Susquehanna Bancshares (SUSQ) 10-Q 2003 Q2 Quarterly report

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 June 30, 2003

OR

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

For the transition period from            to            

Commission file number 0-10674

Susquehanna Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania	23-2201716
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
26 North Cedar St., Lititz, Pennsylvania	17543
(Address of Principal Executive Offices)	(Zip Code)

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

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

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

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

39,763,683 shares of common stock, par value $2.00 per share, as of July 31, 2003.

AVAILABILITY OF INFORMATION

Susquehanna’s Web site is located atwww.susqbanc.com. We make available, free of charge, through our Web site, our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION
Item 1	Financial Statements
	Consolidated Balance Sheets – as of June 30, 2003 and 2002 (unaudited), and December 31, 2002	3
	Consolidated Statements of Income – for the three and six months ended June 30, 2003 and 2002 (unaudited)	4
	Consolidated Statements of Cash Flows – for the six months ended June 30, 2003 and 2002 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2003 and 2002 (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3	Quantitative and Qualitative Disclosures about Market Risk	23
Item 4	Controls and Procedures	31
PART II.	OTHER INFORMATION
Item 4	Submission of Matters to a Vote of Security Holders	32
Item 6	Exhibits and Reports on Form 8-K	33
SIGNATURES		34
EXHIBIT INDEX		35

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)	June 30 2003		December 31 2002		June 30 2002
ASSETS
Cash and due from banks	$	194,550	$	156,320	$	113,414
Short-term investments:
Restricted		51,926		30,611		31,149
Unrestricted		30,359		22,025		19,720
Total short-term investments		82,285		52,636		50,869
Investment securities available for sale, at fair value		1,244,577		1,122,230		1,038,522
Investment securities held to maturity, at amortized cost (Fair values of $3,434, $4,177 and $1,689)		3,434		4,177		1,689
Loans and leases, net of unearned income		3,898,938		3,830,953		3,737,178
Less: Allowance for loan and lease losses		40,329		39,671		39,148
Net loans and leases		3,858,609		3,791,282		3,698,030
Premises and equipment (net)		60,067		60,108		59,361
Accrued income receivable		18,510		20,579		21,521
Bank-owned life insurance		127,815		125,127		123,269
Goodwill		54,897		54,897		54,396
Intangible assets with finite lives		4,685		4,998		5,294
Other assets		139,901		152,293		110,892
Total assets	$	5,789,330	$	5,544,647	$	5,277,257
LIABILITIES
Deposits:
Demand	$	691,200	$	601,272	$	545,375
Interest-bearing demand		1,187,906		1,137,875		976,486
Savings		500,273		470,317		468,774
Time		1,262,671		1,300,445		1,317,126
Time of $100 or more		336,426		321,406		323,204
Total deposits		3,978,476		3,831,315		3,630,965
Short-term borrowings		341,906		266,724		219,003
FHLB borrowings		598,160		543,166		565,121
Vehicle financing		4,958		31,304		106,403
Long-term debt		145,000		180,000		105,000
Accrued interest, taxes, and expenses payable		32,217		40,314		51,474
Deferred taxes		99,012		95,478		50,662
Other liabilities		43,732		22,491		31,498
Total liabilities		5,243,461		5,010,792		4,760,126
SHAREHOLDERS’ EQUITY
Common stock
Authorized: 100,000,000 ($2.00 par value)
Issued: 39,757,469 at June 30, 2003; 39,638,447 at December 31, 2002; and 39,433,663 at June 30, 2002		79,515		79,277		78,867
Surplus		64,578		62,858		58,434
Retained earnings		390,972		375,244		360,204
Accumulated other comprehensive income, net of taxes of $5,860, $8,662, and $10,568, respectively		10,804		16,476		19,626
Total shareholders’ equity		545,869		533,855		517,131
Total liabilities and shareholders’ equity	$	5,789,330	$	5,544,647	$	5,277,257

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

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Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended June 30				Six Months Ended June 30
(Dollars in thousands, except per share)	2003		2002		2003		2002
INTEREST INCOME
Interest and fees on loans and leases	$	60,942	$	65,736	$	122,835	$	130,024
Interest on investment securities:    Taxable		10,833		13,833		22,502		27,116
Tax-exempt		372		618		835		1,322
Interest on short-term investments		198		263		362		700
Total interest income		72,345		80,450		146,534		159,162
INTEREST EXPENSE
Interest on deposits:
Interest-bearing demand		2,466		3,002		5,143		5,908
Savings		599		1,103		1,209		2,180
Time		13,133		16,386		27,098		34,152
Interest on short-term borrowings		872		797		1,569		1,472
Interest on FHLB borrowings		5,598		7,418		11,636		14,679
Interest on vehicle financing		58		1,988		199		4,594
Interest on long-term debt		2,600		2,000		5,382		3,993
Total interest expense		25,326		32,694		52,236		66,978
Net interest income		47,019		47,756		94,298		92,184
Provision for loan and lease losses		2,175		2,434		4,880		4,707
Net interest income after provision for loan and lease losses		44,844		45,322		89,418		87,477
NON-INTEREST INCOME
Service charges on deposit accounts		4,825		4,207		9,290		8,050
Vehicle origination and servicing fees		7,567		6,864		14,570		13,896
Merchant credit card fees		0		2,740		0		6,467
Asset management fees		2,514		2,521		4,800		4,973
Income from fiduciary-related activities		1,427		1,247		2,949		2,498
Gain on sale of loans and leases		2,402		727		4,939		2,139
Income from bank-owned life insurance		1,433		1,630		3,075		3,348
Commissions on insurance sales		1,852		0		4,232		0
Other operating income		2,808		2,474		6,376		5,309
Investment security gains/(losses)		94		4		184		145
Total non-interest income		24,922		22,414		50,415		46,825
NON-INTEREST EXPENSES
Salaries and employee benefits		22,349		19,772		44,703		39,411
Net occupancy expense		3,379		3,077		6,900		6,175
Furniture and equipment expense		2,269		2,144		4,469		4,219
Amortization of intangible assets		157		158		313		326
Vehicle residual value expense		1,657		1,605		3,075		3,270
Vehicle delivery and preparation expense		2,691		2,046		5,585		3,608
Merchant credit card servicing expense		0		2,603		0		6,250
Other operating expenses		13,958		13,695		28,191		26,928
Total non-interest expenses		46,460		45,100		93,236		90,187
Income before income taxes		23,306		22,636		46,597		44,115
Provision for income taxes		6,992		7,017		14,212		13,676
NET INCOME	$	16,314	$	15,619	$	32,385	$	30,439
Per share information:
Basic earnings	$	0.41	$	0.40	$	0.82	$	0.77
Diluted earnings	$	0.41	$	0.39	$	0.81	$	0.77
Cash dividends	$	0.21	$	0.20	$	0.42	$	0.40
Average shares outstanding:    Basic		39,689		39,398		39,673		39,373
Diluted		39,952		39,721		39,927		39,688

