennsylvania		Other
			(Dollars in thousands)
1-4 Family:
	Construction		$	139,906	57.9	%	3.3	%	34.7	%	4.1	%
	Land development			163,798	43.8		4.4		38.4		13.4
	Raw land			1,221	0.0		18.6		81.4		0.0
				304,925	50.1		4.0		36.8		9.1
All Other:
	Construction:
		Investor		260,132	51.2		18.4		29.7		0.7
		Owner-occupied		22,235	2.4		16.0		81.6		0.0
	Land development:
		Investor		102,424	31.0		5.6		45.8		17.6
		Owner-occupied		4,762	66.7		0.0		33.3		0.0
	Raw land:
		Investor		19,313	25.2		2.0		70.6		2.2
		Owner-occupied		500	100.0		0.0		0.0		0.0
				409,366	42.5		14.0		38.5		5.0
Total			$	714,291	45.8		9.7		37.8		6.7

Table 13
Construction, Land Development, and Other Land Loans - Portfolio Characteristics

						Global Debt
				Balance at		Coverage Ratio		Average Loan to
	Category			March 31, 2014		Less than 1.1 Times ⁽¹⁾		Value (current)
				(Dollars in thousands)
	1-4 Family:
		Construction		$	139,906	6.6	%	97.8	%
		Land development			163,798	13.1		70.6
		Raw land			1,221	0.0		68.6
					304,925	10.5		88.2
	All Other:
		Construction:
			Investor		260,132	6.9		86.6
			Owner-occupied		22,235	0.0		59.4
		Land development:
			Investor		102,424	10.1		88.7
			Owner-occupied		4,762	30.6		47.4
		Raw land:
			Investor		19,313	21.9		67.1
			Owner-occupied		500	72.5		73.3
					409,366	9.1		83.3
				$	714,291	9.8		85.7

⁽¹⁾	Global debt coverage ratio is calculated by analyzing the combined cash flows of the borrower, its related entities, and the guarantors (if any). The final global cash flow is divided by the global debt service for the same entities to determine the coverage ratio.

We conduct continuous portfolio reviews of real estate – construction loan relationships in excess of $0.75 million in order to identify potential problem loans. For those loan relationships under $0.75 million, the evaluation of risk is based upon delinquency. The review of loans in excess of $0.75 million consists of:

· Determining whether the project’s economics are achievable within a time frame such that the available cash flow of this and all of the projects of the borrower/guarantor (whether financed or not financed by Susquehanna) is sufficient to pay the required payments of interest plus principal during a rolling fifteen-month projection.

· Determining, based on a review of external sources, the viability/absorption of the projects and whether they align with the borrower/guarantor’s expectations.

· Reviewing quarterly to assess whether the expectations of the borrower/guarantor and the externally supplied information on the market are aligned to determine if the previous assumptions are still valid or need to be adjusted to meet the expectations that Susquehanna be fully repaid.

During this process, we also review the liquidity of any guarantors (the secondary source for continuance of the project) to determine if their liquidity will support any extension of the project due to slower than expected absorption (units leased or sold). If the result of any of the determinations set forth above is negative, we consider the loan to be impaired, and it is included in our evaluation of the allowance for loan and lease losses. If a loan is determined to be impaired, the net realizable value of the loan is calculated by using a current (less than one year old) appraisal, and the short fall is charged off. All partially charged-off loans become part of the calculation for the allowance for loan and lease losses.

Although our impairment and charge-off analyses take into consideration the guarantor’s demonstrated ability and willingness to service the debt, we do not carry any impaired loans at values in excess of the current appraisal due to the loan having a guarantor. Our evaluation of guarantors includes examining their financial wherewithal and their reputation and willingness to work with their lenders. Since the beginning of the global economic slowdown in 2007, we have consistently assessed the probability for completion of a project by determining the guarantor’s liquidity and the cash flow generated by the project based upon current absorption.

Charge-offs are taken in the quarter that we determine that the loan is impaired and there is a probable incurred loss. We exercise our full legal rights to pursue all assets of the borrower and guarantors.

