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 June 30, 2014

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 001-33872

Susquehanna Bancshares, Inc.

(Exact Name of Registrant as Specified in Its Charter)

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

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

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

Yes  x    No  ¨ 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

Yes  x    No  ¨ 

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

Large Accelerated Filer	x	Accelerated Filer	¨
Non-Accelerated Filer	¨  (Do not check if a smaller reporting company)	Smaller Reporting Company	¨

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

Yes  ¨    No  x 

As of July 28, 2014, there were 187,705,957 shares of the registrant’s common stock outstanding, par value $2.00 per share.

SUSQUEHANNA BANCSHARES, INC.
TABLE OF CONTENTS
			Page
PART I. FINANCIAL INFORMATION			3
	Item 1 Financial Statements (Unaudited)		3
		Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013	3
		Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013	4
		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013	5
		Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013	6
		Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2014 and 2013	7
		Notes to Consolidated Financial Statements	8
	Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		54
	Item 3 Quantitative and Qualitative Disclosures About Market Risk		77
	Item 4 Controls and Procedures		80
PART II. OTHER INFORMATION			81
	Item 1 Legal Proceedings		81
	Item 1A Risk Factors		81
	Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		82
	Item 3 Defaults Upon Senior Securities		82
	Item 4 Mine Safety Disclosures		82
	Item 5 Other Information		82
	Item 6 Exhibits		83
SIGNATURES			84
EXHIBIT INDEX			85

2

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
					June 30,		December 31,
					2014		2013
					(in thousands, except share data)
Assets
	Cash and due from banks				$	456,917	$	305,357
	Unrestricted short-term investments					33,369		37,967
			Cash and cash equivalents			490,286		343,324
	Interest-bearing deposits held by consolidated variable interest entities that can be used only to
		settle obligations of the consolidated variable interest entities				1,554		2,347
	Restricted short-term investments					43,926		42,913
	Securities available for sale					2,183,093		2,375,224
	Restricted investment in bank stocks					141,689		158,232
	Loans and leases, net of deferred costs and fees					13,600,254		13,503,392
	Loans held by consolidated variable interest entities that can be used only to settle obligations of
		the consolidated variable interest entities				66,899		72,694
			Less: Allowance for loan and lease losses			144,483		157,608
				Net loans and leases		13,522,670		13,418,478
	Premises and equipment, net					169,975		173,542
	Other real estate and foreclosed assets					11,102		17,573
	Accrued interest receivable					38,878		41,690
	Bank-owned life insurance					450,318		449,320
	Goodwill					1,275,439		1,275,439
	Intangible assets with finite lives					28,579		32,262
	Deferred income tax assets					7,357		6,472
	Other assets					141,760		136,673
				Total Assets	$	18,506,626	$	18,473,489
Liabilities and Shareholders’ Equity
	Deposits:
		Noninterest-bearing			$	1,935,635	$	1,913,526
		Interest-bearing				11,379,359		10,955,846
				Total deposits		13,314,994		12,869,372
	Federal Home Loan Bank short-term borrowings					1,050,000		1,450,000
	Other short-term borrowings					527,079		555,740
	Federal Home Loan Bank long-term borrowings					77,302		81,282
	Other long-term debt					175,222		250,227
	Junior subordinated debentures					146,002		155,002
	Long-term debt of consolidated variable interest entities for which creditors do not have recourse to
		Susquehanna’s general credit				38,809		48,031
	Accrued interest, taxes, and expenses payable					72,664		82,150
	Deferred income tax liabilities					114,119		70,308
	Other liabilities					194,043		193,790
				Total Liabilities		15,710,234		15,755,902
	Shareholders’ equity:
		Common stock, $2.00 par value, 400,000,000 shares authorized; Issued: 188,072,946 at
			June 30, 2014, and 187,676,711 at December 31, 2013			376,146		375,353
		Treasury stock, at cost, 366,587 at June 30, 2014, and 313,568 at December 31, 2013				(3,075)		(2,531)
		Additional paid-in capital				1,657,699		1,652,116
		Retained earnings				794,864		744,215
		Accumulated other comprehensive loss, net of taxes of $16,427  and $25,039, respectively				(29,242)		(51,566)
				Total Shareholders’ Equity		2,796,392		2,717,587
				Total Liabilities and Shareholders’ Equity	$	18,506,626	$	18,473,489
The accompanying notes are an integral part of these consolidated financial statements.

3

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
			Three Months Ended				Six Months Ended
			June 30,				June 30,
			2014		2013		2014		2013
				(in thousands, except per share data)
Interest Income:
	Loans and leases, including fees		$	148,002	$	159,986	$	297,540	$	320,330
	Securities:
		Taxable		9,104		9,683		18,752		19,943
		Tax-exempt		3,439		3,561		6,940		7,155
		Dividends		2,134		1,146		3,899		2,312
	Short-term investments			23		35		42		71
		Total interest income		162,702		174,411		327,173		349,811
Interest Expense:
	Deposits:
		Interest-bearing demand and savings		4,031		4,513		7,993		9,414
		Time		10,246		11,654		19,874		22,886
	Federal Home Loan Bank short-term borrowings			4,597		3,452		9,218		6,823
	Other short-term borrowings			2,031		2,153		4,131		4,306
	Federal Home Loan Bank long-term borrowings			243		303		488		604
	Other long-term debt			(140)		4,239		3,711		8,475
		Total interest expense		21,008		26,314		45,415		52,508
Net interest income				141,694		148,097		281,758		297,303
Provision for loan and lease losses				3,000		12,000		9,000		24,000
Net interest income, after provision for loan and lease losses				138,694		136,097		272,758		273,303
Noninterest Income:
	Service charges on deposit accounts			9,294		9,347		18,294		18,019
	Vehicle origination and servicing fees			2,915		2,407		5,883		5,761
	Wealth management commissions and fees			12,669		13,289		25,388		25,679
	Commissions on property and casualty insurance sales			4,214		4,360		9,880		8,902
	Other commissions and fees			5,401		4,727		10,436		9,055
	Income from bank-owned life insurance			1,672		1,520		3,309		3,028
	Mortgage banking revenue			3,004		3,998		5,414		8,108
	Capital markets revenue			877		3,256		2,117		4,158
	Net realized gain (loss) on sales of securities			3,293		(71)		3,285		(53)
	Other			2,010		6,243		3,432		9,063
		Total noninterest income		45,349		49,076		87,438		91,720
Noninterest Expenses:
	Salaries and employee benefits			68,325		66,888		133,906		129,502
	Occupancy			11,914		11,154		25,761		22,369
	Furniture and equipment			4,058		3,747		8,002		7,325
	Professional and technology services			7,189		5,831		13,259		11,560
	Advertising and marketing			3,567		2,465		7,143		5,765
	FDIC insurance			4,925		4,541		10,046		8,339
	Legal fees			1,656		1,810		3,183		3,680
	Amortization of intangible assets			2,367		3,053		4,906		6,321
	Vehicle lease disposal			2,215		1,313		4,466		2,603
	Other			19,009		18,936		37,585		40,003
		Total noninterest expenses		125,225		119,738		248,257		237,467
Income before income taxes				58,818		65,435		111,939		127,556
Provision for income taxes				15,324		19,787		31,283		39,509
Net Income			$	43,494	$	45,648	$	80,656	$	88,047
Earnings per common share:
		Basic	$	0.23	$	0.24	$	0.43	$	0.47
		Diluted	$	0.23	$	0.24	$	0.43	$	0.47
Cash dividends per common share			$	0.08	$	0.08	$	0.16	$	0.08
Average common shares outstanding:
		Basic		187,637		186,812		187,547		186,710
		Diluted		188,295		187,723		188,296		187,612
The accompanying notes are an integral part of these consolidated financial statements.

4

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
				Three Months Ended				Six Months Ended
				June 30,				June 30,
				2014		2013		2014		2013
					(in thousands)				(in thousands)
Net Income				$	43,494	$	45,648	$	80,656	$	88,047
Other comprehensive income (loss):
	Change in unrealized gain (loss) on securities available for sale				11,241		(53,120)		27,362		(59,291)
			Tax effect and reclassification adjustment		(4,040)		19,177		(9,847)		21,356
					7,201		(33,943)		17,515		(37,935)
	Non-credit related unrealized gain on other-than-temporarily
		impaired debt securities			0		433		0		141
			Tax effect		0		(159)		0		(52)
					0		274		0		89
	Change in unrealized gain on cash flow hedges				3,473		10,081		7,573		14,486
			Tax effect		(1,267)		(3,679)		(2,764)		(5,287)
					2,206		6,402		4,809		9,199
	Changes in postretirement benefit obligations				0		0		0		(26)
			Tax effect		0		0		0		9
					0		0		0		(17)
Total other comprehensive income (loss)					9,407		(27,267)		22,324		(28,664)
Total comprehensive income				$	52,901	$	18,381	$	102,980	$	59,383
The accompanying notes are an integral part of these consolidated financial statements.

5

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
			Six Months Ended
			June 30,
			2014		2013
				(in thousands)
Cash Flows from Operating Activities:
	Net income		$	80,656	$	88,047
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation, amortization, and accretion		31,184		30,051
		Provision for loan and lease losses		9,000		24,000
		Stock compensation expense		2,821		1,473
		Realized (gain) loss on available-for-sale securities, net		(3,285)		53
		Deferred income tax expense		30,315		30,552
		Gain on sale of loans and leases		(4,728)		(9,256)
		Gain on sale of foreclosed assets		(95)		(470)
		(Gain) loss on sale of fixed assets		(69)		285
		Mortgage loans originated for sale		(215,753)		(272,513)
		Proceeds from sale of mortgage loans originated for sale		196,500		287,009
		Increase in cash surrender value of bank-owned life insurance		(3,690)		(2,843)
		Decrease (increase) in accrued interest receivable		2,812		(2,361)
		Increase in accrued interest payable		1,549		1,627
		Decrease in accrued expenses and taxes payable		(11,035)		(5,224)
		Other, net		(1,659)		8,301
	Net cash provided by operating activities			114,523		178,731
Cash Flows from Investing Activities:
	Net (increase) decrease in restricted short-term investments			(220)		28,929
	Activity in available-for-sale securities:
		Sales		42		33,763
		Maturities, repayments, and calls		216,865		354,445
		Purchases		0		(224,074)
	Net decrease in restricted investment in bank stock			16,543		1,685
	Net increase in loans and leases			(108,859)		(301,026)
	Purchase of bank-owned life insurance			0		(4,843)
	Proceeds from bank-owned life insurance			2,692		6,678
	Proceeds from sale of foreclosed assets			10,724		12,661
	Additions to premises and equipment, net			(4,919)		(6,761)
	Net cash provided by (used in) investing activities			132,868		(98,543)
Cash Flows from Financing Activities:
	Net increase in deposits			447,842		184,186
	Net increase (decrease) in other short-term borrowings			(28,661)		(111,512)
	Net decrease in short-term FHLB borrowings			(400,000)		(28,000)
	Repayment of long-term FHLB borrowings			(3,057)		(8,005)
	Repayment of long-term debt			(89,557)		(24,436)
	Proceeds from issuance of common stock			3,555		4,621
	Purchase of treasury stock			(544)		(25)
	Cash dividends paid			(30,007)		(14,948)
	Net cash (used in) provided by financing activities			(100,429)		1,881
Net change in cash and cash equivalents				146,962		82,069
Cash and cash equivalents at January 1				343,324		316,592
Cash and cash equivalents at June 30			$	490,286	$	398,661
Supplemental Disclosure of Cash Flow Information
	Cash paid for interest on deposits and borrowings		$	43,866	$	50,880
	Income tax payments (refunds)			(1,958)		(21,006)
Supplemental Schedule of Noncash Activities
	Real estate acquired in settlement of loans		$	6,687	$	6,987
	Securities purchased not settled			2,729		0
The accompanying notes are an integral part of these consolidated financial statements.

6

SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements Of Changes In Shareholders’ Equity (Unaudited)
(In thousands, except share data)
												Accumulated
			Shares of					Additional				Other
			Common	Common		Treasury		Paid-in		Retained		Comprehensive
			Stock	Stock		Stock		Capital		Earnings		Loss		Total
Balance at January 1, 2013			186,811,642	$	373,623	$	(1,850)	$	1,645,958	$	615,436	$	(37,258)	$	2,595,909
	Total comprehensive income										88,047		(28,664)		59,383
	Issuance of common stock and share-based awards under employee
		benefit plans	471,555		943				3,678						4,621
	Treasury stock purchased						(25)								(25)
	Cash dividends paid on common stock ($0.08 per share)										(14,948)				(14,948)
Balance at June 30, 2013			187,283,197	$	374,566	$	(1,875)	$	1,649,636	$	688,535	$	(65,922)	$	2,644,940
Balance at January 1, 2014			187,676,711	$	375,353	$	(2,531)	$	1,652,116	$	744,215	$	(51,566)	$	2,717,587
	Total comprehensive income										80,656		22,324		102,980
	Issuance of common stock and share-based awards under employee
		benefit plans	396,235		793				5,583						6,376
	Treasury stock purchased						(544)								(544)
	Cash dividends paid on common stock ($0.16 per share)										(30,007)				(30,007)
Balance at June 30, 2014			188,072,946	$	376,146	$	(3,075)	$	1,657,699	$	794,864	$	(29,242)	$	2,796,392
The accompanying notes are an integral part of these consolidated financial statements.

7

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 1. Summary of Significant Accounting Policies

The information contained in this report is unaudited.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information.  Certain prior-year amounts have been reclassified to conform to current period.  In the opinion of management, the information reflects all normal recurring adjustments necessary for a fair statement of results for the three and six months ended June 30, 2014 and 2013. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. Operating results for the three-month and six-month periods ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

The accounting policies of Susquehanna Bancshares, Inc. and Subsidiaries ("Susquehanna"), as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 78 through 85 of Susquehanna’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Use of Estimates

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

Recently Adopted Accounting Guidance

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

In July 2013, FASB issued ASU 2013-10, Derivatives and Hedging (Topic 815) – Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.  This ASU permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to U.S. Treasury interest rates and the London Interbank Offered Rate.  The amendment also removes the restriction on using different benchmark rates for similar hedges.  The adoption of this guidance, in the third quarter of 2013, did not have a material impact on results of operations, financial condition, or disclosures.  For more information, refer to Note 13.  Fair Value Disclosures.

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

8

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Recently Issued Accounting Guidance

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

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

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This guidance supersedes the revenue recognition requirements in Accounting Standards Codification Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Accounting Standards Codification. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This guidance is effective for interim and annual reporting periods beginning after December 15, 2016.  Susquehanna is currently evaluating this amendment to determine the impact on financial condition and results of operations. 

9

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 2.  Investment Securities

The amortized cost and fair values of investment securities at June 30, 2014 and December 31, 2013 were as follows:

				Gross		Gross
		Amortized		Unrealized		Unrealized		Fair
At June 30, 2014		Cost		Gains		Losses		Value
Available-for-Sale:
	U.S. Government agencies	$	95,701	$	276	$	100	$	95,877
	Obligations of states and political subdivisions		379,616		20,922		1,275		399,263
	Agency residential mortgage-backed securities		1,612,979		18,363		10,567		1,620,775
	Non-agency residential mortgage-backed securities		385		1		5		381
	Commercial mortgage-backed securities		5,758		124		0		5,882
	Other structured financial products		24,741		0		12,746		11,995
	Other debt securities		24,064		847		273		24,638
			2,143,244		40,533		24,966		2,158,811
	Other equity securities		24,472		699		889		24,282
Total available-for-sale securities		$	2,167,716	$	41,232	$	25,855	$	2,183,093
				Gross		Gross
		Amortized		Unrealized		Unrealized		Fair
At December 31, 2013		Cost		Gains		Losses		Value
Available-for-Sale:
	U.S. Government agencies	$	110,227	$	343	$	422	$	110,148
	Obligations of states and political subdivisions		389,199		13,386		4,075		398,510
	Agency residential mortgage-backed securities		1,786,133		12,163		20,104		1,778,192
	Non-agency residential mortgage-backed securities		572		1		8		565
	Commercial mortgage-backed securities		8,568		166		0		8,734
	Other structured financial products		25,038		0		13,741		11,297
	Other debt securities		43,156		1,487		557		44,086
			2,362,893		27,546		38,907		2,351,532
	Other equity securities		24,318		557		1,183		23,692
Total available-for-sale securities		$	2,387,211	$	28,103	$	40,090	$	2,375,224

At June 30, 2014 and December 31, 2013, investment securities with carrying values of $1,340,493 and $1,512,824, respectively, were pledged to secure public funds and for other purposes as required by law.

The amortized cost and fair value of U.S. Government agencies, obligations of states and political subdivisions, agency and non-agency residential mortgage-backed securities, commercial mortgage-backed securities, other structured financial products, other debt securities, and residential and commercial mortgage-backed securities, at June 30, 2014 and December 31, 2013, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

			June 30, 2014				December 31, 2013
			Amortized		Fair		Amortized		Fair
			Cost		Value		Cost		Value
Securities available for sale:
	Within one year		$	24,902	$	25,188	$	8,870	$	9,005
	After one year but within five years			99,490		100,391		129,176		130,091
	After five years but within ten years			875,681		887,302		945,637		946,754
	After ten years			1,143,171		1,145,930		1,279,210		1,265,682
		Total	$	2,143,244	$	2,158,811	$	2,362,893	$	2,351,532

10

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Gross realized gains and gross realized losses on investment securities transactions are summarized below. These gains and losses were recognized using the specific identification method and were included in noninterest income.

	Available-for-sale Securities
	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Gross gains	$	3,339	$	26	$	3,364	$	433
Gross losses		(46)		0		(79)		(1)
Other-than-temporary impairment		0		(97)		0		(485)
Net gains	$	3,293	$	(71)	$	3,285	$	(53)

The following table presents Susquehanna’s investments’ gross unrealized losses and the corresponding fair values by investment category and length of time that the securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013.

