Susquehanna Bancshares 10K 2005 Annual report

Annual Report

on Form 10-K

2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the fiscal year ended December 31, 2005

¨	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

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered
None		None

Securities registered pursuant to Section 12(g) of the Act:

common stock, par value $2.00 per share

Indicate by check mark if the registrant is a well-seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b2). Yes x No ¨

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

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $1,119,278,792 as of June 30, 2005, based upon the closing price quoted on the Nasdaq National Market for such date. Shares of common stock held by each executive officer and director and by each person who beneficially owns more than 5% of the outstanding common stock have been excluded in that such persons may under certain circumstances be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes. The number of shares issued and outstanding of the registrant’s common stock as of February 28, 2006, was 46,882,478.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Susquehanna’s definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 3, 2006 are incorporated by reference into Part III of this Annual Report.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS


		Page
	Part I
Item 1.	Business	3
Item 1A.	Risk Factors	15
Item 1B.	Unresolved Staff Comments	19
Item 2.	Properties	20
Item 3.	Legal Proceedings	21
Item 4.	Submission of Matters to a Vote of Security Holders	21

	Part II
Item 5.	Market for Susquehanna’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	22
Item 6.	Selected Financial Data	24
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	65
Item 8.	Financial Statements and Supplementary Data	66
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	112
Item 9A.	Controls and Procedures	112
Item 9B.	Other Information	112

	Part III
Item 10.	Directors and Executive Officers of Susquehanna	113
Item 11.	Executive Compensation	113
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters	113
Item 13.	Certain Relationships and Related Transactions	113
Item 14.	Principal Accountant Fees and Services	113

	Part IV
Item 15.	Exhibits and Financial Statement Schedules	114

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

PART I

Item 1. Business

General

Susquehanna Bancshares, Inc. is a financial holding company that provides a wide range of retail and commercial banking and financial services through our subsidiaries in the mid-Atlantic region. In addition to three commercial banks, we operate a trust and investment company, an asset management company (which provides investment advisory, asset management, brokerage and retirement planning services), a property and casualty insurance brokerage company, a commercial leasing company and a vehicle leasing company. As of December 31, 2005, we had total assets of $7.5 billion, consolidated net loans and leases of $5.2 billion, deposits of $5.3 billion and shareholders’ equity of $780.5 million.

Susquehanna was incorporated in Pennsylvania in 1982. Our executive offices are located at 26 North Cedar Street, Lititz, Pennsylvania 17543. Our telephone number is (717) 626-4721, and our web-site address iswww.susquehanna.net. Our stock is traded on the Nasdaq National Market under the symbol SUSQ. 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 Annual Report on Form 10-K only as an inactive textual reference and do not intend it to be an active link to our web site.

As a financial holding company with operations in multiple states, we manage our subsidiaries on a geographic market basis, which allows each subsidiary operating in different markets to retain its autonomy with regard to loan approvals and product pricing. We believe that this approach differentiates us from other large competitors because it gives our subsidiaries greater flexibility to better serve their markets and increase responsiveness to the needs of local customers. We continue, however, to implement consolidations in selected lines of business, operations and support functions in order to achieve economies of scale and cost savings. We also provide our banking subsidiaries guidance in the areas of credit policy and administration, risk assessment, investment advisory administration, strategic planning, investment portfolio management, asset liability management, liquidity management and other financial, administrative, and control services.

Market Areas

Our Bank Subsidiaries

•

Susquehanna Patriot Bank operates primarily in the suburban Philadelphia, Pennsylvania and southern New Jersey market areas, including Berks, Chester, Delaware, Lehigh, Montgomery, and Northampton counties in Pennsylvania and Burlington, Camden and Gloucester counties in New Jersey. The New Jersey state-chartered bank operates 37 banking offices.

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Susquehanna Bank PA operates primarily in the central Pennsylvania market area, including Lancaster, Lycoming, Northumberland, Snyder, Union and York counties. The Pennsylvania state-chartered bank operates 55 banking offices.

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Susquehanna Bank operates primarily in the market areas of Maryland and southwestern central Pennsylvania, including Allegany, Anne Arundel, Baltimore, Carroll, Garrett, Harford, Howard, Washington and Worcester counties and the City of Baltimore in Maryland; Berkeley County in West Virginia and Bedford, Blair and Franklin counties in Pennsylvania. The Maryland state-chartered bank operates 61 banking offices.

The following table sets forth information, for the year ended December 31, 2005, regarding our bank subsidiaries and our non-bank subsidiaries that had annual revenues in excess of $5.0 million:


Subsidiary	Assets			Percent of Total		Revenues⁽¹⁾		Percent of Total		Pre-tax Income			Percent of Total
	(dollars in thousands)
Bank Subsidiaries:
Susquehanna Patriot Bank⁽²⁾	$	1,980,905		26.5	%	$	77,794	21.2	%	$	38,970		34.7	%
Susquehanna Bank PA⁽³⁾		2,271,001		30.4			102,599	27.9			41,942		37.3
Susquehanna Bank		2,923,502		39.2			122,182	33.3			55,893		49.7

Non-Bank Subsidiaries:
Susquehanna Trust & Investment Company		3,513		0.1			10,788	2.9			1,695		1.5
Valley Forge Asset Management Corp.		28,484		0.4			17,161	4.7			4,523		4.0
Boston Service Company, Inc. (t/a Hann Financial Service Corp.)		193,666		2.6			19,354	5.3			(20,006	)⁽⁴⁾	(17.8	)
Susquehanna Patriot Commercial Leasing Company, Inc.		132,647		1.8			5,049	1.4			233		0.2
The Addis Group, LLC		39,373		0.5			10,839	3.0			2,575		2.3
Consolidation adjustments and other non-bank subsidiaries		(107,084	)	(1.5	)		1,557	0.3			(13,387	)⁽⁵⁾	(11.9	)

TOTAL	$	7,466,007		100.0	%	$	367,323	100.0	%	$	112,438		100.0	%

⁽¹⁾	Revenue equals net interest income and other income.

⁽²⁾	Excludes Susquehanna Patriot Commercial Leasing Company, Inc., a wholly owned subsidiary.

⁽³⁾	Excludes Susquehanna Trust & Investment Company, a wholly owned subsidiary.

⁽⁴⁾

Does not include interest income earned from corporate tax benefits generated by Hann nor incremental benefits to the banks for loans and leases originated by Hann. When these benefits, not recorded on Hann’s books, are taken into consideration, Hann’s pre-tax loss for 2005 would have been $11.5 million. The corresponding reduction in pre-tax income in the bank subsidiaries would have been as follows: Susquehanna Patriot Bank – $2.5 million; Susquehanna Bank PA – $2.9 million; and Susquehanna Bank – $3.1 million.

⁽⁵⁾	Primarily the parent company’s unallocated expenses.

As of December 31, 2005, non-interest income represented 34.1% of our total revenue. Bank subsidiaries contributed 52.5% of total non-interest income, and non-bank affiliates 47.5% of total non-interest income.

We are managed from a long-term perspective with financial objectives that emphasize loan quality, balance sheet liquidity and earnings stability. Consistent with this approach, we emphasize a low-risk loan portfolio derived from our local markets. In addition, we focus on not having any portion of our business dependent upon a single customer or limited group of customers or a substantial portion of our loans or investments concentrated within a single industry or a group of related industries. Our net charge-offs over the past five years have averaged 0.20% of total average loans and leases.

As of December 31, 2005, our total loans and leases (net of unearned income) in dollars and by percentage were as follows:


	(dollars in thousands)
Commercial, financial and agricultural	$	832,695	16.0	%
Real estate – construction		934,601	17.9
Real estate secured – residential		1,355,513	26.0
Real estate secured – commercial		1,257,860	24.1
Consumer		319,925	6.1
Leases		518,065	9.9

Total loans and leases	$	5,218,659	100.0	%

As of December 31, 2005, core deposits funded 71.2% of our lending and investing activities. The following chart reflects the total loans and deposits of our banks and their subsidiaries as of December 31, 2005:


	Loans and Leases			Percent of Total		Deposits		Percent of Total
	(dollars in thousands)
Susquehanna Patriot Bank	$	1,399,312		27.1	%	$	1,375,057	25.9	%
Susquehanna Bank PA		1,614,384		31.2			1,666,598	31.4
Susquehanna Bank		2,206,397		42.7			2,272,118	42.7
Consolidation and elimination adjustments		(52,500	)	(1.0	)		0	0

Total	$	5,167,593		100.0	%	$	5,313,773	100.0	%

Our Non-bank Subsidiaries. Susquehanna Trust & Investment Company and Valley Forge Asset Management Corp. operate primarily in the same market areas as our bank subsidiaries. The Addis Group, LLC operates primarily in southeastern Pennsylvania, southern New Jersey and northern Delaware. Boston Service Company, Inc. (t/a Hann Financial Service Corp.) operates primarily in New Jersey, eastern Pennsylvania and southeastern New York. Susquehanna Patriot Commercial Leasing Company, Inc. operates throughout the continental United States.

While conditions in our market area are presently stable, a variety of factors (e.g., any substantial rise in inflation or unemployment rates, decrease in consumer confidence, natural disasters, war, or political instability) may affect such stability, both in our markets as well as national markets. We will continue our emphasis on managing our funding costs and lending rates to effectively maintain profitability. In addition, we will seek relationships that can generate fee income that is not directly tied to lending relationships. We anticipate that this approach will help mitigate profit fluctuations that are caused by movements in interest rates, business and consumer loan cycles, and local economic factors.

Products and Services

Our Bank Subsidiaries. Our commercial bank subsidiaries operate as an extensive branch network and maintain a strong market presence in our primary markets. They provide a wide-range of retail banking services, including checking, savings and club accounts, check cards, debit cards, money market accounts, certificates of deposit, individual retirement accounts, home equity lines of credit, residential mortgage loans, home improvement loans, student loans, automobile loans, personal loans and internet banking services. They also provide a wide-range of commercial banking services, including business checking accounts, cash management services, money market accounts, land acquisition and development loans, commercial loans, floor plan, equipment and working capital lines of credit, small business loans and internet banking services.

Our Non-bank Subsidiaries. Our non-bank subsidiaries offer a variety of financial services to complement our core banking operations, broaden our customer base, and diversify our revenue sources. The Addis Group, LLC provides commercial, personal property and casualty insurance, and risk management programs for medium and large size companies. Susquehanna Trust & Investment Company, a subsidiary of Susquehanna Bank PA, provides traditional trust and custodial services, and acts as administrator, executor, guardian and managing agent for individuals, businesses and non-profit entities. Valley Forge Asset Management Corp. offers investment advisory, asset management and brokerage services for institutional and high net worth individual clients, and through a subsidiary, retirement planning services. Boston Service Company, Inc. (t/a Hann Financial Service Corp.) provides comprehensive consumer vehicle financing services. Susquehanna Patriot Commercial Leasing Company, Inc., a subsidiary of Susquehanna Patriot Bank, provides comprehensive commercial leasing services.

Our Long-Term Strategy

We manage our business for sustained long-term growth and profitability. Our primary strategies are internal growth through expansion of our customer base in existing markets and external growth through

acquisitions in selected markets. We focus on leveraging customer relationships by cross-selling a comprehensive range of financial services and products by a highly trained and motivated employee sales force. Our long-term strategic plan to enhance shareholder value has three main components: growing our business profitably through the specific methods mentioned above; developing our sales culture; and focusing on risk management. Integrated into our strategic plan under these components are various company-wide initiatives we believe are important to achieving our plan, including technology, rewards, teamwork, training, communications and organizational structure.

Mergers and Acquisitions

Bank Charter Consolidations. On January 21, 2005, our former wholly owned subsidiaries, WNB Bank and First Susquehanna Bank & Trust, were merged into Susquehanna Bank PA. On April 15, 2005, our former wholly owned subsidiaries, Susquehanna Bank; Citizens Bank of Southern Pennsylvania; and First American Bank of Pennsylvania, were merged into Farmers & Merchants Bank and Trust, who subsequently changed its name to Susquehanna Bank.

Brandywine.On February 1, 2005, we acquired Brandywine Benefit Corporation, Rockford Pensions, LLC and JFP Strategies (collectively, “Brandywine”), Wilmington, Delaware, a financial planning, consulting and administration firm specializing in retirement benefit plans for small to medium-sized businesses. JFP Strategies was acquired through an asset-only acquisition; Brandywine Benefit Corporation and Rockford Pensions, LLC were merged into Valley Forge Asset Management Enterprises, LLC (subsequently changing its name to Brandywine Benefits Company, LLC), a wholly owned subsidiary of our wealth management subsidiary, Valley Forge Asset Management Corp.

Minotola.On November 14, 2005, we announced the signing of a definitive merger agreement pursuant to which we will acquire Minotola National Bank (“Minotola”) of Vineland, New Jersey. Under the terms of the Agreement and Plan of Merger among Susquehanna Bancshares, Inc., Susquehanna Patriot Bank and Minotola, for each share of Minotola held, a Minotola shareholder may elect to receive either $3,226 in cash, 134 Susquehanna common shares, or a combination thereof such that 30% of the Minotola shares would be exchanged for cash, and 70% would be exchanged for Susquehanna common stock. It is anticipated that the transaction will be completed by April 30, 2006, pending regulatory approvals.

Future Acquisitions.We routinely evaluate possible future acquisitions of other banks, and may also seek to enter businesses closely related to banking or that are financial in nature, or to acquire existing companies already engaged in such activities, including investment advisory services and insurance brokerage services. Any acquisition by us may require notice to or approval of the Board of Governors of the Federal Reserve System, the Pennsylvania Department of Banking, other regulatory agencies and, in some instances, our shareholders. While any such acquisition may occur in any market area, the four major growth corridors that we are currently focused on are as follows:

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the Lancaster/York/Baltimore corridor, comprised of Lancaster and York counties in Pennsylvania, the City of Baltimore, and Baltimore, Harford, Howard, Carroll and Anne Arundel counties in Maryland;

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the Greater Delaware Valley corridor, comprised of Chester, Montgomery, Delaware and Bucks counties in Pennsylvania, the City of Philadelphia, and Gloucester, Camden, Burlington and Mercer counties in New Jersey;

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the Interstate 81 corridor, comprised of Franklin, Cumberland and Adams counties in Pennsylvania, Washington and Frederick counties in Maryland, and Berkeley and Jefferson counties in West Virginia; and

•

the contiguous market area that would fill in between our current bank subsidiaries.

Other than the Minotola transaction discussed above, we currently have no other formal commitments with respect to the acquisition of any entities, although discussions with prospects occur on a regular and continuing basis.

Employees

As of December 31, 2005, we had 1,991 full-time and 220 part-time employees.

Competition

Financial holding companies and their subsidiaries compete with many institutions for deposits, loans, trust services and other banking-related and financial services. We are subject to competition from less heavily regulated entities such as brokerage firms, money market funds, credit unions, consumer finance and credit card companies and other financial services companies.

The Gramm-Leach-Bliley Act has liberalized many of the regulatory restrictions previously imposed on us, including our subsidiaries. Further legislative proposals are pending or may be introduced which could further affect the financial services industry. It is not possible to assess whether any of such proposals will be enacted, and if enacted, what effect such a proposal would have on our competitive positions in our marketplace.

As a result of state and federal legislation enacted over the past 20 years, consolidation in the industry has continued at a rapid pace. Further, as a result of the relaxation of laws and regulations pertaining to branch banking in the state, and the opportunity to engage in interstate banking, consolidation within the banking industry has had a significant effect on us and our markets. At present, our bank subsidiaries and we compete with numerous super-regional institutions, with significantly greater resources and assets, that conduct banking business throughout the region.

Supervision and Regulation

General. We are a financial holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and are subject to regulation under the Bank Holding Company Act of 1956, as amended. The Bank Holding Company Act requires prior approval of an acquisition of all or substantially all of the assets of a bank or of ownership or control of voting shares of any bank if the share acquisition would give us more than 5% of the voting shares of any bank or bank holding company. It also imposes restrictions, summarized below, on the assets or voting shares of non-banking companies that we may acquire.

Our bank subsidiaries are also subject to regulation and supervision. Susquehanna Bank PA is a Pennsylvania state bank subject to regulation and periodic examination by the Pennsylvania Department of Banking and the Federal Reserve Board. Susquehanna Patriot Bank is a New Jersey state member bank subject to regulation and periodic examination by the New Jersey Department of Banking and Insurance and the Federal Reserve Board. Susquehanna Bank is a Maryland state bank subject to regulation and periodic examination by the Division of Financial Regulation of the Maryland Department of Labor, Licensing and Regulation and the Federal Reserve Board. Susquehanna Trust & Investment Company is a Pennsylvania non-depository trust company subject to regulation and periodic examination by the Pennsylvania Department of Banking. All of our subsidiaries are subject to examination by the Federal Reserve Board even if not otherwise regulated by the Federal Reserve Board, subject to certain conditions in the case of “functionally regulated subsidiaries,” such as broker/dealers and registered investment advisers.

Consistent with the requirements of the Bank Holding Company Act, our only lines of business in 2005 consisted of providing our customers with banking, trust and other financial products and services. These services include commercial banking through our subsidiary banks, trust and related services through Susquehanna Trust & Investment Company, consumer vehicle financing through Boston Service Company, Inc. (t/a Hann Financial Service Corp.), commercial leasing through Susquehanna Patriot Commercial Leasing Company, Inc., investment advisory, asset management, retirement plan consulting and brokerage services through Valley Forge Asset Management Corp. and property and casualty insurance brokerage services through The Addis Group, LLC. Of these activities, banking activities accounted for 88% of our gross revenues in 2005 and 84% of our gross revenues in 2004.

Regulations governing our bank subsidiaries restrict extensions of credit by such institutions to Susquehanna and, with some exceptions, the other Susquehanna affiliates. For these purposes, extensions of credit include loans and advances to and guarantees and letters of credit on behalf of Susquehanna and such affiliates. These regulations also restrict investments by our bank subsidiaries in the stock or other securities of Susquehanna and the covered affiliates, as well as the acceptance of such stock or other securities as collateral for loans to any borrower, whether or not related to Susquehanna.

Our bank subsidiaries are subject to comprehensive federal and state regulations dealing with a wide variety of subjects, including reserve requirements, loan limitations, restrictions as to interest rates on loans and deposits, restrictions as to dividend payments, requirements governing the establishment of branches and numerous other aspects of their operations. These regulations generally have been adopted to protect depositors and creditors rather than shareholders.

Additional Activities. Susquehanna is a “financial holding company” (an “FHC”) under the Gramm-Leach-Bliley Act (the “GLB Act”). As an FHC, we are permitted to engage, directly or through subsidiaries, in a wide variety of activities which are financial in nature or are incidental or complementary to a financial activity, in addition to all of the activities otherwise allowed to us. The additional activities permitted to us as an FHC (if we so determine to conduct them) include, among others, insurance and securities underwriting, merchant banking activities, issuing and selling annuities and securitized interests in financial assets and engaging domestically in activities that bank holding companies previously have been permitted to engage in only overseas. It is expected that in the future other activities will be added to the permitted list. All of these listed activities can be conducted, through an acquisition or on a start-up basis, without prior Federal Reserve Board approval and with only notice to the Federal Reserve Board afterward.

The GLB Act also generally permits well-capitalized national banks and, if state law permits, well-capitalized state chartered banks as well, to form or acquire financial subsidiaries to engage in most of these same activities, with the exception of certain specified activities (insurance underwriting, for example) which must be conducted only at the level of the holding company or a non-bank subsidiary. State chartered banks in Pennsylvania, New Jersey and Maryland are generally allowed to engage (with proper regulatory authority) in activities that are permitted to national banks.

As an FHC, Susquehanna is generally subject to the same regulation as other bank holding companies, including the reporting, examination, supervision and consolidated capital requirements of the Federal Reserve Board. However, in some respects the regulation is modified as a result of FHC status. For example, Susquehanna must continue to satisfy certain conditions (discussed below) to preserve our full flexibility as an FHC. However, as an FHC, Susquehanna (unlike traditional bank holding companies) is permitted to undertake several new types of activities, and to acquire companies engaged in several additional kinds of activities, without prior Federal Reserve Board approval and with only notice afterward. To preserve our FHC status, we must ensure that all of our insured depository institution subsidiaries remain well-capitalized and well-managed for regulatory purposes and earn “satisfactory” or better ratings on their periodic Community Reinvestment Act (“CRA”) examinations.

An FHC ceasing to meet these standards is subject to a variety of restrictions, depending on the circumstances. If the Federal Reserve Board determines that any of the FHC’s subsidiary depository institutions are either not well-capitalized or not well-managed, it must notify the FHC. Until compliance is restored, the Federal Reserve Board has broad discretion to impose appropriate limitations on the FHC’s activities. If compliance is not restored within 180 days, the Board may ultimately require the FHC to divest its depository institutions or in the alternative, to discontinue or divest any activities that are permitted only to FHC bank holding companies.

The potential restrictions are different if the lapse pertains to the CRA requirement. In that case, until all the subsidiary institutions are restored to at least “satisfactory” CRA rating status, the FHC may not engage, directly

or through a subsidiary, in any of the additional activities permissible under the GLB Act nor make additional acquisitions of companies engaged in the additional activities. However, completed acquisitions and additional activities and affiliations previously begun are left undisturbed, as the GLB Act does not require divestiture for this type of situation.

Capital Adequacy. Under the risk-based capital requirements applicable to them, bank holding companies must maintain a ratio of total capital to risk-weighted assets (including the asset equivalent of certain off-balance sheet activities such as acceptances and letters of credit) of not less than 8% (10% in order to be considered “well-capitalized”). At least 4% out of the total capital (6% to be well capitalized) must be composed of common stock, related surplus, retained earnings, qualifying perpetual preferred stock and minority interests in the equity accounts of certain consolidated subsidiaries, after deducting goodwill and certain other intangibles (“tier 1 capital”). The remainder of total capital (“tier 2 capital”) may consist of certain perpetual debt securities, mandatory convertible debt securities, hybrid capital instruments and limited amounts of subordinated debt, qualifying preferred stock, allowance for loan and lease losses, and unrealized gains on equity securities.

At December 31, 2005, our tier 1 capital and total capital (i.e., tier 1 plus tier 2) ratios were 8.53% and 11.61%, respectively.

The Federal Reserve Board has also established minimum leverage ratio guidelines for bank holding companies. These guidelines mandate a minimum leverage ratio of tier 1 capital to adjusted quarterly average total assets less certain amounts (“leverage amounts”) equal to 3% for bank holding companies meeting certain criteria (including those having the highest regulatory rating). All other banking organizations are generally required to maintain a leverage ratio of at least 3% plus an additional cushion of at least 100 basis points and in some cases more. The Federal Reserve Board’s guidelines also provide that bank holding companies experiencing internal growth or making acquisitions are expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a “tangible tier 1 leverage ratio” (i.e., after deducting all intangibles) in evaluating proposals for expansion or new activities. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us. At December 31, 2005, our leverage ratio was 7.77%.

Our subsidiary depository institutions are all subject to similar capital standards promulgated by their respective federal regulatory agencies. No such agency has advised any of our subsidiary institutions of any specific minimum leverage ratios applicable to it.

The federal regulatory authorities’ risk-based capital guidelines are presently based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision (the “BCS”). The BCS is a committee of central bankers and bank supervisors from the major industrialized countries. It develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. In 2004, the BCS proposed a new capital adequacy framework (“Basel II”) for large, internationally active banking organizations to replace Basel I. Basel II is designed to produce a more risk sensitive result than its predecessor. However, Basel II will entail complexities and costs that are expected to effectively limit its practical application to the largest and most internationally active banking organizations, those which can take advantage of economies of scale necessary to absorb the associated expenses. Accordingly, Basel I is expected to continue to apply to most depository institutions in the United States even after full implementation of Basel II.

Community and regional banking organizations responded to the proposed adoption of Basel II in the United States with expressed concern that the new framework would result in regulatory capital charges that differ for similar bank products offered by both large and small banking organizations, to the competitive disadvantage of the community and regional organizations.

In response to these concerns, the federal bank and thrift regulatory agencies (including the Federal Reserve Board) postponed further implementation of Basel II while they “undertook additional analytical work” and, in

the fall of 2005, published for preliminary comment a proposal to make substantial revisions to Basel I. The proposed revisions to the existing framework are intended to enhance the risk-sensitivity of the capital charges assigned to various assets under Basel I, to reflect changes in accounting standards and financial markets and to address the questions of competitive equity raised by the proposed Basel II.

The agencies’ fall 2005 proposal with respect to Basel I would, among other things, increase the number of risk-weight categories to which various credit exposures may be assigned, would expand the use of external credit ratings (such as those given by Moody’s, Standard & Poor’s and Fitch) as credit risk indicators, would expand the range of collateral and guarantors that may justify a lower risk weight, would use loan to value ratios, credit assessments and other broad measures of credit risk in the case of commercial mortgages, would increase the risk weights of certain delinquent or non-accrual assets and would assess a risk-based capital charge to reflect the risks in securitizations backed by revolving retail exposures with early amortization provisions.

If implemented, the new capital rules, including both a new Basel II and a broadly revised Basel I, could affect the minimum capital requirements applicable to us and could otherwise have a competitive impact on us.

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA, requires the federal regulators to take prompt corrective action against any undercapitalized institution. FDICIA establishes five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Well-capitalized institutions significantly exceed the required minimum level for each relevant capital measure. Adequately capitalized institutions include depository institutions that meet but do not significantly exceed the required minimum level for each relevant capital measure. Undercapitalized institutions consist of those that fail to meet the required minimum level for one or more relevant capital measures. Significantly undercapitalized characterizes depository institutions with capital levels significantly below the minimum requirements for any relevant capital measure. Critically undercapitalized refers to depository institutions with minimal capital and at serious risk for government seizure.

Under certain circumstances, a well-capitalized, adequately capitalized or undercapitalized institution may be treated as if the institution were in the next lower capital category. A depository institution is generally prohibited from making capital distributions, including paying dividends, or paying management fees to a holding company if the institution would thereafter be undercapitalized. Institutions that are adequately but not well-capitalized cannot accept, renew or roll over brokered deposits except with a waiver from the Federal Deposit Insurance Corporation (“FDIC”) and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits.

The banking regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories. Depending on the level of an institution’s capital, the agency’s corrective powers include, among other things:

•

prohibiting the payment of principal and interest on subordinated debt;

•

prohibiting the holding company from making distributions without prior regulatory approval;

•

placing limits on asset growth and restrictions on activities;

•

placing additional restrictions on transactions with affiliates;

•

restricting the interest rate the institution may pay on deposits;

•

prohibiting the institution from accepting deposits from correspondent banks; and

•

in the most severe cases, appointing a conservator or receiver for the institution.

A banking institution that is undercapitalized is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan

up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. As of December 31, 2005, all of our depository institution subsidiaries exceeded the required capital ratios for classification as “well capitalized.”

Cross Guarantees. Our insured depository institution subsidiaries are also subject to cross-guaranty liability under federal law. This means that if one FDIC-insured depository institution subsidiary of a multi-institution bank holding company fails or requires FDIC assistance, the FDIC may assess “commonly controlled” depository institutions for the estimated losses suffered by the FDIC. Such liability could have a material adverse effect on the financial condition of any assessed subsidiary institution and on Susquehanna as the common parent. While the FDIC’s cross-guaranty claim is generally junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is generally superior to the claims of shareholders and affiliates.

Source of Strength Doctrine. Under Federal Reserve Board policy and regulation, a bank holding company must serve as a source of financial and managerial strength to each of its subsidiary banks and is expected to stand prepared to commit resources to support each of them. Consistent with this, the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company should generally not maintain a given rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the organization’s capital needs, asset quality and overall financial condition.

Interstate Banking and Branching. Under the Pennsylvania Banking Code of 1965, there is no limit on the number of banks that may be owned or controlled by a Pennsylvania-based bank holding company and the Pennsylvania bank subsidiaries may branch freely throughout the Commonwealth and, with Department of Banking approval, elsewhere in the United States and abroad. The banking laws of New Jersey and Maryland also extend to banks organized under their laws broad powers to operate out-of-state branch offices.

Substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies have been eliminated. In addition, the federal banking agencies are generally permitted to approve merger transactions resulting in the creation of branches by banks outside their home states if the host state into which they propose to branch has enacted authorizing legislation. Of the middle-Atlantic states, Pennsylvania and West Virginia have enacted legislation authorizingde novo branching by banks located in states offering reciprocal treatment to their institutions. Maryland and Ohio have as well, but without the reciprocity requirement. Delaware, New Jersey and New York do not allow entry through fullde novo branching by sister-state banks and require that they enter the state through mergers of established institutions. Liberalizing the branching laws in recent years has had the effect of increasing competition within the markets in which we now operate.

USA Patriot Act of 2001. A major focus of governmental policy applicable to financial institutions in recent years has been the effort to combat money laundering and terrorism financing. The USA Patriot Act of 2001 was enacted to strengthen the ability of the U.S. law enforcement and intelligence communities to achieve this goal. The Act requires financial institutions, including our banking and broker-dealer subsidiaries, to assist in the prevention, detection and prosecution of money laundering and the financing of terrorism. The Act established standards to be followed by institutions in verifying client identification when accounts are opened and provides rules to promote cooperation among financial institutions, regulators and law enforcement organizations in identifying parties that may be involved in terrorism or money laundering.

Regulation of Non-bank Subsidiaries. In addition to Susquehanna Trust & Investment Company, we have other primary non-bank subsidiaries whose activities subject them to licensing and regulation. Boston Service Company, Inc. (t/a Hann Financial Service Corp.) is organized under the laws of New Jersey. It is regulated by Connecticut as a motor vehicle leasing company, by Delaware as a finance or small loan agency, and by New Jersey and Pennsylvania as a sales finance company. Valley Forge Asset Management Corp. is organized under the laws of Pennsylvania. It is registered with the Securities and Exchange Commission (the “SEC”) as an

investment adviser under the Investment Advisers Act of 1940. It is also a registered broker-dealer and is a member of the National Association of Securities Dealers. It is also licensed with the securities commissions of various states. The Addis Group, LLC is organized under the laws of Pennsylvania. It is licensed with the Pennsylvania Insurance Commissioner and the insurance commissioners of 47 other states.

Privacy. Title V of the GLB Act is intended to increase the level of privacy protection afforded to customers of financial institutions, including customers of the securities and insurance affiliates of such institutions, partly in recognition of the increased cross-marketing opportunities created by the Act’s elimination of many of the boundaries previously separating various segments of the financial services industry. Among other things, these provisions require institutions to have in place administrative, technical and physical safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. The Act also requires institutions to furnish consumers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.

Future Legislation. From time to time, various legislation is introduced in Congress and state legislatures with respect to the regulation of financial institutions. Such legislation may change banking statutes and our operating environment or that of our subsidiaries in substantial and unpredictable ways. We cannot determine the ultimate effect that potential legislation, if enacted, or any regulations issued to implement it, would have upon our financial condition or results of operations.

National Monetary Policy. In addition to being affected by general economic conditions, the earnings and growth of Susquehanna and our subsidiaries are affected by the policies of the Federal Reserve Board. An important function of the Federal Reserve Board is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve Board to implement these objectives are open market operations in U.S. Government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.

The monetary policies and regulations of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our future business, earnings and growth cannot be predicted.

Executive Officers

As of December 31, 2005, the executive officers of Susquehanna, their ages and their positions with Susquehanna, are set forth in the following table:


Name	Age	Title
William J. Reuter	56	Chairman of the Board, President and Chief Executive Officer
Gregory A. Duncan	50	Executive Vice President and Chief Operating Officer
Drew K. Hostetter	51	Executive Vice President, Treasurer and Chief Financial Officer
Edward Balderston, Jr.	58	Executive Vice President and Chief Administrative Officer
Michael M. Quick	57	Executive Vice President and Group Executive
David D. Keim	57	Senior Vice President and Chief Risk and Credit Officer
James G. Pierné	54	Senior Vice President and Group Executive
Peter J. Sahd	46	Senior Vice President and Group Executive
Rodney A. Lefever	39	Senior Vice President and Chief Technology Officer
Bernard A. Francis, Jr.	55	Senior Vice President and Group Executive
Lisa M. Cavage	41	Senior Vice President, Secretary and Counsel

William J. Reuter has been a Director of Susquehanna since 1999 and became Chairman of the Board in May 2002. He has been Chief Executive Officer since May 2001 and President since January 2000. From January 1998 until he was named President, he was Senior Vice President. He has also been Chairman of the Board of Susquehanna Bank PA (including its predecessor, Farmers First Bank) since March 2001, and a Director of Susquehanna Bank since 1985 (including its predecessor, Farmers & Merchants Bank and Trust), Boston Service Company, Inc. (t/a Hann Financial Service Corp.) since February 2000, Valley Forge Asset Management Corp. since March 2000, and The Addis Group, LLC. since September 2002.