Guarantors are required to provide us with copies of annual financial statements and tax returns, including all schedules. These financial statements and tax returns are analyzed using variables such as total debt obligation including contingent liabilities (an analysis of those contingent liabilities, the ability to service third-party debt, and whether the cash that is left will support our loan), and a review of financial statements to determine living expenses. These results are part of a fifteen-month rolling projection of the borrower’s and the guarantor’s cash flow. With respect to a potential problem loan, the rolling fifteen-month cash flow projection requires verification of all cash or liquid investments each quarter. In addition, we require that these statements are generally current to within one year.

We are well equipped to underwrite the credit worthiness of our sponsors. Over half of our clients have been successfully operating their businesses within our markets for 15 or more years. In addition, many of our sponsors have been either direct clients or have had successful banking relationships with our Credit Relationship managers at other financial institutions that exceed 10 years. All of the Commercial Real Estate team’s leadership has 20 plus years of in market lending and portfolio management experience. Therefore, we have a strong historical perspective as to how our sponsors performed during all stages of an economic cycle.

We continue to aggressively review our portfolio, contact customers to evaluate their financial situation and where necessary, to work with them to find proactive solutions to help limit the number of loans that become delinquent or go into default. We believe that the remainder of 2014 will be challenging, with the volatility of key commodity prices continuing to impact the commercial and industrial, commercial real estate, and consumer credit segments. However, we also believe that we have the proper monitoring systems in place to recognize issues in an appropriate time frame and to minimize the effect on our financial results.

Goodwill

For information about goodwill, refer to “Note 5. Goodwill” to the financial statements appearing in Part I, Item 1, of this report.

Deposits

Total deposits increased 1.6%, or $210.2 million, from December 31, 2013 to March 31, 2014. Within this category, core deposits such as demand, interest-bearing demand, and savings increased 0.7%.

Time deposits less than $0.1 million increased 2.5%, or $53.0 million, from December 31, 2013 to March 31, 2014. Time deposits greater than $0.1 million increased 5.6%, or $95.7 million, from December 31, 2013 to March 31, 2014. For additional information about deposits, refer to “Note 6. Deposits” to the financial statements appearing in Part I, Item I, of this report.

Borrowings

Total short-term borrowings and long-term debt decreased $273.0 million, or 11.0%, from December 31, 2013 to March 31, 2014. The decline is due to a $300.0 million decrease in Federal Home Loan Bank short-term borrowings made possible by the $210.2 million increase in deposits and not reinvesting the cash flows from the paydowns in the investment securities portfolio.

Shareholders’ Equity

Total shareholders’ equity increased $37.6 million, or 1.4%, during the first three months of 2014. The primary components of the change were net income of $37.2 million, offset by dividends paid to shareholders of $15.0 million, or $.08 per share, and a $12.9 million positive adjustment to accumulated other comprehensive income resulting from increased fair values of available for sale securities.

Capital Adequacy

Capital elements are segmented into two tiers. Tier 1 capital represents shareholders’ equity plus junior subordinated debentures, reduced by excludable intangibles. Tier 2 capital represents certain allowable long-term debt, the portion of the allowance for loan and lease losses and the allowance for credit losses on off-balance-sheet credit exposures equal to 1.25% of risk-adjusted assets, and 45% of the unrealized gain on equity securities. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.” Tier 1 common and tangible common equity includes only common equity.

On July 2, 2013, the Federal Reserve Board, Office of the Comptroller of the Currency, and FDIC approved New Capital Rules that are applicable to bank holding companies and state member banks, relating to the implementation of revised capital standards to reflect the requirements of the Dodd-Frank Act as well as the Basel III international capital standards. The New Capital Rules were effective as of January 1, 2014 but will be phased in over a period of years beginning in 2015 for Susquehanna and ending on January 1, 2019.