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

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Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands) Six months ended June 30,	2003			2002
OPERATING ACTIVITIES:
Net income	$	32,385		$	30,439
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		11,604			4,642
Provision for loan and lease losses		4,880			4,707
Gain on securities transactions		(184	)		(145	)
Deferred income taxes		6,644			6,353
Gain on sale of loans		(4,939	)		(1,899	)
Gain on sale of other real estate owned		(171	)		(63	)
Mortgage loans originated for sale		(120,526	)		(52,294	)
Sale of mortgage loans originated for sale		106,485			58,189
Leases acquired/originated for sale		(123,619	)		(79,415	)
Sale of leases acquired/originated for sale		123,619			80,215
(Increase) decrease in accrued interest receivable		2,069			(253	)
Decrease in accrued interest payable		(3,621	)		(1,824	)
Increase (decrease) in accrued expenses and taxes payable		(403	)		16,646
Other, net		29,763			(13,890	)
Net cash provided by operating activities		63,986			51,408
INVESTING ACTIVITIES:
Net (increase) decrease in restricted short-term investments		(21,315	)		10,435
Proceeds from the sale of available-for-sale securities		63,704			6,003
Proceeds from the maturities, calls, and principal repayments of available-for-sale securities		534,314			132,637
Purchase of available-for-sale securities		(734,864	)		(147,868	)
Net increase in loans and leases		(56,953	)		(226,260	)
Capital expenditures		(3,600	)		(290	)
Net cash used for investing activities		(218,714	)		(225,343	)
FINANCING ACTIVITIES:
Net increase in deposits		147,161			146,634
Net increase in short-term borrowings		75,182			49,200
Net increase (decrease) in FHLB borrowings		54,994			(5,459	)
Net decrease in vehicle financing		(26,346	)		(65,059	)
Repayment of long-term debt		(35,000	)		0
Proceeds from issuance of common stock		1,958			1,282
Dividends paid		(16,657	)		(15,743	)
Net cash provided by financing activities		201,292			110,855
Net increase (decrease) in cash and cash equivalents		46,564			(63,080	)
Cash and cash equivalents at January 1		178,345			196,214
Cash and cash equivalents at June 30	$	224,909		$	133,134
Cash and cash equivalents:
Cash and due from banks	$	194,550		$	113,414
Unrestricted short-term investments		30,359			19,720
Cash and cash equivalents at June 30	$	224,909		$	133,134

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

Interest paid on deposits, short-term borrowings, and long-term debt was $55,857 and $68,703 in 2003 and 2002, respectively. Payments for income taxes totaled $3,033 in 2003 while an income tax refund of $9,200 was received in 2002. Amounts transferred to other real estate owned were $1,347 in 2003 and $1,327 in 2002.

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Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands, except per share data) Six months ended June 30	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total Equity
Balance - January 1, 2002	$	78,796	$	57,986	$	345,508		$	12,009		$	(763	)	$	493,536
Comprehensive income:
Net income						30,439									30,439
Change in unrealized gain/(loss) on securities, net of taxes of $3,844 and reclassification adjustment of $145									7,254						7,254
Change in unrealized gain on recorded interest in securitized assets, net of taxes of $237									363						363
Total comprehensive income						30,439			7,617						38,056
Common stock issued under employee benefit plans		71		448								763			1,282
Cash dividends paid:
Per common share of $0.40						(15,743	)								(15,743	)
Balance - June 30, 2002	$	78,867	$	58,434	$	360,204		$	19,626		$	0		$	517,131
Balance - January 1, 2003	$	79,277	$	62,858	$	375,244		$	16,476		$	0		$	533,855
Comprehensive income:
Net income						32,385									32,385
Change in unrealized gain/(loss) on securities, net of taxes of ($3,110) and reclassification adjustment of $184									(5,775	)					(5,775	)
Change in unrealized gain on recorded interest in securitized assets, net of taxes of $387									103						103
Total comprehensive income						32,385			(5,672	)					26,713
Common stock issued under employee benefit plans (includes related tax benefit of $350)		238		1,720											1,958
Cash dividends paid:
Per common share of $0.42						(16,657	)								(16,657	)
Balance - June 30, 2003	$	79,515	$	64,578	$	390,972		$	10,804		$	0		$	545,869

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

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Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands)

NOTE 1. ACCOUNTING POLICIES

The information contained in this report is unaudited and is subject to year-end adjustments. Certain prior year amounts have been reclassified to conform with current period classifications. The adjustments had no effect on gross revenues, gross expenses or net income. In the opinion of management, the information reflects all adjustments necessary for a fair statement of results for the periods ended June 30, 2003 and 2002.

The accounting policies of Susquehanna Bancshares, Inc. & Subsidiaries, as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 40 through 44 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2002.

Asset Securitizations

Susquehanna uses the securitization of financial assets as a source of funding. Hann Financial Service Corporation (“Hann”) holds the undivided beneficial interest in Hann Auto Trust, a Delaware statutory trust ( the “Origination Trust”), formed by Hann in 1997 for the purpose of originating automobile leases and holding title to the related vehicles. Hann sells beneficial interests in automobile leases and related vehicles originated by the Origination Trust at par to wholly owned, qualified special purpose entities (each a “QSPE”). These transactions are accounted for as sales under the guidelines of SFAS No. 140. Each QSPE retains the right to receive excess cash flows from the sold portfolio. Under SFAS No. 140, Hann is required to recognize a receivable representing the present value of these excess cash flows, which is subordinate to the rights of each of the QSPE’s creditors. The value of this recorded receivable is subject to credit, prepayment, and interest rate risk.

During the third quarter of 2002, Hann entered into a revolving securitization transaction and, as of June 30, 2003, had sold beneficial interests in $192,900 in automobile leases and related vehicles at par to a wholly-owned QSPE. From time to time, the QSPE may purchase beneficial interests in additional automobile leases and related vehicles from Hann. The QSPE finances the purchases by borrowing funds in an amount up to $200,000 from a non-related, asset-backed commercial paper issuer; however, the lender is not committed to make loans to the QSPE. Subsequent purchases by the QSPE are also accounted for as sales under the guidelines of SFAS No. 140.

During the first quarter of 2002, Hann entered into a revolving securitization transaction and, as of June 30, 2003, had sold beneficial interests in $65,900 in automobile leases and related vehicles at par to a wholly-owned QSPE. From time to time, this QSPE may purchase beneficial interests in additional automobile leases and related vehicles from Hann. The QSPE finances such purchases by borrowing funds in an amount up to $80,000 from a non-related, asset-backed commercial paper issuer under a committed facility. Subsequent purchases by the QSPE are also accounted for as sales under the guidelines of SFAS No. 140.

Variable Interest Entity (VIE)

In December 2000, Hann sold and contributed the beneficial interest in $190,000 of automobiles subject to operating leases to a wholly owned special purpose subsidiary (“the Lessee”). The Lessee sold such beneficial interests to a lessor (“the Lessor”), and the Lessor in turn leased the beneficial interest in the automobiles and operating leases back to the Lessee under a Master Lease Agreement that has an eight-year term with an early buyout option on January 14, 2007. For accounting purposes, the transaction is treated as a sale and an operating lease. The Lessor is a Delaware statutory trust and a VIE. The Lessor held the beneficial interest in auto leases with a remaining balance of $122,000 at June 30, 2003.

To support its obligations under the Master Lease Agreement, at closing the Lessee pledged the beneficial interest in an additional $43,000 of automobile leases and related vehicles, which also were sold or contributed to the Lessee. At June 30, 2003, this amount was $47,017.

Under the sale-leaseback transaction, the transaction documents contain several requirements, obligations, liabilities, provisions, and consequences, which become applicable upon the occurrence of an “Early Amortization Event”. After an Early Amortization Event, the Lessee can no longer make substitutions under the Master Lease Agreement, which means that the sales proceeds from the sold vehicles following termination of the related auto leases may not be used to purchase replacement vehicles and leases. Instead, the sales proceeds and other amounts are used to make termination and other related payments under the Master Lease Agreement, which would reduce the income the Lessee is expected to earn over the term of the Master Lease Agreement. These termination and other related payments are amounts sufficient to permit the Lessor (1) to repay its outstanding debt, including any necessary makewhole amounts, (2) return to the Lessor’s equity investors their invested capital, and (3) compensate the Lessor’s

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Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Dollars in thousands)

equity investors for their early return of cash and their loss of tax benefits. Any termination with respect to particular vehicles would relieve the Lessee from the obligation to pay rent with respect to that vehicle. Makewhole amounts would be necessary only if the level of interest rates were lower at the time of the termination payment than the level of interest at the commencement of the transaction. In addition, if the Lessee were unable to substitute new vehicles for terminated vehicles, Susquehanna would be entitled to take depreciation deductions for tax purposes on the vehicles which were not substituted. Susquehanna believes that the occurrence of an Early Amortization Event is remote. The precise amount of these termination and other related payments is subject to a great deal of variability and depends significantly on future interest rates, the sales proceeds for the respective vehicles, the termination dates at which consumer leases terminate and the length of the remaining term of the Master Lease Agreement at the time of the Early Amortization Event. It is virtually impossible to calculate the amount of these termination payments. Even if an Early Amortization Event were to occur, Susquehanna would expect that the present value of these payments would not exceed the present value of the rent avoided and tax benefits gained by a material amount.