	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
June 30, 2014	Value		Losses		Value		Losses		Value		Losses
U.S. Government agencies	$	24,953	$	47	$	1,947	$	53	$	26,900	$	100
Obligations of states and political subdivisions		0		0		59,429		1,275		59,429		1,275
Agency residential mortgage-backed securities		258,383		1,763		331,792		8,804		590,175		10,567
Non-agency residential mortgage-backed securities		0		0		352		5		352		5
Other structured financial products		0		0		11,995		12,746		11,995		12,746
Other debt securities		0		0		6,786		273		6,786		273
Other equity securities		0		0		1,577		889		1,577		889
	$	283,336	$	1,810	$	413,878	$	24,045	$	697,214	$	25,855
	Less than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2013	Value		Losses		Value		Losses		Value		Losses
U.S. Government agencies	$	68,111	$	422	$	0	$	0	$	68,111	$	422
Obligations of states and political subdivisions		73,895		3,910		7,025		165		80,920		4,075
Agency residential mortgage-backed securities		1,030,987		20,104		0		0		1,030,987		20,104
Non-agency residential mortgage-backed securities		530		8		0		0		530		8
Other structured financial products		0		0		11,297		13,741		11,297		13,741
Other debt securities		0		0		6,476		557		6,476		557
Other equity securities		19,111		286		1,619		897		20,730		1,183
	$	1,192,634	$	24,730	$	26,417	$	15,360	$	1,219,051	$	40,090

11

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Non-agency residential mortgage-backed securities. At June 30, 2014, Susquehanna held one security that had unrealized losses, but was not rated below investment grade. None of Susquehanna’s non-agency residential mortgage-backed securities were backed by loans identified by the issuer as subprime or Alt-A collateral. Management has analyzed the collateral underlying these securities with respect to defaults, loan to collateral value ratios, current levels of subordination, and geographic concentrations and concluded that none of these securities are other-than-temporarily impaired.

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

Credit Losses on Non-agency Residential Mortgage-backed and Other Equity Securities for which a Portion of an
Other-than-temporary Impairment was Recognized in Other Comprehensive Income
			Three Months Ended
			June 30,
			2014				2013
					Equity				Equity
			RMBS		Securities		RMBS		Securities
Balance - beginning of period			$	0	$	609	$	1,122	$	512
Additions:
	Amount related to credit losses for which an other-than-
		temporary impairment was not previously recognized		0		0		0		0
	Additional amount related to credit losses for which an other-than-
		temporary impairment was previously recognized		0		0		0		97
Deductions:
	Realized losses			0		0		96		0
Balance - end of period			$	0	$	609	$	1,026	$	609
			Six Months Ended
			June 30,
			2014				2013
					Equity				Equity
			RMBS		Securities		RMBS		Securities
Balance - beginning of period			$	0	$	609	$	768	$	512
Additions:
	Amount related to credit losses for which an other-than-
		temporary impairment was not previously recognized		0		0		325		0
	Additional amount related to credit losses for which an other-than-
		temporary impairment was previously recognized		0		0		63		97
Deductions:
	Realized losses			0		0		130		0
Balance - end of period			$	0	$	609	$	1,026	$	609

Susquehanna estimated the portion of loss attributable to credit using a discounted cash flow model. Susquehanna, in conjunction with a third-party financial advisory firm, assisted with the development of critical assumptions including the expected cash flows of the underlying collateral of the non-agency residential mortgage-backed securities using internal credit risk, interest rate risk, and prepayment risk models that incorporated management’s best estimate of current key assumptions, such as default rates, loss severity, and prepayment rates.  Assumptions used can vary widely from loan to loan and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics, and collateral type. The distribution of underlying cash flows is determined in accordance with the security’s terms. Expected principal and interest cash flows on an other-than-temporarily impaired debt security are discounted using the effective yield of that debt security.

12

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Based on the expected cash flows derived from the model, Susquehanna expects to recover the unrealized loss in accumulated other comprehensive income ($0 and $471 at June 30, 2014 and 2013, respectively). Significant assumptions used in the valuation of these other-than-temporarily impaired securities were as follows:

			Weighted-average (%)
			June 30,
			2014 (1)	2013
		Conditional repayment rate (2)	N/A	10.4%
		Loss severity (3)	N/A	42.0%
		Conditional default rate (4)	N/A	3.6%
(1)	Not applicable as the related securities were sold during 2013.
(2)	Conditional repayment rate represents a rate equal to the proportion of principal balance paid off voluntarily over a certain period of time on an annualized basis.
(3)	Loss severity rates are projected by considering collateral characteristics such as current loan-to-value, original creditworthiness of borrowers (FICO score) and geographic concentration.
(4)	Conditional default rate is an annualized rate of default on a group of mortgages, and represents the percentage of outstanding principal balances in the pool that are in default, which typically equates to the borrower being past due 60 days, 90 days, or possibly already in the foreclosure process.

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

Other structured financial products. Susquehanna’s structured financial product investments are comprised of four pooled trust preferred securities which have an aggregate unrealized loss of $12,746 and $14,543 at June 30, 2014 and 2013, respectively. All of these securities are below investment grade but are of a more senior tranche of the specific issue. Susquehanna has contracted with a third party financial advisory firm (“third party firm”) to assist in its valuation and other-than-temporary impairment analysis of its structured financial product investments. In addition to the valuation work performed by a third party firm which Susquehanna utilizes to support its valuation and other-than-temporary-impairment analysis, management of Susquehanna considered Section 619 of the Dodd-Frank Act (commonly referred to as the “Volcker Rule”). Specifically, Susquehanna considered the interim final rule published by federal regulatory agencies on January 14, 2014, which indicated Susquehanna’s trust preferred securities will remain permissible holdings under the Volcker Rule.

Management has assisted with the development of, and performed a detailed review of the critical assumptions. The review of the inputs for the valuation of the pooled trust preferred securities is performed by the CIC. Key aspects reviewed by CIC include the detail on non-performing financial institutions within the pools of trust preferred securities, the probability of default of the underlying institutions within the pools, the discount rate, trades of similar securities and indexes, and the weighting given to market indications. Susquehanna management believes that the valuation analysis and methodology reasonably supports the value and projected performance of the specific trust preferred securities. Management believes this valuation methodology presents an appropriate approach in the determination of other-than-temporary impairment charges in accordance with GAAP.

Using publicly available financial information, the third party firm’s valuation analysis compares the present value of the expected base cash flows with the amortized cost basis of the trust preferred securities to determine whether Susquehanna expects to receive the entire amortized cost basis of such securities. To make this comparison, the third party firm evaluates two scenarios consisting of three phases each. The two scenarios are: (1) the first dollar loss scenario, and, (2) the expected or forecasted scenario. The three phases associated with each scenario are production of cash flows, application of the cash flows to the percent owned, and assessment of any other-than-temporary impairment.

To determine expected cash flows, the valuation analysis considers credit default rates, call options and deferrals, waterfall structure, and covenants relating to the trust preferred securities. The trust indenture documentation and the trustee reports for each specific trust preferred security issuance provides information regarding deferral rights, call options, various triggers, (including over-

13

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

collateralization triggers), and waterfall structure, which management believes is essential in determining projected base cash flows. The third party firm determines short-term default risk using ratios, including the Texas ratio, that relate to the issuers, capitalization, asset quality, profitability, and liquidity. To determine longer term default probabilities, the third party firm uses an internal scoring approach that relies on key historical financial performance ratios. Management believes that future cash flows for these securities are reasonably developed and supported.

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

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

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

14

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The present value of the expected cash flows for Susquehanna’s specific class and subordinate classes, as well as additional
information about the pooled trust preferred securities, are included in the following tables.
As of June 30, 2014		Pooled Trust #1		Pooled Trust #2		Pooled Trust #3		Pooled Trust #4
Recorded investment		$	3,000	$	7,160	$	7,831	$	6,750
Fair value			1,222		3,988		4,372		2,413
Unrealized loss			(1,778)		(3,172)		(3,459)		(4,337)
Class		B		B		B		A2L
Class face value		$	35,000	$	59,724	$	89,651	$	45,500
Present value of expected cash flows
	for class noted above and all
	subordinated classes (1)	$	170,046	$	199,081	$	326,512	$	159,410
Lowest credit rating assigned		D		Ca		Caa2		Ca
Original collateral		$	623,984	$	501,470	$	700,535	$	487,680
Performing collateral			377,342		318,814		486,061		273,100
Actual defaults			47,400		55,580		49,000		83,500
Actual deferrals			28,500		75,430		67,650		65,580
Projected future defaults			38,438		42,129		44,490		27,172
Actual defaults as a % of original
	collateral		7.6%		11.1%		7.0%		17.1%
Actual deferrals as a % of original
	collateral (2)		4.6%		15.0%		9.7%		13.5%
Actual defaults and deferrals as a % of
	original collateral		12.2%		26.1%		16.7%		30.6%
Projected future defaults as a % of
	original collateral (3)		6.2%		8.4%		6.4%		5.6%
Actual institutions deferring and
	defaulted as a % of total institutions		17.2%		31.5%		20.6%		36.5%
Projected future defaults as a % of
	performing collateral plus
	deferrals		9.5%		10.7%		8.0%		8.0%

15

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

As of June 30, 2013		Pooled Trust #1		Pooled Trust #2		Pooled Trust #3		Pooled Trust #4
Recorded investment		$	3,000	$	7,183	$	8,115	$	6,750
Fair value			1,272		3,231		3,798		2,204
Unrealized loss			(1,728)		(3,952)		(4,317)		(4,546)
Class		B		B		B		A2L
Class face value		$	35,000	$	59,248	$	89,071	$	45,500
Present value of expected cash flows
	for class noted above and all
	subordinated classes (1)	$	162,483	$	190,163	$	305,257	$	150,521
Lowest credit rating assigned		D		Ca		Ca		Ca
Original collateral		$	623,984	$	501,470	$	700,535	$	487,680
Performing collateral			358,342		279,934		470,731		281,488
Actual defaults			30,000		51,580		44,000		77,212
Actual deferrals			80,900		125,810		96,150		93,080
Projected future defaults			54,168		45,809		49,876		39,479
Actual defaults as a % of original
	collateral		4.8%		10.3%		6.3%		15.8%
Actual deferrals as a % of original
	collateral (2)		13.0%		25.1%		13.7%		19.1%
Actual defaults and deferrals as a % of
	original collateral		17.8%		35.4%		20.0%		34.9%
Projected future defaults as a % of
	original collateral (3)		8.7%		9.1%		7.1%		8.1%
Actual institutions deferring and
	defaulted as a % of total institutions		20.0%		38.2%		26.2%		40.9%
Projected future defaults as a % of
	performing collateral plus
	deferrals		12.3%		11.3%		8.8%		10.5%
(1)	Susquehanna determines whether it expects to recover the entire amortized cost basis by comparing the present value of the expected cash flows to be collected with the amortized cost basis. As of June 30, 2014 and 2013, the present value of the current estimated cash flows is equal to or greater than the book value of the trust preferred securities held. Consequently, there is no credit-related other-than-temporary impairment required to be recognized.
(2)	Includes current interest deferrals for the quarter for those institutions deferring as of the date of the assessment of the other-than-temporary impairment. Current deferrals are assumed to continue for twenty quarters, the full contractually permitted deferral period, if the institutions are not projected to default prior to that time.
(3)	Includes those institutions that are performing but are not projected to continue to perform and includes those institutions that are currently deferring interest that are projected to default, based upon third-party proprietary valuation methodology used to determine future defaults. Creditworthiness of each underlying issue in the collateralized debt obligation is determined using publicly available data.

16

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 3. Loans and Leases

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

At June 30, 2014, Susquehanna reclassified approximately $265 million of indirect auto loans from held for investment to held for sale (“HFS loans”).  The loans were transferred to held for sale at their amortized cost basis on the date of transfer and will be measured at the lower of their amortized cost or fair value on an ongoing basis.  Amortized cost was lower than fair value as of June 30, 2014. 

In conjunction with transferring the loans to held for sale, Susquehanna reclassified $1,236 from the allowance for loan loss and reflected this as a reduction in the cost basis of the reclassified loans, which is evident in the allowance roll-forward in Note 4. Allowance for Loan and Lease Losses.  Additionally, all held for sale loans are included in the consumer category in the loan note tables and were current and accruing at June 30, 2014.

Loans and Leases, Net of Deferred Costs and Fees
				June 30,		December 31,
				2014		2013
	Commercial, financial, and agricultural			$	2,422,931	$	2,394,847
	Real estate - construction				748,181		735,877
	Real estate secured - residential				4,178,842		4,204,430
	Real estate secured - commercial				4,053,990		4,068,816
	Consumer				962,618		953,000
	Leases				1,300,591		1,219,116
			Total loans and leases	$	13,667,153	$	13,576,086
	Originated loans and leases			$	12,159,274	$	11,930,946
	Purchased loans and leases				1,507,879		1,645,140
			Total loans and leases	$	13,667,153	$	13,576,086
	Nonaccrual loans and leases			$	105,609	$	100,815
	Loans and leases contractually past due 90 days
		and still accruing			9,190		9,757
	Troubled debt restructurings				40,938		72,133
	Deferred origination costs, net of fees				24,441		21,216
	All overdrawn deposit accounts, reclassified
		as loans and evaluated for collectability			6,477		2,918

	A summary of our net investment in direct lease financing is presented below.
Net Investment in Direct Financing Leases
				June 30,		December 31,
				2014		2013
		Minimum lease payments receivable		$	671,443	$	667,365
		Estimated residual value of leases			712,442		634,875
		Unearned income under lease contracts			(83,294)		(83,124)
			Total leases	$	1,300,591	$	1,219,116

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

17

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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

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

	The following tables present Susquehanna's credit quality indicators by internally assigned grading and by payment activity at
June 30, 2014 and December 31, 2013.
Credit Quality Indicators, at June 30, 2014
	Commercial Credit Exposure
		Credit-risk Profile by Internally Assigned Grade
								Real Estate -		Total
						Real Estate -		Secured -		Commercial
				Commercial		Construction (1)		Commercial (2)		Credit Exposure
Originated loans and leases
	Grade:
		Pass (3)		$	2,168,434	$	517,720	$	3,669,176	$	6,355,330
		Special mention (4)			62,990		20,374		164,431		247,795
		Substandard (5)			71,531		31,753		193,258		296,542
			Total	$	2,302,955	$	569,847	$	4,026,865	$	6,899,667
Purchased loans and leases
	Grade:
		Pass (3)		$	107,421	$	24,172	$	693,000	$	824,593
		Special mention (4)			5,325		19,312		64,620		89,257
		Substandard (5)			7,230		14,295		104,933		126,458
			Total	$	119,976	$	57,779	$	862,553	$	1,040,308
Total loans and leases
	Grade:
		Pass (3)		$	2,275,855	$	541,892	$	4,362,176	$	7,179,923
		Special mention (4)			68,315		39,686		229,051		337,052
		Substandard (5)			78,761		46,048		298,191		423,000
			Total	$	2,422,931	$	627,626	$	4,889,418	$	7,939,975
	Other Credit Exposure
		Credit-risk Profile based on Payment Activity
				Real Estate -
				Secured -						Total Other
				Residential		Consumer		Leases		Credit Exposure
Originated loans and leases
	Performing			$	2,985,504	$	956,065	$	1,299,403	$	5,240,972
	Nonperforming (6)				17,113		334		1,188		18,635
		Total		$	3,002,617	$	956,399	$	1,300,591	$	5,259,607
Purchased loans and leases
	Performing			$	452,350	$	6,219	$	0	$	458,569
	Nonperforming (6)				9,002		0		0		9,002
		Total		$	461,352	$	6,219	$	0	$	467,571
Total loans and leases
	Performing			$	3,437,854	$	962,284	$	1,299,403	$	5,699,541
	Nonperforming (6)				26,115		334		1,188		27,637
		Total		$	3,463,969	$	962,618	$	1,300,591	$	5,727,178

18

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Credit Quality Indicators, at December 31, 2013
	Commercial Credit Exposure
		Credit-risk Profile by Internally Assigned Grade
								Real Estate -		Total
						Real Estate -		Secured -		Commercial
				Commercial		Construction (1)		Commercial (2)		Credit Exposure
Originated loans and leases
	Grade:
		Pass (3)		$	2,133,884	$	478,097	$	3,658,875	$	6,270,856
		Special mention (4)			75,162		33,907		168,464		277,533
		Substandard (5)			60,168		30,583		194,799		285,550
			Total	$	2,269,214	$	542,587	$	4,022,138	$	6,833,939
Purchased loans and leases
	Grade:
		Pass (3)		$	108,898	$	25,070	$	750,241	$	884,209
		Special mention (4)			4,220		19,811		62,208		86,239
		Substandard (5)			12,515		22,247		130,408		165,170
			Total	$	125,633	$	67,128	$	942,857	$	1,135,618
Total loans and leases
	Grade:
		Pass (3)		$	2,242,782	$	503,167	$	4,409,116	$	7,155,065
		Special mention (4)			79,382		53,718		230,672		363,772
		Substandard (5)			72,683		52,830		325,207		450,720
			Total	$	2,394,847	$	609,715	$	4,964,995	$	7,969,557
	Other Credit Exposure
		Credit-risk Profile based on Payment Activity
				Real Estate -
				Secured -						Total Other
				Residential		Consumer		Leases		Credit Exposure
Originated loans and leases
	Performing			$	2,914,547	$	945,379	$	1,217,629	$	5,077,555
	Nonperforming (6)				16,937		1,028		1,487		19,452
		Total		$	2,931,484	$	946,407	$	1,219,116	$	5,097,007
Purchased loans and leases
	Performing			$	491,922	$	6,591	$	0	$	498,513
	Nonperforming (6)				11,007		2		0		11,009
		Total		$	502,929	$	6,593	$	0	$	509,522
Total loans and leases
	Performing			$	3,406,469	$	951,970	$	1,217,629	$	5,576,068
	Nonperforming (6)				27,944		1,030		1,487		30,461
		Total		$	3,434,413	$	953,000	$	1,219,116	$	5,606,529
(1)	Includes only construction loans granted to commercial customers. Construction loans for individuals are included in Real Estate – Secured – Residential, below.
(2)	Includes loans obtained for commercial purposes that are also secured by residential real estate.
(3)	Includes loans identified as having acceptable risk, which are loans for which the possibility of loss is considered unlikely.
(4)	Includes loans considered potentially weak; however, no loss of principal or interest is anticipated.
(5)	Includes loans that are inadequately protected by the current net-worth and paying capacity of the borrower or by the collateral pledged, if any. Loss of principal or interest is considered reasonably possible or likely.
(6)	Includes loans that are on non-accrual status or past due ninety days or more.