Consistent with the international Basel framework, the New Capital Rules include a new minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of 4.5 percent and a Common Equity Tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets that will apply to all supervised financial institutions. The New Capital Rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0 percent to 6.0 percent, establish a minimum leverage ratio of 4.0 percent, and a minimum total capital (Tier 1 plus Tier 2) to risk-weighted assets ratio of 8.0 percent.

The New Capital Rules emphasize Common Equity Tier 1 capital, the most loss-absorbing form of capital, and implements strict eligibility criteria for regulatory capital instruments. The New Capital Rules also improve the methodology for calculating risk-weighted assets to enhance risk sensitivity. The changes to the risk-weighted assets calculation will be effective beginning January 1, 2015.

The New Capital Rules also preclude certain hybrid securities, such as trust preferred securities, from inclusion in bank holding companies’ Tier 1 capital for institutions with over $15 billion in assets as of December 31, 2009. An institution such as Susquehanna, which had less than $15 billion in assets as of December 31, 2009, but that exceeded this threshold before January 1, 2014, the effective date of the New Capital Rules, will be permitted to continue to include these securities in Tier 1 capital, until such a time as the institution acquires another depository institution.

Based on an analysis of the New Capital Rules, management believes that we would be fully compliant with the revised standards as of March 31, 2014 if they had been effective on that date.

We actively review our capital strategies in light of current and anticipated business risks, future growth opportunities, industry standards, and compliance with regulatory requirements. The assessment of overall capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings stability, competitive forces, economic conditions, and strength of management. At March 31, 2014, the capital ratios of Susquehanna exceed the “well-capitalized” thresholds under current capital requirements as shown below.

Table 14
Susquehanna Capital Ratios

			Well-capitalized
		At March 31, 2014	Threshold
	Tier 1 Common Ratio	10.84%	N/A
	Leverage Ratio	9.72%	5.0%
	Tier 1 Capital Ratio	11.95%	6.0%
	Total Risk-based Capital Ratio	13.23%	10.0%

Recently Adopted or Issued Accounting Guidance

For information about the impact that recently adopted or issued accounting guidance will have on our financial statements, refer to “Note 1. Accounting Policies” to the financial statements appearing in Part I, Item 1, of this report.

Risk Management

As a financial services company we assume or incur risk in conjunction with the execution of our day-to-day business activities. The most significant risks we face fall into six main categories: credit risk, market risk, operational risk, legal and regulatory compliance risk, reputation risk, and strategic risk. While we recognize that legal and regulatory compliance risk is typically a component of operational risk, we believe the significance of this sub-category and impact on our operations warrants its own assessment and reporting category. Our risk management activities are centered on the proper identification, measurement, monitoring, reporting, and management of these material risks.

Our Board of Directors (“Board”) is ultimately accountable for the oversight of how management assumes and manages risks in pursuit of preserving shareholder value and driving financial returns. The Board approves the Susquehanna’s risk appetite, assesses the effectiveness of the enterprise risk management framework and governance processes, and oversees management’s handling of issues related to risk mitigation.

To this end, the Board has established a Risk Committee whose primary purpose is to exercise oversight of management’s identification of material risks facing the Company and the management and mitigation of these material risks by the management team. The Board Risk Committee is responsible for the oversight over the enterprise risk management program.

Our risk management governance approach is designed to ensure clear lines of risk management accountability and a structured escalation process for key risk information. We adhere to a concept of the “three lines of defense” whereby the lines of business represent the first line of defense owning risks impacting their businesses as well as the control activities to successfully manage those risks. Risk management personnel comprise the second line of defense providing independent and centralized oversight over all risk categories by aggregating, analyzing and reporting upon risk information. Internal Audit represents the third line of defense providing an independent assessment and testing of the effectiveness of policies, practices, and controls within the first and second lines of defense.

Within our risk appetite framework, we have established specific qualitative and quantitative risk principles as well as risk ranges and limits to facilitate the monitoring of risk across our primary risk categories as such risks are incurred by the lines of business during the ordinary course of conducting their business.

