10-K 1 d10k.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 ----------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- ---------- Commission file number 0-10674 ------- Susquehanna Bancshares, Inc. -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Pennsylvania 23-2201716 ----------------------------------------- ------------------------------------ (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 26 North Cedar St., Lititz, Pennsylvania 17543 ----------------------------------------- ------------------------------------ (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code (717) 626-4721 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered ------------------- ----------------------------------------- None None Securities registered pursuant to Section 12(g) of the Act: common stock, par value $2.00 per share -------------------------------------------------------------------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $820,440,400 as of February 28, 2002, based upon the closing price on the Nadsaq National Market reported for such date. Shares of common stock held by each executive officer and director and by each person who beneficially owns more than 5% of the outstanding common stock have been excluded in that such persons may under certain circumstances be deemed to be affiliates. This determination of executive officer or affiliate status is not necessarily a conclusive determination for other purposes. The number of shares issued and outstanding of the registrant's common stock as of February 28, 2002, was 39,346,049. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 29, 2002, are incorporated by reference into Part III. PART I ------ Item 1. Business ------ -------- General Susquehanna Bancshares, Inc. ("Susquehanna") is a multi-state financial holding company headquartered in Lititz, Pennsylvania. As of December 31, 2001, Susquehanna operated as a super-community financial holding company with nine commercial banks and four non-bank subsidiaries. As of December 31, 2001, Susquehanna had consolidated assets of $5.1 billion, loans receivable of $3.5 billion, deposits of $3.5 billion and shareholders' equity of $494 million. The relative sizes and profitability of Susquehanna's operating subsidiaries as of and for the year ended December 31, 2001, are depicted in the following table: (Dollars in Millions)
--------------------------------------------------------------------------------------------------------------- Subsidiary* Assets Percent of Total Net Income Percent of Total ----------- ------ ---------------- ---------- ---------------- --------------------------------------------------------------------------------------------------------------- Farmers First Bank $1,358.9 26.8% $ 20.3 36.4% Farmers & Merchants Bank and Trust 752.8 14.9 8.2 14.7 First Susquehanna Bank & Trust 326.1 6.5 3.9 7.0 WNB Bank 286.0 5.7 4.5 8.1 Citizens Bank of Southern Pennsylvania 227.3 4.5 2.0 3.6 First American Bank of Pennsylvania 190.4 3.8 1.6 2.9 Susquehanna Bank** 1,080.8 21.3 7.0 12.6 Equity Bank*** 407.7 8.1 4.3 7.7 Founders' Bank*** 169.8 3.4 2.8 5.0 Susque-Bancshares Leasing Company, Inc. (leasing) 14.7 0.3 (0.5) (0.9) Valley Forge Asset Management Corp. 19.4 0.4 0.8 1.4 Boston Service Company, Inc. (t/a Hann Financial 475.2 9.4 5.6 10.1 Service Corporation (auto leasing)) Susque-Bancshares Life Insurance Company 4.6 0.1 0.2 0.4 (life insurance) Consolidation adjustments, including (262.6) (5.2) (5.0) (9.0) Susquehanna, Susquehanna South and Susquehanna East) --------------------------------------------------------------------------------------------------------------- Total $5,051.1 100.0% $ 55.7 100.0% ---------------------------------------------------------------------------------------------------------------
* Includes operations of wholly-owned subsidiaries. ** Subsidiary of Susquehanna's wholly-owned subsidiary, Susquehanna Bancshares South, Inc. ("Susquehanna South"), a non-operating holding company. *** Subsidiaries of Susquehanna's wholly-owned subsidiary, Susquehanna Bancshares East, Inc. ("Susquehanna East"), a non-operating holding company. Susquehanna's depository institution subsidiaries are located in Pennsylvania, Maryland, New Jersey and West Virginia, and provide commercial and retail banking services in central and south central Pennsylvania, principally in Franklin, Lancaster, Northumberland, Snyder, Union, Columbia, York and Lycoming Counties; in southeastern Pennsylvania principally in Montgomery, Chester and Delaware Counties; in southwestern Pennsylvania principally in Bedford and Blair Counties; in western Maryland, principally in Allegany, Garrett and Washington Counties; in northwestern, central and southeastern Maryland, including Baltimore County, Baltimore City, Carroll County, Harford County, Worcester County, Wicomico County and Anne Arundel County; in southern New Jersey, principally in Camden, Burlington and Gloucester Counties; and in eastern West Virginia, principally in Berkeley County, West Virginia. Susquehanna's non-depository institution subsidiaries provide commercial leasing services in Pennsylvania, New Jersey, Maryland, Delaware, West Virginia and northern Virginia; credit life insurance services in central and southeastern Pennsylvania; consumer automobile financing services principally in New Jersey, eastern Pennsylvania, New York and Connecticut; and asset management services principally in southeastern Pennsylvania (Philadelphia, Bucks, Montgomery, Delaware and Chester Counties), New Jersey and Delaware. 2 As a "super-community" financial holding company, Susquehanna's strategy has been to manage its subsidiaries on a decentralized basis, allowing each subsidiary operating in different markets to retain its name and board of directors as well as substantial autonomy in its day to day operations. Susquehanna believes that this strategy permits these institutions greater flexibility to better serve their markets, increasing responsiveness to local needs, and differentiates Susquehanna from other large competitors. Susquehanna continues, however, to implement consolidations in selected lines of business, operations and support functions in order to achieve greater economies of scale and cost savings. Susquehanna also provides its banking subsidiaries guidance in the areas of credit policy and administration, strategic planning, investment portfolio management and other financial and administrative services. As of December 31, 2001, Susquehanna had 420 full-time and 55 part-time employees, and Susquehanna and its subsidiaries, on a consolidated basis, had 1,635 full-time and 308 part-time employees. Susquehanna was incorporated in Pennsylvania in 1982. Its executive offices are located at 26 North Cedar Street, Lititz, Pennsylvania 17543, and its telephone number is (717) 626-4721. Business Susquehanna, through its subsidiaries, provides a wide range of retail and commercial banking and financial services. Its retail banking business strategy is to expand its deposit and other product market share through a high level of customer service, new product offerings, application of new technologies and delivery systems, and selective acquisitions. Susquehanna operates an extensive branch network and has a strong market presence in its primary markets in Pennsylvania, Maryland and New Jersey. As a result of the development of broad banking relations with its customers, core deposits fund 77% of Susquehanna's lending and investing activities. Susquehanna's retail banking services include checking and savings accounts, money market accounts, certificates of deposit, individual retirement accounts, Christmas clubs, mutual funds and annuities (see discussion below), home equity lines of credit, residential mortgage loans, home improvement loans, student loans, automobile loans and personal loans. In 1996, Susquehanna introduced a check card in Pennsylvania and Maryland. In 1998, the check card was introduced in New Jersey. As of December 31, 2001, there were over 190,845 active debit cards (over 249,361 issued). In 2000, Susquehanna also sold its credit card portfolio to a third party purchaser. Simultaneously with this sale, Susquehanna entered into a separate agreement with the purchaser for it to continue to provide credit card products and services to Susquehanna's customers. Susquehanna conducts its mortgage origination and mortgage banking operations in its Pennsylvania and Maryland markets through Susquehanna Mortgage Company, a wholly-owned subsidiary of Susquehanna Bank. Susquehanna's consolidated commercial lending operations include commercial, financial and agricultural lending (12% of the total loan portfolio at December 31, 2001), real estate construction lending (10%), and commercial mortgage lending (25%). Loans originated by each subsidiary are subject to central review and uniform Susquehanna credit standards. Nearly all of Susquehanna's loans are concentrated in the markets served by its insured depository institution subsidiaries. Susquehanna Trust & Investment Company, a subsidiary of Farmers First Bank, renders services as trustee, executor, administrator, guardian, managing agent, custodian and investment advisor and performs other fiduciary activities authorized by law. It operates in Pennsylvania, New Jersey and Maryland. Through its subsidiary, Susque-Bancshares Life Insurance Company, Susquehanna offers certain credit related insurance products. Susquehanna also offers certain leasing services through its subsidiary Susque-Bancshares Leasing Company, Inc., and its wholly owned subsidiary, Susquebanc Lease Co. Susquehanna expanded its leasing service capabilities through its acquisition in February of 2000 of Boston Service Company, Inc. (t/a Hann Financial Service Corp.), which provides comprehensive consumer automobile financing services. 