19

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following tables detail the age analysis of Susquehanna's past due financing receivables as of June 30, 2014 and December 31, 2013.
Age Analysis of Past Due Financing Receivables, as of June 30, 2014
	Financing Receivables that are Accruing
												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	1,297	$	468	$	20	$	1,785	$	2,402,354	$	2,404,139
Real estate - construction			183		745		692		1,620		739,133		740,753
Real estate secured - residential			8,296		3,709		6,018		18,023		4,136,079		4,154,102
Real estate secured - commercial			2,544		12,850		1,903		17,297		3,983,006		4,000,303
Consumer			5,245		1,015		291		6,551		956,024		962,575
Leases			771		316		266		1,353		1,298,319		1,299,672
	Total	$	18,336	$	19,103	$	9,190	$	46,629	$	13,514,915	$	13,561,544
Originated loans and leases		$	16,051	$	17,055	$	4,518	$	37,624	$	12,035,233	$	12,072,857
Purchased loans and leases			2,285		2,048		4,672		9,005		1,479,682		1,488,687
	Total	$	18,336	$	19,103	$	9,190	$	46,629	$	13,514,915	$	13,561,544
	Financing Receivables that are Nonaccruing
												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	95	$	1,436	$	9,246	$	10,777	$	8,015	$	18,792
Real estate - construction			0		0		3,604		3,604		3,824		7,428
Real estate secured - residential			79		544		16,819		17,442		7,298		24,740
Real estate secured - commercial			1,865		98		30,527		32,490		21,197		53,687
Consumer			0		0		10		10		33		43
Leases			0		182		24		206		713		919
	Total	$	2,039	$	2,260	$	60,230	$	64,529	$	41,080	$	105,609
Originated loans and leases		$	1,550	$	2,152	$	49,750	$	53,452	$	32,965	$	86,417
Purchased loans and leases			489		108		10,480		11,077		8,115		19,192
	Total	$	2,039	$	2,260	$	60,230	$	64,529	$	41,080	$	105,609

20

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Age Analysis of Past Due Financing Receivables, as of December 31, 2013
	Financing Receivables that are Accruing
												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	3,640	$	518	$	127	$	4,285	$	2,373,735	$	2,378,020
Real estate - construction			1,631		903		418		2,952		719,695		722,647
Real estate secured - residential			27,441		6,223		7,274		40,938		4,140,127		4,181,065
Real estate secured - commercial			11,583		1,840		667		14,090		4,008,579		4,022,669
Consumer			8,664		1,537		983		11,184		941,769		952,953
Leases			4,275		368		288		4,931		1,212,986		1,217,917
	Total	$	57,234	$	11,389	$	9,757	$	78,380	$	13,396,891	$	13,475,271
Originated loans and leases		$	46,031	$	9,381	$	7,302	$	62,714	$	11,787,333	$	11,850,047
Purchased loans and leases			11,203		2,008		2,455		15,666		1,609,558		1,625,224
	Total	$	57,234	$	11,389	$	9,757	$	78,380	$	13,396,891	$	13,475,271
	Financing Receivables that are Nonaccruing
												Total
		30-59 Days		60-89 Days		90 Days		Total				Financing
		Past Due		Past Due		and Greater		Past Due		Current		Receivables
Commercial		$	4,832	$	855	$	4,850	$	10,537	$	6,290	$	16,827
Real estate - construction			2,176		788		5,320		8,284		4,946		13,230
Real estate secured - residential			609		497		16,518		17,624		5,741		23,365
Real estate secured - commercial			1,320		3,551		19,952		24,823		21,324		46,147
Consumer			0		0		0		0		47		47
Leases			0		199		148		347		852		1,199
	Total	$	8,937	$	5,890	$	46,788	$	61,615	$	39,200	$	100,815
Originated loans and leases		$	8,205	$	3,806	$	39,553	$	51,564	$	29,335	$	80,899
Purchased loans and leases			732		2,084		7,235		10,051		9,865		19,916
	Total	$	8,937	$	5,890	$	46,788	$	61,615	$	39,200	$	100,815

21

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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

Impaired Loans at June 30, 2014
													Average
						Recorded							Recorded
				Unpaid		Investment					Related		Investment		Interest
				Principal		in Impaired			Related		Specific		in Impaired		Income
				Balance		Loans			Charge-offs		Allowance		Loans (2)		Recognized
Impaired loans without a related reserve:
	Commercial, financial, and agricultural			$	21,203	$	18,289		$	2,914			$	18,410	$	238
	Real estate - construction				11,286		10,687			599				10,826		97
	Real estate secured - residential				23,047		22,414			633				22,953		278
	Real estate secured - commercial				127,356		104,750			22,606				103,245		1,435
	Consumer				0		0			0				0		0
		Total impaired loans without a
			related reserve		182,892		156,140	(1)		26,752				155,434		2,048
Impaired loans with a related reserve:
	Commercial, financial, and agricultural				7,941		7,941			0	$	4,307		8,385		56
	Real estate - construction				7,823		3,090			4,733		705		3,139		27
	Real estate secured - residential				23,836		22,218			1,618		2,634		24,350		259
	Real estate secured - commercial				16,543		14,634			1,909		5,197		13,792		305
	Consumer				1,049		1,049			0		114		1,095		21
		Total impaired loans with a
			related reserve		57,192		48,932			8,260		12,957		50,761		668
Total impaired loans:
	Commercial, financial, and agricultural				29,144		26,230			2,914		4,307		26,795		294
	Real estate - construction				19,109		13,777			5,332		705		13,965		124
	Real estate secured - residential				46,883		44,632			2,251		2,634		47,303		537
	Real estate secured - commercial				143,899		119,384			24,515		5,197		117,037		1,740
	Consumer				1,049		1,049			0		114		1,095		21
			Total impaired loans	$	240,084	$	205,072		$	35,012	$	12,957	$	206,195	$	2,716
Impaired loans without a related reserve:
	Originated loans and leases			$	73,346	$	49,039		$	24,307			$	47,805	$	583
	Purchased loans and leases				109,546		107,101			2,445				107,629		1,465
		Total impaired loans without a
			related reserve		182,892		156,140			26,752				155,434		2,048
Impaired loans with a related reserve:
	Originated loans and leases				51,046		43,036			8,010	$	11,556		44,763		561
	Purchased loans and leases				6,146		5,896			250		1,401		5,998		107
		Total impaired loans with a
			related reserve		57,192		48,932			8,260		12,957		50,761		668
Total impaired loans:
	Originated loans and leases				124,392		92,075			32,317		11,556		92,568		1,144
	Purchased loans and leases (3)				115,692		112,997			2,695		1,401		113,627		1,572
			Total impaired loans	$	240,084	$	205,072		$	35,012	$	12,957	$	206,195	$	2,716
(1)	$34,511 of the $156,140 total impaired loans without a related reserve represents loans that had been written down to the fair value of the underlying collateral adjusted for selling costs through direct charge-offs of $26,752.
(2)	Average recorded investment in impaired loans is calculated on a quarterly basis using daily balances.
(3)	$5,896 of the $112,997 purchased impaired loans were subsequently impaired after being acquired.

22

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Impaired Loans at December 31, 2013
													Average
						Recorded							Recorded
				Unpaid		Investment					Related		Investment		Interest
				Principal		in Impaired			Related		Specific		in Impaired		Income
				Balance		Loans			Charge-offs		Allowance		Loans (2)		Recognized
Impaired loans without a related reserve:
	Commercial, financial, and agricultural			$	31,196	$	28,034		$	3,162			$	29,316	$	390
	Real estate - construction				17,851		14,215			3,636				14,715		140
	Real estate secured - residential				28,308		27,645			663				27,800		297
	Real estate secured - commercial				143,664		125,139			18,525				125,003		2,076
	Consumer				0		0			0				14		0
		Total impaired loans without a
			related reserve		221,019		195,033	(1)		25,986				196,848		2,903
Impaired loans with a related reserve:
	Commercial, financial, and agricultural				6,864		5,879			985	$	3,008		5,893		154
	Real estate - construction				15,202		7,288			7,914		1,819		5,831		228
	Real estate secured - residential				37,499		35,153			2,346		4,753		35,273		554
	Real estate secured - commercial				27,238		17,529			9,709		3,827		16,546		325
	Consumer				1,992		1,992			0		218		2,042		56
		Total impaired loans with a
			related reserve		88,795		67,841			20,954		13,625		65,585		1,317
Total impaired loans:
	Commercial, financial, and agricultural				38,060		33,913			4,147		3,008		35,209		544
	Real estate - construction				33,053		21,503			11,550		1,819		20,546		368
	Real estate secured - residential				65,807		62,798			3,009		4,753		63,073		851
	Real estate secured - commercial				170,902		142,668			28,234		3,827		141,549		2,401
	Consumer				1,992		1,992			0		218		2,056		56
			Total impaired loans	$	309,814	$	262,874		$	46,940	$	13,625	$	262,433	$	4,220
Impaired loans without a related reserve:
	Originated loans and leases			$	88,900	$	66,086		$	22,814			$	65,341	$	749
	Purchased loans and leases				132,119		128,947			3,172				131,507		2,154
		Total impaired loans without a
			related reserve		221,019		195,033			25,986				196,848		2,903
Impaired loans with a related reserve:
	Originated loans and leases				78,015		58,343			19,672	$	11,612		55,881		1,172
	Purchased loans and leases				10,780		9,498			1,282		2,013		9,704		145
		Total impaired loans with a
			related reserve		88,795		67,841			20,954		13,625		65,585		1,317
Total impaired loans:
	Originated loans and leases				166,915		124,429			42,486		11,612		121,222		1,921
	Purchased loans and leases (3)				142,899		138,445			4,454		2,013		141,211		2,299
			Total impaired loans	$	309,814	$	262,874		$	46,940	$	13,625	$	262,433	$	4,220
(1)	$43,363 of the $195,033 total impaired loans without a related reserve represents loans that had been written down to the fair value of the underlying collateral adjusted for selling costs through direct charge-offs of $25,986.
(2)	Average recorded investment in impaired loans is calculated on a quarterly basis using daily balances.
(3)	$9,498 of the $138,445 purchased impaired loans were subsequently impaired after being acquired.

23

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following table presents Troubled Debt Restructurings (TDR's), by class segment:
				June 30,		December 31,
				2014		2013
		Commercial, financial, and agricultural		$	4,228	$	6,885
		Real estate - construction			322		615
		Real estate secured - residential			18,414		31,623
		Real estate secured - commercial			16,903		31,295
		Consumer			1,071		1,715
			Total performing TDRs		40,938		72,133
		Non-performing TDRs (1)			20,465		22,676
			Total TDRs	$	61,403	$	94,809
		Performing TDRs			67%		76%
		Non-performing TDRs			33%		24%
(1)	These loans are included in the 90 day past due and non-accrual categories.

	The following table provides detail of TDR balance and activity for the periods presented:
		Three months ended				Six months ended
		June 30,				June 30,
		2014		2013		2014		2013
Performing TDRs, beginning of period		$	39,555	$	65,773	$	72,133	$	67,775
	New restructurings as TDRs		3,213		7,187		4,083		25,069
	Repayments and payoffs		(566)		(1,013)		(1,005)		(3,250)
	Charge-offs after restructuring		(14)		(6,604)		(429)		(6,725)
	Transfer to nonaccrual, past due 90 days or greater, non-performing TDRs		(1,248)		(1,212)		(5,688)		(6,042)
	Transfer out of TDR status (1)		0		(272)		(28,155)		(12,613)
	Other, net (2)		(2)		(37)		(1)		(392)
Performing TDRs, end of period		$	40,938	$	63,822	$	40,938	$	63,822
Non-performing TDRs (3), end of period		$	20,465	$	20,500	$	20,465	$	20,500
Performing TDRs			67%		76%		67%		76%
Non-performing TDRs			33%		24%		33%		24%
(1)	Loans that have performed in accordance with the renegotiated terms for a minimum of six consecutive months with payments and at the time of renegotiation the loan's interest rate represented a then current market interest rate for a loan of similar risk.
(2)	Includes $203 transferred to OREO in 2013.
(3)	Included in Age Analysis of Past Due Financing Receivables.

24

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The following tables present Susquehanna’s loan modification activities that were considered troubled debt restructurings for the three and six month periods ended June 30, 2014 and 2013.

			Recorded Investment
						Post-		Financial Effect of
				Pre-Modification		Modification		Modification
			Number of	Recorded		Recorded		Recorded
Three months ended June 30, 2014			Loans	Investment		Investment		Investment(1)		Interest (2)
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	0	$	0	$	0	$	0	$	0
		Combination of modification types	0		0		0		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	7		1,401		1,401		0		0
		Combination of modification types	4		793		793		0		8
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	1		375		375		0		0
	Consumer
		Bankruptcies and maturity date extensions	12		81		81		0		0
		Combination of modification types	0		0		0		0		0
	Total		24	$	2,650	$	2,650	$	0	$	8
Originated loans and leases			21	$	2,129	$	2,129	$	0	$	53
Purchased loans and leases			3		521		521		0		(45)
	Total		24	$	2,650	$	2,650	$	0	$	8
(1)	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
(2)	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.
					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			3	$	998
		Real estate - construction			0		0
		Real estate secured - residential			2		179
		Real estate secured - commercial			0		0
		Consumer			6		36
		Total			11	$	1,213
Originated loans and leases					10	$	1,093
Purchased loans and leases					1		120
		Total			11	$	1,213

25

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

			Recorded Investment
						Post-		Financial Effect of
				Pre-Modification		Modification		Modification
			Number of	Recorded		Recorded		Recorded
Three months ended June 30, 2013			Loans	Investment		Investment		Investment(1)		Interest (2)
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	11	$	1,041	$	1,041	$	0	$	0
		Combination of modification types	1		241		241		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	1		117		117		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	40		2,912		2,912		0		0
		Combination of modification types	10		1,186		1,186		0		56
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	5		949		949		0		0
		Combination of modification types	0		0		0		0		0
	Consumer
		Bankruptcies and maturity date extensions	63		741		741		0		0
		Combination of modification types	0		0		0		0		0
	Total		131	$	7,187	$	7,187	$	0	$	56
Originated loans and leases			121	$	6,458	$	6,458	$	0	$	56
Purchased loans and leases			10		729		729		0		0
	Total		131	$	7,187	$	7,187	$	0	$	56
(1)	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
(2)	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.
					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			5	$	6,621
		Real estate - construction			0		0
		Real estate secured - residential			5		509
		Real estate secured - commercial			0		0
		Consumer			14		66
		Total			24	$	7,196
Originated loans and leases					22	$	6,859
Purchased loans and leases					2		337
		Total			24	$	7,196

26

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

			Recorded Investment
								Financial Effect of
				Pre-Modification		Post-Modification		Modification
			Number of	Recorded		Recorded		Recorded
Six months ended June 30, 2014			Loans	Investment		Investment		Investment(1)		Interest (2)
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	6	$	102	$	102	$	0	$	0
		Combination of modification types	0		0		0		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	13		1,851		1,851		0		0
		Combination of modification types	7		1,100		1,100		0		(8)
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	0		0		0		0		0
		Combination of modification types	1		375		375		0		0
	Consumer
		Bankruptcies and maturity date extensions	14		92		92		0		0
		Combination of modification types	0		0		0		0		0
	Total		41	$	3,520	$	3,520	$	0	$	(8)
Originated loans and leases			37	$	2,933	$	2,933	$	0	$	37
Purchased loans and leases			4		587		587		0		(45)
	Total		41	$	3,520	$	3,520	$	0	$	(8)
(1)	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
(2)	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.
					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			11	$	2,027
		Real estate - construction			0		0
		Real estate secured - residential			8		397
		Real estate secured - commercial			4		2,599
		Consumer			21		159
		Total			44	$	5,182
Originated loans and leases					40	$	2,536
Purchased loans and leases					4		2,646
		Total			44	$	5,182

27

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

			Recorded Investment
								Financial Effect of
				Pre-Modification		Post-Modification		Modification
			Number of	Recorded		Recorded		Recorded
Six months ended June 30, 2013			Loans	Investment		Investment		Investment(1)		Interest (2)
Troubled Debt Restructurings
	Commercial, financial, and agricultural
		Bankruptcies and maturity date extensions	23	$	8,534	$	8,534	$	0	$	0
		Combination of modification types	1		241		241		0		0
	Real estate - construction
		Bankruptcies and maturity date extensions	2		137		137		0		0
		Combination of modification types	0		0		0		0		0
	Real estate secured - residential
		Bankruptcies and maturity date extensions	99		8,323		8,323		0		0
		Combination of modification types	17		2,502		2,502		0		(72)
	Real estate secured - commercial
		Bankruptcies and maturity date extensions	12		2,499		2,499		0		0
		Combination of modification types	1		1,436		1,436		0		(196)
	Consumer
		Bankruptcies and maturity date extensions	150		1,397		1,397		0		0
		Combination of modification types	0		0		0		0		0
	Total		305	$	25,069	$	25,069	$	0	$	(268)
Originated loans and leases			287	$	22,607	$	22,607	$	0	$	(225)
Purchased loans and leases			18		2,462		2,462		0		(43)
	Total		305	$	25,069	$	25,069	$	0	$	(268)
(1)	Financial effects impacting the recorded investment include principal payments, advances, charge-offs, and capitalized past-due amounts.
(2)	Represents the present value of interest rate concessions discounted at the effective rate of the original loan.
					Number of	Recorded
					Loans	Investment
Troubled Debt Restructurings that Subsequently
	Defaulted during the current period
		Commercial, financial, and agricultural			12	$	7,301
		Real estate - construction			2		137
		Real estate secured - residential			13		1,290
		Real estate secured - commercial			3		447
		Consumer			33		205
		Total			63	$	9,380
Originated loans and leases					58	$	8,843
Purchased loans and leases					5		537
		Total			63	$	9,380

28

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The unpaid principal balance and the related carrying amount of acquired loans are as follows:
				June 30,		December 31,
				2014		2013
	Credit impaired purchased loans evaluated individually for
		incurred credit losses
			Unpaid principal balance	$	139,097	$	176,351
			Carrying amount		112,997		138,445
	Other purchased loans evaluated collectively for incurred credit
		losses
			Unpaid principal balance		1,393,362		1,509,870
			Carrying amount		1,394,882		1,506,695
	Total purchased loans
			Unpaid principal balance		1,532,459		1,686,221
			Carrying amount		1,507,879		1,645,140

The changes in the accretable discount related to the purchased credit impaired loans are as follows:
		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2014		2013		2014		2013
Balance - beginning of period		$	43,058	$	58,817	$	46,219	$	62,868
	Accretion recognized during the period		(2,572)		(5,723)		(5,733)		(12,293)
	Net reclassification from non-accretable to accretable		2,833		(3,907)		2,833		(1,388)
Balance - end of period		$	43,319	$	49,187	$	43,319	$	49,187

