The following pages of this report present management's discussion and analysis of the consolidated financial condition and results of operations of Susquehanna Bancshares, Inc. and its subsidiaries.

Certain statements in this document may be considered to be "forward-looking statements" as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words "expect," "estimate," "project," "anticipate," "should," "intend," "probability," "risk," "target," "objective" and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited to, our expectations regarding the benefits associated with participating in the Capital Purchase Program; Susquehanna's potential exposures to various types of market risks, such as interest rate risk and credit risk; whether Susquehanna's allowance for loan and lease losses is adequate to meet probable loan and lease losses; our ability to maintain loan growth; our ability to maintain sufficient liquidity; our expectations regarding the amount of savings to be generated by the merger of our bank subsidiaries; our ability to manage credit quality; out ability to monitor the impact of the recession moving into the commercial and industrial, commercial real estate, and consumer segments; the impact of a breach by Auto Lenders, a third-party residual value guarantor of our auto leasing subsidiary, on residual loss exposure; the unlikelihood that more than 10% of the home equity line of credit loans in securitization transactions will convert from variable interest rates to fixed interest rates; our ability to collect all amounts due under our outstanding synthetic collateralized debt obligations; our expectation of the net asset value after liquidation of a mutual fund; further declines in the fair value of our wealth management subsidiaries could trigger future impairment; and our ability to achieve our 2009 financial goals. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about essential model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and could be materially different from what actually occurs in the future. As a result, actual income gains and losses could materially differ from those that have been estimated. Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to:

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

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

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

• the adequacy of loss reserves;

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

• continued relationships with major customers;

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

• adverse national and regional economic and business conditions;

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

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

• the ability to hedge certain risks economically;

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

• greater reliance on wholesale funding because our loan growth has outpaced our deposit growth, and we have no current access the securitization markets;

• the pace of our loan growth compared to our deposit growth;

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

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

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

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

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

Susquehanna's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Application of these principles involves significant judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are based

on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations.

Our most critical accounting estimates are presented in Note 1 to the consolidated financial statements. Furthermore, we believe that the determination of the allowance for loan and lease losses, the valuation of recorded interests in securitized assets, the valuation of goodwill, and the determination of the fair value of certain financial instruments under the guidance of FAS No. 157, "Fair Value Measurements," and FSP No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active" to be the accounting areas that require the most subjective and complex judgments.

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

Valuations for our investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, investment valuation is based on pricing models, quotes for similar investment securities, and observable yield curves and spreads. In addition to valuation, management must assess whether there are any declines in value below the carrying value of the investments that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of income. For additional information on management's consideration of investment valuation and other then temporary impairment, refer to "Note 4. Investment Securities" and "Note 23. Fair Value Disclosures" to the consolidated financial statements appearing in Part II, Item 8.

Recorded interests in securitized assets are established and accounted for based on discounted cash flow modeling techniques which require management to make estimates regarding the amount and timing of expected future cash flows, including estimates of repayment rates, credit loss experience, and discount rates that consider the risk involved. Since the values of these assets are sensitive to changes in estimates, the valuation of recorded interests in securitized assets is considered a critical accounting estimate. Note 1 and Note 21 provide additional information regarding recorded interests.

Management evaluates the valuation of goodwill on an annual basis and more often if situations or the economic environment warrant it. In performing these evaluations, managements makes critical estimates to determine the fair value of its reporting units. Such estimates include assumptions used in determining cash flows and evaluation of appropriate market multiples.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement dates. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity'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. As defined in FAS No. 157, "Fair Value Measurements," Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date. Level 2 inputs are other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the

asset or liability. For additional information about our financial assets and financial liabilities carried at fair value, refer to "Note 23. Fair Value Disclosures" to the consolidated financial statements appearing in Part II, Item 8.

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

Bank Merger

On October 10, 2008, we merged our three bank subsidiaries together. Susquehanna Bank and Susquehanna Bank DV were merged into Susquehanna Bank PA which subsequently changed its name to Susquehanna Bank. This initiative, planned and implemented over a six-month period, was designed to improve efficiency, customer service, and product delivery. Expenses related to the merger resulted in a $2.5 million pre-tax charge in the third quarter, but we expect that the merger will generate annual savings of approximately $20.0 million beginning in 2009.

Capital Purchase Program

Susquehanna was one of many banks to participate in the U.S. Treasury Department's voluntary Capital Purchase Program ("CPP"). Under the program, we applied for and received $300.0 million in capital, with the transaction having been completed on December 12, 2008. In return, we issued to the Treasury $300.0 million in shares of Fixed Rate Cumulative Perpetual Preferred Stock with an initial annual dividend rate of 5.0% and warrants to purchase approximately 3.0 million shares of Susquehanna common stock at an exercise price of $14.86 per share.