At the end of the lease term under the Master Lease Agreement, the Lessee has agreed to act as a remarketing agent for the Lessor if the Lessor decides to sell the beneficial interest in the leases and related vehicles. The Lessee has agreed that if the aggregate net proceeds of such sale are less than the Lease End Value of the beneficial interest in the leases and related vehicles at that time, the Lessee will pay to the Lessor the excess, if any, of the Lease End Value over the aggregate net proceeds of such sale. “Lease End Value” is the lower of (1) the aggregate wholesale “clean” value of the vehicles (as shown in theBlack Book Official Used Car Market Guide Monthly) or (2) $38,000. If the leases and related vehicles are worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38,000.

Recent Accounting Pronouncements.

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” The objective of this interpretation is to provide guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, non-controlling interests, and results of operations of a VIE need to be included in a company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive the majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. The provisions of this interpretation became effective upon issuance. As of June 30, 2003, Susquehanna had variable interests in securitization trusts. All but one of these trusts are qualifying special purpose entities, which are exempt from the consolidation requirements of FIN 46. For the trust that is not a qualifying special purpose entity, Susquehanna has determined that this entity will remain off-balance sheet under the guidelines of FIN 46.

In April 2003, the Financial Accounting Standards Board issued FAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The changes in the statement improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this Statement (1) clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to include the occurrence or nonoccurrence of a specified event, and (4) amends certain other existing pronouncements. These changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. Generally, SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, with all provisions to be applied prospectively. Adoption of this statement is not expected to have a significant impact on Susquehanna’s financial condition or results of operations.

In May 2003, the Financial Accounting Standards Board issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities in statements of financial position. Statement No. 150 affects the issuer’s accounting for three types of freestanding financial instruments: mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets; instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets; and obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuer’s shares. This statement was effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. Adoption of this statement has not had a significant impact on Susquehanna’s financial condition or results of operation.

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Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Dollars in thousands)

NOTE 2. INVESTMENT SECURITIES

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

	June 30, 2003				December 31, 2002
	Amortized cost		Fair value		Amortized cost		Fair value
Available-for-sale:
U.S. Treasury	$	1,201	$	1,279	$	1,201	$	1,304
U.S. Government agencies		37,038		37,261		66,591		67,003
State & municipal		26,984		28,102		41,100		42,365
Mortgage-backed		1,129,491		1,138,484		961,341		978,861
Corporates		2		2		0		0
Equities		39,413		39,449		32,664		32,697
		1,234,129		1,244,577		1,102,897		1,122,230
Held-to-maturity:
State & municipal		3,434		3,434		4,177		4,177
		3,434		3,434		4,177		4,177
Total investment securities	$	1,237,563	$	1,248,011	$	1,107,074	$	1,126,407

NOTE 3. LOANS AND LEASES

Loans and leases, net of unearned income at June 30, 2003 and December 31, 2002, were as follows:

	June 30, 2003			December 31, 2002
Commercial, financial, and agricultural	$	554,965		$	478,181
Real estate - construction		472,685			456,663
Real estate secured - residential		1,231,315			1,246,939
Real estate secured - commercial		987,194			988,633
Consumer		335,925			343,537
Leases		316,854			317,000
Total loans and leases	$	3,898,938		$	3,830,953
Net investment in direct financing leases at June 30, 2003 and December 31, 2002 is as follows:
Minimum lease payments receivable	$	171,019		$	175,378
Estimated residual value of leases		177,571			176,329
Unearned income under lease contracts		(31,736	)		(34,707	)
Total leases	$	316,854		$	317,000
An analysis of impaired loans as of June 30, 2003 and December 31, 2002, is as follows:
Impaired loans without a related reserve	$	1,086		$	4,300
Impaired loans with a reserve		8,096			6,114
Total impaired loans	$	9,182		$	10,414
Reserve for impaired loans	$	2,461		$	1,234

An analysis of impaired loans for the three and six month periods ended June 30, 2003 and 2002 is as follows:

	Three Months ended June 30,				Six Months ended June 30,
	2003		2002		2003		2002
Average balance of impaired loans	$	7,506	$	9,085	$	6,939	$	8,062
Interest income on impaired loans (cash-basis)		27		18		44		58

9

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Dollars in thousands, except per share data)

NOTE 4. BORROWINGS

	June 30, 2003		December 31, 2002
Short-term borrowings at June 30, 2003 and December 31, 2002, were as follows:
Securities sold under repurchase agreements	$	308,427	$	201,369
Federal funds purchased	$	29,850	$	57,225
Treasury tax and loan notes		3,629		8,130
Total short-term borrowings	$	341,906	$	266,724
Long-term debt at June 30, 2003 and December 31, 2002, was as follows:
Subsidiaries:
Term notes due July, 2003	$	10,000	$	10,000
Term notes due July, 2003		5,000		5,000
Term notes due July, 2004		5,000		5,000
Parent:
Senior notes due February, 2003		0		35,000
Subordinated notes due February, 2005		50,000		50,000
Subordinated notes due November, 2012		75,000		75,000
Total long-term debt	$	145,000	$	180,000

NOTE 5. EARNINGS-PER-SHARE (shares in thousands)

The following tables set forth the calculation of basic and diluted earnings per share for the three months ended and six months ended June 30, 2003 and 2002.

	For the three months ended June 30
	2003					2002
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	16,314	39,689	$	0.41	$	15,619	39,398	$	0.40
Effect of Diluted Securities:
Stock options outstanding			263					323
Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	16,314	39,952	$	0.41	$	15,619	39,721	$	0.39

For the three months ended June 30, 2003 and 2002, average options to purchase 461 and 233 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares; and the options were, therefore, antidilutive.

	For the six months ended June 30
	2003					2002
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	32,385	39,673	$	0.82	$	30,439	39,373	$	0.77
Effect of Diluted Securities:
Stock options outstanding			254					315
Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	32,385	39,927	$	0.81	$	30,439	39,688	$	0.77

For the six months ended June 30, 2003 and 2002, average options to purchase 748 and 229 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares; and the options were, therefore, antidilutive.

10

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Dollars in thousands, except per share data)

NOTE 6. STOCK-BASED COMPENSATION

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

Pursuant to FAS No. 123, “Accounting for Stock-Based Compensation,” as amended by FAS No. 148, “Accounting for Stock-Based Compensation - Transitions and Disclosure,” disclosure requirements, pro forma net income, and earnings per share are presented in the following table as if compensation cost for stock options was determined under the fair value method and amortized to expense over the options’ vesting periods. On May 21, 2003, 288 options were granted to employees and directors with an option price of $22.42 per share on the date of grant. In addition, on June 30, 2003, 20 shares were purchased under the ESPP at a price of $18.756 per share.

	For the three months ended June 30				For the six months ended June 30
	2003		2002		2003		2002
Net income, as reported	$	16,314	$	15,619	$	32,385	$	30,439
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		170		162		364		298
Pro forma net income	$	16,144	$	15,457	$	32,021	$	30,141
Earnings per share:
Basic - as reported	$	0.41	$	0.40	$	0.82	$	0.77
Basic - pro forma	$	0.41	$	0.39	$	0.81	$	0.77
Diluted - as reported	$	0.41	$	0.39	$	0.81	$	0.77
Diluted - pro forma	$	0.40	$	0.39	$	0.80	$	0.76

11

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Dollars in thousands, except per share data)

Note 7. SECURITIZATION ACTIVITY

During 2002 and 2001, Susquehanna sold the beneficial interests in automobile leases in securitization transactions. In all those securitizations, Susquehanna retained servicing responsibilities and subordinated interests. Susquehanna receives annual servicing fees approximating 1.0% of the outstanding balance and rights to future cash flows arising after the investors have received the return for which they contracted. Susquehanna recognizes no servicing asset, as servicing income approximates servicing costs. The investors and the securitization trusts have no recourse to Susquehanna’s other assets, except retained interests, for failure of debtors to pay when due. Susquehanna’s retained interests are subordinate to investors’ interests. Their value is subject to credit, prepayment, and interest rate risks on the transferred financial assets.