The Risk Management Committee of the Board formally convenes no less than quarterly to discuss with management the status of our current and prospective risk profile as measured by risk attributes within each of our key risk categories (credit, market, operational, legal and regulatory compliance, reputation, strategic). Matters of material risk identified by the first, second, or third line of defense would be escalated to the Board more frequently than the quarterly discussion.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market Risks

The types of market risk exposures generally faced by us include:

· equity market price risk;

· liquidity risk; and

· interest rate risk.

Due to the nature of our operations, foreign currency and commodity price risk are not significant to us.

Equity Market Price Risk

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

Liquidity Risk

Company Liquidity

Our primary sources of liquidity at the parent holding company level are dividends from Susquehanna Bank, dividends from non-bank subsidiaries, investment income, proceeds from the sale of investments, and net proceeds from borrowings and capital offerings. During the three month periods ended March 31, 2014 and 2013, our primary uses of liquidity at the parent holding company level were the payment of interest to holders of notes and capital securities, the payment of dividends to common shareholders, the repurchase of our common stock, and operating expenses of the parent holding company. During the three month periods ended March 31, 2014 and 2013, a total of 18,700 and 1,800 shares of common stock were repurchased at a cost of $204,000 and $21,000, respectively. There are certain restrictions on the payment of dividends by Susquehanna Bank. At March 31, 2014, $22.4 million was available for dividend distribution to the parent holding company from its banking subsidiary. During the three month periods ended March 31, 2014 and 2013, Susquehanna Bank paid dividends to the parent holding company of $26.4 million per period, respectively. Additional liquidity is available to us through equity or debt offerings. The ability to execute these transactions could be affected by adverse credit ratings or market conditions.

Management is not aware of any events that are reasonably likely to have a material adverse effect on the parent holding company’s liquidity.

Bank Liquidity

Management believes the sources of liquidity at the Bank are sufficient to support our banking operations.

Susquehanna Bank’s primary sources of liquidity are deposit accounts, purchased funds, repurchase agreements, borrowings, and the sale, maturity, or call of investment securities. Susquehanna’s primary use of liquidity is the origination and purchase of loans; extension of credit; purchase of investment securities; management of working capital; and funding debt and capital service. Deposits represented 85.3% and 83.5% of total bank funding as of March 31, 2014 and December 31, 2013, respectively. Brokered deposits at March 31, 2014 and December 31, 2013 were $550.6 million and $566.8 million representing 4.2% and 4.4% of total deposits, respectively. At March 31, 2014 and December 31, 2013, Susquehanna Bank had approximately $4.1 billion and $4.1 billion, respectively, available under a collateralized line of credit with the Federal Home Loan Bank of Pittsburgh; and $2.9 billion and $2.5 billion, respectively, of additional borrowing capacity subject to the pledge of additional collateral. Susquehanna Bank pledged certain auto leases, certain auto loans, certain commercial finance leases, and certain investment securities to the Federal Reserve’s Discount Window to obtain collateralized borrowing availability. At March 31, 2014 and December 31, 2013, Susquehanna Bank had unused collateralized borrowing availability at the Federal Reserve’s Discount Window of $1.6 and $1.5 billion, respectively.

Susquehanna Bank had unrestricted investment securities with a market value of $1.0 billion for the periods ended March 31, 2014 and December 31, 2013.

The Board has designated a management Asset and Liability Committee (“ALCO”) to develop strategies, policies, and procedures to identify, measure, monitor, and control liquidity risk pursuant to its liquidity management policy. The liquidity management policy is commensurate with the complexity, risk profile, and scope of operations of the Bank and reflects its risk

appetite, tolerances, key risk indicators, and reporting requirements that are deemed appropriate in order to operate in a safe and sound manner. The liquidity management policy includes the Bank’s contingency funding plan that assesses liquidity needs that may arise from certain stress events that are bank-specific, as well as the result of external factors.

