Susquehanna Bancshares (SUSQ) 10-Q 2007 Q3 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 September 30, 2007

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 October 31, 2007, there were 52,206,918 shares of the registrant’s common stock outstanding, par value $2.00 per share.

SUSQUEHANNA BANCSHARES, INC.

TABLE OF CONTENTS

		Page
PART I.	FINANCIAL INFORMATION
Item 1	Financial Statements
	Consolidated Balance Sheets – as of September 30, 2007 and 2006, and December 31, 2006 (unaudited)	3
	Consolidated Statements of Income – for the three and nine months ended September 30, 2007 and 2006 (unaudited)	4
	Consolidated Statements of Cash Flows – for the nine months ended September 30, 2007 and 2006 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2007 and 2006 (unaudited)	7
	Notes to the Consolidated Financial Statements (unaudited)	8
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4	Controls and Procedures	34
PART II.	OTHER INFORMATION
Item 1	Legal Proceedings	35
Item 1A	Risk Factors	35
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3	Defaults Upon Senior Securities	35
Item 4	Submission of Matters to a Vote of Security Holders	35
Item 5	Other Information	35
Item 6	Exhibits	36
SIGNATURES		37
EXHIBIT INDEX		38

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

	September 30 2007			December 31 2006			September 30 2006
	(in thousands, except share data)
Assets
Cash and due from banks	$	202,237		$	194,785		$	186,485
Unrestricted short-term investments		110,484			70,996			41,238
Cash and cash equivalents		312,721			265,781			227,723
Restricted short-term investments		241			33,533			33,666
Securities available for sale		1,548,708			1,397,420			1,303,362
Securities held to maturity (fair values approximate$4,840; $6,146; and $6,199)		4,840			6,146			6,199
Loans and leases, net of unearned income		5,842,883			5,560,997			5,517,513
Less: Allowance for loan and lease losses		58,687			62,643			61,142
Net loans and leases		5,784,196			5,498,354			5,456,371
Premises and equipment, net		110,372			106,305			106,379
Foreclosed assets		10,331			1,544			2,085
Accrued income receivable		33,600			31,044			30,055
Bank-owned life insurance		270,398			264,398			261,879
Goodwill		339,010			335,005			335,005
Intangible assets with finite lives		19,648			19,092			20,011
Investment in and receivables from unconsolidated entities		134,335			121,663			128,009
Other assets		155,549			144,849			172,119
Total Assets	$	8,723,949		$	8,225,134		$	8,082,863
Liabilities and Shareholders’ Equity
Deposits:
Demand	$	887,657		$	959,654		$	961,573
Interest-bearing demand		2,054,246			2,004,596			1,855,802
Savings		417,997			477,447			497,188
Time		1,592,698			1,528,298			1,604,560
Time of $100 or more		1,025,763			907,594			914,087
Total deposits		5,978,361			5,877,589			5,833,210
Short-term borrowings		488,999			401,964			346,898
FHLB borrowings		795,462			528,688			491,630
Long-term debt		150,028			150,036			150,038
Junior subordinated debentures		71,980			72,244			72,381
Accrued interest, taxes, and expenses payable		43,373			54,800			81,388
Deferred taxes		149,958			145,825			125,828
Other liabilities		103,606			57,702			52,801
Total Liabilities		7,781,767			7,288,848			7,154,174
Shareholders’ equity:
Common stock, $2.00 par value, 100,000,000 shares authorized; Issued: 52,206,918 at September 30, 2007; 52,080,419 at December 31, 2006; and 51,829,972 at September 30, 2006		104,353			104,161			103,660
Additional paid-in capital		349,275			345,840			340,523
Retained earnings		503,613			505,861			497,469
Accumulated other comprehensive loss, net of taxes of$(8,109); $(10,541); and $(7,010), respectively		(15,059	)		(19,576	)		(12,963	)
Total Shareholders’ Equity		942,182			936,286			928,689
Total Liabilities and Shareholders’ Equity	$	8,723,949		$	8,225,134		$	8,082,863

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

	Three Months Ended September 30				Nine Months Ended September 30
	2007		2006		2007			2006
	(in thousands, except per share data)
Interest Income:
Loans and leases, including fees	$	107,585	$	108,924	$	312,825		$	301,084
Securities:
Taxable		17,598		12,758		48,633			36,154
Tax-exempt		425		191		1,238			556
Dividends		1,074		951		3,166			2,701
Short-term investments		1,019		966		3,411			2,551
Total interest income		127,701		123,790		369,273			343,046
Interest Expense:
Deposits:
Interest-bearing demand		15,119		13,780		47,982			36,640
Savings		869		1,548		2,922			3,494
Time		30,128		26,981		86,814			71,295
Short-term borrowings		5,033		4,267		12,805			9,955
FHLB borrowings		7,106		6,811		16,236			19,824
Long-term debt		3,372		3,272		9,955			8,860
Total interest expense		61,627		56,659		176,714			150,068
Net interest income		66,074		67,131		192,559			192,978
Provision for loan and lease losses		2,414		2,241		6,347			6,191
Net interest income, after provision for loan and lease losses		63,660		64,890		186,212			186,787
Noninterest Income:
Service charges on deposit accounts		7,378		7,610		21,035			19,258
Vehicle origination, servicing, and securitization fees		3,658		5,209		11,564			14,365
Asset management fees		5,235		4,370		14,638			13,771
Income from fiduciary-related activities		1,594		1,543		4,937			4,568
Commissions on brokerage, life insurance, and annuity sales		1,239		1,025		3,917			3,271
Commissions on property and casualty insurance sales		2,556		2,432		9,589			9,541
Income from bank-owned life insurance		2,765		2,551		8,064			7,335
Net gain on sale of loans and leases		1,297		9,095		6,822			14,402
Net realized gain (loss) on securities		0		90		(11,741	)		5
Other		4,568		5,155		14,896			14,493
Total noninterest income		30,290		39,080		83,721			101,009
Noninterest Expenses:
Salaries and employee benefits		35,518		33,166		104,634			95,671
Occupancy		5,669		5,378		17,443			15,662
Furniture and equipment		2,908		2,822		8,717			8,128
Advertising and marketing		2,233		1,889		6,866			7,711
Amortization of intangible assets		651		630		1,897			1,601
Vehicle lease disposal		3,082		3,973		9,261			10,842
Other		16,002		18,993		49,435			56,589
Total noninterest expenses		66,063		66,851		198,253			196,204
Income before income taxes		27,887		37,119		71,680			91,592
Provision for income taxes		7,994		11,878		21,243			29,309
Net Income	$	19,893	$	25,241	$	50,437		$	62,283
Earnings per share:
Basic	$	0.38	$	0.49	$	0.97		$	1.25
Diluted	$	0.38	$	0.49	$	0.97		$	1.25
Cash dividends paid	$	0.25	$	0.24	$	0.75		$	0.72
Average shares outstanding:
Basic		52,174		51,803		52,132			49,809
Diluted		52,221		51,926		52,208			49,949

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)

Nine months ended September 30,	2007			2006
Cash Flows from Operating Activities:
Net income	$	50,437		$	62,283
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion		11,707			13,568
Provision for loan and lease losses		6,347			6,191
Realized loss (gain) on available-for-sale securities, net		11,741			(5	)
Deferred income taxes		1,701			(1,618	)
Gain on sale of loans and leases		(6,822	)		(14,402	)
Gain on sale of other real estate owned		(214	)		(59	)
Mortgage loans originated for sale		(79,403	)		(68,240	)
Proceeds from sale of mortgage loans originated for sale		81,647			70,252
Loans and leases originated/acquired for sale, net of payments received		(297,188	)		(267,976	)
Net proceeds from sale of loans and leases originated/acquired for sale		252,493			339,420
Increase in cash surrender value of bank-owned life insurance		(7,438	)		(7,335	)
Increase in accrued interest receivable		(2,556	)		(3,631	)
Increase in accrued interest payable		2,932			4,818
(Decrease) increase in accrued expenses and taxes payable		(14,359	)		25,103
Other, net		(31,783	)		(51,974	)
Net cash (used in) provided by operating activities		(14,739	)		106,395
Cash Flows from Investing Activities:
Net decrease (increase) in restricted short-term investments		33,292			(7,330	)
Activity in available-for-sale securities:
Sales		333,366			127,564
Maturities, repayments, and calls		286,955			77,013
Purchases		(739,721	)		(299,554	)
Net proceeds from sale of loans and leases in banks’ portfolios		0			312,870
Net increase in loans and leases		(276,727	)		(233,841	)
Cash flows received from retained interests		25,102			21,582
Proceeds from bank-owned life insurance		1,438			2,745
Acquisitions, net of cash and cash equivalents acquired		(3,114	)		(15,379	)
Additions to premises and equipment		(11,982	)		(10,221	)
Net cash used in investing activities		(357,410	)		(24,551	)
Cash Flows from Financing Activities:
Net increase (decrease) in deposits		100,772			(1,104	)
Net increase in short-term borrowings		87,035			39,375
Net increase (decrease) in FHLB borrowings		266,774			(177,036	)
Repayment of long-term debt		(8	)		0
Proceeds from issuance of junior subordinated debentures		0			50,000
Proceeds from issuance of common stock		3,475			3,849
Tax benefit from exercise of stock options		152			394
Cash dividends paid		(39,111	)		(36,104	)
Net cash provided by (used in) financing activities		419,089			(120,626	)