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

	As of June 30								For the Six Months Ended June 30
	Principal Balance				Leases Past Due 30 Days or More				Net Credit Losses
	2003		2002		2003		2002		2003		2002
Total leases serviced	$	1,439,324	$	1,353,509	$	2,982	$	2,250	$	264	$	169
Less:
Leases securitized		341,714		179,082		210		102		88		3
Leases serviced for others (1)		861,791		799,074		2,508		1,610		106		98
Leases held in portfolio	$	235,819	$	375,353	$	264	$	538	$	70	$	68

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

	Six Months Ended June 30
	2003		2002
Proceeds from lease securitizations	$	115,584	$	117,186
Amounts derecognized		123,619		79,415
Servicing fees received		1,359		801
Other cash flows received on retained interests		4,038		1,084

Set forth below is a summary of the fair values of the interest-only strips, key economic assumptions used to arrive at the fair values, and the sensitivity of the June 30, 2003 fair values to immediate 10% and 20% adverse changes in those assumptions. The sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption: in reality changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

Automobile Leases	Fair Value		Weighted- average Life (in months)	Monthly Prepayment Speed			Expected Cumulative Credit Losses			Annual Discount Rate (2)
Third quarter 2002 transaction - Interest-Only Strip
As of June 30, 2003	$	6,100	33		0.10	%		0.10	%		1.96	%
Decline in fair value of 10% adverse change				$	10		$	10		$	34
Decline in fair value of 20% adverse change					20			20			68
First quarter 2002 transaction - Interest-Only Strip
As of June 30, 2003		2,697	24		0.10	%		0.10	%		1.52	%
Decline in fair value of 10% adverse change				$	3		$	3		$	8
Decline in fair value of 20% adverse change					6			6			16
2001 transaction - Interest-Only Strip
As of June 30, 2003		2,386	6		0.10	%		0.10	%		0.98	%
Decline in fair value of 10% adverse change				$	0		$	0		$	1
Decline in fair value of 20% adverse change					0			0			2

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

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

12

Item 2

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

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

Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited, to Susquehanna’s potential exposures to various types of market risks, such as interest rate risk and credit risk. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:

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

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

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

• the adequacy of loss reserves;

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

• continued relationships with major customers;

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

• adverse national and regional economic and business conditions;

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

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

• the inability to hedge certain risks economically;

• our ability to effectively implement technology driven products and services;

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

• our success in managing the risks involved in the foregoing.

We encourage readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. Forward-looking

13

statements speak only as of the date they are made. We do not update 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.

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

Results of Operations

Summary of 2003 Compared to 2002

Net income for the second quarter of 2003 was $16.3 million, a 4.5% increase from net income of $15.6 million in the second quarter of 2002. For the first six months of 2003, net income was $32.4 million, a 6.4% increase from net income for the same period during 2002.

During the second quarter of 2003, our net interest income decreased by 1.5%, to $47.0 million in 2003 from $47.8 million in 2002. Non-interest income continued to improve as it increased by 11.2%, to $24.9 million for the second quarter of 2003 from $22.4 million for the second quarter of 2002. Non-interest income represented 34.6% of total revenues for the second quarter of 2003 and 31.9% for the second quarter of 2002. Non-interest expenses increased 3.0%, to $46.5 million for the second quarter of 2003 from $45.1 million for the second quarter of 2002.

During the first six months of 2003, our net interest income increased by 2.3%, and non-interest income increased by 7.7%, from the comparable period in 2002. Non-interest income represented 34.8% of total revenues for the first six months of 2003 and 33.7% for the first six months of 2002. This improvement in net interest income and non-interest income was partially offset by a 3.4% increase in non-interest expenses from the comparable period in 2002.

Additional information is as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Diluted Earnings per Share	$	0.41		$	0.39		$	0.81		$	0.77
Return on Average Assets		1.15	%		1.20	%		1.17	%		1.19	%
Return on Average Equity		12.14	%		12.37	%		12.16	%		12.24	%

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

14

Net Interest Income – Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which decreased to $47.0 million in the second quarter of 2003, from $47.8 million for the same period in 2002. For the six months ended June 30, 2003, net interest income was $94.3 million compared with $92.2 million for the same period in 2002.

Net interest income is the income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans and leases, income from investment securities, and income from short-term investments. The amount of interest income is dependent upon many factors, including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates, and levels of non-performing assets. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds, and the levels of non-interest bearing demand deposits and equity capital.

Table 1 presents average balances, taxable equivalent interest income, interest expenses, and yields earned or paid on these assets and liabilities. For purposes of calculating taxable equivalent interest income, tax-exempt interest has been adjusted using a marginal tax rate of 35% in order to equate the yield to that of taxable interest rates. Net interest income as a percentage of net interest income and other income was 65.4% for the quarter ended June 30, 2003 and 68.1% for the quarter ended June 30, 2002. Net interest income as a percentage of net interest income and other income was 65.2% for the six months ended June 30, 2003 and 66.3 for the six months ended June 30, 2002.

Net interest income for the second quarter of 2003 decreased $0.7 million over the second quarter of 2002. Average earning assets in the second quarter of 2003 increased $408.3 million over the same period in 2002, with average loans and leases increasing $156.3 million, average investment securities increasing $232.7 million, and lower yielding, short-term investments increasing $19.3 million. Average interest-bearing liabilities increased $296.4 million, with average interest-bearing deposits increasing $250.3 million, average vehicle financing decreasing $118.5 million, and average other debt increasing $164.5 million. In addition, average non-interest bearing demand deposits increased $88.8 million in the second quarter of 2003 over the second quarter of 2002. The decrease in net interest income is primarily the result of average yields on earning assets declining more than the average cost of deposits, as interest rates remain at their lowest level in decades. Since we are an asset-sensitive institution, where assets reprice more quickly than liabilities, the net interest margin experienced further compression as interest rates declined and decreased to 3.69% in the second quarter of 2003 from 4.08% in the second quarter of 2002.

Net interest income for the six months ended June 30, 2003 increased $2.1 million compared to the same period in 2002. Average earning assets for the first six months of 2003 increased $385.9 million over the same period in 2002, with average loans and leases increasing $210.3 million, average investment securities increasing $183.1 million, and lower yielding, short-term investments decreasing $7.5 million. Average interest-bearing liabilities increased

15

$268.3 million, with average interest-bearing deposits increasing $259.4 million, average vehicle financing decreasing $128.3 million, and average other debt increasing $137.2 million. Average non-interest bearing demand deposits increased $81.3 million for the first six months of 2003 compared with the first six months of 2002. The increase in net interest income is primarily the result of the net increase in average interest-earning assets. The net interest margin, however, experienced further compression and decreased to 3.78% for the first six months of 2003 from 4.01% for the first six months of 2002, as we are an asset-sensitive institution in a declining 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 at a level adequate to absorb management’s estimate of probable losses in the loan and lease portfolio. Our provision for loan and lease losses is based upon management’s quarterly review of the loan and lease portfolio. The purpose of the review is to assess credit quality, identify impaired loans and leases, analyze delinquencies, ascertain growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets we serve.

As illustrated in Table 2, the provision was $2.2 million in the second quarter of 2003, a decrease of $0.3 million from the same period in 2002. Net charge-offs were $2.1 million for the three-month period ended June 30, 2003 versus $1.8 million in the corresponding three-month period ended 2002. The allowance for loan and lease losses as a percentage of period-end loans and leases was 1.03% at June 30, 2003 and 1.05% at June 30, 2002

For the six months ended June 30, 2003, the provision was $4.9 million, an increase of $0.2 million over the $4.7 million provision for the first six months of 2003, while net charge-offs increased from $3.3 million in 2002 to $4.2 million in 2003.