Interest Rate Risk

We define interest rate risk as the risk to earnings and equity arising from the behavior of interest rates. These behaviors include increases and decreases in interest rates as well as continuation of the current interest rate environment. The Asset Liability & Interest Rate Risk Management Policy (the “ALM Policy”) provides a comprehensive management process for identifying, measuring, monitoring, and managing interest rate risk. The ALM Policy is commensurate with the complexity, risk profile, and scope of operations and reflects the risk appetite, interest rate risk tolerances, and key risk indicators of the Company. The Board has designated ALCO, through the treasury group, to implement the ALM Policy and to develop strategies to manage interest rate risk.

Our interest rate risk principally consists of reprice, option, basis risk, and yield curve risk. Reprice risk results from differences in the maturity or repricing characteristics of asset and liability portfolios. Option risk arises from embedded options in the investment and loan portfolios such as investment securities calls and loan prepay options. Option risk also exists since deposit customers may withdraw funds at their discretion in response to general market conditions, competitive alternatives to existing accounts or other factors. The exercise of such options may result in higher costs or lower revenue for the Company. Basis risk refers to the potential for changes in the underlying relationship between market rates or indices, which subsequently result in narrowing spreads on interest-earning assets and interest-bearing liabilities. Basis risk also exists in administered rate liabilities, such as interest-bearing checking accounts, savings accounts and money market accounts where the price sensitivity of such products may vary relative to general markets rates. Yield curve risk refers to the adverse consequences of nonparallel shifts in the yield curves of various market indices that impact our assets and liabilities.

We use simulation analysis as a primary method to assess earnings at risk and equity at risk due to assumed changes in interest rates. Management uses the results of its various simulation analyses in combination with other data and observations to formulate strategies designed to maintain interest rate risk within risk tolerances.

Earnings at risk is defined as the change in net interest income (excluding provision for loan and lease losses and income tax expense) due to assumed changes in interest rates. Earnings at risk is generally used to assess interest rate risk over relatively short time horizons. We compute earnings at risk on a monthly basis over one and two-year time horizons.

Equity at risk is defined as the change in the net economic value of assets and liabilities due to changes in interest rates compared to a base net economic value. The discounted present value of all cash flows represents our economic value of equity. Equity at risk is generally considered a measure of the long-term interest rate exposures of the balance sheet at a point in time. We compute equity at risk on a monthly basis.

We conduct scenario analyses across a range of instantaneous, parallel, and sustained interest rate shocks and measures the percent of change in earnings and equity relative to a base case scenario assuming no movement in interest rates. The range of interest rate shocks includes upward and downward movements of rates through 400 basis points in 100 basis point increments, subject to market conditions that may render certain rate shocks impracticable. For example, during the current period of ultra-low interest rates, downward interest rate shocks have been suspended. The ALM Policy defines this series of scenario analysis as Core Scenarios. The size and composition of the balance sheet is held constant for the Core Scenarios. Measures of earnings at risk computed over a one-year time horizon and equity at risk produced from the Core Scenarios are defined as key risk indicators and are compared to risk tolerances established by the ALCO and the Board.

We conduct scenario analysis across a range of other changes in interest rates including ramped rate changes, non-parallel rate changes, and changes in key interest rates that do not move in tandem for upward and downward interest rate shocks. The specific interest rate scenarios that are analyzed are developed by the treasury group in consultation with the ALCO. We also conduct scenario analyses assuming changes in the size and composition of the balance sheet to support business planning, budgeting, and forecasting.

Simulation analysis involves the use of several assumptions including, but not limited to, the timing of cash flows such as investment security calls, loan prepayment speeds, deposit attrition rates, the interest rate sensitivity of loans and deposits relative to general market rates, and the behavior of interest rates and spreads. Furthermore, equity at risk simulation uses assumptions regarding discount rates that value cash flows. Simulation analysis is highly dependent on model assumptions that may vary from actual outcomes. For example, higher levels of interest rate sensitivity of deposits to upward movements in interest rates may adversely impact net interest income. Additionally, slower prepayment speeds of loans may adversely impact the economic value of equity in a rising interest rate environment. Key simulation assumptions are subject to stress testing to assess the impact of assumptions changes on earnings at risk and equity at risk. We also use back-testing to assess the effectiveness of simulation analysis in identifying, measuring, monitoring, and managing interest rate risk.

