Susquehanna Bancshares (SUSQ) 10-Q 2006 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2006

or

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

For the transition period from                            to                            

Commission File Number 0-10674

Susquehanna Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

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

Large Accelerated Filer  x                     Accelerated Filer  ¨                     Non-Accelerated Filer  ¨

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

Yes  ¨    No  x

As of April 20, 2006, there were 46,959,110 shares of the Registrant’s common stock outstanding, par value $2.00 per share.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS

PART I.	FINANCIAL INFORMATION
Item 1	Financial Statements
	Consolidated Balance Sheets – as of March 31, 2006 and 2005 (unaudited), and December 31, 2005	3
	Consolidated Statements of Income – for the three months ended March 31, 2006 and 2005 (unaudited)	4
	Consolidated Statements of Cash Flows - for the three months ended March 31, 2006 and 2005 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2006 and 2005 (unaudited)	7
	Notes to the Consolidated Financial Statements (unaudited)	8
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3	Quantitative and Qualitative Disclosures about Market Risk	24
Item 4	Controls and Procedures	31
PART II.	OTHER INFORMATION
Item 1	Legal Proceedings	33
Item 1A	Risk Factors	33
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 3	Defaults Upon Senior Securities	33
Item 4	Submission of Matters to a Vote of Security Holders	33
Item 5	Other Information	33
Item 6	Exhibits	33
SIGNATURES		34
EXHIBIT INDEX		35

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

	March 31 2006			December 31 2005			March 31 2005
	(in thousands, except share data)
Assets
Cash and due from banks	$	175,838		$	196,557		$	173,427
Unrestricted short-term investments		64,517			69,948			32,166
Cash and cash equivalents		240,355			266,505			205,593
Restricted short-term investments		27,979			26,336			27,045
Securities available for sale		1,204,698			1,147,862			1,227,119
Securities held to maturity (fair values approximate$6,330; $6,399; and $6,599)		6,330			6,399			6,599
Loans and leases, net of unearned income		5,042,755			5,218,659			4,990,889
Less: Allowance for loan and lease losses		53,999			53,714			53,127
Net loans and leases		4,988,756			5,164,945			4,937,762
Premises and equipment, net		88,862			88,058			87,729
Foreclosed assets		2,596			2,620			1,949
Accrued income receivable		25,491			24,223			22,799
Bank-owned life insurance		259,326			257,289			251,907
Goodwill		242,976			242,718			242,533
Intangible assets with finite lives		11,135			11,574			12,922
Investment in and receivables from unconsolidated entities		153,546			104,069			112,205
Other assets		126,017			123,409			117,134
	$	7,378,067		$	7,466,007		$	7,253,296
Liabilities and Shareholders’ Equity
Deposits:
Demand	$	902,816		$	918,854		$	870,302
Interest-bearing demand		1,755,688			1,774,759			1,680,066
Savings		449,310			458,906			565,449
Time		1,473,661			1,381,959			1,350,168
Time of $100 or more		774,141			774,709			640,080
Total deposits		5,355,616			5,309,187			5,106,065
Short-term borrowings		193,825			307,523			398,521
FHLB borrowings		622,674			668,666			625,393
Long-term debt		150,000			150,000			150,000
Junior subordinated debentures		22,647			22,777			23,196
Accrued interest, taxes, and expenses payable		56,033			49,836			52,483
Deferred taxes		129,123			131,789			105,925
Other liabilities		63,536			45,759			45,624
Total liabilities		6,593,454			6,685,537			6,507,207
Shareholders’ equity:
Common stock, $2.00 par value, 100,000,000 shares authorized; Issued: 46,927,699 at March 31, 2006; 46,853,193 at December 31, 2005; and 46,623,122 at March 31, 2005		93,855			93,706			93,246
Additional paid-in capital		232,401			231,085			226,863
Unearned restricted stock		(186	)		0			0
Retained earnings		477,740			471,290			439,844
Accumulated other comprehensive loss, net of taxes of$(10,361); $(8,406); and $(7,465), respectively		(19,197	)		(15,611	)		(13,864	)
Total shareholders’ equity		784,613			780,470			746,089
	$	7,378,067		$	7,466,007		$	7,253,296

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

3

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended March 31
	2006			2005
	(in thousands, except per share data)
Interest Income:
Loans and leases, including fees	$	91,364		$	79,855
Securities:
Taxable		10,847			10,630
Tax-exempt		176			481
Dividends		837			632
Short-term investments		738			304
Total interest income		103,962			91,902
Interest Expense:
Deposits:
Interest-bearing demand		10,617			5,442
Savings		622			603
Time		20,341			14,153
Short-term borrowings		2,718			1,917
FHLB borrowings		7,453			7,496
Long-term debt		2,474			2,879
Total interest expense		44,225			32,490
Net interest income		59,737			59,412
Provision for loan and lease losses		2,675			2,750
Net interest income, after provision for loan and lease losses		57,062			56,662
Noninterest Income:
Service charges on deposit accounts		5,055			4,963
Vehicle origination, servicing, and securitization fees		4,005			3,202
Asset management fees		4,768			4,384
Income from fiduciary-related activities		1,494			1,481
Commissions on brokerage, life insurance, and annuity sales		1,100			1,218
Commissions on property and casualty insurance sales		4,348			3,296
Income from bank-owned life insurance		2,168			2,272
Net (loss) gain on sale of loans and leases		3,292			3,698
Net gain on securities		(64	)		121
Other		3,684			3,335
Total noninterest income		29,850			27,970
Noninterest Expenses:
Salaries and employee benefits		29,974			29,282
Occupancy		5,149			5,039
Furniture and equipment		2,485			2,348
Amortization of intangible assets		425			364
Vehicle residual value		902			2,804
Vehicle delivery and preparation		2,489			3,436
Other		19,533			18,807
Total noninterest expenses		60,957			62,080
Income before income taxes		25,955			22,552
Provision for income taxes		8,254			7,149
Net Income	$	17,701		$	15,403
Earnings per share:
Basic	$	0.38		$	0.33
Diluted	$	0.38		$	0.33
Cash dividends	$	0.24		$	0.23
Average shares outstanding:
Basic		46,874			46,609
Diluted		47,029			46,825