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)

Net change in cash and cash equivalents		46,940		(38,782	)
Cash and cash equivalents at January 1		265,781		266,505
Cash and cash equivalents at September 30	$	312,721	$	227,723
Supplemental Disclosure of Cash Flow Information
Cash paid for interest on deposits and borrowings	$	173,782	$	145,250
Income tax payments	$	19,256	$	10,283
Supplemental Schedule of Noncash Investing and Financing Activities
Real estate acquired in settlement of loans	$	15,732	$	1,905
Interests retained in securitizations	$	47,920	$	54,190
Leases acquired in clean-up call	$	22,682	$	12,284
Securities purchased, not settled	$	34,930	$	0
Acquisition of Minotola National Bank:
Common stock issued	$	0	$	115,149
Fair value of assets acquired (noncash)	$	0	$	653,339
Liabilities assumed	$	0	$	522,811
Cash dividends declared, not paid	$	13,574	$	0

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

Susquehanna Bancshares, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except share data)

	Shares of Common Stock	Common Stock		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balance at January 1, 2006	46,853,193	$	93,706	$	231,085	$	471,290		($	15,611	)	$	780,470
Comprehensive income:
Net income							62,283						62,283
Change in unrealized loss on securities available for sale, net of tax effect and reclassification adjustment										2,541			2,541
Change in unrealized loss on recorded interests in securitized assets, net of tax effect										1,640			1,640
Change in unrealized gain on cash flow hedges, net of tax effect and reclassification adjustment of $940										(1,533	)		(1,533	)
Total comprehensive income													64,931
Common stock issued in acquisition	4,797,870		9,596		105,553								115,149
Common stock and options issued under employee benefit plans (including related tax benefit of $394)	178,909		358		3,885								4,243
Cash dividends declared ($0.72 per share)							(36,104	)					(36,104	)
Balance at September 30, 2006	51,829,972	$	103,660	$	340,523	$	497,469		($	12,963	)	$	928,689
Balance at January 1, 2007	52,080,419	$	104,161	$	345,840	$	505,861		($	19,576	)	$	936,286
Comprehensive income:
Net income							50,437						50,437
Change in unrealized loss on securities available for sale, net of tax effect and reclassification adjustment of $7,632										5,144			5,144
Change in unrealized gain on recorded interests in securitized assets, net of tax effect										208			208
Change in unrealized gain on cash flow hedges, net of tax effect and reclassification adjustment of $(202)										(835	)		(835	)
Total comprehensive income													54,954
Common stock and options issued under employee benefit plans (including related tax benefit of $152)	126,499		192		3,435								3,627
Cash dividends declared ($1.01 per share)							(52,685	)					(52,685	)
Balance at September 30, 2007	52,206,918	$	104,353	$	349,275	$	503,613		($	15,059	)	$	942,182

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

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 1. Accounting Policies

The information contained in this report is unaudited and is subject to year-end adjustments. Certain prior year amounts have been reclassified to conform with current period classifications. The reclassifications 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 September 30, 2007 and 2006. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

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 76 through 86 of the Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Recent Accounting Pronouncements.

In February 2007, the Financial Accounting Standards Board issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Statement 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. Statement 159 is effective as of the beginning of an entity's first fiscal year beginning after November 15, 2007. Susquehanna is evaluating the impact of Statement 159 on its results of operations and financial condition.

In September 2006, the Financial Accounting Standards Board issued Statement No. 157, “Fair Value Measurements.” Statement 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. While Statement 157 does not require any new fair value measurements, the application of this Statement will change current practice for some entities. Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Susquehanna is evaluating the impact of Statement 157 on its results of operations and financial condition.

In September 2006, the Financial Accounting Standards Board reached a consensus on Emerging Issues Task Force Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” Issue 06-4 requires an employer to recognize a liability for future benefits in accordance with FAS No. 106, if, in substance, a postretirement benefit plan exists. The consensus in this Issue is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. Entities are to recognize the effects of applying the consensus in this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. Susquehanna is a party to split-dollar life insurance arrangements and is currently evaluating the impact of Issue 06-4 on its results of operations and financial condition.

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Tax Positions.” This interpretation clarifies the application of FAS No. 109, “Accounting for Income Taxes,” by establishing a threshold condition that a tax position must meet for any part of the benefit of that position to be recognized in the financial statements. FASB Interpretation No. 48 also provides guidance concerning measurement, derecognition, classification, and disclosure of tax positions and is effective for fiscal years beginning after December 15, 2006. Adoption of this interpretation has not had a material impact on results of operations or financial condition. Disclosures required by this Statement are presented in Note 10.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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 was effective for separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that began after September 15, 2006. Adoption of this statement has not had 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 was effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that began after September 15, 2006. Adoption of this statement has not had a material effect on results of operations or financial condition with regard to the recently created interest-only strip.

NOTE 2. Acquisitions

Community Banks, Inc.

On May 1, 2007, Susquehanna announced the signing of a definitive merger agreement pursuant to which Susquehanna will acquire Community Banks, Inc. in a stock and cash transaction valued at approximately $860,000. Under the terms of the merger agreement, shareholders of Community will be entitled to elect to receive for each share of Community common stock that they own, either $34.00 in cash or 1.48 shares of Susquehanna common stock. On October 2, 2007, the shareholders of both Susquehanna and Community approved the merger. Pending the expected regulatory approvals and the satisfaction of other closing conditions, the consummation of the merger is expected to occur on or about November 16, 2007. The acquisition will be accounted for under the purchase method in accordance with FAS No. 141, “Business Combinations.”

During the fourth quarter of 2007, Susquehanna anticipates offering up to $150,000 in capital efficient notes in order to finance the cash portion of the merger consideration to be paid to Community shareholders and for other working capital purposes. The exact terms of the securities will not be determined until shortly before the offering is to be consummated.

Widmann, Siff & Co., Inc.

On August 1, 2007, Susquehanna acquired Widmann, Siff & Co. Inc., an investment advisory firm in Radnor, Pa. Widmann, Siff had more that $300,000 in assets under management, including accounts serving individuals, pension and profit-sharing plans, corporations, and family trusts. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in Susquehanna's consolidated financial statements.

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

Minotola National Bank

On April 21, 2006, Susquehanna acquired Minotola National Bank in a stock and cash transaction valued at approximately $172,000. The acquisition of Minotola, with total assets of $607,000 and fourteen branch locations, has provided Susquehanna with an opportunity to expand its franchise into high-growth markets in southern New Jersey. The acquisition was accounted for under the purchase method, and all transactions since that date are included in Susquehanna's consolidated financial statements.

As part of the Minotola acquisition, Susquehanna recorded a $5,514 addition to the allowance for loan and lease losses. Susquehanna evaluated Minotola's loan portfolio at the time of acquisition and did not identify any impaired loans as defined in Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” and FAS No. 114, “Accounting by Creditors for Impairment of a Loan.” Therefore, as required by FAS No. 141, “Business Combinations,” Susquehanna recorded Minotola's loan portfolio at present value, determined at the then current interest rates, net of the allowance for loan and lease losses in accordance with management's evaluation of FAS No. 5, “Accounting for Contingencies.”

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

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

Amortized costs and fair values of securities were as follows:

	September 30, 2007				December 31, 2006
	Amortized cost		Fair value		Amortized cost		Fair value
Available-for-sale:
U.S. Government agencies	$	475,927	$	479,262	$	512,192	$	509,872
State & municipal		36,396		35,555		27,369		27,141
Mortgage-backed		888,251		882,020		730,873		714,747
Other debt securities		72,287		65,472		72,368		72,282
Equities		86,708		86,399		73,393		73,378
		1,559,569		1,548,708		1,416,195		1,397,420
Held-to-maturity:
State & municipal		4,840		4,840		6,146		6,146
Total investment securities	$	1,564,409	$	1,553,548	$	1,422,341	$	1,403,566

Gross realized gains and gross realized losses on investment securities transactions are summarized below:

	Available- for-Sale
For the three months ended September 30, 2007
Gross gains	$	0
Gross losses		0
Net losses	$	0
For the three months ended September 30, 2006
Gross gains	$	123
Gross losses		(33	)
Net gains	$	90
For the nine months ended September 30, 2007
Gross gains	$	93
Gross losses		(11,834	)
Net losses	$	(11,741	)
For the nine months ended September 30, 2006
Gross gains	$	1,022
Gross losses		(1,017	)
Net gains	$	5