3 Through Susquehanna's acquisition of Valley Forge Asset Management Corp. in March of 2000, which represented Susquehanna's first acquisition of an investment advisory services corporation, Susquehanna and its subsidiaries offer a broad range of investment advisory, asset management and brokerage services to its customers. Susquehanna's subsidiaries also have referral fee arrangements with other investment advisors/broker-dealers. On October 12, 2001, Susquehanna's national bank subsidiaries, Citizens National Bank of Southern Pennsylvania, First American National Bank of Pennsylvania and First National Trust Bank converted into Pennsylvania state-chartered banks under the names Citizens Bank of Southern Pennsylvania, First American Bank of Pennsylvania and First Susquehanna Bank & Trust, respectively, and Equity Bank, National Association, converted into a New Jersey state-chartered bank under the name Equity Bank. On that same date, Susquehanna Bank converted from a federally-chartered savings bank into a Maryland state-chartered bank. On November 2, 2001, Williamsport National Bank converted into a Pennsylvania state-chartered bank under the name WNB Bank. Susquehanna and its subsidiaries do not have any portion of their business dependent upon a single or limited number of customers, the loss of which would have a material adverse effect on their business; no substantial portion of their loans or investments are concentrated within a single industry or group of related industries. The businesses of Susquehanna and its subsidiaries are not seasonal in nature. Susquehanna contemplates that in the future it will evaluate and may acquire, or may cause its subsidiaries to acquire, other banks or savings associations or other entities permitted by applicable law. Susquehanna may acquire state and national banks whose principal business activities are in Pennsylvania and in states which have not opted out of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (as described below). Susquehanna may also seek to enter businesses closely related to banking or that are financial in nature, or to acquire existing companies already engaged in such activities, which includes savings associations. Any acquisition by Susquehanna may require notice to or approval of the Board of Governors of the Federal Reserve System, the Pennsylvania Department of Banking, other regulatory agencies and, in some instances, its shareholders. Susquehanna currently has no formal commitments with respect to the acquisition of any entities, although discussions with prospects occur on a regular and continuing basis. Supervision and Regulation General. Susquehanna is a financial holding company registered with the ------- Board of Governors of the Federal Reserve System ("Board") and is subject to regulation under the Bank Holding Company Act of 1956, as amended. This law (the "BHC Act") requires prior approval of an acquisition of assets or of ownership or control of voting shares of any bank if the acquisition would give Susquehanna more than 5% of the voting shares of any bank or bank holding company. It also imposes restrictions, summarized below, on the assets or voting shares of non-banking companies which Susquehanna may acquire. Susquehanna's insured depository institution subsidiaries are also subject to regulation and supervision. Farmers First Bank, Citizens Bank of Southern Pennsylvania, First Susquehanna Bank & Trust, First American Bank of Pennsylvania and WNB Bank are all Pennsylvania state banks subject to regulation and periodic examination by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation (the "FDIC"). Founders' Bank is a Pennsylvania state member bank subject to regulation and periodic examination by the Board and the Pennsylvania Department of Banking. Equity Bank is a New Jersey state member bank subject to regulation and periodic examination by the New Jersey Department of Banking and Insurance and the Board. Farmers & Merchants Bank and Trust and Susquehanna Bank are both Maryland state banks subject to regulation and periodic examination by the Division of Financial Regulation of the Maryland Department of Labor, Licensing and Regulation and the FDIC. Susquehanna Trust & Investment Company is a Pennsylvania non-depository trust company subject to regulation and periodic examination by the Pennsylvania Department of Banking. Because Susquehanna is a financial holding company, all of its subsidiaries are subject to examination by the Board even if not otherwise regulated by the Board. Consistent with the requirements of the BHC Act, Susquehanna's only lines of business in 2001 consisted of providing to its customers commercial banking, trust and other banking-related services and products. These 4 included commercial banking through its nine subsidiary banks, trust services through Susquehanna Trust & Investment Company, credit life insurance through another subsidiary, leasing operations through two subsidiaries and investment advisory services through an additional subsidiary. Of these activities, commercial banking activities accounted for 87% of Susquehanna's gross revenues in 2000 and 85% of Susquehanna's gross revenues in 2001. Regulations governing Susquehanna and its subsidiary depository institutions restrict extensions of credit by such institutions to Susquehanna and, with some exceptions, the other Susquehanna affiliates. For these purposes, extensions of credit include loans and advances to and guarantees and letters of credit on behalf of Susquehanna and such affiliates. These regulations also restrict investments by Susquehanna's depository institution subsidiaries in the stock or other securities of Susquehanna and the covered affiliates as well as the acceptance of such stock or other securities as collateral for loans to any borrower, whether or not related to Susquehanna. Susquehanna's insured depository institution subsidiaries are subject to comprehensive federal and state regulations dealing with a wide variety of subjects, including reserve requirements, loan limitations, restrictions as to interest rates on loans and deposits, restrictions as to dividend payments, requirements governing the establishment of branches and numerous other aspects of their operations. These regulations generally have been adopted to protect depositors and creditors rather than shareholders. Financial Modernization Legislation. In 2000, Susquehanna elected to become ----------------------------------- a "financial holding company" (an "FHC") under the Gramm-Leach-Bliley Act (the "GLB Act"). As an FHC, Susquehanna is permitted to engage, directly or through subsidiaries, in a wide variety of activities not previously allowed to it which are financial in nature or are incidental or complimentary to a financial activity, in addition to engaging in all of the activities previously allowed to it, whether or not presently conducted. The new activities additionally permitted to Susquehanna as an FHC (if it so determines to conduct them) include, among others, insurance and securities underwriting, merchant banking activities, issuing and selling annuities and securitized interests in financial assets and engaging domestically in activities that bank holding companies previously have been permitted to engage in only overseas. It is expected that in the future other activities will be added to the permitted list. All of these listed activities can be conducted, through an acquisition or on a start-up basis, without prior Board approval and with only notice to the Board afterward. The GLB Act also generally permits well-capitalized national banks and, if state law permits, well-capitalized state chartered banks as well, to form or acquire financial subsidiaries to engage in most of these same activities, with the exception of certain specified activities (insurance underwriting, for example) which must be conducted only at the level of the holding company or a nonbank subsidiary. State chartered banks in Pennsylvania, New Jersey and Maryland are generally allowed to engage (with proper regulatory authority) in activities that are permitted to national banks. As an FHC, Susquehanna is generally subject to the same regulation as other bank holding companies, including the reporting, examination, supervision and consolidated capital requirements of the Board. However, in some respects the regulation is modified as a result of FHC status. For example, Susquehanna must continue to satisfy certain conditions (discussed below) to preserve its full flexibility as an FHC. However, as an FHC, Susquehanna (unlike traditional bank holding companies) is permitted to undertake several new types of activities, and to acquire companies engaged in several additional kinds of activities, without prior Board approval and with only notice afterward. To preserve its FHC status, Susquehanna must ensure that all of its insured depository institution subsidiaries remain well-capitalized and well-managed for regulatory purposes and earn "satisfactory" or better ratings on their periodic Community Reinvestment Act ("CRA") examinations. An FHC ceasing to meet these standards is subject to a variety of restrictions, depending on the nature of the problem. If the Board determines that any of the FHC's subsidiary depository institutions are either not well-capitalized or not well-managed, it must notify the FHC. Until compliance is restored, the Board has broad discretion to impose appropriate limitations on the FHC's activities. If compliance is not restored within 180 days, the Board may ultimately require the FHC to divest its depository institutions or in the alternative, to discontinue or divest any activities that are permitted only to FHC bank holding companies. 5 The potential restrictions are different if the lapse pertains to the CRA requirement. In that case, until all the subsidiary institutions are restored to at least "satisfactory" CRA rating status, the FHC may not engage, directly or through a subsidiary, in any of the new activities permissible under the GLB Act nor make additional acquisitions of companies engaged in the new activities. However, completed acquisitions and new activities and affiliations previously begun are left undisturbed, as the GLB Act does not require divestiture for this type of problem. Capital Adequacy. Under the risk-based capital requirements applicable to ---------------- them, bank holding companies must maintain a ratio of total capital to risk-weighted assets (including the asset equivalent of certain off-balance sheet activities such as acceptances and letters of credit) of not less than 8% (10% in order to be considered "well-capitalized"). At least 4% out of the total capital (6% to be well capitalized) must be composed of common stock, retained earnings, noncumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, after deducting goodwill and certain other intangibles ("tier 1 capital"). The remainder of total capital ("tier 2 capital") may consist of mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock and loan loss allowance. At December 31, 2001, Susquehanna's tier 1 capital and total capital (i.e., tier 1 plus tier 2) ratios were 10.82% and 12.53%, respectively. The Board has also established minimum leverage ratio guidelines for bank holding companies. These guidelines mandate a minimum leverage ratio of tier 1 capital to adjusted quarterly average total assets less certain amounts ("leverage amounts") equal to 3% for bank holding companies meeting certain criteria (including those having the highest regulatory rating). All other banking organizations are generally required to maintain a leverage ratio of at least 3% plus an additional cushion of at least 100 basis points and in some cases more. The Board's guidelines also provide that bank holding companies experiencing internal growth or making acquisitions are expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Board will continue to consider a "tangible tier 1 leverage ratio" (i.e., after deducting all intangibles) in evaluating proposals for expansion or new activities. The Board has not advised Susquehanna of any specific minimum leverage ratio applicable to it. At December 31, 2001, Susquehanna's leverage ratio was 8.69%. Susquehanna's subsidiary depository institutions are all subject to similar capital standards promulgated by their respective federal