Gregory A. Duncan was appointed Chief Operating Officer in May 2001 and Executive Vice President in January 2000. From January 1998 until his appointment as Executive Vice President, he was Senior Vice President–Administration. He was appointed President and Chief Executive Officer of Susquehanna Bank PA in October 2005.

Drew K. Hostetter was appointed Executive Vice President in May 2001 and has been Treasurer and Chief Financial Officer since 1998. From January 2000 until his appointment as Executive Vice President, he was Senior Vice President. He was also appointed as Chairman of Hann Financial Service Corp. in February 2004.

Edward Balderston, Jr. was appointed Executive Vice President and Chief Administrative Officer in June 2004. From May 2001 until his appointment as Executive Vice President and Chief Administrative Officer, he was Senior Vice President and Group Executive. From May 1998 until his appointment as Senior Vice President and Group Executive, he was Vice President in Charge of Marketing and Human Resources.

Michael M. Quick was appointed Executive Vice President and Group Executive in May 2005. From June 2004 until his appointment as Executive Vice President and Group Executive, he was Senior Vice President and Group Executive. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive of Susquehanna. He was appointed Chairman and Chief Executive Officer of Susquehanna Patriot Bank in November 2005. From June 2004 until his appointment as Chairman and Chief Executive Officer of the bank, he was Chairman of Susquehanna Patriot Bank. From March 1998 until his appointment as Chairman, he was President and Chief Executive Officer of Equity Bank.

David D. Keim was appointed Senior Vice President and Chief Risk and Credit Officer in April 2002. From May 2001 until his appointment as Senior Vice President and Chief Risk and Credit Officer, he was Senior Vice President and Group Executive. From April 1998 until his appointment as Senior Vice President and Group Executive, he was Vice President.

James G. Pierné was appointed as Senior Vice President and Group Executive in June 2004. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive. He has been Chairman, President and Chief Executive Officer of Susquehanna Bank (including its predecessor, Farmers & Merchants Bank and Trust) since March 2002. He also served as President and Chief Executive Officer of Farmers & Merchants Bank and Trust from March 2000 to March 2002. From March 1999 until his appointment as President and Chief Executive Officer, he was Executive Vice President of Farmers & Merchants Bank and Trust. From 1993 until his appointment as Executive Vice President, he was Senior Vice President of Farmers & Merchants Bank and Trust.

Peter J. Sahd was appointed Senior Vice President and Group Executive in June 2004. From May 2001 until his appointment as Senior Vice President and Group Executive, he was Vice President and Group Executive. From April 1999 until his appointment as Vice President and Group Executive, he was Director — Alternative Delivery Services. Prior to joining Susquehanna, Mr. Sahd served as Senior Vice President, Operations, of Fulton Bank from August 1994 until April 1999.

Rodney A. Lefever was appointed Senior Vice President and Chief Technology Officer in June 2004. From May 2002 until his appointment as Senior Vice President and Chief Technology Officer, he was Vice President

and Chief Technology Officer. From April 2001 until his appointment as Vice President and Chief Technology Officer, he was Chief Technology Officer. Prior to joining Susquehanna, he served as Director, Earthlink Everywhere, Earthlink, Inc. from September 2000 until April 2001, as the President of New Business Development, OneMain.com Inc. from December 1999 until September 2000 and the President of D&E Supernet (and its predecessors) from March 1995 until December 1999.

Bernard A. Francis, Jr. was appointed Senior Vice President and Group Executive in May, 2005. From June 2004 until his appointment as Senior Vice President and Group Executive, he was Vice President. From March 2000, he has been President and Chief Executive Officer of Valley Forge Asset Management Corp.

Lisa M. Cavage was appointed Senior Vice President in May 2005. From May 2001 until her appointment as Senior Vice President, she was Vice President. She has been Counsel to Susquehanna since March 1998.

There are no family relationships among the executive officers of Susquehanna. The executive officers are elected or appointed by the Board of Directors of Susquehanna and serve until the appointment or election and qualification of their successor or their earlier death, resignation or removal. There are no arrangements or understandings between any of them and any other person pursuant to which any of them was selected an officer of Susquehanna.

Item 1A. Risk Factors

We may not be able to continue to grow our business, which may adversely impact our results of operations.

Our total assets have grown from approximately $3.5 billion at December 31, 1997, prior to restatements for pooling of interests, to $7.5 billion at December 31, 2005. Our business strategy calls for continued expansion. Our ability to continue to grow depends, in part, upon our ability to open new branch locations, successfully attract deposits, identify favorable loan and investment opportunities and acquire other bank and non-bank entities. In the event that we do not continue to grow, our results of operations could be adversely impacted.

Our ability to grow successfully will depend on whether we can continue to fund this growth while maintaining cost controls and asset quality, as well as on factors beyond our control, such as national and regional economic conditions and interest rate trends. If we are not able to control costs and maintain asset quality, such growth could adversely impact our earnings and financial condition.

If we are unable to complete our pending merger with Minotola, or we are unable to successfully integrate operations or achieve the anticipated cost savings relating to the integration of our operations, we may experience significant charges to earnings that may adversely affect our stock price, operating results and financial condition.

In November 2005, we entered into a definitive agreement to acquire by merger all of the outstanding shares of Minotola National Bank. Minotola received approval of the merger from its shareholders; regulatory approval is still pending. Under the terms of the merger agreement, in addition to various termination rights granted to each of us and Minotola for breach of representations, warranties and covenants, Minotola may unilaterally terminate the merger if our stock price falls below certain levels as described in the merger agreement, and if we do not elect to increase the amount of merger consideration to be paid to Minotola shareholders to appropriately adjust for such a decline in our stock price.

If the transaction does not close for any reason, we will not realize the anticipated benefits of the Minotola transaction.

We must consolidate and integrate the operations of Minotola with our business. Integration efforts often take a significant amount of time, place a significant strain on our managerial, operational and financial resources and could prove to be more difficult and expensive than we predicted. If we fail to realize the expected benefits from this acquisition, or from acquisitions we may consummate in the future, whether as a result of unidentified risks, integration difficulties, regulatory setbacks or otherwise, our business, results of operations and financial condition could be adversely affected.

In addition, if we are unable to complete the merger with Minotola, we will experience charges for merger and merger related expenses that may include transactions costs, such as fees for attorneys and accountants. The incurrence of these charges could adversely affect our results of operations for particular quarterly or annual periods.

Geographic concentration in one market may unfavorably impact our operations.

Our operations are heavily concentrated in the Mid-Atlantic region. As a result of this geographic concentration, our results depend largely on economic conditions in these and surrounding areas. Deterioration in economic conditions in this market could:

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increase loan delinquencies;

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increase problem assets and foreclosures;

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increase claims and lawsuits;

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decrease the demand for our products and services; and

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decrease the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with nonperforming loans and collateral coverage.

Loss of certain of our key officers would adversely affect our business.

Our future operating results are substantially dependent on the continued service of William J. Reuter, our Chairman, President and Chief Executive Officer; Gregory A. Duncan, our Executive Vice President and Chief Operating Officer; Drew K. Hostetter, our Executive Vice President and Chief Financial Officer; Michael M. Quick, our Executive Vice President and Group Executive; James G. Pierné, our Senior Vice President and Group Executive; and Bernard A. Francis, Jr., our Senior Vice President and Group Executive. The loss of the services of Messrs. Reuter, Duncan, Hostetter, Quick, Pierné, and Francis would have a negative impact on our business because of their expertise and years of industry experience. In addition, the loss of the services of Mr. Reuter would have a negative impact on our business because of his leadership, business development skills and community involvement. We do not maintain key man life insurance on Messrs. Reuter, Duncan, Hostetter, Quick, Pierné, or Francis.

Our exposure to credit risk, because we focus on commercial lending, could adversely affect our earnings and financial condition.

There are certain risks inherent in making loans. These risks include interest rate changes over the time period in which loans may be repaid, risks resulting from changes in the economy, risks inherent in dealing with borrowers and, in the case of a loan backed by collateral, risks resulting from uncertainties about the future value of the collateral.

Commercial loans, including commercial real estate, are generally viewed as having a higher credit risk than residential real estate or consumer loans because they usually involve larger loan balances to a single borrower and are more susceptible to a risk of default during an economic downturn. Our consolidated commercial lending operations include commercial, financial and agricultural lending, real estate construction lending and commercial mortgage lending, which comprised 16.0%, 17.9% and 24.1% of our total loan portfolio, respectively, as of December 31, 2005. Construction financing typically involves a higher degree of credit risk than commercial mortgage lending. Risk of loss on a construction loan depends largely on the accuracy of the initial estimate of the property’s value at completion of construction compared to the estimated cost (including interest) of construction. If the estimated property value proves to be inaccurate, the loan may be inadequately collateralized.

Because our loan portfolio contains a significant number of commercial real estate, commercial and industrial loans and construction loans, the deterioration of these loans may cause a significant increase in nonperforming loans. An increase in nonperforming loans could cause an increase in loan charge-offs and a corresponding increase in the provision for loan losses, which could adversely impact our financial condition and results of operations.

If our allowance for loan and lease losses is not sufficient to cover actual loan and lease losses, our earnings would decrease.

In an attempt to mitigate any loan and lease losses that we may incur, we maintain an allowance for loan and lease losses based on, among other things, national and regional economic conditions, historical loss experience and delinquency trends. However, we cannot predict loan and lease losses with certainty, and we cannot assure you that charge-offs in future periods will not exceed the allowance for loan and lease losses. If charge-offs exceed our allowance, our earnings would decrease. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan and lease losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination. Factors that require an increase in our allowance for loan and lease losses could reduce our earnings.

Changes in interest rates may adversely affect our earnings and financial condition.

Our net income depends primarily upon our net interest income. Net interest income is 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, investment securities and short-term investments. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and the levels of nonperforming loans. 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.

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets.

We attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest- rate-sensitive assets and interest-rate-sensitive liabilities. However, interest-rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.

Adverse economic and business conditions in our market area may have an adverse effect on our earnings.

Substantially all of our business is with customers located within Pennsylvania, Maryland and New Jersey. Generally, we make loans to small to mid-sized businesses whose success depends on the regional economy. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. Adverse economic and business conditions in our market area could reduce our growth rate, affect our borrowers’ ability to repay their loans and, consequently, adversely affect our financial condition and performance. For example, a loss of market confidence in vehicle leasing paper and related residual values could have a negative effect on our vehicle leasing subsidiary’s ability to fund future vehicle lease originations. If this should occur, our vehicle leasing subsidiary’s revenues and earnings would be adversely affected. Further, we place substantial reliance on real estate as collateral for our loan portfolio. A sharp downturn in real estate values in our market area could leave many of our loans inadequately collateralized. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings could be adversely affected.

If we are not able to securitize assets, it could negatively affect our liquidity and capital ratios.

We use the securitization of financial assets as a source of funding and a means to manage capital. It is part of our core business. If we were not able to securitize these assets for any reasons, including without limitation, market conditions, a failure to maintain our investment-grade senior unsecured long-term debt ratings, or regulatory changes, it could negatively affect our capital ratios and require us to rely more heavily on other sources of funding such as repos, brokered deposits and the Federal Home Loan Bank (“FHLB”).

Adverse business conditions in our vehicle leasing subsidiary could adversely affect our financial performance.

Through our subsidiary, Boston Service Company, Inc. (t/a Hann Financial Service Corp.), we are involved in the vehicle leasing business. In 2005, Hann suffered a decrease in its vehicle origination, servicing, and

securitization fees, due to a combination of decreased lease origination volumes and decreased fees from securitization transactions due to the current interest rate environment. We believe that this reduction in volume principally resulted from special financing offers provided by the major automobile manufacturers with whom Hann competes. If these special financing offers continue, our financial performance could be negatively impacted. Additionally, in 2005, vehicle residual value expense at Hann increased significantly based upon service agreements with Auto Lenders Liquidation Center, Inc., a third party residual value guarantor. Under the terms of these servicing agreements, vehicle residual value expense will be substantially less in 2006, 2007, and 2008. Beyond 2008, vehicle residual value expense could once again increase depending upon the used vehicle market conditions. If this were to happen, it could have a negative impact on our financial performance after 2008.

Competition from other financial institutions in originating loans, attracting deposits and providing various financial services may adversely affect our profitability.

Our banking subsidiaries face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that our banking subsidiaries originate and the interest rates they may charge on these loans.

In attracting business and consumer deposits, our banking subsidiaries face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns and better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.

Our banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over our banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share and adversely affect our earnings and financial condition.

We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements, which could reduce our ability to effectively compete.

The financial services industry is undergoing rapid technological changes with frequent introduction of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial service institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services to enhance customer convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete.

Government regulation significantly affects our business.

The banking industry is heavily regulated, and such regulations are intended primarily for the protection of depositors and the federal deposit insurance funds, not shareholders. As a financial holding company, we are subject to regulation by the Federal Reserve Board. Our three bank subsidiaries, as of December 31, 2005, are also regulated by the Federal Reserve Board and are subject to regulation by the state banking departments of the state in which they are chartered. These regulations affect lending practices, capital structure, investment practices, dividend policy and growth. In addition, we have non-bank operating subsidiaries from which we derive income. Several of these non-bank subsidiaries engage in providing investment management and insurance brokerage services, which industries are also heavily regulated on both a state and federal level. In addition, changes in laws, regulations and regulatory practices affecting the financial service industry may limit the manner in which we may conduct our business. Such changes may adversely affect us, including our ability to offer new products and services, obtain financing, attract deposits, make loans and leases and achieve satisfactory spreads, and may also result in the imposition of additional costs on us. As a public company, we are also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of 2002, as well as any applicable rules or regulations promulgated by the SEC or The NASDAQ Stock Market, Inc. Complying with these standards, rules and regulations may impose administrative costs and burdens on us.

The Pennsylvania business corporation law and various anti-takeover provisions under our articles of incorporation could impede the takeover of the company.

Various Pennsylvania laws affecting business corporations may have the effect of discouraging offers to acquire Susquehanna, even if the acquisition would be advantageous to shareholders. In addition, we have various anti-takeover measures in please under our articles of incorporation. Any one or more of these measures may impede the takeover of Susquehanna without the approval of our board of directors and may prevent our shareholders from taking part in a transaction in which they could realize a premium over the current market price of our common stock.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2.Properties

We reimburse our subsidiaries for space and services utilized. In 2005, we also leased office space located at 13511 Label Lane, Hagerstown, Maryland, for our loan servicing center.

Our bank subsidiaries operate 153 branches and 17 free-standing automated teller machines. They own 72 of the branches and lease the remaining 81. Five additional locations are owned or leased by our bank subsidiaries to facilitate operations and expansion. We believe that the properties currently owned and leased by our subsidiaries are adequate for present levels of operation.

As of December 31, 2005, the offices (including executive offices) of our bank subsidiaries were as follows:


Subsidiary	Location of Executive Office	Executive Office Owned/Leased	Location of Offices (including executive office)
Susquehanna Bank PA	9 East Main Street Lititz, Pennsylvania	Owned	55 banking offices in Lancaster, Lycoming, Northumberland, Snyder, Union and York counties, Pennsylvania

Susquehanna Bank	59 West Washington Street Hagerstown, Maryland	Owned	61 banking offices in Bedford, Blair and Franklin counties, Pennsylvania; Baltimore City, Allegany, Anne Arundel, Baltimore, Carroll, Garrett, Harford, Howard, Washington and Worcester counties, Maryland; and Berkeley County, West Virginia

Susquehanna Patriot Bank	8000 Sagemore Drive Suite 8101 Marlton, New Jersey	Owned	37 banking offices in Burlington, Camden and Gloucester counties, New Jersey; and Berks, Chester, Delaware, Lehigh, Montgomery and Northampton counties, Pennsylvania

As of December 31, 2005, the offices (including executive offices) of our non-bank subsidiaries were as follows:


Subsidiary	Location of Executive Office	Executive Office Owned/Leased	Location of Offices (including executive office)
Susquehanna Trust & Investment Company	26 North Cedar Street Lititz, Pennsylvania	Leased	8 offices in Franklin, Lancaster, Lycoming, Montgomery and Northumberland counties, Pennsylvania; Camden County, New Jersey; and Washington County, Maryland

Boston Service Company, Inc., t/a Hann Financial Service Corp.	One Centre Drive Jamesburg, New Jersey	Leased	2 offices located in Gloucester and Middlesex counties, New Jersey

Valley Forge Asset Management Corp.	120 South Warner Road King of Prussia, Pennsylvania	Leased	2 offices located in Chester and Montgomery counties, Pennsylvania

The Addis Group, LLC	2500 Renaissance Boulevard King of Prussia, Pennsylvania	Leased	1 office located in Montgomery County, Pennsylvania

Susquehanna Patriot Commercial Leasing Company, Inc.	1566 Medical Drive Suite 201 Pottstown, PA 19464	Leased	1 office located in Montgomery County, Pennsylvania

Item 3. Legal Proceedings.

There are no material proceedings to which Susquehanna or any of our subsidiaries are a party or by which, to Susquehanna’s knowledge, we, or any of our subsidiaries, are threatened. All legal proceedings presently pending or threatened against Susquehanna or our subsidiaries involve routine litigation incidental to our business or that of the subsidiary involved and are not material in respect to the amount in controversy.

Item 4. Submission of Matters to a Vote of Security Holders.

There were no matters submitted to a vote of security holders during the fourth quarter of 2005.

PART II

Item 5. Market for Susquehanna’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Market Information. Susquehanna common stock is listed for quotation on the Nasdaq National Market System. Set forth below are the quarterly high and low sales prices of Susquehanna’s common stock as reported on the Nasdaq National Market System for the years 2005 and 2004, and cash dividends paid. The table represents prices between dealers and does not include retail markups, markdowns or commissions and does not necessarily represent actual transactions.


Year	Period	Cash Dividends Paid		Price Range Per Share
Year	Period	Cash Dividends Paid		Low		High
2005	1^st Quarter	$	0.23	$	23.38	$	25.44
	2^nd Quarter		0.23		20.50		25.06
	3^rd Quarter		0.23		23.42		27.30
	4^th Quarter		0.24		22.01		25.20

2004	1^st Quarter	$	0.22	$	24.33	$	27.12
	2^nd Quarter		0.22		22.18		26.47
	3^rd Quarter		0.22		22.36		25.64
	4^th Quarter		0.23		24.35		26.65

As of February 28, 2006, there were 6,831 record holders of Susquehanna common stock.

Dividend Policy. Dividends paid by Susquehanna are provided from dividends paid to us by our subsidiaries. Our ability to pay dividends is largely dependent upon the receipt of dividends from our bank subsidiaries. Both federal and state laws impose restrictions on the ability of these subsidiaries to pay dividends. These include the Pennsylvania Banking Code of 1965 in the case of Susquehanna Bank PA, the Financial Institutions Article of the Annotated Code of Maryland in the case of Susquehanna Bank, the New Jersey Banking Act of 1948 in the case of Susquehanna Patriot Bank, the Federal Reserve Act in the case of all three banks, and the applicable regulations under such laws. The net capital rules of the SEC under the Securities Exchange Act of 1934 also limit the ability of Valley Forge Asset Management Corp. to pay dividends to us. In addition to the specific restrictions, summarized below, the banking and securities regulatory agencies also have broad authority to prohibit otherwise permitted dividends proposed to be made by an institution regulated by them if the agency determines that their distribution would constitute an unsafe or unsound practice.

The Federal Reserve Board has issued policy statements which provide that, as a general matter, insured banks and bank holding companies should pay dividends only out of current operating earnings.

For state-chartered banks which are members of the Federal Reserve System, the approval of the Federal Reserve Board is required for the payment of dividends by the bank subsidiary in any calendar year if the total of all dividends declared by the bank in that calendar year, including the proposed dividend, exceeds the current year’s net income combined with the retained net income for the two preceding calendar years. “Retained net income” for any period means the net income for that period less any common or preferred stock dividends declared in that period. Moreover, no dividends may be paid by such bank in excess of its undivided profits account.

Dividends by a Pennsylvania state-chartered bank may be paid only out of accumulated net earnings and are restricted by the requirement that the bank set aside to a surplus fund each year at least 10% of its net earnings until the bank’s surplus equals the amount of its capital (a requirement presently satisfied in the case of Susquehanna Bank PA). Furthermore, a Pennsylvania bank may not pay a dividend if the payment would result in a reduction of the surplus account of the bank.

A Maryland state-chartered bank may pay dividends out of undivided profits or, with the approval of the Maryland Commissioner of Financial Regulation, from surplus in excess of 100% of required capital stock. If, however, the surplus of a Maryland bank is less than 100% of its capital stock, cash dividends may not be paid in excess of 90% of net earnings.

A New Jersey state-chartered bank may pay dividends on its capital stock unless the capital stock of the bank would be impaired after the payment. In addition, the bank must have a capital surplus after payment of the dividend of at least 50% of its capital stock or, if not, the payment would not reduce the surplus of the bank.

Within the regulatory restrictions described above, each of our bank subsidiaries presently has the ability to pay dividends. At December 31, 2005, $44.0 million in the aggregate was available for dividend distributions during calendar 2006 to us from our bank subsidiaries without regulatory approval and with their remaining well-capitalized. Also, our non-bank subsidiaries at December 31, 2005 had approximately $85.0 million which they could dividend to us without regulatory approval. We presently expect that cash dividends will continue to be paid by our subsidiaries in the future at levels comparable with those of prior years.

Item 6. Selected Financial Data.

Susquehanna Bancshares, Inc. & Subsidiaries


Year ended December 31,	2005			2004⁽¹⁾			2003			2002			2001
	( Amounts in thousands, except per share data)
Interest income	$	387,020		$	321,759		$	286,020		$	316,713		$	341,295
Interest expense		144,775			107,741			99,014			129,473			169,051
Net interest income		242,245			214,018			187,006			187,240			172,244
Provision for loan and lease losses		12,335			10,020			10,222			10,664			7,310
Noninterest income		125,078			114,590			101,750			94,150			84,166
Noninterest expenses		242,550			219,042			189,430			181,663			167,763
Income before taxes		112,438			99,546			89,104			89,063			81,337
Net income		79,563			70,180			62,373			61,721			55,716
Cash dividends declared on common stock		43,432			38,471			34,167			31,985			30,228

*Per Common Share Amounts*
Net income:
Basic	$	1.70		$	1.61		$	1.57		$	1.56		$	1.42
Diluted		1.70			1.60			1.56			1.55			1.41
Cash dividends declared on common stock	$	0.93		$	0.89		$	0.86		$	0.81		$	0.77
Dividend payout ratio		54.6	%		54.8	%		54.8	%		51.8	%		54.3	%

*Financial Ratios*
Return on average total assets		1.07	%		1.04	%		1.09	%		1.17	%		1.14	%
Return on average shareholders’ equity		10.52			10.73			11.58			12.02			11.78
Return on average tangible shareholders’ equity⁽²⁾		16.06			14.36			13.16			13.76			13.88
Net interest margin		3.76			3.60			3.65			3.96			3.91
Efficiency ratio		65.58			66.15			65.09			63.96			64.64
Efficiency ratio excluding Hann⁽²⁾		57.97			61.09			62.25			61.52			64.23
Average equity/Average assets		10.18			9.65			9.41			9.73			8.85

*Capital Ratios*
Leverage		7.77	%		7.30	%		8.34	%		8.60	%		8.68	%
Total capital		11.61			11.30			12.06			13.13			12.53

*Credit Quality*
Net charge-offs/Average loans and leases		0.24	%		0.16	%		0.18	%		0.23	%		0.21	%
Nonperforming assets/Loans and leases plus OREO		0.38			0.41			0.65			0.56			0.55
ALLL/Nonperforming loans and leases		309			265			172			218			243
ALLL/Total loans and leases		1.03			1.03			1.00			1.04			1.07

*Year-End Balances*
Total assets	$	7,466,007		$	7,475,073		$	5,953,107		$	5,544,647		$	5,088,954
Investment securities		1,154,261			1,245,414			988,222			1,126,407			1,021,091
Loans and leases, net of unearned income		5,218,659			5,253,008			4,263,272			3,830,953			3,519,498
Deposits		5,309,187			5,130,682			4,134,467			3,831,315			3,484,331
Total borrowings		1,148,966			1,395,365			1,099,403			1,021,194			1,016,845
Shareholders’ equity		780,470			751,694			547,382			533,855			493,536

*Selected Share Data*
Common shares outstanding (period end)		46,853			46,593			39,861			39,638			39,344
Average common shares outstanding:
Basic		46,711			43,585			39,742			39,496			39,263
Diluted		46,919			43,872			40,037			39,781			39,593
At December 31:
Book value per share	$	16.66		$	16.13		$	13.73		$	13.47		$	12.54
Market price per common share	$	23.68		$	24.95		$	25.01		$	20.84		$	20.85
Common shareholders		6,857			6,981			6,650			6,131			6,340

⁽¹⁾	On June 10, 2004, we completed our acquisition of Patriot Bank Corp. The acquisition was accounted for under the purchase method, and all transactions since that date are included in our consolidated financial statements.

⁽²⁾	Supplemental Reporting of Non-GAAP-based Financial Measures

Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP 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 which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average equity to return on average tangible equity is set forth below.


Return on average equity (GAAP basis)	10.52	%	10.73	%	11.58	%	12.02	%	11.78	%
Effect of excluding average intangible assets and related amortization	5.54	%	3.63	%	1.58	%	1.74	%	2.10	%
Return on average tangible equity	16.06	%	14.36	%	13.16	%	13.76	%	13.88	%

Efficiency ratio excluding Hann is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable GAAP-based measure is the efficiency ratio. We measure our efficiency ratio by dividing noninterest expenses by the sum of net interest income, on a FTE basis, and noninterest income. The presentation of an efficiency ratio excluding Hann is computed as the efficiency ratio excluding the effect of our auto leasing subsidiary, Hann Financial. Management believes this to be a preferred measure because it excludes the volatility of vehicle residual value and vehicle delivery and preparation expense of Hann and provides better visibility into our core business activities. A reconciliation of efficiency ratio to our efficiency ratio excluding Hann is set forth below.


Efficiency ratio (GAAP basis)	65.58	%	66.15	%	65.09	%	63.96	%	64.64	%
Effect of excluding Hann	7.61	%	5.06	%	2.84	%	2.44	%	0.41	%
Efficiency ratio excluding Hann	57.97	%	61.09	%	62.25	%	61.52	%	64.23	%

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

The following pages of this report present management’s discussion and analysis of the consolidated financial condition and results of operations of Susquehanna Bancshares, Inc. and its subsidiaries. Unless the context requires otherwise, the terms “Susquehanna,” “we,” “us,” and “our” refer to Susquehanna Bancshares, Inc. and its subsidiaries.

Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited to, Susquehanna’s potential exposures to various types of market risks, such as interest rate risk; credit risk; whether Susquehanna’s allowance for loan and lease losses is adequate to meet probable loan and lease losses; the impact of a breach by Auto Lenders on residual loss exposure; the likelihood of an occurrence of an Early Amortization Event (as defined in this report); the anticipated conclusion of our sale leaseback transaction at the end of 2006; expectations regarding our branding strategy and internal realignment plans and their potential impact on our efficiency ratios and earnings; expectations regarding the timing of the Minotola transaction; and expectations regarding the future performance of Hann. 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 which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

•

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

•

the adequacy of the allowance for loan and lease losses;

•

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

•

continued relationships with major customers;

•

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

•

adverse economic and business conditions;

•

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

•

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

•

the inability to hedge certain risks economically;

•

our ability to effectively implement technology driven products and services;

•

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

•

our success in managing the risks involved in the foregoing.

We encourage readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. Forward-looking statements speak only as of the date they are made. We do not intend to update publicly any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events except as required by law.

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

The following information refers to the parent company and its wholly owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) (“Hann”), Conestoga Management Company, Susquehanna Bank PA and subsidiaries, Susquehanna Patriot Bank and subsidiaries (“Susquehanna Patriot”), Susquehanna Bank and subsidiaries, Susque-Bancshares Life Insurance Co. (dissolved in December 2005), Valley Forge Asset Management Corp. and subsidiaries (“VFAM”), and The Addis Group, LLC (“Addis”).

Critical Accounting Estimates

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

Our most critical accounting estimates are presented in Note 1 to the consolidated financial statements. Furthermore, we believe that the determination of the allowance for loan and lease losses and the valuation of recorded interests in securitized assets to be the accounting areas that require the most subjective and complex judgments. The treatment of securitizations and off-balance sheet financing is discussed in detail in the section titled “Securitizations and Off-Balance Sheet Financings.”

The allowance for loan and lease losses represents management’s estimate of probable credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance for loan and lease losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan and lease losses.

Recorded interests in securitized assets are established and accounted for based on discounted cash flow modeling techniques which require management to make estimates regarding the amount and timing of expected future cash flows, including assumptions about lease repayment rates, credit loss experience, and discount rates that consider the risk involved. Since the values of these assets are sensitive to changes in assumptions, the valuation of recorded interests in securitized assets is considered a critical accounting estimate. Note 1 and the section titled “Securitizations and Off-Balance Sheet Financings” provide additional information regarding recorded interests.

Any material effect on the consolidated financial statements related to these critical accounting areas is also discussed within the body of this document.

Executive Overview

2005 was a year of significant progress in many areas. We completed the consolidation of our eight community banks into three banks, launched an advertising campaign to promote our brand, and announced plans to acquire Minotola National Bank in New Jersey.

The following table compares our 2005 financial goals to actual results:


	Goal	Actual
Fully diluted earnings per share	$1.70 - $1.80	$1.70
Return on average tangible equity*	16.00%	16.06%
Net interest margin	3.70%	3.76%
Efficiency ratio excluding Hann*	58.50%	57.97%
Loan growth (adjusted for securitizations)	8.0%	12.0%
Deposit growth (adjusted for branch sales)	8.0%	4.8%
Noninterest income growth	10.0%	9.2%

*	Non-GAAP-based financial measures. Further information regarding non-GAAP-based financial measures can be found on page 29, “Supplemental Reporting of Non-GAAP-based Financial Measures.”

In 2005, we continued to face challenges with our auto leasing subsidiary, Hann. As a result, throughout most of the year, we worked with a major investment banking firm to explore strategic alternatives with respect to it. In the end, we decided that for now, it would be in the best interest of shareholders to continue to hold and operate the business, instead of selling the business at a significant discount. We will, however, continue to monitor and actively manage the business while keeping all of our strategic options open. Because of an expected return to normal lease origination volumes; a reduction in residual value guarantee premiums under contract for the next 3 years; an expected reduction in costs due to a new state-of-the-art reconditioning center by our third party residual value guarantor; recently enacted changes in federal vicarious liability laws that will reduce insurance costs; and the anticipated conclusion of our sale leaseback transaction at the end of 2006, we expect significant improvement at Hann in 2006 and a return to profitability in 2007.

At the end of 2005, we also announced that due to the growing trend in the financial services industry not to provide earnings guidance, we were discontinuing the practice going forward. Because of this, in 2006, we do not

include fully diluted earnings per share, return on average tangible equity, nor efficiency ratio excluding Hann in our published financial goals. Our financial goals for 2006 are as follows:


Net interest margin	3.80	%
Loan growth (adjusted for securitizations)	10.0	%
Deposit growth	8.0	%
Noninterest income growth	10.0	%
Noninterest expense growth	5.0	%

These financial goals include $16.0 million of securitization gains. The timing and amount of these associated securitizations, which we use as a funding source and a means to manage capital, are difficult to predict. Consequently, quarterly earnings will fluctuate.

Acquisitions

Minotola National Bank

On November 14, 2005, we announced the signing of a definitive merger agreement pursuant to which we will acquire Minotola National Bank in a stock and cash transaction valued at approximately $165 million. The acquisition of Minotola, with total assets of $623 million and fourteen branch locations provides us with an opportunity to expand our franchise into high-growth markets in southern New Jersey.

Under the terms of the merger agreement, for each share of Minotola stock held, a Minotola shareholder may elect to receive either $3,226 in cash, 134 common shares of Susquehanna, or a combination thereof such that 30% of the Minotola shares would be exchanged for cash, and 70% would be exchanged for Susquehanna common stock. We anticipate that the transaction will be completed by April 30, 2006, pending regulatory approvals.

Brandywine Benefits Corporation and Rockford Pensions, LLC

On February 1, 2005, we acquired Brandywine Benefits Corporation and Rockford Pensions, LLC (collectively “Brandywine”) located in Wilmington, Delaware. Brandywine is a financial planning, consulting and administration firm specializing in retirement benefit plans for small-to-medium-sized businesses and is a wholly owned subsidiary of Brandywine Benefits Corp., LLC, which in turn is a wholly owned subsidiary of VFAM. The acquisition was accounted for under the purchase method, and all transactions since that date are included in our consolidated financial statements

Patriot Bank Corp.