NOTE 4. Loans and Leases

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

	September 30, 2007			December 31, 2006
Commercial, financial, and agricultural	$	1,189,156		$	978,522
Real estate - construction		1,040,852			1,064,452
Real estate secured - residential		1,268,434			1,147,741
Real estate secured - commercial		1,618,789			1,577,534
Consumer		296,206			313,848
Leases		429,446			478,900
Total loans and leases	$	5,842,883		$	5,560,997
Leases held for sale (included in “Leases,” above)	$	189,161		$	226,637
Home equity line of credit loans held for sale (included in “Real estate secured - residential,” above)	$	51,723		$	17,473
Net investment in direct financing leases was as follows:
Minimum lease payments receivable	$	347,658		$	369,732
Estimated residual value of leases		138,897			172,477
Unearned income under lease contracts		(57,109	)		(63,309	)
Total leases	$	429,446		$	478,900

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

An analysis of impaired loans, as of September 30, 2007 and December 31, 2006, is as follows:

Impaired loans without a related reserve	$	7,162	$	11,468
Impaired loans with a reserve		9,081		8,620
Total impaired loans	$	16,243	$	20,088
Reserve for impaired loans	$	1,945	$	1,877
An analysis of impaired loans, for the three months and nine months ended September 30, 2007 and 2006, is as follows:
	Three Months Ended September 30,
	2007		2006
Average balance of impaired loans	$	15,435	$	9,232
Interest income on impaired loans (cash-basis)		39		52
	Nine Months Ended September 30,
	2007		2006
Average balance of impaired loans	$	17,722	$	8,382
Interest income on impaired loans (cash-basis)		41		123
NOTE 5. Borrowings
Short-term borrowings were as follows:
	September 30, 2007		December 31, 2006
Securities sold under repurchase agreements	$	291,612	$	249,728
Federal funds purchased		195,515		150,000
Treasury tax and loan notes		1,872		2,236
Total short-term borrowings	$	488,999	$	401,964
Long-term debt was as follows:
Subordinated notes due November, 2012	$	75,000	$	75,000
Subordinated notes due May, 2014		75,000		75,000
Other		28		36
Junior subordinated notes callable 2007		21,980		22,244
Junior subordinated notes callable 2011		50,000		50,000
Total long-term debt	$	222,008	$	222,280

NOTE 6. Earnings per Share

The following tables set forth the calculation of basic and diluted earnings per share for the three-month and nine-month periods ended September 30, 2007 and 2006.

	For the three months ended September 30
	2007					2006
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	19,893	52,174	$	0.38	$	25,241	51,803	$	0.49
Effect of Diluted Securities:
Stock options and restricted shares outstanding			47					123
Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	19,893	52,221	$	0.38	$	25,241	51,926	$	0.49

For the three months ended September 30, 2007 and 2006, average options to purchase 1,657 and 997 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.

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

	For the nine months ended September 30
	2007					2006
	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic Earnings per Share:
Income available to common shareholders	$	50,437	52,132	$	0.97	$	62,283	49,809	$	1.25
Effect of Diluted Securities:
Stock options and restricted shares outstanding			76					140
Diluted Earnings per Share:
Income available to common shareholders and assuming conversion	$	50,437	52,208	$	0.97	$	62,283	49,949	$	1.25

For the nine months ended September 30, 2007 and 2006, average options to purchase 1,657 and 997 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 February 28, 2007, Susquehanna’s Compensation Committee granted to directors and certain employees nonqualified stock options to purchase an aggregate of 589 shares of common stock with an exercise price of $24.26. In addition, the Committee awarded to certain employees an aggregate of 25 restricted shares with a grant-date fair value of $24.26.

The fair value of $4.08 for each of the 2007 options and $4.24 for each of the 2006 options was estimated on the date of grant using the Black-Scholes-Merton model, with the assumptions noted in the following table:

	2007		2006
Volatility	20.59	%	21.44	%
Expected dividend yield	4.00	%	3.80	%
Expected term (in years)	6.5		6.0
Risk-free rate	4.44	%	4.30	%

NOTE 8. Pension and Other Postretirement Benefits

Components of Net Periodic Benefit Cost

	Three months ended September 30
	Pension Benefits						Supplemental Executive Retirement Plan				Other Postretirement Benefits
	2007			2006			2007		2006		2007		2006
Service cost	$	927		$	1,086		$	26	$	16	$	138	$	111
Interest cost		1,137			1,070			56		55		148		113
Expected return on plan assets		(1,762	)		(1,573	)		0		0		0		0
Amortization of prior service cost		9			(10	)		31		31		28		23
Amortization of transition obligation (asset)		(2	)		(17	)		0		0		28		28
Amortization of net actuarial (gain) or loss		13			217			15		22		33		11
Net periodic benefit cost	$	322		$	773		$	128	$	124	$	375	$	286
	Nine months ended September 30
	Pension Benefits						Supplemental Executive Retirement Plan				Other Postretirement Benefits
	2007			2006			2007		2006		2007		2006
Service cost	$	3,091		$	3,032		$	78	$	48	$	414	$	313
Interest cost		3,433			3,116			164		165		444		328
Expected return on plan assets		(5,280	)		(4,579	)		0		0		0		0
Amortization of prior service cost		23			(30	)		93		93		84		55
Amortization of transition obligation (asset)		(2	)		(51	)		0		0		84		84
Amortization of net actuarial (gain) or loss		81			651			37		66		99		33
Net periodic benefit cost	$	1,346		$	2,139		$	372	$	372	$	1,125	$	813

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2006, that it expected to contribute $122 to its pension plan and $328 to its other postretirement benefit plan in 2007. As of September 30, 2007, $92 of contributions have been made to its pension plans, and $230 of contributions have been made to its other postretirement benefit plan. Susquehanna anticipates contributing an additional $30 to fund its pension plan in 2007 for a total of $122, and $98 to its other postretirement benefit plan for a total of $328.

NOTE 9. Derivative Financial Instruments and Hedging Activities

Beginning in February 2007, Susquehanna entered into amortizing interest rate swaps with an aggregate notional amount of $131,524. For purposes of Susquehanna’s consolidated financial statements, the entire notional amount of the swaps is designated as a cash flow hedge of expected future cash flows associated with a forecasted sale of auto leases. These transactions are subject to FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” At September 30, 2007, the unrealized loss, net of taxes, recorded in accumulated other comprehensive income was ($633).

Beginning in April 2006, Susquehanna entered into amortizing interest rate swaps with an aggregate notional amount of $266,866. For purposes of Susquehanna’s consolidated financial statements, the entire notional amount of the swaps was designated as a cash flow hedge of expected future cash flows associated with a forecasted sale of auto leases. These transactions were subject to FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” On February 8, 2007, the swaps were terminated. On February 14, 2007, the forecasted sales of auto leases occurred, and the ($202) loss reported in accumulated other comprehensive income at December 31, 2006, 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. At September 30, 2007, the unrealized gain, net of taxes, recorded in accumulated other comprehensive income was $336.

The following table summarizes our derivative financial instruments at September 30, 2007:

Notional Amount		Fair Value			Variable Rate	Fixed Rate
$	131,524	$	(974	)	One-month LIBOR	4.571% to 5.206	%
	25,000		178		Three-month LIBOR	3.935	%
	25,000		339		Three-month LIBOR	4.083	%
$	181,524	$	(457	)

NOTE 10. Uncertainty in Income Taxes

Susquehanna adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. There was no impact on Susquehanna’s financial position or results of operations as a result of the implementation of Interpretation No. 48. At the time of adoption, Susquehanna had $1,421 of unrecognized tax benefits, of which $1,208, if recognized, would affect the effective tax rate. The company does not anticipate a significant change to the total amount of unrecognized tax benefits within the next twelve months.

Susquehanna recognizes interest and penalties related to unrecognized tax benefits in income tax expense. Susquehanna had approximately $183 for the payment of interest and penalties accrued at January 1, 2007.

Susquehanna and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, Susquehanna is no longer subject to U.S. federal, state, and local examinations by tax authorities for years before 2003. There is currently one state examination of Susquehanna’s tax returns in progress.

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

Automobile Leases

2007 Transaction

In February 2007, Susquehanna securitized $300,414 of closed-end motor vehicle leases and recorded a pre-tax gain of $2,709 (which includes a loss recognized on the associated cash-flow hedge) in noninterest income. Retained interests in the securitization totaled $51,930 and included $7,774 in subordinated notes, $40,147 in equity certificates of the securitization trust, and a $4,009 interest-only strip. The initial carrying values of these retained interests were determined by allocating the carrying value among the assets sold and retained based on their relative fair values at the date of sale. The initial carrying value of the interest-only strip was estimated at the date of sale by discounting projected future cash flows. Susquehanna has retained the right to service the leases; however, no servicing asset or liability was recognized because expected servicing costs are approximately equal to expected servicing fee income, which approximates market value. Transaction costs associated with this securitization were included as a component of gain on sale. The subordinated notes retained in the transaction, which do not bear interest, have been rated by independent rating agencies. Their final maturity date is January 14, 2013.