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

4

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands) Three months ended March 31,	2006			2005
Cash Flows from Operating Activities:
Net income	$	17,701		$	15,403
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		3,681			5,646
Provision for loan and lease losses		2,675			2,750
Realized loss (gain) on sales of available-for-sale securities, net		64			(121	)
Deferred income taxes		(735	)		(2,364	)
Gain on sale of loans and leases		(3,292	)		(3,698	)
Gain on sale of other real estate owned		(108	)		(43	)
Mortgage loans originated for sale		(17,934	)		(39,722	)
Proceeds from sale of mortgage loans originated for sale		18,695			42,283
Loans and leases originated for sale, net of payments received		(74,667	)		(49,040	)
Net proceeds from sale of leases originated for sale		302,887			5,218
Increase in cash surrender value of bank-owned life insurance		(2,272	)		(2,216	)
Increase in accrued interest receivable		(1,268	)		(1,138	)
Increase in accrued interest payable		1,225			1,396
Increase in accrued expenses and taxes payable		4,972			11,228
Other, net		10,106			(32,845	)
Net cash provided by (used in) operating activities		261,730			(47,263	)
Cash Flows from Investing Activities:
Net (increase) decrease in restricted short-term investments		(1,643	)		145
Activity in available-for-sale securities:
Sales		38,675			49,168
Maturities, repayments and calls		7,747			64,696
Purchases		(108,336	)		(119,797	)
Net proceeds from sale of leases in banks’ portfolios		0			318,350
Net increase in loans and leases		(103,403	)		(14,472	)
Cash flows received from retained interests		5,061			5,025
Purchase of bank-owned life insurance		235			0
Acquisitions, net of cash acquired		0			(3,227	)
Additions to premises and equipment		(2,983	)		(6,179	)
Net cash (used in) provided by investing activities		(164,647	)		293,709
Cash Flows from Financing Activities:
Net increase (decrease) in deposits		46,429			(24,617	)
Net decrease in short-term borrowings		(113,698	)		(22,348	)
Net decrease in FHLB borrowings		(45,992	)		(125,827	)
Repayment of long-term debt		0			(50,000	)
Proceeds from issuance of common stock		1,042			539
Tax benefit from exercise of stock options		237			0
Cash dividends paid		(11,251	)		(10,718	)
Net cash used in financing activities		(123,233	)		(232,971	)

5

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Net change in cash and cash equivalents		(26,150	)		13,475
Cash and cash equivalents at January 1		266,505			192,118
Cash and cash equivalents at March 31	$	240,355		$	205,593
Supplemental Disclosure of Cash Flow Information
Cash paid for interest on deposits and borrowings	$	43,000		$	31,094
Income tax payments	$	3,594		$	425
Supplemental Schedule of Noncash Investing Activities
Real estate acquired in settlement of loans	$	624		$	1,241
Interests retained in securitizations	$	53,253		$	48,920

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

6

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands, except share data)

	Shares of Common Stock	Common Stock		Additional Paid-in Capital		Unearned Restricted Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)		Total
Balance at January 1, 2005	46,592,930	$	93,186	$	226,384	$	0		$	435,159		($3,035	)	$	751,694
Comprehensive income:
Net income										15,403					15,403
Change in unrealized loss on securities available for sale, net of tax effect and reclassification adjustment												(10,860	)		(10,860	)
Change in unrealized loss on recorded interests in securitized assets, net of tax effect												(79	)		(79	)
Unrealized gain on cash flow hedges, net of tax effect												110			110
Total comprehensive income															4,574
Common stock issued under employee benefit plans (including related tax benefit of $114)	30,192		60		479										539
Cash dividends declared ($0.23 per share)										(10,718	)				(10,718	)
Balance at March 31, 2005	46,623,122	$	93,246	$	226,863	$	0		$	439,844		($13,864	)	$	746,089
Balance at January 1, 2006	46,853,193	$	93,706	$	231,085	$	0		$	471,290		($15,611	)	$	780,470
Comprehensive income:
Net income										17,701					17,701
Change in unrealized loss on securities available for sale, net of tax effect and reclassification adjustment												(2,831	)		(2,831	)
Change in unrealized loss on recorded interests in securitized assets, net of tax effect												(139	)		(139	)
Change in unrealized gain on cash flow hedges, net of tax effect and reclassification adjustment of $940												(616	)		(616	)
Total comprehensive income															14,115
Common stock issued under employee benefit plans (including related tax benefit of $237)	66,316		133		1,133										1,266
Restricted stock issued under employee benefit plans, net of amortization	8,190		16		183		(186	)							13
Cash dividends declared ($0.24 per share)										(11,251	)				(11,251	)
Balance at March 31, 2006	46,927,699	$	93,855	$	232,401		($186	)	$	477,740		($19,197	)	$	784,613

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

7

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1. Accounting Policies

The information contained in this report is unaudited and is subject to year-end adjustments. Certain prior year amounts have been reclassified to conform with current period classifications. The adjustments had no effect on gross revenues, gross expenses or net income. In the opinion of management, the information reflects all adjustments necessary for a fair statement of results for the periods ended March 31, 2006 and 2005.

The accounting policies of Susquehanna Bancshares, Inc. and Subsidiaries, as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 71 through 80 of the Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005.

Recent Accounting Pronouncements.

In March 2006, the Financial Accounting Standards Board issued Statement No. 156, “Accounting for Servicing of Financial Assets.” Statement 156, which is an amendment to FAS No. 140, simplifies the accounting for servicing assets and liabilities, such as those common with mortgage securitization activities. The new Standard clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or a servicing liability; requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; and permits an entity with a separately recognized servicing asset or servicing liability to choose either the Amortization Method or Fair Value Method for subsequent measurement. Statement No. 156 is effective for separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, with early adoption permitted. Adoption of this statement is not expected to have a material effect on results of operations or financial condition.

In February 2006, the Financial Accounting Standards Board issued Statement No. 155, “Accounting for Certain Hybrid Instruments,” which is an amendment of Statements No. 133 and 140. Statement No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. The statement also clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement No. 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends Statement No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. Statement No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Adoption of this statement is not expected to have a material effect on results of operations or financial condition.

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 adoption of FAS No. 123(R). The guidance in the FSP was effective November 10, 2005. Susquehanna has adopted FAS 123(R) using modified prospective application and may make a one-time election to adopt the transition method described in this FSP. An entity may take up to one year from its initial adoption of FAS No. 123(R) 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.

8

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

NOTE 2. Acquisitions

Minotola National Bank

On April 21, 2006, Susquehanna acquired Minotola National Bank in a stock and cash transaction valued at approximately $165,000. The acquisition of Minotola, with total assets of $633,000 and fourteen branch locations, provides Susquehanna with an opportunity to expand its franchise into high-growth markets in southern New Jersey.

The acquisition of Minotola is considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”

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.