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

Other Notable Events

On January 21, 2005, we merged two of our subsidiary banks, First Susquehanna Bank and Trust and WNB Bank, into our Susquehanna Bank PA subsidiary. On April 15, 2005, we merged three of our subsidiary banks, Susquehanna Bank; Citizens Bank of Southern Pennsylvania; and First American Bank of Pennsylvania, into our Farmers & Merchants Bank subsidiary, which subsequently changed its name to Susquehanna Bank. These actions were taken as part of the consolidation plan we first announced in October 2004.

Results of Operations

Summary of 2005 Compared to 2004

Net income for the year ended December 31, 2005 was $79.6 million, an increase of $9.4 million, or 13.4%, over net income of $70.2 million in 2004. Net interest income increased 13.2%, to $242.2 million for 2005, from $214.0 million in 2004. Non-interest income increased 9.2%, to $125.1 million for 2005, from $114.6 million in 2004, and non-interest expenses increased 10.7%, to $242.6 million for 2005, from $219.0 million for 2004.

Additional information is as follows:


	Twelve Months Ended December 31,
	2005			2004
Diluted Earnings per Share	$	1.70		$	1.60
Return on Average Assets		1.07			1.04	%
Return on Average Equity		10.52	%		10.73	%
Return on Average Tangible Equity⁽¹⁾		16.06	%		14.36	%
Efficiency Ratio		65.58	%		66.15	%
Efficiency Ratio excluding Hann⁽¹⁾		57.97	%		61.09	%

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

(1) Supplemental Reporting of Non-GAAP-based Financial Measures

Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP 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. A reconciliation of return on average equity to return on average tangible equity is set forth below.


Return on average equity (GAAP basis)	10.52	%	10.73	%
Effect of excluding average intangible assets and related amortization	5.54	%	3.63	%
Return on average tangible equity	16.06	%	14.36	%

Efficiency ratio excluding Hann is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable GAAP-based measure is the efficiency ratio. We measure our efficiency ratio by dividing noninterest expenses by the sum of net interest income, on an FTE basis, and noninterest income. The presentation of an efficiency ratio excluding Hann is computed as the efficiency ratio excluding the effect of our auto leasing subsidiary, Hann Financial. Management believes this to be a preferred measure because it excludes the volatility of vehicle residual values and vehicle delivery and preparation expense of Hann and provides better visibility into our core business activities. A reconciliation of efficiency ratio to efficiency ratio excluding Hann is set forth below.


Efficiency ratio (GAAP basis)	65.58	%	66.15	%
Effect of excluding Hann	7.61	%	5.06	%
Efficiency ratio excluding Hann	57.97	%	61.09	%

Net Interest Income — Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which increased to $242.2 million in 2005, as compared to $214.0 million in 2004. Net interest income as a percentage of net interest income plus other income

was 66% for the twelve months ended December 31, 2005, 65% for the twelve months ended December 31, 2004, and 65% for the twelve months ended December 31, 2003.

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

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

Interest Rates and Interest Differential - Tax Equivalent Basis


	2005						2004						2003
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
	(Dollars in thousands)
Assets
Short-term investments	$	61,767		$	1,789	2.90	$	72,405		$	815	1.13	$	77,505		$	705	0.91
Investment securities:
Taxable		1,180,762			44,066	3.73		1,159,860			42,513	3.67		1,104,863			37,893	3.43
Tax-advantaged		27,390			1,852	6.76		33,141			2,411	7.27		30,842			2,217	7.19

Total investment securities		1,208,152			45,918	3.80		1,193,001			44,924	3.77		1,135,705			40,110	3.53

Loans and leases, (net):
Taxable		5,153,910			336,508	6.53		4,668,299			273,781	5.86		3,910,353			243,236	6.22
Tax-advantaged		80,553			5,313	6.60		75,565			4,743	6.28		59,179			4,222	7.13

Total loans and leases		5,234,463			341,821	6.53		4,743,864			278,524	5.87		3,969,532			247,458	6.23

Total interest-earning assets		6,504,382		$	389,528	5.99		6,009,270		$	324,263	5.40		5,182,742		$	288,273	5.56

Allowance for loan and lease losses		(54,170	)					(49,012	)					(40,868	)
Other nonearning assets		979,932						816,524						582,652

Total assets	$	7,430,144					$	6,776,782					$	5,724,526

Liabilities
Deposits:
Interest-bearing demand	$	1,736,130		$	28,866	1.66	$	1,640,525		$	16,803	1.02	$	1,195,656		$	9,473	0.79
Savings		522,346			2,318	0.44		552,950			2,115	0.38		498,157			1,999	0.40
Time		2,037,019			64,979	3.19		1,776,623			49,484	2.79		1,601,495			51,419	3.21
Short-term borrowings		378,706			9,727	2.57		358,348			4,261	1.19		352,271			3,582	1.02
FHLB borrowings		744,312			28,634	3.85		640,397			22,529	3.52		587,305			22,420	3.82
Long-term debt		177,295			10,251	5.78		190,649			12,550	6.58		141,425			10,120	7.16

Total interest-bearing liabilities		5,595,808		$	144,775	2.59		5,159,492		$	107,742	2.09		4,376,309		$	99,013	2.26

Demand deposits		876,150						783,551						646,971
Other liabilities		201,572						179,584						162,828

Total liabilities		6,673,530						6,122,627						5,186,108
Equity		756,614						654,155						538,418

Total liabilities & shareholders’ equity	$	7,430,144					$	6,776,782					$	5,724,526

Net interest income / yield on average earning assets				$	244,753	3.76				$	216,521	3.60				$	189,260	3.65

Additional Information

Average loan balances include non accrual loans.

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

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

Table 1 presents average balances, taxable equivalent interest income and expense and yields earned or paid on these assets and liabilities. For purposes of calculating taxable equivalent interest income, tax-exempt interest has been adjusted using a marginal tax rate of 35% in order to equate the yield to that of taxable interest rates. Table 2 illustrates the changes in net interest income caused by changes in average volume, rates, and yields.

The $28.2 million increase in our net interest income in 2005, as compared to 2004, was primarily the result of the net contribution from interest-earning assets and interest-bearing liabilities acquired from Patriot in June 2004. In addition, since we are an asset-sensitive institution, where assets reprice more quickly than liabilities, we experienced improvement in our net interest margin, from 3.60% for 2004, to 3.76% for 2005, due to recent increases in interest rates. We have, however, reduced our asset-sensitivity by offering premium rates on interest-bearing deposits, primarily indexed money market accounts, since June 1, 2005. These promotional deposit programs were instituted so that we would continue to be competitive in our marketplace.

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 the section titled “Market Risks.”

TABLE 2 - Changes in Net Interest Income - Tax Equivalent Basis


	2005 Versus 2004 Increase (Decrease) Due to Change in									2004 Versus 2003 Increase (Decrease) Due to Change in
	Average Volume			Average Rate			Total			Average Volume			Average Rate			Total
	(Dollars in thousands)
Interest Income
Other short-term investments	$	(136	)	$	1,110		$	974		$	(48	)	$	158		$	110
Investment securities:
Taxable		802			751			1,553			1,941			2,679			4,620
Tax-advantaged		(399	)		(160	)		(559	)		167			27			194

Total investment securities		403			591			994			2,108			2,706			4,814
Loans (net of unearned income):
Taxable		29,902			32,825			62,727			45,065			(14,520	)		30,545
Tax-advantaged		323			247			570			1,071			(550	)		521

Total loans		30,225			33,072			63,297			46,136			(15,071	)		31,066

Total interest-earning assets	$	30,492		$	34,773		$	65,265		$	48,196		$	(12,206	)	$	35,990

Interest Expense
Deposits:
Interest-bearing demand	$	1,021		$	11,042		$	12,063		$	4,103		$	3,227		$	7,330
Savings		(124	)		327			203			213			(97	)		116
Time		7,835			7,660			15,495			5,284			(7,219	)		(1,935	)
Short-term borrowings		255			5,211			5,466			64			615			679
FHLB borrowings		3,882			2,223			6,105			1,942			(1,833	)		109
Long - term debt		(842	)		(1,457	)		(2,299	)		3,293			(863	)		2,430

Total interest-bearing liabilities		12,027			25,006			37,033			14,899			(6,170	)		8,729

Net Interest Income	$	18,465		$	9,767		$	28,232		$	33,297		$	(6,036	)	$	27,261

Changes which are due in part to volume and in part to rate are allocated in proportion to their relationship to the amounts of changes attributed directly to volume and rate.

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 portfolio. The purpose of the review is to assess loan quality, identify impaired loans and leases, analyze delinquencies, ascertain loan and lease growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets we serve.

Commercial and commercial real estate loans are internally risk rated, using a standard rating system, by our loan officers and periodically reviewed by loan quality personnel. Consumer loans, residential real estate loans, and leases are generally analyzed in the aggregate as they are of relatively small dollar size and homogeneous in nature.

Under our methodology for calculating the allowance for loan and lease losses, loss rates for the last three years on a rolling quarter-to-quarter basis are determined for: (a) commercial credits (including agriculture, commercial, commercial real estate, land acquisition, development and construction) and (b) consumer credits (including residential real estate, consumer direct, consumer indirect, consumer revolving, and leases). The loss rates are calculated for each affiliate bank, and they are applied to loan balances of the portfolio segments described above.

In addition to using loss rates, non-accrual loans of $0.25 million or greater are reviewed for impairment as required under FAS No. 114. Those loans that have specific loss allocations are identified and included in the reserve allocation. Risk-rated loans that are not reviewed for impairment are segregated into homogeneous pools with loss allocation rates that reflect the severity of risk. Loss rates are adjusted by applying other factors to the calculations. These factors include adjustment for current economic trends, delinquency and risk trends, credit concentrations, credit administration and other special allocations for unusual events or changes in products.

This methodology provides an in-depth analysis of the portfolios of our banks and reflects the estimated losses within the various portfolios. Reserve allocations are then reviewed and consolidated. This process is performed on a quarterly basis, including a risk-rated review of commercial credit relationships at the banking affiliates.

Prior to 2002, we did not have a standard risk rating system for affiliate banks. The banks used their own methodology for calculating the allowance, and loss data was not broken out in as many categories, particularly real estate loans, because the data was not available. Table 10, “Allocation of Allowance for Loan and Lease Losses,” reflects comparative data for 2005, 2004, 2003, and 2002 using the revised methodology. If data were available, and we could retroactively apply our current methodology to 2001, we believe the allocation between the categories of real estate — construction and real estate — mortgage would be consistent with 2005, 2004, 2003, and 2002 allocations.

Determining the level of the allowance for possible 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 event in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and lease losses is adequate to meet probable loan and lease losses at December 31, 2005. There can be no assurance, however, that we will not sustain losses in future periods that could be greater than the size of the allowance at December 31, 2005.

The provision for loan and lease losses was $12.3 million for 2005, and $10.0 million in 2004. This $2.3 million increase in the provision was the result of a $5.0 million increase in net charge-offs in 2005, as compared to 2004. The increase in net charge-offs was caused by a $3.6 million net charge-off related to one customer in the telecommunications industry.

The allowance for loan and lease losses at December 31, 2005 was 1.03% of period-end loans and leases, or $53.7 million, and 1.03%, or $54.1 million, at December 31, 2004.

Should the economic climate deteriorate, borrowers may experience increasing difficulty in meeting their payment obligations, and the level of non-performing loans and assets, charge-offs, and delinquencies could rise and require further increases in the provision. In addition, regulatory authorities, as an integral part of their examinations, periodically review the level of the allowance for loan and lease losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.

It is our policy not to renegotiate the terms of a commercial loan simply because of a delinquency status. Rather, a commercial loan is typically transferred to non-accrual status if it is not well secured and in the process of collection, and is considered delinquent in payment if either principal or interest is past due 90 days or more. Interest income received on impaired commercial loans in 2005 and 2004 was $0.16 million and $0.10 million, respectively. Interest income that would have been recorded on these loans under the original terms was $0.3 million and $1.1 million for 2005 and 2004, respectively. At December 31, 2005, we had no outstanding commitments to advance additional funds with respect to these impaired loans.

Consumer loans are typically charged-off when they are 120 days past due unless they are secured by real estate. Loans secured by real estate are evaluated on the basis of collateral value. Loans that are well-secured may continue to accrue interest, while other loans are charged down to net realizable value or placed on non-accrual depending upon their loan to value ratio.

Table 3 is an analysis of the provision levels as well as the activity in the allowance for loan and lease losses for the past five years. Table 4 reflects the five-year history of non-performing assets and loans and leases contractually past due 90 days and not placed on non-accrual. At December 31, 2005, non-performing assets totaled $20.0 million and included $2.6 million in other real estate acquired through foreclosure. At December 31, 2004, non-performing assets totaled $21.7 million, and included $1.3 million in other real estate acquired through foreclosure.

TABLE 3 - Provision and Allowance for Loan and Lease Losses


	2005			2004			2003			2002			2001
	(Dollars in thousands)
Allowance for loan and lease losses, January 1	$	54,093		$	42,672		$	39,671		$	37,698		$	37,187
Allowance acquired in business combination		0			9,149			0			0			539
Additions to provision for loan and lease losses charged to operations		12,335			10,020			10,222			10,664			7,310
Loans and leases charged-off during the year:
Commercial, financial, and agricultural		8,827			2,211			2,340			3,261			2,563
Real estate - construction		45			0			0			3			69
Real estate secured - residential		1,407			948			956			1,271			451
Real estate secured - commercial		1,805			1,845			1,413			1,143			750
Consumer		3,455			3,607			3,561			3,657			3,178
Leases		2,816			2,248			1,840			1,697			2,413

Total charge-offs		18,355			10,859			10,110			11,032			9,424

Recoveries of loans and leases previously charged-off:
Commercial, financial, and agricultural		1,694			611			614			283			271
Real estate - construction		0			0			0			16			115
Real estate secured - residential		370			298			289			66			185
Real estate secured - commercial		1,007			96			128			0			63
Consumer		1,649			1,493			1,421			1,852			1,326
Leases		921			613			437			124			126

Total recoveries		5,641			3,111			2,889			2,341			2,086

Net charge-offs		12,714			7,748			7,221			8,691			7,338

Allowance for loan and lease losses, December 31,	$	53,714		$	54,093		$	42,672		$	39,671		$	37,698

Average loans and leases outstanding	$	5,234,463		$	4,743,864		$	3,969,532		$	3,705,572		$	3,537,316
Period-end loans and leases		5,218,659			5,253,008			4,263,272			3,830,953			3,519,498
Net charge-offs as a percentage of average loans and leases		0.24	%		0.16	%		0.18	%		0.23	%		0.21	%
Allowance as a percentage of period-end loans and leases		1.03	%		1.03	%		1.00	%		1.04	%		1.07	%

TABLE 4 - Non-Performing Assets


At December 31,	2005			2004			2003			2002			2001
	(Dollars in thousands)
Loans contractually past due 90 days and still accruing	$	8,998		$	10,217		$	6,538		$	8,208		$	11,498

Non-performing assets:
Nonaccrual loans:
Commercial, financial, and agricultural	$	2,921		$	1,866		$	1,735		$	3,252		$	1,588
Real estate - construction		0			0			128			1,148			1,536
Real estate secured - residential		5,629			5,801			4,157			3,819			2,557
Real estate secured - commercial		5,872			10,611			12,963			9,192			6,702
Consumer		76			146			54			245			41
Leases		2,894			1,983			0			534			3,092
Restructured loans		0			0			5,823			0			0
Other real estate owned		2,620			1,340			2,893			3,151			3,761

Total non-performing assets	$	20,012		$	21,747		$	27,753		$	21,341		$	19,277

Total non-performing assets as a percentage of period-end loans and leases and other real estate owned		0.38	%		0.41	%		0.65	%		0.56	%		0.55	%
Allowance for loan and lease losses as a percentage of non-performing loans and leases		309	%		265	%		172	%		218	%		243	%

Real estate acquired through foreclosure is carried at its fair value, which is calculated as the lower of the recorded amount of the loan for which the foreclosed property served as collateral, or the fair market value of the property as determined by a current appraisal less estimated costs to sell. Prior to foreclosure, the recorded amount of the loan is written-down, if necessary, to fair value by charging the allowance for loan and lease losses. Subsequent to foreclosure, gains or losses on the sale of real estate acquired through foreclosure are recorded in operating income, and any losses determined as a result of periodic valuations are charged to other operating expense.

Loans with principal and/or interest delinquent 90 days or more and still accruing interest totaled $9.0 million at December 31, 2005, a decrease from $10.2 million at December 31, 2004. A softening of certain segments of the economy may adversely affect certain borrowers and may cause additional loans to become past due beyond 90 days or be placed on non-accrual status because of the uncertainty of receiving full payment of either principal or interest on these loans.

Potential problem loans consist of loans that are performing under contract but for which potential credit problems have caused us to place them on our internally monitored loan list. These loans, which are not included in Table 4, totaled $29.8 million at December 31, 2005, and $30.1 million at December 31, 2004. Depending upon the state of the economy and its impact on these borrowers, as well as future events, such as regulatory examination assessments, these loans and others not currently so identified could be classified as non-performing assets in the future.

Noninterest Income

Noninterest income, as a percentage of net interest income plus noninterest income, was 34%, 35%, and 35% for 2005, 2004, and 2003, respectively.

Noninterest income increased $10.5 million, or 9.2%, in 2005, over 2004. This net increase primarily is composed of the following:

•

Increasedasset management fees of $3.5 million;

•

Increasedcommissions on property and casualty insurance sales of $2.0 million;

•

Increased netgains on sales of loans and leases of $5.3 million;

•

Increased netgains on the sales of bank branches of $2.0 million;

•

Increasedother income of $2.8 million; and

•

Decreasedvehicle origination, servicing, and securitization fees of $4.2 million.

Asset management fees and commissions on brokerage, life insurance, and annuity sales. As part of our strategy to increase other fee-based income, we continued to focus on enhancing the wealth management aspect of our business. As a result, asset management fees increased 24.1%, as assets under administration at VFAM increased 4.8%, to $3.8 billion at December 31, 2005, from $3.6 billion at December 31, 2004. This increase is also due, in part, to our strategic acquisitions.

Commissions on property and casualty insurance sales. The 21.2% increase in commissions on property and casualty insurance sales is attributed to new business, growth in existing business, and better than expected contingency fee income in the first quarter of 2005.

Gains on sales of loans and leases.The 55.2% increase in gains on sales of loans and leases can be attributed to the sale and subsequent securitization of $239.8 million in home equity line of credit loans (“HELOCs”) in the fourth quarter of 2005. The net gain relating to this transaction was $6.7 million.

Net gains on the sales of bank branches.During 2005, we sold six bank branches and realized an aggregate net pre-tax gain of $5.2 million. During 2004, we sold four bank branches and realized an aggregate net pre-tax gain of $3.2 million. These sales were part of our effort to enhance the efficiency of our branch network through our previously announced plans to consolidate and/or sell several locations.

Other income.The 22.4% increase in other income for 2005, is directly related to the inclusion of Patriot operations for the entire year.

Vehicle origination, securitization, and servicing fees.The 21.1% decrease in vehicle origination, servicing, and securitization fees was primarily due to a combination of decreased lease origination volumes and decreased fees from securitization transactions at Hann. The decrease in securitization fees is due to the current interest rate environment.

Noninterest Expenses

Noninterest expenses increased $23.5 million, or 10.7%, in 2005, over 2004. This net increase primarily is composed of the following:

•

Increasedsalaries and employee benefits of $8.1 million;

•

Increasedoccupancy and furniture and equipment expense of $4.2 million;

•

Increasedvehicle residual value expense of $4.3 million;

•

Decreasedvehicle delivery and preparation expense of $3.3 million; and

•

Increasedother expenses of $9.9 million;

Salaries and employee benefits.The largest component of noninterest expense is salaries and employee benefits, which increased 7.6% in 2005. This increase is primarily the result of the Patriot acquisition, normal annual salary increases, new revenue producing positions, and higher benefit costs. Offsetting this increase was a decline in related expenses due to our charter consolidations.

On December 14, 2005, our Board of Directors approved the accelerated vesting, effective as of December 15, 2005, of all unvested stock options granted to employees and directors in 2002 and 2004. The

decision to accelerate the vesting of these options primarily was made to reduce non-cash compensation expense that would have been recorded in our income statement in future periods as a result of the adoption of FAS No. 123(R), “Share-Based Payment,” in January 2006. We estimate that, as a result of this action, approximately $0.4 million of compensation expense will have been eliminated in 2006, approximately $0.3 million of compensation expense will have been eliminated in 2007, and approximately $0.2 million of compensation expense will have been eliminated in 2008. As a result of the accelerated vesting of these options, compensation expense totaling $0.1 million was included in our results of operations for 2005.

Occupancy and furniture and equipment. Charges for occupancy and furniture and equipment increased 16.9% in 2005. The increase can be attributed to the Patriot acquisition and general increases in the costs of doing business, predominantly in the categories of rent expense and maintenance expense.

Vehicle residual value.As we had anticipated, vehicle residual value expense increased for 2005, based upon servicing agreements with Auto Lenders, our third-party residual value guarantor. However, due to improving market conditions, residual value guarantee premiums are contractually committed to decrease by $5.5 million in 2006, and by another $2.7 million in 2007. For further information, refer to the discussion concerning Vehicle Leasing Residual Value Risk on page 50 of this Form 10-K.

Vehicle delivery and preparation. The 23.2% decrease in these expenses is due to efficiencies recognized through the operation of the new reconditioning center at Auto Lenders. In addition, fewer vehicle leases matured in 2005.

Other expense. All other expenses increased $9.9 million, net (see Table 5). The inclusion of Patriot operations since June 10, 2004, contributed to a general increase in all expense categories. In addition, we incurred increased advertising and marketing expenses relating to our branding initiative in 2005.

TABLE 5 - Analysis of Other Expenses


Year ended December 31,	2005		2004		2003
	(Dollars in thousands)
Advertising, marketing, and public relations	$	8,671	$	6,948	$	5,874
FDIC and other insurance		5,369		5,048		3,146
Legal and consulting		5,268		4,552		3,528
Postage and delivery		6,267		5,983		5,461
All other		51,219		44,332		39,170

Total	$	76,794	$	66,863	$	57,179

Income Taxes

Our effective tax rates for 2005 and 2004 were 29.2% and 29.5%, respectively.

During 2005, Susquehanna instituted a request under a particular state’s voluntary compliance process to establish the right to loss carryforwards. This process was completed with the state in October, 2005. Due to the establishment of loss carryforwards in an additional state, as well as other initiatives undertaken during the fourth quarter of 2005, Susquehanna has assessed that all of the remaining state net operating losses are realizable at December 31, 2005, and the valuation allowance was released.

Offsetting the impact of the release of the valuation allowance was a reduced level of tax-advantaged income.

Financial Condition

Summary of 2005 Compared to 2004

Total assets at December 31, 2005 and 2004 were $7.5 billion. Loans and leases, as a result of two securitization transactions completed by our banking subsidiaries in 2005, experienced a slight decrease, to $5.2 billion at December 31, 2005, from $5.3 billion at December 31, 2004. Deposits increased to $5.3 billion, from $5.1 billion during the same time period. Equity capital was $780.5 million at December 31, 2005, or $16.66 per share, compared to $751.7 million, or $16.13 per share, at December 31, 2004.

Investment Securities

We follow FAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” This accounting pronouncement requires the segregation of investment securities into three categories, each having a distinct accounting treatment:

•

held-to-maturity;

•

trading; or

•

available-for-sale.

Securities identified as “held-to-maturity” continue to be carried at their amortized cost and, except for limited circumstances, may not be sold prior to maturity. Securities identified as “available-for-sale” must be reported at their market or “fair” value, and the difference between that value and their amortized cost is recorded in the equity section, net of taxes, as a component of other comprehensive income. Consequently, our total equity was negatively impacted by $15.2 million, as the unrealized losses, net of taxes, on available-for-sale securities increased from a loss of $2.3 million at December 31, 2004, to a loss of $17.5 million at December 31, 2005. We do not believe any individual unrealized loss represents a material other-than-temporary impairment. Unrealized losses recorded for U.S. Government agencies and mortgage-backed securities are attributable to changes in interest rates. We have both the intent and the ability to hold the securities for a time necessary to recover the amortized cost.

Investment securities available for sale decreased $93.1 million, from December 31, 2004, to December 31, 2005. This decrease occurred because we chose to use some of the cash inflows from sales, maturities, and repayments of securities to fund loan growth rather than reinvest in additional securities. In addition, the $23.5 million increase in unrealized losses in the portfolio also contributed to the decrease.

Securities identified as “trading account securities” are marked-to-market with the change recorded in the income statement. Presently, we do not engage in trading activity, but we do engage in active portfolio management, that requires the majority of our security portfolios to be identified as “available-for-sale.” While FAS 115 requires segregation into “held-to-maturity” and “available-for-sale” categories (see Table 6), it does not change our policy concerning the purchase of only high quality securities. Strategies employed address liquidity, capital adequacy, and net interest margin considerations, which then determine the assignment of purchases into these two categories. Table 7 illustrates the maturities of these security portfolios and the weighted-average yields based upon amortized costs. Yields are shown on a tax equivalent basis assuming a 35% federal income tax rate.

At December 31, 2005, we held no securities of any one issuer where the aggregate book value exceeded ten percent of shareholders’ equity. Furthermore, there were no investment securities whose ratings were less than investment grade at December 31, 2005 and 2004.

TABLE 6 - Carrying Value of Investment Securities


Year ended December 31,	2005				2004				2003
	Available- for-Sale		Held-to- Maturity		Available- for-Sale		Held-to- Maturity		Available- for-Sale		Held-to- Maturity
	(Dollars in thousands)
U.S. Treasury	$	0	$	0	$	0	$	0	$	202	$	0
U.S. Government agencies		399,039		0		262,340		0		84,679		0
State and municipal		11,771		6,399		38,219		4,469		18,793		4,340
Other securities		64,139		0		7,365		0		7,409		0
Mortgage-backed securities		602,564		0		868,266		0		832,248		0
Equity securities		70,349		0		64,755		0		40,551		0

Total investment securities	$	1,147,862	$	6,399	$	1,240,945	$	4,469	$	983,882	$	4,340

TABLE 7 - Maturities of Investment Securities


At December 31, 2005	Within 1 Year			After 1 Year but Within 5 Years			After 5 Years but Within 10 Years			After 10 Years			Total
	(Dollars in thousands)
Available-for-Sale
U.S. Government agencies
Fair value	$	31,323		$	366,383		$	771		$	562		$	399,039
Amortized cost		31,389			372,389			776			544			405,098
Yield		4.13	%		3.70	%		5.18	%		5.80	%		3.74	%
Corporate debt securities
Fair value	$	0		$	17,221		$	0		$	46,918		$	64,139
Amortized cost		0			17,411			0			46,851			64,262
Yield		0.00	%		4.23	%		0.00	%		5.21	%		4.94	%
Mortgage-backed securities
Fair value	$	0		$	201,526		$	210,438		$	190,600		$	602,564
Amortized cost		0			208,160			218,720			196,467			623,347
Yield		0.00	%		4.18	%		4.02	%		4.30	%		4.16	%
State and municipal securities
Fair value	$	222		$	10,280		$	603		$	666		$	11,771
Amortized cost		220			10,319			600			664			11,803
Yield (TE)		7.32	%		5.54	%		8.92	%		8.49	%		5.91	%
Equity securities
Fair value													$	70,349
Amortized cost														70,338
Yield														3.96	%

Held-to-Maturity

State and municipal
Fair value	$	0		$	0		$	0		$	6,399		$	6,399
Amortized cost		0			0			0			6,399			6,399
Yield		0.00	%		0.00	%		0.00	%		3.92	%		3.92	%
Total Securities

Fair value	$	31,545		$	595,410		$	211,812		$	245,145		$	1,154,261
Amortized cost		31,609			608,279			220,096			250,925			1,181,247
Yield		4.15	%		3.91	%		4.04	%		4.47	%		4.06	%

Weighted-average yields are based on amortized cost. For presentation in this table, yields on tax-exempt securities have been calculated on a tax-equivalent basis.

Information included in this table regarding mortgage-backed securities in based on final maturities.

Loans and Leases

In March 2005, our banking subsidiaries entered into a term securitization transaction in which we collectively sold and contributed beneficial interests in a portfolio of automobile leases and related vehicles with an aggregate balance of $366.8 million. In December 2005, we entered into a term securitization transaction in which we sold a portfolio of HELOCs with an aggregate balance of $239.8 million. Internal growth within the loan and lease portfolio was approximately $575.8 million. As a result, loans and leases decreased $30.8 million, net, from December 31, 2004, to December 31, 2005.

In general, we believe that the internal growth that occurred in our loan portfolio in 2005 was accomplished through our sales and marketing efforts. We remain committed, however, to maintaining credit quality and doing business in our market area with customers we know.

Table 8 presents loans outstanding, by type of loan, in our portfolio for the past five years. In general, the composition of our loan portfolio, by percentage of total loans, has remained relatively unchanged from December 31, 2004, to December 31, 2005. The greatest percentage changes were between real estate construction loans, which increased by 3.8% of total loans and leases, and residential real estate loans, which decreased by 4.7% of total loans and leases as a result of the HELOC securitization.

TABLE 8 - Loan and Lease Portfolio


At December 31,	2005				2004				2003				2002				2001
	Amount		Percentage of Loans to Total Loans and Leases		Amount		Percentage of Loans to Total Loans and Leases		Amount		Percentage of Loans to Total Loans and Leases		Amount		Percentage of Loans to Total Loans and Leases		Amount		Percentage of Loans to Total Loans and Leases
	(Dollars in thousands)
Commercial, financial, and agricultural	$	832,695	16.0	%	$	760,106	14.5	%	$	621,438	14.6	%	$	478,181	12.5	%	$	434,780	12.4	%
Real estate:
construction		934,601	17.9			741,660	14.1			549,672	12.9			456,663	11.9			359,445	10.2
residential		1,355,513	26.0			1,611,999	30.7			1,306,371	30.6			1,246,939	32.5			1,140,678	32.4
commercial		1,257,860	24.1			1,252,753	23.8			1,016,360	23.8			988,633	25.8			822,416	23.4
Consumer		319,925	6.1			351,846	6.7			337,989	7.9			343,537	9.0			325,170	9.2
Leases		518,065	9.9			534,644	10.2			431,442	10.2			317,000	8.3			437,009	12.4

Total	$	5,218,659	100.0	%	$	5,253,008	100.0	%	$	4,263,272	100.0	%	$	3,830,953	100.0	%	$	3,519,498	100.0	%

Our bank subsidiaries have historically reported a significant amount of loans secured by real estate, as depicted in Table 8. Many of these loans have real estate collateral taken as additional security not related to the acquisition of the real estate pledged. Open-end home equity loans totaled $150.7 million at December 31, 2005, and an additional $138.7 million was lent against junior liens on residential properties at December 31, 2005. Senior liens on 1 - 4 family residential properties totaled $945.9 million at December 31, 2005, and much of the $1.3 billion in loans secured by non-farm, non-residential properties represented collateralization of operating lines of credit, or term loans that finance equipment, inventory, or receivables. Loans secured by farmland totaled $45.1 million, while loans secured by multi-family residential properties totaled $120.3 million at December 31, 2005.

Table 9 represents the maturity of commercial, financial, and agricultural loans, as well as real estate construction loans. Table 10 presents the allocation of the allowance for loan and lease losses by type of loan.

Substantially all of our loans and leases are to enterprises and individuals in our market area. As shown in Table 11, there is no concentration of loans to borrowers in any one industry, or related industries, which exceeds 10% of total loans.

TABLE 9 - Loan Maturity and Interest Sensitivity


At December 31, 2005
Maturity	Under One Year		One to Five Years		Over Five Years		Total
	(Dollars in thousands)
Commercial, financial, and agricultural	$	291,953	$	419,680	$	121,062	$	832,695
Real estate - construction		513,341		348,237		73,023		934,601

	$	805,294	$	767,917	$	194,085	$	1,767,296

Rate sensitivity of loans with maturities greater than 1 year
Variable rate			$	404,538	$	142,563	$	547,101
Fixed rate				363,379		51,522		414,901

			$	767,917	$	194,085	$	962,002

TABLE 10 - Allocation of Allowance for Loan and Lease Losses


At December 31,	2005		2004		2003		2002		2001
	(Dollars in thousands)
Commercial, financial, and agricultural	$	15,413	$	14,066	$	9,772	$	10,317	$	8,783
Real estate - construction (1)		5,548		3,339		3,095		2,721		10,388
Real estate secured - residential (1)		7,578		9,275		7,448		7,412		N/A
Real estate secured - commercial (1)		11,571		13,760		12,764		10,488		N/A
Real estate - mortgage (1)		N/A		N/A		N/A		N/A		8,545
Consumer		5,475		5,779		5,704		5,077		6,423
Leases		6,645		6,050		2,566		2,414		1,923
Overdrafts		18		0		0		0		0
Unused commitments		1,466		1,345		1,060		1,094		1,110
Unallocated		0		479		263		148		526

Total	$	53,714	$	54,093	$	42,672	$	39,671	$	37,698

(1)

In 2002, the methodology used for calculating the allowance for loan and lease losses was changed. Prior years’ information is not available in this format. We believe that, if we could retroactively apply the current methodology to 2001, the allocation between real estate construction and real estate mortgage would be consistent with 2005, 2004, 2003, and 2002.