2006 Transaction

In March 2006, Susquehanna securitized $356,140 of closed-end motor vehicle leases and recorded a pre-tax gain of $1,937 (which includes a gain recognized on the associated cash-flow hedge) in noninterest income. Retained interests in the securitization totaled $53,953 and included $10,482 in subordinated notes, $42,812 in equity certificates of the securitization trust, and a $659 interest-only strip. The initial carrying values of these retained interests were determined by allocating the carrying value among the assets sold and retained based on their relative fair values at the date of sale. The initial carrying value of the interest-only strip was estimated at the date of sale by discounting projected future cash flows. Susquehanna has retained the right to service the leases; however, no servicing asset or liability was recognized because expected servicing costs are approximately equal to expected servicing fee income, which approximates market value. Transaction costs associated with this securitization were included as a component of gain on sale. The subordinated notes retained in the transaction, which do not bear interest, have been rated by independent rating agencies. Their final maturity date is February 14, 2012.

2002 Revolving Transaction

In July 2007, Susquehanna, as servicer, issued a clean-up call for this securitization and acquired $33,397 in lease receivables.

Home Equity Loans

2006 Transaction

In September 2006, Susquehanna securitized $349,403 of fixed-rate home mortgage loans and variable-rate line of credit loans and recorded a pre-tax gain of $8,225 in noninterest income. Retained interests in the securitization totaled $21,244 and included $2,745 in subordinated notes, and $18,499 in interest-only strips. The initial carrying value of the interest-only strips was estimated at the date of sale by discounting projected future cash flows. Susquehanna has retained the right to service the loans and recorded a servicing asset of $2,334. Transaction costs associated with this securitization were included as a component of gain on sale. The subordinated notes retained in the transaction, which bear interest at one-month LIBOR plus .75%, were rated by independent rating agencies and have a final maturity date of August 2036.

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

Key economic assumptions used in measuring certain retained interests at the date of securitization were as follows:

	Gain Recognized		Weighted- average Life (in months)	Prepayment Speed		Expected Credit Losses		Annual Discount Rate		Annual Coupon Rate to Investors
Automobile Leases
2007 transaction	$	2,709	19	2.00%-4.00	%	0.05	%	5.18	%	5.25%-5.61	%
2006 transaction		1,937	22	2.00-4.00		0.05		5.28		4.99-5.58
Home Equity Loans
2006 transaction	$	8,225
Fixed-rate portion			56	10.00	*	0.10	%	6.60	%	30-day LIBOR+ 0.17% - 1.25	%
Variable-rate portion			20	45.00	*	0.06		6.60		30-day LIBOR+ 0.15	%

* Constant Prepayment Rate

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

	Principal Balance				Loans and Leases Past Due 30 Days or More				For the Nine Months Ended Sept 30
									Net Credit Losses (Recoveries)
	Sept 30, 2007		December 31, 2006		Sept 30, 2007		December 31, 2006		2007			2006
Loans and leases held in portfolio	$	5,842,883	$	5,560,997	$	79,147	$	98,242	$	10,303		$	4,277
Leases securitized		573,118		618,902		1,335		1,023		314			146
Home equity loans securitized		355,616		463,266		842		2,620		52			0
Leases serviced for others (1)		72,406		210,386		936		1,054		(122	)		(41	)
Total loans and leases serviced	$	6,844,023	$	6,853,551	$	82,260	$	102,939	$	10,547		$	4,382

(1) Amounts at September 30, 2007 include agency arrangements. Amounts at December 31, 2006 include the sale/leaseback transaction and agency arrangements.

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

	Three Months Ended Sept 30				Nine Months Ended Sept 30
	2007		2006		2007		2006
Automobile Leases
Proceeds from securitizations	$	0	$	0	$	252,493	$	302,887
Amounts derecognized		0		0		300,414		356,140
Servicing fees received		1,593		2,181		5,667		6,585
Other cash flows received from retained interests		11,190		8,745		19,083		21,582
	Three Months Ended Sept 30				Nine Months Ended Sept 30
	2007		2006		2007		2006
Home Equity Loans
Proceeds from securitizations	$	0	$	338,597	$	0	$	338,597
Amounts derecognized		0		351,150		0		351,150
Additional draws conveyed to the trusts		13,850		15,267		46,342		44,014
Servicing fees received		387		331		1,273		849
Other cash flows received from retained interests		1,779		0		6,019		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 September 30, 2007 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.

Susquehanna’s analysis of the information presented below indicates that any adverse change of 20% in the key economic assumptions would not have a significant effect on the fair value of the Company’s interest-only strips.

As of September 30, 2007

	Fair Value		Weighted- average Life (in months)	Monthly Prepayment Speed			Expected Cumulative Credit Losses			Annual Discount Rate (1)
Automobile Leases
2007 transaction - Interest-Only Strip	$	2,592	16		3.60	%		0.05	%		7.79	%
Decline in fair value of 10% adverse change				$	0		$	15		$	21
Decline in fair value of 20% adverse change					1			30			41
2006 transaction - Interest-Only Strip	$	1,094	8		4.00	%		0.05	%		7.83	%
Decline in fair value of 10% adverse change				$	1		$	6		$	5
Decline in fair value of 20% adverse change					3			12			11
2005 transaction - Interest-Only Strip	$	502	4		3.00	%		0.05	%		7.68	%
Decline in fair value of 10% adverse change				$	0		$	1		$	1
Decline in fair value of 20% adverse change					0			1			3
2004 revolving transaction - Interest-Only Strip	$	79	6		6.00	%		0.00	%		5.13	%
Decline in fair value of 10% adverse change				$	0		$	0		$	0
Decline in fair value of 20% adverse change					0			0			0

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

	Fair Value		Weighted- average Life (in months)	Constant Prepayment Rate		Expected Cumulative Credit Losses			Annual Discount Rate (1)
Home Equity Loans
2006 transaction - Interest-Only Strips
Fixed-rate portion	$	8,226	43		15.00		0.04	%		10.00	%
Decline in fair value of 10% adverse change				$	266	$	21		$	225
Decline in fair value of 20% adverse change					515		42			435
Variable-rate portion	$	2,832	20		45.00		0.06	%		10.00	%
Decline in fair value of 10% adverse change				$	203	$	7		$	62
Decline in fair value of 20% adverse change					381		13			122
2005 transaction - Interest-Only Strips	$	7,673	22		40.00		0.06	%		10.00	%
Decline in fair value of 10% adverse change				$	425	$	12		$	166
Decline in fair value of 20% adverse change					803		23			323

(1) The annual discount rate is based on fair-value estimates of similar instruments.

In the quarter ended September 30, 2007, Susquehanna’s monthly analysis of the cash flows associated with securitized assets indicated that the fixed-rate home equity loans included in the 2006 Home Equity securitization were experiencing faster than expected prepayments. Accordingly, the constant prepayment rate associated with these fixed-rate loans was increased from 10% to 15%, which approximates actual current experience. As a result, a $1,200 other-than-temporary impairment charge was recognized. Susquehanna did not identify adverse cash flows associated with its other securitized prime loans and leases.

As of September 30, 2007, and subsequent to the evaluation of adverse cash flows resulting in the other-than-temporary impairment charges on the fixed-rate home equity loans, the deterioration in the credit markets resulted in significant widening of yields associated with mortgage-related financial instruments. This deterioration prompted Susquehanna to re-evaluate the discount rates that were being utilized to calculate the fair value of the interest-only strips for all of its securitization transactions. This evaluation required Susquehanna to increase its discount rates, from a range of 4.25% to 6.60% as of June 30, 2007, to a range of 5.13% to 10.00% as of September 30, 2007, to reflect current market conditions and estimated fair values of these instruments. Susquehanna’s evaluation included consideration of actual historical cash flows of the underlying loans and leases and current yields on financial instruments with risk attributes similar to the underlying loans and leases. Susquehanna’s securitized loans and leases were originated in our market and do not contain exposure to sub-prime or alternative documentation (commonly referred to as “Alt-A”) loans and leases.

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 unlikelihood that more than 10% of the home equity line of credit loans in securitization transactions will convert from variable interest rates to fixed interest rates; expectations regarding the future performance of Hann; our ability to consummate the Community acquisition and to complete an offering of securities to finance the cash portion of the merger consideration; and our ability to achieve our 2007 financial goals. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:

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

• 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 loss reserves;

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

• continued relationships with major customers;

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

• adverse national and regional economic and business conditions;

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

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

• the ability to hedge certain risks economically;

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

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

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

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

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

The following information refers to the parent company and its wholly owned subsidiaries: Boston Service Company, Inc., (t/a Hann Financial Service Corporation) (“Hann”), Conestoga Management Company, Susquehanna Bank PA and subsidiaries, Susquehanna Bank DV and subsidiaries, 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 iswww.susquehanna.net. We make available free of charge, through the Investor Relations section of our web site, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We include our web-site address in this Quarterly Report on Form 10-Q as an inactive textual reference only.