From time to time, key model assumptions may be modified to improve the effectiveness of simulation analysis. Management modified certain key assumptions during calendar year 2013 and in the assessment of our interest rate risk profile as of December 31, 2013. The model assumptions modifications included changes to the prepayment speeds of residential mortgage loans (the assumption changes generally reflected slower loan prepayment speeds); increases in the price sensitivity of certain deposit products; increases in the present value discount rates applied to cash flows of the loan portfolio for upward interest rate shocks; and changes to the non-maturity deposit attrition rates (an acceleration of attrition rates resulting in shorter assumed average lives). Model assumptions were also modified to discount deposit liabilities using a yield curve from the Federal Home Loan Bank of Pittsburgh cost of funds for bullet debt maturities rather than discount deposit liabilities using a single market rate applied to the respective deposit balances. The use of the yield curve from the FHLB bullet debt results in applying higher discount rates to non-maturity deposit liabilities based on their assumed average lives that are derived from deposit attrition rates.

Table 15 summarizes the results of the Core Scenarios for equity at risk and earnings at risk assuming instantaneous, parallel, and sustained upward interest rate shocks of 100 and 200 basis points at March 31, 2014 and December 31, 2013 and 2012. The results for equity at risk assuming a 200 basis point increase in interest rates produces a negative 1.6% change in equity while the results for earnings at risk assuming a 200 basis point increase in interest rates produces a positive 4.9% change in net interest income over a one-year time horizon. Equity at risk and earnings at risk may not produce highly correlated results due to the fundamental nature of the two simulation techniques. Equity at risk measures cash flows over time horizons that capture the interest rate characteristics of assets and liabilities that may change within one year and beyond one year. In contrast, the calculation of earnings at risk is focused on the interest rate characteristics of assets and liabilities that may alter earnings within a one-year time horizon.

Table 15
Susquehanna Rate Shock Analysis

		Net Interest Income		Economic Value of Equity
		+100bp	+200bp	+100bp	+200bp
	March 31, 2014	1.9%	4.9%	-0.7%	-1.6%
	December 31, 2013	1.0%	3.7%	-1.5%	-2.7%
	Risk-tolerance	-7.5%	-10.0%	-15.0%	-25.0%

Derivative Financial Instruments and Hedging Activities

Our interest rate risk management strategy involves hedging the repricing characteristics of certain assets and liabilities so as to mitigate adverse effects on our net interest margin and cash flows from changes in interest rates. While we do not participate in speculative derivatives trading, we consider it prudent to use certain derivative instruments to add stability to our interest income and expense, to modify the duration of specific assets and liabilities, and to manage our exposure to interest rate movements.

Additionally, we execute derivative instruments in the form of interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that we minimize our net risk exposure resulting from such transactions. We do not use credit default swaps in our investment or hedging operations.

For additional information about our derivative financial instruments, refer to “Note 12. Derivative

Financial Instruments” and “Note 14. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Vehicle Leasing Residual Value Risk

In an effort to manage the vehicle residual value risk arising from the auto leasing business of Hann and our affiliate bank, Hann and the bank have entered into arrangements with Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) pursuant to which Hann or the bank, as applicable, effectively transferred to Auto Lenders substantially all residual value risk of its respective auto lease portfolio, and all residual value risk on any new leases originated over the term of the applicable agreement. Auto Lenders, which was formed in 1990, is a used-vehicle remarketer with five retail locations in New Jersey and has access to various wholesale facilities throughout the country. Under these arrangements, Auto Lenders agrees to purchase the beneficial interest in all vehicles returned by the obligors at the scheduled expiration of the related leases for a purchase price equal to the stated residual value of such vehicles. Stated residual values of new leases are set in accordance with the standards approved in advance by Auto Lenders. Under a servicing agreement with Auto Lenders, Hann agrees to make monthly guaranty payments to Auto Lenders based upon a negotiated schedule covering a three-year period. At the end of each year, the servicing agreement may be renewed by the mutual agreement of the parties for an additional one-year term, beyond the current three-year term, subject to renegotiation of the payments. During the renewal process, we periodically evaluate the best remarketing and/or residual guarantee alternatives for Hann and our bank subsidiary.