regulatory agencies. No such agency has advised any of Susquehanna's subsidiary institutions of any specific minimum leverage ratios applicable to it. FDICIA Capital Categories. The Federal Deposit Insurance Corporation ------------------------- Improvement Act of 1991 ("FDICIA") requires the federal regulators to take prompt corrective action against any undercapitalized institution. FDICIA establishes five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Well-capitalized institutions significantly exceed the required minimum level for each capital measure (currently, risk-based and leverage). Adequately capitalized institutions include depository institutions that meet the required minimum level for each capital measure. Undercapitalized institutions consist of those that fail to meet the required minimum level for one or more relevant capital measures. Significantly undercapitalized characterizes depository institutions with capital levels significantly below the minimum requirements. Currently, all of Susquehanna's depository institution subsidiaries qualify as well-capitalized. Cross Guarantees. Susquehanna's insured depository institution subsidiaries ---------------- are also subject to cross-guaranty liability under federal law. This means that if one FDIC-insured depository institution subsidiary of a multi-institution bank holding company fails or requires FDIC assistance, the FDIC may assess "commonly controlled" depository institutions for the estimated losses suffered by the FDIC. Such liability could have a material adverse effect on the financial condition of any assessed subsidiary institution and on Susquehanna as the common parent. While the FDIC's cross-guaranty claim is generally junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is generally superior to the claims of shareholders and affiliates. Source of Strength Doctrine. Under Board policy, a bank holding company is --------------------------- expected to serve as a source of financial strength to each of its subsidiary banks and to stand prepared to commit resources to support each of them. Consistent with this policy, the Board has stated that, as a matter of prudent banking, a bank holding 6 company should generally not maintain a given rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the corporation's capital needs, asset quality and overall financial condition. Interstate Banking and Branching. Under the Pennsylvania Banking Code of -------------------------------- 1965, there is no limit on the number of banks that may be owned or controlled by a Pennsylvania-based bank holding company and the Pennsylvania bank subsidiaries may branch freely throughout the Commonwealth and, with Department of Banking approval, elsewhere in the United States and abroad. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 eliminated substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies. The same Act generally permits the federal banking agencies to approve merger transactions resulting in the creation of branches by banks outside their home states if the host state into which they propose to branch has enacted authorizing legislation. Of the middle-Atlantic states, Pennsylvania, Ohio and West Virginia have enacted legislation authorizing such "de novo" branching by banks located in states offering reciprocal treatment to their institutions. Maryland has as well, but without the requirement of reciprocity. Delaware, New Jersey and New York do not allow de novo branching by sister-state banks and require that they enter the state through mergers of established institutions. Liberalizing the branching laws in recent years has had the effect of increasing competition within the markets in which Susquehanna now operates. Regulation of Nonbank Subsidiaries. Susquehanna has four direct non-bank ---------------------------------- subsidiaries, all wholly-owned: Susque-Bancshares Life Insurance Company, a reinsurance company, Susque-Bancshares Leasing Company, Inc., a leasing company, Hann Financial Service Corp., a consumer automobile financing and leasing company, and Valley Forge Asset Management Corp., an investment advisory firm. Susque-Bancshares Life Insurance Company is organized under Arizona law to operate as a credit life, health and accident reinsurer to the extent permitted by Pennsylvania law. It is regulated by the Arizona Department of Insurance and is subject to periodic review by that Department. Susque-Bancshares Leasing Company, Inc. is organized under the laws of the Commonwealth of Pennsylvania and owns a single leasing company subsidiary with commercial finance powers. Hann Financial Service Corp. is organized under New Jersey law and is also authorized to do business in Pennsylvania, New York and Connecticut. It is regulated by Connecticut as a motor vehicle leasing company, by Delaware as a finance or small loan agency, and by New Jersey and Pennsylvania as a sales finance company. Valley Forge Asset Management Corp. is organized under the laws of Pennsylvania. It is registered with the Securities and Exchange Commission (the "SEC") as an investment advisor under the Investment Advisers Act of 1940. It is also a registered broker-dealer and is a member of the National Association of Securities Dealers (the "NASD"). It is also licensed with the securities commissions of various states. Privacy. Title V of the GLB Act is intended to increase the level of ------- privacy protection afforded to customers of financial institutions, including the securities and insurance affiliates of such institutions, partly in recognition of the increased cross-marketing opportunities created by the Act's elimination of many of the boundaries previously separating various segments of the financial services industry. Among other things, these provisions require institutions to have in place administrative, technical and physical safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. The Act also requires institutions to furnish consumers at the outset of the relationship and annually thereafter written disclosures concerning the institution's privacy policies. Environmental Impact Statement. Compliance by Susquehanna and its ------------------------------ subsidiaries with federal, state and local environmental protection laws during 2001 had no material effect upon capital expenditures or earnings or upon the competitive position of Susquehanna and its subsidiaries and is also not expected to materially affect such expenditures, earnings or competition during 2002. Pending Legislation. From time to time, legislation is proposed for ------------------- enactment before the United States Congress and before the Pennsylvania General Assembly which could result in various changes in the laws and regulations applicable to Susquehanna and its subsidiaries. It is not possible at this time to predict if or when any 7 such legislation might become law or the extent to which it might affect the business or competitive status of Susquehanna and its subsidiaries. National Monetary Policy. In addition to being affected by general economic ------------------------ conditions, the earnings and growth of Susquehanna and its subsidiaries are affected by the policies of regulatory authorities, including the Board, the FDIC, the SEC, the NASD and state agencies. An important function of the Board is to regulate the money supply and credit conditions. Among the instruments used by the Board to implement these objectives are open market operations in U.S. Government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. The monetary policies and regulations of the Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon the future business, earnings and growth of Susquehanna and its subsidiaries cannot be predicted. Competition Financial holding companies and their subsidiaries compete with many institutions for deposits, loans, trust services and other banking-related and financial services. Susquehanna and its subsidiaries are subject to competition from less heavily regulated entities such as brokerage firms, money market funds, consumer finance and credit card companies and other financial services companies. The GLB Act has liberalized many of the regulatory restrictions previously imposed on Susquehanna and its subsidiaries. Further legislative proposals are pending or may be introduced which could further effect the financial services industry. It is not possible to assess whether any of such proposals will be enacted, and if enacted, what effect such a proposal would have on the competitive positions of Susquehanna in its market place. As a result of state and federal legislation enacted over the past 20 years, consolidation in the industry has continued at a rapid pace. Further, as a result of relaxation of laws and regulations pertaining to branch banking in the state, and the opportunity to engage in interstate banking, the consolidation within the banking industry has had a significant competitive effect on Susquehanna and its markets. At present, Susquehanna and its subsidiary depository institutions compete with numerous super-regional institutions with significantly greater resources and assets which conduct banking business throughout the region. Business Trends Current business trends include a stable interest rate environment, a relatively strong and diverse local economy and fluctuating consumer confidence. While conditions are presently stable, a variety of factors (e.g., any substantial rise in the inflation or unemployment rates), may effect such stability, both in Susquehanna's markets as well as national markets. Susquehanna will continue its emphasis on control of funding costs and lending rates to effectively maintain profitability. In addition, Susquehanna will seek relationships which can generate fee income which is not directly tied to lending relationships. Susquehanna anticipates that this approach will help dampen its earnings fluctuations which are driven by movement in interest rates, business and consumer loan cycles, and local economic factors. Executive Officers The executive officers of Susquehanna, their ages and their positions with Susquehanna, are set forth in the following table: 8
Name Age Title ---- --- ----- William J. Reuter(1) 52 President and Chief Executive Officer Gregory A. Duncan(2) 46 Executive Vice President and Chief Operating Officer Drew K. Hostetter(3) 47 Executive Vice President, Treasurer and Chief Financial Officer Edward Balderston, Jr.(4) 54 Senior Vice President and Group Executive David D. Keim (5) 53 Senior Vice President and Group Executive Michael M. Quick (6) 53 Vice President and Group Executive James G. Pierne (7) 50 Vice President and Group Executive Peter J. Sahd (8) 42 Vice President and Group Executive William T. Belden(9) 52 Vice President and Group Executive Rodney A. Lefever (10) 35 Chief Technology Officer Charles W. Luppert (11) 60 Vice President