��

TABLE 11 - Loan Concentrations

At December 31, 2005, Susquehanna’s portfolio included the following industry concentrations:


	Permanent		Construction		All Other		Total Amount		% Nonperforming in Each Category
	(Dollars in thousands)
Residential construction	$	52,761	$	295,396	$	12,044	$	360,201	0.01
Land development (site work) construction		29,186		261,927		12,025		303,138	0.00
Real estate - residential		224,138		25,405		7,988		257,531	0.37
Motor vehicles		189,904		6,663		34,234		230,801	0.06
Lessors of professional offices		113,873		26,757		0		140,630	0.00
Manufacturing		39,512		541		91,351		131,404	0.37
Commercial and industrial construction		51,264		51,063		5,527		107,854	0.01
Retail consumer goods		57,559		3,439		44,457		105,455	0.94
Contractors		30,281		5,961		49,332		85,574	0.12
Public services		24,285		4,184		48,523		76,992	0.19
Hotels / motels		65,288		8,239		531		74,058	0.00
Medical services		35,161		2,404		31,655		69,220	0.00
Agriculture		40,592		1,418		17,601		59,611	0.18
Restaurants/Bars		41,300		1,456		10,963		53,719	2.74
Wholesalers		13,347		404		37,308		51,059	0.28

Goodwill and Other Identifiable Intangible Assets

As a result of the Brandywine acquisition in February 2005, we recognized goodwill of $1.9 million and a customer list intangible of $1.3 million. Furthermore, in the second quarter of 2005, we recorded additional goodwill of $0.2 million as a result of a contingent earn-out agreement related to a previous Patriot acquisition.

Investment in and Receivables from Unconsolidated Entities

Concurrent with the lease-securitization transaction in March 2005, our banking subsidiaries recorded investments in and receivables from unconsolidated entities of $48.5 million. This amount represents receivables from the unconsolidated qualified special purpose entities that were established to transact the securitization, which resulted in a $2.9 million gain on sale of leases.

Deposits

Our deposit base is consumer-oriented, consisting of time deposits, primarily certificates of deposit with various terms, interest-bearing demand accounts, savings accounts, and demand deposits. Average deposit balances by type and the associated average rate paid are summarized in Table 12.

TABLE 12 - Average Deposit Balances


Year ended December 31,	2005				2004				2003
	Average Balance		Average Rate Paid		Average Balance		Average Rate Paid		Average Balance		Average Rate Paid
	(Dollars in thousands)
Demand deposits	$	876,150	0.00	%	$	783,551	0.00	%	$	646,971	0.00	%
Interest-bearing demand deposits		1,736,130	1.66			1,640,525	1.02			1,195,656	0.79
Savings deposits		522,346	0.44			552,950	0.38			498,157	0.40
Time deposits		2,037,019	3.19			1,776,623	2.79			1,601,495	3.21

Total	$	5,171,645			$	4,753,649			$	3,942,279

Total deposits increased $178.5 million, or 3.5%, from December 31, 2004 to December 31, 2005. During 2005, we sold five branch locations and associated deposits totaling $60.1 million. Also, in 2004, we sold branch deposits totaling approximately $44.2 million. These sales were part of our realignment and consolidation project.

Of the net increase in total deposits, $51.4 million was in brokered certificates of deposit, which are being utilized as an alternative funding source to support the increase in our loan portfolio. In addition, we redesigned the money-management products offered to some of our municipal customers and consequently transferred approximately $71.1 million in funds that had been invested in securities sold under repurchase agreements into certificates of deposit greater than $0.1 million.

We do not rely upon time deposits of $0.1 million or more as a principal source of funds, as they represent only 14.6% of total deposits. Table 13 presents a breakdown by maturity of time deposits of $0.1 million or more as of December 31, 2005.

TABLE 13 - Deposit Maturity

The maturities of time deposits of $0.1 million or more at December 31, 2005 were as follows:


(Dollars in thousands)
Three months or less	$	297,770
Over three months through six months		84,101
Over six months through twelve months		165,796
Over twelve months		227,042

Total	$	774,709

Short-term Borrowings

Short-term borrowings, which include securities sold under repurchase agreements, federal funds purchased, and Treasury tax and loan notes, decreased by $113.3 million, or 26.9%, from December 31, 2004, to December 31, 2005. The greatest decrease within this category occurred in securities sold under repurchase agreements (as discussed above), which decreased $101.3 million, from $307.8 million at December 31, 2004, to $206.5 million at December 31, 2005.

Federal Home Loan Bank Borrowings and Long-term Debt

Federal Home Loan Bank borrowings decreased $82.6 million, and long-term debt decreased $50.5 million, from December 31, 2004, to December 31, 2005. The decrease in FHLB borrowings was accomplished through the utilization of proceeds from the HELOC securitization. Prior to the securitization in December 2005, FHLB borrowings were used to support the increase in our loan portfolio. The decrease in long-term debt was the result of our repayment, at maturity on February 1, 2005, of $50.0 million aggregate principal amount of 9.0% subordinated notes.

Contractual Obligations and Commercial Commitments

Table 14 presents certain of our contractual obligations and commercial commitments, including Susquehanna’s guarantees on behalf of its subsidiaries, and their expected year of payment or expiration.

TABLE 14 - Contractual Obligations and Commercial Commitments


	Payments Due by Period
Contractual Obligations	Total		Less than 1 Year		1 - 3 Years		4 - 5 Years		Over 5 Years
	(Dollars in thousands)
Certificates of deposit	$	2,156,668	$	1,292,476	$	681,330	$	179,392	$	3,470
FHLB borrowings		668,666		46,976		274,676		235,474		111,540
Long-term debt		172,777		0		0		0		172,777
Operating leases		64,273		7,717		12,585		9,579		34,392
Sale-leaseback transaction		93,939		30,035		58,035		5,869		0
Contingent cash collateral		35,111		0		0		35,111		0
Residual value guaranty fees		11,700		5,700		6,000		0		0

	Commitment Expiration by Period
Other Commercial Commitments	Total		Less than 1 Year		1 - 3 Years		4 - 5 Years		Over 5 Years
	(Dollars in thousands)
Stand-by letters of credit	$	143,078	$	118,986	$	24,092	$	0	$	0
Guarantees		11,492		0		3,492		8,000		0
Commercial commitments		407,187		309,811		97,376		0		0
Real estate commitments		654,149		250,997		403,152		0		0

Capital Adequacy

Risk-based capital ratios, based upon guidelines adopted by bank regulators in 1989, focus upon credit risk. Assets and certain off-balance sheet items are segmented into one of four broad risk categories and weighted according to the relative percentage of credit risk assigned by the regulatory authorities. Off-balance sheet instruments are converted into a balance sheet credit equivalent before being assigned to one of the four risk-weighted categories. To supplement the risk-based capital ratios, the regulators issued a minimum leverage ratio guideline (Tier 1 capital as a percentage of average assets less excludable intangibles).

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 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.”

The maintenance of a strong capital base at both the parent company level as well as at each bank affiliate is an important aspect of our philosophy. We, and each of our bank subsidiaries, have leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity is considered “well capitalized” under regulatory guidelines.

Market Risks

The types of market risk exposures generally faced by banking entities include:

•

equity market price risk;

•

liquidity risk;

•

interest rate 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. However, 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 also discussed below.

Equity Market Price Risk

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

Liquidity Risk

The maintenance of adequate liquidity — the ability to meet the cash requirements of our customers and other financial commitments — is a fundamental aspect of our asset/liability management strategy. Our policy of diversifying our funding sources — purchased funds, repurchase agreements, and deposit accounts — allows us to avoid undue concentration in any single financial market and also to avoid heavy funding requirements within short periods of time. At December 31, 2005, our bank subsidiaries had approximately $656.6 million available to them under collateralized lines of credit with various FHLBs; and $409.6 million more was available provided that additional collateral had been pledged.

Liquidity is not entirely dependent on increasing our liability balances. Liquidity is also evaluated by taking into consideration maturing or readily marketable assets. Unrestricted short-term investments amounted to $69.9 million for the year ended December 31, 2005 and represented additional sources of liquidity.

As an additional source of liquidity, we periodically enter into securitization transactions in which we sell the beneficial interests in leases and related vehicles to qualified special purpose entities. Most recently, we entered into a term securitization transaction of HELOCs. The purchase of these assets is financed through the issuance of asset-backed notes to third-party investors. During 2005, net proceeds from these transactions totaled $584.8 million.

Interest Rate Risk

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

We employ a variety of methods to monitor interest rate risk. These methods include basic gap analysis, which points to directional exposure; routine rate shocks simulation; and evaluation of the change in economic value of equity. Board directed guidelines have been adopted for both the rate shock simulations and economic value of equity exposure limits. By dividing the assets and liabilities into three groups, fixed rate, floating rate and those which reprice only at our discretion, strategies are developed to control the exposure to interest rate fluctuations.

Our interest rate risk using the static gap analysis is presented in Table 15. This method reports the difference between interest-rate sensitive assets and liabilities at a specific point in time. Management uses the static gap methodology to identify our directional interest-rate risk. Table 15 also illustrates our estimated interest rate sensitivity (periodic and cumulative) gap positions as calculated as of December 31, 2005 and 2004. These estimates include anticipated prepayments on commercial and residential loans, mortgage-backed securities, in addition to certain repricing assumptions relative to our core deposits. Traditionally, an institution with more assets repricing than liabilities over a given time frame is considered asset sensitive, and one with more liabilities repricing than assets is considered liability sensitive. An asset sensitive institution will generally benefit from rising rates, and a liability sensitive institution will generally benefit from declining rates. Static gap analysis is widely accepted because of its simplicity in identifying interest rate risk exposure; but it ignores market spread adjustments, the changing mix of the balance sheet, planned balance sheet management strategies, and the change in prepayment assumptions.

TABLE 15 - Balance Sheet Gap Analysis


At December 31, 2005	1-3 months			3-12 months			1-3 years			Over 3 years			Total
	(Dollars in thousands)
Assets
Short-term investments	$	96,284		$	0		$	0		$	0		$	96,284
Investments		272,035			157,070			509,706			215,450			1,154,261
Loans and leases, net of unearned income		2,050,147			799,609			1,540,375			828,528			5,218,659

Total	$	2,418,466		$	956,679		$	2,050,081		$	1,043,978		$	6,469,204

Liabilities
Interest-bearing demand	$	817,775		$	214,260		$	547,568		$	195,156		$	1,774,759
Savings		18,691			56,076			283,395			100,744			458,906
Time		145,824			599,909			495,344			140,882			1,381,959
Time in denominations of $100 or more		297,407			249,984			185,086			42,232			774,709
Total borrowings		530,609			3,170			301,065			314,122			1,148,966

Total	$	1,810,306		$	1,123,399		$	1,812,458		$	793,136		$	5,539,299

Impact of other assets, other liabilities, capital, and noninterest-bearing deposits:	$	(55,707	)	$	(172,621	)	$	(527,614	)	$	(173,963	)
Interest Sensitivity Gap:
Periodic	$	552,453		$	(339,341	)	$	(289,991	)	$	76,879
Cumulative					213,112			(76,879	)		0
Cumulative gap as a percentage of total assets		7	%		3	%		-1	%		0	%

At December 31, 2004	1-3 months			3-12 months			1-3 years			Over 3 years			Total
	(Dollars in thousands)
Assets
Short-term investments	$	58,372		$	0		$	0		$	362		$	58,734
Investments		139,716			222,272			501,504			381,922			1,245,414
Loans and leases, net of unearned income		2,072,313			727,635			1,274,575			1,178,485			5,253,008

Total	$	2,270,401		$	949,907		$	1,776,079		$	1,560,769		$	6,557,156

Liabilities
Interest-bearing demand	$	291,079		$	366,940		$	829,026		$	278,032		$	1,765,077
Savings		34,359			102,924			316,686			105,561			559,530
Time		197,689			452,771			506,804			210,018			1,367,282
Time in denominations of $100 or more		194,830			171,667			167,301			51,584			585,382
Total borrowings		770,931			35,193			47,346			541,895			1,395,365

Total	$	1,488,888		$	1,129,495		$	1,867,163		$	1,187,090		$	5,672,636

Impact of other assets, other liabilities, capital and noninterest-bearing deposits:	$	0		$	(213,352	)	$	(480,041	)	$	(191,127	)
Interest Sensitivity Gap:
Periodic	$	781,513		$	(392,940	)	$	(571,125	)	$	182,552
Cumulative					388,573			(182,552	)		0
Cumulative gap as a percentage of total assets		10	%		5	%		-2	%		0	%

In addition to static gap reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, we also utilize simulation analysis that measures our exposure to interest

rate risk. The financial simulation 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 at one percent intervals. The income effect and economic value of defined categories of financial instruments is calculated by the model using estimated cash flows based on embedded options, prepayments, early withdrawals, and weighted average contractual rates and terms. For economic value calculations, the model also considers discount rates for similar financial instruments. The economic values of longer-term fixed-rate financial instruments are generally more sensitive to changes in interest rates. Adjustable-rate and variable-rate financial instruments largely reflect only a change in economic value representing the difference between the contractual and discounted rates until the next contractual interest rate repricing date, unless subject to rate caps and floors.

A portion of our loan portfolio consists of commercial and residential mortgage loans containing embedded options, which permit the borrower to repay the principal balance of the loan prior to maturity (“prepayments”) without penalty. A loan’s susceptibility for prepayment is dependent upon a number of factors, including the current interest rate versus the contractual interest rate of the loan, the financial ability of the borrower to refinance, the economic benefit, and the availability of refinancing at attractive terms in addition to general changes in customers needs. Refinancing may also depend upon economic and other factors in specific geographic areas that affect the sales and price levels of residential property. In a changing interest rate environment, prepayments may increase or decrease depending on the current relative levels and expectations of future short-term and long-term interest rates.

Changes in market rates and general economic conditions will have an impact on an organization’s mortgage-backed security portfolio. This will have an associated change on our sensitivity position in changing economic times. Savings and checking deposits generally may be withdrawn upon the customer’s request without prior notice. A continuing relationship with customers resulting in future deposits and withdrawals is generally predictable, resulting in a dependable source of funds. Time deposits generally have early withdrawal penalties, while term FHLB borrowings and subordinated notes have prepayment penalties, which discourage customer withdrawal of time deposits and prepayment of FHLB borrowings and subordinated notes prior to maturity.

Our floating-rate loan portfolio is primarily indexed to national interest rate indices. The portfolio is funded by interest-bearing liabilities which are determined by other indices, primarily deposits and FHLB borrowings. A changing interest rate environment may result in different levels of changes to the different indices resulting in disproportionate changes in the value of, and the net earnings generated from such financial instruments. Basis risk is the result of this inconsistent change in the indices, with historical relationships not always being a good indicator.

Tables 16 and 17 reflect the estimated income effect and economic value of assets, liabilities and equity calculated using certain assumptions we determined as of December 31, 2005, and 2004, at then current interest rates and at hypothetical higher and lower interest rates in 1% and 2% increments. Based upon the current interest-rate environment, we believe that interest rates will be flat to a 1% increase in 2006. As noted in Table 16, the economic value of equity at risk as of December 31, 2005 is -1%, at an interest rate change of positive 1%, while Table 17 discloses that net interest income at risk as of December 31, 2005 is 1%, at an interest rate change of positive 1%.

At December 31, 2005, we were an asset-sensitive institution and should benefit from a continued rise in interest rates in 2006, if that should occur.

TABLE 16 - Balance Sheet Shock Analysis


At December 31, 2005	-2%			-1%			Base Present Value			1%			2%
	(Dollars in thousands)
Assets
Cash and due from banks	$	196,557		$	196,557		$	196,557		$	196,557		$	196,557
Short-term investments		96,284			96,284			96,284			96,284			96,284
Investment securities:
Held-to-maturity		6,399			6,399			6,399			6,399			6,399
Available-for-sale		1,183,769			1,169,682			1,149,185			1,124,103			1,097,967
Loans and leases, net of unearned income		5,319,160			5,254,795			5,193,337			5,129,571			5,061,065
Other assets		800,245			800,245			800,245			800,245			800,245

Total assets	$	7,602,414		$	7,523,962		$	7,442,007		$	7,353,159		$	7,258,517

Liabilities
Deposits:
Non-interest bearing		861,934			846,340			831,158			816,374			801,976
Interest-bearing		4,360,236			4,312,878			4,272,250			4,228,634			4,186,073
Total borrowings		1,167,737			1,131,111			1,105,794			1,088,437			1,070,933
Other liabilities		227,383			227,383			227,383			227,383			227,383

Total liabilities		6,617,290			6,517,712			6,436,585			6,360,828			6,286,365
Total economic equity		987,025			1,009,560			1,010,088			998,302			979,378
Off balance sheet		1,901			3,310			4,666			5,971			7,226

Total liabilities and equity	$	7,602,414		$	7,523,962		$	7,442,007		$	7,353,159		$	7,258,517

Economic equity ratio		13	%		13	%		14	%		14	%		13	%
Value at risk	$	(23,063	)	$	(528	)	$	0		$	(11,786	)	$	(30,710	)
% Value at risk		-2	%		0	%		0	%		-1	%		-3	%

At December 31, 2004	-2%			-1%			Base Present Value			1%			2%
	(Dollars in thousands)
Assets
Cash and due from banks	$	160,574		$	160,574		$	160,574		$	160,574		$	160,574
Short-term investments		59,248			59,248			59,248			59,248			59,248
Investment securities:
Held-to-maturity		4,652			4,555			4,461			4,370			4,281
Available-for-sale		1,272,163			1,262,941			1,250,260			1,217,944			1,177,465
Loans and leases, net of unearned income		5,358,087			5,285,541			5,212,443			5,135,232			5,056,609
Other assets		802,187			802,187			802,187			802,187			802,187

Total assets	$	7,656,911		$	7,575,046		$	7,489,173		$	7,379,555		$	7,260,364

Liabilities
Deposits:
Non-interest bearing		807,724			788,528			770,010			752,140			734,889
Interest-bearing		4,263,365			4,203,808			4,148,725			4,091,392			4,037,260
Total borrowings		1,524,990			1,491,500			1,459,134			1,430,274			1,406,956
Other liabilities		197,332			197,332			197,332			197,332			197,332

Total liabilities		6,793,411			6,681,168			6,575,201			6,471,138			6,376,437
Total economic equity		867,309			895,474			913,431			905,814			879,334
Off balance sheet		3,809			1,596			(541	)		(2,603	)		(4,593	)

Total liabilities and equity	$	7,656,911		$	7,575,046		$	7,489,173		$	7,379,555		$	7,260,364

Economic equity ratio		11	%		12	%		12	%		12	%		12	%
Value at risk	$	(46,122	)	$	(17,957	)	$	0		$	(7,617	)	$	(34,097	)
% Value at risk		-5	%		-2	%		0	%		-1	%		-4	%

TABLE 17 - Net Interest Income Shock Analysis


At December 31, 2005	-2%			-1%			Base Scenario			1%			2%
	(Dollars in thousands)
Interest income:
Short-term investments	$	3,583		$	5,403		$	7,253		$	9,102		$	10,961
Investments		39,213			44,198			47,876			50,557			53,192
Loans and leases		316,650			338,928			360,798			381,654			401,830

Total interest income		359,446			388,529			415,927			441,313			465,983

Interest expense:
Interest-bearing demand and savings		19,943			29,982			42,930			53,475			64,020
Time		65,781			72,709			79,689			86,684			93,699
Total borrowings		42,888			46,372			50,837			56,905			62,996

Total interest expense		128,612			149,063			173,456			197,064			220,715

Net interest income	$	230,834		$	239,466		$	242,471		$	244,249		$	245,268

Net interest income at risk	$	(11,637	)	$	(3,005	)	$	0		$	1,778		$	2,797
% Net interest income at risk		-5	%		-1	%		0	%		1	%		1	%


At December 31, 2004	-2%			-1%			Base Scenario			1%			2%
	(Dollars in thousands)
Interest income:
Short-term investments	$	169		$	944		$	1,894		$	2,875		$	3,870
Investments		34,005			41,118			49,046			52,272			53,756
Loans and leases		273,287			296,675			319,644			341,804			363,311

Total interest income		307,461			338,737			370,584			396,951			420,937

Interest expense:
Interest-bearing demand and savings		8,858			15,113			24,198			31,327			39,002
Time		43,484			48,119			53,844			60,004			66,234
Total borrowings		34,653			40,629			47,846			55,610			63,369

Total interest expense		86,995			103,861			125,888			146,941			168,605

Net interest income	$	220,466		$	234,876		$	244,696		$	250,010		$	252,332

Net interest income at risk	$	(24,230	)	$	(9,820	)	$	0		$	5,314		$	7,636
% Net interest income at risk		-10	%		-4	%		0	%		2	%		3	%

Derivative Financial Instruments and Hedging Activities

On March 16, 2005, we entered into a $219.8 million amortizing interest rate swap; and throughout the remainder of 2005, we entered into three incremental swaps totaling $109.8 million. For purposes of Susquehanna’s consolidated financial statements, the $329.6 million amortizing interest rate swaps (the hedging instruments) are designated as cash flow hedges of expected future cash flows (proceeds) associated with a forecasted sale of auto leases (the hedged forecasted transaction). This transaction is subject to FAS No. 133 (as amended), “Accounting for Derivative Instruments and Hedging Activities.” At December 31, 2005, the unrealized gain, net of taxes, recorded in other comprehensive income was $1.7 million.

Our risk management objective and strategy is to mitigate our exposure to changes in interest rates associated with future securitizations of auto leases. We are meeting this objective by entering into forward-starting, pay-fixed and receive-LIBOR interest rate swaps. The swaps are expected to be effective in hedging the risk of changes in expected future cash flows associated with the forecasted sale of auto leases due to changes in the LIBOR swap rate, the designated interest rate being hedged, over the term of the hedging relationship.

Since the critical terms of the swaps and the hedged forecasted transaction match at inception, and it is probable that the swap counterparty will not default on the swaps, we have concluded at inception that the hedging relationship is expected to be highly effective at achieving offsetting changes in cash flows. Throughout the life of the hedging relationship, both retrospective evaluations and prospective assessments of hedge effectiveness will be performed at least quarterly. Assuming the hedging relationship qualifies as highly effective, the actual swaps will then be recorded on the balance sheet at fair value, and accumulated other comprehensive income will be adjusted to a balance that reflects the lesser of either the cumulative change in the fair value of the actual swaps or the cumulative change in the fair value of a “perfect” hypothetical swap. At the date of securitization, the balance in accumulated other comprehensive income will be reclassified to earnings when the associated gain on sale from securitization is recognized. At December 31, 2005, the hedges were assessed as prospectively effective.

In June 2005, we entered into two $25.0 million interest rate swaps to hedge the interest rate risk exposure on $50.0 million of our variable-rate debt. Our risk management objective with respect to this interest rate swap is to hedge the risk of changes in our cash flows attributable to changes in the LIBOR swap rate.

Prospective effectiveness evaluations will be performed by qualitatively assessing on an ongoing basis that the critical terms of the swap and hedged transactions still match, and will periodically review the credit quality of the swap counterparty to evaluate whether it is probable that the swap counterparty will not default. At December 31, 2005, the hedges were considered effective because all the critical terms matched.

The following table summarizes our derivative financial instruments at December 31, 2005:


Notional Amount		Fair Value		Variable Rate	Fixed Rate
(Dollars in thousands)
$	329,627	$	1,446	one-month LIBOR	4.365% - 4.80%
	25,000		473	three-month LIBOR	3.935
	25,000		696	three-month LIBOR	4.083

$	379,627	$	2,615

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 banks, Hann and the banks have entered into arrangements with Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) pursuant to which Hann or a bank, as applicable, effectively transferred to Auto Lenders 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 four 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 also agrees to make monthly guaranty payments to Auto Lenders based upon a negotiated schedule covering a three-year period. At the end of each year, the servicing agreement may be renewed by the mutual agreement of the parties for an additional one-year term, beyond the current three-year term, subject to renegotiation of the payments for the additional year. During the renewal process, we periodically obtain competitive quotes from third parties to determine the best remarketing and/or residual guarantee alternatives for Hann and our bank affiliates.

Securitizations and Off-Balance Sheet Financings

The following table summarizes our securitization and off-balance sheet financings:


	As of December 31, 2005		As of December 31, 2004
	(Dollars in thousands)
Lease Securitization Transactions	$	576,890	$	431,673
HELOC Securitization Transaction		221,930		0
Agency Arrangements and Lease Sales		414,897		586,491
Sale-Leaseback Transactions		94,934		112,600
Leases and Loans Held in Portfolio		5,218,659		5,253,008

Total Leases and Loans Serviced	$	6,527,310	$	6,383,772

Securitization Transactions

We use the securitization of financial assets as a source of funding and a means to manage capital. Hann and the banking subsidiaries sell beneficial interests in automobile leases and related vehicles and home equity loans to qualified special purpose entities (each a “QSPE”). These transactions are accounted for as sales under the guidelines of FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125),” and a net gain or loss is recognized at the time of the initial sale.

The QSPEs then issue beneficial interests in the form of senior and subordinated asset-backed securities backed or collateralized by the assets sold to the QSPEs. The senior classes of the asset-basked securities typically receive investment grade credit ratings at the time of issuance. These ratings are generally achieved through the creation of lower-rated subordinated classes of asset-backed securities, as well as subordinated interests retained by Susquehanna.

Each QSPE retains the right to receive excess cash flows from the sold portfolio. Under FAS No. 140, Susquehanna is required to recognize a receivable representing the present value of the anticipated excess cash flows at the time of sale. These interest-only strips are subordinate to the rights of each of the QSPE’s creditors. The value of these interest-only strips is subject to credit, prepayment, and interest rate risk.

Summary of HELOC Securitization Transaction

In December 2005, one of our banking subsidiaries, Susquehanna Bank PA, entered into a term securitization transaction of HELOCs (the “2005 HELOC transaction”). Some of the loans sold were originated by two of our other banking subsidiaries, Susquehanna Bank and Susquehanna Patriot Bank, and sold to Susquehanna Bank PA immediately prior to the closing of the securitization. In connection with the 2005 HELOC transaction, Susquehanna Bank PA sold a portfolio of loans with an aggregate total of approximately $239.8 million to a wholly owned special purpose subsidiary (the “Transferor”). In the transaction documents for the 2005 HELOC transaction Susquehanna Bank PA provides, among other things, representations and warranties with respect to the home equity loans transferred. In the event that any such representations and warranties were materially untrue with respect to any assets when transferred, the affected loans must be repurchased by Susquehanna Bank PA. We provide a guaranty of such repurchase obligation. The Transferor sold the portfolio acquired from Susquehanna Bank PA to a newly formed statutory trust (the “Issuer”). The equity interests of the Issuer are owned by the Transferor. The Transferor financed the purchase of the portfolio of HELOCs from Susquehanna Bank PA primarily through the issuance by the Issuer of $239.8 million of floating-rate asset-backed notes to third-party investors. In connection with the securitization, Susquehanna retained servicing responsibilities for the loans.

Some of the HELOCs, which generally accrue interest at a variable rate, include a feature that permits the obligor to “convert” all or a portion of the loan from a variable interest rate to a fixed interest rate. Under the transaction documents for the 2005 HELOC transaction, if the aggregate principal balance of loans converted to fixed-rate loans exceeds 10% of the outstanding aggregate principal balance of the portfolio, then Susquehanna

Bank PA is required to repurchase converted loans in excess of this 10% threshold until the aggregate principal balance of loans repurchased by Susquehanna Bank PA for this reason is equal to 10% of the original principal balance of the loans. If, after giving effect to any repurchase by Susquehanna Bank PA of loans with converted balances, the aggregate principal balance of fixed-interest-rate loans exceeds 10% of the aggregate principal balance of the portfolio, then an interest rate protection agreement between the Issuer and Susquehanna becomes operative. Under the interest rate protection agreement, the Issuer will be obligated to make fixed payments, which will be based on the fixed rates of the converted mortgage loans, and we will be obligated to make floating payments, which will be based on the indices of the variable-rate mortgage loans. We do not expect to repurchase any converted loans nor enter into any interest rate protection agreements.

The initial recorded interest-only strips for this transaction were $8.0 million, and the fair value of these interest-only strips at December 31, 2005, was $7.3 million. In addition, as servicer for these loans, we recorded a servicing asset of $1.3 million.

The reduction in the interest-only strips was expected based upon cash flow estimates for the first collection period. Future monthly amortization of these interest-only strips is projected to be significantly less.

Summary of Vehicle Lease Securitization Transactions

In order to facilitate securitizations and other off-balance sheet financings, Hann formed Hann Auto Trust, a Delaware statutory trust (the “Origination Trust”), in 1997. Hann purchases vehicles and related leases directly from motor vehicle dealers. The motor vehicle dealers title these vehicles in the name of the Origination Trust at the time of the purchase. Titles to the vehicles and the leases are then held by the Origination Trust, and the Origination Trust acts as lessor under the leases. Hann initially owns the beneficial interest in all leases and related vehicles. Hann’s beneficial interest is often referred to as the “Undivided Trust Interest” or “UTI.” Hann creates and transfers beneficial interests in the Origination Trust that represent just the rights in the pool of leases and related vehicles included in securitization, sale-leaseback, agency, and other transactions through a special unit of beneficial interest called a “SUBI.” There is no need to undertake the effort and expense of retitling the vehicles because the legal owner of the vehicles, the Origination Trust, does not change. At any time, a lease and related vehicle will be allocated to the UTI, and then to a SUBI, if it is beneficially owned by a securitization entity, a third party, or otherwise included in a financing transaction.

In connection with our securitization transactions, we transferred beneficial interests in automobile leases and related vehicles originated by the Origination Trust to qualified special purpose entities. Hann acts as servicer for the securitized portfolio and receives a servicing fee based upon a percentage of the value of assets serviced. We do not provide recourse for losses resulting from defaults under the leases. Each securitization transaction also provides that the beneficial interest in any leases and related vehicles that fail to meet the factual representations about those assets made by us in each transaction must be repurchased and reallocated to Hann’s beneficial interest in the Origination Trust.

Each QSPE retains the right to receive excess cash flows from the sold portfolio. The leases, for accounting purposes, are treated as direct financing receivables as a result of a residual purchase agreement with Auto Lenders. Although we have not retained residual value risk in the 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 interest-only strips recognized by us. As of December 31, 2005, the aggregate amount of all such interest-only strips in connection with lease securitizations was $4.1 million.

In March 2005, each of our wholly owned commercial and retail banking subsidiaries (each, a “Sponsor Subsidiary”) entered into a term securitization transaction. In connection with this transaction, each Sponsor Subsidiary sold and contributed the beneficial interest in a portfolio of automobile leases and related vehicles to a separate wholly owned QSPE (each QSPE a “Transferor” and, collectively the “Transferors”). Collectively, the Sponsor Subsidiaries sold and contributed the beneficial interest in $366.8 million of automobile leases and related vehicles to the Transferors. However, the transaction documents for the 2005 transaction provide, among other things, that any assets that failed to meet the eligibility requirements when transferred by the applicable

Sponsor Subsidiary must be repurchased by such Sponsor Subsidiary. Each Transferor sold and contributed the portfolio acquired from the related Sponsor Subsidiary to a newly formed statutory trust (the “Issuer”). The equity interests of the Issuer are owned pro rata by the Transferors (based on the value of the portfolio conveyed by each Transferor to the Issuer). The Transferors financed the purchases of the beneficial interests from the Sponsor Subsidiaries primarily through the issuance by the Issuer of $329.4 million of fixed-rate asset-backed notes to third-party investors. The Issuer also issued $11.1 million of notes, which will be retained pro rata by the Transferors in the same ratio as the Transferors retain the equity interests of the Issuer.

The initial recorded interest-only strip for this transaction was $2.3 million, and the fair value of this interest-only strip at December 31, 2005, was $1.4 million.