9

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

NOTE 3. Investment Securities

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

	March 31, 2006				December 31, 2005
	Amortized cost		Fair value		Amortized cost		Fair value
Available-for-sale:
U.S. Government agencies	$	487,036	$	480,212	$	405,098	$	399,039
State & municipal		11,267		11,204		11,803		11,771
Mortgage-backed		597,845		573,675		623,347		602,564
Other debt securities		70,270		70,123		64,262		64,139
Equities		69,621		69,484		70,338		70,349
		1,236,039		1,204,698		1,174,848		1,147,862
Held-to-maturity:
State & municipal		6,330		6,330		6,399		6,399
Total investment securities	$	1,242,369	$	1,211,028	$	1,181,247	$	1,154,261

NOTE 4. Loans and Leases

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

	March 31, 2006			December 31, 2005
Commercial, financial, and agricultural	$	857,788		$	832,695
Real estate - construction		1,013,137			934,601
Real estate secured - residential		1,346,389			1,355,513
Real estate secured - commercial		1,276,681			1,257,860
Consumer		315,751			319,925
Leases		233,009			518,065
Total loans and leases	$	5,042,755		$	5,218,659
Leases held for sale (included in “Leases,” above)	$	44,058		$	340,572
Home equity line of credit loans held for sale (included in “Real estate secured - residential,” above)	$	15,041		$	0
The net investment in direct financing leases was as follows:
Minimum lease payments receivable	$	227,914		$	321,798
Estimated residual value of leases		37,864			259,462
Unearned income under lease contracts		(32,769	)		(63,195	)
Total leases	$	233,009		$	518,065
An analysis of impaired loans, as of March 31, 2006 and December 31, 2005, is as follows:
Impaired loans without a related reserve	$	2,234		$	1,731
Impaired loans with a reserve		1,746			2,066
Total impaired loans	$	3,980		$	3,797
Reserve for impaired loans	$	1,016		$	1,312
An analysis of impaired loans, for the three-month periods ended March 31, 2006 and 2005, is as follows:
	Three Months Ended March 31,
	2006			2005
Average balance of impaired loans	$	3,692		$	5,823
Interest income on impaired loans (cash-basis)		35			13

10

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

NOTE 5. Borrowings

Short-term borrowings were as follows:

	March 31, 2006		December 31, 2005
Securities sold under repurchase agreements	$	193,632	$	206,502
Federal funds purchased		0		96,200
Treasury tax and loan notes		193		4,821
Total short-term borrowings	$	193,825	$	307,523
Long-term debt was as follows:
Subordinated notes due November, 2012	$	75,000	$	75,000
Subordinated notes due May, 2014		75,000		75,000
Junior subordinated notes callable 2007		22,647		22,777
Total long-term debt	$	172,647	$	172,777

NOTE 6. Earnings per Share

The following tables set forth the calculation of basic and diluted earnings per share for the three-month periods ended March 31, 2006 and 2005.

	For the three months ended March 31
	2006					2005
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	17,701	46,874	$	0.38	$	15,403	46,609	$	0.33
Effect of Diluted Securities:
Stock options and restricted shares outstanding			155					216
Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	17,701	47,029	$	0.38	$	15,403	46,825	$	0.33

For the three months ended March 31, 2006 and 2005, average options to purchase 1,033 and 511 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents under FAS No. 123(R) were antidilutive.

NOTE 7. Share-Based Compensation

On January 1, 2006, Susquehanna adopted FAS No. 123(R), “Share-Based Payment.” As a result, compensation cost related to share-based payment transactions is now recognized in Susquehanna's financial statements using modified prospective application. For the three months ended March 31, 2006, share-based compensation expense totaling $144 has been included in salaries and employee benefits expense in the Consolidated Statement of Income.

Prior to adopting FAS No. 123(R), Susquehanna’s stock-based compensation was accounted for using the intrinsic value method set forth in the now-superseded APB Opinion 25. Under APB 25, no compensation expense was recognized. Pursuant to the disclosure requirements of FAS No. 123(R), pro forma net income and earnings per share for the three-month period ended March 31, 2005 are presented in the following table as if compensation cost for stock options was determined under the fair value method and recognized as expense over the options’ vesting periods. On March 1, 2005, options to purchase 151 shares of common stock were granted to employees and directors for past service. The fair value of the options on the date of grant was $4.35, and the options vested immediately.

	For the three months ended March 31, 2005
Net income, as reported	$	15,403
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		708
Pro forma net income	$	14,695
Earnings per share:
Basic - as reported	$	0.33
Basic - pro forma	$	0.32
Diluted - as reported	$	0.33
Diluted - pro forma	$	0.31

11

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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 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. Options typically will vest one- third at the end of years three, four and five.

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.

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) in January 2006.

The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton model, with the assumptions noted in the following table. Expected volatilities are based on the historical volatility of Susquehanna stock, based on the monthly high stock price over the past six years. The expected term of options granted is based upon historical exercise behavior of all employees and directors. The risk-free rate is based on zero coupon treasury rates in effect on the grant date of the options.

	2006		2005			2004
Volatility	21.44	%		20.60	%	21.37	%
Expected dividend yield	3.80	%		3.80	%	3.60	%
Expected term (in years)	6			7		7
Risk-free rate	4.30	%		4.28	%	3.65	%
A summary of option activity under the Plans as of March 31, 2006, is presented below:
	Options		Weighted- average Exercise Price			Weighted- average Remaining Contractual Term
Outstanding at January 1, 2006	1,697		$	20.77
Granted	275			24.34
Forfeited	11			22.24
Exercised	64			13.85
Outstanding at March 31, 2006	1,897		$	21.54		5.9
Exercisable at March 31, 2006	1,303		$	20.95		4.8

The weighted-average grant-date fair value of options granted during the years 2006, 2005, and 2004 was $4.24, $4.35, and $4.38, respectively. The total intrinsic value of options exercised during 2006 and the years ended December 31, 2005 and 2004, was $678, $1,848, and $2,957, respectively.

A summary of the status of Susquehanna’s nonvested shares as of March 31, 2006, and changes during the quarter ended March 31, 2006 is presented below:

	Shares	Weighted- average Grant-date Fair Value
Nonvested at January 1, 2006	330	$	3.89
Granted	275		4.24
Vested	0		0
Forfeited	11		4.03
Nonvested at March 31, 2006	594	$	4.05

As of March 31, 2006, there was $1,765 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized through 2011.