Determining the level of the allowance for possible loan and lease losses at any given period is difficult, particularly during uncertain economic periods. We must make estimates using information and assumptions that are often subject to rapid change. The review of the loan and lease portfolio is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and leases losses is adequate to meet probable future loan and lease losses at June 30, 2003. There can be no assurance, however, that we will not sustain losses in future periods, which could be greater than the size of the allowance at June 30, 2003.

16

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 1 - DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY

(dollars in thousands)

Interest rates and interest differential - taxable equivalent basis

	For the Three Month Period Ended June 30, 2003						For the Three Month Period Ended June 30, 2002
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short - term investments	$	72,147		$	198	1.10	$	52,843		$	263	2.00
Investment securities:
Taxable		1,213,515			10,833	3.58		958,583			13,833	5.79
Tax - advantaged		31,817			572	7.21		54,023			952	7.07
Total investment securities		1,245,332			11,405	3.67		1,012,606			14,785	5.86
Loans and leases, (net):
Taxable		3,794,545			60,311	6.38		3,645,093			65,110	7.16
Tax - advantaged		54,839			971	7.10		48,015			965	8.06
Total loans and leases		3,849,384			61,282	6.39		3,693,108			66,075	7.18
Total interest - earning assets		5,166,863		$	72,885	5.66		4,758,557		$	81,122	6.84
Allowance for loan and lease losses		(40,533	)					(39,155	)
Other non - earning assets		553,462						490,699
Total assets	$	5,679,792					$	5,210,101
Liabilities
Deposits:
Interest - bearing demand	$	1,168,672		$	2,466	0.85	$	938,783		$	3,003	1.28
Savings		497,769			599	0.48		467,067			1,103	0.95
Time		1,608,768			13,133	3.27		1,619,017			16,386	4.06
Short - term borrowings		328,404			872	1.07		195,226			796	1.64
FHLB borrowings		591,902			5,598	3.79		600,568			7,419	4.95
Vehicle financing		8,017			58	2.90		126,500			1,987	6.30
Long - term debt		145,000			2,600	7.19		105,000			2,000	7.64
Total interest - bearing liabilities		4,348,532		$	25,326	2.34		4,052,161		$	32,694	3.24
Demand deposits		630,442						541,669
Other liabilities		161,866						109,916
Total liabilities		5,140,840						4,703,746
Equity		538,952						506,355
Total liabilities & shareholders’ equity	$	5,679,792					$	5,210,101
Net interest income / yield on average earning assets				$	47,559	3.69				$	48,428	4.08

1. Average loan balances include non accrual loans.

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

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

17

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 1 - DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY (continued)

(dollars in thousands)

Interest rates and interest differential - taxable equivalent basis

	For the Six Month Period Ended June 30, 2003						For the Six Month Period Ended June 30, 2002
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short - term investments	$	66,162		$	362	1.10	$	73,659		$	700	1.92
Investment securities:
Taxable		1,158,743			22,502	3.92		954,078			27,116	5.73
Tax - advantaged		36,148			1,284	7.16		57,734			2,034	7.10
Total investment securities		1,194,891			23,786	4.01		1,011,812			29,150	5.81
Loans and leases, (net):
Taxable		3,772,063			121,448	6.49		3,570,648			128,819	7.28
Tax - advantaged		54,881			2,134	7.84		45,985			1,854	8.13
Total loans and leases		3,826,944			123,582	6.51		3,616,633			130,673	7.29
Total interest - earning assets		5,087,997		$	147,730	5.86		4,702,104		$	160,523	6.88
Allowance for loan and lease losses		(40,286	)					(38,701	)
Other non - earning assets		552,713						495,563
Total assets	$	5,600,424					$	5,158,966
Liabilities
Deposits:
Interest - bearing demand	$	1,162,802		$	5,143	0.89	$	928,939		$	5,909	1.28
Savings		489,107			1,208	0.50		456,198			2,180	0.96
Time		1,610,680			27,098	3.39		1,618,022			34,152	4.26
Short - term borrowings		294,680			1,569	1.07		185,283			1,471	1.60
FHLB borrowings		570,396			11,636	4.11		588,971			14,680	5.03
Vehicle financing		13,867			199	2.89		142,156			4,593	6.52
Long - term debt		151,381			5,382	7.17		105,000			3,993	7.67
Total interest - bearing liabilities		4,292,913		$	52,235	2.45		4,024,569		$	66,978	3.36
Demand deposits		610,477						529,135
Other liabilities		160,040						103,827
Total liabilities		5,063,430						4,657,531
Equity		536,994						501,435
Total liabilities & shareholders’ equity	$	5,600,424					$	5,158,966
Net interest income / yield on average earning assets				$	95,495	3.78				$	93,545	4.01

1. Average loan balances include non accrual loans.

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

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

18

Non-interest Income

Non-interest income increased $2.5 million, or 11.2%, from $22.4 million in the second quarter of 2002, to $24.9 million in the second quarter of 2003. This net increase is primarily the result of $1.9 million in commissions on insurance sales recognized in the second quarter of 2003 from The Addis Group, Inc. (“Addis”), which was acquired in June 2002; increased gains on the sale of loans and leases of $1.7 million; increased vehicle origination and servicing fees of $0.7 million at Hann; and increased service charges on deposit accounts of $0.6 million. These comparative increases were partially offset by the absence of merchant credit card fees (we exited the merchant credit card business in September 2002) in 2003. Merchant credit card fees for the second quarter of 2002 were $2.7 million.

Non-interest income increased $3.6 million, or 7.7%, from $46.8 million for the six months ended June 30, 2002 to $50.4 million for the six months ended June 30, 2003. This net increase is primarily the result of $4.2 million in commissions on insurance sales recognized for the first six months of 2003 from Addis; increased gains on the sale of loans and leases of $2.8 million; and increased service charges on deposit accounts of $1.2 million. These comparative increases were partially offset by the absence of merchant credit card fees in 2003. Merchant credit card fees for the first six months of 2002 were $6.5 million.

Non-interest income as a percentage of net interest income and non-interest income was 34.6% for the quarter ended June 30, 2003 compared with 31.9% for the comparable period in 2002. Non-interest income as a percentage of net interest income and non-interest income was 34.8% for the six months ended June 30, 2003 compared with 33.7% for the comparable period in 2002.

Non-interest Expenses

Total non-interest expenses increased $1.4 million, or 3.0%, from $45.1 million in the second quarter of 2002 to $46.5 million in the second quarter of 2003. For the six months ended June 30, 2003, total non-interest expenses increased $3.0 million, or 3.4%, to $93.2 million from $90.2 million during the same period in 2002.

The quarter-to-quarter increase was primarily due to increases in salaries and benefits expense of 13.0%, or $2.6 million, as a result of the Addis acquisition in June 2002, normal annual salary increases, and an increased sales force. Vehicle delivery and preparation expense increased by 31.5%, or $0.6 million, due to Hann’s increased ability to sell cars through a third party used vehicle remarketer rather than through auction, as well as the increased volume of cars coming off lease. These comparative increases were partially offset by the absence of merchant credit card servicing expenses in 2003. Merchant credit card servicing expenses for the second quarter of 2002 were $2.6 million.

The $3.0 million increase in non-interest expenses between the six-month period ended June 30, 2002 and the six-month period ended June 30, 2003 is attributable to the same factors described above. Salaries and benefits expense increased by 13.4%, and vehicle delivery and preparation expenses increased by 54.8%. For the six months ended June 30, 2002, merchant

19

credit card servicing expenses were $6.3 million.

Income Taxes

Susquehanna’s effective tax rate for the second quarter of 2003 was 30.0% and 31.0% for the second quarter of 2002. For the six months ended June 30, 2003, our effective tax rate was 30.5% and 31.0% for the six months ended June 30, 2002.