NOTE 4. Allowance for Loan and Lease Losses

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

29

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		An analysis of the allowance for loan and lease losses for the three and six months ended June 30, 2014 and 2013 are presented in the following tables:
					Three Months Ended June 30, 2014
									Real Estate		Real Estate
							Real Estate -		Secured -		Secured -
					Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at April 1, 2014					$	48,016	$	21,718	$	22,078	$	44,486	$	2,097	$	14,788	$	967	$	154,150
	Charge-offs					(9,094)		(339)		(3,290)		(1,077)		(1,341)		(801)		0		(15,942)
	Recoveries					1,820		796		837		347		328		383		0		4,511
	Transfer for loans designated as held for sale					0		0		0		0		(1,236)		0		0		(1,236)
	Provision					659		(3,995)		1,751		3,196		1,428		(495)		456		3,000
Balance at June 30, 2014					$	41,401	$	18,180	$	21,376	$	46,952	$	1,276	$	13,875	$	1,423	$	144,483
					Six Months Ended June 30, 2014
									Real Estate		Real Estate
							Real Estate -		Secured -		Secured -
					Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at January 1, 2014					$	40,590	$	26,189	$	24,076	$	48,261	$	2,266	$	15,259	$	967	$	157,608
	Charge-offs					(13,608)		(630)		(7,120)		(3,684)		(2,579)		(1,721)		0		(29,342)
	Recoveries					3,152		1,178		1,871		820		711		721		0		8,453
	Transfer for loans designated as held for sale					0		0		0		0		(1,236)		0		0		(1,236)
	Provision					11,267		(8,557)		2,549		1,555		2,114		(384)		456		9,000
Balance at June 30, 2014					$	41,401	$	18,180	$	21,376	$	46,952	$	1,276	$	13,875	$	1,423	$	144,483
Balance at June 30, 2014
	Individually evaluated for impairment:
			Originated loans and leases		$	4,281	$	704	$	2,181	$	4,276	$	114	$	0			$	11,556
			Purchased loans and leases			26		0		453		922		0		0				1,401
				Total	$	4,307	$	704	$	2,634	$	5,198	$	114	$	0			$	12,957
	Collectively evaluated for impairment:
			Originated loans and leases		$	37,094	$	17,476	$	18,742	$	41,754	$	1,162	$	13,875	$	1,423	$	131,526
			Purchased loans and leases			0		0		0		0		0		0		0		0
				Total	$	37,094	$	17,476	$	18,742	$	41,754	$	1,162	$	13,875	$	1,423	$	131,526
Financing receivables:
Balance at June 30, 2014					$	2,422,931	$	748,181	$	4,178,842	$	4,053,990	$	962,618	$	1,300,591			$	13,667,153
Balance at June 30, 2014
	Individually evaluated for impairment:
			Originated loans and leases		$	16,378	$	3,283	$	24,201	$	47,167	$	1,046	$	0			$	92,075
			Purchased loans and leases			9,851		10,495		20,431		72,217		3		0				112,997
				Total	$	26,229	$	13,778	$	44,632	$	119,384	$	1,049	$	0			$	205,072
	Collectively evaluated for impairment:
			Originated loans and leases		$	2,262,865	$	686,743	$	3,560,563	$	3,301,084	$	955,353	$	1,300,591			$	12,067,199
			Purchased loans and leases			133,837		47,660		573,647		633,522		6,216		0				1,394,882
				Total	$	2,396,702	$	734,403	$	4,134,210	$	3,934,606	$	961,569	$	1,300,591			$	13,462,081

30

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

				Three Months Ended June 30, 2013
								Real Estate		Real Estate
						Real Estate -		Secured -		Secured -
				Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at April 1, 2013				$	30,462	$	25,549	$	36,542	$	66,977	$	2,997	$	13,714	$	136	$	176,377
	Charge-offs				(10,829)		(1,170)		(2,607)		(842)		(788)		(1,202)		0		(17,438)
	Recoveries				2,040		1,725		601		2,083		239		967		0		7,655
	Provision				8,564		(2,536)		3,180		609		707		1,271		205		12,000
Balance at June 30, 2013				$	30,237	$	23,568	$	37,716	$	68,827	$	3,155	$	14,750	$	341	$	178,594
				Six Months Ended June 30, 2013
								Real Estate		Real Estate
						Real Estate -		Secured -		Secured -
				Commercial		Construction		Residential		Commercial		Consumer		Leases		Unallocated		Total
Allowance for credit losses:
Balance at January 1, 2013				$	30,207	$	25,171	$	41,276	$	70,053	$	3,722	$	13,341	$	250	$	184,020
	Charge-offs				(20,866)		(5,933)		(5,620)		(5,445)		(1,346)		(2,321)		0		(41,531)
	Recoveries				4,036		2,187		1,252		2,805		561		1,264		0		12,105
	Provision				16,860		2,143		808		1,414		218		2,466		91		24,000
Balance at June 30, 2013				$	30,237	$	23,568	$	37,716	$	68,827	$	3,155	$	14,750	$	341	$	178,594
Balance at June 30, 2013
	Individually evaluated for impairment:
		Originated loans and leases		$	3,007	$	1,145	$	3,629	$	5,155	$	145	$	0			$	13,081
		Purchased loans and leases			0		0		0		0		0		0				0
			Total	$	3,007	$	1,145	$	3,629	$	5,155	$	145	$	0			$	13,081
	Collectively evaluated for impairment:
		Originated loans and leases		$	27,104	$	22,013	$	26,965	$	61,997	$	3,010	$	14,750	$	341	$	156,180
		Purchased loans and leases			126		410		7,122		1,675		0		0		0		9,333
			Total	$	27,230	$	22,423	$	34,087	$	63,672	$	3,010	$	14,750	$	341	$	165,513
Financing receivables:
Balance at June 30, 2013				$	2,289,159	$	769,722	$	4,098,938	$	4,029,454	$	908,328	$	1,062,161			$	13,157,762
Balance at June 30, 2013
	Individually evaluated for impairment:
		Originated loans and leases		$	10,905	$	10,948	$	31,226	$	63,615	$	1,334	$	0			$	118,028
		Purchased loans and leases			13,899		13,355		39,713		74,402		117		0				141,486
			Total	$	24,804	$	24,303	$	70,939	$	138,017	$	1,451	$	0			$	259,514
	Collectively evaluated for impairment:
		Originated loans and leases		$	2,142,345	$	649,535	$	3,211,466	$	3,218,759	$	898,527	$	1,062,161			$	11,182,793
		Purchased loans and leases			122,010		95,884		816,533		672,678		8,350		0				1,715,455
			Total	$	2,264,355	$	745,419	$	4,027,999	$	3,891,437	$	906,877	$	1,062,161			$	12,898,248

31

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 5. Goodwill

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

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

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

Susquehanna performed its annual goodwill impairment assessments in the second quarter of 2014 and determined that the fair value of each of its reporting units exceeded its book value, and that there was no goodwill impairment.

Bank Reporting Unit

Goodwill assigned to the bank reporting unit at the annual assessment dates of May 31, 2014 and 2013 was $1,165,200. Fair value of the bank reporting unit was determined using a market approach, which uses prices and other relevant information reported for market transactions involving recent non-distressed sales of comparable financial institutions in the United States, with particular consideration given to transactions within Susquehanna’s market, to value the bank reporting unit. The following table shows the ratios used at May 31, 2014 and 2013.

		Annual	Annual
Ratio		May 31, 2014	May 31, 2013
Price to book		1.48x	1.57x
Price to tangible book		1.70x	1.80x
Price to earnings(1)		20.5x	22.1x
(1)	Last twelve months earnings.

Fair value of the bank reporting unit exceeded carrying value by 25.4% at May 31, 2014, and by 44.6% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is unnecessary.

Wealth Management Reporting Unit

Goodwill assigned to the wealth management reporting unit at the annual assessment dates of May 31, 2014 and 2013 was $82,746. Fair value of the wealth management reporting unit was determined utilizing the market approach and the income approach. The market approach measures the fair value of the reporting unit using transaction multiples reported for market transactions involving comparable wealth management business. The income approach measures the fair value of the reporting unit by converting the reporting unit’s future earnings over ten years, assuming a weighted increase in the reporting unit’s revenues and a weighted increase in the reporting unit’s expenses, to a single present (discounted) amount, based on a discount rate. The following table shows the factors used in the income approach at May 31, 2014 and 2013.

32

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	Annual	Annual
Factors	May 31, 2014	May 31, 2013
Discount rate	19.5%	18.4%
Weighted-average increase in revenues	4.2%	5.0%
Weighted-average increase in expenses	4.7%	3.3%

Fair value of the wealth management reporting unit exceeded carrying value by 51.5% at May 31, 2014 and by 45.9% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is unnecessary.

Property and Casualty Insurance Reporting Unit

Goodwill assigned to the property and casualty insurance reporting unit at the annual assessment dates of May 31, 2014 and 2013 was $17,177. Fair value of the property and casualty insurance reporting unit was determined using the market approach, which measures the fair value of the reporting unit using recent sales of comparable property and casualty insurance companies in Susquehanna’s market. Susquehanna uses two key ratios to measure the fair value of the property and casualty insurance reporting unit: average price to book and median price to earnings. The following table shows the ratios used at May 31, 2014 and 2013.

	Annual	Annual
Ratio	May 31, 2014	May 31, 2013
Average price to book	1.34X	1.15X
Median price to earnings	21.1X	18.1X

Fair value of the property and casualty insurance reporting unit exceeded carrying value by 25.6% at May 31, 2014 and by 21.7% at May 31, 2013. Since the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and the second step in the analysis is not required.

33

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 6. Deposits
	Deposits consisted of the following at June 30, 2014 and December 31, 2013:
		June 30,		December 31,
		2014		2013
Noninterest-bearing:
	Demand	$	1,935,635	$	1,913,526
Interest-bearing:
	Interest-bearing demand		2,883,679		2,909,376
	Money market		3,025,430		3,144,106
	Savings		1,136,044		1,077,923
	Time		2,266,815		2,113,209
	Time of $100 or more		2,067,391		1,711,232
Total deposits		$	13,314,994	$	12,869,372

NOTE 7.  Income Taxes

Our effective income tax rate for the three months ended June 30, 2014 and 2013 was 26.1% and 30.2%, respectively.  Our effective income tax rate for the six months ended June 30, 2014 and 2013 was 27.9% and 31.0%, respectively.   The estimated annual effective income tax rates used in calculating the income tax expense for the reporting periods ended June 30, 2014 and 2013 were impacted by the level of permanent differences, including tax-advantaged income, and by Low Income Housing and other tax credits, resulting in effective income tax rates below statutory rates for the interim reporting periods.  The change in the estimated annual effective income tax rates used to calculate income tax expense was influenced by the amount of tax-advantaged income relative to total income for the second quarter of 2014, as compared to the amount of tax-advantaged income relative to total income for the second quarter of 2013.  Additionally, adjustments for income tax expense/(benefit) from discrete items recorded for the three months ended June 30, 2014 and 2013 impacted the effective income tax rate by (4.2%) and (0.5%), respectively.  The net deferred discrete income tax benefit recorded during the period for the effect of recent enactment of state tax legislation caused a reduction in the effective income tax rate for the three months ended June 30, 2014 of (4.2%).

34

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 8. Accumulated Other Comprehensive Loss
		The balances and changes in balances by component of accumulated other comprehensive income (loss) are shown in the following tables:
									Unrealized				Accumulated
					Unrealized Gains (Losses) on				Gains (Losses)		Post-		Other
					Investment securities				on Cash Flow		retirement		Comprehensive
					With OTTI		All other		Hedges		Benefits		Loss
Balance, April 1, 2014					$	(279)	$	3,119	$	(19,080)	$	(22,409)	$	(38,649)
	AOCI before reclassifications, net of tax					0		9,341		(1,362)		0		7,979
	Amounts reclassified from AOCI:
		Interest expense				0		0		5,489		0		5,489
		Net realized loss (gain) on sales of securities				0		(3,293)		0		0		(3,293)
			Total before income taxes			0		(3,293)		5,489		0		2,196
			Less: Income taxes			0		1,153		(1,921)		0		(768)
				Net of income taxes		0		(2,140)		3,568		0		1,428
	Net change in AOCI					0		7,201		2,206		0		9,407
Balance, June 30, 2014					$	(279)	$	10,320	$	(16,874)	$	(22,409)	$	(29,242)
Balance, April 1, 2013					$	(1,024)	$	33,529	$	(31,839)	$	(39,321)	$	(38,655)
	AOCI before reclassifications, net of tax					211		(33,926)		3,368		0		(30,347)
	Amounts reclassified from AOCI:
		Interest expense				0		0		4,668		0		4,668
		Net realized loss (gain) on sales of securities				97		(26)		0		0		71
			Total before income taxes			97		(26)		4,668		0		4,739
			Less: Income taxes			(34)		9		(1,634)		0		(1,659)
				Net of income taxes		63		(17)		3,034		0		3,080
	Net change in AOCI					274		(33,943)		6,402		0		(27,267)
Balance, June 30, 2013					$	(750)	$	(414)	$	(25,437)	$	(39,321)	$	(65,922)
Balance, January 1, 2014					$	(279)	$	(7,195)	$	(21,683)	$	(22,409)	$	(51,566)
	AOCI before reclassifications, net of tax					0		19,650		(2,265)		0		17,385
	Amounts reclassified from AOCI:
		Interest expense				0		0		10,883		0		10,883
		Net realized loss (gain) on sales of securities				0		(3,285)		0		0		(3,285)
			Total before income taxes			0		(3,285)		10,883		0		7,598
			Less: Income taxes			0		1,150		(3,809)		0		(2,659)
				Net of income taxes		0		(2,135)		7,074		0		4,939
	Net change in AOCI					0		17,515		4,809		0		22,324
Balance, June 30, 2014					$	(279)	$	10,320	$	(16,874)	$	(22,409)	$	(29,242)
Balance, January 1, 2013					$	(839)	$	37,521	$	(34,636)	$	(39,304)	$	(37,258)
	AOCI before reclassifications, net of tax					(226)		(37,654)		3,218		(17)		(34,679)
	Amounts reclassified from AOCI:
		Interest expense				0		0		9,202		0		9,202
		Net realized loss (gain) on sales of securities				485		(432)		0		0		53
			Total before income taxes			485		(432)		9,202		0		9,255
			Less: Income taxes			(170)		151		(3,221)		0		(3,240)
				Net of income taxes		315		(281)		5,981		0		6,015
	Net change in AOCI					89		(37,935)		9,199		(17)		(28,664)
Balance, June 30, 2013					$	(750)	$	(414)	$	(25,437)	$	(39,321)	$	(65,922)

35

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 9. Pension and Other Postretirement Benefits
Components of Net Periodic Benefit Cost
		Three Months Ended June 30,
										Other Postretirement
		Pension Benefits				SERP				Benefits
		2014		2013		2014		2013		2014		2013
Service cost		$	0	$	1,333	$	71	$	313	$	316	$	337
Interest cost			1,922		1,794		122		102		247		217
Expected return on plan assets			(2,337)		(2,412)		0		0		0		0
Amortization of prior service cost			0		6		37		54		28		29
Amortization of transition obligation			0		0		0		0		0		2
Amortization of net actuarial loss			121		757		29		57		0		42
	Net periodic postretirement benefit cost	$	(294)	$	1,478	$	259	$	526	$	591	$	627
			Six Months Ended June 30,
										Other Postretirement
		Pension Benefits				SERP				Benefits
		2014		2013		2014		2013		2014		2013
Service cost		$	0	$	2,666	$	143	$	626	$	633	$	674
Interest cost			3,845		3,588		245		204		493		434
Expected return on plan assets			(4,673)		(4,823)		0		0		0		0
Amortization of prior service cost			0		12		73		109		57		58
Amortization of transition obligation			0		0		0		0		0		4
Amortization of net actuarial loss			241		1,514		57		113		0		84
	Net periodic postretirement benefit cost	$	(587)	$	2,957	$	518	$	1,052	$	1,183	$	1,254

Employer Contributions

Susquehanna previously disclosed in its financial statements for the year ended December 31, 2013, that it expected to contribute $559 to its pension plans and $782 to its other postretirement benefit plan in 2014. As of June 30, 2014, $280 of contributions had been made to its pension plans, and $391 of contributions had been made to its other postretirement benefit plan. Susquehanna anticipates contributing an additional $279 to fund its pension plans in 2014, for a total of $559, and an additional $391 to it other postretirement benefit plan, for a total of $782.

36

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 10. Earnings per Share ("EPS")
	The following tables set forth the calculation of basic and diluted EPS for the three-month and six-month periods ended
June 30, 2014 and 2013.
Basic earnings per common share
		Three Months Ended June 30,				Six Months Ended June 30,
		2014		2013		2014		2013
Net income applicable to common shareholders		$	43,494	$	45,648	$	80,656	$	88,047
Average common shares outstanding			187,637		186,812		187,547		186,710
Basic earnings per common share		$	0.23	$	0.24	$	0.43	$	0.47
Diluted earnings per common share
		Three Months Ended June 30,				Six Months Ended June 30,
		2014		2013		2014		2013
Net income available to common shareholders		$	43,494	$	45,648	$	80,656	$	88,047
Average common shares outstanding			187,637		186,812		187,547		186,710
Dilutive potential common shares			658		911		749		902
Total diluted average common shares outstanding			188,295		187,723		188,296		187,612
Diluted earnings per common share		$	0.23	$	0.24	$	0.43	$	0.47

For the three months ended June 30, 2014 and 2013, average options to purchase 1,226 and 1,490 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents were antidilutive. For the six months ended June 30, 2014 and 2013, average options to purchase 1,219 and 1,530 shares, respectively, were outstanding but were not included in the computation of diluted EPS because the options’ common stock equivalents were antidilutive.

NOTE 11. Derivative Financial Instruments

Risk Management Objective of Using Derivatives

Susquehanna is exposed to certain risks arising from both its business operations and economic conditions. Susquehanna manages economic risk exposures, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments. Susquehanna enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are impacted by changes in interest rates. Susquehanna’s derivative financial instruments are used to manage differences in the amount, timing, and duration of its known or expected cash payments principally those related to certain variable-rate liabilities. Susquehanna also has derivatives that are a result of a service it provides to certain qualifying customers. Susquehanna manages a matched book with respect to its derivative instruments offered as a part of this service to its customers in order to minimize its interest rate risk resulting from such transactions. All derivatives are recorded at fair value.

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

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

Cash Flow Hedges of Interest Rate Risk

Susquehanna uses interest rate derivatives to manage its exposure to interest rate movements and add stability to interest income and expense. Susquehanna primarily uses interest rate swaps as part of its interest rate risk management strategy. For example, Susquehanna may issue variable-rate debt and then enter into a receive-variable pay-fixed-rate interest rate swap with the same

37

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

payment timing and notional amount to convert the interest payments to a net fixed-rate basis for all or a portion of the term of the long-term debt. As of June 30, 2014, December 31, 2013, and June 30, 2013, Susquehanna had 13, 14, and 14 interest rate swaps, respectively for each period, with an aggregate notional amount of $1,117,859, $1,146,437, and $1,150,284, respectively that were designated as cash flow hedges of interest-rate risk.

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

Amounts recorded in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on Susquehanna’s variable-rate liabilities. During the next 12 months, Susquehanna estimates that $20,243 will be reclassified as an expense to net interest income.

Non-designated Derivatives

Derivatives not designated as hedges are used to manage Susquehanna’s exposure to interest rate movements and other identified risks but do not meet the strict requirements of hedge accounting. Changes in the fair value of derivatives not designated in hedging relationships are recognized directly in earnings.