12

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

NOTE 8. Benefit Plans

Components of Net Periodic Benefit Cost

	Three months ended March 31
	Pension Benefits						Other Benefits
	2006			2005			2006		2005
Service cost	$	933		$	840		$	96	$	86
Interest cost		1,054			992			105		93
Expected return on plan assets		(1,468	)		(1,327	)		0		0
Amortization of prior service cost		21			(14	)		12		12
Amortization of transition obligation (asset)		(17	)		(17	)		28		28
Amortization of net actuarial (gain) or loss		239			220			11		6
Net periodic benefit cost	$	762		$	694		$	252	$	225

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2005, that it expected to contribute $117 to its pension plans and $247 to its other postretirement benefit plan in 2006. As of March 31, 2006, $30 of contributions have been made to its pension plans, and $80 of contributions have been made to its other postretirement benefit plan. Susquehanna anticipates contributing an additional $87 to fund its pension plans in 2006 for a total of $117, and $168 to its other postretirement benefit plan for a total of $247.

NOTE 9. Goodwill and Other Intangible Assets

The change in the carrying amount of goodwill for the three months ended March 31, 2006, is as follows:

Balance as of January 1, 2006	$	242,718
Additional goodwill related to contingent earn-out agreement associated with the Brandywine acquisition		258
Balance at March 31, 2006	$	242,976

NOTE 10. Derivative Financial Instruments and Hedging Activities

On March 16, 2005, Susquehanna entered into a $219,836 amortizing interest rate swap; and subsequently, Susquehanna entered into three incremental swaps totaling $109,791. For purposes of Susquehanna’s consolidated financial statements, the $329,627 amortizing interest rate swaps were designated as cash flow hedges of expected future cash flows associated with a forecasted sale of auto leases. This transaction was subject to FAS No. 133 (as amended), “Accounting for Derivative Instruments and Hedging Activities.” On March 14, 2006, the swaps were terminated, and Susquehanna received payment of $2,688 from the swap counterparty. On March 22, 2006, the forecasted sale of auto leases occurred, and the $940 reported in accumulated other comprehensive income at December 31, 2005 was reclassified to gain on sale of loans and leases.

In June 2005, Susquehanna entered into two $25,000 interest rate swaps to hedge the interest rate risk exposure on $50,000 of variable-rate debt. The risk management objective with respect to these interest rate swaps is to hedge the risk of changes in cash flow attributable to changes in the LIBOR swap rate.

Prospective effectiveness evaluations are performed by qualitatively assessing that the critical terms of the swaps and hedged transactions still match, and a review of the credit quality of the swap counterparty is periodically performed to evaluate whether it is probable that the swap counterparty will not default. At March 31, 2006, the hedges were assessed as effective.

The following table summarizes our derivative financial instruments at March 31, 2006:

Notional Amount		Fair Value		Variable Rate	Fixed Rate
$	25,000	$	635	Three-month LIBOR	3.935	%
	25,000		1,032	Three-month LIBOR	4.083	%
$	50,000	$	1,667

13

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

Note 11. 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 to manage capital.

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.

	Principal Balance				Loans and Leases Past Due 30 Days or More				For the Three Months Ended March 31
									Net Credit Losses (Recoveries)
	March 31, 2006		December 31, 2005		March 31, 2006		December 31, 2005		2006			2005
Loans and leases held in portfolio	$	5,042,755	$	5,218,659	$	59,971	$	80,592	$	2,390		$	3,716
Leases securitized		867,626		576,890		467		848		73			(20	)
Home equity lines of credit securitized		203,265		221,930		64		208		6			0
Leases serviced for others (1)		482,233		509,831		2,498		2,451		(17	)		36
Total loans and leases serviced	$	6,595,879	$	6,527,310	$	63,000	$	84,099	$	2,452		$	3,732

(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 follows:

Automobile Leases	Three Months Ended March 31
	2006		2005
Proceeds from securitizations	$	302,887	$	323,568
Amounts derecognized		356,140		372,488
Servicing fees received		1,741		1,454
Other cash flows received from retained interests		5,061		5,025
	Three Months Ended March 31
Home Equity Lines of Credit	2006		2005
Proceeds from securitizations	$	0	$	0
Amounts derecognized		0		0
Additional draws conveyed to the trust		13,437		0
Servicing fees received		271		0
Other cash flows received from 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 March 31, 2006 fair values to immediate 10% and 20% adverse changes in those assumptions. The sensitivities are hypothetical and should be used with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption: in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

14

As of March 31, 2006

Automobile Leases	Fair Value		Weighted- average Life (in months)	Monthly Prepayment Speed			Expected Cumulative Credit Losses			Annual Discount Rate (1)
2006 transaction - Interest-Only Strip	$	660	22		3.00	%		0.05	%		5.26	%
Decline in fair value of 10% adverse change				$	9		$	28		$	6
Decline in fair value of 20% adverse change					18			56			12
2005 transaction - Interest-Only Strip	$	1,152	13		3.00	%		0.05	%		3.99	%
Decline in fair value of 10% adverse change				$	14		$	13		$	0
Decline in fair value of 20% adverse change					20			25			1
2004 revolving transaction - Interest-Only Strip	$	373	22		3.00	%		0.00	%		5.28	%
Decline in fair value of 10% adverse change				$	1		$	0		$	1
Decline in fair value of 20% adverse change					2			0			2
2003 revolving transaction - Interest-Only Strip	$	0	14		2.00	%		0.00	%		5.28	%
Decline in fair value of 10% adverse change				$	0		$	0		$	0
Decline in fair value of 20% adverse change					0			0			0
2003 transaction - Interest-Only Strip	$	671	3		5.00	%		0.00	%		2.13	%
Decline in fair value of 10% adverse change				$	0		$	0		$	0
Decline in fair value of 20% adverse change					0			0			0
Home Equity Lines of Credit	Fair Value		Weighted- average Life (in months)	Constant Prepayment Rate			Expected Cumulative Credit Losses			Annual Discount Rate (2)
2005 transaction - Interest-Only Strips	$	7,654	29		48.00	%		0.15	%		6.50	%
Decline in fair value of 10% adverse change				$	468		$	46		$	152
Decline in fair value of 20% adverse change					853			92			299

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

(2) The annual discount rate is based upon a cost estimate for issuing Tier 1 Capital.

15

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

Management’s discussion and analysis of the significant changes in the consolidated results of operations, financial condition, and cash flows of Susquehanna Bancshares, Inc. and its subsidiaries is set forth below for the periods indicated. Unless the context requires otherwise, the terms “Susquehanna,” “we,” “us,” and “our” refer to Susquehanna Bancshares, Inc. and its subsidiaries.

Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective,” and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited to, Susquehanna’s potential exposures to various types of market risks, such as interest rate risk and credit risk; whether Susquehanna’s allowance for loan and lease losses is adequate to meet probable loan and lease losses; the impact of a breach by Auto Lenders Liquidation Center, Inc. (“Auto Lenders”) on residual loss exposure; the likelihood of an occurrence of an Early Amortization Event; 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.