Late in the third quarter of 2004, Hann entered into a revolving securitization transaction (the “2004 transaction”). In connection with this transaction, Hann sells and contributes beneficial interests in automobile leases and related vehicles to a wholly owned QSPE. From time to time, the QSPE may purchase the beneficial interests in additional automobile leases and related vehicles from Hann. Transfers to the QSPE are accounted for as sales under the guidelines of FAS No. 140. The QSPE finances the purchases by borrowing funds in an amount up to $200.0 million from a non-related, asset-backed commercial paper issuer (the “lender”). During 2005, Hann made transfers to the QSPE of beneficial interests in $5.7 million in automobile leases and related vehicles. Neither Hann nor Susquehanna provides recourse for credit losses. However, the QSPE’s obligation to pay Hann the servicing fee each month is subordinate to the QSPE’s obligation to pay interest, principal and fees due on the loans. Therefore, if the QSPE suffers credit losses on its assets, it may have insufficient funds to pay the servicing fee to Hann. Additionally, if an early amortization event were to occur under the QSPE’s loan agreement, Hann, as servicer, would not receive payments of the servicing fee until all interest, principal and fees due on the loans have been paid (although the servicing fee will continue to accrue).

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

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

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

The fair value of the associated interest-only strip at December 31, 2005, was $0.4 million.

In July 2003, Hann entered into a term securitization transaction (the “2003 transaction”). In this transaction, Hann sold and contributed the beneficial interest in $239.5 million in automobile leases and related vehicles to a wholly owned QSPE. The QSPE financed the purchase of the beneficial interest primarily by issuing $233.0 million of asset-backed notes.

The initial recorded interest-only strip for this transaction was $12.0 million, and the fair value of this interest-only strip at December 31, 2005 was $1.3 million.

During the third quarter of 2002, Hann entered into a revolving securitization transaction and sold and contributed beneficial interests in automobile leases and related vehicles to a wholly owned QSPE. From time to

time, the QSPE may purchase the beneficial interests in additional automobile leases and related vehicles from Hann. Transfers to the QSPE are accounted for as sales under the guidelines of FAS No. 140. The QSPE finances the purchases by borrowing funds in an amount up to $250.0 million from a non-related, asset-backed commercial paper issuer (a “lender”); however, the lender is not committed to make loans to the QSPE. Neither Hann nor Susquehanna provides recourse for credit losses. However, the QSPE’s obligation to pay Hann the servicing fee each month is subordinate to the QSPE’s obligation to pay interest, principal and fees due on the loans. Therefore, if the QSPE suffers credit losses on its assets, it may have insufficient funds to pay the servicing fee to Hann. Additionally, if an early amortization event were to occur under the QSPE’s loan agreement, Hann, as servicer, 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).

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

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

The fair value of this interest-only strip at December 31, 2005, was $0.9 million.

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

Agency Agreements and Lease Sales

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

During the second quarter of 2002, Hann entered into an agency arrangement. In connection with that arrangement, we entered into an agreement under which we guarantee Auto Lenders’ performance of its obligations to the agency client (the “Residual Interest Agreement”). Auto Lenders has agreed to purchase leased vehicles in the agency client’s portfolio at the termination of the leases for the full residual value of those vehicles. In the event the agency client incurs any losses, costs or expenses as a result of any failure of Auto Lenders to perform this purchase obligation, we will compensate the agency client for any final liquidation losses with respect to such leased vehicle. However, our liability is limited to 12% of the maximum aggregate residual value of all leases purchased by the agency client. At December 31, 2005, the total residual value of the vehicles in the portfolio for this transaction was $29.1 million, and our maximum obligation under the Residual Interest Agreement at December 31, 2005, was $3.5 million.

Sale-leaseback Transaction

In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”).

The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that has an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor is treated as a sale and an operating lease and qualifies as a sale and leaseback under FAS No. 13. The Lessor is a Delaware statutory trust and a variable interest entity (a “VIE”). The Lessor held the beneficial interest in vehicles and auto leases with a remaining balance of approximately $94.9 million at December 31, 2005. To support its obligations under the Master Lease Agreement, at closing the Lessee pledged the beneficial interest in an additional $43.0 million of automobile leases and related vehicles, which were also sold or contributed to the Lessee. At December 31, 2005, the beneficial interest in additional automobile leases and related vehicles pledged by the Lessee was $45.6 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) to return to the Lessor’s equity investors their invested capital, and (3) to 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, we would be entitled to take depreciation deductions for tax purposes on the vehicles that were not substituted. We believe that the likelihood of 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 $35.1 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 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 (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 were to be worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38 million. The Servicing Agreement with Auto Lenders does not apply to the sale-leaseback transaction.

related vehicles. If the option is exercised, the Lessee will pay to the Lessor the purchase price under the early buyout option (the “EBO Price”). The EBO Price may, at the Lessee’s option, be payable either 100% on the EBO Date or, if our senior unsecured long-term debt rating on the EBO Date is at least Baa2 (and not on negative credit watch with negative implications) by Moody’s and BBB by Standard & Poor’s (and not on credit watch with negative implications) and certain other conditions are met, in installments. The Lessee must also pay the out-of-pocket costs and expenses (including all transfer taxes and legal fees and expenses) incurred by the Lessor, the trustees and their affiliates in connection with such purchase.

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

Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. The servicing fees paid to Hann under the lease securitization transactions, the sale-leaseback transaction, agency agreements, and lease sales approximate current market value. Hann has not recorded servicing assets nor liabilities with regard to those transactions, because its expected servicing costs are approximately equal to its expected servicing income.

The parent company acts as servicer for securitized HELOCs and has recorded a servicing asset of $1.3 million based on the present value of estimated future net servicing income. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Overall however, we enter into securitization transactions primarily to achieve low-cost funding for the growth of our loan and lease portfolio and to manage capital, and not primarily to maximize our ongoing servicing fee revenue. In the future, in regard to lease securitizations, if servicing costs were to exceed servicing income, we would record the present value of that liability as an expense.

Our policy regarding the impairment of HELOC servicing assets is to evaluate the assets based upon the fair value of the rights as compared to amortized cost. Fair value is based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance to the extent that fair value is less than the capitalized amount.

Summary of Susquehanna’s Potential Exposure under Off-Balance Sheet Financings as of December 31, 2005.

Sale-Leaseback Transaction

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

Additionally, as discussed above, the transaction documents contain several requirements, obligations, liabilities, provisions, and consequences that become applicable upon the occurrence of an Early Amortization Event, as described 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, we would expect that the present value of these payments would not exceed the present value of the rent avoided and tax benefits gained by a material amount. We believe that the occurrence of any Early Amortization Event is remote.

vehicles. The Lessee has agreed that if the aggregate net proceeds of such sale are less then the Lease End Value of the beneficial interest in the leases and related vehicles at that time, the Lessee will pay to the Lessor the excess, if any, of the Lease End Value over the aggregate net proceeds of such sale. If the leases and related vehicles were to be worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38 million.

Agency Agreements and Lease Sales

Under the agency arrangements, our maximum obligation under the Residual Interest Agreement at December 31, 2005, was $3.5 million.

Recent Accounting Pronouncements

In November 2005, the Financial Accounting Standards Board issued FASB Staff Position (FSP) FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” to provide an alternative transition method for accounting for the tax effects of share-based payment awards to employees. This method comprises (a) a computational component that establishes a beginning balance of the additional-paid-in-capital pool related to employee compensation and (b) a simplified method to determine the subsequent impact on the pool of employee awards that are fully vested and outstanding upon the adoption of FAS No. 123(R). The guidance in this FSP was effective November 10, 2005. An entity that adopts FAS No. 123(R) using either modified retrospective or modified prospective application may make a one-time election to adopt the transition method described in this FSP. An entity may take up to one year from the later of its initial adoption of FAS No. 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. An entity that elects the transition method described in this FSP is not required to justify the preferability of its election. Susquehanna is evaluating its options at this time.

Also in November 2005, the Financial Accounting Standards Board issued FASB Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. In addition, for all investments in an unrealized loss position, specific disclosures are required. The guidance in this FSP was effective for periods beginning after December 15, 2005, with earlier application permitted. The required disclosures relating to this FSP are presented in Note 4 of the Consolidated Financial Statements.

Also in November 2005, the Financial Accounting Standards Board issued FASB Staff Position FAS 140-2, “Clarification of the Application of Paragraphs 40(b) and 40(c) of FASB Statement No. 140.” This FSP stipulates that (a) unexpected subsequent events outside the control of the transferor, such as prepayments of assets of the QSPE, that were not contemplated when the beneficial interests of the QSPE were issued will not harm the qualified status of the QSPE and (b) purchases of previously issued beneficial interests by a transferor from outside parties that are held temporarily and are classified as trading securities will not be considered when determining whether the requirements of paragraphs 40(b) and 40(c) are met. The guidance in this FSP was effective November 9, 2005 and has not had an effect on Susquehanna’s results of operations or financial condition.

In October 2005, the Financial Accounting Standards Board issued FASB Staff Position FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FASB Statement No. 123(R).” This FSP provides guidance on determining the grant date for an award as defined in FAS No. 123(R). The FSP stipulates that, assuming all other criteria in the grant date definition are met, a mutual understanding of the key terms and conditions of an award to an individual employee is presumed to exist upon the award’s approval in accordance with the relevant corporate governance requirements, provided that the key terms and conditions of an award (a) cannot be negotiated by the recipient with the employer because the award is a unilateral grant, and (b) are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. The guidance in this FSP shall be applied upon initial adoption of Statement 123(R) and is not expected to have an effect on Susquehanna’s results of operations or financial condition.

In August 2005, the Financial Accounting Standards Board issued FASB Staff Position FAS 123(R)-1, “Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R).” This FSP states that a freestanding financial instrument issued to an employee in exchange for past or future employee services that is subject to FAS No. 123(R) shall continue to be subject to the recognition and measurement provisions of FAS No. 123(R) throughout the life of the instruments, unless its terms are modified when the holder is no longer an employee. Modifications of that instrument shall be subject to the modification guidance in paragraph A232 of 123(R). Following modification, recognition and measurement of the instrument should be determined through reference to other applicable GAAP. The guidance in the FSP shall be applied upon initial adoption of FAS No. 123(R) and is not expected to have an effect on Susquehanna’s results of operations or financial condition.

In June 2005, the Financial Accounting Standards Board issued Statement No. 154, “Accounting Changes and Error Corrections, a replacement of APB No. 20 and FAS No. 3.” Statement No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. In addition Statement No. 154 requires that a change in method of depreciation, amortization, or depletion, for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. Opinion No. 20 previously required that such a change be reported as a change in accounting principle. Statement No. 154 carries forward many provisions of Opinion No. 20 without change, including the provisions related to the reporting of a change in accounting estimate, a change in reporting entity, and the correction of an error. Statement No. 154 also carries forward the provisions of Statement No. 3 that govern reporting accounting changes in interim financial statements. Statement No. 154 is effective for accounting changes and corrections of error made in fiscal years beginning after December 15, 2005. Adoption of this statement has not had an effect on Susquehanna’s results of operations or financial condition.

In April 2005, the Securities and Exchange Commission approved a new rule that, for public companies delays the effective date of FAS No. 124 (revised 2004), “Share-Based Payment” (FAS 123(R).) Under the SEC’s rule, FAS 123(R) is now effective for public companies for annual, rather than interim, periods that began after June 15, 2005. For most public companies the delay eliminated the comparability issues that would have arisen from adopting FAS No. 123(R) in the middle of a fiscal year as originally required. Except for this deferral of the effective date, the guidance in FAS 123(R) is unchanged.

In December 2004, the Financial Accounting Standards Board issued FAS No. 123 (revised 2004), “Share-Based Payment.” Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured on the fair value of the equity or liability instruments issued. Susquehanna will adopt this FAS on January 1, 2006, and select the Modified Prospective Application as its transition method. It is estimated that adoption of Statement 123(R) will reduce Susquehanna’s net income by approximately $0.2 million in 2006.

In March 2005, the Financial Accounting Standards Board issued FASB Staff Position No. FIN 46(R)-5, “Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities.” The FSP gives guidance to a reporting enterprise on determining whether it holds an implicit variable interest in a variable interest entity (“VIE”) or potential VIE. For entities to which Interpretation 46(R) has been applied, the FSP was to be applied in the first reporting period beginning after March 3, 2005. Application of this FSP has not had a material effect on Susquehanna’s results of operations or financial condition.

measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, with its provisions to be applied prospectively. Adoption of this Statement has not had a material effect on Susquehanna’s results of operations or financial condition.

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

In December 2003, the Financial Accounting Standards Board reissued FIN 46 (FIN 46R) with certain modifications and clarifications. Application of this guidance was effective for interest in certain VIEs, commonly referred to as special-purpose entities (SPEs) as of December 31, 2003. Application for all other types of entities is required for periods ending after March 15, 2004, unless previously applied. Considering these modifications and clarifications, management has determined that consolidation of the VIE noted above is still not required.

Summary of 2004 Compared to 2003

Results of Operations

Net income for the year ended December 31, 2004 was $70.2 million, an increase of $7.8 million, or 12.5%, over 2003 net income of $62.4 million. Net interest income increased to $214.0 million for 2004, from $187.0 million in 2003. Our earnings performance continued to be enhanced by improvements in non-interest income, which, during the year 2004, equaled 35% of total revenues and increased $12.8 million over 2003. Non-interest expenses increased 15.6%, to $219.0 million for 2004, from $189.4 million for 2003.

Additional information is as follows:


	Twelve Months Ended December 31,
	2004			2003
Diluted Earnings per Share	$	1.60		$	1.56
Return on Average Assets		1.04	%		1.09	%
Return on Average Equity		10.73	%		11.58	%
Return on Average Tangible Equity⁽¹⁾		14.36	%		13.16	%
Efficiency Ratio		66.15	%		65.09	%
Efficiency Ratio excluding Hann⁽¹⁾		61.09	%		62.25	%

(1) Supplemental Reporting of Non-GAAP-based Financial Measures

Susquehanna has presented a return on average tangible equity, which is a non-GAAP financial measure and is most directly comparable to the GAAP measurement of return on average equity. For purposes of computing

return on average tangible equity, we have excluded the balance of intangible assets and their related amortization expense from our calculation of return on average tangible equity to allow us to review the core operating results of our company. This is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average tangible equity to return on average equity is set forth below.


Return on average equity (GAAP basis)	10.73	%	11.58	%
Effect of excluding average intangible assets and related amortization	3.63	%	1.58	%
Return on average tangible equity	14.36	%	13.16	%

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


Efficiency ratio (GAAP basis)	66.15	%	65.09	%
Effect of excluding Hann	5.06	%	2.84	%
Efficiency ratio excluding Hann	61.09	%	62.25	%

Net Interest Income — Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which increased in 2004, to $214.0 million, as compared to the $187.0 million attained in 2003. Net interest income as a percentage of net interest income plus other income was 65% for the twelve months ended December 31, 2004, 65% for the twelve months ended December 31, 2003, and 67% for the twelve months ended December 31, 2002.

The increase in our net interest income in 2004, as compared to 2003, was primarily the result of the net contribution from interest-earning assets and interest-bearing liabilities acquired from Patriot. In addition, since we are an asset-sensitive institution, where assets reprice more quickly than liabilities, we experienced modest improvements in our net interest margin in the third and fourth quarters of 2004, due to increases in interest rates. These improvements, however, were not enough to significantly offset the decline experienced in the first half of 2004, and consequently, our net interest margin for 2004 decreased five basis points, to 3.60%, from 3.65% for 2003.

Provision and Allowance for Loan and Lease Losses

The provision for loan and lease losses was $10.0 million for 2004 and $10.2 million in 2003. This $0.2 million decrease in the provision was the result of the continuing strength of our asset quality as evidenced by the decrease in total non-performing assets as a percentage of period-end loans and leases plus other real estate owned, from 0.65% at December 31, 2003, to 0.41% at December 31, 2004 The allowance for loan and lease losses at December 31, 2004 was 1.03% of period-end loans and leases, or $54.1 million, compared with 1.00% or $42.7 million at December 31, 2003.

Interest income received on impaired commercial loans in 2004 and 2003 was $0.10 million and $0.06 million, respectively. Interest income that would have been recorded on these loans under the original terms was $1.0 million and $0.7 million for 2004 and 2003, respectively. At December 31, 2004, we had no outstanding commitments to advance additional funds with respect to these impaired loans.

At December 31, 2004, non-performing assets totaled $21.7 million and included $1.3 million in other real estate acquired through foreclosure. At December 31, 2003, non-performing assets totaled $27.8 million, and included $2.9 million in other real estate acquired through foreclosure and a $5.8 million restructured loan.

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

Loans with principal and/or interest delinquent 90 days or more and still accruing interest were $10.2 million at December 31, 2004, an increase from the $6.5 million at December 31, 2003.

Potential problem loans consisted of loans that were performing under contract but for which potential credit problems have caused us to place them on our internally monitored loan list. Such loans totaled $30.1 million at December 31, 2004, and $22.5 million at December 31, 2003. We did not consider this increase to be indicative of any particular trends, as changes to risk ratings occur in the normal course of business.

Noninterest Income

Noninterest income, as a percentage of net interest income plus noninterest income, was 35%, 35% and 33% for 2004, 2003, and 2002, respectively.

Noninterest income increased $12.8 million, or 12.6%, in 2004, over 2003. This net increase was composed primarily of the following:

•

Increasedservice charges on deposit accounts of $2.1 million;

•

Increasedasset management fees of $4.1 million;

•

Increasedcommissions on brokerage, life insurance, and annuity sales of $1.9 million;

•

Increasedincome from bank-owned life insurance of $2.1 million;

•

Increased netgains on sales of securities of $2.6 million;

•

Netgains on the sales of branch deposits of $3.2 million (included in other); and

•

Decreasedvehicle origination, servicing, and securitization fees of $6.3 million.

Service charges on deposit accounts. The 10.7% increase in service charges on deposit accounts was directly related to the acquisition of Patriot and to the increase in demand deposits, from $724.5 million at December 31, 2003, to $853.4 million at December 31, 2004.

Asset management fees and commissions on brokerage, life insurance, and annuity sales. As part of our strategy to increase other fee-based income, we continued to focus on enhancing the wealth management aspect of our business. As a result, asset management fees increased 40.3%, as assets under management at VFAM increased 27.3%, to $3.6 billion at December 31, 2004, from $2.8 billion at December 31, 2003. The Patriot acquisition contributed $354.6 million to the increase in assets under management. Commissions on brokerage, life insurance, and annuity sales increased 94.9%, to $4.0 million for 2004, from $2.1 million for 2003.

Income from bank-owned life insurance.The 30.8% increase in income from bank-owned life insurance for 2004 was be attributed to the purchase of $50.0 million of life insurance in the third quarter of 2003, $4.9 million in the first quarter of 2004, and $25.0 million in the third quarter of 2004. In addition, we acquired $19.0 million of bank-owned life insurance through the Patriot acquisition.

Net gains on sales of securities.In July and August of 2004, as part of a restructuring of our investment portfolio in response to the Patriot acquisition and EITF 03-01, “The Meaning of Other-than-Temporary Impairment and Its Application to Certain Investments,” we sold approximately $107.0 million in securities and realized a net, pre-tax gain of approximately $3.8 million.

Net gains on the sales of branch deposits.In the third and fourth quarters of 2004, we sold four branch locations of several banking subsidiaries. We realized an aggregate net pre-tax gain of $3.2 million on the sale of their deposits, totaling $44.2 million, to other financial institutions. These sales were part of our effort to enhance the efficiency of our branch network through our previously announced plans to consolidate and/or sell several locations.

Vehicle origination, securitization, and servicing fees.The 24.3% decrease in vehicle origination, servicing, and securitization fees was primarily due to a reduction in securitization fees as a result of the roll-off of earlier securitizations and lower lease origination volumes.

Noninterest Expenses

Noninterest expenses increased $29.6 million, or 15.6%, in 2004, over 2003. Salaries and employee benefits, the largest component of noninterest expense, increased $15.0 million, or 16.4%, from 2003 to 2004. The increase in salaries and benefits was primarily the result of the Patriot acquisition, normal annual salary increases, new revenue producing positions, and higher benefit costs.

Charges for occupancy increased $1.9 million, or 13.8%, in 2004, from 2003. The increase was attributed to the Patriot acquisition and general increases in the costs of doing business, predominantly in the categories of rent expense and real estate taxes.

Vehicle delivery and preparation expense for 2004 increased $3.0 million over the prior year’s expense due to an increase in the number of vehicles that were turned in at the end of the lease and needed to be prepared for sale, as opposed to being purchased by the lessee. We believed that the increase in the number of vehicles that were turned in at the end of the lease was caused by new-car manufacturers continuing to offer attractive financing incentives.

All other expenses increased $9.7 million, net. The inclusion of Patriot operations since June 10, 2004, contributed to a general increase in all expense categories. In addition, we incurred expenses relating to our branding initiative of $1.3 million and expenses relating to our bank realignment project of $0.6 million.

Income Taxes

Our effective tax rates for 2004 and 2003 were 29.5% and 30.0%, respectively. The reduction in the effective tax rate for 2004 was primarily related to increased tax-advantaged income as a result of the Patriot acquisition and additional purchases of bank-owned life insurance.

Financial Condition

Summary

Total assets at December 31, 2004 were $7.5 billion, an increase of 25.6%, as compared to total assets of $6.0 billion at December 31, 2003. Loans and leases increased to $5.3 billion at December 31, 2004, from $4.3 billion at December 31, 2003; while deposits increased to $5.1 billion, from $4.1 billion during the same time period. Equity capital was $751.7 million at December 31, 2004, or $16.13 per share, compared to $547.4 million, or $13.73 per share, at December 31, 2003.

Acquisition of Patriot Bank Corp on June 10, 2004

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


Assets
Cash and cash equivalents	$	13,804
Securities		303,625
Loans and leases, net of allowance of 9,149		642,255
Premises and other equipment		11,776
Goodwill and other intangibles		190,570
Deferred taxes		11,655
Other assets		35,034

Total assets acquired	$	1,208,719

Liabilities
Deposits	$	648,797
Borrowings		341,271
Other liabilities		9,685

Total liabilities assumed		999,753

Net assets acquired	$	208,966

Investment Securities

Securities identified as “held-to-maturity” continued to be carried at their amortized cost. Securities identified as “available-for-sale” were reported at their market or “fair” value, and the difference between that value and their amortized cost was recorded in the equity section, net of taxes, as a component of other comprehensive income. As a result, our total equity was negatively impacted by $0.1 million as the unrealized losses, net of taxes, on available-for-sale securities increased slightly, from a loss of $2.2 million at December 31, 2003, to a loss of $2.3 million at December 31, 2004. This increased loss was due to the interest-rate environment.

Investment securities available for sale increased $257.1 million from December 31, 2003, to December 31, 2004. As part of the Patriot acquisition, we acquired $303.6 million in available-for-sale securities; however, in July and August of 2004, as part of a restructuring of our investment portfolio in anticipation of the ramifications of EITF 03-01, we sold approximately $107.0 million of these securities.

At December 31, 2004, we held no securities of one issuer, other than U. S. Government obligations, where the aggregate book value exceeded ten percent of shareholders’ equity. Furthermore, there were no investment securities whose ratings were less than investment grade at December 31, 2004 and 2003.

Loans and Leases

Loans and leases increased $989.7 million, from December 31, 2003, to December 31, 2004. Of this increase, Patriot accounted for $651.5 million, resulting in internal core growth of $338.2 million. In general, we believed that the internal growth that occurred in our loan portfolio in 2004 was accomplished through our sales and marketing efforts.

In general, the composition of our loan portfolio, by percentage of total loans, remained relatively unchanged from December 31, 2003, to December 31, 2004. The greatest percentage changes were between real estate construction loans, which increased by 1.2% of total loans and leases, and consumer loans, which decreased by 1.2% of total loans and leases.

Our bank subsidiaries have historically reported a significant amount of loans secured by real estate. Many of these loans have real estate collateral taken as additional security not related to the acquisition of the real estate pledged. Open-end home equity loans totaled $371.4 million at December 31, 2004, and an additional $137.6 million was lent against junior liens on residential properties at December 31, 2004. Senior liens on 1 - 4 family residential properties totaled $990.0 million at December 31, 2004, and much of the $1.2 billion in loans secured by non-farm, non-residential properties represented collateralization of operating lines, or term loans that finance equipment, inventory, or receivables. Loans secured by farmland totaled $46.2 million, while loans secured by multi-family residential properties totaled $113.0 million at December 31, 2004.

Substantially all of our loans and leases were to enterprises and individuals in our market area. There was no concentration of loans to borrowers in any one industry, or related industries, which exceeded 10% of total loans.

Goodwill and Other Identifiable Intangible Assets

As a result of the Patriot acquisition, we recognized goodwill of $181.5 million, a core deposit intangible of $8.0 million, that will be amortized over ten years, and customer lists of $1.1 million, that will be amortized over five and ten years.

During the third quarter of 2003, cash payments of $4.2 million resulting from the attainment of certain earnings targets were recorded as additional goodwill relating to the Addis acquisition of 2002.

Deposits

Total deposits increased $996.2 million, from December 31, 2003 to December 31, 2004. Of this increase, Patriot accounted for $648.8 million. Also, in the third and fourth quarters of 2004, as part of our realignment project, we sold branch deposits totaling approximately $44.2 million. The net result of these transactions was an increase in total deposits of $391.6 million. Of this net increase, $169.3 million was in brokered certificates of deposit, which were utilized as an alternative funding source to support the increase in our loan portfolio. We believed that the remainder of the net increase was a direct result of the continuing success of our bank subsidiaries in carrying out our retail and corporate sales initiatives.

Short-term Borrowings

Short-term borrowings, which included securities sold under repurchase agreements, federal funds purchased, and Treasury tax and loan notes, increased by $65.3 million, or 18.4%, from December 31, 2003 to December 31, 2004. The greatest increase within this category occurred in Federal funds purchased, which increased from $55.3 million at December 31, 2003, to $108.6 million at December 31, 2004.

Federal Home Loan Bank Borrowings and Long-term Debt

Federal Home Loan Bank borrowings increased $137.4 million and long-term debt increased $93.3 million from December 31, 2003, to December 31, 2004. Of the increase in FHLB borrowings, the fair value of debt assumed through the Patriot acquisition accounted for $275.6 million, resulting in a net decrease of $138.2 million. The net increase in long-term debt was the result of the fair value of junior subordinated debentures, $23.6 million, assumed through the Patriot acquisition, the issuance of $75.0 million in subordinated notes in May 2004, and the repayment of a subsidiary’s $5.0 million term note in July 2004.

On May 3, 2004, we completed the private placement of $75.0 million aggregate principal amount of 4.75% fixed rate/floating rate subordinated notes due May 1, 2014. We used the net proceeds from the offering to fund the cash portion of the Patriot acquisition and the remaining balance to increase our liquidity and capital position in anticipation of future growth and for general corporate purposes. The notes qualify as Tier 2 Capital under the capital guidelines established by the Federal Reserve Board.

Capital Adequacy

Item 7A.Quantitative and Qualitative Disclosures About Market Risk

The discussion concerning the effects of liquidity risk and interest rate risk on us is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risks” in Item 7 hereof under the section entitled “Market Risk.”

Item 8. Financial Statements and Supplementary Data

The following consolidated financial statements of Susquehanna are submitted herewith:


		Page Reference
Consolidated Balance Sheets at December 31, 2005 and 2004		67

Consolidated Statements of Income for the years ended December 31, 2005, 2004, and 2003		68

Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004, and 2003		69

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2005, 2004, and 2003		70

Notes to Consolidated Financial Statements		71

Management’s Responsibility for Financial Statements and Report on Internal Control over Financial Reporting		109

Report of Independent Registered Public Accounting Firm		110

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets


Year ended December 31,	2005			2004
	(in thousands, except share data)
Assets
Cash and due from banks	$	196,557		$	160,574
Short-term investments:
Restricted		26,336			27,190
Unrestricted		69,948			31,544

Total short-term investments		96,284			58,734

Securities available for sale		1,147,862			1,240,945
Securities held to maturity (fair values approximate$6,399 and $4,469)		6,399			4,469
Loans and leases, net of unearned income		5,218,659			5,253,008
Less: Allowance for loan and lease losses		53,714			54,093

Net loans and leases		5,164,945			5,198,915

Premises and equipment, net		88,058			83,606
Foreclosed assets		2,620			1,340
Accrued income receivable		24,223			21,661
Bank-owned life insurance		257,289			249,691
Goodwill		242,718			240,632
Intangible assets with finite lives		11,574			11,960
Investment in and receivables from unconsolidated entities		104,069			68,384
Other assets		123,409			134,162

	$	7,466,007		$	7,475,073

Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing	$	918,854		$	853,411
Interest-bearing		4,390,333			4,277,271

Total deposits		5,309,187			5,130,682
Short-term borrowings		307,523			420,868
FHLB borrowings		668,666			751,220
Long-term debt		150,000			200,000
Junior subordinated debentures		22,777			23,277
Accrued interest, taxes, and expenses payable		49,836			41,255
Deferred taxes		131,789			114,050
Other liabilities		45,759			42,027

Total liabilities		6,685,537			6,723,379

Commitments and contingencies (Notes 12 and 13)

Shareholders’ equity:
Common stock, $2.00 par value, 100,000,000 shares authorized; Issued:46,853,193 at December 31, 2005 and 46,592,930 at December 31, 2004		93,706			93,186
Additional paid-in capital		231,085			226,384
Retained earnings		471,290			435,159
Accumulated other comprehensive loss, net of taxes of$(8,406) and $(1,634)		(15,611	)		(3,035	)

Total shareholders’ equity		780,470			751,694

	$	7,466,007		$	7,475,073

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

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income


Years ended December 31,	2005		2004		2003
	(in thousands, except per share data)
Interest Income:
Loans and leases, including fees	$	339,960	$	276,864	$	245,980
Securities:
Taxable		41,400		40,383		36,793
Tax-exempt		1,205		1,566		1,441
Dividends		2,666		2,131		1,101
Short-term investments		1,789		815		705

Total interest income		387,020		321,759		286,020

Interest Expense:
Deposits:
Interest-bearing demand		28,866		16,802		9,473
Savings		2,318		2,115		1,999
Time		64,979		49,485		51,419
Short-term borrowings		9,727		4,260		3,583
FHLB borrowings		28,634		22,529		22,420
Long-term debt		10,251		12,550		10,120

Total interest expense		144,775		107,741		99,014

Net interest income		242,245		214,018		187,006
Provision for loan and lease losses		12,335		10,020		10,222

Net interest income, after provision for loan and lease losses		229,910		203,998		176,784

Noninterest Income:
Service charges on deposit accounts		21,442		21,913		19,798
Vehicle origination, servicing, and securitization fees		15,616		19,783		26,132
Asset management fees		17,882		14,411		10,274
Income from fiduciary-related activities		5,911		6,232		5,783
Commissions on brokerage, life insurance, and annuity sales		4,447		4,012		2,059
Commissions on property and casualty insurance sales		11,142		9,191		8,354
Income from bank-owned life insurance		9,105		9,105		6,963
Net gain on sale of loans and leases		14,966		9,645		9,700
Net gain on sale of bank branches		5,194		3,209		0
Net gain on securities		4,188		4,683		2,110
Other		15,185		12,406		10,577

Total noninterest income		125,078		114,590		101,750

Noninterest Expenses:
Salaries and employee benefits		114,197		106,127		91,151
Occupancy		18,853		15,718		13,813
Furniture and equipment		10,110		9,059		8,712
Amortization of intangible assets		1,520		1,124		626
Vehicle residual value		9,986		5,721		6,486
Vehicle delivery and preparation		11,090		14,430		11,463
Other		76,794		66,863		57,179

Total noninterest expenses		242,550		219,042		189,430

Income before income taxes		112,438		99,546		89,104
Provision for income taxes		32,875		29,366		26,731

Net Income	$	79,563	$	70,180	$	62,373

Earnings per share:
Basic	$	1.70	$	1.61	$	1.57
Diluted	$	1.70	$	1.60	$	1.56
Cash dividends	$	0.93	$	0.89	$	0.86
Average shares outstanding:
Basic		46,711		43,585		39,742
Diluted		46,919		43,872		40,037

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

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows


Years ended December 31,	2005				2004			2003
	( in thousands)
Cash Flows from Operating Activities:
Net income	$	79,563			$	70,180		$	62,373
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		18,671				19,196			24,072
Provision for loan and lease losses		12,335				10,020			10,222
Realized gain on sales of available-for-sale securities, net		(4,188	)			(4,683	)		(2,110	)
Deferred income taxes		24,513				21,949			20,823
Gain on sale of loans and leases		(14,966	)			(9,645	)		(9,700	)
Gain on sale of other real estate owned		(210	)	��		(443	)		(252	)
Mortgage loans originated for sale		(132,253	)			(119,800	)		(189,584	)
Proceeds from sale of mortgage loans originated for sale		135,595				125,511			200,234
Leases originated for sale, net of payments received		(334,371	)			(274,909	)		(259,105	)
Proceeds from sale of leases acquired/originated for sale		323,568				227,671			130,069
Increase in cash surrender value of bank-owned life insurance		(9,105	)			(9,105	)		(6,963	)
Net gain on sale of branch offices		(5,194	)			(3,209	)		0
Contribution to defined benefit pension plan		(6,000	)			(8,000	)		(3,500	)
(Increase) decrease in accrued interest receivable		(2,562	)			(4,167	)		3,085
Increase (decrease) in accrued interest payable		2,224				2,840			(4,076	)
Increase (decrease) in accrued expenses and taxes payable		6,357				15,062			(448	)
Other, net		(30,503	)			(31,887	)		(8,935	)