Executive Commentary

Updated Financial Goals for 2007

Our updated financial goals for 2007, excluding the Community Banks acquisition expected to be completed in November of 2007 and associated one-time costs and excluding the second quarter investment loss from the restructuring program (for information regarding the restructuring, see the discussion under the heading “Financial Condition—Securities Available for Sale” in this Quarterly Report on Form 10-Q), are as follows:

	Previously Published Goal		Updated Goal
Net interest margin	3.67	%	3.67	%
Loan growth (adjusted for securitizations)	12.0	%	12.0	%
Deposit growth	5.0	%	4.0	%
Noninterest income growth	(5.0	)%	(6.0	)%
Noninterest expense growth	1.2	%	1.0	%
Tax rate	30.3	%	29.7	%

These financial goals include only one securitization in 2007, which already has occurred in the first quarter. The home-equity-loan securitization planned for the fourth quarter is no longer being considered due to our improved liquidity position resulting from our anticipated acquisition of Community Banks and our charter change for Susquehanna Bank DV as we moved from the Federal Home Loan Bank of New York to the Federal Home Loan Bank of Pittsburgh. The move to the Federal Home Loan Bank of Pittsburgh increased our borrowing capacity as its collateral verification standards are less limiting than those at the Federal Home Loan Bank of New York.

Acquisitions

Community Banks, Inc.

On May 1, 2007, we announced the signing of a definitive merger agreement pursuant to which we will acquire Community Banks, Inc. in a stock and cash transaction valued at approximately $860.0 million. Under the terms of the merger agreement, shareholders of Community will be entitled to elect to receive for each share of Community common stock that they own, either $34.00 in cash or 1.48 shares of Susquehanna common stock. On October 2, 2007, the shareholders of both Community and Susquehanna approved the merger transaction. Pending the expected regulatory approvals and the satisfaction of other closing conditions, the consummation of the merger is expected to occur on or about November 16, 2007. The acquisition will be accounted for under the purchase method in accordance with FAS No. 141, “Business Combinations.”

Widmann, Siff & Co., Inc.

On August 1, 2007, we acquired Widmann, Siff & Co., Inc., and investment advisory firm in Radnor, Pa. Widmann, Siff had more than $300.0 million in assets under management, including accounts serving individuals, pension and profit-sharing plans, corporations, and family trusts. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Widmann, Siff was considered immaterial for purpose of the disclosures required by FAS No. 141, “Business combinations.”

Minotola National Bank

On April 21, 2006, we acquired Minotola National Bank in a stock and cash transaction valued at approximately $172 million. The acquisition of Minotola, with total assets of $607 million and fourteen branch locations, has significantly enhanced our presence in the high-growth markets in southern New Jersey. The acquisition was accounted for under the purchase method, and all transactions since that date are included in our consolidated financial statements.

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

Results of Operations

Summary of 2007 Compared to 2006

Net income for the third quarter of 2007 was $19.9 million, a decrease of $5.3 million, or 21.2%, over net income of $25.2 million for the third quarter of 2006. Net interest income decreased 1.6%, to $66.1 million for the third quarter of 2007, from $67.1 million for the third quarter of 2006. Noninterest income decreased 22.5%, to $30.3 million for the third quarter of 2007, from $39.1 million for the third quarter of 2006. Noninterest expenses decreased 1.2%, to $66.1 million for the third quarter of 2007, from $66.9 million for the third quarter of 2006.

Results for the third quarter of 2006 include a pre-tax gain of $8.2 million that we recognized in a home-equity-loan securitization. There were no securitization transactions in the third quarter of 2007.

Net income for the first nine months of 2007 was $50.4 million, a decrease of $11.8 million, or 19.0%, over net income of $62.3 million for the first nine months of 2006. Net interest income decreased 0.2%, to $192.6 million for the first nine months of 2007, from $193.0 million for the first nine months of 2006. Noninterest income decreased 17.1%, to $83.7 million for the first nine months of 2007, from $101.0 million for the first nine months of 2006. Noninterest expenses increased 1.0%, to $198.3 million for the first nine months of 2007, from $196.2 million for the first nine months of 2006.

Results for the nine-month period ended September 30, 2007 were significantly affected by an investment portfolio restructuring in June 2007 which created a pre-tax loss of $11.8 million. For additional information regarding the restructuring, see the discussion under the heading “Financial Condition—Securities Available for Sale” in this Quarterly Report on Form 10-Q.

Additional information is as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Diluted Earnings per Share	$	0.38		$	0.49		$	0.97		$	1.25
Return on Average Assets		0.93	%		1.21	%		0.81	%		1.05	%
Return on Average Equity		8.39	%		10.99	%		7.16	%		9.73	%
Return on Average Tangible Equity (1)		13.83	%		18.32	%		11.81	%		15.58	%
Efficiency Ratio		67.97	%		62.54	%		71.14	%		66.32	%
Efficiency Ratio excluding Hann (1)		65.27	%		57.40	%		68.80	%		60.99	%
Net Interest Margin		3.64	%		3.76	%		3.66	%		3.80	%

(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 measure is return on average equity which is calculated using GAAP- based amounts. 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.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Return on average equity (GAAP basis)	8.39	%	10.99	%	7.16	%	9.73	%
Effect of excluding average intangible assets and related amortization	5.44	%	7.33	%	4.65	%	5.85	%
Return on average tangible equity	13.83	%	18.32	%	11.81	%	15.58	%

Efficiency ratio excluding Hann is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable measure is efficiency ratio which is calculated using GAAP-based amounts. 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.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Efficiency ratio (GAAP basis)	67.97	%	62.54	%	71.14	%	66.32	%
Effect of excluding Hann	2.70	%	5.14	%	2.34	%	5.33	%
Efficiency ratio excluding Hann	65.27	%	57.40	%	68.80	%	60.99	%

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 September 30, 2007						For the Three-Month Period Ended September 30, 2006
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short-term investments	$	92,110		$	1,019	4.39	$	78,232		$	966	4.90
Investment securities:
Taxable		1,444,726			18,672	5.13		1,274,232			13,709	4.27
Tax-advantaged		41,487			655	6.26		17,992			295	6.51
Total investment securities		1,486,213			19,327	5.16		1,292,224			14,004	4.30
Loans and leases, (net):
Taxable		5,618,807			106,455	7.52		5,696,372			107,835	7.51
Tax-advantaged		93,359			1,737	7.38		89,303			1,675	7.44
Total loans and leases		5,712,166			108,192	7.51		5,785,675			109,510	7.51
Total interest-earning assets		7,290,489		$	128,538	6.99		7,156,131		$	124,480	6.90
Allowance for loan and lease losses		(61,900	)					(62,017	)
Other non-earning assets		1,237,046						1,182,023
Total assets	$	8,465,635					$	8,276,137
Liabilities
Deposits:
Interest-bearing demand	$	2,097,339		$	15,119	2.86	$	1,866,568		$	13,780	2.93
Savings		430,305			869	0.80		517,312			1,548	1.19
Time		2,565,452			30,128	4.66		2,518,686			26,981	4.25
Short-term borrowings		464,610			5,033	4.30		373,462			4,267	4.53
FHLB borrowings		620,809			7,106	4.54		648,835			6,811	4.16
Long-term debt		222,026			3,372	6.03		222,509			3,272	5.83
Total interest-bearing liabilities		6,400,541		$	61,627	3.82		6,147,372		$	56,659	3.66
Demand deposits		880,724						982,026
Other liabilities		243,810						235,919
Total liabilities		7,525,075						7,365,317
Equity		940,560						910,820
Total liabilities and shareholders’ equity	$	8,465,635					$	8,276,137
Net interest income / yield on average earning assets				$	66,911	3.64				$	67,821	3.76

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.

Susquehanna Bancshares, Inc. and Subsidiaries

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

(dollars in thousands)

Interest rates and interest differential—taxable equivalent basis

	For the Nine-Month Period Ended September 30, 2007						For the Nine-Month Period Ended September 30, 2006
	Average Balance			Interest		Rate (%)	Average Balance			Interest		Rate (%)
Assets
Short-term investments	$	91,851		$	3,411	4.97	$	75,581		$	2,551	4.51
Investment securities:
Taxable		1,429,643			51,799	4.84		1,240,745			38,855	4.19
Tax-advantaged		40,323			1,905	6.32		18,169			854	6.28
Total investment securities		1,469,966			53,704	4.88		1,258,914			39,709	4.22
Loans and leases, (net):
Taxable		5,471,681			309,576	7.56		5,431,832			298,207	7.34
Tax-advantaged		89,457			4,998	7.47		82,182			4,427	7.20
Total loans and leases		5,561,138			314,574	7.56		5,514,014			302,634	7.34
Total interest-earning assets		7,122,955		$	371,689	6.98		6,848,509		$	344,894	6.73
Allowance for loan and lease losses		(62,424	)					(58,546	)
Other non-earning assets		1,228,005						1,107,726
Total assets	$	8,288,536					$	7,897,689
Liabilities
Deposits:
Interest-bearing demand	$	2,102,416		$	47,982	3.05	$	1,812,671		$	36,640	2.70
Savings		453,234			2,922	0.86		498,421			3,494	0.94
Time		2,509,837			86,814	4.62		2,381,654			71,295	4.00
Short-term borrowings		390,149			12,805	4.39		323,972			9,955	4.11
FHLB borrowings		532,404			16,236	4.08		655,763			19,824	4.04
Long-term debt		222,114			9,955	5.99		202,843			8,860	5.84
Total interest-bearing liabilities		6,210,154		$	176,714	3.80		5,875,324		$	150,068	3.41
Demand deposits		897,463						943,239
Other liabilities		239,090						223,571
Total liabilities		7,346,707						7,042,134
Equity		941,829						855,555
Total liabilities and shareholders’ equity	$	8,288,536					$	7,897,689
Net interest income / yield on average earning assets				$	194,975	3.66				$	194,826	3.80

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.