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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, Valley Forge Asset Management Corp. and subsidiaries (“VFAM”), and The Addis Group, LLC (“Addis”).

Availability of Information

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

Subsequent Event

On April 19, 2006, we completed a private placement to an institutional investor of $50.0 million of fixed/floating rate trust preferred securities, through a newly formed Delaware trust affiliate, Susquehanna TP Trust 2006-1 (the “Trust”). The trust preferred securities mature in June 2036, are redeemable at our option beginning after five years, and bear interest initially at a rate of 6.392% per annum through the interest payment date in June 2011 and, after the interest payment date in June 2011, at a rate per annum equal to the three-month LIBOR plus 1.33%.

The proceeds from the sale of the trust preferred securities were used by the Trust to purchase $51.5 million in aggregate principal amount of our fixed/floating rate junior subordinated notes. The net proceeds to us from the sale of the notes to the Trust will be used to finance our acquisition of Minotola National Bank.

The notes were issued pursuant to a Junior Subordinated Indenture, dated April 19, 2006, between us, as issuer, and the trustee. Like the trust preferred securities, the notes bear interest initially at a rate of 6.392% per annum through the interest payment date in June 2011 and, after the interest payment date in June 2011, at a rate per annum equal to the three-month LIBOR plus 1.33%. Our interest payments will be used to pay the quarterly distributions payable by the Trust to the holder of the trust preferred securities. However, so long as no event of default, as described below, has occurred under the notes, we may defer interest payments on the notes (in which case the Trust will be entitled to defer distributions otherwise due on the trust preferred securities) for up to twenty quarters.

The notes are subordinated to the prior payments of any of our other indebtedness that, by its terms, is not similarly subordinated. The trust preferred securities will be recorded as a long-term liability on our balance sheet; however, for regulatory purposes the trust preferred securities will be treated as Tier 1 or Tier 2 capital under rulings of the Federal Reserve Board, our primary federal regulatory agency.

The notes mature on June 15, 2036, but may be redeemed at the Company’s option at any time on or after June 15, 2011 or at any time upon certain events, such as a change in the regulatory capital treatment of the notes,

17

the Trust being deemed an investment company or the occurrence of certain adverse tax events. Except upon the occurrence of certain events described above, we may redeem the notes at their aggregate principal amount, plus accrued and unpaid interest, if any. If the notes are redeemed in connection with the certain events described above, if the redemption occurs before the Interest Payment Date in June 2011, the redemption price will be the greater of 107.5% of the principal amount of the notes, plus accrued and unpaid interest (including additional interest) on the notes to the redemption date, or as determined by the quotation agent, the sum of the present values of the scheduled payments of principal and interest on the notes during the fixed-rate-period remaining life of the Debentures (assuming the notes matured on the interest payment date in June 2011) discounted to the redemption date on a quarterly basis at the Treasury Rate, plus accrued and unpaid interest (including additional interest) on the notes to such redemption date, or if the redemption date occurs on or after the interest payment date in June 2011, 100% of the principal amount of the notes being redeemed, plus accrued and unpaid interest (including any additional interest) on such notes to the redemption date.

The notes may be declared immediately due and payable at the election of the trustee or holders of 25% of aggregate principal amount of outstanding notes upon the occurrence of any event of default. An event of default generally means a default in the payment of any interest following our deferral of interest payments by twenty consecutive quarters, a default in the payment of the principal amount of the notes at maturity, a default in our performance, or breach, of any covenant or warranty in the Indenture which is not cured within sixty days, the institution of any bankruptcy or similar proceedings by or against us or the liquidation or winding up of the Trust, other than as contemplated in the Indenture.

We also have entered into a Guarantee Agreement, dated April 19, 2006, pursuant to which we have agreed to guarantee the payment by the Trust of distributions of the trust preferred securities, and the payment of principal of the trust preferred securities when due, either at maturity or on redemption, but only if and to the extent that the Trust fails to pay distributions on or principal of the trust preferred securities after having received interest payments or principal payments on the note from us for the purpose of paying those distributions or the principal amount of the trust preferred securities.

Acquisitions

Minotola National Bank

On April 21, 2006, we acquired Minotola National Bank in a stock and cash transaction valued at approximately $165 million. The acquisition of Minotola, with total asset of $633 million and fourteen branch locations, provides us with an opportunity to expand our franchise into high-growth markets in southern New Jersey.

The acquisition of Minotola is considered immaterial for purposes of the disclosures required by FAS No. 141, “Business Combinations.”

Brandywine Benefits Corporation and Rockford Pensions, LLC

On February 1, 2005, we acquired Brandywine Benefits Corporation and Rockford Pension, LLC, located in Wilmington, Delaware. Brandywine was a financial planning, consulting and administration firm specializing in retirement benefit plans for small-to-medium-sized businesses. Brandywine was merged into Valley Forge Asset Management Enterprises, LLC, a wholly owned subsidiary of our wealth management affiliate, VFAM. The acquisition was accounted for under the purchase method, and all transactions since that date are included in our consolidated financial statements.

Results of Operations

Summary of 2006 Compared to 2005

Net income for the first quarter of 2006, was $17.7 million, an increase of $2.3 million, or 14.9%, over net income of $15.4 million for the first quarter of 2005. Net interest income increased 0.6%, to $59.7million for the

18

first quarter of 2006, from $59.4 million for the first quarter of 2005. Non-interest income increased 6.7%, to $29.9 million for the first quarter of 2006, from $28.0 million for the first quarter of 2005. Non-interest expenses decreased 1.8%, to $61.0 million for the first quarter of 2006, from $62.1 million for the first quarter of 2005.

Additional information is as follows:

	Three Months Ended March 31,
	2006			2005
Diluted Earnings per Share	$	0.38		$	0.33
Return on Average Assets		0.96	%		0.83	%
Return on Average Equity		9.19	%		8.35	%
Return on Average Tangible Equity (1)		13.83	%		12.85	%
Efficiency Ratio		67.67	%		70.47	%
Efficiency Ratio excluding Hann (1)		61.88	%		61.28	%
Net Interest Margin		3.76	%		3.71	%

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)	9.19	%	8.35	%
Effect of excluding average intangible assets and related amortization	4.64	%	4.50	%
Return on average tangible equity	13.83	%	12.85	%

Efficiency ratio excluding Hann is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable GAAP-based measure is 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 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)	67.67	%	70.47	%
Effect of excluding Hann	5.79	%	9.19	%
Efficiency ratio excluding Hann	61.88	%	61.28	%

19

Susquehanna Bancshares, Inc. and Subsidiaries

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

(dollars in thousands)