Our intention is to use the $300 million received through the CPP for loan growth. As stated in Item 7, we currently project net loan growth of 8% in 2009. With a loan portfolio of $9.65 billion at year-end 2008, this projection would mean loan growth of approximately $750 million in the current year. This increase would follow the 10% net increase in loans (or approximately $900 million) that we achieved in 2008. Susquehanna has a history of sound asset quality, and we were able to generate this level of loan growth while maintaining credit quality ratios superior to the majority of our peer group. While these projections represent our present intentions, we must reserve the right to react to unforeseen regulatory, legislative or economic changes.

We believe that looking at overall lending provides the best insight into how a bank is operating as an engine of economic growth in local communities. As you can see from our projection above, we expect our overall loan growth in 2009 to more than double the amount of capital we received through the Capital Purchase Program.

We believe that participating in the Capital Purchase Program is in the best interests of our shareholders, customers, and the communities that we serve. This funding gives us a foundation to generate additional lending to our customers, and it also builds our capital reserves for additional security against the uncertain nature of the economy.

Allowance for Loan and Lease Losses

The deterioration in economic conditions has impacted our credit quality. Net charge-offs as a percentage of average loans and leases were 0.42% for 2008, compared to 0.25% for 2007. Non-performing assets as a percentage of loans, leases, and other real estate owned were 1.22% for 2008, compared to 0.81% for 2007. Given the pressures facing our customers and loan portfolio, we increased our provision for loan and lease losses

to $63.8 million for 2008, compared to $21.8 million for 2007. See the discussion regarding loan and lease losses in "Results of Operations, Provision and Allowance for Loan and Lease Losses."

The following table compares our 2008 financial goals to actual results:

                                                 Goal     Actual
                    Net interest margin          3.70 %     3.62 %
                    Loan growth                   8.0 %     10.3 %
                    Deposit growth                1.0 %      1.4 %
                    Noninterest income growth    45.0 %     17.9 %
                    Noninterest expense growth   26.0 %     32.6 %
                    Tax rate                     30.0 %     24.6 %

Given the current economic climate and real estate trends, we recognize that the tightening credit market poses challenges for financial institutions. However, we believe that it creates opportunities as well. With that in mind, our financial goals for 2009 are as follows:

                                                          Goal
            Net interest margin                            3.70 %
            Loan growth (adjusted for securitizations)      8.0 %
            Deposit growth                                  1.0 %
            Noninterest income growth                       6.0 %
            Noninterest expense growth                     (1.0 %)
            Tax rate                                       32.0 %
            Preferred dividend and discount accretion    $ 16.7  million

These financial goals include no securitization activity in 2009.

Stratton Holding Company

On April 30, 2008, we completed the acquisition of Stratton Holding Company, an investment management company based in Plymouth Meeting, Pennsylvania with approximately $3.0 billion in assets under management. Stratton became a wholly owned subsidiary of Susquehanna and part of the family of Susquehanna wealth management companies. The addition of Stratton brings increased diversification in our investment expertise, including experience in mutual fund management. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Stratton was considered immaterial for purposes of the disclosures required by FAS No. 141, "Business Combinations."

Community Banks, Inc.

On November 16, 2007, we completed the acquisition of Community Banks, Inc. ("Community") in a stock and cash transaction valued at approximately $871.0 million. Under the terms of the merger agreement, shareholders of Community were entitled to elect to receive for each share of Community common stock that they owned, either $34.00 in cash or 1.48 shares of Susquehanna common stock. The acquisition expands our territory into the Harrisburg market and deepens our foundation in central Pennsylvania. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. See Note 2 to our consolidated financial statements for the disclosures required by FAS No. 141, "Business Combinations."

Widmann, Siff & Co., Inc.

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

Minotola National Bank

On April 21, 2006, we acquired Minotola National Bank in a stock and cash transaction valued at approximately $172.0 million. The acquisition of Minotola, with total assets of $607.0 million and fourteen branch locations, significantly enhanced our presence in the high-growth markets in southern New Jersey. The acquisition was accounted for under the purchase method, and all transactions since the acquisition date are included in our consolidated financial statements. The acquisition of Minotola was considered immaterial for purposes of the disclosures required by FAS No. 141, "Business Combinations."

Summary of 2008 Compared to 2007

The acquisition of Community Banks, Inc. on November 16, 2007 has had a significant impact on our results of operations for the year ended December 31, 2008. Consequently, comparisons to the years ended December 31, 2007 and 2006 may not be particularly meaningful.