Financial Condition

Summary of 2003 compared to 2002

Total assets at June 30, 2003 were $5.8 billion, compared with $5.5 billion at December 31, 2002 and $5.3 billion at June 30, 2002. Equity capital was $545.9 million at June 30, 2003, or $13.73 per share, compared to $533.9 million, or $13.47 per share, at December 31, 2002, and $517.1 million, or $13.11 per share, at June 30, 2002.

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

Investment Securities Available for Sale

Investment securities available for sale increased $122.3 million from December 31, 2002 to June 30, 2003 and $206.1 million from June 30, 2002 to June 30, 2003. While we have experienced growth in both our loan and lease portfolio and in total deposits, the deposit growth has been greater. We have, therefore, used the excess funds to purchase investment securities.

Loans and Leases

Loans and leases increased $68.0 million from December 31, 2002 to June 30, 2003 and $161.8 million from June 30, 2002 to June 30, 2003. We believe that these increases, as well as those experienced in total deposits, are a direct result of the bank subsidiaries’ successful implementation of our retail and corporate sales initiatives that were begun in 2002.

Deposits

Total deposits increased $147.2 million from December 31, 2002 to June 30, 2003 and $347.5 million from June 30, 2002 to June 30, 2003.

Borrowings

Total borrowings increased $68.8 million from December 31, 2002 to June 30, 2003 and $94.5 million from June 30, 2002 to June 30, 2003. The greatest increase within this category, from December 31, 2002 to June 30, 2003, occurred in securities sold under agreements to repurchase, which increased from $201.4 million at December 31, 2002 to $308.4 million at June 30, 2003. This increase represents an additional source of funding secured through brokers,

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which has been initiated to take advantage of the low-interest-rate environment.

Risk Assets

Table 3 shows an increase in non-accrual loans and leases from $16.8 million at June 30, 2002 to $20.1 million at June 30, 2003. Loans and leases past due 90 days or more and still accruing decreased from $10.0 million at June 30, 2002 to $7.0 million at June 30, 2003. The percentage of non-performing assets to period-end loans and other real estate owned increased from 0.53% at June 30, 2002 to 0.72% at June 30, 2003. The percentage of loan and lease loss reserve to non-performing loans and leases was 153.12% at June 30, 2003 compared with 232.64% at June 30, 2002.

At June 30, 2003, Susquehanna had a restructured loan totaling $6.3 million with a long-time borrower. This loan, secured by a hotel facility in our marketplace, was classified as a potential problem loan at December 31, 2002. The borrower has been making interest-only payments and is not delinquent under the modified terms as of June 30, 2003.

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Susquehanna Bancshares, Inc. and Subsidiaries

(dollars in thousands)

TABLE 2 - ALLOWANCE FOR LOAN AND LEASE LOSSES

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Balance - Beginning of period	$	40,281		$	38,532		$	39,671		$	37,698
Additions charged to operating expenses		2,175			2,434			4,880			4,707
		42,456			40,966			44,551			42,405
Charge-offs		(3,083	)		(2,425	)		(5,734	)		(4,427	)
Recoveries		956			607			1,512			1,170
Net charge-offs		(2,127	)		(1,818	)		(4,222	)		(3,257	)
Balance - Period end	$	40,329		$	39,148		$	40,329		$	39,148
Net charge-offs as a percent of average loans and leases (annualized)		0.22	%		0.20	%		0.22	%		0.18	%
Allowance as a percent of period-end loans and leases		1.03	%		1.05	%		1.03	%		1.05	%
Average loans and leases	$	3,849,384		$	3,693,108		$	3,826,944		$	3,616,633
Period-end loans and leases		3,898,938			3,737,178			3,898,938			3,737,178

TABLE 3 - RISK ASSETS

	June 30, 2003			December 31, 2002			June 30, 2002
Nonperforming assets:
Nonaccrual loans and leases	$	20,078		$	18,190		$	16,828
Restructured accrual loans		6,260			0			0
Other real estate owned		1,925			3,151			3,174
Total nonperforming assets	$	28,263		$	21,341		$	20,002
As a percent of period-end loans and leases and other real estate owned		0.72	%		0.56	%		0.53	%
Coverage ratio		153.12	%		218.09	%		232.64	%
Loans and leases contractually past due 90 days and still accruing	$	7,036		$	8,208		$	9,995

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Capital Resources

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

The minimum Tier 1 capital ratio is 4%; Susquehanna’s ratio at June 30, 2003 was 10.23%. The minimum total capital (Tier 1 and 2) ratio is 8%; Susquehanna’s ratio at June 30, 2003 was 12.71%. The minimum leverage ratio is 4%; Susquehanna’s leverage ratio at June 30, 2003 was 8.56%. Susquehanna and each of its banking subsidiaries have leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity is considered “well-capitalized” under regulatory guidelines.

Item 3

Quantitative and Qualitative Disclosures about Market Risk

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

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

Equity Market Price Risk

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

Liquidity Risk

Liquidity and interest rate risk are related but distinctly different from one another. The maintenance of adequate liquidity — the ability to meet the cash requirements of our customers and other financial commitments — is a fundamental aspect of our asset/liability management strategy. Our policy of diversifying our funding sources — purchased funds, repurchase agreements, and deposit accounts — enables us to avoid undue concentration in any single financial market and also to avoid heavy funding requirements within short periods of time. At June 30, 2003, our bank subsidiaries had unused lines of credit available to them from various Federal Home Loan Banks totaling approximately $741 million.

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Liquidity, however, is not entirely dependent on increasing our liability balances. Liquidity also can be generated from maturing or readily marketable assets. The carrying value of investment securities maturing within one year totaled to $16.4 million at June 30, 2003. These maturing investments represented 1.3% of total investment securities available for sale. Unrestricted short-term investments amounted to $30.4 million and represent additional sources of liquidity. Consequently, our exposure to liquidity risk is not considered significant.

Interest Rate Risk

Closely related to the management of liquidity is the management of interest rate risk. Interest rate risk management focuses on maintaining stability in the net interest margin, an important factor in earnings growth. Interest rate sensitivity is the matching or mismatching of the maturity and rate structure of the interest-earning assets and interest-bearing liabilities. It is our objective to control the difference in the timing of the rate changes for these assets and liabilities to preserve a satisfactory net interest margin. In doing so, we endeavor to maximize earnings in an environment of changing interest rates. There is, however, a lag in maintaining the desired matching because the repricing of products occurs at varying time intervals.

We employ a variety of methods to monitor interest rate risk. By dividing the assets and liabilities into three groups — fixed rate, floating rate and those which reprice only at our discretion — we develop strategies that are designed to minimize exposure to interest rate fluctuations. We use gap and interest rate shock analyses to evaluate interest rate sensitivity at a given point in time. Periodic gap reports compare the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates. We also utilize an in-house simulation model that measures our exposure to interest rate risk. This model calculates the income effect and the economic value of assets, liabilities and equity at current and forecasted interest rates, and at hypothetical higher and lower interest rates using one percent intervals.

Our policy, as approved by our Board of Directors, is to experience no more than a 15% decline in net interest income and no more than a 30% decline in the economic value of equity for a 300 basis point shock (immediate change) in interest rates. The assumptions used for the interest rate shock analysis are reviewed and updated at least quarterly. Based upon the most recent interest rate shock analysis, we were within the Board’s approved guidelines at a down 100 basis point shock and an up 300 basis point shock. Any down rate shock scenario greater than 100 basis points is considered remote, as the current federal funds rate is only 1.00%.

At June 30, 2003, we continue to be an asset-sensitive institution and should benefit from a rise in interest rates in the future, if that should occur. If rates should fall further, we likely will experience additional compression in our net interest margin.

Vehicle Leasing Residual Value Risk

In the third quarter of 2000, Hann entered into a Servicing Agreement with Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) pursuant to which Hann effectively transferred to Auto Lenders all residual value risk of the managed auto lease portfolio originated by Hann, and all residual value risk on any new leases originated over the term of the agreement.