(1) William J. Reuter was appointed Senior Vice President of Susquehanna on January 21, 1998 and promoted to President of Susquehanna on January 19, 2000. He was appointed as Chief Executive Officer on May 25, 2001. He was appointed as Chairman of the Board of Farmers & Merchants Bank and Trust on March 21, 2000. He was also the principal executive officer of Farmers & Merchants Bank and Trust until March 21, 2000, and had been employed by that subsidiary bank in a substantially equivalent position for more than the past five years. In 1996 Mr. Reuter was named an executive officer of Susquehanna South, and from 1997 until April 19, 2000, its wholly-owned subsidiary, Susquehanna Bank. Mr. Reuter was appointed Chairman of the Board of Susquehanna Bank on April 19, 2000. (2) Gregory A. Duncan was also the principal executive officer of Citizens National Bank of Southern Pennsylvania until September 1, 1999, and had been employed by that subsidiary bank in a substantially equivalent position since 1992. He was appointed Senior Vice President - Administration, of Susquehanna on January 21, 1998, was promoted to Executive Vice President on January 19, 2000, and was promoted to Chief Operating Officer on May 25, 2001. He was also appointed President of Susque-Bancshares Life Insurance Company on June 14, 1999 and Secretary of Susque-Bancshares Leasing Company, Inc. on July 15, 1998. (3) Drew K. Hostetter was appointed Assistant Treasurer of Susquehanna in 1995, was promoted to Treasurer in 1996 and promoted to Vice President, Treasurer and Chief Financial Officer in 1998. He was promoted to Senior Vice President on January 19, 2000 and was promoted to Executive Vice President on May 25, 2001. Mr. Hostetter was also appointed Treasurer and Assistant Secretary of Susquebanc Lease Co. on September 17, 1998 and Assistant Treasurer of Susquehanna East on April 18, 1997. Prior to joining Susquehanna, Mr. Hostetter served as Senior Vice President and Corporate Controller of MNC Financial, Baltimore, Maryland, from 1992 to 1994. (4) Edward Balderston, Jr. was appointed Senior Vice President and Group Executive of Susquehanna on May 25, 2001. Prior to that, he served as Vice President of Susquehanna in charge of Marketing and Human Resources from May of 1998 to May of 2001, Susquehanna's Director of Marketing and Human Resources from May 1997 to May of 1998, and as Senior Vice President, Administrative Services, of Farmers First Bank from December 1988 to May 1997. (5) David D. Keim was appointed Senior Vice President and Group Executive of Susquehanna on May 25, 2001. He was appointed as President of Susque-Bancshares Leasing Company, Inc. on July 19, 2000. Prior to that, he served as Vice President of Susquehanna from April 15, 1998 to May 24, 2001, and as Senior Vice President of Susque-Bancshares Leasing Company, Inc. from April 17, 1991 to July 18, 2000. (6) Michael M. Quick was appointed Vice President and Group Executive of Susquehanna on May 25, 2001. He also serves as President and Chief Executive Officer of Equity Bank and has served in that capacity since March 3, 1998 and as President and Chief Executive Officer of Susquehanna East since April 15, 2000. Prior to joining Susquehanna, Mr. Quick served as President and Chief Operating Officer of Equity National Bank from March 17, 1995 to March 3, 1998. (7) James G. Pierne was appointed as Vice President and Group Executive of Susquehanna on May 25, 2001. Since March of 2000, he has also served as President and Chief Executive Officer of Farmers & Merchants Bank 9 and Trust. Prior to that, he served as Executive Vice President of Farmers & Merchants Bank and Trust from March of 1999 until February of 2000, and as that bank's Senior Vice President from March of 1993 until February of 1999. (8) Peter J. Sahd was appointed as Vice President and Group Executive of Susquehanna on May 25, 2001. Prior to that, he served as Director, Alternative Delivery Services of Susquehanna from April 12, 1999 until May 25, 2001. Prior to joining Susquehanna, Mr. Sahd served as Senior Vice President, Operations, of Fulton Bank from August 23, 1994 until April 9, 1999. (9) William T. Belden is also a principal executive officer of Farmers First Bank, having been appointed as President and Chief Operating Officer in 1995 and promoted to President and Chief Executive Officer on March 22, 1999. He was promoted to a Group Executive on December 31, 2001. (10) Rodney A. Lefever joined Susquehanna as its Chief Technology Officer on April 30, 2001. Prior to joining Susquehanna, he served as Director, Earthlink Everywhere, Earthlink, Inc. from September of 2000 until April of 2001, as the President of New Business Development, OneMain.com Inc. from December of 1999 until September of 2000 and the President of D&E Supernet (and its predecessors) from March of 1995 until December of 1999. (11) Charles W. Luppert is also the principal executive officer of WNB Bank and has been employed by that subsidiary bank in a substantially equivalent position for more than the past five years. There are no family relationships among the executive officers of Susquehanna nor are there any arrangements or understandings between any of them and any other person pursuant to which any of them was selected an officer of Susquehanna. Item 2. Properties ------ ---------- Susquehanna reimburses its subsidiaries for space and services utilized. It also leases office space located at Topflight Airpark, Showalter Road, Hagerstown, Maryland for its loan servicing center, and office space located at 701 South Broad Street, Lititz, Pennsylvania, for its Audit, Human Resources, Loan Review, Marketing and Sales Support departments. Susquehanna's subsidiary depository institutions operate 146 branches and 31 free-standing automated teller machines. The depository institutions own 82 of the branches and lease the remaining 64. Nine additional locations are owned or leased by subsidiary banks to facilitate operations and expansion. Management of Susquehanna believes that the properties currently owned and leased by its subsidiaries are adequate for present levels of operation. As of December 31, 2001, the offices (including executive offices) of Susquehanna's depository institution subsidiaries, were as follows:
Executive Office Location of Offices Subsidiary Location of Executive Office Owned/Leased (including executive office) ---------- ---------------------------- ---------------- ---------------------------- Farmers First Bank 9 East Main Street Owned 43 banking offices in Lancaster Lititz, Pennsylvania and York Counties, Pennsylvania Citizens Bank of 35 North Carlisle Street Owned 8 banking offices in Franklin Southern Pennsylvania Greencastle, Pennsylvania County, Pennsylvania First Susquehanna Bank & Trust 400 Market Street Owned 12 banking offices in Sunbury, Pennsylvania Northumberland, Snyder, Columbia and Union Counties, Pennsylvania
10
Executive Office Location of Offices Subsidiary Location of Executive Office Owned/Leased (including executive office) ---------- ---------------------------- ---------------- ---------------------------- WNB Bank 329 Pine Street Owned 7 banking offices in Lycoming Williamsport, Pennsylvania County, Pennsylvania Farmers & Merchants Bank and 59 West Washington Street Owned 32 banking offices in Trust Hagerstown, Maryland Washington, Allegany and Garrett Counties, Maryland and Berkeley County, West Virginia Susquehanna Bank 100 West Road Leased 22 banking offices located in Towson, Maryland Baltimore City and Baltimore, Harford, Anne Arundel, Carroll, Worcester and Wicomico Counties, Maryland First American Bank of 140 East Main Street Owned 6 banking offices in Bedford Pennsylvania Everett, Pennsylvania and Blair Counties, Pennsylvania Equity Bank 8000 Sagemore Drive Leased 13 banking offices in Camden, Suite 8101 Gloucester and Burlington Marlton, New Jersey Counties, New Jersey Founders' Bank 101 Bryn Mawr Avenue Leased 3 banking offices in Bryn Mawr, Pennsylvania Montgomery, Chester and Delaware Counties, Pennsylvania
The executive offices of Susquehanna Trust & Investment Company are located at 24 North Cedar Street, Lititz, Pennsylvania. The trust company leases this facility, as well as the facilities for each of its 5 branch offices. The executive offices of Hann Financial Service Corp. are located at One Centre Drive, Jamesburg, New Jersey. It leases both this facility and a second facility located at 1051 North Black Horse Pike, Williamstown, New Jersey. The executive offices of Valley Forge Asset Management Corp. are located at 120 South Warner Road, King of Prussia, Pennsylvania. Valley Forge Asset Management Corp. leases this facility. Item 3. Legal Proceedings. ------ ----------------- There are no material proceedings to which Susquehanna or any of its subsidiaries are a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Susquehanna and its subsidiaries involve routine litigation incidental to the business of Susquehanna or the subsidiary involved and are not material in respect to the amount in controversy. Item 4. Submission of Matters to a Vote of Security Holders. ------ --------------------------------------------------- There were no matters submitted to a vote of security holders during the fourth quarter of 2001. 11 PART II ------- Item 5. Market for Susquehanna Capital Stock and Related Shareholder Matters. ------ -------------------------------------------------------------------- Susquehanna common stock is listed for quotation on the National Association of Securities Dealers National Market System. Set forth below are the quarterly high and low sales prices of Susquehanna's common stock as reported on the Nasdaq National Market System for the years 2000 and 2001, and cash dividends paid. The table represents prices between dealers and does not include retail markups, markdowns or commissions and does not necessarily represent actual transactions. -------------------------------------------------------- Price Range Per Share* ---------------------- -------------------------------------------------------- Cash ---- Dividends --------- Year Period Paid Low High ---- ------ ---- ------ ------- 2000 1st Quarter $.17 $11.25 $ 15.88 Common 2nd Quarter .17 12.38 15.00 Common 3rd Quarter .17 12.00 15.44 Common 4th Quarter .19 12.88 17.98 Common 2001 1st Quarter $.19 $15.00 $18.875 Common 2nd Quarter .19 16.25 20.81 Common 3rd Quarter .19 18.15 22.83 Common 4th Quarter .20 19.95 22.24 Common -------------------------------------------------------- As of February 28, 2002, there were 6,298 record holders of Susquehanna common stock. Dividends paid by Susquehanna are provided from dividends paid to it by its subsidiaries. Susquehanna's ability to pay dividends is largely dependent upon the receipt of dividends from its bank subsidiaries. Both federal and state laws impose restrictions on the ability of these subsidiaries to pay dividends. These include the Pennsylvania Banking Code in the case of Farmers First Bank, Citizens Bank of Southern Pennsylvania, First American Bank of Pennsylvania, First Susquehanna Bank & Trust and WNB Bank, the Financial Institutions Article of the Annotated Code of Maryland in the case of Farmers & Merchants Bank and Trust and Susquehanna Bank, the Federal Reserve Act in the case of Founders' Bank and Equity Bank, and the