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures

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

(b) Change in Internal Control Over Financial Reporting

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

PART II--OTHER INFORMATION

Item 1. Legal Proceedings.

Susquehanna and its subsidiaries are engaged in lines of business that are heavily regulated and involve a large volume of financial transactions with numerous customers through offices in Pennsylvania, Maryland, New Jersey and West Virginia. Although we have developed policies and procedures to minimize the impact of legal noncompliance and other disputes, litigation presents an ongoing risk. In the ordinary course of operations, Susquehanna and our subsidiaries are subject to routine litigation incidental to our business.

Overdraft Litigation

On July 29, 2011, Susquehanna Bank was named as a defendant in a purported class action lawsuit filed by two New Jersey customers of the bank in the United States District Court of Maryland. The suit challenges the manner in which checking account overdraft fees were charged and the policies related to the posting order of debit card and other checking account transactions. The suit makes claims under New Jersey’s consumer fraud act and under the common law for breach of contract, breach of the covenant of good faith and fair dealing, unconscionability, conversion and unjust enrichment. The case was transferred for pretrial proceedings to pending multi-district litigation in the U.S. District Court for the Southern District of Florida.

To avoid the costs, risks and uncertainties inherent in litigation and without admitting any of the allegations in the complaint, Susquehanna in good faith participated in mediation with plaintiffs’ counsel and as a result of negotiations following from the mediation, on December 20, 2012, Susquehanna and counsel for plaintiffs entered into a Summary Agreement, subject to preliminary and final approval of the settlement and dismissal of the action with prejudice by the Court. On October 25, 2013, Susquehanna and the plaintiffs entered into a comprehensive agreement to settle the action. On November 13, 2013, the United States District Court for the Southern District of Florida preliminarily approved the settlement agreement and directed that notice of the settlement be sent to prospective class members.

The aggregate settlement amount did not have a material adverse effect on our results of operation, financial position, or cash flows.

Final approval of the settlement and a judgment dismissing the case was entered by court order dated April 1, 2014. Distributions to class members will be made in accordance with the terms of the approved settlement and no further material legal proceedings are anticipated.

Lehman Litigation

In September 2010, Lehman Brothers Special Financing, Inc. (“LBSF”) filed suit in the United States Bankruptcy court for the Southern District of New York against certain indenture trustees, certain special-purpose entities (issuers) and a class of noteholders and trust certificate holders who received distributions from the trustees, including Susquehanna, to recover funds that were allegedly improperly paid to the noteholders in forty-seven separate collateralized debt obligation transactions (“CDO”). In June 2007, two of our affiliates each purchased $5.0 million in AAA rated Class A Notes of a CDO offered by Lehman Brothers, Inc. Concurrently with the issuance of the notes, the issuer entered into a credit swap with LBSF. Lehman Brothers Holdings, Inc. (“LBHI”) guaranteed LBSF’s obligations to the issuer under the credit swap. When LBHI filed for bankruptcy in September 2008, an Event of Default under the indenture occurred, and the trustee declared the notes to be immediately due and payable. Susquehanna was repaid its principal on the notes in September 2008.

This legal proceeding is in its early stages of discovery; thus it is not yet possible for us to estimate potential loss, if any. Although it is not possible to predict the ultimate resolution or financial liability with respect to this litigation, management, after consultation with legal counsel, currently does not anticipate that the aggregate liability, if any, arising out of this proceeding will have a material adverse effect on our financial position, or cash flows; although, at the present time, management is not in a position to determine whether such proceeding will have a material effect on our results of operations in any future quarterly reporting period.