Net Interest Income — Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which decreased to $66.1 million for the third quarter of 2007, as compared to $67.1 million for the same period in 2006. For the nine months ended September 30, 2007, net interest income decreased to $192.6 million, as compared to $193.0 million for the same period in 2006.

Net interest income as a percentage of net interest income plus noninterest income was 68.6% for the quarter ended September 30, 2007, and 63.2% for the quarter ended September 30, 2006. Net interest income as a percentage of net interest income plus noninterest income was 69.7% for the nine months ended September 30, 2007, and 65.6% for the nine months ended September 30, 2006.

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 $1.1 million decrease in our net interest income for the third quarter of 2007, as compared to the third quarter of 2006, was primarily the result of a decrease in net interest margin. Our net interest margin declined from 3.76% for the third quarter of 2006, to 3.64% for the third quarter of 2007. This decrease in net interest margin was primarily due to an increased volume of average interest-bearing liabilities, a 16 basis point increase in rates paid on the average balances of those interest-bearing liabilities, and a $101.3 million decrease in noninterest-bearing demand deposits. The 16-basis-point increase in rates paid on average balances of interest-bearing liabilities was partially offset by a 9-basis-point increase in yields on average interest-earning assets. The decrease in net interest margin was partially offset by a $134.4 million increase in average interest-earning assets.

The $0.4 million decrease in our net interest income for the first nine months of 2007, as compared to the first nine months of 2006, was primarily the result of a decrease in our net interest margin. Our net interest margin declined from 3.80% for the first nine months of 2006, to 3.66% for the first nine months of 2007. This decrease in net interest margin was primarily due to a 39 basis point increase in rates paid on average interest-bearing liabilities and a $45.8 million decrease in noninterest-bearing demand deposits. The 39 basis point increase in rates paid on average balances on interest-bearing liabilities was partially offset by a 25 basis point increase in yields on average interest-earning assets. The decrease in net interest margin was partially offset by a $274.4 million increase in average interest-earning assets.

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 $2.4 million for the third quarter of 2007, and $2.2 million for the third quarter of 2006. The provision for loan and lease losses was $6.3 million for the first nine months of 2007, and $6.2 million for the first nine months of 2006.

Net charge-offs for the third quarter of 2007 increased to $5.6 million, or 0.39% of average loans and leases when compared to net charge-offs for the third quarter of 2006 of $1.2 million, or 0.08% of average loans and leases. Our historic normal range for net charge-offs as a percentage of average loans and leases is between 0.15% and 0.25%. Net charge-offs for the third quarter of 2007 included a $2.5 million charge-off on a commercial real estate credit in Pennsylvania. Net charge-offs for the first nine months of 2007 were $10.3 million, or 0.25% of average loans and leases, which is within our historic range.

The allowance for loan and lease losses was 1.00% of period-end loans and leases, or $58.7 million at September 30, 2007; 1.13% of period-end loans and leases, or $62.6 million, at December 31, 2006; and 1.11% of period-end loans and leases, or $61.1 million, at September 30, 2006.

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 September 30, 2007. 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 September 30, 2007.

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 2 - Allowance for Loan and Lease Losses

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
	(dollars in thousands)
Balance - Beginning of period	$	61,871		$	60,138		$	62,643		$	53,714
Additions through acquisition		0			0			0			5,514
Additions charged to operating expenses		2,414			2,241			6,347			6,191
		64,285			62,379			68,990			65,419
Charge-offs		(6,628	)		(3,467	)		(13,150	)		(8,703	)
Recoveries		1,030			2,230			2,847			4,426
Net charge-offs		(5,598	)		(1,237	)		(10,303	)		(4,277	)
Balance - Period end	$	58,687		$	61,142		$	58,687		$	61,142
Net charge-offs as a percent of average loans and leases (annualized)		0.39	%		0.08	%		0.25	%		0.10	%
Allowance as a percent of period-end loans and leases		1.00	%		1.11	%		1.00	%		1.11	%
Average loans and leases	$	5,712,166		$	5,785,675		$	5,561,138		$	5,514,014
Period-end loans and leases		5,842,883			5,517,513			5,842,883			5,517,513

Noninterest Income

Third Quarter 2007 Compared to Third Quarter 2006

Noninterest income, as a percentage of net interest income plus noninterest income, was 31.4% for the third quarter of 2007, and 36.8% for the third quarter of 2006.

Noninterest income decreased $8.8 million, or 22.5%, for the third quarter of 2007, over the third quarter of 2006. This net decrease was composed primarily of the following:

• Decreasedvehicle origination, servicing, and securitization fees of $1.6 million and

• Decreasedgains on sale of loans and leases of $7.8 million.

Vehicle origination, servicing, and securitization fees.The 29.8% decrease was the result of a decrease in vehicle lease originations and managed balances due to significant competition from the captive finance companies.

Gains on sale of loans and leases.During the third quarter of 2006, we recognized an $8.2 million gain in a home-equity-loan securitization. There were no securitization transactions during the third quarter of 2007.

Nine Months ended September 30, 2007 Compared to Nine Months ended September 30, 2006

Noninterest income, as a percentage of net interest income plus noninterest income, was 30.3% for the nine-month period ended September 30, 2007, and 34.4% for the nine-month period ended September 30, 2006.

Noninterest income decreased $17.3 million, or 17.1%, for the nine-month period ended September 30, 2007, over the comparable period in 2006. This net decrease was composed primarily of the following:

• Increasedservice charges on deposit accounts of $1.8 million;

• Decreasedvehicle origination, servicing, and securitization fees of $2.8 million;

• Decreasedgains on sale of loans and leasesof $7.6 million; and

• Increasednet realized losses on securities of $11.7 million.

Service charges on deposit accounts.The 9.2% increase was the result of improvements initiated in the second quarter of 2006 relating to the processing of customer overdrafts and the inclusion of Minotola operations for the entire nine months of 2007 as opposed to approximately five months in 2006. (Minotola was acquired on April 21, 2006.)

Vehicle origination, servicing, and securitization fees.The 19.5% decrease was the result of a decrease in vehicle lease originations and managed balances due to significant competition from the captive finance companies.

Gains on sale of loans and leases.During the first nine months of 2006, we recognized gains totaling $10.2 million on the sales of loans and leases in two securitization transactions. During the first nine months of 2007, we recognized a gain of $2.8 million in one securitization transaction.

Net realized losses on securities.The increase was a direct result of our investment portfolio restructuring that occurred in June 2007. The restructuring involved the sale of $233.0 million in available-for-sale securities, or approximately 16.0% of our total investment portfolio. For additional information regarding the restructuring, see the discussion under the heading “Financial Condition -Securities Available for Sale” in this Quarterly Report on Form 10-Q.

Noninterest Expenses

Third Quarter 2007 Compared to Third Quarter 2006

Noninterest expenses decreased $0.8 million, or 1.2%, from $66.9 million for the third quarter of 2006, to $66.1 million for the third quarter of 2007. This net decrease was composed primarily of the following:

• Increasedsalaries and employee benefits of $2.4 million;

• Decreasedvehicle lease disposal expenses of $0.9 million; and

• Decreasedother expenses of $3.0 million.

Salaries and employee benefits. The largest component of noninterest expense is salaries and employee benefits, which increased 7.1% for the third quarter of 2007, as compared to the third quarter of 2006. This increase was primarily the result of normal annual salary increases and higher benefit costs.

Vehicle lease disposal. The 22.4% decrease primarily was the result of increased efficiencies at the reconditioning center and lower residual guarantee expense.

Other expense. The 15.7% decrease primarily was due to the elimination of monthly rental expense as a result of a termination of the sale-leaseback transaction on January 12, 2007, which is described below under the heading “Financial Condition –Loans and Leases.”