Interest rates and interest differential - taxable equivalent basis

	For the Three-Month Period Ended March 31, 2006							For the Three-Month Period Ended March 31, 2005
	Average Balance			Interest			Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short - term investments	$	72,452		$	738		4.13	$	57,294		$	304	2.15
Investment securities:
Taxable		1,174,068			11,685		4.04		1,203,399			11,262	3.80
Tax - advantaged		17,744			269		6.15		41,889			740	7.16
Total investment securities		1,191,812			11,954		4.07		1,245,288			12,002	3.91
Loans and leases, (net):
Taxable		5,168,004			90,616		7.11		5,182,080			79,008	6.18
Tax - advantaged		69,022			1,151		6.76		85,298			1,303	6.20
Total loans and leases		5,237,026			91,767		7.11		5,267,378			80,311	6.18
Total interest - earning assets		6,501,290		$	104,459		6.52		6,569,960		$	92,617	5.72
Allowance for loan and lease losses		(54,388	)						(53,841	)
Other non - earning assets		996,407							970,556
Total assets	$	7,443,309						$	7,486,675
Liabilities
Deposits:
Interest - bearing demand	$	1,745,682		$	10,617		2.47	$	1,738,757		$	5,442	1.27
Savings		450,149			622		0.56		562,487			603	0.43
Time		2,209,693			20,341		3.73		1,986,594			14,153	2.89
Short - term borrowings		307,122			2,718		3.59		394,445			1,917	1.97
FHLB borrowings		692,962			7,453		4.36		807,935			7,496	3.76
Long - term debt		172,732			2,474		5.81		190,457			2,879	6.13
Total interest - bearing liabilities		5,578,340		$	44,225		3.22		5,680,675		$	32,490	2.32
Demand deposits		869,721							869,561
Other liabilities		214,100							188,299
Total liabilities		6,662,161							6,738,535
Equity		781,148							748,140
						��
Total liabilities and shareholders’ equity	$	7,443,309						$	7,486,675
Net interest income / yield on average earning assets				$	60,234		3.76				$	60,127	3.71

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.

20

Net Interest Income — Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which increased slightly to $59.7 million in the first quarter of 2006, as compared to $59.4 million for the same period in 2005. Net interest income as a percentage of net interest income plus other income was 66.7% for the quarter ended March 31, 2006, and 68.0% for the quarter ended March 31, 2005.

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 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.

The $0.3 million increase in our net interest income for the first quarter of 2006, as compared to the first quarter of 2005, was primarily the result of our net interest margin improving from 3.71% for the first quarter of 2005, to 3.76% for the first quarter of 2006. This increase in net interest margin was due to a rising interest-rate environment with Susquehanna being an asset-sensitive institution.

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

Provision and Allowance for Loan and Lease Losses

The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses at a level adequate to absorb management’s estimate of probable losses in the loan and lease portfolio. Our provision for loan and lease losses is based upon management’s quarterly review of the loan 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.

As illustrated in Table 2, the provision for loan and lease losses was $2.7 million for the first quarter of 2006, and $2.8 million for the first quarter of 2005. This $0.1 million decrease in the provision is the result of a $1.3 million decrease in net charge-offs. The allowance for loan and lease losses was 1.07% of period-end loans and leases, or $54.0 million at March 31, 2006, and 1.06% of period-end loans and leases, or $53.1 million, at March 31, 2005.

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 March 31, 2006. 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 March 31, 2006.

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Susquehanna Bancshares, Inc. and Subsidiaries

(dollars in thousands)

TABLE 2 - Allowance for Loan and Lease Losses

	Three Months Ended March 31,
	2006			2005
Balance - Beginning of period	$	53,714		$	54,093
Additions charged to operating expenses		2,675			2,750
		56,389			56,843
Charge-offs		(3,525	)		(4,691	)
Recoveries		1,135			975
Net charge-offs		(2,390	)		(3,716	)
Balance - Period end	$	53,999		$	53,127
Net charge-offs as a percent of average loans and leases (annualized)		0.19	%		0.29	%
Allowance as a percent of period-end loans and leases		1.07	%		1.06	%
Average loans and leases	$	5,237,026		$	5,267,378
Period-end loans and leases		5,042,755			4,990,889

TABLE 3 - Risk Assets

	March 31, 2006			December 31, 2005			March 31, 2005
Nonperforming assets:
Nonaccrual loans and leases	$	16,355		$	17,392		$	19,085
Restructured loans	$	2,393			0			0
Other real estate owned		2,596			2,620			1,949
Total nonperforming assets	$	21,344		$	20,012		$	21,034
As a percent of period-end loans and leases plus other real estate owned		0.42	%		0.38	%		0.42	%
Coverage ratio		288.03	%		308.84	%		278.37	%
Loans and leases contractually past due 90 days and still accruing	$	6,100		$	8,998		$	10,018

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Noninterest Income

Noninterest income, as a percentage of net interest income plus noninterest income, was 33.3% for the first quarter of 2006 and 32.0% for the first quarter of 2005.

Noninterest income increased $1.9 million, or 6.7%, for the first quarter of 2006, over the first quarter of 2005. This net increase is composed primarily of the following:

• Increasedvehicle origination, servicing, and securitization fees of $0.8 million; and

• Increasedcommissions on property and casualty insurance sales of $1.1 million.

Vehicle origination, securitization, and servicing fees.The 25.1% increase in vehicle origination, servicing, and securitization fees was primarily due to higher origination and securitization fees.

Commissions on property and casualty insurance sales.The 31.9% increase in commissions on property and casualty insurance sales for the first quarter of 2006 can be attributed to new business and better than expected contingency fee income.

Noninterest Expenses

Noninterest expenses decreased $1.1 million, or 1.8%, from $62.1 million for the first quarter of 2005, to $61.0 million for the first quarter of 2006. This net decrease is composed primarily of the following:

• Increasedsalaries and employee benefits of $0.7 million;

• Decreasedvehicle residual value expense of $1.9 million; and

• Decreasedvehicle delivery and preparation expense of $0.9 million.

Salaries and employee benefits. The largest component of noninterest expense is salaries and employee benefits, which increased 2.4% from the first quarter of 2005, compared to the first quarter of 2006. The increase in salaries and benefits was primarily the result of normal annual salary increases and higher benefit costs. In addition, $0.1 million was recorded as share-based compensation expense as a result of our adoption of FAS No. 123(R), “Share-based Payment” on January 1, 2006.

Vehicle residual value expense. The 67.8% decrease is the result of the contractual decrease in residual value guarantee premiums for 2006.