Net cash provided by (used in) operating activities		63,474				26,581			(33,795	)

Cash Flows from Investing Activities:
Net decrease (increase) in restricted short-term investments		854				17,627			(14,206	)
Activity in available-for-sale securities:
Sales		182,152				270,669			122,730
Maturities, repayments and calls		251,681				468,697			854,670
Purchases		(366,521	)			(689,126	)		(872,453	)
Net proceeds from sale of loans in banks’ portfolios		239,071				0			0
Net increase in loans and leases		(196,200	)			(305,828	)		(320,146	)
Cash flows received on retained interests		16,498				6,008			4,134
Purchase of bank-owned life insurance		0				(29,900	)		(50,000	)
Acquisitions, net of cash acquired		(3,412	)			(38,105	)		0
Additions to premises and equipment		(13,195	)			(16,444	)		(9,940	)

Net cash provided by (used in) investing activities		110,928				(316,402	)		(285,211	)

Cash Flows from Financing Activities:
Net increase in deposits		238,999				391,658			303,152
Sale of branch deposits, net of premium received		(54,904	)			(41,031	)		0
Net (decrease) increase in short-term borrowings		(113,345	)			65,315			57,525
Net (decrease) increase in FHLB borrowings		(82,554	)			(180,624	)		70,684
Repayment of long-term debt		(50,000	)			(5,000	)		(50,000	)
Proceeds from issuance of long-term debt		0				74,356			0
Proceeds from issuance of common stock		5,221				5,351			3,852
Cash dividends paid		(43,432	)			(38,471	)		(34,167	)

Net cash (used in) provided by financing activities		(100,015	)			271,554			351,046

Net change in cash and cash equivalents		74,387				(18,267	)		32,040
Cash and cash equivalents at January 1		192,118				210,385			178,345

Cash and cash equivalents at December 31	$	266,505			$	192,118		$	210,385

Cash and cash equivalents:
Cash and due from banks	$	196,557			$	160,574		$	176,240
Unrestricted short-term investments		69,948				31,544			34,145

Cash and cash equivalents at December 31	$	266,505			$	192,118		$	210,385

Supplemental Disclosure of Cash Flow Information

Cash paid for interest on deposits and borrowings	$	142,551			$	104,901		$	103,090
Income tax payments (refunds)	$	4,093			$	(3,287	)	$	(9,112	)

Supplemental Schedule of Noncash Investing Activities

Real estate acquired in settlement of loans	$	4,972			$	1,711		$	3,394
Interests retained in securitization	$	48,466			$	19,027		$	9,043

Acquisition of Patriot Bank Corp.
Common stock issued	$	0			$	168,232		$	0
Fair value of assets acquired (noncash)	$	0			$	1,143,006		$	0
Liabilities assumed	$	0			$	999,753		$	0

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

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity


Years Ended December 31, 2005, 2004, and 2003	Shares of Common Stock	Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
	(in thousands, except share data)
Balance, January 1, 2003	39,638,447	$	79,277	$	62,858	$	375,244		$	16,476		$	533,855
Comprehensive income:
Net income							62,373						62,373
Change in unrealized gain on securities available for sale, net of taxes of $(7,903) and reclassification adjustment of $2,110										(14,678	)		(14,678	)
Change in unrealized gain on recorded interest in securitized assets, net of taxes of $(2,075)										(3,853	)		(3,853	)

Total comprehensive income													43,842

Common stock issued under employee benefit plans (including related tax benefit of $709)	222,870		446		3,406								3,852
Cash dividends declared ($0.86 per share)							(34,167	)					(34,167	)

Balance, December 31, 2003	39,861,317		79,723		66,264		403,450			(2,055	)		547,382

Comprehensive income:
Net income							70,180						70,180
Change in unrealized gain on securities available for sale, net of taxes of $(81) and reclassification adjustment of $3,044										(151	)		(151	)
Change in unrealized gain on recorded interests in securitized assets, net of taxes of $(426)										(829	)		(829	)

Total comprehensive income													69,200

Common stock issued in acquisition	6,402,074		12,804		155,428								168,232
Common stock issued under employee benefit plans (including related tax benefit of $1,035)	329,539		659		4,692								5,351
Cash dividends declared ($0.89 per share)							(38,471	)					(38,471	)

Balance, December 31, 2004	46,592,930		93,186		226,384		435,159			(3,035	)		751,694

Comprehensive income:
Net income							79,563						79,563
Change in unrealized loss on securities available for sale, net of taxes of $(8,227) and reclassification adjustment of $2,722										(15,279	)		(15,279	)
Change in unrealized gain on recorded interests in securitized assets, net of taxes of $539 and reclassification adjustments										1,003			1,003
Unrealized gain on cash flow hedges, net of taxes of $915										1,700			1,700

Total comprehensive income													66,987

Common stock issued under contingent earnings agreement	21,012		42		426								468
Common stock issued under employee benefit plans (including related tax benefit of $647)	239,251		478		4,275								4,753
Cash dividends declared ($0.93 per share)							(43,432	)					(43,432	)

Balance, December 31, 2005	46,853,193	$	93,706	$	231,085	$	471,290		$	(15,611	)	$	780,470

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

Notes to Consolidated Financial Statements

Years Ended December 31, 2005, 2004, and 2003

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

1. Summary of Significant Accounting Policies

The accounting and reporting policies of Susquehanna Bancshares, Inc. and subsidiaries (collectively “Susquehanna”) conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry. The more significant policies follow:

Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the parent company and its wholly owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) (“Hann”), Conestoga Management Company, Susquehanna Bank PA and subsidiaries, Susquehanna Patriot Bank and subsidiaries, Susquehanna Bank and subsidiaries, Susque-Bancshares Life Insurance Co. (dissolved in December 2005), Valley Forge Asset Management Corp. and subsidiaries (“VFAM”), and The Addis Group, LLC (“Addis”) as of and for the years ended December 31, 2005, 2004, and 2003. All significant intercompany balances and transactions have been eliminated in consolidation.

Nature of Operations. Susquehanna is a financial holding company that operates three commercial banks with an aggregate of 153 branches and non-bank subsidiaries that provide, among others, leasing; trust and related services; consumer vehicle financing; investment advisory, asset management, and brokerage services; and property and casualty insurance brokerage services. Susquehanna’s primary source of revenue is derived from loans to customers, who are predominately small and middle-market businesses and middle-income individuals.

Use of Estimates.The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan and lease losses and recorded interests in securitized assets.

Significant Concentrations of Credit Risk.Substantially all of Susquehanna’s loans and leases are to enterprises and individuals in its market area. There is no concentration of loans to borrowers in any one industry, or related industries, that exceeds 10% of total loans.

Reclassifications. For comparative purposes, prior years’ consolidated financial statements have been reclassified to conform to report classifications of the current year. The reclassifications had no effect on net income.

Cash and Cash Equivalents. For purposes of reporting cash flows, cash and cash equivalents include cash, balances due from banks, and unrestricted short-term investments. Unrestricted short-term investments consist of interest-bearing deposits in other banks, federal funds sold, commercial paper, and money market funds with an original maturity of three months or less.

Securities Sold Under Agreements to Repurchase.Securities sold under agreements to repurchase are treated as debt and are reflected as a liability in the consolidated statements of financial condition. The book value of securities pledged to secure the repurchase agreements remains in the securities portfolio.

Securities. Susquehanna classifies debt and equity securities as either “held-to-maturity” or “available-for-sale.” Susquehanna does not have any securities classified as “trading” at December 31, 2005 or 2004. Investments for which management has the intent, and Susquehanna has the ability to hold to maturity, are carried at the lower of cost or market adjusted for amortization of premium and accretion of discount.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Amortization and accretion are calculated principally using the interest method over the term of the securities. All other securities are classified as “available-for-sale” and reported at fair value. Changes in unrealized gains and losses, net of related deferred taxes, for “available-for-sale” securities are reported in other comprehensive income.

Securities classified as “available-for-sale” include investments management intends to use as part of its asset/liability management strategy. Those securities that have long-term unrealized gains, in which fair value is greater than cost, may be sold in response to changes in interest rates, resultant prepayment risk, and other factors. Management has the ability and intent to hold those securities that have unrealized losses due to changes in interest rates for a time necessary to recover the amortized cost. Realized gains and losses on the sale of securities are recognized using the specific identification method and are included in Noninterest Income in the Consolidated Statements of Income.

Loans. Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are stated at their outstanding unpaid principal balances, net of any deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield to the related loans. These amounts are generally being amortized over the contractual life of the loan.

Allowance for Loan and Lease Losses. The allowance for loan and lease losses is established, as losses are estimated to have occurred, through a provision for loan and lease losses charged to earnings. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed, and recoveries on previously charged-off loans and leases are credited to the allowance.

The allowance for loan and lease losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectibility of the loans and leases in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is somewhat subjective, as it requires estimates that are susceptible to revision as more information becomes available.

Susquehanna considers a loan to be impaired, based upon current information and events, if it is probable that Susquehanna will be unable to collect payments of principal or interest according to the contractual terms of the loan agreement. Adversely risk-rated loans that are not evaluated for impairment on an individual basis are grouped in homogeneous pools based on severity of risk. Larger homogeneous groups of small-balance loans, such as residential mortgages and installment loans, are collectively evaluated for impairment. Non-accrual commercial loans greater than $250 are evaluated for impairment on an individual basis. An insignificant delay or shortfall in the amounts of payments, when considered independent of other factors, would not cause a loan to be rendered impaired. Insignificant delays or shortfalls may include, depending on specific facts and circumstances, those that are associated with temporary operational downturns or seasonal delays.

Management performs quarterly reviews of Susquehanna’s loan portfolio to identify impaired loans. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the net realizable value of the collateral.

Loans continue to be classified as impaired until they are brought fully current, and the continued collection of scheduled interest and principal is considered probable. When an impaired loan or portion of an impaired loan is determined to be uncollectable, the portion deemed uncollectable is charged against the related allowance. Subsequent recoveries, if any, are credited to the allowance.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Off-Balance Sheet Credit Related Financial Instruments.In the ordinary course of business, Susquehanna has entered into commitments to extend credit, including commitments under commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.

Derivative Financial Instruments.For asset/liability management purposes, Susquehanna uses interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process and are linked to specific assets or liabilities, and have high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.

Susquehanna utilizes interest rate swap agreements to hedge the variable cash flows associated with existing variable-rate debt and forecasted auto lease securitizations. The derivatives were designated as cash flow hedges and the effective potion of changes in the fair value of the derivative is initially reported in accumulated other comprehensive income and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective potion of changes in the fair value of the derivative is recognized directly in earnings. Susquehanna assesses the effectiveness of each hedging relationship at least quarterly by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. Susquehanna does not use derivatives for trading or speculative purposes.

Foreclosed Assets. Other real estate property acquired through foreclosure or other means is recorded at the lower of its carrying value, or fair value of the property at the transfer date less estimated selling costs. Costs to maintain other real estate are expensed as incurred.

Premises and Equipment. Land is carried at cost. Buildings, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or ten to twenty years. Maintenance and normal repairs are charged to operations as incurred, while additions and improvements to buildings and furniture and equipment are capitalized. Gains or losses on disposition of assets are reflected in operations.

In accordance with FAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” long-lived assets are evaluated for impairment by management on an on-going basis. Impairment may occur whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Transfers of Financial Assets.Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from Susquehanna, (2), the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) Susquehanna does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Goodwill and Other Intangible Assets. Susquehanna follows FAS No. 141, “Business Combinations,” and FAS No. 142, “Goodwill and Other Intangible Assets.” Net assets of companies acquired in purchase transactions are recorded at their fair value at the date of acquisition. Core deposit and other intangible assets acquired in acquisitions are identified and amortized on a straight-line basis over their useful lives. The excess of the purchase price over the fair value of net assets acquired, or goodwill, is no longer amortized in accordance with FAS No. 142.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

During the first quarter of 2002, Susquehanna completed the transitional impairment test of goodwill. In all instances, estimated fair values exceeded book values; and therefore, no write-down of goodwill was required as of January 1, 2002. In addition, Susquehanna performed its annual impairment testing required by FAS No. 142 in each subsequent year. As of December 31, 2005, 2004, and 2003, no impairment loss was required to be recognized.

Interest Income on Loans and Leases. Interest income on commercial, consumer, and mortgage loans is recorded on the interest method. Interest income on installment loans and leases is recorded on the interest method and the actuarial method. Loan fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment to the related loan yield on the interest method, over the contractual life of the related loans.

Nonaccrual loans are those loans on which the accrual of interest has ceased and where all previously accrued but not collected interest is reversed. Loans, other than consumer loans, are placed on nonaccrual status when principal or interest is past due 90 days or more and the loan is not well-collateralized and in the process of collection or immediately, if, in the opinion of management, full collection is doubtful. Interest accrued but not collected as of the date of placement on nonaccrual status is reversed and charged against current income. Susquehanna does not accrue interest on impaired loans. While a loan is considered impaired or on nonaccrual status, subsequent cash interest payments received either are applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of the ultimate collectibility of principal and interest. In any case, the deferral or non-recognition of interest does not constitute forgiveness of the borrower’s obligation. Consumer loans are recorded in accordance with the Uniform Retail Classification regulation adopted by the FDIC. Generally, the regulation requires that consumer loans be charged off to the allowance for loan losses when they become 120 days or more past due.

Segment Reporting. FAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that public business enterprises report financial and descriptive information about their reportable operating segments. Based on the guidance provided by the statement, Susquehanna has determined that its only reportable segment is Community Banking, and all services offered by Susquehanna relate to Community Banking.

Comprehensive Income. Susquehanna reports comprehensive income in accordance with FAS No. 130, “Reporting Comprehensive Income.” Components of comprehensive income, as detailed in the Consolidated Statements of Changes in Shareholders’ Equity are net of tax. Comprehensive income includes a reclassification adjustment for net realized gains/ (losses) included in net income of $2,722; $3,044; and $2,110 for the years ended December 31, 2005, 2004, and 2003, respectively.

Asset Securitizations.Susquehanna uses the securitization of financial assets as a source of funding and for capital management. Hann and the banking subsidiaries sell beneficial interests in automobile leases and related vehicles and home equity loans to wholly owned, qualified special purpose entities (each a “QSPE”). These transactions are accounted for as sales under the guidelines of FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125),” and a net gain or loss is recognized at the time of the initial sale.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Each QSPE retains the right to receive excess cash flows from the sold portfolio. Under FAS No. 140, Susquehanna is required to recognize a receivable representing the present value of the anticipated excess cash flows at the time of sale. This recorded receivable is subordinate to the rights of each of the QSPE’s creditors. The value of these recorded receivables is subject to credit, prepayment, and interest rate risk.

For more details on Susquehanna’s securitization activities, see Note 19 to these consolidated financial statements.

Recorded Interests in Securitized Assets.In accordance with FAS No. 140, recorded interests in securitized assets, including debt securities and interest-only strips, are initially recorded at their allocated carrying amounts based on the relative fair value of assets sold and retained or liabilities assumed. Recorded interests are subsequently carried at fair value, which is generally estimated based on the present value of expected cash flows, calculated using management’s best estimates of key assumptions, including credit losses, loan repayment speeds and discount rates commensurate with the risks involved. If the fair value of an interest-only strip falls below the unamortized portion of the original retained interest, other than for temporary circumstances, then an impairment would be recognized.

Servicing Fees under Securitization Transactions, the Sale-Leaseback Transaction, Agency Agreements, and Lease Sales.Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. The servicing fees paid to Hann under the lease securitization transactions, the sale-leaseback transaction, agency agreements, and lease sales approximate current market value. Hann has not recorded servicing assets nor liabilities with regard to those transactions, because its expected servicing costs are approximately equal to its expected servicing income.

The parent company acts as servicer for securitized HELOCs and has recorded a servicing asset based on the present value of estimated future net servicing income. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Overall however, Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its loan and lease portfolio and to manage capital, and not primarily to maximize its ongoing servicing fee revenue. In the future, in regard to lease securitizations, if servicing costs were to exceed servicing income, Susquehanna would record the present value of that liability as an expense.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned. The amortization of servicing rights is netted against loan servicing fee income.

Federal Income Taxes. Deferred income taxes reflect the temporary tax consequences on future years of differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.

Earnings per Common Share. Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by Susquehanna relate solely to outstanding stock options, and are determined using the treasury stock method.

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 the disclosure requirements of FAS No. 123, “Accounting for Stock Based Compensation,” as amended by FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” 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.


	For the Years Ended December 31,
	2005			2004			2003
Net income, as reported	$	79,563		$	70,180		$	62,373
Less: pro forma expense related to options granted, net of tax benefit		(2,063	)		(941	)		(788	)

Pro forma net income	$	77,500		$	69,239		$	61,585

Basic earnings per share:
As reported	$	1.70		$	1.61		$	1.57
Pro forma	$	1.66		$	1.59		$	1.55
Diluted earnings per share:
As reported	$	1.70		$	1.60		$	1.56
Pro forma	$	1.65		$	1.58		$	1.54

The fair values of stock options granted were estimated at the date of grant using a Black-Scholes option-pricing model. The following weighted-average assumptions were used in the model to determine the fair value of options granted:


	2005			2004			2003
Dividend yield		3.8	%		3.6	%		3.6	%
Expected volatility		20.6	%		21.4	%		22.5	%
Risk-free interest rate		4.38	%		3.6	%		3.1	%
Expected life (in years)		7.0			7.0			7.0
Weighted-average fair value of options at the date of grant	$	4.35		$	4.38		$	3.86

For additional details on Susquehanna’s stock-based compensation plan, see Note 15 to the consolidated financial statements.

Variable Interest Entities (VIE).In January 2003, the FASB issued FIN 46, which provides guidance on how to identify a variable interest entity and determine when the assets, liabilities, noncontrolling interests, and results of operations of a VIE are to be included in an entity’s consolidated financial statements. A VIE exists when either the total equity investment at risk is not sufficient to permit the entity to finance its activities by itself, or the equity investors lack one of three characteristics associated with owning a controlling financial

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

interest. Those characteristics include the direct or indirect ability to make decisions about an entity’s activities through voting rights or similar rights, the obligation to absorb the expected losses of an entity if they occur, or the right to receive the expected residual returns of the entity if they occur. As of December 31, 2005, we have a variable interest in the Lessor in a sale-leaseback transaction.

In December 2000, Hann sold and contributed the beneficial interest in $190,000 of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that has an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor is treated as a sale and an operating lease and qualifies as a sale and leaseback under FAS No. 13. The Lessor is a Delaware statutory trust and a variable interest entity (a “VIE”). The Lessor held the beneficial interest in vehicles and auto leases with a remaining balance of approximately $94,934 at December 31, 2005. 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 were also sold or contributed to the Lessee. At December 31, 2005, the beneficial interest in additional automobile leases and related vehicles pledged by the Lessee was $45,645. The Lessor is not a QSPE; however, under the guidelines set forth in FIN 46, consolidation of this entity is not required.

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, we would be entitled to take depreciation deductions for tax purposes on the vehicles that were not substituted. We believe that the likelihood of 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 $35,111 letter of credit from an eligible financial institution for the benefit of the equity participants in the transaction to secure its obligations.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

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 (i) the aggregate wholesale “clean” value of the vehicles (as shown in the Black Book Official Used Car Market Guide Monthly) or (ii) $38,000. If the leases and related vehicles were to be worthless at such time, the maximum exposure to Susquehanna and its subsidiaries under these provisions would be $38,000. The Servicing Agreement with Auto Lenders does not apply to the sale-leaseback transaction.

Under the Master Lease Agreement, the Lessee has an early buyout option on January 14, 2007 (the “EBO Date”) under which the Lessee can repurchase all, but not less than all, of the beneficial interests in leases and related vehicles. If the option is exercised, the Lessee will pay to the Lessor the purchase price under the early buyout option (the “EBO Price”). The EBO Price may, at the Lessee’s option, be payable either 100% on the EBO Date or, if our senior unsecured long-term debt rating on the EBO Date is at least Baa2 (and not on negative credit watch with negative implications) by Moody’s and BBB by Standard & Poor’s (and not on credit watch with negative implications) and certain other conditions are met, in installments. The Lessee must also pay the out-of-pocket costs and expenses (including all transfer taxes and legal fees and expenses) incurred by the Lessor, the trustees and their affiliates in connection with such purchase.

Recent Accounting Pronouncements.

In November 2005, the Financial Accounting Standards Board issued FASB Staff Position (FSP) FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” to provide an alternative transition method for accounting for the tax effects of share-based payment awards to employees. This method comprises (a) a computational component that establishes a beginning balance of the additional-paid-in- capital pool related to employee compensation and (b) a simplified method to determine the subsequent impact on the pool of employee awards that are fully vested and outstanding upon the adoption of FAS No. 123(R). The guidance in this FSP was effective November 10, 2005. An entity that adopts FAS No. 123(R) using either modified retrospective or modified prospective application may make a one-time election to adopt the transition method described in this FSP. An entity may take up to one year from the later of its initial adoption of FAS No. 123(R) or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. An entity that elects the transition method described in this FSP is not required to justify the preferability of its election. Susquehanna is evaluating its options at this time.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Prospective Application as its transition method. It is estimated that adoption of Statement 123(R) will reduce Susquehanna’s net income by approximately $234 in 2006.

In December 2004, The Financial Accounting Standards Board issued FAS No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” The amendments made by FAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, with its provisions to be applied prospectively. Adoption of this Statement has not had a material effect on Susquehanna’s financial condition or results of operations.

2. Acquisitions

Minotola National Bank

On November 14, 2005, Susquehanna announced the signing of a definitive merger agreement pursuant to which Susquehanna will acquire Minotola National Bank in a stock and cash transaction valued at approximately $165,000. The acquisition of Minotola, with total assets of $623,000 and fourteen branch locations, provides Susquehanna with an opportunity to expand its franchise into high-growth markets in southern New Jersey.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Under the terms of the merger agreement, for each share of Minotola stock held, a Minotola shareholder may elect to receive either three thousand, two hundred twenty-six dollars in cash, one hundred thirty-four common shares of Susquehanna, or a combination thereof such that 30 percent of the Minotola shares would be exchanged for cash, and 70 percent would be exchanged for Susquehanna common stock. It is anticipated that the transaction will be completed by April 30, 2006, pending regulatory approvals.

Brandywine Benefits Corporation and Rockford Pensions, LLC

On February 1, 2005, Susquehanna acquired Brandywine Benefits Corporation and Rockford Pensions, LLC (collectively “Brandywine”) located in Wilmington, Delaware. Brandywine is a financial planning, consulting and administration firm specializing in retirement benefit plans for small-to-medium-sized businesses. Brandywine Benefits Corporation is a wholly owned subsidiary of Brandywine Benefits Corp., LLC, which in turn is a wholly owned subsidiary of VFAM.

The acquisition of Brandywine is considered immaterial for purposes of the disclosures required by FAS No. 141.

Patriot Bank Corp.

On June 10, 2004, Susquehanna acquired 100% of the outstanding voting shares of Patriot Bank Corp., a financial services company with total assets in excess of $1,000,000, and the holding company for Patriot Bank. The results of Patriot’s operations have been included in the consolidated financial statements since that date. Concurrent with the closing, Susquehanna merged Patriot Bank into Equity Bank, a wholly owned Susquehanna subsidiary. The combined bank is now known as Susquehanna Patriot Bank.

Under the terms of the merger, each share of Patriot common stock was exchanged for 1.143 shares of Susquehanna common stock, $30.00 in cash, or a combination thereof, resulting in the issuance of 6,402 shares of Susquehanna common stock and a cash payment of $42,513. The total purchase price was $208,966. The value of the common shares issued was determined on the market price of Susquehanna common shares at the close of business immediately prior to the announcement.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

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


Assets
Cash and cash equivalents	$	13,804
Securities		303,625
Loans and leases, net of allowance of $9,149		642,255
Premises and other equipment		11,776
Goodwill and other intangibles		190,570
Deferred taxes		11,655
Other assets		35,034

Total assets acquired	$	1,208,719

Liabilities
Deposits	$	648,797
Borrowings		341,271
Other liabilities		9,685

Total liabilities assumed		999,753

Net assets acquired	$	208,966

Of the $190,570 of acquired intangible assets, $7,976 was assigned to core deposit intangibles that will be amortized over 10 years, and $1,085 was assigned to customer lists that will be amortized over 5 and 10 years.

Presented below is certain unaudited pro forma information for the year ended December 31, 2004, as if Patriot had been acquired on January 1, 2004. These results combine the historical results of Patriot, including the termination of certain employee benefit programs and costs incurred in connection with the merger, with Susquehanna’s consolidated statements of income and, while certain adjustments were made for the estimated impact of purchase accounting adjustments, they are not necessarily indicative of what would have occurred had the acquisition taken place on the indicated date.


	For the Year Ended December 31,
	2005 Actual		2004
Net income	$	79,563	$	61,957
Basic EPS	$	1.70	$	1.34
Diluted EPS	$	1.70	$	1.33

3. Short-term Investments

The book values of short-term investments and weighted-average interest rates on December 31, 2005 and 2004, were as follows:


	2005				2004
	Book Value		Rates		Book Value		Rates
	Book Value		Rates		Book Value		Rates
Interest-bearing deposits in other banks	$	33,318	2.52	%	$	30,920	1.79	%
Money market funds		58,489	3.36			23,580	1.40
Commercial paper purchased		4,477	4.20			4,234	2.43

Total	$	96,284			$	58,734

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

4. Investment Securities

The amortized cost and fair values of investment securities at December 31, 2005 and 2004, were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
At December 31, 2005
Available-for-Sale:
U.S. Government agencies	$	405,098	$	33	$	6,092	$	399,039
Obligations of states and political subdivisions		11,803		35		67		11,771
Mortgage-backed securities		623,347		138		20,921		602,564
Other debt securities		64,262		78		201		64,139
Equity securities		70,338		332		321		70,349

		1,174,848		616		27,602		1,147,862
Held-to-Maturity:
State and municipal		6,399		0		0		6,399

Total investment securities	$	1,181,247	$	616	$	27,602	$	1,154,261

At December 31, 2004
Available-for-Sale:
U.S. Government agencies	$	263,835	$	289	$	1,784	$	262,340
Obligations of states and political subdivisions		37,050		1,175		6		38,219
Mortgage-backed securities		872,324		5,316		9,374		868,266
Other debt securities		7,376		3		14		7,365
Equity securities		63,840		1,024		109		64,755

		1,244,425		7,807		11,287		1,240,945
Held-to-Maturity:
State and municipal		4,469		0		0		4,469

Total investment securities	$	1,248,894	$	7,807	$	11,287	$	1,245,414

At December 31, 2005 and 2004, investment securities with carrying values of $825,780 and $900,312 respectively, were pledged to secure public funds and for other purposes as required by law.

There were no investment securities whose ratings were less than investment grade at December 31, 2005 and 2004.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The amortized cost and fair value of U.S. Treasury, U.S. Government agencies, obligations of states and political subdivisions, corporate debt securities, and mortgage-backed securities, at December 31, 2005, 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.


	Amortized Cost		Fair Value
Securities Available-for-Sale:
Within one year	$	31,609	$	31,545
After one year but within five years		608,279		595,410
After five years but within ten years		220,096		211,812
After ten years		244,526		238,746

		1,104,510		1,077,513

Securities Held-to-Maturity:
Within one year		0		0
After one year but within five years		0		0
After five years but within ten years		0		0
After ten years		6,399		6,399

		6,399		6,399

Total debt securities	$	1,110,909	$	1,083,912

The gross realized gains and gross realized losses on investment securities transactions are summarized below.


	Available- for-Sale		Held-to- Maturity
For the year ended December 31, 2005
Gross gains	$	5,097	$	0
Gross losses		909		0

Net gains	$	4,188	$	0

For the year ended December 31, 2004
Gross gains	$	5,344	$	0
Gross losses		661		0

Net gains	$	4,683	$	0

For the year ended December 31, 2003
Gross gains	$	3,987	$	0
Gross losses		1,877		0

Net gains	$	2,110	$	0

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The following table presents our 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 December 31, 2005 and 2004.


	Less than 12 Months				12 Months or More				Total
December 31, 2005	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Government Agencies	$	128,265	$	1,415	$	179,204	$	4,677	$	307,469	$	6,092
States and political subdivisions		7,982		67		50		0		8,032		67
Mortgage-backed securities		177,423		3,879		404,796		17,042		582,219		20,921
Other debt securities		23,266		146		1,945		55		25,211		201
Equity securities		951		66		12,574		255		13,525		321

Total	$	337,887	$	5,573	$	598,569	$	22,029	$	936,456	$	27,602


	Less than 12 Months				12 Months or More				Total
December 31, 2004	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Government Agencies	$	196,864	$	1,784	$	0	$	0	$	196,864	$	1,784
States and political subdivisions		1,315		4		232		2		1,547		6
Mortgage-backed securities		450,343		4,956		178,760		4,418		629,103		9,374
Other debt securities		1,986		14		0		0		1,986		14
Equity securities		7,316		109		0		0		7,316		109

Total	$	657,824	$	6,867	$	178,992	$	4,420	$	836,816	$	11,287

Management does not believe any individual unrealized loss as of December 31, 2005, represents a material other-than-temporary impairment. The unrealized losses reported for U.S. Government agencies and mortgage-backed securities relate primarily to securities issued by Federal Home Loan Banks, the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”). These unrealized losses are predominantly attributable to changes in interest rates. Susquehanna has both the intent and the ability to hold the securities represented in the previous table for a time necessary to recover the amortized cost.

5. Loans and Leases

Loans and leases, net of unearned income of $64,803 and $56,844 at December 31, 2005 and December 31, 2004, respectively, and net of deferred origination costs of $8,641 and $8,596 at December 31, 2005 and 2004, respectively, were as follows:


	2005		2004
Commercial, financial and agricultural	$	832,695	$	760,106
Real estate - construction		934,601		741,660
Real estate secured - residential		1,355,513		1,611,999
Real estate secured - commercial		1,257,860		1,252,753
Consumer		319,925		351,846
Leases, primarily automobile		518,065		534,644

Total	$	5,218,659	$	5,253,008

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Included in loans and leases are the aggregate balances of all overdrawn deposit accounts. These “loans” are evaluated under management’s current model for collectibility. At December 31, 2005 and 2004, the aggregate balances of overdrawn deposit accounts reclassified as loans were $1,825 and $4,916, respectively.

Net investment in direct financing leases was as follows:


	2005			2004
Minimum lease payments receivable	$	321,798		$	332,016
Estimated residual value of leases		259,462			260,514
Unearned income under lease contracts		(63,195	)		(57,886	)

Total leases	$	518,065		$	534,644

At December 31, 2005 and 2004, leases held for sale totaled $340,572 and $378,386, respectively.

On December 29, 2000, Hann sold $190,000 of operating leases in a sale-leaseback transaction. An additional $45,645, recorded as lease financing receivables, is held by Hann as collateral in the transaction. Under the structure of the sale of the automobile leases, Hann sells the ownership of the automobiles and leases the vehicles back from the investors in a sale-leaseback transaction.

The original term of the leaseback transaction is approximately eight years with an early buyout option on January 14, 2007. The difference in lease payments received from the consumer and paid to the investor, net of amortized costs, is recognized in vehicle origination and servicing fees on the statements of income.

Listed below are Hann’s minimum future lease payments under this arrangement.


2006	$	30,035
2007		27,722
2008		30,313
2009		5,869
Subsequent years		0

	$	93,939

Substantially all of Susquehanna’s loans and leases are to enterprises and individuals in its market area. There is no concentration of loans to borrowers in any one industry, or related industries, that exceeds 10% of total loans.

Management performs quarterly reviews of Susquehanna’s commercial loans greater than $250 to identify impaired loans. The measurement of impaired loans is based upon the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral- dependent loans are measured for impairment based on the net realizable value of the collateral.