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

At June 30, 2014 and 2013, Susquehanna had 285 and 263 derivative transactions, respectively, related to these risk management activities with an aggregate notional amount of $1,806,139 and $1,605,531, respectively. For the three-month and six-month periods ended June 30, 2014, Susquehanna recognized a net loss of $902 and $1,612, respectively, and for the three-month and six-month periods ended June 30, 2013, Susquehanna recognized a net gain of $1,848 and $1,615, respectively, related to changes in fair value of the derivatives in this program.

Credit-risk-related Contingent Features

Susquehanna has agreements with certain of its derivative counterparties that contain the following provisions:

·if Susquehanna defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Susquehanna could also be declared in default on its derivative obligations;

·if Susquehanna fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions, and Susquehanna would be required to settle its obligations under the agreements;

·if Susquehanna fails to maintain a specified minimum leverage ratio, then Susquehanna could be declared in default on its derivative obligations;

At June 30, 2014 and December 31, 2013, the fair value of derivatives in a net liability position, which includes accrued interest and any credit valuation adjustments related to these agreements, was $43,164 and $50,247, respectively. At June 30, 2014 and December 31, 2013, Susquehanna had minimum collateral posting thresholds with certain of its derivative counterparties and had posted cash collateral of $43,826 and $42,813, respectively. If Susquehanna had breached any of the above provisions at June 30, 2014, it would have been required to settle its obligations under the agreements at termination value and would have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the respective counterparty.

38

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Fair Value of Derivative Instruments
		Fair Values of Derivative Instruments
		June 30, 2014
		Asset Derivatives			Liability Derivatives
		Balance Sheet			Balance Sheet
		Location	Fair Value		Location	Fair Value
Derivatives designated as hedging instruments
	Interest rate contracts	Other assets	$	641	Other liabilities	$	23,570
Derivatives not designated as hedging instruments
	Interest rate contracts	Other assets		23,945	Other liabilities		19,594
Total derivatives			$	24,586		$	43,164
		Fair Values of Derivative Instruments
		December 31, 2013
		Asset Derivatives			Liability Derivatives
		Balance Sheet			Balance Sheet
		Location	Fair Value		Location	Fair Value
Derivatives designated as hedging instruments
	Interest rate contracts	Other assets	$	1,419	Other liabilities	$	31,662
Derivatives not designated as hedging instruments
	Interest rate contracts	Other assets		22,897	Other liabilities		18,585
Total derivatives			$	24,316		$	50,247

39

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

The Effect of Derivative Instruments on Comprehensive Income
Three Months Ended June 30, 2014
							Location of Loss	Amount of Loss
			Location of Loss		Amount of Loss		Recognized in	Recognized in
	Amount of Gain		Reclassified from		Reclassified from		Income	Income
Derivatives in Cash Flow	Recognized		Accumulated OCI		Accumulated OCI		(Ineffective	(Ineffective
Hedging Relationships	in OCI		into Income		into Income		Portion)	Portion)
Interest rate contracts:	$	2,200		Interest expense	$	(5,489)	Other expense	$	0
		Location of Loss	Amount of Loss
		Recognized	Recognized
Derivatives Not Designated		in Income	in Income
as Hedging Instruments		on Derivatives	on Derivatives
Interest rate contracts:		Other income	$	(902)
		Other expense		0
Three Months Ended June 30, 2013
							Location of Loss	Amount of Loss
			Location of Loss		Amount of Loss		Recognized in	Recognized in
	Amount of Gain		Reclassified from		Reclassified from		Income	Income
Derivatives in Cash Flow	Recognized		Accumulated OCI		Accumulated OCI		(Ineffective	(Ineffective
Hedging Relationships	in OCI		into Income		into Income		Portion)	Portion)
Interest rate contracts:	$	6,401		Interest expense	$	(4,668)	Other expense	$	0
		Location of Gain	Amount of Gain
		Recognized	Recognized
Derivatives Not Designated		in Income	in Income
as Hedging Instruments		on Derivatives	on Derivatives
Interest rate contracts:		Other income	$	1,848
		Other expense		0

40

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Six Months Ended June 30, 2014
							Location of Loss	Amount of Loss
			Location of Loss		Amount of Loss		Recognized in	Recognized in
	Amount of Gain		Reclassified from		Reclassified from		Income	Income
Derivatives in Cash Flow	Recognized		Accumulated OCI		Accumulated OCI		(Ineffective	(Ineffective
Hedging Relationships	in OCI		into Income		into Income		Portion)	Portion)
Interest rate contracts:	$	4,809		Interest expense	$	(10,883)	Other expense	$	0
		Location of Loss	Amount of Loss
		Recognized	Recognized
Derivatives Not Designated		in Income on	in Income on
as Hedging Instruments		Derivatives	Derivatives
Interest rate contracts:		Other income	$	(1,612)
		Other expense		0
Six Months Ended June 30, 2013
							Location of Loss	Amount of Loss
			Location of Loss		Amount of Loss		Recognized in	Recognized in
	Amount of Gain		Reclassified from		Reclassified from		Income	Income
Derivatives in Cash Flow	Recognized		Accumulated OCI		Accumulated OCI		(Ineffective	(Ineffective
Hedging Relationships	in OCI		into Income		into Income		Portion)	Portion)
Interest rate contracts:	$	9,199		Interest expense	$	(9,202)	Other expense	$	0
		Location of Gain	Amount of Gain
		(Loss) Recognized	(Loss) Recognized
Derivatives Not Designated		in Income	in Income
as Hedging Instruments		on Derivatives	on Derivatives
Interest rate contracts:		Other income	$	1,616
		Other expense		(1)

41

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 12.  Balance Sheet Offsetting

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

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

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

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

42

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

	The following table provides information about financial instruments that are eligible for offset at June 30, 2014 and December
31, 2013.
Balance Sheet Netting Disclosure about Offsetting Assets and Liabilities
							Net Amounts
							Presented in
							the		Gross Amounts Not Offset in the
			Gross				Consolidated		Consolidated Balance Sheet
			Amounts		Gross Amounts		Balance		Financial		Cash
			Recognized		Offset		Sheet		Instruments		Collateral		Net Amount
June 30, 2014
Financial assets:
	Derivatives		$	24,586	$	0	$	24,586	$	0	$	(1,250)	$	23,336
Financial liabilities:
	Derivatives		$	43,164	$	0	$	43,164	$	0	$	(43,826)	$	(662)
	Repurchase agreements			275,830		0		275,830		(275,830)		0		0
		Total	$	318,994	$	0	$	318,994	$	(275,830)	$	(43,826)	$	(662)
December 31, 2013
Financial assets:
	Derivatives		$	24,316	$	0	$	24,316	$	0	$	(3,940)	$	20,376
Financial liabilities:
	Derivatives		$	50,247	$	0	$	50,247	$	0	$	(42,813)	$	7,434
	Repurchase agreements			295,800		0		295,800		(295,800)		0		0
		Total	$	346,047	$	0	$	346,047	$	(295,800)	$	(42,813)	$	7,434

43

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		The table below presents the offsetting of derivative assets and derivative liabilities as of June 30, 2014 and December 31,
2013.
				Derivative Assets and Collateral								Derivative Liabilities and Collateral
				Held by Counterparty								Pledged by Counterparty
				Amounts		Gross Amounts						Amounts		Gross Amounts
				Presented in		Not Offset						Presented in		Not Offset
				the		in the Consolidated						the		in the Consolidated
				Consolidated		Balance Sheet						Consolidated		Balance Sheet
				Balance		Financial		Cash		Net		Balance		Financial		Cash		Net
June 30, 2014				Sheet		Instruments		Collateral		Amount		Sheet		Instruments		Collateral		Amount
Cleared Agreements:
	Clearing member A			$	0	$	0	$	0	$	0	$	6,641	$	0	$	(9,992)	$	(3,351)
					0		0		0		0		6,641		0		(9,992)		(3,351)
Bilateral Agreements:
	Counterparty:
		Dealer A			774		0		0		774		3,869		0		(3,120)		749
		Dealer B			965		0		0		965		3,305		0		(2,040)		1,265
		Dealer C			54		0		0		54		1,181		0		(1,150)		31
		Dealer D			2,345		0		(1,250)		1,095		1,265		0		0		1,265
		Dealer E			0		0		0		0		16,261		0		(18,600)		(2,339)
		Dealer F			0		0		0		0		3,080		0		(4,200)		(1,120)
		Dealer G			0		0		0		0		2,664		0		(3,130)		(466)
		Dealer H			0		0		0		0		876		0		(1,060)		(184)
		Dealer I			0		0		0		0		400		0		(280)		120
		Dealer J			0		0		0		0		18		0		0		18
		End User			20,448		0		0		20,448		3,604		0		(254)		3,350
					24,586		0		(1,250)		23,336		36,523		0		(33,834)		2,689
			Total	$	24,586	$	0	$	(1,250)	$	23,336	$	43,164	$	0	$	(43,826)	$	(662)
December 31, 2013
Cleared Agreements:
	Clearing member A			$	19	$	0	$	0	$	19	$	1,077	$	0	$	(3,993)	$	(2,916)
					19		0		0		19		1,077		0		(3,993)		(2,916)
Bilateral Agreements:
	Counterparty:
		Dealer A			2,836		0		0		2,836		3,840		0		(1,290)		2,550
		Dealer B			2,412		0		0		2,412		3,306		0		(1,400)		1,906
		Dealer C			359		0		0		359		684		0		(550)		134
		Dealer D			5,571		0		(3,940)		1,631		688		0		0		688
		Dealer E			0		0		0		0		21,251		0		(24,100)		(2,849)
		Dealer F			0		0		0		0		5,081		0		(6,100)		(1,019)
		Dealer G			0		0		0		0		3,966		0		(4,260)		(294)
		Dealer H			0		0		0		0		770		0		(1,120)		(350)
		Dealer I			0		0		0		0		121		0		0		121
		Dealer J			0		0		0		0		18		0		0		18
		End User			13,119		0		0		13,119		9,445		0		0		9,445
					24,297		0		(3,940)		20,357		49,170		0		(38,820)		10,350
			Total	$	24,316	$	0	$	(3,940)	$	20,376	$	50,247	$	0	$	(42,813)	$	7,434

44

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

NOTE 13. Fair Value Disclosures

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

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

Fair Value Hierarchy

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

The accounting guidance requires the measurement of fair value to maximize the use of observable inputs and minimize the use of unobservable inputs. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect Susquehanna’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

Valuation Processes and Controls over Fair Value Measurement

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

Valuation Methodologies and Inputs

The following is a description of Susquehanna’s valuation methodologies and more significant inputs for assets and liabilities measured at fair value. These methods may produce a fair value measurement that may not be indicative of future fair values. Furthermore, while Susquehanna believes that its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Susquehanna uses a third-party pricing service and third-party financial advisory firms in determining the fair value of its securities. Certain fair value measurements are derived from market-based pricing matrices that were developed using observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads and broker quotes. For certain other fair value measurements, when market observable data is not available due to the lack of an active market for a given security, the valuation of the security involves assistance of a third-party financial advisory firm and substantial judgment by management.

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

Cash and due from banks and short-term investments

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment securities

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

45

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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

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

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

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

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

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

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

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

Restricted investments in bank stocks

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

Loans and leases

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

46

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Deposits

The fair values of demand, interest-bearing demand, and savings deposits are the amounts payable on demand at the balance sheet date; recognition of the inherent funding value of these instruments is not permitted. The carrying value of variable-rate time deposits approximates fair value. The fair value of fixed-rate time deposits is based upon the discounted value of future cash flows expected to be paid at maturity, using the U.S. Treasury yield curve.

Short-term borrowings

For those short-term instruments, the carrying amount approximates fair value.

FHLB borrowings and long-term debt

Fair values were based upon quoted rates of similar instruments issued by banking institutions with similar credit ratings. The carrying amounts of accrued interest payable approximate fair values.

Derivatives

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

The methodology nets the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates derived from observable market interest rate curves. Susquehanna incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Susquehanna has considered the impact of netting and any applicable credit enhancements, such as collateral postings and thresholds, mutual settlements, and guarantees.

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

Although Susquehanna has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives may use Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2014 and 2013, Susquehanna has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Susquehanna has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

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

For additional information regarding derivatives, refer to “Note 11 – Derivative Financial Instruments” above.

Off-balance-sheet items

The fair values of unused commitments to lend and standby letters of credit are considered to be the same as their contractual amounts.

47

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Assets and Liabilities Measured at Fair Value on a Recurring Basis
		The following tables present the financial instruments carried at fair value at June 30, 2014 and December 31, 2013, on the
consolidated balance sheets and by levels within the valuation hierarchy.
						Fair Value Measurements at Reporting Date Using
						Quoted Prices in		Significant
						Active Markets for		Other		Significant
						Identical		Observable		Unobservable
						Instruments		Inputs		Inputs
Description				June 30, 2014		(Level 1)		(Level 2)		(Level 3)
Assets
Available-for-sale securities:
	U.S. Government Agencies			$	95,877	$	0	$	95,877	$	0
	Obligations of states and political
		subdivisions			399,263		0		399,263		0
	Agency residential mortgage-backed
		securities			1,620,775		0		1,620,775		0
	Non-agency residential mortgage-
		backed securities			381		0		381		0
	Commercial mortgage-backed
		securities			5,882		0		5,882		0
	Other structured financial products				11,995		0		0		11,995
	Other debt securities				24,638		0		24,638		0
	Other equity securities				24,282		21,479		0		2,803
Derivatives: (1)
	Designated as hedging instruments				641		0		641		0
	Not designated as hedging
		instruments			23,945		0		23,945		0
			Total	$	2,207,679	$	21,479	$	2,171,402	$	14,798
Liabilities
Derivatives: (2)
	Designated as hedging instruments			$	23,570	$	0	$	23,570	$	0
	Not designated as hedging
		instruments			19,594		0		19,594		0
			Total	$	43,164	$	0	$	43,164	$	0

48

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

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

49

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs
		The following tables present roll-forwards of the balance sheet amounts for the three and six month periods ended June 30, 2014
and 2013, for financial instruments classified by Susquehanna within Level 3 of the valuation hierarchy.
				Available-for-sale Securities
								Non-
								agency
						Other		Residential
						Structured		Mortgage-
				Equity		Financial		backed
				Securities		Products		Securities		Total
Balance at April 1, 2014				$	2,816	$	11,419	$	0	$	14,235
	Total gains or losses (realized/unrealized):
		Included in other comprehensive income (before taxes)			(13)		576		0		563
Balance at June 30, 2014				$	2,803	$	11,995	$	0	$	14,798
Balance at April 1, 2013				$	3,157	$	9,977	$	25,592	$	38,726
	Total gains or losses (realized/unrealized):
		Included in earnings:
			Other-than-temporary impairment (1)		(97)		0		0		(97)
		Included in other comprehensive income (before taxes)			(240)		529		(1,043)		(754)
Balance at June 30, 2013				$	2,820	$	10,506	$	24,549	$	37,875
Balance at January 1, 2014				$	2,797	$	11,297	$	0	$	14,094
	Total gains or losses (realized/unrealized):
		Included in other comprehensive income (before taxes)			6		698		0		704
Balance at June 30, 2014				$	2,803	$	11,995	$	0	$	14,798
Balance at January 1, 2013				$	3,156	$	9,550	$	26,800	$	39,506
	Total gains or losses (realized/unrealized):
		Included in earnings:
			Other-than-temporary impairment (1)		(97)		0		(388)		(485)
		Included in other comprehensive income (before taxes)			(239)		956		(1,863)		(1,146)
Balance at June 30, 2013				$	2,820	$	10,506	$	24,549	$	37,875
(1)	Included in noninterest income, net impairment losses recognized in earnings.

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

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired loans

Impaired collateral dependent loans and other loans where the carrying value is based on the fair value of the underlying collateral minus selling costs, such as residential mortgage loans charged off in accordance with regulatory guidance, are measured at fair value on a nonrecurring basis. The fair value of the underlying collateral is incorporated into the estimate of the impairment of a loan. Most of Susquehanna’s impaired collateral dependent loans are secured by real estate. The value of the real estate collateral is determined through appraisals performed by third-party, licensed appraisers. As part of Susquehanna’s overall valuation process, management evaluates these third-party appraisals to ensure that they are representative of the exit prices in Susquehanna’s principal markets. Susquehanna considers the appraisals used in its impairment analysis to be Level 3 inputs. When the value of the real estate, less estimated selling costs, is less than the principal balance of the loan, a specific reserve is established. Impaired loans are reviewed at least quarterly for additional impairment, and reserves are adjusted accordingly.

50

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Foreclosed Assets

Other real estate property acquired through foreclosure is recorded at the lower of its carrying value or the fair value of the related real estate collateral at the transfer date, less estimated selling costs. The value of the real estate collateral is determined through appraisals performed by third party licensed appraisers. As part of Susquehanna’s overall valuation process, management evaluates these third-party appraisals to ensure that they are representative of the exit prices in Susquehanna’s principal markets. Susquehanna considers the appraisals used in its impairment analysis to be Level 3 inputs.

	The following tables present assets measured at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013,
on the consolidated balance sheets and by the valuation hierarchy.
				Quoted
				Prices
				in Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
				Instruments		Inputs		Inputs
	Description	June 30, 2014		(Level 1)		(Level 2)		(Level 3)
	Impaired loans	$	35,975	$	0	$	0	$	35,975
	Foreclosed assets		10,302		0		0		10,302
		$	46,277	$	0	$	0	$	46,277
				Quoted
				Prices
				in Active		Significant
				Markets for		Other		Significant
				Identical		Observable		Unobservable
				Instruments		Inputs		Inputs
	Description	December 31, 2013		(Level 1)		(Level 2)		(Level 3)
	Impaired loans	$	54,216	$	0	$	0	$	54,216
	Foreclosed assets		16,555		0		0		16,555
		$	70,771	$	0	$	0	$	70,771

	The following table details the quantitative information about Level 3 fair value measurements:
		Fair Value at		Valuation		Range
Asset		June 30, 2014		Technique(s)	Unobservable Input	(Weighted Average)
Other structured financial products (1)		$	11,995	Discounted Cash Flow	Credit default rates, call options and deferrals, waterfall structure, and covenants.	Varies by individual security, refer to Note 2
Other equity securities			2,803	Discounted Cash Flow	Cash flows from dividends and terminal value	0.2x - 1.4x
						(0.8x)
Impaired loans			35,975	Discounted Cash Flow	Cash flows based upon current discount rates and terminal value	0.6% - 14.1%
						(3.6%)
Foreclosed assets			10,302	Discounted Cash Flow	Third party appraisals less estimated selling costs	0.0% - 100.0%
						(32.7%)

51

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

		Fair Value at		Valuation		Range
Asset		December 31, 2013		Technique(s)	Unobservable Input	(Weighted Average)
Other structured financial products (1)		$	11,297	Discounted Cash Flow	Credit default rates, call options and deferrals, waterfall structure, and covenants.	Varies by individual security, refer to Note 2
Other equity securities			2,797	Discounted Cash Flow	Cash flows from dividends and terminal value	0.2x - 1.5x
						(0.8x)
Impaired loans			54,216	Discounted Cash Flow	Cash flows based upon current discount rates and terminal value	0.8% - 8.0%
						(3.9%)
Foreclosed assets			16,555	Discounted Cash Flow	Third party appraisals less estimated selling costs	0.0% - 100.0%
						(29.6%)
(1)	The significant unobservable inputs used in the fair value measurement of Susquehanna's other structured financial products are conditional repayment rate, loss severity, and conditional default rate. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and directionally opposite change in the assumption used for repayment rate.