Vehicle delivery and preparation expense. The 27.6% decrease in these expenses is the result of efficiencies recognized through the operation of the new reconditioning center at Auto Lenders and fewer off-lease vehicles being returned to Hann.

Income Taxes

Our effective tax rate for the first quarter of 2006 was 31.8% and 31.7% for the first quarter of 2005.

Financial Condition

Summary of 2006 Compared to 2005

Total assets at March 31, 2006 were $7.4 billion, a decrease of 1.2%, as compared to total assets of $7.5 billion at December 31, 2005. Loans and leases decreased to $5.0 billion at March 31, 2006, from $5.2 billion at

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December 31, 2005. Equity capital was $784.6 million at March 31, 2006, or $16.72 per share, compared to $780.5 million, or $16.66 per share, at December 31, 2005.

Loans and Leases

In March 2006, our banking subsidiaries entered into a term securitization transaction in which they collectively sold and contributed beneficial interests in a portfolio of automobile leases and related vehicles with an aggregate total of $356.1 million. Internal growth in the loan and lease portfolio during the first quarter of 2006 was approximately $178.1 million. As a result, loans and leases decreased $175.9 million, from December 31, 2005, to March 31, 2006.

Risk Assets

Table 3 shows a decrease in non-accrual loans and leases, from $17.4 million at December 31, 2005, to $16.4 million at March 31, 2006. Loans and leases past due 90 days or more and still accruing interest decreased, from $9.0 million at December 31, 2005, to $6.1 million at March 31, 2006. The percentage of non-performing assets to period-end loans and leases plus other real estate owned increased from 0.38% at December 31, 2005, to 0.42% at March 31, 2006, as a result of a $2.4 million addition to restructured loans. Consequently, the percentage of loan and lease loss reserves to non-performing loans and leases (coverage ratio) decreased from 308.8% at December 31, 2005, to 288.0% at March 31, 2006.

Investment in and Receivables from Unconsolidated Entities

Concurrent with the lease securitization transaction in March 2006, our banking subsidiaries recorded investments in and receivables from unconsolidated entities of $53.3 million, representing notes and equity certificates of the issuer.

Borrowings

Short-term borrowings decreased $113.7 million, and Federal Home Loan Bank borrowings decreased $46.0 million, from December 31, 2005, to March 31, 2006. These decreases were accomplished through the utilization of proceeds received in the March 2006 securitization transaction.

Capital Adequacy

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

The minimum Tier 1 capital ratio is 4%; our ratio at March 31, 2006, was 8.72%. The minimum total capital (Tiers 1 and 2) ratio is 8%; our ratio at March 31, 2006, was 11.83%. The minimum leverage ratio is 4%; our leverage ratio at March 31, 2006, was 7.93%. 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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

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.

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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 March 31, 2006, our bank subsidiaries had approximately $685.9 million available to them under collateralized lines of credit with various FHLBs; and approximately $403.1 million more would be available provided that additional collateral would have 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 $64.5 million at March 31, 2006 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 loans and leases to qualified special purpose entities (QSPEs). In March 2006, we entered into a term securitization transaction of leases and related vehicles. The purchase of these assets by the QSPEs was financed through the issuance of asset-backed notes to third-party investors. As of March 31, 2006, net proceeds from this transaction totaled $302.9 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 policy, as approved by our Board of Directors, is designed so that we experience no more than a 15% decline in net interest income and no more than a 30% decline in the economic value of equity for a 300 basis point shock (immediate change) in interest rates. The assumptions used for the interest rate shock analysis are reviewed and updated at least quarterly. Based upon the most recent interest rate shock analysis, we were within the Board’s approved guidelines at a down 300 basis point shock and an up 300 basis point shock.

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Derivative Financial Instruments and Hedging Activities

On March 16, 2005, we entered into a $219.8 million amortizing interest rate swap; and subsequently, we entered into three incremental swaps totaling $109.8 million. For purposes of our consolidated financial statements, the $329.6 million amortizing interest rate swaps were designated as cash flow hedges of expected future cash flows associated with a forecasted sale of auto leases. This transaction is subject to FAS No. 133 (as amended), “Accounting for Derivative Instruments and Hedging Activities.” On March 14, 2006, the swaps were terminated, and we received payment of $2.7 million from the swap counterparty. On March 22, 2006, the forecasted sale of auto leases occurred, and the $0.9 million reported in other comprehensive income at December 31, 2005, was reclassified to gain on sale of loans and leases.

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

The following table summarizes our derivative financial instruments at March 31, 2006:

Notional Amount	Fair Value	Variable Rate	Fixed Rate
	(dollars in thousands)
$25,000	$635	Three-month LIBOR	3.935%
25,000	1,032	Three-month LIBOR	4.083%
$50,000	$1,667

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.

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Securitizations and Off-Balance Sheet Financings

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

	As of March 31, 2006		As of March 31, 2005
	(dollars in thousands)
Lease Securitization Transactions*	$	867,626	$	765,515
HELOC Securitization Transactions*		203,265		0
Agency Arrangements and Lease Sales*		391,926		338,385
Sale-Leaseback Transactions*		90,307		108,047
Leases and Loans Held in Portfolio		5,042,755		4,990,889
Total Leases and Loans Serviced	$	6,595,879	$	6,202,836

* Off-balance sheet

Securitization Transactions

As of March 31, 2006, the aggregate fair value of all recorded interest-only strips in connection with securitizations was $10.5 million. For a description of the accounting policies for measuring the interest-only strips, the characteristics of the securitization transactions, including the gain or loss from sale, and the key assumptions used in measuring the fair value of the interest-only strips, see “Note 1 – Summary of Significant Accounting Policies” under the captions “Asset Securitizations” and “Recorded Interests in Securitized Assets” to the financial statements appearing in our Annual Report on Form 10-K/A for the year ended December 31, 2005, and “Note 11, Securitization Activity” to the financial statements appearing in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Summary of 2006 Securitization Transaction

In March 2006, each of our wholly owned commercial and retail banking subsidiaries (each, a “Sponsor Subsidiary”) entered into a term securitization transaction (the “2006 transaction”). In connection with the 2006 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 $356.1 million in automobile leases and related vehicles to the Transferors. However, the transaction documents for the 2006 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 $311.9 million of fixed-rate asset-backed notes to third-party investors. The Issuer also issued $10.5 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 $0.7 million.

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Summary of Prior Years’ Securitization Transactions

HELOCs

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 March 31, 2006, was $7.7 million.

Leases

In March 2005, each of our wholly owned commercial and retail banking subsidiaries entered into a term securitization transaction (the “2005 transaction”). In connection with the 2005 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. Collectively, the Sponsor Subsidiaries sold and contributed the beneficial interest in $366.8 million in 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 March 31, 2006, was $1.2 million.