An analysis of impaired loans at December 31, 2005, 2004, and 2003, is presented as follows:


	2005		2004		2003
Impaired loans without a related reserve	$	1,731	$	3,024	$	2,232
Impaired loans with a reserve		2,066		3,687		7,423

Total impaired loans	$	3,797	$	6,711	$	9,655

Reserve for impaired loans	$	1,312	$	1,194	$	1,657
Average balance of impaired loans	$	4,450	$	7,946	$	8,089
Interest income on impaired loans (cash basis)	$	159	$	104	$	54
Interest income that would have been recorded under original terms	$	313	$	1,094	$	757

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

6. Allowance for Loan and Lease Losses

Changes in the allowance for loan and lease losses were as follows:


	2005			2004			2003
Balance - January 1,	$	54,093		$	42,672		$	39,671
Additions through acquisition		0			9,149			0
Provision charged to operating expense		12,335			10,020			10,222
Charge-offs		(18,355	)		(10,859	)		(10,110	)
Recoveries		5,641			3,111			2,889

Net charge-offs		(12,714	)		(7,748	)		(7,221	)

Balance - December 31,	$	53,714		$	54,093		$	42,672

7. Premises and Equipment

Property, buildings, and equipment at December 31, were as follows:


	2005		2004
Land	$	12,627	$	12,810
Buildings		67,150		66,136
Furniture and equipment		76,733		64,538
Leasehold improvements		17,972		15,437
Land improvements		1,201		1,097

		175,683		160,018
Less: accumulated depreciation and amortization		87,625		76,412

	$	88,058	$	83,606

Depreciation and amortization expense charged to operations totaled $8,638 in 2005, $7,892 in 2004, and $7,087 in 2003.

All subsidiaries lease certain banking branches and equipment under operating leases that expire on various dates through 2030. Renewal options are available for periods up to 20 years. Minimum future rental commitments under non-cancelable leases, as of December 31, 2005, were as follows:


	Operating Leases
2006	$	7,717
2007		6,650
2008		5,935
2009		5,153
2010		4,426
Subsequent years		34,392

	$	64,273

Total rent expense charged to operations totaled $7,769 in 2005, $7,201 in 2004, and $5,997 in 2003.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

8. Goodwill and Other Intangible Assets

The gross carrying amounts and accumulated amortization of identifiable intangible assets as of December 31, 2005 and 2004 were as follows:


	December 31, 2005					December 31, 2004
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Amortizing intangible assets:
Core deposit intangibles	$	13,991	$	(4,556	)	$	13,991	$	(3,193	)
Customer lists		2,219		(185	)		1,085		(44	)
Favorable lease adjustments		393		(288	)		393		(272	)

Total	$	16,603	$	(5,029	)	$	15,469	$	(3,509	)

In 2005, $1,326 was recorded as a customer list intangible relating to the Brandywine acquisition and is being amortized over 15 years. In 2004, as a result of the Patriot acquisition, $7,976 was recognized as a core deposit intangible which is being amortized over 10 years. Also, $1,085 was assigned to customer list intangibles and is being amortized over 5 and 10 years.

The following is the activity in the goodwill account during the periods presented:


Goodwill at January 1, 2004	$	59,123
Goodwill acquired through the Patriot acquisition, deemed to be non-tax deductible		181,509

Goodwill at December 31, 2004		240,632
Goodwill acquired through the Brandywine acquisition, deemed to be tax deductible		1,901
Additional goodwill related to contingent earn-out agreement associated with the Patriot acquisition		185

Goodwill at December 31, 2005	$	242,718

The following table sets forth the actual and estimated pre-tax amortization expense of amortizing intangible assets.


Aggregate Amortization Expense for the Year Ended December 31:
2005	$	1,520
Estimated Amortization Expense for the Year Ended December 31:
2006	$	1,541
2007		1,541
2008		1,541
2009		1,315
2010		1,311

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

9. Deposits

Deposits at December 31 were as follows:


	2005		2004
Noninterest-bearing:
Demand	$	918,854	$	853,411
Interest-bearing:
Interest-bearing demand		1,774,759		1,765,077
Savings		458,906		559,530
Time		1,381,959		1,366,214
Time of $100 or more		774,709		586,450

Total deposits	$	5,309,187	$	5,130,682

10. Borrowings

Short-Term Borrowings

Short-term borrowings and weighted-average interest rates, at December 31, were as follows:


	2005				2004				2003
	Amount		Rate		Amount		Rate		Amount		Rate
Securities sold under repurchase agreements	$	206,502	2.20	%	$	307,765	1.52	%	$	295,512	0.90	%
Federal funds purchased		96,200	4.14			108,600	2.35			55,250	1.11
Treasury tax and loan notes		4,821	4.00			4,503	2.00			4,422	0.75

	$	307,523			$	420,868			$	355,184

Securities sold under agreements to repurchase are classified as secured short-term borrowings. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The securities underlying the repurchase agreements remain in available-for-sale investment securities.

Additional information pertaining to securities sold under repurchase agreements follows:


	2005			2004			2003
Average amounts outstanding	$	270,154		$	301,344		$	290,603
Average interest rate		2.25	%		1.05	%		0.92	%
Maximum amount outstanding at any month end	$	309,418		$	362,514		$	368,775

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Federal Home Loan Bank Borrowings


December 31,	2005		2004
Due 2005, 2.04% to 2.44%	$	0	$	240,000
Due 2006, 2.49% to 6.65%		46,976		92,121
Due 2007, 2.44% to 6.20%		60,149		10,165
Due 2008, 3.515% to 5.50%		214,527		152,214
Due 2009, 5.34%		0		3,000
Due 2010, 4.02% to 6.17%		235,474		152,530
Due 2011, 3.25% to 5.33%		61,384		96,687
Due 2012 through 2021, 3.25% to 6.51%		50,156		4,503

	$	668,666	$	751,220

Susquehanna subsidiary banks are members of the Federal Home Loan Banks of Atlanta, New York, and Pittsburgh and, as such, can take advantage of FHLB programs for overnight and term advances at published daily rates. Under the terms of a blanket collateral agreement, advances from FHLBs are collateralized by qualifying first mortgages. In addition, all of the subsidiaries’ stock in the FHLBs is pledged as collateral for such debt. Advances available under these agreements are limited by available and qualifying collateral and the amount of FHLB stock held by the borrower.

Under this program, Susquehanna subsidiary banks had lines of credit available to them totaling $1,728,604 and $1,404,436, of which $662,347 and $739,602 was outstanding at December 31, 2005 and 2004, respectively. At December 31, 2005, Susquehanna subsidiaries could have borrowed an additional $656,641 based on qualifying collateral, and $409,616 more could be borrowed provided that additional collateral would have been pledged. Such additional borrowings would require the subsidiaries to increase their investment in FHLB stock by approximately $31,703.

Long-Term Debt (1)


	2005				2004
	Amount		Rate		Amount		Rate
Subordinated notes due February 1, 2005	$	0	—	%	$	50,000	9.00	%
Subordinated notes due November 1, 2012		75,000	6.05			75,000	6.05
Subordinated notes due May 2014		75,000	4.75			75,000	4.75
Junior subordinated notes callable 2007		22,777	6.59	(2)		23,277	6.04	(2)

	$	172,777			$	223,277

(1)	The notes require interest-only payments throughout their term with the entire principal balance paid at maturity.

(2)	Reflects the effect of purchase accounting adjustments.

Subordinated Notes due May 2014

On May 3, 2004, Susquehanna completed the private placement of $75,000 aggregate principal amount of 4.75% fixed rate/floating rate subordinated notes due May 1, 2014. Susquehanna used the net proceeds from the offering to fund the cash portion of the Patriot acquisition and the remaining balance to increase its liquidity and

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

capital position in anticipation of future growth and for general corporate purposes. The notes qualify as Tier 2 Capital under the capital guidelines established by the Federal Reserve Board and were offered and sold by Susquehanna to several initial purchasers, who then resold the notes only to “qualified institutional buyers” in accordance with Rule 144A of the Securities Act of 1933, as amended, and Regulation S.

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

On October 28, 2004, Susquehanna completed an exchange offer relating to these notes pursuant to which it exchanged all of the original note for an identical form of notes that were registered under the Securities Exchange Act of 1934, as amended.

Junior Subordinated Notes

As part of the Patriot acquisition, Susquehanna assumed $20,500 in junior subordinated debt issued to Patriot Capital Trust I and Patriot Capital Trust II. The aggregate fair value of this debt at the date of acquisition was $23,554. The $15,500 in debentures issued to Patriot Capital Trust I bear interest at 10.30% and are callable on or after July 1, 2007. If these debentures are not called, they must be redeemed upon maturity in 2027. The $5,000 in debentures issued to Patriot Capital Trust II bear interest at the 180-day LIBOR plus 3.70%, and the rate at December 31, 2005 was 7.06%. The debentures are callable on any April 22 or October 22 after April 22, 2007. If these debentures are not called, they must be redeemed upon maturity in 2032.

11. Income Taxes

The components of the provision for income taxes are as follows:


	2005			2004		2003
Current:
Federal	$	3,305		$	18,370	$	1,985
State		4,674			700		2,101

Total current		7,979			19,070		4,086

Deferred:
Federal		28,926			8,413		22,501
State		(4,030	)		1,883		144

Total deferred		24,896			10,296		22,645

Total income tax expense	$	32,875		$	29,366	$	26,731

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The provision for income taxes differs from the amount derived from applying the statutory income tax rate to income before income taxes as follows:


	2005					2004					2003
	Amount			Rate		Amount			Rate		Amount			Rate
Provision at statutory rates	$	39,353		35.00	%	$	34,841		35.00	%	$	31,186		35.00	%
Tax-advantaged income		(4,560	)	(4.06	)		(4,737	)	(4.76	)		(3,990	)	(4.48	)
Other, net		(1,918	)	(1.70	)		(738	)	(0.74	)		(465	)	(0.52	)

Total	$	32,875		29.24	%	$	29,366		29.50	%	$	26,731		30.00	%

As of December 31, 2005, Susquehanna had federal net operating loss carryforwards of $108,578 (net of projected 2005 utilization) which begin to expire in 2019, and state net operating loss carryforwards of $367,197 which begin to expire in 2009.

Accounting for income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax return. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The components of the net deferred tax asset/(liability) as of December 31 were as follows:


	2005			2004
Deferred tax assets:
Reserve for loan losses	$	20,295		$	16,601
Deferred directors fees		446			532
Deferred compensation		1,526			465
Nonaccrual loan interest		515			730
Amortization of market value purchase adjustments		0			7,496
Federal net operating losses		38,002			73,636
State net operating losses		21,481			17,210
State net operating loss valuation allowance		0			(2,940	)
Federal alternative minimum tax credit carryover		7,100			4,868
State alternative minimum tax credit carryover		1,181			486
Federal low-income housing tax credit carryover		3,714			2,803
Charitable contributions carryover		763			0
Post-retirement benefits		1,938			1,674
Unrealized investment securities losses		9,488			1,262
Unrealized (gain) loss on residual interest		(167	)		373
Unrealized (gain) loss on cash flow hedges		(915	)		0
Other assets		197			81

Total deferred tax assets		105,564			125,277

Deferred tax liabilities:
Prepaid pension expense		(6,217	)		(4,722	)
Amortization of market value purchase adjustments		(87	)		0
Deferred loan costs		(4,959	)		(3,457	)
FHLB stock dividends		(370	)		(372	)
Premises and equipment		(2,819	)		(3,620	)
Operating lease income, net		(142,000	)		(149,588	)
Deferred gain on sale of leases		(80,640	)		(77,494	)
Other liabilities		(261	)		(74	)
Total deferred tax liabilities		(237,353	)		(239,327	)

Net deferred liability	$	(131,789	)	$	(114,050	)

12. Financial Instruments with Off-balance Sheet Risk

Susquehanna is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to originate loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of condition. The contract or notional amount of those instruments reflects the extent of involvement Susquehanna has in particular classes of financial instruments.

Susquehanna’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the contractual amount of these instruments. Susquehanna uses the same credit policies for these instruments as it does for on-balance sheet instruments.

Standby letters of credit are conditional commitments issued by Susquehanna to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment does not necessarily represent future cash requirements. Susquehanna evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Susquehanna upon extension of credit, is based upon management’s credit evaluation of the borrower.

Financial instruments whose contractual amounts represent off-balance sheet credit risk at December 31, 2005 and 2004, were as follows:


	2005		2004
Standby letters of credit	$	143,078	$	124,840
Real estate commitments		620,430		644,320
Unused portion of home equity lines		335,791		380,557
Commercial commitments		440,906		416,295

13. Contingent Liabilities

There are no material proceedings to which Susquehanna or any of our subsidiaries are a party or by which, to Susquehanna’s knowledge, we, or any subsidiaries, are threatened. All legal proceedings presently pending or threatened against Susquehanna or our subsidiaries involve routine litigation incidental to the business of Susquehanna or the subsidiary involved and are not material in respect to the amount in controversy.

Susquehanna, from time-to-time and in the ordinary course of business, enters into guarantees of certain financial obligations. The total amounts outstanding at December 31,2005 and 2004, respectively, on those guarantees were $11,492 and $14,688.

14. Capital Adequacy

Risk-based capital ratios, based upon guidelines adopted by bank regulators in 1989, focus upon credit risk. Assets and certain off-balance sheet items are segmented into one of four broad-risk categories and weighted according to the relative percentage of credit risk assigned by the regulatory authorities. Off-balance sheet instruments are converted into a balance sheet credit equivalent before being assigned to one of the four risk-weight categories. To supplement the risk-based capital ratios, the regulators issued a minimum leverage ratio guideline (Tier 1 capital as a percentage of average assets less excludable intangibles).

Capital elements are segmented into two tiers. Tier 1 capital represents shareholders’ equity plus the 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 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.”

The following table illustrates these capital ratios for each banking subsidiary and Susquehanna on a consolidated basis. 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.

On January 21, 2005, Susquehanna merged two of its subsidiary banks, First Susquehanna Bank and Trust and WNB Bank into its Susquehanna Bank PA subsidiary. On April 15, 2005, Susquehanna merged three of its

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

subsidiary banks, Susquehanna Bank, Citizens Bank of Southern Pennsylvania, and First American Bank of Pennsylvania, into its Farmers & Merchants Bank subsidiary, which subsequently changed it name to Susquehanna Bank.


At December 31, 2005	Tier I Capital Ratio (A)		Total Capital Ratio (B)		Leverage Ratio (C)
Minimum Required Ratio	4.00	%	8.00	%	4.00	%
Susquehanna Bank PA	10.83		11.75		9.36
Susquehanna Patriot Bank	8.79		11.04		7.25
Susquehanna Bank	9.01		10.99		7.83
Total Susquehanna	8.53	%	11.61	%	7.77	%

(A)

Tier I capital divided by year-end risk-adjusted assets, as defined by the risk-based capital guidelines.

(B)

Total capital divided by year-end risk-adjusted assets.

(C)

Tier I capital divided by average total assets less disallowed intangible assets.


At December 31, 2004	Tier I Capital Ratio (A)		Total Capital Ratio (B)		Leverage Ratio (C)
Minimum Required Ratio	4.00	%	8.00	%	4.00	%
Citizens Bank of Southern Pennsylvania	10.86		12.11		7.37
Equity Bank	8.36		10.70		6.66
Susquehanna Bank PA	9.65		10.58		8.41
Farmers & Merchants Bank and Trust	8.40		11.82		6.44
First American Bank of Pennsylvania	10.63		11.39		8.78
First Susquehanna Bank & Trust	10.26		11.04		7.53
Susquehanna Bank	7.46		10.52		6.83
WNB Bank	12.29		13.53		9.60
Total Susquehanna	8.13	%	11.30	%	7.30	%

(A)

Tier I capital divided by year-end risk-adjusted assets, as defined by the risk-based capital guidelines.

(B)

Total capital divided by year-end risk-adjusted assets.

(C)

Tier I capital divided by average total assets less disallowed intangible assets.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

15. Benefit Plans

Pension Plan and Other Postretirement Benefits

Susquehanna maintains a single non-contributory pension plan that covers substantially all full-time employees. In addition, Susquehanna offers life insurance and other benefits to its retirees. A summary of the plans at December 31, is as follows:


	Pension Benefits									Other Benefits
	2005			2004			2003			2005			2004			2003
Change in Projected Benefit Obligation
Projected Benefit obligation at beginning of year	$	66,781		$	57,345		$	50,466		$	5,916		$	4,368		$	4,469
Service cost (excluding administrative expenses)		3,549			2,896			2,242			354			305			191
Interest cost		3,833			3,556			3,349			348			323			257
Plan participants’ contributions		0			0			0			230			194			206
Change in plan provisions		0			1,821			0			0			0			0
Actuarial (gain) loss		1,137			4,076			3,716			240			1,148			(348	)
Benefits paid		(2,621	)		(2,913	)		(2,428	)		(453	)		(422	)		(407	)
Curtailments/settlements		0			0			0			0			0			0

Projected benefit obligation at end of year	$	72,679		$	66,781		$	57,345		$	6,635		$	5,916		$	4,368

Change in Plan Assets
Fair value of plan assets at beginning of year	$	63,656		$	53,069		$	44,521		$	0		$	0		$	0
Actual return on plan assets		3,270			5,522			7,554			0			0			0
Employer contributions		6,120			8,120			3,620			223	*		228	*		201	*
Expenses		0			(142	)		(198	)		0			0			0
Plan participants’ contributions		0			0			0			230			194			206
Benefits paid		(2,620	)		(2,913	)		(2,428	)		(453	)		(422	)		(407	)

Fair value of plan assets at end of year	$	70,426		$	63,656		$	53,069		$	0		$	0		$	0


* Cash contributions made to providers, insurers, trusts, or participants for payment of claims.

Net Amount Recognized
Funded status	$	(2,253	)	$	(3,125	)	$	(4,276	)	$	(6,635	)	$	(5,916	)	$	(4,368	)
Unrecognized net actuarial (gain) loss		15,896			13,426			10,673			441			202			(946	)
Unrecognized prior service cost		869			811			(1,065	)		172			220			268
Unrecognized transition obligation (asset)		(75	)		(142	)		(210	)		799			912			1,025

Prepaid/(accrued) benefit cost	$	14,437		$	10,970		$	5,122		$	(5,223	)	$	(4,582	)	$	(4,021	)

Amounts Recognized in the Statement of Financial Position
Prepaid benefit cost	$	16,188		$	12,406
Accrued benefit liability		(2,599	)		(2,544	)
Deferred costs related to plan amendments		848			1,108

Net amount recognized	$	14,437		$	10,970

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The accumulated benefit obligation for the defined pension benefits plan was $68,756 and $64,575 at December 31, 2005 and 2004, respectively.

Components of Net Periodic Benefit Cost


	Pension Benefits									Other Benefits
	2005			2004			2003			2005		2004		2003
Service cost	$	3,548		$	2,897		$	2,243		$	354	$	305	$	192
Interest cost		3,834			3,556			3,349			348		323		257
Expected return on plan assets		(5,309	)		(4,413	)		(3,914	)		0		0		0
Amortization of prior service cost		(58	)		(57	)		(235	)		48		48		48
Amortization of transition obligation (asset)		(68	)		(68	)		(68	)		113		113		113
Amortization of net actuarial (gain) or loss		706			357			540			0		0		(49	)

Net periodic benefit cost	$	2,653		$	2,272		$	1,915		$	863	$	789	$	561

Additional Information

The weighted average assumptions used in the actuarial computation of the plans’ benefit obligations were as follows:


	Pension Benefits						Other Benefits
	2005		2004		2003		2005		2004		2003
Discount rate	5.75	%	5.75	%	6.25	%	5.75	%	5.75	%	6.25	%
Rate of compensation increase	3.25	%	3.25	%	3.75	%	N/A		N/A		N/A

The weighted average assumptions used in the actuarial computation of the plans’ net periodic cost were as follows:


Discount rate	5.75	%	6.25	%	6.75	%	5.75	%	6.25	%	6.75	%
Expected return on plan assets	8.50	%	8.50	%	9.00	%	N/A		N/A		N/A
Rate of compensation increase	3.25	%	3.75	%	4.50	%	N/A		N/A		N/A

The expected long-term rate of return was estimated using market benchmarks for equities and bonds applied to the defined pension benefit plan’s target asset allocation. The expected return on equities was computed using a valuation methodology, which projected future returns based on current equity valuations while looking at historical returns, as well. Due to active management of the plan’s assets, the return on the equity investments of the plan historically has exceeded general market returns. Management estimated the rate by which the plan’s assets would perform to the market in the future looking at historical performance and adjusting for changes in the asset allocations.

For the plan year ending December 31, 2006, expected employer contributions to the pension benefit and other benefit plans are $2,821 and $247, respectively; and, for the same year, expected employee contributions are $0 and $224, respectively. The 2006 plan assumptions used to determine net periodic cost will be a discount rate of 5.75% and an expected long-term return on plan assets of 8.50%. The assumed discount rate was determined by matching Susquehanna’s projected pension payments to high quality Aa bonds of similar duration. The payment projections used a seventy-five year payout projection.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

The investment objective of the pension plan is to maximize total return by emphasizing growth at a reasonable price. The plan’s equity portfolio consists primarily of large-cap stocks. Equity investments are diversified and sector weighted. Industry growth prospects and economic sentiment are major considerations in the investment process, but risk reduction is achieved through diversification and active portfolio management. In June 2005, the plan sold all of its holdings of Susquehanna Bancshares common stock (66 shares). At December 31, 2004, the plan assets included 64 shares of Susquehanna common stock.

The pension plan’s debt securities portfolio consists of bonds rated A or higher at the time of purchase. The current portfolio consists primarily of U.S. Treasuries and agency securities, high quality corporates and money market investments. A credit analysis is conducted to ensure that the appropriate liquidity, industry diversification, safety, maximum yield and minimum risk are achieved. A laddered approach to maturity distribution is taken depending on market conditions, but is primarily limited to ten years or less.

The target and actual allocations expressed as a percentage of the plan’s assets are presented as follows:


For the year ended	Target 2006		2005		2004
Equity securities	40-60	%	59	%	55	%
Debt securities	40-60	%	41	%	45	%

Total			100	%	100	%

The assumed health care trend rates used to determine the benefit obligation for the other benefit plans are as follows:


For the year ended	2005		2004
Health care cost trend rate	8.50	%	8.50	%
Ultimate rate	5.00	%	5.00	%
Year that the ultimate rate is reached	2012		2012

The impact of one-percentage-point change in assumed health care cost trend rates is as follows:


	Increase		Decrease
Effect on service cost plus interest cost components of net periodic postretirement benefit cost	$	19	$	(16	)
Effect on benefit obligation as of December 31, 2005	$	173	$	(152	)

Estimated aggregate future benefit payments for pension and other benefits, which reflect expected future service, as appropriate, are as follows:


2006	$	3,293
2007		3,429
2008		3,458
2009		3,646
2010		3,851
Year 2011-2015		24,918

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

401(k) Plan

Susquehanna maintains a 401(k) savings plan which allows employees to invest a percentage of their earnings, matched up to a certain amount specified by Susquehanna. Contributions to the savings plan, which are included in salaries and benefits expense, amounted to $2,141 in 2005, $1,937 in 2004, and $1,606 in 2003.

Stock-based Compensation

Susquehanna offers an Employee Stock Purchase Plan (“ESPP”) that allows employees to purchase Susquehanna common stock up to 5% of their salary at a discount to the market price, through payroll deductions.

On December 16, 1998, Susquehanna acquired Cardinal Bancorp, Inc. (“Cardinal”), a Pennsylvania bank holding company. Cardinal, prior to the merger with Susquehanna, had issued 135.1 Stock Purchase Options to the members of Cardinal’s board of directors. Susquehanna succeeded Cardinal as a party to the options as a result of the merger. The option prices ranged from a low of $6.483 to a high of $10.25.

On June 10, 2004, Susquehanna acquired Patriot Bank Corp. Patriot, prior to the merger with Susquehanna, had 41.9 Stock Purchase Options outstanding. Susquehanna succeeded Patriot as a party to the options as a result of the merger. The option prices range from a low of $5.74 to a high of $11.98.

Susquehanna implemented an Equity Compensation Plan (“Compensation Plan”) in 1996 under which Susquehanna may grant options to its employees and directors for up to 2,462.5 shares of common stock. Under the Compensation Plan, the exercise price of each nonqualified option equals the market price of the company’s stock on the date of grant, and an option’s maximum term is ten years. Options are granted upon approval of the Board of Directors and typically vest one-third at the end of years three, four and five. The option prices range from a low of $13.00 to a high of $25.47. This Compensation Plan expires in 2006.

In May 2005, Susquehanna’s shareholders approved the 2005 Equity Compensation Plan (“the 2005 Plan”). Subject to adjustment in certain circumstances, the 2005 Plan authorized up to 2,000 shares of common stock for issuance. Incentives under the 2005 Plan consist of incentive stock options, non-qualified stock options, restricted stock grants, restricted stock unit grants, and stock appreciation rights. The exercise price of any stock option granted under the 2005 Plan will be the fair market value of such stock on the date that option is granted, and the exercise period may not exceed ten years.

On December 14, 2005, the Board or Directors of Susquehanna approved the accelerated vesting, effective as of December 15, 2005, of all unvested stock options granted to employees and directors in 2002 and 2004. The decision to accelerate the vesting of these options was made primarily to reduce non-cash compensation expense that would have been recorded in Susquehanna’s income statement in future periods as a result of the adoption of FAS No. 123(R), “Share-Based Payment,” in January 2006. Susquehanna estimates that, as a result of this action, approximately $435 of compensation expense will have been eliminated in 2006, approximately $316 of compensation expense will have been eliminated in 2007, approximately $200 of compensation expense will have been eliminated in 2008, and approximately $24 of compensation expense will have been eliminated in 2009. As a result of the accelerated vesting of these options, compensation expense totaling approximately $107 is included in Susquehanna’s results of operations for 2005, and options to purchase approximately 288 shares of Susquehanna’s common stock became exercisable immediately.

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

A summary of the status of Susquehanna’s stock option plan is presented below.


	2005				2004				2003
	Options		Weighted- average Exercise Price		Options		Weighted- average Exercise Price		Options		Weighted- average Exercise Price
Outstanding at beginning of year		1,751	$	19.86		1,820	$	18.78		1,736	$	17.56
Granted		151		24.95		142		25.16		288		22.42
Assumed through acquisition		0		0.00		42		9.44		0		0.00
Forfeited		29		22.30		13		22.94		29		19.46
Reinstated		0		0.00		13		13.31		0		0.00
Exercised		176		15.01		253		12.85		175		12.64

Outstanding at end of year		1,697	$	20.77		1,751	$	19.86		1,820	$	18.78

Options exercisable at year-end		1,367	$	20.62		880	$	18.12		791	$	17.78

Weighted-average fair value of options granted during the year	$	4.35			$	4.38			$	3.86

Information pertaining to options outstanding at December 31, 2005 is as follows:


	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number Outstanding	Weighted- average Remaining Contractual Life	Weighted- average Exercise Price		Number Exercisable	Weighted- average Exercise Price

$7.50 - $17.24	220	3.35	$	13.03	220	$	13.03
$17.25 - $18.25	492	4.01		17.75	427		17.83
$18.26 - $25.50	985	6.42		24.01	720		24.60

Outstanding at end of year	1,697	5.33	$	20.77	1,367	$	20.62

16. Earnings per Share

The following tables sets forth the calculation of basic and diluted earnings per share:


	2005					2004					2003
For the Year Ended December 31,	Income		Average Shares	Per Share Amount		Income		Average Shares	Per Share Amount		Income		Average Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	79,563	46,711	$	1.70	$	70,180	43,585	$	1.61	$	62,373	39,742	$	1.57
Effect of Diluted Securities:
Stock options outstanding			208		0.00			287		0.01			295		0.01

Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	79,563	46,919	$	1.70	$	70,180	43,872	$	1.60	$	62,373	40,037	$	1.56

100

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

For the years ended December 31, 2005, 2004, and 2003, average options to purchase 502, 140, and 220 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ exercise prices were greater than the average market price of the common shares; and the options were, therefore, antidilutive.

Note 17. Related Party Transactions

Certain directors and executive officers of Susquehanna and its affiliates, including their immediate families and companies in which they are principal owners (more than 10%), were indebted to banking subsidiaries. In the opinion of management, such loans are consistent with sound banking practices and are within applicable regulatory bank lending limitations and in compliance with applicable rules and regulations of the Securities and Exchange Commission. Susquehanna relies on the directors and executive officers for the identification of their associates.

The activity of loans to such persons whose balances exceeded $60 during 2005, 2004, and 2003 follows:


	2005			2004			2003
Balance - January 1	$	40,277		$	48,195		$	45,394
Additions		21,745			45,300			75,079
Deductions:
Amounts collected		20,193			37,502			72,427
Other changes		(22,819	)		(15,716	)		149

Balance - December 31	$	19,010		$	40,277		$	48,195

18. Regulatory Restrictions of Subsidiaries

Susquehanna is limited by regulatory provisions in the amount it can receive in dividends from its banking subsidiaries. Accordingly, at December 31, 2005, $44,000 was available for dividend distribution to Susquehanna in 2006 from its banking subsidiaries.

Included in cash and due from banks are balances required to be maintained by banking subsidiaries on deposit with the Federal Reserve. The amounts of such reserves are based on percentages of certain deposit types and totaled $35,100 at December 31, 2005 and $34,300 at December 31, 2004.

In accordance with certain lease and retail loan financing arrangements, Hann maintains prescribed amounts of cash in accounts with the respective financial institutions. The total of such amounts represents restricted cash of $26,336 and $27,200 at December 31, 2005 and 2004, respectively.

Under current Federal Reserve regulations, the banking subsidiaries are limited in the amount they may lend to the parent company and its nonbank subsidiaries. Loans to a single affiliate may not exceed 10%, and loans to all affiliates may not exceed 20% of the bank’s capital stock, surplus, and undivided profits plus the allowance for loan and lease losses. Loans from subsidiary banks to nonbank affiliates, including the parent company, are also required to be collateralized according to regulatory guidelines.

Susquehanna’s mortgage banking and broker/dealer subsidiaries are also required to maintain minimum net worth capital requirements with various governmental agencies. The mortgage banking subsidiary’s net worth requirements are governed by the Department of Housing and Urban Development, and the broker/dealer’s net worth requirements are governed by the United States Securities and Exchange Commission. As of December 31, 2005, these subsidiaries met their respective minimum net worth capital requirements.

101

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

19. Securitization Activity

Since 2001, Susquehanna has sold the beneficial interests in automobile leases in securitization transactions. In 2005, Susquehanna entered into a term securitization transaction in which it sold a portfolio of home equity line of credit loans. In all those securitizations, Susquehanna retained servicing responsibilities and subordinated interests. Susquehanna receives annual servicing fees and rights to future cash flows arising after the investors have received the return for which they contracted. Susquehanna enters into securitization transactions primarily to achieve low-cost funding for the growth of its loan portfolio and capital management.

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 loan and lease sales serviced by Susquehanna, including securitization transactions.


	As of December 31								For the Year Ended December 31
	Principal Balance				Loans and Leases Past Due 30 Days or More				Net Credit Losses (Recoveries)
	2005		2004		2005		2004		2005		2004
Loans and leases held in portfolio	$	5,218,659	$	5,253,008	$	80,592	$	77,053	$	12,714	$	7,748
Leases securitized		576,890		431,673		848		516		292		(9	)
Home equity lines of credit securitized		221,930		0		208		0		0		0
Leases serviced for others (1)		509,831		699,091		2,451		2,062		14		340

Total loans and leases serviced	$	6,527,310	$	6,383,772	$	84,099	$	79,631	$	13,020	$	8,079

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

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


Automobile Leases	Year Ended December 31
	2005		2004
Proceeds from securitizations	$	323,568	$	227,671
Amounts derecognized		372,488		246,698
Servicing fees received		7,985		4,251
Other cash flows received on retained interests		16,498		6,008


Home Equity Lines of Credit	Year Ended December 31
	2005		2004
Proceeds from securitizations	$	239,071	$	0
Amounts derecognized		239,766		0
Servicing fees received		127		0
Other cash flows received on retained interests		0		0

The following table sets forth 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 December 31, 2005 fair values to

102

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

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

As of December 31, 2005


Automobile Leases	Fair Value		Weighted- average Life (in months)	Monthly Prepayment Speed			Expected Cumulative Credit Losses (2)			Annual Discount Rate (1)
2005 transaction - Interest-Only Strip	$	1,423	15		2.90	%		0.00	%		3.94	%
Decline in fair value of 10% adverse change				$	22		$	0.00		$	1
Decline in fair value of 20% adverse change					37			0			2

2004 revolving transaction - Interest-Only Strip	$	443	25		3.00	%		0.00	%		4.85	%
Decline in fair value of 10% adverse change				$	2		$	0.00		$	4
Decline in fair value of 20% adverse change					4			0			8

2003 revolving transaction - Interest-Only Strip	$	915	17		2.00	%		0.00	%		4.84	%
Decline in fair value of 10% adverse change				$	0		$	0.00		$	6
Decline in fair value of 20% adverse change					0			0			12

2003 transaction - Interest-Only Strip	$	1,297	6		5.00	%		0.00	%		2.13	%
Decline in fair value of 10% adverse change				$	1		$	0.00		$	1
Decline in fair value of 20% adverse change					2			0			2


Home Equity Lines of Credit	Fair Value		Weighted- average Life (in months)	Constant Prepayment Rate			Expected Cumulative Credit Losses			Annual Discount Rate (1)
2005 transaction - Interest-Only Strips	$	7,258	32		45.00	%		0.15	%		6.50	%
Decline in fair value of 10% adverse change				$	491		$	46		$	0
Decline in fair value of 20% adverse change					908			93			0

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

(2)	The expected cumulative credit loss assumption is supported by historical credit loss experience.