Furthermore, results of operations for the year ended December 31, 2008 include the following pre-tax charges:

• a $6.5 million loss related to an interest rate swap termination;

• a $2.5 million merger charge composed of the following:

                  Employee termination benefits   $ 1.60 million
                  Legal fees                        0.25 million
                  Technology costs                  0.65 million

• a $17.5 million securities impairment charge; and

• a $2.1 million VFAM customer-loss contingency.

Also, results of operations for the twelve months ending December 31, 2007 include a pre-tax loss of $11.8 million related to a restructuring of our investment portfolio.

Net income for the year ended December 31, 2008, was $82.6 million, an increase of $13.5 million, or 19.6%, over net income of $69.1 million in 2007. Net interest income increased 44.4%, to $398.3 million for 2008, from $275.9 million in 2007. Noninterest income increased 17.9%, to $142.3 million for 2008, from $120.7 million in 2007, and noninterest expenses increased 32.6%, to $367.2 million for 2008, from $277.0 million for 2007.

Additional information is as follows:

                                                        Twelve Months
                                                            Ended
                                                        December 31,
                                                      2008        2007
              Diluted Earnings per Common Share      $  0.95     $  1.23
              Return on Average Assets                  0.62 %      0.78 %
              Return on Average Equity                  4.80 %      6.66 %
              Return on Average Tangible Equity(1)     13.35 %     11.56 %
              Efficiency Ratio                         66.46 %     69.10 %
              Net Interest Margin                       3.62 %      3.67 %

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

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

Return on average tangible equity is a non-GAAP-based financial measure calculated using non-GAAP amounts. The most directly comparable measure is return on average equity, which is calculated using GAAP-based amounts. We calculate return on average tangible equity by excluding the balance of intangible assets and their related amortization expense from our calculation of return on average equity. Management uses the return on average tangible equity in order to review our core operating results. Management believes that this is a better measure of our performance. In addition, this is consistent with the treatment by bank regulatory agencies, which excludes goodwill and other intangible assets from the calculation of risk-based capital ratios. A reconciliation of return on average equity to return on average tangible equity is set forth below.

                                                                    2008        2007
Return on average equity (GAAP basis)                                4.80 %      6.66 %
Effect of excluding average intangible assets and related
amortization                                                         8.55 %      4.90 %
Return on average tangible equity                                   13.35 %     11.56 %

Net Interest Income - Taxable Equivalent Basis

Our major source of operating revenues is net interest income, which increased to $398.3 million in 2008, as compared to $275.9 million in 2007. Net interest income as a percentage of net interest income plus other income was 74% for the twelve months ended December 31, 2008, 70% for the twelve months ended December 31, 2007, and 65% for the twelve months ended December 31, 2006.

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

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

Table 1 - Distribution of Assets, Liabilities and Shareholders' Equity



Interest Rates and Interest Differential - Tax Equivalent Basis



                                                  2008                                2007                               2006
                                      Average                    Rate     Average                   Rate     Average                   Rate
                                      Balance        Interest    (%)      Balance       Interest    (%)      Balance       Interest    (%)
                                                                            (Dollars in thousands)
Assets
Short-term investments              $    101,715     $   2,411   2.37   $    97,583     $   4,782   4.90   $    81,939     $   3,669   4.48
Investment securities:
Taxable                                1,759,424        91,531   5.20     1,485,561        73,837   4.97     1,261,515        53,463   4.24
Tax-advantaged                           296,211        19,560   6.60        69,389         4,380   6.31        20,506         1,300   6.34

Total investment securities            2,055,635       111,091   5.40     1,554,950        78,217   5.03     1,282,021        54,763   4.27

Loans and leases, (net):
Taxable                                8,972,747       581,070   6.48     5,876,948       439,680   7.48     5,434,490       400,923   7.38
Tax-advantaged                           197,249        14,375   7.29       102,930         7,708   7.49        83,322         5,987   7.19

Total loans and leases                 9,169,996       595,445   6.49     5,979,878       447,388   7.48     5,517,812       406,910   7.37

Total interest-earning assets         11,327,346     $ 708,947   6.26     7,632,411     $ 530,387   6.95     6,881,772     $ 465,342   6.76

Allowance for loan and lease
losses                                   (98,321 )                          (64,993 )                          (59,465 )
Other noninterest-earning assets       2,089,321                          1,337,310                          1,127,513

Total assets                        $ 13,318,346                        $ 8,904,728                        $ 7,949,820

Liabilities
Deposits:
Interest-bearing demand             $  2,604,337     $  33,667   1.29   $ 2,173,731     $  61,572   2.83   $ 1,846,483     $  51,424   2.78
Savings                                  723,612         4,848   0.67       480,065         4,278   0.89       496,056         4,960   1.00
. . .