applicable regulations under such laws. The net capital rules of the SEC under the Securities Exchange Act of 1934 also limit the ability of Valley Forge Asset Management Corp. to pay dividends to Susquehanna. In addition to the specific restrictions, summarized below, the banking and securities regulatory agencies also have broad authority to prohibit otherwise permitted dividends proposed to be made by an institution regulated by them if the agency determines that their distribution would constitute an unsafe or unsound practice. The Board and the FDIC have issued policy statements which provide that, as a general matter, insured banks and bank holding companies may pay dividends only out of current operating earnings. For state-chartered banks which are members of the Federal Reserve System (like Founders' Bank and Equity Bank), the approval of the applicable federal regulatory agency is required for the payment of dividends by the bank subsidiary in any calendar year if the total of all dividends declared by the bank in that calendar year exceeds the current year's retained net income combined with the retained net income for the two preceding years. "Retained net income" for any period means the net income for that period less any common or preferred stock 12 dividends declared in that period. Moreover, no dividends may be paid by such bank in excess of its undivided profits account. Dividends payable by a Pennsylvania state-chartered bank are restricted by the requirement that the bank set aside to a surplus fund each year at least 10% of its net earnings until the bank's surplus equals the amount of its capital (a requirement presently satisfied in the case of all of the Pennsylvania state bank subsidiaries of Susquehanna). Furthermore, a Pennsylvania bank may not pay a dividend if the payment would result in a reduction of the surplus available to the bank. A Maryland state-chartered bank may pay dividends out of undivided profits or, with the approval of the Maryland Bank Commissioner, from surplus in excess of 100% of required capital stock. If, however, the surplus of a Maryland bank is less than 100% of its required capital stock, cash dividends may not be paid in excess of 90% of net earnings. Within the regulatory restrictions described above, each of the insured depository institution subsidiaries of Susquehanna presently has the ability to pay dividends and at December 31, 2001, $13,340,000 in the aggregate was available for dividend distributions during calendar 2002 to Susquehanna from its insured depository institution subsidiaries without regulatory approval. Susquehanna presently expects that cash dividends will continue to be paid by its subsidiaries in the future at levels comparable with those of prior years. 13 Item 6. Selected Financial Data. ------ ----------------------- See Page 15. 14 Selected Financial Data
-------------------------------------------------------------------------------------------------------------------- Dollars in thousands, except per share -------------------------------------------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 1998 1997 -------------------------------------------------------------------------------------------------------------------- Interest income $ 341,295 $ 353,416 $ 335,086 $ 335,614 $ 305,789 Interest expense 169,051 188,464 173,526 176,265 149,907 Net interest income 172,244 164,952 161,560 159,349 155,882 Provision for loan and lease losses 7,310 3,726 11,203 5,780 4,806 Other income 84,166 74,010 53,459 39,106 31,126 Other expenses 167,763 155,581 141,788 124,014 116,485 Income before taxes 81,337 79,655 62,028 68,661 65,717 Net income 55,716 54,962 43,523 46,804 44,770 Cash dividends declared on common stock 30,228 27,092 22,918 20,132 18,371 Dividend payout ratio 54.3% 49.3% 52.7% 43.0% 41.0% Per Common Share Amounts* -------------------------------------------------------------------------------------------------------------------- Net income--Basic $ 1.42 $ 1.40 $ 1.11 $ 1.19 $ 1.16 Net income--Diluted 1.41 1.40 1.10 1.18 1.15 Cash dividends declared on common stock 0.77 0.70 0.62 0.57 0.55 Financial Ratios -------------------------------------------------------------------------------------------------------------------- Return on average total assets 1.14% 1.15% 0.94% 1.06% 1.14% Return on average stockholders' equity 11.78 13.01 10.45 11.75 12.43 Net interest margin 3.91 3.83 3.82 3.98 4.34 Average stockholders' equity to average assets 8.85 8.85 8.95 9.05 9.17 Tangible Operating Results -------------------------------------------------------------------------------------------------------------------- Tangible net income $ 59,095 $ 58,075 $ 46,498 $ 49,056 $ 47,745 Tangible earnings per share 1.51 1.48 1.18 1.25 1.24 Return on tangible average shareholders' equity 13.81% 15.08% 12.13% 13.51% 14.79% Return on tangible average assets 1.23 1.23 1.01 1.12 1.23 Year-End Balances -------------------------------------------------------------------------------------------------------------------- Total assets $5,051,092 $4,792,856 $4,804,997 $4,589,287 $4,130,138 Investment securities 1,021,091 898,604 912,048 951,744 723,745 Loans and leases, net of unearned income 3,519,498 3,433,610 3,469,661 3,248,818 3,072,685 Deposits 3,484,331 3,249,013 3,180,520 3,216,879 3,041,466 Total borrowings 1,016,845 1,030,812 1,157,025 915,676 652,926 Stockholders' equity 493,536 453,437 415,022 412,587 382,772 Selected Share Data* -------------------------------------------------------------------------------------------------------------------- Common shares outstanding (period end) 39,344 39,221 39,382 39,262 39,275 Average common shares outstanding--Basic 39,263 39,262 39,320 39,228 38,656 Average common shares outstanding--Diluted 39,593 39,365 39,497 39,548 38,911 At December 31: Book value per share $ 12.54 $ 11.56 $ 10.54 $ 10.51 $ 9.75 Market price per common share 20.85 16.50 15.88 20.47 25.50 Common stockholders 6,340 6,543 6,720 6,662 6,238
* Amounts adjusted for the three-for-two stock splits in July 1997 and 1998. 15 Item 7. Management's Discussion and Analysis of Results of Operations and ------ ----------------------------------------------------------------- Financial Condition ------------------- See Pages 17 to 32. 16 Management's Discussion and Analysis of Results of Operations and Financial Condition 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., including its subsidiaries (collectively, "Susquehanna"): Farmers First Bank; Farmers & Merchants Bank and Trust; First American Bank of Pennsylvania; First Susquehanna Bank & Trust; WNB Bank; Citizens Bank of Southern Pennsylvania; Susquehanna Bancshares East, Inc. and its commercial bank subsidiaries Equity Bank and Founders' Bank; Susquehanna Bancshares South, Inc. and its commercial bank subsidiary Susquehanna Bank; Boston Service Company, Inc., t/a Hann Financial Service Corp. ("Hann"); Susque-Bancshares Leasing Co., Inc.; Susque-Banc-shares Life Insurance Company; Valley Forge Asset Management Corp.; and Conestoga Management Company, a non-operating, passive investment subsidiary. Certain statements in this document may be considered to be "forward-looking statements" as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words "expect," "estimate," "project," "anticipate," "should," "intend," "probability," "risk," "target," "objective," and similar expressions or variations on such expressions. In particular, this document includes forward-looking statements relating, but not limited to, Susquehanna's potential exposures to various types of market risks, such as interest rate risk and credit risk. Such statements are subject to certain risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about key 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: general economic conditions in market areas in which Susquehanna has significant business activities or investments; the monetary and interest rate policies of the Board of Governors of the Federal Reserve System; inflation; deflation; unanticipated turbulence in interest rates; changes in laws, regulations, and taxes; changes in competition and pricing environments; natural disasters; the inability to hedge certain risks economically; the adequacy of loss reserves; acquisitions or restructuring; technological changes; changes in consumer spending and saving habits; and the success of Susquehanna in managing the risks involved in the foregoing. The management of Susquehanna encourages 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. Susquehanna does not update 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. The following discussion and analysis, the purpose of which is to provide investors and others with information that Susque-hanna's management believes to be necessary for an understanding of its 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. Results of Operations Summary of 2001 Compared to 2000 Susquehanna's net income for the year ended December 31, 2001, increased $0.7 million, or 1%, over 2000 net income of $55.0 million. Susquehanna's earnings performance was enhanced by significant improvements in non-interest income, which during the year 2001 exceeded 33% of total revenues. The $10.2 million improvement in non-interest income over the year ended December 31, 2000, was split almost equally between banking activities and non-bank affiliate operations. Diluted earnings per share ("EPS") increased 1% from $1.40 per share for the year ended 2000 to $1.41 per share for the year ended 2001. Return on average assets ("ROA") and return on average equity ("ROE") finished at 1.14% and 11.78 %, respectively, for the year 2001, compared with 1.15% and 13.01%, respectively, for 2000. Through various acquisitions utilizing the purchase method of accounting for business combinations, Susquehanna has created intangible assets. Amortization of such intangible assets is a non-cash charge that significantly affects Susquehanna's earnings and financial ratios. Tangible net income is actual net income increased by the tax-effected amortization of those intangible assets that are deducted from stockholders' equity in determining Tier I capital. For 2001, tangible net income, basic earnings per share, ROA, and ROE were $59.1 million, $1.51, 1.23%, and 13.81%, respectively, compared to 2001 actual net income, basic earnings per share, ROA, and ROE of $55.7 million, $1.42, 1.14%, and 11.78%, respectively. Tangible net income, basic earnings per share, ROA, and ROE for 2000 were $58.1 million, $1.48, 1.23%, and 15.08%, respectively. Net Interest Income - Taxable Equivalent Basis The major source of operating revenues for Susquehanna is net interest income, which rose to a level of $172.2 million in 2001, $7.3 million, or 4%, above the $164.9 million attained in 2000. Net interest income increased in 2001 despite the substantial decline in the levels of total interest income, which was more than offset by a decline in total interest expense. These declines are the direct result of the Federal Reserve Bank's lowering of interest rates eleven times during 2001. 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, income from investment securities and in- 17 come from 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 levels of nonperforming loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds, and the levels of non-interest-bearing demand deposits and equity capital. Table 1 presents average balances, taxable equivalent interest income and expenses, and yields earned or paid on these assets and liabilities of Susquehanna. 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. Net interest income as apercentage of net interest income and other income was 67%, 69%, and 75% for the twelve months ended December 31, 2001, 2000 and 1999, respectively. Table 2 illustrates that the increase in net interest income in 2001 compared with 2000 was primarily attributable to volumes. The average growth in interest-earning assets of $67 million in 2001 over 2000 was due to a $39 million increase in loans and a $28 million increase in Susquehanna's investment portfolio. As illustrated in Table 1, the tax equivalent yield on earning assets for 2001 decreased to 7.68% from 8.09% in 2000. This decrease was due to the steady drop in interest rates throughout 2001, which was the primary cause for the $13.0 million decrease in taxable equivalent interest income. Table 2 also illustrates that the decrease in interest expense in 2001 compared TABLE 1 - Distribution of Average Assets, Liabilities, and Stockholders' Equity Interest Rates and Interest Differential--Tax Equivalent Basis