52

Susquehanna Bancshares, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

Additional Disclosures about Fair Value of Financial Instruments
	The following table represents the carrying amounts and estimated fair values of Susquehanna's financial instruments.  The
methods and assumptions used to estimate the fair value of each class of financial instruments are described above.
			June 30, 2014
			Carrying
			Amount		Fair Value		Level 1		Level 2		Level 3
	Financial assets:
		Cash and due from banks	$	456,917	$	456,917	$	456,917	$	0	$	0
		Short-term investments		78,849		78,849		0		78,849		0
		Investment securities		2,183,093		2,183,093		21,479		2,146,816		14,798
		Restricted investment in bank stocks		141,689		141,689		0		141,689		0
		Loans and leases		13,667,153		13,678,712		0		0		13,678,712
		Derivatives		24,586		24,586		0		24,586		0
	Financial liabilities:
		Deposits		13,314,994		12,472,338		0		12,472,338		0
		Short-term borrowings		527,079		527,079		0		527,079		0
		FHLB borrowings		1,127,302		1,131,404		0		1,131,404		0
		Long-term debt		360,033		361,178		0		361,178		0
		Derivatives		43,164		43,164		0		43,164		0
			December 31, 2013
			Carrying
			Amount		Fair Value		Level 1		Level 2		Level 3
	Financial assets:
		Cash and due from banks	$	305,357	$	305,357	$	305,357	$	0	$	0
		Short-term investments		83,227		83,227		0		83,227		0
		Investment securities		2,375,224		2,375,224		20,895		2,340,235		14,094
		Restricted investment in bank stocks		158,232		158,232		0		158,232		0
		Loans and leases		13,576,086		13,463,676		0		0		13,463,676
		Derivatives		24,316		24,316		0		24,316		0
	Financial liabilities:
		Deposits		12,869,372		11,901,099		0		11,901,099		0
		Short-term borrowings		555,740		555,740		0		555,740		0
		FHLB borrowings		1,531,282		1,531,606		0		1,531,606		0
		Long-term debt		453,260		461,247		0		461,247		0
		Derivatives		50,247		50,247		0		50,247		0

53

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

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

Forward-Looking Statements.

We regularly communicate information concerning our business activities to investors, the news media, securities analysts, and others as part of our normal operations.  Some of these communications, including this Quarterly Report on Form 10-Q, contain “forward-looking statements,” for which we claim the protection of the safe harbor provisions of  the U.S. Private Securities Litigation Reform Act of 1995. These include statements pertaining to our future business plans; regulatory capital and capital management, and capital resources generally; management; general economic conditions; the impact of new regulations on our business; accounting policies and estimates; our potential exposures to various types of market risks, such as interest rate risk and credit risk; expectations regarding future acquisitions; whether our allowance for loan and lease losses is appropriate to meet probable loan and lease losses; our ability to evaluate loan collateral and guarantors; our ability to achieve loan and deposit growth; our ability to maintain sufficient liquidity; our ability to manage credit quality; and our ability to achieve our 2014 operating and financial goals.  Forward-looking statements are often accompanied by, and identified with, terms such as “expect,” “estimate,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “target,” “objective” and similar expressions or variations on such expressions. Actual results may differ significantly from those described in or implied by such forward-looking statements due to various factors and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market-risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from estimates. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:

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

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

·decreases in our loan and lease origination volume;

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

·adverse changes in regional real estate values;

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

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

·impairment of our goodwill or other assets;

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

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

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

·capital and liquidity strategies, including the expected impact of capital and liquidity requirements under the Basel III capital and liquidity framework;

54

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

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

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

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

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

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

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

·the effects of and changes in trade, monetary and fiscal policies, and laws, including interest rate policies of the Federal Reserve Board;

·the effects of and changes in the rate of FDIC premiums; and

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

We encourage readers of this report to understand forward-looking statements to be strategic objectives rather than absolute targets of future performance. Forward-looking statements speak only as of the date they are made. We do not intend to update publicly any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events except as required by law.  A more detailed description of the factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this filing is included in Item 1A of Annual Report on Form 10-K for the year ended December 31, 2013, available at www.sec.gov.

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

The following information refers to Susquehanna Bancshares, Inc. and its wholly owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) (“Hann”), Susquehanna Bank and subsidiaries, Valley Forge Asset Management Corp. (“VFAM”), Stratton Management Company and subsidiary (“Stratton”), and The Addis Group, LLC (“Addis”).

Availability of Information

Our web-site address is www.susquehanna.net. We make available free of charge, through the Investor Relations section of our web site, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We include our web-site address in this report as an inactive textual reference only.  Information contained on our website is not incorporated into and does not constitute part of this report.

Critical Accounting Policies

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

55

in that they are important to the portrayal of Susquehanna’s financial condition and results.  These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout the Consolidated Financial Statements, accompanying footnotes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Recent Legislation

In July 2013, the Federal Reserve Board, Office of the Comptroller of the Currency and FDIC approved final rules to implement the Basel III capital framework. The rules were effective on January 1, 2014 and will be phased-in over a multiple year period, becoming fully effective on January 1, 2019.  The new capital rules call for higher quality capital with higher minimum capital level requirements. Consistent with the international Basel framework, the rules include a new minimum ratio of Common Equity Tier 1 (“CET1”) capital to risk-weighted assets of 4.5 percent.  The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0 percent to 6.0 percent, establish a minimum leverage ratio of 4.0 percent, and a minimum total capital (Tier 1 plus Tier 2) to risk-weighted assets ratio of 8.0 percent.  The rules also revise the definition of capital by expanding the conditions for the inclusion of equity capital instruments and minority interests in Tier 1 capital.  In addition, the rules implement a new “capital conservation buffer” of 2.5 percent (when fully phased-in), composed entirely of CET1, on top of the minimum risk-weighted ratios, and will impose limitations on capital distributions and certain discretionary bonus payments if any of the minimum risk-weighted capital ratios plus the new capital conservation buffer are not met.  Management has evaluated these new rules and believes that Susquehanna, and Susquehanna Bank would have had sufficient capital at June 30, 2014 to meet the fully phased in increased requirements had they been in effect on that date.

Recent Developments

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

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

At June 30, 2014, Susquehanna reclassified approximately $265 million of indirect auto loans from held for investment to held for sale.  For additional information, refer to “Note 3. Loans and Leases” to the financial statements appearing in Part I, Item 1, of this report.

On July 16, 2014, Susquehanna’s Board of Directors authorized the repurchase of up to 3.5% of its outstanding shares of common stock through December 31, 2014.  As of June 30, 2014 approximately 187.7 million shares of Susquehanna common stock were outstanding.  The timing and amount of any share repurchases under Susquehanna’s share repurchase authorization will be determined by management based on market conditions and other considerations, and such repurchases may be effected in the open market, through negotiated transactions, or through plans designed to comply with Rule 10b5-1(c) under the Securities Exchange Act of 1934, as amended.  The repurchase program may be discontinued at any time.  Susquehanna does not expect any share repurchases to have a material effect on its liquidity or capital resources.

Executive Overview

Consolidated net income available to common shareholders for the second quarter of 2014 was $43.5 million, down 4.7% compared to $45.6 million earned during the same period in 2013. On a diluted per common share basis, earnings for the second quarter of 2014 were $0.23, down 4.2% compared to $0.24 for the same period in 2013. Susquehanna’s results of operations for the second quarter of 2014 produced an annualized return on average assets of 0.95% and an annualized return on average tangible

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shareholders’ equity, a non-GAAP ratio, of 12.34% compared to the prior year ratios of 1.01% and 14.30%, respectively.  For additional information on non-GAAP ratios, refer to “Table 3, Reconciliation of Non-GAAP Measures”.

The following tables present a summary of our results of operations and key financial measures for the periods ended June 30, 2014 and 2013.

Table 1
Summary of Second Quarter 2014 Compared to Second Quarter 2013, and Six Months Ended June 30, 2014 Compared to Six Months Ended June 30, 2013
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2014		2013		% Change		2014		2013		% Change
		(Dollars in thousands)
Net income	$	43,494	$	45,648	(4.7)	%	$	80,656	$	88,047	(8.4)	%
Net interest income		141,694		148,097	(4.3)			281,758		297,303	(5.2)
Provision for loan and lease losses		3,000		12,000	(75.0)			9,000		24,000	(62.5)
Non-interest income		45,349		49,076	(7.6)			87,438		91,720	(4.7)
Non-interest expense		125,225		119,738	4.6			248,257		237,467	4.5

Table 2
Key Susquehanna Financial Measures
		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2014			2013			2014			2013
	Diluted Earnings per Common Share	$	0.23		$	0.24		$	0.43		$	0.47
	Return on Average Assets		0.95	%		1.01	%		0.88	%		0.98	%
	Return on Average Shareholders' Equity		6.30	%		6.91	%		5.91	%		6.75	%
	Return on Average Tangible Shareholders' Equity (1)		12.34	%		14.30	%		11.68	%		14.09	%
	Efficiency Ratio (1)		65.63	%		59.57	%		65.90	%		59.86	%
	Net Interest Margin		3.63	%		3.88	%		3.62	%		3.92	%
(1)	For information regarding Supplemental Reporting of Non-GAAP-based Financial Measurements, refer to "Table 3 - Reconciliation of Non-GAAP Measures".

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Table 3
Reconciliation of Non-GAAP Measures
(Dollars in thousands, except per share)
			Three Months Ended						Six Months Ended
			June 30,						June 30,
			2014			2013			2014			2013
Tangible Book Value per Common Share
End of period balance sheet data
	Shareholders' equity		$	2,796,392		$	2,644,940		$	2,796,392		$	2,644,940
	Goodwill and other intangible assets			(1,304,018)			(1,311,176)			(1,304,018)			(1,311,176)
		Tangible common equity (numerator)	$	1,492,374		$	1,333,764		$	1,492,374		$	1,333,764
Common shares outstanding (denominator)				187,706			187,023			187,706			187,023
	Tangible book value per common share		$	7.95		$	7.13		$	7.95		$	7.13
	Tangible book value per share is a non-GAAP based financial measure calculated using non-GAAP based amounts. The most
directly comparable GAAP based measure is book value per share. In order to calculate tangible book value per share, we divide tangible common equity, which is a non-GAAP based measure calculated as common shareholders' equity less intangible assets, by the number of shares of common stock outstanding. In contrast, book value per share is calculated by dividing total common shareholders' equity by the number of shares of common stock outstanding. Management uses tangible book value per share to assess our capital position and ratios.
Return on Average Tangible Shareholders' Equity
Return on average shareholders' equity (GAAP basis)				6.30	%		6.91	%		5.91	%		6.75	%
Effect of excluding average intangible assets and related
	amortization			6.04	%		7.39	%		5.77	%		7.34	%
	Return on average tangible shareholders' equity			12.34	%		14.30	%		11.68	%		14.09	%
	Return on average tangible equity is a non-GAAP based financial measure calculated using non-GAAP based amounts. The
most directly comparable GAAP-based measure is return on average equity. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios.
Efficiency Ratio
Noninterest operating expense (numerator)			$	125,225		$	119,738		$	248,257		$	237,467
Taxable-equivalent net interest income				145,447			151,916			289,258			304,995
Other income				45,349			49,076			87,438			91,720
	Denominator			190,796			200,992			376,696			396,715
	Efficiency ratio			65.63	%		59.57	%		65.90	%		59.86	%
	The efficiency ratio is a non-GAAP based financial measure. Management excludes merger-related expenses and certain other
selected items when calculating this ratio, which is used to measure the relationship of operating expenses to revenues.

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		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2014			2013			2014			2013
Net Interest Margin (excluding purchase accounting)
Reported net interest margin (GAAP basis)			3.63	%		3.88	%		3.62	%		3.92	%
Adjustments for purchase accounting:
	Loans and leases		(0.12)	%		(0.27)	%		(0.14)	%		(0.27)	%
	Deposits		(0.03)	%		(0.06)	%		(0.03)	%		(0.06)	%
	Borrowings		(0.10)	%		(0.01)	%		(0.06)	%		(0.01)	%
	Net Interest Margin (excluding purchase accounting)		3.38	%		3.54	%		3.39	%		3.58	%
	Net interest margin (excluding purchase accounting) is a non-GAAP based financial measure using non-GAAP based amounts.
The most directly comparable GAAP based measure is net interest margin. In order to calculate net interest margin (excluding purchase accounting) we subtract the effects of amortizing/accreting purchase accounting valuation amounts from net interest income, and divide the remainder by average earning assets. Our management uses net interest margin (excluding purchase accounting) to measure and monitor the impact of the current economic environment on our net interest income and believes that this measure is more representative of our ongoing earnings power because it excludes the effect of valuation variables used to arrive at the acquisition fair value recorded on the acquisition date. We believe this non-GAAP measure, when taken together with the corresponding GAAP measure, provides meaningful supplemental information to investors regarding our performance. However, this non-GAAP measure should be considered in addition to, and not as a substitute for or preferable to, net interest margin prepared in accordance with GAAP.

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Table 4
Distribution of Assets, Liabilities and Shareholders' Equity
Interest Rates and Interest Differential - Tax Equivalent Basis
			For the Three Month Period Ended						For the Three Month Period Ended
			June 30, 2014						June 30, 2013
			Average					Average
			Balance		Interest		Rate (%)	Balance		Interest		Rate (%)
			(Dollars in thousands)
Assets
Short-term investments			$	80,954	$	23	0.11	$	106,740	$	34	0.13
Investment securities:
		Taxable		2,013,166		11,238	2.24		2,107,031		10,830	2.06
		Tax-advantaged		382,524		5,291	5.55		396,960		5,478	5.54
	Total investment securities			2,395,690		16,529	2.77		2,503,991		16,308	2.61
Loans and leases, (net):
		Taxable		13,154,917		144,471	4.40		12,690,334		156,561	4.95
		Tax-advantaged		434,616		5,432	5.01		419,794		5,326	5.09
	Total loans and leases			13,589,533		149,903	4.42		13,110,128		161,887	4.95
Total interest-earning assets				16,066,177		166,455	4.16		15,720,859		178,229	4.55
Allowance for loan and lease losses				(154,710)					(179,273)
Other noninterest-earning assets				2,466,660					2,529,880
Total assets			$	18,378,127				$	18,071,466
Liabilities
Deposits:
Interest-bearing demand
		Interest-bearing demand	$	5,998,086	$	3,726	0.25	$	5,983,543	$	4,219	0.28
		Savings		1,134,421		305	0.11		1,080,427		294	0.11
		Time		4,129,738		10,245	1.00		3,892,237		11,653	1.20
Short-term borrowings				552,367		2,030	1.47		728,497		2,154	1.19
FHLB borrowings				1,174,611		4,840	1.65		1,041,577		3,754	1.45
Long-term debt				396,367		(138)	(0.14)		496,240		4,239	3.43
Total interest-bearing liabilities				13,385,590		21,008	0.63		13,222,521		26,313	0.80
Demand deposits				1,869,372					1,911,667
Other liabilities				354,500					288,964
Total liabilities				15,609,462					15,423,152
Equity				2,768,665					2,648,314
Total liabilities & shareholders' equity			$	18,378,127				$	18,071,466
Net interest income / yield on
		average earning assets				145,447	3.63				151,916	3.88
Taxable equivalent adjustment						(3,753)					(3,819)
Net interest income - as reported					$	141,694				$	148,097

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Table 4
Distribution of Assets, Liabilities and Shareholders' Equity
Interest Rates and Interest Differential - Tax Equivalent Basis
			For the Six Month Period Ended					For the Six Month Period Ended
			June 30, 2014					June 30, 2013
			Average					Average
			Balance		Interest		Rate (%)	Balance		Interest		Rate (%)
			(Dollars in thousands)
Assets
Short-term investments			$	81,909	$	41	0.10	$	108,037	$	71	0.13
Investment securities:
		Taxable		2,065,278		22,651	2.21		2,154,321		22,256	2.08
		Tax-advantaged		385,231		10,677	5.59		399,197		11,008	5.56
	Total investment securities			2,450,509		33,328	2.74		2,553,518		33,264	2.63
Loans and leases, (net):
		Taxable		13,145,644		290,552	4.46		12,596,683		313,413	5.02
		Tax-advantaged		436,427		10,752	4.97		423,563		10,697	5.09
	Total loans and leases			13,582,071		301,304	4.47		13,020,246		324,110	5.02
Total interest-earning assets				16,114,489		334,673	4.19		15,681,801		357,445	4.60
Allowance for loan and lease losses				(156,070)					(182,075)
Other noninterest-earning assets				2,460,609					2,551,682
Total assets			$	18,419,028				$	18,051,408
Liabilities
Deposits:
		Interest-bearing demand	$	6,015,217	$	7,400	0.25	$	5,939,576	$	8,842	0.30
		Savings		1,117,278		592	0.11		1,064,741		572	0.11
		Time		4,020,822		19,874	1.00		3,835,477		22,886	1.20
Short-term borrowings				611,681		4,131	1.36		772,910		4,306	1.12
FHLB borrowings				1,280,280		9,706	1.53		1,098,292		7,427	1.36
Long-term debt				423,666		3,712	1.77		502,356		8,475	3.40
Total interest-bearing liabilities				13,468,944		45,415	0.68		13,213,352		52,508	0.80
Demand deposits				1,850,223					1,915,046
Other liabilities				346,546					291,599
Total liabilities				15,665,713					15,419,997
Equity				2,753,315					2,631,411
Total liabilities & shareholders' equity			$	18,419,028				$	18,051,408
Net interest income / yield on
	average earning assets					289,258	3.62				304,937	3.92
Taxable equivalent adjustment						(7,500)					(7,634)
Net interest income - as reported					$	281,758				$	297,303

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Table 5
Changes in Net Interest Income - Tax Equivalent Basis
		Three months ended June 30, 2014						Six months ended June 30, 2014
		versus June 30, 2013						versus June 30, 2013
		Increase (Decrease)						Increase (Decrease)
		Due to Change in (1)						Due to Change in (1)
		Average		Average				Average		Average
		Volume		Rate		Total		Volume		Rate		Total
		(Dollars in thousands)
Interest Income
Other short-term investments		$	(7)	$	(4)	$	(11)	$	(16)	$	(14)	$	(30)
Investment securities:
	Taxable		(490)		898		408		(389)		784		395
	Tax-advantaged		(200)		13		(187)		(338)		7		(331)
Total investment securities			(690)		911		221		(727)		791		64
Loans (net of unearned income):
	Taxable		5,480		(17,570)		(12,090)		3,352		(26,213)		(22,861)
	Tax-advantaged		185		(79)		106		175		(120)		55
Total loans			5,665		(17,649)		(11,984)		3,527		(26,333)		(22,806)
Total interest-earning assets		$	4,968	$	(16,742)	$	(11,774)	$	2,784	$	(25,556)	$	(22,772)
Interest Expense
Deposits:
	Interest-bearing demand	$	10	$	(503)	$	(493)	$	6	$	(1,448)	$	(1,442)
	Savings		14		(3)		11		22		(2)		20
	Time		667		(2,075)		(1,408)		196		(3,208)		(3,012)
Short-term borrowings			(578)		454		(124)		(537)		362		(175)
FHLB borrowings			512		574		1,086		1,317		962		2,279
Long-term debt			(709)		(3,668)		(4,377)		(1,170)		(3,593)		(4,763)
Total interest-bearing liabilities			(84)		(5,221)		(5,305)		(166)		(6,927)		(7,093)
Net Interest Income		$	5,052	$	(11,521)	$	(6,469)	$	2,950	$	(18,629)	$	(15,679)
(1)	Changes that are due in part to volume and in part to rate are allocated in proportion to their relationship to the amounts of changes directly to volume and rate.