20. Derivative Financial Instruments

Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS No. 133), as amended and interpreted, established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by FAS No. 133, Susquehanna records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

103

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Susquehanna’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, Susquehanna primarily uses interest rate swaps as part of its hedging strategy. During 2005, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt and a forecasted auto lease securitization. The derivatives were designated as cash flow hedges and the effective portion of changes in the fair value of the derivative was initially reported in accumulated other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. Susquehanna assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. At December 31, 2005, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, Susquehanna does not use derivatives for trading or speculative purposes.

At December 31, 2005, derivatives with a fair value of $2,638 were included in other assets, and derivatives with a fair value of $23 were included in other liabilities. The change in net unrealized gains/losses of $1,700 in 2005 for derivatives designated as cash flow hedges is separately disclosed in the statement of changes in shareholders’ equity. Hedge ineffectiveness was immaterial during 2005.

Amounts reported in accumulated other comprehensive income related to derivatives hedging the variability in cash flows associated with the forecasted sale of auto leases will be reclassified to gain on sale of loans and leases when the auto leases are sold, and amounts reported in accumulated other comprehensive income related to derivatives hedging forecasted interest payments will be reclassified to interest expense as interest payments are made on the variable-rate debt. During 2006, Susquehanna estimates that an additional $1,800 will be reclassified from other comprehensive income. As of December 31, 2005, Susquehanna is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of one month (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

21. Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties within active markets. This excludes the results under a forced liquidation scenario. Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. This is the most accurate way to determine fair values. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using the present value discounted cash flow models or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. As a result, Susquehanna’s ability to actually realize these derived values cannot be assured.

The following estimated fair values may vary significantly between institutions based on the estimates and assumptions used in the various valuation methodologies. The disclosure requirements exclude disclosure of nonfinancial assets such as buildings, as well as certain financial instruments such as leases.

Susquehanna also has several intangible assets which are not included in the fair value disclosures such as customer lists and core deposit intangibles. Accordingly, the aggregate estimated fair values presented do no represent the underlying value of Susquehanna. The following methods and assumptions were used to estimate the fair value of each class of financial instrument presented.

Cash and Due from Banks and Short-term Investments. The fair values of cash and due from banks and short-term investments are deemed to be the same as their carrying values.

104

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Investment Securities. The fair value of investment securities is estimated based on quoted market prices, where available. When quoted market prices are not available, fair values are based upon quoted market prices of comparable instruments.

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

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

Short-term Borrowings. The carrying amounts reported in the balance sheet represent a reasonable estimate of fair value since these liabilities mature in less than one year.

FHLB Borrowings and Long-Term Debt. Fair values were based upon quoted rates of similar instruments issued by banking companies with similar credit ratings.

Derivative Financial Instruments. Fair values for interest rate swap agreements are based upon the amounts required to settle the contracts.

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

The following table represents the carrying amount and estimated fair value of Susquehanna’s financial instruments at December 31:


	2005				2004
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Cash and due from banks	$	196,557	$	196,557	$	160,574	$	160,574
Short-term investments		96,284		96,284		58,734		58,734
Investment securities		1,154,261		1,154,261		1,245,414		1,245,414
Loans and leases, net of unearned income		5,218,659		5,193,337		5,253,008		5,266,536

Financial liabilities:
Deposits		5,309,187		5,103,408		5,130,682		5,152,074
Short-term borrowings		307,523		307,523		420,868		420,868
FHLB borrowings		668,666		664,444		751,220		779,912
Long-term debt		172,777		171,229		223,277		225,994

On-balance sheet derivative financial instruments:
Cash flow hedges		2,615		2,615		0		0

105

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

22. Condensed Financial Statements of Parent Company

Financial information pertaining only to Susquehanna Bancshares, Inc. is as follows:

Balance Sheets


	December 31,
	2005		2004
Assets
Cash in subsidiary banks	$	1,347	$	496
Investments in and receivables from consolidated subsidiaries		926,587		947,678
Other investment securities		4,315		1,487
Premises and equipment, net		4,352		3,354
Other assets		25,184		29,962

Total assets	$	961,785	$	982,977

Liabilities and Shareholder’s Equity
Long-term debt	$	150,000	$	200,000
Junior subordinated debentures		22,777		23,277
Other liabilities		8,538		8,006

Total liabilities		181,315		231,283
Shareholders’ equity		780,470		751,694

Total liabilities and shareholders’ equity	$	961,785	$	982,977

Statements of Income


	Years Ended December 31,
	2005		2004			2003
Income:
Dividends from bank subsidiaries	$	48,500	$	66,500		$	17,300
Dividends from nonbank subsidiaries		6,733		2,400			3,530
Interest, dividends and gains on sales of investment securities		43		42			41
Interest and management fees from bank subsidiaries		43,944		39,951			37,676
Interest and management fees from non bank subsidiaries		2,059		2,012			2,029
Miscellaneous		3,051		1,241			634

Total income		104,330		112,146			61,210

Expenses:
Interest		10,251		12,943			9,445
Other		55,431		46,819			41,294

Total expenses		65,682		59,762			50,739

Income before taxes, and equity in undistributed income of subsidiaries		38,648		52,384			10,471
Income tax provision (benefit)		5,872		(1,861	)		(1,122	)
Equity in undistributed net income of subsidiaries		46,787		15,935			50,780

Net Income	$	79,563	$	70,180		$	62,373

106

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Statements of Cash Flows


	Years Ended December 31,
	2005			2004			2003
Cash Flows from Operating Activities:
Net income	$	79,563		$	70,180		$	62,373
Adjustment to reconcile net income to cash provided by operating activities:
Depreciation and amortization		2,811			2,151			2,002
Realized (gain) loss on sale of available for sale securities		0			2			0
Equity in undistributed net income of subsidiaries		(46,787	)		(15,935	)		(50,780	)
Decrease (increase) in other assets		3,534			(11,742	)		(1,717	)
Increase (decrease) in accrued expenses payable		253			(401	)		(3,266	)
Other, net		(3,368	)		347			(1,504	)

Net cash provided by operating activities		36,006			44,602			7,108

Cash Flows from Investing Activities:
Purchase of investment securities		(2,842	)		(1,500	)		(2,899	)
Proceeds from the sale/maturities of investment securities		0			1,498			774
Capital expenditures		(2,190	)		(1,579	)		(442	)
Net investment in subsidiaries		61,500			(41,422	)		60,850
Acquisitions		(3,412	)		(42,513	)		0

Net cash (used in) provided by investing activities		53,056			(85,516	)		58,283

Cash Flows from Financing Activities:
Proceeds from issuance of common stock		5,221			5,351			3,852
Proceeds from issuance of long-term debt		0			74,356			0
Repayment of long-term debt		(50,000	)		0			(35,000	)
Dividends paid		(43,432	)		(38,471	)		(34,167	)

Net cash (used in) provided by financing activities		(88,211	)		41,236			(65,315	)

Net increase (decrease) in cash and cash equivalents		851			322			76
Cash and cash equivalents at January 1,		496			174			98

Cash and cash equivalents at December 31,	$	1,347		$	496		$	174

107

Notes to Consolidated Financial Statements—(Continued)

Years Ended December 31, 2005, 2004, and 2003

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

Note 23. Summary of Quarterly Financial Data (Unaudited)

The unaudited quarterly results of consolidated operations for the years ended December 31, 2005 and 2004, are as follows:


	2005
Quarter Ended	Mar 31		Jun 30		Sep 30		Dec 31
Interest income	$	91,902	$	93,524	$	98,938	$	102,658
Interest expense		32,490		33,622		38,232		40,433

Net interest income		59,412		59,902		60,706		62,225
Provision for loan and lease losses		2,750		2,480		3,215		3,890

Net interest income after provision for loan and lease losses		56,662		57,422		57,491		58,335
Non-interest income		27,970		30,223		27,176		39,708
Non-interest expense		62,080		60,037		58,548		61,884

Income before income taxes		22,552		27,608		26,119		36,159
Applicable income taxes		7,149		8,902		8,358		8,466

Net income	$	15,403	$	18,706	$	17,761	$	27,693

Earnings per common share:
Basic	$	0.33	$	0.40	$	0.38	$	0.59
Diluted		0.33		0.40		0.38		0.59

	2004
Quarter Ended	Mar 31		Jun 30		Sep 30		Dec 31
Interest income	$	69,587	$	74,194	$	87,448	$	90,530
Interest expense		22,906		24,840		29,036		30,960

Net interest income		46,681		49,354		58,412		59,570
Provision for loan and lease losses		1,700		2,107		2,783		3,430

Net interest income after provision for loan and lease losses		44,981		47,247		55,629		56,140
Non-interest income		27,074		27,354		30,122		30,040
Non-interest expense		49,303		51,361		59,502		58,875

Income before income taxes		22,752		23,240		26,249		27,305
Applicable income taxes		6,826		6,742		7,743		8,056

Net income	$	15,926	$	16,498	$	18,506	$	19,249

Earnings per common share:
Basic	$	0.40	$	0.40	$	0.40	$	0.41
Diluted		0.40		0.40		0.40		0.41

108

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS and REPORT

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Susquehanna Bancshares, Inc. (the Company) is responsible for the preparation of the Company’s consolidated financial statements and related information as they appear in this report Management believes that the consolidated financial statements of Susquehanna Bancshares, Inc. fairly reflect the form and substance of transactions and that the financial statements present the Company’s financial position and results of operations in conformity with generally accepted accounting principles. Management also has included in the Company’s financial statements amounts that are based on estimates and judgments which it believes are reasonable under the circumstances.

The independent registered public accounting firm of PricewaterhouseCoopers LLP audits the Company’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).

The Board of Directors of the Company has an Audit Committee composed of four non-management Directors. The Committee meets periodically with financial management, the internal auditors and the independent registered public accounting firm to review accounting, control, auditing, corporate governance and financial reporting matters.

Management of Susquehanna Bancshares., Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework inInternal Control—Integrated Framework,management concluded that our internal control over financial reporting was effective as of December 31, 2005. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

March 14, 2006

109

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

of Susquehanna Bancshares, Inc.:

We have completed an integrated audit of Susquehanna Bancshares, Inc.’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005 and audits of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Susquehanna Bancshares, Inc. and its subsidiaries (“the Company”) at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control – Integrated Frameworkissued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

110

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers LLP

Washington DC

March 14, 2006

111

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There has been no change in Susquehanna’s principal accountants in over two years. There have been no disagreements with such principal accountants on any matters of accounting principles, practices, financial statement disclosure, auditing scope or procedures.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.Susquehanna has established disclosure controls and procedures to ensure that material information relating to the Susquehanna, including its consolidated subsidiaries, is made known to the officers who certify the Company’s financial reports and to other members of senior management and the Board of Directors.

We carried out an evaluation, under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the design and operating effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2005, Susquehanna’s disclosure controls and procedures are effective to ensure that the information required to be disclosed by Susquehanna in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

Management’s Report on Internal Control Over Financial Reporting.Management of Susquehanna Bancshares, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control – Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2005. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

Management’s Responsibility for Financial Statements and Report on Internal Control over Financial Reporting is included herein in Part II, Item 8, “Financial Statements and Supplementary Data.”

Changes in Internal Controls.There were no significant changes in Susquehanna’s internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation, including any significant deficiencies or material weaknesses in internal controls that would require corrective action.

Item 9B. Other Information

Not applicable.

112

PART III

Item 10. Directors and Executive Officers of Susquehanna

Certain portions of the information required by this Item will be included in the 2006 Proxy Statement in the Election of Directors section, the Corporate Governance section, the Director and Executive Officer Compensation section, and the Compliance with Section 16(a) of the Exchange Act section, each of which sections is incorporated herein by reference. The information concerning our executive officers required by this item is provided under the caption “Executive Officers” in Item 1, Part I of this Annual Report on Form 10-K.

Item 11. Executive Compensation

The information required by this Item will be included in the 2006 Proxy Statement in the Director and Executive Officer Compensation section, and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

The information required by this Item will be included in the 2006 Proxy Statement in the Principal Holders of Voting Securities and Holdings of Management section and the Director and Executive Officer Compensation – Equity Compensation Plan Information section, and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

The information required by this Item will be included in the 2006 Proxy Statement in the Certain Relationships and Related Transactions section, and is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

The information required by this Item will be included in the 2006 Proxy Statement in the Fees Billed by Independent Accountant to Susquehanna section, and is incorporated herein by reference.

113

PART IV

Item 15. Exhibits and Financial Statement Schedules

(a)	The following documents are filed as part of this report:

(1)

Financial Statements. See Item 8 of this report for the consolidated financial statements of Susquehanna and its subsidiaries (including the index to financial statements).

(2)

Financial Statement Schedules. Not Applicable.

(3)

Exhibits. A list of the Exhibits to this Form 10-K is set forth in (b) below.

(b)

Exhibits.

(2)

Plan of acquisition, reorganization, arrangement, liquidation or succession.

2.1

Agreement and Plan of Merger among Susquehanna, Susquehanna Patriot Bank and Minotola National Bank., dated as of November 12, 2005, is incorporated by reference to Annex A of Susquehanna’s Registration Statement on Form S-4, Registration No. 333-130414. Schedules to this Agreement are omitted. Pursuant to paragraph (2) of Item 601(b) of Regulation S-K, Susquehanna agrees to furnish a copy of such schedules to the SEC upon request.

(3) 3.1

Articles of Incorporation. Incorporated by reference to Susquehanna’s Registration Statement on Form S-4 (registration no. 33-53608) filed on October 22, 1992 and to Exhibit 3.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998.

3.2

By-laws are attached hereto as Exhibit 3.2.

(4)

Instruments defining the rights of security holders including indentures. The rights of the holders of Susquehanna’s Common Stock and the rights of Susquehanna’s note holders are contained in the following documents or instruments, which are incorporated herein by reference.

4.1

Form of Subordinated Note/Indenture incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-3, Registration No. 33-87624.

4.2

Indenture dated as of November 4, 2002 by and between Susquehanna and JP Morgan Trust Company, National Association, relating to the 6.05% subordinated notes due 2012, incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-4, Registration No. 333-102265.

4.3

Global Note relating to the 6.05% subordinated notes due 2012, dated February 27, 2003 is incorporated by reference to Exhibit 4.3 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

4.4

Registration Rights Agreement dated as of November 4, 2002 by and among Susquehanna and Keefe Bruyette & Woods Inc. and Sandler O’Neill Partners, L.P. is incorporated by reference to Exhibit 4.3 to Susquehanna’s Registration Statement on Form S-4, Registration Statement No. 333-102265.

4.5

First Supplemental Indenture, dated May 3, 2004, to Indenture dated November 4, 2002, by and between Susquehanna and J.P. Morgan Trust Company, National Association, relating to the 4.75% fixed rate/floating rate subordinated notes due 2014 is incorporated by reference to Exhibit 4.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.

4.6

Global Note to the 4.75% subordinated notes due 2014, dated May 3, 2004, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.

114

4.7

Registration Rights Agreement dated as of May 3, 2004 by and among Susquehanna and Keefe Bruyette & Woods Inc. and Sandler O’Neill Partners, L.P. is incorporated by reference to Exhibit 4.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.

(10)

Material Contracts.

10.1

Employment Agreement, dated March 25, 2005, between Susquehanna and William J. Reuter is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

10.2

Employment Agreement, dated March 25, 2005, between Susquehanna and Gregory A. Duncan is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

10.3

Employment Agreement, dated March 25, 2005, between Susquehanna and Drew K. Hostetter is incorporated by reference to Exhibit 10.3 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

10.4

Employment Agreement dated November 4, 2003, but effective as of January 1, 2004, between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr. is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. First Amendment to Employment Agreement dated January 18, 2005 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K filed January 21, 2005.*

10.5

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

10.6

Employment Agreement, dated March 25, 2005, between Susquehanna and James G. Pierné is incorporated by reference to Exhibit 10.4 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

10.7

Employment Agreement dated July 28, 2004 between Susquehanna Patriot Bank and David Swoyer is incorporated by reference to Exhibit 10.13 of Susquehanna’s Annual Report on Form 10-Q for the fiscal year ended December 31, 2004.*

10.8

Susquehanna’s Key Executive Incentive Plan 2005 Plan Summary, dated March 29, 2005, is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed April 4, 2005.*

10.9

Description of (i) the setting of base salaries for Susquehanna’s named executive officers for the year ended December 31, 2005, (ii) the awarding of discretionary cash bonus awards for Susquehanna’s named executive officers, (iii) the grants of non-qualified stock options under the Key Executive Incentive Plan long term incentive formula to Susquehanna’s named executive officers, and (iv) the discretionary grant of non-qualified stock options to members of Susquehanna’s board of directors, is incorporated by reference to Susquehanna’s Current Report on Form 8-K, filed February 18, 2005.*

10.10

Specific performance goals and bonuses criteria relating to executives participating in Susquehanna’s 2005 Key Executive Incentive Plan is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed June 3, 2005.*

10.11

Description of accelerated vesting of certain stock option grants is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K/A, filed December 22, 2005.

10.12

Contingent Earnings Agreement dated December 23, 1999 between Susquehanna, Valley Forge Asset Management Corp. and certain associated persons named therein, together with

115

Contingent Earnings Agreement Amendment No. 1, dated November 20, 2000, are incorporated by reference to Exhibit 10.20 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.*

10.13

Susquehanna’s Executive Deferred Income Plan, effective January 1, 1999, is incorporated by reference to Exhibit 10 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.*

10.14

Susquehanna’s Supplemental Executive Retirement Plan as amended and restated effective January 1, 1998 is incorporated by reference to Exhibit 10(iv) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Supplemental Executive Retirement Plan Amendment 2004-1, dated January 21, 2004, is incorporated by reference to Exhibit 10.5 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004.*

10.15

Forms of The Insurance Trust for Susquehanna Bancshares Banks and Affiliates Split Dollar Agreement and Split Dollar Policy Endorsement are incorporated by reference to Exhibit 10(v) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.*

10.16

Susquehanna’s Key Employee Severance Pay Plan, adopted in 1999 and amended on May 26, 2000 and on February 22, 2001, is incorporated by reference to Exhibit 10 of Susquehanna’s Annual Report on Form 10-K for fiscal year ended December 31, 1999 and to Exhibit 10(i) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.*

10.17

Descriptions of Executive Supplemental LTD Plan and Executive Life Insurance Policy are incorporated by reference to the descriptions of the same in Exhibit 10.19 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.*

10.18

Susquehanna’s 2005 Equity Compensation Plan is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005.*

10.19

Susquehanna’s Equity Compensation Plan is incorporated by reference to Exhibit 10.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005.*

10.20

The Stock Option Purchase of Cardinal Bancorp, Inc. effective April 13, 1993, the 1994 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 12, 1994, the 1995 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 11, 1995, the 1996 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 9, 1996, and the 1997 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 8, 1997 are incorporated by reference to Exhibits 99.1, 99.2, 99.3, 99.4 and 99.5, respectively, of Susquehanna’s Registration Statement on Form S-8, Registration No. 333-85655.

10.21

The Amended and Restated Patriot Bank Corp. 1996 Stock-Based Incentive Plan is incorporated by reference to Exhibit 99.1 of Susquehanna’s Registration Statement on Form S-8 (File No. 333-116346).*

10.22

The Patriot Bank Corp. 2002 Stock Option Plan is incorporated by reference to Exhibit 99.2 of Susquehanna’s Registration Statement on Form S-8 (File No. 333-116346).*

10.23

Directors’ Fee Schedule is incorporated by reference to Exhibit 10.18 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.*

10.24

Supplemental Retirement and Death Benefit Agreement, dated May 25, 2001, between Patriot Bank and James A. Bentley, Jr. is incorporated by reference by Exhibit 10.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.*

10.25

2002 Amended Servicing Agreement dated January 1, 2002 between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is

116

incorporated by reference to Exhibit 10(vi) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. First Amendment to the 2002 Amended Servicing Agreement dated April 25, 2002 is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. Second Amendment to the 2002 Servicing Agreement is incorporated by reference to Exhibit 10.6 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Third Amendment to the 2002 Amended Servicing Agreement dated as of April 1, 2003 by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. and Fourth Amendment to the 2002 Amended Servicing Agreement dated as of April 2, 2004 by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. are incorporated by reference to Exhibit 10.6 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. Fifth Amendment to the 2002 Amended Servicing Agreement by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is incorporated by reference to Exhibit 10.8 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005. Sixth Amendment to the 2002 Amended Servicing Agreement by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is attached hereto as Exhibit 10.25.

(14)

Code of Ethics

14.1

A copy of Susquehanna’s Code of Ethics is available on Susquehanna’s website at www.susquehanna.net. Click on “Investor Relations,” then “Governance Documents,” then “Code of Ethics of Susquehanna Bancshares, Inc.”

(21)

Subsidiaries of the registrant. Filed herewith.

(23)

Consent of PricewaterhouseCoopers LLP. Filed herewith.

(31)

Rule 13a-14(a)/15d-14(a) Certifications

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. Filed herewith.

*	Management contract or compensation plan or arrangement required to be filed or incorporated as an exhibit.

(c)	Financial Statement Schedule. None Required.

117

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

By:		/s/ WILLIAM J. REUTER
		William J. Reuter, President and Chief Executive Officer

Dated: March 14, 2006

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ WILLIAM J. REUTER (William J. Reuter)	President, Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer)	March 14, 2006

/s/ DREW K. HOSTETTER (Drew K. Hostetter)	Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)	March 14, 2006

/s/ CHLOÉ R. EICHELBERGER (Chloé R. Eichelberger)	Director	March 14, 2006

/s/ JAMES G. APPLE (James G. Apple)	Director	March 14, 2006

/s/ WAYNE E. ALTER, JR. (Wayne E. Alter, Jr.)	Director	March 14, 2006

/s/ JOHN M. DENLINGER (John M. Denlinger)	Director	March 14, 2006

/s/ OWEN O. FREEMAN, JR. (Owen O. Freeman, Jr.)	Director	March 14, 2006

/s/ HENRY H. GIBBEL (Henry H. Gibbel)	Director	March 14, 2006

/s/ WILLIAM B. ZIMMERMAN (William B. Zimmerman)	Director	March 14, 2006

/s/ T. MAX HALL (T. Max Hall)	Director	March 14, 2006

118

SECURITIES AND EXCHANGE COMMISSION

SUSQUEHANNA BANCSHARES, INC.

Form 10-K, December 31, 2005

[SIGNATURES CONTINUED]


Signature	Title	Date

/s/ M. ZEV ROSE (M. Zev Rose)	Director	March 14, 2006

/s/ E. SUSAN PIERSOL (E. Susan Piersol)	Director	March 14, 2006

/s/ GUY W. MILLER, JR. (Guy W. Miller, Jr.)	Director	March 14, 2006

/s/ ROGER V. WIEST (Roger V. Wiest)	Director	March 14, 2006

/s/ BRUCE A. HEPBURN (Bruce A. Hepburn)	Director	March 14, 2006

/s/ RUSSELL J. KUNKEL (Russell J. Kunkel)	Director	March 14, 2006

[END OF SIGNATURE PAGES]

119

EXHIBIT INDEX


Exhibit Numbers		Description and Method of Filing
(2)	Plan of acquisition, reorganization, arrangement, liquidation or succession.

	2.1	Agreement and Plan of Merger among Susquehanna, Susquehanna Patriot Bank and Minotola National Bank., dated as of November 12, 2005, is incorporated by reference to Annex A of Susquehanna’s Registration Statement on Form S-4, Registration No. 333-130414. Schedules to this Agreement are omitted. Pursuant to paragraph (2) of Item 601(b) of Regulation S-K, Susquehanna agrees to furnish a copy of such schedules to the SEC upon request.

(3)	3.1	Articles of Incorporation. Incorporated by reference to Susquehanna’s Registration Statement on Form S-4 (registration no. 33-53608) filed on October 22, 1992 and to Exhibit 3.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998.

	3.2	By-laws are attached hereto as Exhibit 3.2.

(4)	Instruments defining the rights of security holders including indentures. The rights of the holders of Susquehanna’s Common Stock and the rights of Susquehanna’s note holders are contained in the following documents or instruments, which are incorporated herein by reference.

	4.1	Form of Subordinated Note/Indenture incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-3, Registration No. 33-87624.

	4.2	Indenture dated as of November 4, 2002 by and between Susquehanna and JP Morgan Trust Company, National Association, relating to the 6.05% subordinated notes due 2012, incorporated by reference to Exhibit 4.1 to Susquehanna’s Registration Statement on Form S-4, Registration No. 333-102265.

	4.3	Global Note relating to the 6.05% subordinated notes due 2012, dated February 27, 2003 is incorporated by reference to Exhibit 4.3 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

	4.4	Registration Rights Agreement dated as of November 4, 2002 by and among Susquehanna and Keefe Bruyette & Woods Inc. and Sandler O’Neill Partners, L.P. is incorporated by reference to Exhibit 4.3 to Susquehanna’s Registration Statement on Form S-4, Registration Statement No. 333-102265.

	4.5	First Supplemental Indenture, dated May 3, 2004, to Indenture dated November 4, 2002, by and between Susquehanna and J.P. Morgan Trust Company, National Association, relating to the 4.75% fixed rate/floating rate subordinated notes due 2014 is incorporated by reference to Exhibit 4.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.

	4.6	Global Note to the 4.75% subordinated notes due 2014, dated May 3, 2004, is incorporated by reference to Exhibit 4.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.

	4.7	Registration Rights Agreement dated as of May 3, 2004 by and among Susquehanna and Keefe Bruyette & Woods Inc. and Sandler O’Neill Partners, L.P. is incorporated by reference to Exhibit 4.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.
(10)	Material Contracts.

	10.1	Employment Agreement, dated March 25, 2005, between Susquehanna and William J. Reuter is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

120


Exhibit Numbers		Description and Method of Filing
	10.2	Employment Agreement, dated March 25, 2005, between Susquehanna and Gregory A. Duncan is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

	10.3	Employment Agreement, dated March 25, 2005, between Susquehanna and Drew K. Hostetter is incorporated by reference to Exhibit 10.3 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

	10.4	Employment Agreement dated November 4, 2003, but effective as of January 1, 2004, between Susquehanna, Valley Forge Asset Management Corporation and Bernard A. Francis, Jr. is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. First Amendment to Employment Agreement dated January 18, 2005 is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K filed January 21, 2005.*

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

	10.6	Employment Agreement, dated March 25, 2005, between Susquehanna and James G. Pierné is incorporated by reference to Exhibit 10.4 of Susquehanna’s Current Report on Form 8-K, filed March 29, 2005.*

	10.7	Employment Agreement dated July 28, 2004 between Susquehanna Patriot Bank and David Swoyer is incorporated by reference to Exhibit 10.13 of Susquehanna’s Annual Report on Form 10-Q for the fiscal year ended December 31, 2004.*

	10.8	Susquehanna’s Key Executive Incentive Plan 2005 Plan Summary, dated March 29, 2005, is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed April 4, 2005.*

	10.9	Description of (i) the setting of base salaries for Susquehanna’s named executive officers for the year ended December 31, 2005, (ii) the awarding of discretionary cash bonus awards for Susquehanna’s named executive officers, (iii) the grants of non-qualified stock options under the Key Executive Incentive Plan long term incentive formula to Susquehanna’s named executive officers, and (iv) the discretionary grant of non-qualified stock options to members of Susquehanna’s board of directors, is incorporated by reference to Susquehanna’s Current Report on Form 8-K, filed February 18, 2005.*

	10.10	Specific performance goals and bonuses criteria relating to executives participating in Susquehanna’s 2005 Key Executive Incentive Plan is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed June 3, 2005.*

	10.11	Description of accelerated vesting of certain stock option grants is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K/A, filed December 22, 2005.

	10.12	Contingent Earnings Agreement dated December 23, 1999 between Susquehanna, Valley Forge Asset Management Corp. and certain associated persons named therein, together with Contingent Earnings Agreement Amendment No. 1, dated November 20, 2000, are incorporated by reference to Exhibit 10.20 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.*

	10.13	Susquehanna’s Executive Deferred Income Plan, effective January 1, 1999, is incorporated by reference to Exhibit 10 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.*

121


Exhibit Numbers		Description and Method of Filing
	10.14	Susquehanna’s Supplemental Executive Retirement Plan as amended and restated effective January 1, 1998 is incorporated by reference to Exhibit 10(iv) of Susquehanna’s
		Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Supplemental Executive Retirement Plan Amendment 2004-1, dated January 21, 2004, is incorporated by reference to Exhibit 10.5 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004.*

	10.15	Forms of The Insurance Trust for Susquehanna Bancshares Banks and Affiliates Split Dollar Agreement and Split Dollar Policy Endorsement are incorporated by reference to Exhibit 10(v) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.*

	10.16	Susquehanna’s Key Employee Severance Pay Plan, adopted in 1999 and amended on May 26, 2000 and on February 22, 2001, is incorporated by reference to Exhibit 10 of Susquehanna’s Annual Report on Form 10-K for fiscal year ended December 31, 1999 and to Exhibit 10(i) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.*

	10.17	Descriptions of Executive Supplemental LTD Plan and Executive Life Insurance Policy are incorporated by reference to the descriptions of the same in Exhibit 10.19 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.*

	10.18	Susquehanna’s 2005 Equity Compensation Plan is incorporated by reference to Exhibit 10.1 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005.*

	10.19	Susquehanna’s Equity Compensation Plan is incorporated by reference to Exhibit 10.2 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005.*

	10.20	The Stock Option Purchase of Cardinal Bancorp, Inc. effective April 13, 1993, the 1994 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 12, 1994, the 1995 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 11, 1995, the 1996 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 9, 1996, and the 1997 Stock Purchase Option of Cardinal Bancorp, Inc. effective April 8, 1997 are incorporated by reference to Exhibits 99.1, 99.2, 99.3, 99.4 and 99.5, respectively, of Susquehanna’s Registration Statement on Form S-8, Registration No. 333-85655.

	10.21	The Amended and Restated Patriot Bank Corp. 1996 Stock-Based Incentive Plan is incorporated by reference to Exhibit 99.1 of Susquehanna’s Registration Statement on Form S-8 (File No. 333-116346).*

	10.22	The Patriot Bank Corp. 2002 Stock Option Plan is incorporated by reference to Exhibit 99.2 of Susquehanna’s Registration Statement on Form S-8 (File No. 333-116346).*

	10.23	Directors’ Fee Schedule is incorporated by reference to Exhibit 10.18 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.*

	10.24	Supplemental Retirement and Death Benefit Agreement, dated May 25, 2001, between Patriot Bank and James A. Bentley, Jr. is incorporated by reference by Exhibit 10.3 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004.*

122


Exhibit Numbers		Description and Method of Filing
	10.25	2002 Amended Servicing Agreement dated January 1, 2002 between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. First Amendment to the 2002 Amended Servicing Agreement dated April 25, 2002 is incorporated by reference to Exhibit 10(vi) of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002. Second Amendment to the 2002 Servicing Agreement is incorporated by reference to Exhibit 10.6 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Third Amendment to the 2002 Amended Servicing Agreement dated as of April 1, 2003 by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. and Fourth Amendment to the 2002 Amended Servicing Agreement dated as of April 2, 2004 by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. are incorporated by reference to Exhibit 10.6 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004. Fifth Amendment to the 2002 Amended Servicing Agreement by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is incorporated by reference to Exhibit 10.8 of Susquehanna’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005. Sixth Amendment to the 2002 Amended Servicing Agreement by and between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is attached hereto as Exhibit 10.25.

(14)	Code of Ethics

	14.1	A copy of Susquehanna’s Code of Ethics is available on Susquehanna’s website atwww.susquehanna.net. Click on “Investor Relations,” then “Governance Documents,” then “Code of Ethics of Susquehanna Bancshares, Inc.”

(21)	Subsidiaries of the registrant. Filed herewith.

(23)	Consent of PricewaterhouseCoopers LLP. Filed herewith.

(31)	Rule 13a-14(a)/15d-14(a) Certifications

	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. Filed herewith.

*	Management contract or compensation plan or arrangement required to be filed or incorporated as an exhibit.

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Susquehanna Bancshares (SUSQ) Inactive 10-K2005 FY Annual report

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