--------------------------------------------------------------------------------------------------------------------------------- Dollars in thousands 2001 2000 1999 --------------------------------------------------------------------------------------------------------------------------------- Average Rate Average Rate Average Rate Assets Balance Interest % Balance Interest % Balance Interest % --------------------------------------------------------------------------------------------------------------------------------- Short-term investments $ 88,379 $ 3,539 4.00 $ 50,715 $ 2,937 5.79 $ 67,021 $ 3,089 4.61 Investment securities: Taxable 834,066 51,219 6.14 824,902 53,238 6.45 811,255 50,394 6.21 Tax-advantaged 72,090 5,115 7.10 90,898 6,455 7.10 116,037 8,189 7.06 --------------------------------------------------------------------------------------------------------------------------------- Total investment securities 906,156 56,334 6.22 915,800 59,693 6.52 927,292 58,583 6.32 --------------------------------------------------------------------------------------------------------------------------------- Loans and leases (net): Taxable 3,444,049 280,730 8.15 3,393,175 289,827 8.54 3,298,442 273,387 8.29 Tax-advantaged 43,945 3,820 8.69 55,970 4,952 8.85 49,380 4,451 9.01 --------------------------------------------------------------------------------------------------------------------------------- Total loans and leases 3,487,994 284,550 8.16 3,449,145 294,779 8.55 3,347,822 277,838 8.30 --------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 4,482,529 344,423 7.68 4,415,660 $357,409 8.09 4,342,135 $339,510 7.82 ================================================================================================================================= Allowance for loan and lease losses (38,409) (41,340) (41,011) Other non-earning assets 423,029 401,395 351,187 --------------------------------------------------------------------------------------------------------------------------------- Total assets $4,867,149 $4,775,715 $4,652,311 ================================================================================================================================= Liabilities & Stockholders' Equity Deposits: Interest-bearing demand $ 834,950 $ 18,145 2.20 $ 773,552 $ 22,080 2.85 $ 785,175 $ 20,359 2.59 Savings 420,818 6,324 1.50 420,512 7,709 1.83 444,938 8,166 1.84 Time 1,568,646 84,222 5.37 1,552,939 85,216 5.49 1,519,267 77,488 5.10 Short-term borrowings 211,033 7,976 3.78 199,001 11,597 5.83 122,406 5,754 4.70 FHLB borrowings 446,835 23,656 5.29 388,078 23,139 5.96 354,644 19,600 5.53 Long-term debt 101,329 7,843 7.74 99,105 7,762 7.83 95,000 7,481 7.87 Vehicle financing 293,885 20,886 7.11 416,295 30,961 7.44 451,841 34,679 7.68 --------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 3,867,496 169,052 4.37 3,849,482 $188,464 4.90 3,773,271 $173,527 4.60 --------------------------------------------------------------------------------------------------------------------------------- Demand deposits 468,319 441,894 421,055 Other liabilities 58,362 61,725 41,614 --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 4,394,177 4,353,101 4,235,940 --------------------------------------------------------------------------------------------------------------------------------- Stockholders' equity 472,972 422,614 416,371 --------------------------------------------------------------------------------------------------------------------------------- Total liabilities & stockholders' equity $4,867,149 $4,775,715 $4,652,311 ================================================================================================================================= Net interest income/yield on average earning assets $175,371 3.91 $168,945 3.83 $165,983 3.82 =================================================================================================================================
For purposes of calculating loan yields, the average loan volume includes nonaccrual loans. For purposes of calculating yields on tax-advantaged interest income, the taxable equivalent is made to equate tax-advantaged interest on the same basis as taxable interest. The marginal tax rate is 35%. 18 with 2000 was also attributed to lower interest rates. Decreases in rates paid for interest-bearing deposits, short-term borrowings, and Federal Home Loan Bank ("FHLB") borrowings were the primary reasons for the $19.4 million decrease in interest expense. Consequently, the average cost of funds decreased from 4.90% in 2000 to 4.37% in 2001. Also contributing to the lower cost of funds was an increase in lower cost deposits offsetting a decrease in higher cost borrowings. As a result of the preceding comments, Susquehanna's net interest margin, on a taxable equivalent basis, increased from 3.83% in 2000 to 3.91% in 2001. Variances do occur in the net interest margin, as an exact repricing of assets and liabilities is not possible. A further explanation of the impact of asset and liability repricing is found in the section titled "Market Risks." Provision and Allowance for Loan and Lease Losses The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses at a level adequate to absorb management's estimate of inherent losses in the loan and lease portfolio. Susquehanna's provision for loan and lease losses is based upon management's quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries,and assess general economic conditions in the markets its affiliates serve. Commercial and real estate loans are internally risk rated by Susquehanna's loan officers and periodically reviewed by loan quality personnel. Consumer, residential real estate loans, and leases are generally analyzed in the aggregate as they are of relative small dollar size and homogeneous in nature. In addition to economic conditions, consideration of loan portfolio diversification, delinquency, and historic loss experience, consideration is also given in examinations performed by the regulatory authorities. To determine the allowance and corresponding loan and lease loss provision, the amount required for specific loans is first determined. For certain commercial and construction loans, this amount is based upon specific borrower data determined by reviewing individual non-performing, delinquent, or potentially troubled credits. The remaining commercial loans as well as consumer, residential real estate, and lease allowances, which may include specific reserves, generally are based upon recent charge-off and delinquency history, other known trends and expected losses over the remaining lives of these loans, as well as the condition of local, regional, and national economies. In addition, a reserve for unused commitments is determined using the same criteria applied to the remaining commercial portfolio by risk-rating type. Table 2 - Changes in Net Interest Income - Tax Equivalent Basis
------------------------------------------------------------------------------------------------ 2001 Versus 2000 2000 Versus 1999 Increase /(Decrease) Increase/ (Decrease) Due to Change in Due to Change in ------------------------------------------------------------------------------------------------ Average Average Average Average Dollars in thousands Volume Rate Total Volume Rate Total ------------------------------------------------------------------------------------------------ Interest Income Other short-term investments $ 1,706 $ (1,104) $ 602 $ (846) $ 694 $ (152) Investment securities: Taxable 586 (2,605) (2,019) 858 1,986 2,844 Tax-advantaged (1,335) (5) (1,340) (1,785) 51 (1,734) ------------------------------------------------------------------------------------------------ Total investment securities (749) (2,610) (3,359) (927) 2,037 1,110 Loans (net of unearned income): Taxable 4,296 (13,393) (9,097) 7,968 8,472 16,440 Tax-advantaged (1,046) (86) (1,132) 584 (83) 501 ------------------------------------------------------------------------------------------------ Total loans 3,250 (13,479) (10,229) 8,553 8,388 16,941 ------------------------------------------------------------------------------------------------ Total interest-earning assets $ 4,207 $(17,193) $(12,986) $ 6,780 $11,119 $17,899 ================================================================================================ Interest Expense Deposits: Interest-bearing demand $ 1,392 $ (5,327) $ (3,935) $ (305) $ 2,026 $ 1,721 Savings 6 (1,391) (1,385) (448) (9) (457) Time 856 (1,850) (994) 1,747 5,981 7,728 Short-term borrowings 665 (4,286) (3,621) 4,225 1,618 5,843 FHLB borrowings 3,278 (2,761) 517 1,927 1,612 3,539 Long-term debt 173 (92) 81 322 (41) 281 Vehicle financing (8,753) (1,322) (10,075) (2,668) (1,050) (3,718) ------------------------------------------------------------------------------------------------ Total interest-bearing liabilities (2,383) (17,029) (19,412) 4,800 10,137 14,937 ------------------------------------------------------------------------------------------------ Net interest income $ 6,590 $ (164) $ 6,426 $ 1,979 $ 983 $ 2,962 ================================================================================================