Net Interest Income-Taxable Equivalent Basis

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

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

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Net interest income on a fully taxable-equivalent basis totaled $145.4 million for the second quarter of 2014 compared to $151.9 million for the same period in 2013.  The decrease of $6.5 million in our taxable equivalent net interest income was the result of the decline in interest earned on earning assets exceeding the decline in interest paid on rate related liabilities. 

The net interest margin for the second quarter of 2014 was 3.63%, a 25 basis point decline from 3.88% for the same period in 2013.  The decline in the net interest margin results primarily from the runoff of higher yielding earning assets, existing loans repricing at lower rates, lower spreads to base indices on our variable rate loans, and partially offset by lower funding costs of deposits and borrowings.  The net interest margin is positively affected by the recognition of purchase accounting benefit from the loan portfolio.  The purchase accounting benefit recorded in the second quarter of 2014 was 12 basis points, a decrease of 15 basis points from the 27 basis points recorded during the same period in 2013.  Net interest margin, excluding purchase accounting, declined 16 basis points from 3.54% in the second quarter of 2013 to 3.38% for the same period in 2014. 

Net interest margin for the six month periods ended June 30, 2014 and 2013 was 3.62% and 3.92%, respectively. The 30 basis point decline in the net interest margin results primarily from originating lower yielding loans due to competition, and existing loans repricing to lower rates, partially offset by lower funding costs of deposits and borrowings.  The purchase accounting benefit from the loan portfolio for the six month periods ended June 30, 2014 and 2013 was 14 and 27 basis points, respectively. Net interest margin, excluding purchase accounting, declined 19 basis points from 3.58% in 2013 to 3.39% in 2014.  For additional information related to our net interest margin, excluding purchase accounting, refer to “Table 3, Reconciliation of Non-GAAP Measures”. 

We expect the purchase accounting benefit from the loan portfolio to continue into the future, but would note that the timing of this benefit is not certain.  While the purchase accounting marks on the purchased credit impaired loans (“PCI loans”) are accreted at a pool level the non-PCI fair value marks are accreted at the individual loan level.  While the credit mark on the non-PCI loans was always established at a discount, the interest mark on the non-PCI loans were individually established at either premiums or discounts depending upon the terms of the loan compared to market at acquisition date.  Accordingly when non-PCI loans prepay or refinance any remaining purchase accounting mark is accreted into interest income, the impact of which would vary depending upon whether the remaining marks were premiums or discounts.  Accordingly, the impact upon the net interest margin is difficult to predict.

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

Provision and Allowance for Loan and Lease Losses

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

Net charge-offs for the second quarter of 2014 increased to $11.4 million, or 0.34% of average loans and leases, when compared to net charge-offs for the second quarter of 2013 of $9.8 million, or 0.30% of average loans and leases. Net charge-offs for the six months ended June 30, 2014 decreased to $20.9 million, or 0.31% of average loans and leases, when compared to net charge-offs for the six months ended June 30, 2013 of $29.4 million, or 0.46% of average loans and leases. Nonaccrual loans increased slightly during this period, from $105.1 million at June 30, 2013 to $105.6 million at June 30, 2014. However, non-performing assets comprised of non-accrual loans plus foreclosed real estate, declined from $123.5 million, or 0.94% of total loans and leases at June 30, 2013, to $115.9 million, or 0.85% of total loans and leases at June 30, 2014. “Table 6 – Provision and Allowance for Loan and Lease Losses” provides detail of charge-offs and recoveries by loan category.

The allowance for loan and lease losses was 1.06% of period-end loans and leases, or $144.5 million, at June 30, 2014; 1.16% of period-end loans and leases, or $157.6 million, at December 31, 2013; and 1.36% of period-end loans and leases, or $178.6 million, at June 30, 2013.

Significant drivers of the allowance for loan and lease losses include charge-off history, with the most recent periods receiving a more significant weighting, loan portfolio composition, ratio of legacy loans to total loans, loan growth, and internal risk weightings.  Our charge-offs have declined during recent quarters which results in the need for a lower allowance for loan loss.  Also contributing to the need for a lower allowance for loan loss in the second quarter of 2014 was the majority of the loan growth was in categories with historically lower loss factors.  Additionally, during the recent quarter we experienced positive credit migration in our internal risk ratings, which influence the loss factors applied to pools of loans.  The need for a smaller allowance for loan loss resulted in a lower provision expense compared to the second quarter of 2013.

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Determining the level of the allowance for probable loan and lease losses at any given point in time is difficult, particularly during uncertain economic periods. We must make estimates using assumptions and information that is often subjective and changing rapidly. The review of the loan and lease portfolios is a continuing process in light of a changing economy and the dynamics of the banking and regulatory environment. In our opinion, the allowance for loan and lease losses is appropriate to meet probable incurred loan and lease losses at June 30, 2014. There can be no assurance, however, that we will not sustain loan and lease losses in future periods greater than the size of the allowance at June 30, 2014.

Table 6
Provision and Allowance for Loan and Lease Losses
				Three Months Ended				Six Months Ended
				June 30				June 30
				2014		2013		2014		2013
				(Dollars in thousands)
	Balance - beginning of period			$	154,150	$	176,377	$	157,608	$	184,020
		Additions			3,000		12,000		9,000		24,000
		Transfer for loans designated as held for sale			(1,236)		0		(1,236)		0
		Charge-offs:
			Commercial, financial, and agricultural		(9,094)		(10,829)		(13,608)		(20,866)
			Real estate - construction		(339)		(1,170)		(630)		(5,933)
			Real estate secured - residential		(3,290)		(2,607)		(7,120)		(5,620)
			Real estate secured - commercial		(1,077)		(842)		(3,684)		(5,445)
			Consumer		(1,341)		(788)		(2,579)		(1,346)
			Leases		(801)		(1,202)		(1,721)		(2,321)
		Total charge-offs			(15,942)		(17,438)		(29,342)		(41,531)
		Recoveries:
			Commercial, financial, and agricultural		1,820		2,040		3,152		4,036
			Real estate - construction		796		1,725		1,178		2,187
			Real estate secured - residential		837		601		1,871		1,252
			Real estate secured - commercial		347		2,083		820		2,805
			Consumer		328		239		711		561
			Leases		383		967		721		1,264
		Total recoveries			4,511		7,655		8,453		12,105
		Net charge-offs			(11,431)		(9,783)		(20,889)		(29,426)
	Balance - end of period			$	144,483	$	178,594	$	144,483	$	178,594
	Average loans and leases outstanding			$	13,589,533	$	13,110,128	$	13,582,071	$	13,020,246
	Period-end loans and leases				13,667,153		13,157,762		13,667,153		13,157,762
	Net charge-offs as a percentage of average loans
		and leases (annualized)			0.34%		0.30%		0.31%		0.46%
	Allowance as a percentage of period-end loans
		and leases			1.06%		1.36%		1.06%		1.36%

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Noninterest Income

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

Noninterest Income
	The following table presents a breakdown of Susquehanna's noninterest income.
Table 7
Noninterest Income
						% Change						% Change
		Three Months				2014		Six Months				2014
		Ended June 30,				vs.		Ended June 30,				vs.
		2014		2013		2013		2014		2013		2013
		Dollars in thousands
Service charges on deposit accounts		$	9,294	$	9,347	(0.6)	%	$	18,294	$	18,019	1.5	%
Vehicle origination and servicing fees			2,915		2,407	21.1			5,883		5,761	2.1
Wealth management commissions and fees			12,669		13,289	(4.7)			25,388		25,679	(1.1)
Commissions on property and casualty
	insurance sales		4,214		4,360	(3.3)			9,880		8,902	11.0
Other commissions and fees			5,401		4,727	14.3			10,436		9,055	15.3
Income from bank-owned life insurance			1,672		1,520	10.0			3,309		3,028	9.3
Mortgage banking revenue			3,004		3,998	(24.9)			5,414		8,108	(33.2)
Capital markets revenue			877		3,256	(73.1)			2,117		4,158	(49.1)
Net realized gain (loss) on sales of securities			3,293		(71)	4,538.0			3,285		(53)	6,098.1
Other			2,010		6,243	(67.8)			3,432		9,063	(62.1)
	Total noninterest income	$	45,349	$	49,076	(7.6)		$	87,438	$	91,720	(4.7)

Second Quarter 2014 Compared to Second Quarter 2013

Noninterest income totaled $45.3 million for the three month period ended June 30, 2014 compared to $49.1 million for the same period in 2013.  Noninterest income as a percentage of total revenue (net interest income plus noninterest income) was 24.2% in 2014 compared to 24.9% in 2013.

Vehicle origination and servicing fees totaled $2.9 million, an increase of $0.5 million, or 21.1% compared to 2013. The increase is primarily due to higher vehicle leasing originations at our Hann subsidiary as a result of postponed demand due to the inclement winter weather experienced by the Mid-Atlantic region during the first quarter of 2014.

Wealth management commissions and fees decreased $0.6 million, or 4.7% from 2013.  The decline is primarily due to lower trading activity due to reduced market volatility.

Other commissions and fees totaled $5.4 million, an increase of $0.7 million, or 14.3%, compared to $4.7 million in 2013.  The increase is primarily due to increased commissions and fees associated with debit/credit card activity, and letters of credit.

Mortgage banking revenue declined $1.0 million, or 24.9%, to $3.0 million for the second quarter of 2014, compared to $4.0 million during the same period in 2013.  The volume of mortgages sold declined 28.3% from the second quarter of 2013 due to lower originations during the latter half of the first quarter resulting from the inclement weather the Mid-Atlantic region experienced in the first quarter of 2014.

Capital markets revenue totaled $0.9 million, a decrease of $2.4 million, or 73.1%, compared to 2013.  Our commercial lending originations during the quarter did not generate the number of potential customers for our interest rate swap product as did the commercial loan originations during the same quarter in 2013.

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Net realized gain (loss) on securities increased $3.4 million over 2013 due to redemption calls of several securities in 2014, as compared to fewer calls in 2013.

Other income decreased $4.2 million, or 67.8%, to $2.0 million in 2014, compared to $6.2 million in 2013.  Primary contributors to the 2014 decrease were: $2.5 million decline in insurance death benefits; $1.0 million decline in gains on OREO and fixed asset sales; $0.2 million decrease in rents received; and, $0.5 million decrease in other miscellaneous income.

The remaining noninterest income decreased $47 thousand, or 0.3%, compared to 2013.  Refer to “Table 7 – Noninterest Income” for detail of fluctuations in other categories of noninterest income.

Six months ended June 30, 2014 compared to Six months ended June 30, 2013

Noninterest income totaled $87.4 million for the six month period ended June 30, 2014 compared to $91.7 million for the same period in 2013.  Noninterest income as a percentage of total revenue (net interest income plus noninterest income) was 23.7% in 2014 compared to 23.6% in 2013.

Commissions on property and casualty insurance sales increased $1.0 million, or 11.0%, to $9.9 million in 2014, compared to $8.9 million in 2013.  The main contributor to this increase is an additional $0.9 million of insurance carrier incentives paid in the first quarter of 2014.

Other commissions and fees totaled $10.4 million, an increase of $1.4 million, or 15.3%, compared to $9.1 million in 2013.  The increase is primarily due to increased commissions and fees associated with debit/credit card activity of $0.9 million, and letter of credit fees of $0.7 million, offset by decreases in other miscellaneous fees of $0.2 million.

Mortgage banking revenue declined $2.7 million, or 33.2%, to $5.4 million for the first six months of 2014, compared to $8.1 million during the same period in 2013.  The volume of mortgages sold declined 38.5% from the first six months of 2013 due to lower originations during the latter half of the first quarter resulting from the inclement weather the Mid-Atlantic region experienced in the first quarter of 2014.

Capital markets revenue totaled $2.1 million, a decrease of $2.0 million, or 49.1%, compared to 2013.  Our commercial lending originations during 2014 did not generate the number of potential customers for our interest rate swap product as did the commercial loan originations during 2013.

Net realized gain (loss) on securities increased $3.3 million over 2013 due to redemption calls of several securities in 2014, as compared to fewer calls in 2013.

Other income decreased $5.6 million, or 62.1%, to $3.4 million in 2014, compared to $9.1 million in 2013.  Primary contributors to the 2014 decrease were: $3.2 million decline in insurance death benefits; $0.9 million decline in gain on sale of OREO and fixed assets; $0.7 million decline in gain on sale of SBA loans; $0.5 million decline of one-time signing bonus related to merchant services; $0.4 million decline in credit card provider royalties (now classified in Other commissions and fees); $0.3 million decline in rents received; and, $0.4 million increase in other miscellaneous income.

The remaining noninterest income increased $0.4 million, or 0.7%, compared to 2013.  Refer to “Table 7 – Noninterest Income” for detail of fluctuations in other categories of noninterest income.

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Noninterest Expense
	The following table presents a breakdown of Susquehanna's noninterest expense.
Table 8
Noninterest Expense
						% Change						% Change
		Three Months				2014		Six Months				2014
		Ended June 30,				vs.		Ended June 30,				vs.
		2014		2013		2013		2014		2013		2013
		Dollars in thousands
Salaries and employee benefits		$	68,325	$	66,888	2.1	%	$	133,906	$	129,502	3.4	%
Occupancy			11,914		11,154	6.8			25,761		22,369	15.2
Furniture and equipment			4,058		3,747	8.3			8,002		7,325	9.2
Professional and technology services			7,189		5,831	23.3			13,259		11,560	14.7
Advertising and marketing			3,567		2,465	44.7			7,143		5,765	23.9
FDIC insurance			4,925		4,541	8.5			10,046		8,339	20.5
Legal fees			1,656		1,810	(8.5)			3,183		3,680	(13.5)
Amortization of intangible assets			2,367		3,053	(22.5)			4,906		6,321	(22.4)
Vehicle lease disposal			2,215		1,313	68.7			4,466		2,603	71.6
Other			19,009		18,936	0.4			37,585		40,003	(6.0)
	Total noninterest expenses		125,225		119,738	4.6			248,257		237,467	4.5

Second Quarter 2014 Compared to Second Quarter 2013

Noninterest expenses totaled $125.2 million for the three month period ended June 30, 2014 compared to $119.7 million for the same period in 2013.

Salaries and benefits are our largest single noninterest expense and include salaries, wages, commissions, stock-based compensation, incentives, pension, and other employee benefit costs.  Total salaries and benefits expenses increased $1.4 million, or 2.1%, in 2014 compared to 2013.  This increase is due to normal salary increases, and additional personnel to ensure our compliance with the increased governmental regulations issued as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act and strategic corporate initiatives. Partially offsetting these increases are decreases in sales commissions and other performance incentives.

Professional and technology expenses increased 23.3%, or $1.4 million, to $7.2 million in 2014 compared to $5.8 million in 2013.  The primary driver was increased consulting fees related to investments in risk management, stress testing, and technology to comply with changing regulations.

Advertising and marketing costs increased $1.1 million, or 44.7%, to $3.6 million in 2014, due to increased costs related to deposit gathering campaigns, and a $0.8 million reclassification of postage from Other expenses.

Vehicle lease disposal expenses increased $0.9 million, or 68.7%, as a result of a 98% increase in the value of terminated leases, and a new quarterly contract amount with Auto Lenders Liquidation Center, Inc. to effectively transfer substantially all residual value risk.

The remaining noninterest expenses decreased $0.7 million, or 1.6% compared to 2013.  Refer to “Table 8 – Noninterest Expense” for detail of fluctuations in other categories of noninterest expense.

Six months ended June 30, 2014 Compared to Six months ended June30, 2013

Noninterest expenses totaled $248.3 million for the six month period ended June 30, 2014 compared to $237.5 million for the same period in 2013.

Salaries and benefits are our largest single noninterest expense and include salaries, wages, commissions, stock-based compensation, incentives, pension, and other employee benefit costs.  Total salaries and benefits expenses increased $4.4 million, or 3.4%, in 2014 compared to 2013.  This increase is due to normal salary increases, and additional personnel to ensure our compliance

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with the increased governmental regulations and strategic corporate initiatives.  Partially offsetting these increases are decreases in sales commissions and other performance incentives.

Occupancy expense increased 15.2%, or $3.4 million, to $25.8 million in 2014 compared to $22.4 million in 2013.  The primary drivers were increased grounds maintenance of $1.1 million due to winter weather, and additional rent expense of $2.3 million, resulting from the sale / leaseback transaction executed in the fourth quarter of 2013.

Professional and technology expenses increased 14.7%, or $1.7 million, to $13.3 million in 2014 compared to $11.6 million in 2013.  The primary drivers were increased consulting fees related to investments in risk management, stress testing, and technology to comply with changing regulations of $1.0 million, and outside vendor services of $0.7 million.

Advertising and marketing costs increased $1.4 million, or 23.9%, to $7.1 million in 2014, due to increased costs related to our deposit gathering campaigns, and a $0.8 million reclassification of postage from Other expenses.

FDIC insurance costs increased $1.7 million, or 20.5%, to $10.0 million in 2014, due to the FDIC’s change in methodology for reporting various quantitative factors included in the assessment calculation.