Other Legal Proceedings and Investigations

Susquehanna and certain of its subsidiaries have been named as defendants in various legal actions arising out of the normal course of business, including claims against entities to which Susquehanna is a successor as a result of business combinations. In the opinion of management, the ultimate resolution of these lawsuits should not have a material adverse effect on Susquehanna’s business, consolidated financial position or results of operations. It is possible, however, that future developments could result in an unfavorable ultimate outcome for or resolution of any one or more of the lawsuits in which Susquehanna or its subsidiaries are defendants, which may be material to Susquehanna’s results of operations for a particular quarterly reporting period. Litigation is inherently uncertain, and management cannot make assurances that Susquehanna will prevail in any of these actions, nor can management reasonably estimate the amount of damages that Susquehanna might incur.

In addition, from time to time, Susquehanna receives subpoenas and other requests for information from various federal and state governmental and regulatory authorities in connection with certain industry-wide, company-specific or other investigations or proceedings. Susquehanna’s policy is to be fully cooperative with such inquiries. Any of these matters may result in material adverse consequences to Susquehanna and/or its directors, officers and other personnel, including: adverse judgments, findings, settlements, fines, penalties, orders, injunctions or other actions; amendments and/or restatements of Susquehanna’s filings with the Securities and Exchange Commission and/or its financial statements, as applicable; and determinations of material weaknesses in our disclosure controls and procedures. Investigations by regulatory authorities may from time to time result in civil or criminal referrals to law enforcement authorities such as the Department of Justice or a United States Attorney. Among other matters, Susquehanna has received a subpoena from the Department of Justice requiring the production of documents in connection with a civil investigation focused on, among other things, return deposit rates for payment processor and certain merchant customers of Susquehanna Bank. Susquehanna has responded to the subpoena and continues to cooperate with the government’s investigation, which is ongoing. In the event that the Department of Justice were to bring any proceeding, demand or claim against Susquehanna as a result of the investigation, such action could include the Department of Justice seeking injunctive and monetary relief against Susquehanna under the Financial Institutions Reform, Recovery and Enforcement Act of 1989.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.†

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

3.1	Amended and Restated Articles of Incorporation, dated May 6, 2011, incorporated by reference to Exhibit 3.1 to Susquehanna’s Quarterly Report on Form 10-Q, filed August 8, 2011.


3.2	Amended and Restated By-Laws, dated December 10, 2013, incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 13, 2013.


31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1.

31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2.

32	Section 1350 Certifications are filed herewith as Exhibit 32.

101.INS	XBRL Instance Document

101.SCH	XBRL Taxonomy Extension Schema Document

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB	XBRL Taxonomy Extension Label Linkbase Document

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document

†	Upon request by the SEC, the registrant agrees to furnish to the SEC a copy of any instrument with respect to unregistered long-term debt of the registrant in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K promulgated under the Exchange Act.

SIGNATURES

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

SUSQUEHANNA BANCSHARES, INC.

May 8, 2014 /s/ William J. Reuter William J. Reuter

Chairman and Chief Executive Officer

May 8, 2014 /s/ Michael W. Harrington

Michael W. Harrington

Executive Vice President and Chief

Financial Officer

EXHIBIT INDEX

3.1	Amended and Restated Articles of Incorporation, dated May 6, 2011, incorporated by reference to Exhibit 3.1 to Susquehanna’s Quarterly Report on Form 10-Q, filed August 8, 2011.


3.2	Amended and Restated By-Laws, dated December 10, 2013, incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 13, 2013.


31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1.

31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2.

32	Section 1350 Certifications are filed herewith as Exhibit 32.

101.INS	XBRL Instance Document

101.SCH	XBRL Taxonomy Extension Schema Document

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB	XBRL Taxonomy Extension Label Linkbase Document

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

Susquehanna Bancshares (SUSQ) Inactive 10-Q2014 Q1 Quarterly report

Content analysis

Item 3. Quantitative and Qualitative Disclosures About Market Risk.