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Auto Lenders, which was formed in 1990, is a used vehicle remarketer with three retail locations in New Jersey and access to various wholesale facilities throughout the country. Under this Servicing Agreement, Auto Lenders agrees to purchase the beneficial interest in all vehicles returned by the obligors at the scheduled expiration of the related leases for a purchase price equal to the stated residual value of such vehicles. Further, Hann agrees to set its stated residual values of new leases in accordance with the standards approved in advance by Auto Lenders. Hann also agrees to make monthly guaranty payments to Auto Lenders based upon a fixed 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, Hann periodically obtains competitive quotes from third parties to determine the best remarketing alternative for Hann.

Securitizations and Off-Balance Sheet Vehicle Lease Financings

Background. Asset securitizations and other off-balance sheet financings can further affect liquidity and interest rate risk. Hann holds the undivided beneficial interest in Hann Auto Trust, a Delaware statutory trust (the “Origination Trust”), formed by Hann in 1997 for the purpose of originating automobile leases and holding title to the related vehicles. Automobile leases originated by the Origination Trust are financed primarily in four ways:

• asset securitization transactions;

• sale-leaseback transactions;

• agency arrangements with, and lease sales to, other financial institutions; and

• other sources of funds, including internally generated sources.

Assets financed through the use of the first three methods generally are not reflected on Susquehanna’s consolidated balance sheet. As of June 30, 2003, Hann’s off-balance sheet, managed portfolio was funded in the following manner: asset securitization transactions, $341.7 million; a sale-leaseback transaction, $122.1 million; and agency arrangements and lease sales, $739.7 million.

In comparison, as of June 30, 2003, Hann’s on-balance sheet, managed portfolio totaled $235.8 million. All of Hann’s securitizations and off-balance sheet financings primarily are done to fund the assets originated by the Origination Trust and, in some cases, to enable Susquehanna to more efficiently utilize its required regulatory capital.

Securitization Transactions. In connection with its securitization transactions, Hann sells beneficial interests in automobile leases and related vehicles originated by the Origination Trust at par to a wholly-owned, qualified special purpose entity (each a “QSPE”). These transactions are accounted for as sales under the guidelines of SFAS No. 140. Each QSPE retains the right to receive excess cash flows from the sold portfolio. Under SFAS No. 140, Hann is required to recognize a receivable representing the present value of these excess cash flows (each a “PV Receivable”), which is subordinate to the rights of each QSPE’s creditors. The value of this recorded PV Receivable is subject to credit, prepayment, and interest rate risk. Further, although neither Hann nor Susquehanna has retained residual value risk in the

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automobile leases and related vehicles, in the event of a breach by Auto Lenders, a QSPE may suffer residual losses, which we expect would decrease the value of the PV Receivable recognized by Hann. As of June 30, 2003, the aggregate fair value of all such recorded PV Receivables in connection with Hann securitizations was $11.2 million.

Summary of Prior Years’ Securitization Transactions

During the third quarter of 2002, Hann entered into a revolving securitization transaction (the “third-quarter transaction”) and, as of June 30, 2003, had sold beneficial interests in $192.9 million in automobile leases and related vehicles at par to a wholly owned QSPE. From time to time, the QSPE may purchase beneficial interests in additional automobile leases and related vehicles from Hann. The QSPE finances the purchases by borrowing funds in an amount up to $200.0 million from a non-related, asset-backed commercial paper issuer (a “lender”); however, the lender is not committed to make loans to the QSPE. Hann continues to act as servicer for the sold portfolio, and Hann receives a servicing fee based upon a percentage of the dollar amount of assets serviced. The third-quarter transaction and subsequent purchases by the QSPE are accounted for as sales under the guidelines of SFAS 140. Neither Hann nor Susquehanna provide recourse for credit losses. However, the QSPE’s obligation to pay Hann the servicing fee each month is subordinate to the QSPE’s obligation to pay interest, principal and fees due on the loans. Therefore, if the QSPE suffers credit losses on its assets, it may have insufficient funds to pay the servicing fee to Hann. Additionally, if an early amortization event occurs under the QSPE’s loan agreement, Hann, as servicer, will not receive payments of the servicing fee until all interest, principal and fees due on the loans have been paid (although the servicing fee will continue to accrue).

During the first quarter of 2002, Hann entered into a revolving securitization transaction (the “first-quarter transaction”) and, as of June 30, 2003, had sold beneficial interests in $65.9 million in automobile leases and related vehicles at par to a wholly owned QSPE. From time to time, this QSPE may purchase beneficial interests in additional automobile leases and related vehicles from Hann. The QSPE finances such purchases by borrowing funds in an amount up to $80.0 million from a non-related, asset-backed commercial paper issuer, the lender, under a committed facility (subject to the satisfaction of certain conditions to additional loans). Hann continues to act as servicer for the sold portfolio and receives a servicing fee based upon a percentage of the dollar amount of assets serviced. Like the third-quarter transaction, the first-quarter transaction is accounted for as a sale under the guidelines of SFAS 140. Neither Hann nor Susquehanna provide recourse in the first-quarter transaction for credit losses. However, Susquehanna has reimbursement obligations to the lender under a letter of credit in an amount up to $20.0 million if Auto Lenders breaches its obligations under the first-quarter transaction to purchase leased vehicles at the scheduled termination or expiration of the leases for the full stated residual value of the vehicles.

The debt issued in the third-quarter transaction and the first-quarter transaction bears a floating rate of interest. In the third-quarter transaction, the QSPE is required to obtain an interest rate hedge agreement if the weighted average fixed interest rate of its assets is less than a targeted portfolio yield calculated monthly. Neither Hann nor Susquehanna has any obligation to obtain such a hedge agreement for the QSPE, but the failure of the QSPE to obtain a required

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hedge agreement would be an event of default under its loan documents. In the first-quarter transaction, the lender may enter into an interest rate hedge agreement at the expense of the QSPE if the amount on deposit in a yield supplement account is less than a targeted balance, which takes into account the current market swap rate.

The transaction documents for each of the third-quarter transaction and the first-quarter transaction contain several requirements, obligations, liabilities, provisions and consequences, including events of default, which become applicable upon, among other conditions, the failure of the sold portfolio to meet certain performance tests. Each transaction also provides that any assets that fail to meet the eligibility requirements set forth in each transaction must be repurchased by Hann and reallocated to Hann’s beneficial interest in the Origination Trust. Further, with respect to the first-quarter transaction, the occurrence of certain negative events not directly related to the QSPE (such as the imposition of a tax or ERISA lien on Hann’s assets, the entry of a large uninsured judgment against Hann or the bankruptcy of Hann, Auto Lenders or Susquehanna) will be an event of default under the related loan agreement.

The initial recorded PV Receivable for the third-quarter transaction and subsequent purchases by the QSPE was $4.1 million and the fair value of this PV Receivable at June 30, 2003 was $6.1 million. The initial recorded PV Receivable for the first-quarter transaction was $1.2 million, and the fair value of this PV Receivable at June 30, 2003 was $2.7 million.

In connection with a securitization transaction entered into in July 2003, the first-quarter transaction was terminated in July 2003.

In 2001, Hann entered into one asset securitization transaction. The transaction documents contain several requirements, obligations, liabilities, provisions and consequences, including events of default, which become applicable upon, among other conditions, the failure of the sold and pledged portfolios to meet certain performance tests. The QSPE generally retains the right to receive excess cash flows from the sold portfolio and, under SFAS No. 140, Hann is required to recognize a receivable representing the present value of these excess cash flows, which is subordinate to the investors’ interests. The value of this recorded interest is subject to credit, prepayment, and interest rate risks. At June 30, 2003, this recorded interest was $2.4 million of which $0.3 million represents the remaining interest-only asset and $2.1 million is a valuation adjustment which is recognized as other comprehensive income, net of taxes.

Sale-leaseback Transactions. In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles subject to operating leases to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and operating leases back to the Lessee under a Master Lease Agreement that has an eight year term with an early buyout option on January 14, 2007. For accounting purposes, the transaction is treated as a sale and an operating lease. The Lessor is a Delaware statutory trust and a Variable Interest Entity (a “VIE”).