Nine Months ended September 30, 2007 Compared to Nine Months ended September 30, 2006

Noninterest expenses increased $2.0 million, or 1.0%, from $196.2 million for the nine-month period ended September 30, 2006 to $198.3 million for the comparable period in 2007. This net increase was composed primarily of the following:

• Increasedsalaries and employee benefits of $9.0 million;

• Increasedoccupancy expense of $1.8 million;

• Decreasedadvertising and marketing expenses of $0.8 million;

• Decreasedvehicle lease disposal expenses of $1.6 million; and

• Decreasedother expenses of $7.2 million.

Salaries and employee benefits. The largest component of noninterest expense is salaries and employee benefits, which increased 9.4% for the first nine months of 2007, as compared to the first nine months of 2006. This increase was primarily the result of the inclusion of Minotola operations for the entire nine months in 2007 as opposed to approximately five months in 2006, normal annual salary increases, and higher benefit costs.

Occupancy. The 11.4% increase primarily was the result of the inclusion of Minotola operations for the entire nine months in 2007 as opposed to approximately five months in 2006.

Advertising and marketing.The 11.0% decrease was primarily the result of a reduction in our advertising budget for 2007 as compared to 2006.

Vehicle lease disposal. The 14.6% decrease primarily was the result of increased efficiencies at the reconditioning center and lower residual guarantee expense.

Other expense. The 12.6% decrease primarily was due to the elimination of monthly rental expense as a result of a termination of the sale-leaseback transaction on January 12, 2007, which is described below under the heading “Financial Condition –Loans and Leases.”

Income Taxes

Our effective tax rate for the third quarter of 2007 was 28.67%. Our effective tax rate for the third quarter of 2006 was 32.00%. The decrease is due to an increase in tax-advantaged income and projected federal income tax credits.

Our effective tax rate for the first nine months of 2007 was 29.64%. Our effective tax rate for the first nine months of 2006 was 32.00%. The decrease is due to an increase in tax-advantaged income and an increase in projected federal income tax credits.

Financial Condition

Summary of September 30, 2007 Compared to December 31, 2006

Total assets at September 30, 2007 were $8.7 billion, an increase of 6.1%, as compared to total assets at December 31, 2006. Total deposits increased to $6.0 billion at September 30, 2007, from $5.9 billion at December 31, 2006. Equity capital was $942.2 million at September 30, 2007, or $18.05 per share, compared to $936.3 million, or $17.98 per share, at December 31, 2006.

On September 5, 2007, our board of directors declared a fourth quarter dividend of $0.26 per share on our common stock, payable on November 20, 2007 to shareholders of record at November 1, 2007. Historically, fourth quarter dividends have been declared in October. As a result, at September 30, 2007, our equity capital was reduced by $13.6 million.

Securities Available for Sale

Securities available for sale increased $151.3 million from December 31, 2006 to September 30, 2007. The increase occurred because, as part of our investment management strategy, we purchased mortgage-backed securities in the third quarter of 2007 to replace securities that will be maturing in the short-term as we expect interest rates to decline further in the fourth quarter of 2007.

During May and June of 2007, while planning for the Community acquisition and the resulting growth and composition of the investment portfolio, our management performed a comprehensive review of our available-for-sale investments. Management determined that for administrative and operational purposes, small remaining portions in mortgage-backed securities (“odd lots,” or securities with remaining par amounts of less than $2.0 million) should be sold. These odd lots, totaling $182.0 million, resulted from previous mergers and bank consolidations and from principal amortization over time. Additionally, we determined that all collateralized mortgage obligations, regardless of the remaining par amount, with an aggregate total of $51.0 million should be sold. Many of these mortgages were acquired in the historic low-interest-rate environment of 2002 through 2004. This investment portfolio restructuring is expected to reduce administrative costs of managing odd lots, improve the yield on the investment portfolio, and enhance related net interest margin and net interest income.

The restructuring involved the sale of approximately 16.0% of our available-for-sale investment portfolio, and resulted in a pre-tax charge of approximately $11.8 million in June 2007. There was minimal impact on shareholders’ equity, as the decline in value of the investments had been reflected previously in accumulated other comprehensive income.

The proceeds from the sales of these securities were reinvested in a diversified mix of Federal Agency bullet debentures and commercial and residential mortgage-backed securities with higher yields, longer duration, and positive convexity attributes. The sold securities had a weighted-average yield of 3.76%, while the proceeds were reinvested in securities with an expected yield of 5.75%. We believe that this restructuring will better position our investment portfolio and overall balance sheet to perform well in the current interest-rate environment and for the anticipated merger with Community.

Loans and Leases

Loans and leases increased $281.9 million, from December 31, 2006 to September 30, 2007. The increase primarily occurred in the commercial, financial, and agricultural category, as loan demand is still solid in our market area.

On January 12, 2007, we exercised an early buyout option associated with Hann’s sale-leaseback transaction. As a result, Hann acquired approximately $78.4 million of beneficial interests in automobile leases and related vehicles. A significant portion of these automobile leases and related vehicles was sold to our banking subsidiaries and subsequently included in the February 2007 $300.4 million vehicle lease securitization transaction.

Risk Assets

While total nonperforming assets increased $1.5 million, from December 31, 2006 to September 30, 2007, Table 3 shows that there have been notable changes among the categories within nonperforming assets.

• Nonaccrual loans and leases decreased, from $30.3 million at December 31, 2006 to $26.6 million at September 30, 2007. The net decrease primarily was the result of the transfer of two credits totaling $9.3 million from nonaccrual status to other real estate owned, offset by two other credits totaling $4.5 being placed on nonaccrual status.

• Restructured loans decreased, from $5.4 million at December 31, 2006, to $1.9 million at September 30, 2007 due to the reclassification to performing status in the first quarter of 2007 of a loan included in restructured debt at December 31, 2006.

• Other real estate owned increased, from $1.5 million at December 31, 2006, to $10.3 million at September 30, 2007. This increase primarily was the result of the transfer of the two credits mentioned above from nonaccrual status to other real estate owned. Before the transfer, these two credits were charged-down by $3.5 million.

We also anticipate that a $12.0 million construction loan may move to nonaccrual status in the fourth quarter of 2007. Our current valuation of the collateral supporting this credit is sufficient to cover the principal balance.

Recently, there has been significant turmoil in the sub-prime mortgage market. As a result of our underwriting guidelines, our home equity loan and auto lease securitizations do not contain sub-prime exposure. Our retained interests in these transactions are comprised of loans originated in our geographic market area. In addition, our investment and loan portfolios do not include exposure to sub-prime or Alt-A programs.

Susquehanna Bancshares, Inc. and Subsidiaries

TABLE 3 - Risk Assets

	September 30, 2007			December 31, 2006			September 30, 2006
	(dollars in thousands)
Nonperforming assets:
Nonaccrual loans and leases	$	26,556		$	30,325		$	21,176
Restructured loans		1,867			5,376			2,295
Other real estate owned		10,331			1,544			2,085
Total nonperforming assets	$	38,754		$	37,245		$	25,556
As a percent of period-end loans and leases plus other real estate owned		0.66	%		0.67	%		0.46	%
Coverage ratio		206.48	%		175.47	%		260.50	%
Loans and leases contractually past due 90 days and still accruing	$	9,459		$	9,364		$	16,853

Investment in and Receivables from Unconsolidated Entities

Concurrent with the lease securitization transaction in February 2007, our banking subsidiaries recorded investments in and receivables from unconsolidated entities of $47.9 million, representing notes and equity certificates of the issuer.

Deposits

While total deposits increased 1.7%, from $5.9 billion at December 31, 2006, to $6.0 billion at September 30, 2007, noninterest-bearing deposits decreased 7.5%, from $959.7 million at December 31, 2006, to $887.7 million at September 30, 2007. Interest-bearing demand deposits increased by 2.5%, from $2.0 billion at December 31, 2006, to $2.1 billion at September 30, 2007. If this trend continues in 2007, we anticipate that our net interest margin could be negatively impacted in future quarters.

Borrowings

Short-term borrowings increased 21.7%, from $402.0 million at December 31, 2006, to $489.0 million at September 30, 2007, and FHLB borrowings increased 50.5%, from $528.7 million to $795.5 million during the same timeframe. These increases are due to fact that the increase in total deposits has been insufficient to support our growth in loans and leases. In addition, securities available for sale increased by $151.3 million, from December 31, 2006, to September 20, 2007, because we purchased securities in the third quarter of 2007 to replace those that will be maturing in the short term.

We anticipate offering up to $150 million in capital efficient notes during the fourth quarter of 2007 to finance the cash portion of the merger consideration to be paid to CommunityBanks’ shareholders and for other working capital purposes. We may increase the size of the trust preferred offering, depending upon existing market conditions, to raise proceeds for additional working capital and general corporate purposes. The exact terms of the trust preferred securities will not be determined until shortly before the offering is to be consummated.

Capital Adequacy

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

The minimum Tier 1 capital ratio is 4%; our ratio at September 30, 2007, was 8.93%. The minimum total capital (Tiers 1 and 2) ratio is 8%; our ratio at September 30, 2007, was 11.72%. The minimum leverage ratio is 4%; our leverage ratio at September 30, 2007, was 8.26%. 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.