Changes which are due in part to volume and in part to rate are allocated in proportion to their relationship to the amounts of changes attributed directly to volume and rate. 19 To ensure adequacy to a higher degree of confidence, a portion of the allowance for loan and lease losses is considered unallocated. The unallocated portion of the allowance is the amount which, when added to these allocated amounts, brings the total to the amount deemed adequate by management at that time. This unallocated portion is available to absorb losses sustained anywhere within the loan and lease portfolios. Table 10 presents this allocation. The loan portfolio represents loans and leases made primarily within Susquehanna's market area, which includes principally central and southeastern Pennsylvania, Maryland, and New Jersey, and to a lesser extent, southwestern Pennsylvania, Con-necticut, Delaware, West Virginia, northern Virginia, and the southern tier of New York state. Determining the level of the allowance for possible loan and lease losses at any given period is difficult, particularly during deteriorating or uncertain economic periods. Management must make estimates using assumptions and information which is often subjective and changing rapidly. The review of the loan and lease portfolios is a continuing event in light of a changing economy and the dynamics of the banking and regulatory environment. In management's opinion, the allowance for loan and lease losses is adequate at December 31, 2001. There can be no assurance, however, that Susquehanna will not sustain losses in future periods, which could be greater than the size of the allowance at December 31, 2001. As illustrated in Table 3, the provision for loan and lease losses was $7.3 million for 2001 compared to $3.7 million in 2000. Net charge-offs, as presented in Table 3, were $7.3 million in 2001 compared with $7.9 million in 2000. The allowance for loan and lease losses at December 31, 2001, was 1.07% of period-end loans and leases, or $37.7 million, compared with 1.08% or $37.2 million at December 31, 2000. Should the economic climate deteriorate further, borrowers may experience difficulty, and the level of non-performing loans and assets, charge-offs, and delinquencies could rise and require further increases in the provision. In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan and lease losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination. It is the policy of Susquehanna not to renegotiate the terms of a loan simply because of a delinquency status. Rather, a loan is typically transferred to non-accrual status if it is not well secured and in the process of collection, and is considered delinquent in payment if either principal or interest is past due beyond 90 days. Interest income received on non-performing loans in 2001 and 2000 was $1.0 million and $0.9 million, respectively. Interest income which would have been recorded on these loans under the original terms was $1.3 million and $1.5 million for 2001 and 2000, respectively. At December 31, 2001, Sus-quehanna had no outstanding commitments to advance additional funds with respect to these non-performing loans. Table 3 is an analysis of the provision levels as well as the activity in the allowance for loan and lease losses for the past five years. Table 4 reflects the five-year history of non-performing assets and loans and leases contractually past due 90 days and still accruing. Total non-performing assets at December 31, 2001 and 2000, were $19.3 and $20.6 million, respectively, including $3.8 million and $4.0 million, respectively, in other real estate acquired through foreclosure. Non-performing assets as a percentage of period-end loans and leases and other real estate owned was 0.55% at December 31, 2001, a decline from 0.60% at December 31, 2000. Real estate acquired through foreclosure is carried at its fair value, which is calculated as the lower of the recorded amount of the loan for which the foreclosed property served as collateral, or the fair market value of the property as determined by a current appraisal less estimated costs to sell. Prior to foreclosure, the recorded amount of the loan is written-down, if necessary, to fair value by charging the allowance for loan and lease losses. Subsequent to foreclosure, gains or losses on the sale of real estate acquired through foreclosure are recorded in operating income, and any losses determined as a result of periodic valuations are charged to other operating expense. Loans with principal and/or interest delinquent 90 days or more and still accruing interest were $11.5 million at December 31, 2001, a decrease from $13.8 million at December 31, 2000. A softening of certain segments of the economy may adversely affect certain borrowers and may cause additional loans to become past due beyond 89 days or be placed on non-accrual status because of uncertainty of receiving full payment of either principal or interest on these loans. Potential problem loans consist of loans that are performing under contract but for which potential credit problems have caused Susquehanna to place them on its internally monitored loan list. At December 31, 2001, such loans, which are not included in Table 4, amounted to $12.9 million. Depending upon the state of the economy and the impact thereon to these borrowers, as well as future events such as regulatory examination assessments, these loans and others not currently so identified could be classified as non-performing assets in the future. Related Party Transaction and Residual Value Risk In the third quarter of 2000, Hann entered into a Servicing Agreement with Auto Lenders Liquidation Center, Inc. ("Auto Lenders"), pursuant to which Hann effectively transferred to Auto Lenders all residual risk of the managed auto lease portfolio originated by Hann and all residual risk on any new leases originated over the term of the agreement. Michael J. Wimmer, who is a member of Susquehanna's Board of Directors and the chief executive officer of Hann, along with his immediate family, owns 100% of the outstanding equity interest of Auto Lenders. Auto Lenders, which was formed in 1990, is a used vehicle remarketer with three retail locations in New Jersey. Under this Servicing Agreement, Auto Lenders agreed 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. Further, Hann agreed to set its stated residual values in accordance with the standards approved in advance by Auto Lenders, and Hann agreed to pay to Auto Lenders an upfront fee of $3.1 million, as shown in Table 3, to cover all the auto leases serviced by Hann which had been originated by Hann prior to the agreement. Hann also agreed to make monthly guaranty payments to Auto Lenders based upon a fixed 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 pay- 20 ments. During the renewal process, competitive quotes are obtained by Hann from third parties to determine the best remarketing alternative for Hann. The aggregate fees paid by Hann to Auto Lenders under the Servicing Agreement in 2001 were $9.2 million. Under the Servicing Agreement, Auto Lenders retains all residual gains and bears all residual losses with respect to the vehicles. The obligations of Auto Lenders under the Servicing Agreement are secured by a Guaranty dated December 31, 2001, executed by Mr. Wimmer in favor of Hann. Other Income Non-interest income, recorded as other income, consists of: service charges on deposit accounts; commissions and fees received for credit cards (merchant processing), travelers' checks sales, money orders, and investment advisory services; fees for trust services; vehicle origination and servicing fees; income generated from bank-owned life insurance and reinsurance activities; net gains and losses on security transactions; net gains on sales of loans; and other miscellaneous income, such as safe deposit box rents and net gains on the sale of other real estate and branch offices. Other income as a percentage of net interest income and other income was 33%, 31%, and 25% for 2001, 2000, and 1999, respectively. Non-interest income increased $10.2 million, or 14%, in 2001 over 2000. Asset management fees increased $2.5 million from 2000 to 2001 as a result of an increase in assets under manage- TABLE 3 - Provision and Allowance for Loan and Lease Losses
----------------------------------------------------------------------------------------------------------------------- Dollars in thousands 2001 2000 1999 1998 1997 ----------------------------------------------------------------------------------------------------------------------- Allowance for loan and lease losses, January 1 $ 37,187 $ 44,465 $ 39,440 $ 39,316 $ 38,464 Allowance acquired in business combination 539 0 0 0 1,460 Allowance transferred to third-party guarantor 0 3,057 0 0 0 Additions to provision for loan and lease losses charged to operations 7,310 3,726 11,203 5,780 4,806 Loans and leases charged-off during the year: Commercial, financial, agricultural, and leases 4,976 3,880 3,181 2,039 1,612 Real estate--mortgage 1,270 1,634 2,050 1,657 1,355 Consumer 3,178 4,186 3,188 3,413 3,820 ----------------------------------------------------------------------------------------------------------------------- Total charge-offs 9,424 9,700 8,419 7,109 6,787 ----------------------------------------------------------------------------------------------------------------------- Recoveries of loans and leases previously charged-off: Commercial, financial, agricultural, and leases 397 275 550 428 413 Real estate--mortgage 363 369 812 182 71 Consumer 1,326 1,109 879 843 889 ----------------------------------------------------------------------------------------------------------------------- Total recoveries 2,086 1,753 2,241 1,453 1,373 ----------------------------------------------------------------------------------------------------------------------- Net charge-offs 7,338 7,947 6,178 5,656 5,414 ----------------------------------------------------------------------------------------------------------------------- Allowance for loan and lease losses, December 31 $ 37,698 $ 37,187 $ 44,465 $ 39,440 $ 39,316 ======================================================================================================================= Average loans and leases outstanding $3,537,316 $3,449,145 $3,347,822 $3,140,339 $2,891,979 Period-end loans and leases 3,519,498 3,433,610 3,469,661 3,248,818 3,072,685 Net charge-offs as a percentage of average loans and leases 0.21% 0.23% 0.18% 0.18% 0.19% Allowance as a percentage of period-end loans and leases 1.07% 1.08% 1.28% 1.21% 1.28% =======================================================================================================================
TABLE 4--Non-Performing Assets
---------------------------------------------------------------------------------------------------------------------- Dollars in thousands ---------------------------------------------------------------------------------------------------------------------- At December 31 2001 2000 1999 1998 1997 ---------------------------------------------------------------------------------------------------------------------- Loans contractually past due 90 days and still accruing $ 11,498 $ 13,798 $ 10,360 $ 10,645 $ 7,248 ====================================================================================================================== Non-performing assets: Nonaccrual loans: Commercial, financial, agricultural, and leases 4,680 3,856 1,510 1,659 934 Real estate--mortgage 10,795 12,568 20,989 18,409 21,995 Consumer 41 117 271 343 622 Restructured loans 0 0 0 1,258 93 Other real estate owned 3,761 4,039 4,703 4,745 4,547 ---------------------------------------------------------------------------------------------------------------------- Total non-performing assets $ 19,277 $ 20,580 $ 27,473 $ 26,414 $ 28,191 ====================================================================================================================== Total non-performing assets as a percentage of period-end loans and leases and other real estate owned 0.55% 0.60% 0.79% 0.81% 0.92% ====================================================================================================================== Allowance for loan and lease losses as a percentage of non-performing loans 243% 225% 195% 182% 166% ======================================================================================================================