To support its obligations under the Master Lease Agreement, at closing the Lessee pledged the beneficial interest in an additional $43.0 million of automobile leases and related

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vehicles, which were also sold or contributed to the Lessee. At June 20, 2003, this amount was $47.0 million.

Under the sale-leaseback transaction discussed above, the transaction documents contain several requirements, obligations, liabilities, provisions, and consequences that become applicable upon the occurrence of an “Early Amortization Event.” After an Early Amortization Event, the Lessee can no longer make substitutions under the Master Lease Agreement, which means that the sales proceeds from the sold vehicles following termination of the related auto leases may not be used to purchase replacement vehicles and leases. Instead, the sales proceeds and other amounts are used to make termination and other related payments under the Master Lease Agreement, which would reduce the income the Lessee is expected to earn over the term of the Master Lease Agreement. These termination and other related payments are amounts sufficient to permit the Lessor (1) to repay its outstanding debt, including any necessary makewhole amounts, (2) return to the Lessor’s equity investors their invested capital, and (3) compensate the Lessor’s equity investors for their early return of cash and their loss of tax benefits. Any termination with respect to particular vehicles would relieve the Lessee from the obligation to pay rent with respect to that vehicle. Makewhole amounts would be necessary only if the level of interest rates were lower at the time of the termination payment than the level of interest at the commencement of the transaction. In addition, if the Lessee were unable to substitute new vehicles for terminated vehicles, Susquehanna would be entitled to take depreciation deductions for tax purposes on the vehicles that were not substituted. Susquehanna believes that the occurrence of any Early Amortization Event is remote. The precise amount of these termination and other related payments is subject to a great deal of variability and depends significantly on future interest rates, the sales proceeds for the respective vehicles, the termination dates at which consumer leases terminate, and the length of the remaining term of the Master Lease Agreement at the time of the Early Amortization Event. It is virtually impossible to calculate the amount of these termination payments. Even if an Early Amortization Event were to occur, Susquehanna would expect that the present value of these payments would not exceed the present value of the rent avoided and tax benefits gained by a material amount. An Early Amortization Event includes the failure of the sold and pledged portfolios to meet certain performance tests or the failure of Susquehanna to continue to maintain its investment-grade senior unsecured long-term debt ratings. In addition, if Susquehanna fails to maintain its investment-grade senior unsecured long-term debt ratings, then Susquehanna must obtain a $34.7 million letter of credit from an eligible financial institution for the benefit of the equity participants in the transaction to secure its obligations under the guarantee discussed below.

At the end of the lease term under the Master Lease Agreement, the Lessee has agreed to act as a remarketing agent for the Lessor if the Lessor decides to sell the beneficial interest in the leases and related vehicles. The Lessee has agreed that, if the aggregate net proceeds of such sale are less then the Lease End Value of the beneficial interest in the leases and related vehicles at that time, the Lessee will pay to the Lessor the excess, if any, of the Lease End Value over the aggregate net proceeds of such sale. “Lease End Value” is the lower of (i) the aggregate wholesale “clean” value of the vehicles (as shown in theBlack Book Official Used Car Market Guide Monthly) or (ii) $38 million. If the leases and related vehicles are worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38 million.

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

Summary of Prior Year’s Agency Agreement

During the second quarter of 2002, Hann entered into an agency arrangement. In connection with that arrangement, Susquehanna entered into a Residual Interest Agreement under which it guarantees Auto Lenders’ performance of its obligations to the new agency client. Auto Lenders has agreed to purchase leased vehicles in the agency client’s portfolio at the termination of the leases for the full residual value of those vehicles. In the event the agency client incurs any losses, costs or expenses as a result of any failure of Auto Lenders to perform this purchase obligation, Susquehanna will compensate the agency client for any final liquidation losses with respect to such leased vehicle. However, Susquehanna’s liability is limited to 12% of the maximum aggregate residual value of all leases purchased by the agency client. At June 30, 2003, the total residual value of the vehicles in the portfolio for this transaction was $58.4 million, and our maximum obligation under the Residual Interest Agreement at June 30, 2003, was $7.0 million.

Summary of Susquehanna’s Potential Exposure under Off-Balance Sheet Vehicle Lease Financings as of June 30, 2003.

Securitization Transactions

Under certain asset securitization transactions, Susquehanna has reimbursement obligations to lenders under letter of credit facilities if Auto Lenders breaches its obligations under the securitization transactions to purchase leased vehicles at the scheduled termination or expiration of the leases for the full stated residual value of the vehicles. At June 30, 2003, Susquehanna would be obligated to make payments in an amount up to $40.5 million under these letters of credit upon a breach by Auto Lenders.

Sale-Leaseback Transaction

Under the existing sale-leaseback transaction, Susquehanna guarantees certain obligations of the Lessee, which is a wholly owned special purpose subsidiary of Hann. If Susquehanna fails to maintain its investment-grade senior unsecured long-term debt ratings, then it must obtain a $34.7 million letter of credit from an eligible financial institution for the benefit of the equity participants in the transaction to secure its obligations under the guarantee. Susquehanna has also obtained from a third party an $8.0 million letter of credit for the benefit of an equity participant

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if Susquehanna fails to make payments under the guarantee.

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

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

Agency Agreements and Lease Sales

Under the agency arrangements, Susquehanna’s maximum obligation at June 30, 2003 was $7.0 million.

Miscellaneous

Additionally, Susquehanna is required to maintain contingent vehicle liability insurance coverage with regard to most of these transactions. This same coverage is also maintained on vehicles within our own portfolio. Because vehicles are leased in the State of New York, a vicarious liability state, the ability to maintain our coverage or the premium cost could potentially have a negative impact on Susquehanna. The basic coverage policy is renewable annually and expires in 2004.

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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 controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

(b) Change in Internal Control over Financial Reporting

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

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PART II. OTHER INFORMATION

Item 4

Submission of Matters to a Vote of Security Holders

Susquehanna’s Annual Meeting of Shareholders was held on May 21, 2003. Susquehanna’s shareholders were asked to vote on a proposal to elect four directors to the Class of 2006. The following directors were nominated by the board of directors and elected to Susquehanna’s board of directors’ Class of 2006 by the holders of Susquehanna common stock (the following details the voting results with respect to each director nominee, including the number of shares not voted at all (Not Present) and the proxies that brokers did not vote in full (Broker Non-Voted)):

Nominee	Number of Votes
Henry H. Gibble
For	29,735,805
Withhold/Abstain	397,872
Not Present	9,136,376
Broker Non-Voted	405,130
Bruce A. Hepburn
For	28,931,853
Withhold/Abstain	1,201,824
Not Present	9,136,376
Broker Non-Voted	405,130
M. Zev Rose
For	29,813,627
Withhold/Abstain	320,050
Not Present	9,136,376
Broker Non-Voted	405,130
Roger V. Wiest
For	29,816,319
Withhold/Abstain	317,358
Not Present	9,136,376
Broker Non-Voted	405,130

Other directors whose term of office as a director continued after the meeting are as follows: Wayne E. Alter, Jr., James G. Apple, John M. Denlinger, Chloe R. Eichelberger, T. Max Hall, William B. Zimmerman, C. William Hetzer, Jr., Owen O. Freeman, Jr., Guy W. Miller, Jr., and William J. Reuter.

No other matters were submitted for shareholder action.

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Item 6

Exhibits and Reports on Form 8-K

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

31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer
31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer
32	Section 1350 Certifications

(b) Reports on Form 8-K.

(i) On April 22, 2003, Susquehanna filed a report on Form 8-K regarding its issuance of a press release announcing financial results for its first quarter.

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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.
August 14, 2003	/s/ William J. Reuter
	William J. Reuter
	Chairman, President and Chief Executive Officer
August 14, 2003	/s/ Drew K. Hostetter
	Drew K. Hostetter
	Executive Vice President and Chief Financial Officer

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EXHIBIT INDEX

Exhibit Numbers	Description and Method of Filing
31.1	Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer
31.2	Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer
32	Section 1350 Certifications

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