Securitizations and Off-Balance-Sheet Financings

The following table summarizes the components of loans and leases serviced:

	As of September 30, 2007		As of September 30, 2006
	(dollars in thousands)
Lease Securitization Transactions*	$	573,118	$	688,665
Home Equity Loan Securitization Transactions*		355,616		504,226
Agency Arrangements and Lease Sales*		72,406		169,688
Sale-Leaseback Transaction*		0		78,705
Leases and Loans Held in Portfolio		5,842,883		5,517,513
Total Leases and Loans Serviced	$	6,844,023	$	6,958,797

* Off-balance-sheet

Securitization Transactions

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

For additional information concerning the accounting policies for initially measuring interest-only strips, the characteristics of securitization transactions, including the gain or loss from sale, the key assumptions used in measuring the fair value of the interest-only strips, and descriptions of prior years’ securitization transactions, see the following sections of our Annual Report on Form 10-K for the year ended December 31, 2006:

• “Securitizations and Off-Balance-Sheet Financings” on pages 52 through 59;

• “Note 1. Summary of Significant Accounting Policies” under the captionsAsset Securitizations andServicing Fees under Securitization Transactions, the Sale-Leaseback Transaction, Agency Agreements and Lease Sales on pages 79 and 80; and

• “Note 20. Securitization Activity” on pages 108 through 113.

Also see “Note 11. Securitization Activity” to the financial statements appearing in Part I, Item 1, of this Quarterly Report on Form 10-Q.

Summary of the 2007 Securitization Transaction

In February 2007, each of our wholly owned commercial and retail banking subsidiaries (each, a “Sponsor Subsidiary”) entered into a term securitization transaction (the “2007 transaction”). In connection with the 2007 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 $300.4 million in automobile leases and the related vehicles to the Transferors. However, the transaction documents for the 2007 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 $260.3 million of fixed-rate asset-backed notes to third-party investors. The Issuer also issued an additional $7.8 million of notes, which have been retained pro rata by the Transferors in the same ratio as the Transferors retain the equity interests of the Issuer.

The gain recognized in this transaction was $2.7 million. The initial interest-only strip recognized in this transaction was $4.0 million.

Sale-Leaseback Transaction

In December 2000, Hann sold and contributed the beneficial interest in $190 million of automobiles and related auto leases owned by the Origination Trust to a wholly owned special purpose subsidiary (the “Lessee”). The Lessee sold such beneficial interests to a lessor (the “Lessor”), and the Lessor in turn leased the beneficial interests in the automobiles and auto leases back to the Lessee under a Master Lease Agreement that had an eight-year term. For accounting purposes, the sale-leaseback transaction between the Lessee and the Lessor was treated as a sale and an operating lease and qualified as a sale and leaseback under FAS No. 13.

During the third quarter of 2006, we notified the Lessor of our intention to exercise the early buyout option, and the transaction was terminated January 12, 2007. The early buyout option price was $93.7 million and was comprised of $78.4 million of beneficial interests in automobile leases and related vehicles and payment of $15.3 million in cash, which had been recognized in other operating expense in prior years. A significant portion of the automobile leases and related vehicles that Hann acquired in conjunction with the early buyout option was sold to our banking subsidiaries and included in the vehicle lease securitization transaction that closed February 14, 2007.

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.

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 above.

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 September 30, 2007, our bank subsidiaries had approximately $727.9 million available to them under collateralized lines of credit with various FHLBs; and approximately $1.3 billion more would have been available provided that additional collateral had been pledged.

Liquidity is not entirely dependent on increasing our liability balances. Liquidity is also evaluated by taking into consideration maturing or readily marketable assets. Unrestricted short-term investments totaled $110.5 million at September 30, 2007 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 February 2007, 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. Net proceeds from this transaction totaled $252.5 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. At September 30, 2007, we were slightly liability-sensitive and should benefit if interest rates decline.

Derivative Financial Instruments and Hedging Activities

Beginning in February 2007, we entered into amortizing interest rate swaps with an aggregate notional amount of $131.5 million. For purposes of our consolidated financial statements, the entire notional amount of the swaps is designated as a cash flow hedge of expected future cash flows associated with a forecasted sale of auto leases. These transactions are subject to FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” At September 30, 2007, the unrealized loss, net of taxes, recorded in accumulated other comprehensive income was $0.6 million.

Beginning in April 2006, we entered into amortizing interest rate swaps with an aggregate total of $266.9 million. For purposes of our consolidated financial statements, the entire notional amount of the swaps was designated as a cash flow hedge of expected future cash flows associated with a forecasted sale of auto leases. This transaction was subject to FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” On February 8, 2007, the swaps were terminated. On February 14, 2007, the forecasted sale of auto leases occurred, and the $0.2 million loss reported in other comprehensive income at December 31, 2006, was reclassified to gain on sale of loans and leases.

In June 2005, we entered into two $25.0 million interest rate swaps to hedge the interest rate risk exposure on $50.0 million of 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. At September 30, 2007, the unrealized gain, net of taxes, recorded in accumulated other comprehensive income totaled $0.3 million.

The following table summarizes our derivative financial instruments as of September 30, 2007:

Notional Amount		Fair Value			Variable Rate	Fixed Rate
(dollars in thousands)
$	131,524	$	(974	)	One-month LIBOR	4.571% to 5.206	%
	25,000		178		Three-month LIBOR	3.935	%
	25,000		339		Three-month LIBOR	4.083	%
$	181,524	$	(457	)

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 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.

Item 4. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures

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

(b) Change in Internal Control Over Financial Reporting

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

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

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 to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. In addition to those risk factors, Susquehanna shareholders carefully should consider the following additional risk factor:

Our pending merger with Community Banks, Inc. may not be consummated. If consummated, we may not realize the expected benefits from the merger.

The merger agreement for the pending Community Banks, Inc. merger contains conditions that, if not satisfied or waived, would result in the merger not occurring. These conditions include, among others:

• the continued accuracy of the representations and warranties contained in the merger agreement;

• the performance by each party of its obligations under the merger agreement; and

• the listing of such stock for trading on the NASDAQ Stock Market.

In addition, both Susquehanna and Community have rights to terminate the merger agreement prior to consummation upon the occurrence of certain specified conditions or events.

If we do not consummate the merger with Community, we will not realize any of the anticipated benefits of combining the companies. If we do consummate the merger, our estimates regarding earnings, cash flow and cost savings resulting from the transaction may prove to be incorrect. Further, unexpected costs and challenges may arise whenever businesses with different operations or management are combined, and we may experience unanticipated difficulties in the assimilation of the Community operations and workforce, thus delaying the benefits of the merger. As a result of any of the foregoing factors, our results of operations and financial performance could be adversely affected.

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:

2.1	Amended and Restated Agreement and Plan of Merger between Susquehanna and Community Banks, Inc. is incorporated by reference to Exhibit 2.1 of Susquehanna’s Registration Statement on Form S-4/A, filed August 10, 2007
3.1	Amended and Restated By-laws of Susquehanna are incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed October 19, 2007
10.1	Employment Agreement, dated July 25, 2007, between Susquehanna and Michael M. Quick is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.2	Employment Agreement, dated July 25, 2007, between Susquehanna and James G. Pierne is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.3	Employment Agreement, dated July 25, 2007, between Susquehanna and Edward Balderston, Jr. is incorporated by reference to Exhibit 10.3 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.4	Description of cash bonus payable to Bernard A. Francis, Jr. is incorporated by reference to Susquehanna’s Current Report on Form 8-K, filed August 22, 2007
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.
November 8, 2007	/s/ William J. Reuter
	William J. Reuter
	Chairman, President and Chief Executive Officer
November 8, 2007	/s/ Drew K. Hostetter
	Drew K. Hostetter
	Executive Vice President, Treasurer, and Chief Financial Officer

EXHIBIT INDEX

Exhibit Numbers	Description and Method of Filing
2.1	Amended and Restated Agreement and Plan of Merger between Susquehanna and Community Banks, Inc. is incorporated by reference to Exhibit 2.1 of Susquehanna’s Registration Statement on Form S-4/A, filed August 10, 2007
3.1	Amended and Restated By-laws of Susquehanna are incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed October 19, 2007
10.1	Employment Agreement, dated July 25, 2007, between Susquehanna and Michael M. Quick is incorporated by reference to Exhibit 10.1 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.2	Employment Agreement, dated July 25, 2007, between Susquehanna and James G. Pierne is incorporated by reference to Exhibit 10.2 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.3	Employment Agreement, dated July 25, 2007, between Susquehanna and Edward Balderston, Jr. is incorporated by reference to Exhibit 10.3 of Susquehanna’s Current Report on Form 8-K, filed July 30, 2007
10.4	Description of cash bonus payable to Bernard A. Francis, Jr. is incorporated by reference to Susquehanna’s Current Report on Form 8-K, filed August 22, 2007
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