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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”). There were no transfers made to the QSPE during the first quarter of 2006. 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 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 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 this interest-only strip at March 31, 2006 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 March 31, 2006 was $0.7 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).

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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.

Agency Agreements and Lease Sales

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

During the second quarter of 2002, Hann entered into an agency arrangement. In connection with that arrangement, we entered into an agreement under which we guarantee Auto Lenders’ performance of its obligations to the new agency client (the “Residual Interest Agreement”). Auto Lenders has agreed to purchase leased vehicles in the agency client’s portfolio at the termination of the leases for the full residual value of those vehicles. In the event the agency client incurs any losses, costs or expenses as a result of any failure of Auto Lenders to perform this purchase obligation, we will compensate the agency client for any final liquidation losses with respect to such leased vehicle. However, our liability is limited to 12% of the maximum aggregate residual value of all leases purchased by the agency client. At March 31, 2006, the total residual value of the vehicles in the portfolio for this transaction was $22.4 million, and our maximum obligation under the Residual Interest Agreement at March 31, 2006, was $2.7 million. We have evaluated this obligation under FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others – an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34” and FAS No. 5, “Accounting for Contingencies” and have determined that no liability exists at March 31, 2006.

Sale-leaseback Transactions

In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that has an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor is treated as a sale and an operating lease and qualifies as a sale and leaseback under FAS No. 13. The Lessor held the beneficial interest in vehicles and auto leases with a remaining balance of approximately $90.3 million at March 31, 2006. 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 March 31, 2006, the beneficial interest in additional automobile leases and related vehicles pledged by the Lessee was $43.7 million.

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Summary of Susquehanna’s Potential Exposure under Off-Balance Sheet Vehicle Lease Financings as of March 31, 2006.

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 $35.0 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.

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

Agency Agreements and Lease Sales

Under the agency arrangements, our maximum obligation under the Residual Interest Agreement at March 31, 2006 was $2.7 million. We have evaluated this obligation under FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others – an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34” and FAS No. 5, “Accounting for Contingencies” and have determined that no liability exists at March 31, 2006.

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures

Susquehanna’s management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), including a review of the remediation plan and the changes to our disclosure controls and procedures described below, as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company can be detected.

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Status of Remediation of Material Weakness in Internal Control

As reported in Item 9A of our Form 10-K/A for the fiscal year ended December 31, 2005, management concluded that as of December 31, 2005, our disclosure controls and procedures were ineffective due to an internal control deficiency that constituted a material weakness in our internal control over financial reporting. Our controls did not ensure that our presentation of cash flows relating to the origination, repayment and disposition of vehicle leases was in accordance with generally accepted accounting principles. Specifically, shortly after the Audit Committee approved the originally filed Form 10-K for the fiscal year ended December 31, 2005, erroneous changes were made to the consolidated statements of cash flows by our financial reporting unit without notifying our Chief Financial Officer, as required by our internal control procedures, on the basis that the changes were considered to be appropriate and immaterial. As a result, the originally filed 2005 Form 10-K included erroneous changes to the consolidated statements of cash flows that were not approved by our Chief Financial Officer or our Audit Committee.

As of the end of the period covered by this report, management implemented additional internal control procedures in order to address the identified material weakness in our internal control over financial reporting. Specifically, during the fiscal first quarter, we implemented the following supplemental procedures, which were made a part of our corporate governance and financial reporting process and which:

• institute additional levels of review by executive management, the Disclosure Committee and our financial reporting unit of all financial information presented in quarterly and annual reports on Forms 10-Q and 10-K; and

• detail the approval process of, and limit how changes may be made to such reports subsequent to approval by our Audit Committee.

(b) Change in Internal Control Over Financial Reporting

Other than as described above, there was no change in our internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. 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 1A. Risk Factors.

There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005.

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

None

Item 3. Defaults Upon Senior Securities

None

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

None

Item 5. Other Information.

None

Item 6. Exhibits.

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

10.1	Description of (i) grants of nonqualified stock options to Susquehanna’s directors and named executive officers; (ii) cash bonus awards to Susquehanna’s named executive officers; and (iii) grants of restricted stock awards to Susquehanna’s named executive officers, is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.2	Employment Agreement, dated January 10, 2006, between Susquehanna and Peter J. Sahd is incorporated by reference to Exhibit 10.1 to Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.3	Employment Agreement, dated January 23, 2006, between Susquehanna and Rodney A. Lefever is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.4	Description of cash bonus payment to Bernard A. Francis, Jr. is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed January 30, 2006.
10.5	Description of base salaries for the year ended December 31, 2006 for Susquehanna’s named executive officers is incorporated by reference to Item1.01 of Susquehanna’s Current Report on Form 8-K, filed February 13, 2006.

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10.6	Susquehanna’s Director Compensation Schedule, effective as of January 1, 2006, is incorporated by reference to Exhibit 99.1 of Susquehanna’s Current Report on Form 8-K, filed March 17, 2006.
31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer
31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer
32	Section 1350 Certifications

SIGNATURES

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

	SUSQUEHANNA BANCSHARES, INC.
May 2, 2006	/s/ William J. Reuter
	William J. Reuter
	Chairman, President and Chief Executive Officer
May 2, 2006	/s/ Drew K. Hostetter
	Drew K. Hostetter
	Executive Vice President and Chief Financial Officer

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EXHIBIT INDEX

Exhibit Numbers	Description and Method of Filing
10.1	Description of (i) grants of nonqualified stock options to Susquehanna’s directors and named executive officers; (ii) cash bonus awards to Susquehanna’s named executive officers; and (iii) grants of restricted stock awards to Susquehanna’s named executive officers, is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.2	Employment Agreement, dated January 10, 2006, between Susquehanna and Peter J. Sahd is incorporated by reference to Exhibit 10.1 to Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.3	Employment Agreement, dated January 23, 2006, between Susquehanna and Rodney A. Lefever is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed January 24, 2006.
10.4	Description of cash bonus payment to Bernard A. Francis, Jr. is incorporated by reference to Item 1.01 of Susquehanna’s Current Report on Form 8-K, filed January 30, 2006.
10.5	Description of base salaries for the year ended December 31, 2006 for Susquehanna’s named executive officers is incorporated by reference to Item1.01 of Susquehanna’s Current Report on Form 8-K, filed February 13, 2006.
10.6	Susquehanna’s Director Compensation Schedule, effective as of January 1, 2006, is incorporated by reference to Exhibit 99.1 of Susquehanna’s Current Report on Form 8-K, filed March 17, 2006.
31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer
31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer
32	Section 1350 Certifications

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