Vehicle lease disposal expenses increased $1.9 million, or 71.6%, as a result of a 75% increase in the value of terminated leases, and a new quarterly contract amount with Auto Lenders Liquidation Center, Inc. to effectively transfer substantially all residual value risk.

Other expenses in 2014 totaled $37.6 million, a decrease of $2.4 million, or 6.0% from 2013’s amount of $40.0 million.  This decrease is the result of lower operating risk losses of $2.6 million and OREO and foreclosure expense of $1.6 million, partially offset by increased insurance expenses of $0.9 million and Pennsylvania shares tax of $0.9 million.

The remaining noninterest expenses decreased $1.2 million, or 7.1% compared to 2013.  Refer to “Table 8 – Noninterest Expense” for detail of fluctuations in other categories of noninterest expense.

Income Taxes

For information about our income taxes, refer to “Note 7. Income Taxes” to the financial statements appearing in Part I, Item 1, of this report.

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Financial Condition
Table 9
Summary of June 30, 2014 Compared to December 31, 2013
		June 30,		December 31,
		2014		2013		% Change
		(Dollars in thousands, except per share)
	Total assets	$	18,506,626	$	18,473,489	0.2	%
	Investment securities available for sale		2,183,093		2,375,224	(8.1)
	Loans and leases		13,667,153		13,576,086	0.7
	Deposits		13,314,994		12,869,372	3.5
	Shareholders' equity		2,796,392		2,717,587	2.9
	Book value per common share		14.90		14.50	2.8
	Tangible book value per common share		7.95		7.52	5.7

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

At June 30, 2014, we had made no elections to use fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value. In addition, non-financial assets and non-financial liabilities have not been measured at fair value because we have made the determination that the impact on our financial statements would be minimal.  For additional information about our financial assets and financial liabilities carried at fair value, refer to “Note 13. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Securities Available for Sale

Securities available for sale decreased 8.1%, or $192.1 million from December 31, 2013 resulting from a strategic decision, in early 2014, not to purchase securities due to the current low interest rate environment.  As interest rates increase, Susquehanna anticipates increasing the volume of securities purchases.  For additional information about our investment securities portfolio, refer to “Note 2. Investment Securities” and  “Note 13. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Loans and Leases

Loans and leases totaled $13.7 billion at June 30, 2014 and $13.6 billion at December 31, 2013.  For additional information about our loan portfolio, refer to “Note 3. Loans and Leases” to the financial statements appearing in Part I, Item 1, of this report.

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Risk Assets
Table 10
Risk Assets
			June 30,		December 31,
			2014		2013		% Change
			(Dollars in thousands)
Non-performing assets:
	Nonaccrual loans and leases:
		Commercial, financial, and agricultural	$	18,792	$	16,827	11.7	%
		Real estate - construction		7,428		13,230	(43.9)
		Real estate secured - residential		24,740		23,365	5.9
		Real estate secured - commercial		53,687		46,147	16.3
		Consumer		43		47	(8.5)
		Leases		919		1,199	(23.4)
	Total nonaccrual loans and leases			105,609		100,815	4.8
	Foreclosed real estate			10,302		16,555	(37.8)
Total non-performing assets			$	115,911	$	117,370	(1.2)
Total non-performing assets as a percentage of period-end
	loans and leases and foreclosed real estate			0.85%		0.86%	(1.2)
Allowance for loan and lease losses as a percentage of
	nonaccrual loans and leases			137%		156%	(12.2)
Loans contractually past due 90 days and still accruing			$	9,190	$	9,757	(5.8)
Performing troubled debt restructurings				40,938		72,133	(43.2)

Nonperforming assets decreased from $117.4 million at December 31, 2013, to $115.9 million at June 30, 2014. Consequently, total nonperforming assets as a percentage of period-end loans and leases plus foreclosed real estate decreased from 0.86% at December 31, 2013 to 0.85% at June 30, 2014.  Troubled debt restructurings decreased $31.2 million, from $72.1 million at December 31, 2013 to $40.9 million at June 30, 2014, resulting from our curing evaluation process.

Of the $205.1 million of impaired loans (nonaccrual, non-consumer loan relationships greater than $1.0 million plus accruing restructured loans) at June 30, 2014,  $156.1 million, or 76.1%, had no related reserve(refer to “Note 3. Loans and Leases – Impaired Loans” to the financial statements appearing in Part I, Item 1, of this report.)The determination that no related reserve for collateral-dependent loans was required was based on the net realizable value of the underlying collateral less costs to sell.

At June 30, 2014, real estate – construction loans comprised only 5.5% of our total loan and lease portfolio, but accounted for 7.0% of nonaccrual loans and leases and 12.6% of our allowance for loan and lease losses.  As a result, we consider real estate - construction loans to be higher-risk loans. Additional information about our real estate – construction loan portfolio is presented in Tables 11, 12, and 13. Categories within these tables are defined as follows:

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

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

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

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Table 11
Construction, Land Development, and Other Land Loans - Portfolio Status
			Balance at				Past Due		Past Due				Other		Net
			June 30,		% of Total		30-89		90 Days and		Non		Internally		Charge-
Category			2014		Construction		Days		Still Accruing		Accrual		Monitored	(1)	Offs	(2)	Reserve	(3)
			(Dollars in thousands)
1-4 Family:
	Construction		$	146,972	19.6	%	0.1	%	0.0	%	0.5	%	4.7	%	(1.1)	%	2.6	%
	Land development			172,541	23.1		0.0		0.2		0.4		10.9		(1.0)		2.5
	Raw land			1,242	0.2		0.0		0.0		0.0		2.5		22.2		3.0
				320,755	42.9		0.1		0.1		0.4		8.0		(0.9)		2.5
All Other:
	Construction:
		Investor		276,101	36.9		0.0		0.0		1.4		5.0		0.6		2.3
		Owner-occupied		31,924	4.3		0.0		0.0		0.5		0.0		0.0		1.9
	Land development:
		Investor		94,934	12.7		0.8		0.0		1.4		26.5		4.0		2.8
		Owner-occupied		4,653	0.6		0.0		0.0		16.9		7.3		5.2		1.8
	Raw land:
		Investor		19,353	2.6		0.0		1.8		0.0		4.7		(2.0)		1.9
		Owner-occupied		461	0.1		0.0		0.0		0.0		77.7		0.0		3.3
				427,426	57.1		0.2		0.1		1.4		9.5		1.3		2.3
Total			$	748,181	100.0		0.1		0.1		1.0		8.9		0.4		2.4
(1)	Represents loans with initial signs of some financial weakness and potential problem loans that are on our internally monitored loan list, excluding non-accrual and past-due loans reflected in the prior three columns.
(2)	Represents the amount of net charge-offs in each category for the last twelve months divided by the category loan balance at June 30, 2014 plus the net charge-offs.
(3)	Represents the amount of the allowance for loan and lease losses allocated to this category divided by the category loan balance at June 30, 2014.

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Table 12
Construction, Land Development, and Other Land Loans - Collateral Locations
			Balance at		Geographical Location by %
Category			June 30, 2014		Maryland		New Jersey		Pennsylvania		Other
			(Dollars in thousands)
1-4 Family:
	Construction		$	146,972	59.2	%	3.3	%	30.7	%	6.8	%
	Land development			172,541	42.9		5.2		38.6		13.3
	Raw land			1,242	0.0		18.2		81.8		0.0
				320,755	50.2		4.4		35.1		10.3
All Other:
	Construction:
		Investor		276,101	50.8		14.3		32.0		2.9
		Owner-occupied		31,924	1.7		34.4		63.9		0.0
	Land development:
		Investor		94,934	32.6		6.0		42.8		18.6
		Owner-occupied		4,653	67.2		0.0		32.8		0.0
	Raw land:
		Investor		19,353	24.6		1.9		70.1		3.4
		Owner-occupied		461	100.0		0.0		0.0		0.0
				427,426	42.1		13.2		38.5		6.2
Total			$	748,181	45.6		9.4		37.0		8.0

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Table 13
Construction, Land Development, and Other Land Loans - Portfolio Characteristics
						Global Debt
				Balance at		Coverage Ratio		Average Loan to
	Category			June 30, 2014		Less than 1.1 Times (1)		Value (current)
				(Dollars in thousands)
	1-4 Family:
		Construction		$	146,972	6.0	%	103.5	%
		Land development			172,541	10.3		79.3
		Raw land			1,242	0.0		68.6
					320,755	8.6		94.5
	All Other:
		Construction:
			Investor		276,101	19.9		87.1
			Owner-occupied		31,924	0.0		66.5
		Land development:
			Investor		94,934	9.8		69.8
			Owner-occupied		4,653	31.1		47.4
		Raw land:
			Investor		19,353	21.1		76.7
			Owner-occupied		461	77.7		73.3
					427,426	17.4		75.9
				$	748,181	13.0		85.3
(1)	Global debt coverage ratio is calculated by analyzing the combined cash flows of the borrower, its related entities, and the guarantors (if any).  The final global cash flow is divided by the global debt service for the same entities to determine the coverage ratio.

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

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

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

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

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

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

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

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

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

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

Goodwill

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

Deposits

Total deposits increased 3.5%, or $445.6 million, from December 31, 2013 to June 30, 2014. Within this category, core deposits such as demand, interest-bearing demand, and savings decreased 0.7%.

Time deposits less than $0.1 million increased 7.3%, or $153.6 million, from December 31, 2013 to June 30, 2014.  Time deposits greater than $0.1 million increased 20.8%, or $356.2 million, from December 31, 2013 to June 30, 2014.  For additional information about deposits, refer to “Note 6. Deposits” to the financial statements appearing in Part I, Item I, of this report.

Borrowings

Total short-term borrowings and long-term debt decreased $525.9 million, or 20.7%, from December 31, 2013 to June 30, 2014.  The decline is due to a $400.0 million decrease in Federal Home Loan Bank short-term borrowings made possible by the use of $445.6 million increase in deposits and not reinvesting the cash flows from the paydowns in the investment securities portfolio.

On May 31, 2014, a 4.75% Subordinated Note having an aggregate balance of $75.0 million matured.  The Note, plus all accrued and unpaid distributions thereon, was fully paid to the Note holder(s).

On June 30, 2014, we completed a redemption of an outstanding 12% Trust Preferred Security, having an aggregate liquidation amount of $5.33 million, that was issued by Tower Bancorp, Inc. which was acquired by Susquehanna Bancshares, Inc. on February 17, 2012.  The Trust Preferred Security, which by its terms had a final repayment date of April 28, 2019, was redeemed at the full amount of $5.33 million plus all accrued and unpaid distributions thereon to the redemption date.  The transaction resulted in the accretion of the remaining purchase accounting valuation of $3.7 million, which reduced interest expense for the period.

Susquehanna funded these repayments from available cash.

Shareholders’ Equity

Total shareholders’ equity increased $78.8 million, or 2.9%, during the first six months of 2014.  The primary components of the change were net income of $80.7 million, offset by dividends paid to shareholders of $30.0 million, or $.16 per share, and a $22.3 million positive adjustment to accumulated other comprehensive income resulting from increased fair values of available for sale securities.

Capital Adequacy

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

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

Consistent with the international Basel III framework, the New Capital Rules include a new minimum ratio of Common Equity Tier 1 (“CET1”) capital to risk-weighted assets of 4.5 percent. The New Capital Rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0 percent to 6.0 percent, establish a minimum leverage ratio of 4.0 percent, and a minimum total capital (Tier 1 plus Tier 2) to risk-weighted assets ratio of 8.0 percent.  In addition, the rules implement a new “capital conservation buffer” of 2.5 percent (when fully phased-in), composed entirely of CET1, on top of the minimum risk-weighted capital ratios.  This capital conservation buffer is designed to absorb losses in times of economic stress.

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

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

Based on an analysis of the New Capital Rules, management believes that we would be fully compliant with the revised standards as of June 30, 2014 if they had been effective on that date.

We actively review our capital strategies in light of current and anticipated business risks, future growth opportunities, industry standards, and compliance with regulatory requirements.  The assessment of overall capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings stability, competitive forces, economic conditions, and strength of management.  At June 30, 2014, the capital ratios of Susquehanna exceed the “well-capitalized” thresholds under current capital requirements as shown below.

Table 14
Susquehanna Capital Ratios
			Well-capitalized
		At June 30, 2014	Threshold
	Tier 1 Common Ratio	11.03%	N/A
	Leverage Ratio	9.90%	5.0%
	Tier 1 Capital Ratio	12.07%	6.0%
	Total Risk-based Capital Ratio	13.27%	10.0%

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Recently Adopted or Issued Accounting Guidance

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

Risk Management

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

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

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

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

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

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

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market Risks

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

·equity market price risk;

·liquidity risk; and

·interest rate risk.

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

Equity Market Price Risk

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

Liquidity Risk

Company Liquidity

Our primary sources of liquidity at the parent holding company level are dividends from Susquehanna Bank, dividends from non-bank subsidiaries, investment income, proceeds from the sale of investments, and net proceeds from borrowings and capital offerings.  During the six month periods ended June 30, 2014 and 2013, our primary uses of liquidity at the parent holding company level were the payment of interest to holders of notes and capital securities, the payment of dividends to common shareholders, the repurchase of our common stock, and operating expenses of the parent holding company. During the six month periods ended June 30, 2014 and 2013, a total of 53,000 and 2,100 shares of common stock were repurchased at a cost of $544,000 and $25,000, respectively.  There are certain restrictions on the payment of dividends by Susquehanna Bank.  At June 30, 2014, $40.6 million was available for dividend distribution to the parent holding company from its banking subsidiary.  During the six month periods ended June 30, 2014 and 2013, Susquehanna Bank paid dividends to the parent holding company of $52.7 million per period, respectively.  Additional liquidity is available to us through equity or debt offerings.  The ability to execute these transactions could be affected by adverse credit ratings or market conditions.

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

Bank Liquidity

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

Susquehanna Bank’s primary sources of liquidity are deposit accounts, purchased funds, repurchase agreements, borrowings, and the sale, maturity, or call of investment securities. Susquehanna’s primary use of liquidity is the origination and purchase of loans; extension of credit; purchase of investment securities; management of working capital; and funding debt and capital service.  Deposits represented 86.6% and 83.5% of total bank funding as of June 30, 2014 and December 31, 2013, respectively.  Brokered deposits at June 30, 2014 and December 31, 2013 were $650.7 million and $566.8 million representing 4.9% and 4.4% of total deposits, respectively.  At June 30, 2014 and December 31, 2013, Susquehanna Bank had approximately $4.1 billion at each period available under a collateralized line of credit with the Federal Home Loan Bank of Pittsburgh; and $3.0 billion and $2.5 billion, respectively, of additional borrowing capacity subject to the pledge of additional collateral.  Susquehanna Bank pledged certain auto leases, certain auto loans, certain commercial finance leases, and certain investment securities to the Federal Reserve’s Discount Window to obtain collateralized borrowing availability.  At June 30, 2014 and December 31, 2013, Susquehanna Bank had unused collateralized borrowing availability at the Federal Reserve’s Discount Window of $1.6 and $1.5 billion, respectively.

Susquehanna Bank had unrestricted investment securities with a market value of $0.9 billion for the periods ended June 30, 2014 and December 31, 2013.

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

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

Interest Rate Risk

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

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

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

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

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

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

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

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

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

Table 15 summarizes the results of the Core Scenarios for equity at risk and earnings at risk assuming instantaneous, parallel, and sustained upward interest rate shocks of 100 and 200 basis points at June 30, 2014 and December 31, 2013.  The results for equity at risk assuming a 200 basis point increase in interest rates produces a negative 0.8% change in equity while the results for earnings at risk assuming a 200 basis point increase in interest rates produces a positive 5.9% change in net interest income over a one-year time horizon.  Equity at risk and earnings at risk may not produce highly correlated results due to the fundamental nature of the two simulation techniques.  Equity at risk measures cash flows over time horizons that capture the interest rate characteristics of assets and liabilities that may change within one year and beyond one year.  In contrast, the calculation of earnings at risk is focused on the interest rate characteristics of assets and liabilities that may alter earnings within a one-year time horizon.

Table 15
Susquehanna Rate Shock Analysis
		Net Interest Income		Economic Value of Equity
		+100bp	+200bp	+100bp	+200bp
	June 30, 2014	2.4%	5.9%	0.0%	-0.8%
	December 31, 2013	1.0%	3.7%	-1.5%	-2.7%
	Risk-tolerance	-7.5%	-10.0%	-15.0%	-25.0%

Derivative Financial Instruments and Hedging Activities

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

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

For additional information about our derivative financial instruments, refer to “Note 11. Derivative

Financial Instruments” and  “Note 13. Fair Value Disclosures” to the financial statements appearing in Part I, Item 1, of this report.

Vehicle Leasing Residual Value  Risk

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

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Item 4. Controls and Procedures.

(a)Evaluation of Disclosure Controls and Procedures

Susquehanna’s management, with the participation of Susquehanna’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of Susquehanna’s disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Susquehanna believes that a 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.

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PART II--OTHER INFORMATION

Item 1.  Legal Proceedings. 

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

   Lehman Litigation

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

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

Other Legal Proceedings and Investigations

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

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

Item 1A. Risk Factors.

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

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

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None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information.

None.

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Item 6. Exhibits.†
The Exhibits filed as part of this report are as follows:
3.1	Amended and Restated Articles of Incorporation, dated May 6, 2011, incorporated by reference to Exhibit 3.1 to Susquehanna’s Quarterly Report on Form 10-Q, filed August 8, 2011.
3.2	Amended and Restated By-Laws, dated December 10, 2013, incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 13, 2013.
31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1.
31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2.
32	Section 1350 Certifications are filed herewith as Exhibit 32.
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document
†	Upon request by the SEC, the registrant agrees to furnish to the SEC a copy of any instrument with respect to unregistered long-term debt of the registrant in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K promulgated under the Exchange Act.

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SIGNATURES

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

                                                                                           SUSQUEHANNA BANCSHARES, INC.

August 7, 2014                                                                 /s/ William J. Reuter                                                                                                                                                                                           William J. Reuter

                                                                                            Chairman and Chief Executive Officer

August 7, 2014                                                                 /s/ Michael W. Harrington                                                                                                                                                                                                 Michael W. Harrington

                                                                                    Executive Vice President and Chief

                                                                                            Financial Officer

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EXHIBIT INDEX
3.1	Amended and Restated Articles of Incorporation, dated May 6, 2011, incorporated by reference to Exhibit 3.1 to Susquehanna’s Quarterly Report on Form 10-Q, filed August 8, 2011.
3.2	Amended and Restated By-Laws, dated December 10, 2013, incorporated by reference to Exhibit 3.1 of Susquehanna’s Current Report on Form 8-K, filed December 13, 2013.
31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer is filed herewith as Exhibit 31.1.
31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer is filed herewith as Exhibit 31.2.
32	Section 1350 Certifications are filed herewith as Exhibit 32.
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document

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