21 ment. Service charges on deposit accounts increased $2.9 million in 2001 over 2000 as the introduction of a new overdraft program improved fee collection significantly. Contributing to the $2.2 million increase in other operating income was improved debit card volume resulting from new marketing efforts. Gain on sale of loans and leases was $4.2 million in 2001 compared with $3.9 million in 2000. During the second quarter of 2001, Hann sold approximately $117 million in automobile leases. In conjunction with this transaction, Hann realized a $1.7 million gain on the sale. During 2001, Susquehanna affiliate banks sold approximately $118 million of mortgage loans that were originated for resale. In conjunction with the sale of mortgage loans, Susquehanna realized approximately $2.5 million in gains. In the third quarter of 2000, Susquehanna sold its credit card portfolio, which resulted in a gain of $1.8 million. During 2000, Susquehanna affiliate banks sold approximately $114 million of mortgage loans which resulted in a gain of $2.1 million. All other categories experienced modest gains over the prior year, as well. Other Expenses Non-interest expenses are categorized into the following nine groupings: employee-related expenses, which include salaries, fringe benefits, and employment taxes; occupancy expenses, which include depreciation, rents, maintenance, utilities, and insurance; furniture and equipment expenses, which include depreciation, rents, and maintenance; amortization of intangible assets; vehicle residual value expense; vehicle delivery and preparation expense; merchant credit card servicing expense; restructuring charges; and other expenses (detailed in Table 5) incurred in operating Susquehanna's business. Non-interest expense increased $12.2 million, or 8%, in 2001 over 2000. Salaries and employee benefits increased $5.7 million, or 8%, from 2000 to 2001. The increase in salaries and benefits was primarily due to normal annual salary increases, recent branch openings, new revenue producing positions, and higher health benefit costs. Table 5 - Analysis of Other Expenses Dollars in thousands ------------------------------------------------------------------ Year ended December 31 2001 2000 1999 ------------------------------------------------------------------ Advertising, marketing, and public relations $ 4,865 $ 4,051 $ 3,938 Audits and examinations 1,214 1,353 723 Communications 3,938 3,149 2,827 Directors' fees 1,291 1,255 1,212 Legal and professional 3,768 5,702 4,880 Life Insurance Company related expenses 967 1,058 924 Other real estate 2,568 1,071 1,089 Outside services 3,989 4,711 3,735 PA shares/capital stock tax 2,571 2,284 2,407 Postage and delivery 4,806 3,631 3,438 Stationery and supplies 3,123 3,204 3,359 FDIC insurance 596 642 769 All other 16,051 14,977 13,539 ------------------------------------------------------------------ Total $49,747 $47,088 $42,840 ================================================================== Charges for occupancy and equipment increased $1.6 million, or 16%, in 2001 from 2000, the result of recent branch openings, and the full-year impact of central processing established throughout the second half of 2000. Amortization of intangible assets increased $0.4 million in 2001 from 2000. Vehicle residual value expense in 2001 decreased $3.2 million from 2000. In the third quarter of 2000, Hann entered into a Servicing Agreement, described earlier in the section "Related Party Transaction and Residual Value Risk," to guarantee all residual values of vehicle leases serviced by Hann. Consequently, year 2000 vehicle residual value expense included both actual residual value losses and residual value guarantee fees, whereas year 2001 included only residual value guarantee fees. Vehicle delivery and preparation expense for 2001 increased $4.0 million over the prior year's expense due to costs associated with an increased number of vehicles being prepared for retail sale during 2001. All other expenses increased $2.7 million (see Table 5), with notable increases in postage and delivery costs of $1.2 million, and other real estate expenses of $1.5 million. While modest increases were realized in most of the other categories, a decrease of $1.9 million was recorded in legal and professional, primarily due to less acquisition-related activity. Income Taxes Susquehanna's effective tax rate for 2001 was 31.5% compared to 31.0% in 2000. The effective rate for 2001 was increased because of reduced levels of tax-advantaged income. As tax-advantaged loans and securities continue to mature, and the opportunities for investment in additional tax-advantaged enterprises become less attractive due to certain provisions of the Tax Reform Act of 1986, effective tax rates may increase in the years ahead. However, beginning in 2002, as required by the FASB that issued SFAS 142, Susquehanna will no longer amortize goodwill created in previous business combinations. The reduction in pre-tax amortization expense of $3.3 million will have a favorable impact on Susquehanna's effective tax rate, as most of the amortization expense was not deductible from taxable income. FINANCIAL CONDITION Investment Securities Susquehanna follows SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities." This accounting pronouncement requires the segregation of investment securities into three categories, each having a distinct accounting treatment: held-to-maturity, trading, or available-for-sale. Securities identified as "held-to-maturity" continue to be carried at their amortized cost and, except for limited circumstances, may not be sold prior to maturity. Securities identified as "available-for-sale" must be reported at their market or "fair" value, and the difference between that value and their amortized cost recorded in the equity section, net of taxes. As a result, total equity of Susquehanna was positively impacted by $10.9 million as the "unrealized gains or losses for available-for-sale securities," changed from a negative $0.8 million at December 31, 2000, to a positive $10.1 million at December 31, 2001. Securities identified as "trading account securities" are marked-to-market, with the change recorded in the income statement. Presently, Susquehanna does not engage in trading activ- 22 TABLE 6 - Carrying Value of Investment Securities
--------------------------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 --------------------------------------------------------------------------------------------------- Available- Held-to- Available- Held-to- Available- Held-to- Dollars in thousands for-Sale Maturity for-Sale Maturity for-Sale Maturity --------------------------------------------------------------------------------------------------- U.S. Treasury $ 1,302 $ 0 $ 3,307 $ 0 $ 16,683 $ 0 U.S. Government agencies 88,289 0 359,773 0 338,990 0 State and municipal 64,712 1,778 63,922 15,833 69,599 32,070 Other securities 20,844 0 16,641 0 17,682 0 Mortgage-backed securities 808,981 0 403,094 486 399,428 1,020 Equity securities 35,185 0 35,548 0 36,576 0 --------------------------------------------------------------------------------------------------- Total investment securities $1,019,313 $1,778 $882,285 $16,319 $878,958 $33,090 ===================================================================================================
ity, but does engage in active portfolio management, which requires the majority of its security portfolios be identified as "available-for-sale." While SFAS 115 requires segregation into "held-to-maturity" and "available-for-sale" categories (see Table 6), it does not change Susquehanna's policy concerning the purchase of only high-quality securities. Strategies employed address liquidity, capital adequacy, and net interest margin considerations which then determine the assignment of purchases into these two categories. Table 7 illustrates the maturities of these security portfolios and the weighted average yields based upon amortized costs. Yields are shown on a tax equivalent basis assuming a 35% federal income tax rate. At December 31, 2001, Susquehanna held no securities of one issuer, other than U.S. Government obligations, where the aggregate book value exceeded ten percent of stockholders' equity. Susquehanna adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as of January 1, 2001. Concurrent with adoption of this standard, and as permitted by its provisions, approximately $14.3 million of securities held-to-maturity were reclassified as securities available-for-sale. This reclassification resulted in an after-tax gain of approximately $0.3 million, which was recorded in other comprehensive income. Loans and Leases Table 8 presents the loans outstanding, by type of loan, in Susquehanna's portfolio for the past five years. In 2001, mortgage loans increased $29 million, commercial loans increased $63 million, and construction loans grew by $95 million compared to 2000. Consumer loans declined $26 million in 2001 from 2000. Susquehanna's banking subsidiaries have historically reported a significant amount of loans secured by real estate, as depicted in Table 8. Many of these loans have real estate collateral taken as additional security not related to the acquisition of the real estate pledged. Open-end home equity loans amounted to $103 million at December 31, 2001, and an additional $162 million was lent against junior liens on residential properties during 2001. During 2001, senior liens on 1-4 family residential properties totaled $817 million, and much of the $784 million in loans secured by non-farm, non-residential properties represented collateralization of operating lines, or term loans that finance equipment, inventory, or receivables. Loans secured by farmland totaled $38 million, while loans secured by multi-family residential properties totaled $59 million at December 31, 2001. Leases declined by $77 million in 2001 compared to 2000, as most of Hann's new lease production in 2001 was either sold or originated for other institutions. Table 9 represents the maturity of commercial, financial, and agricultural loans as well as real estate construction loans. These loans with maturities after 2002 consist of $170 million with fixed-rate pricing and $240 million with variable-rate pricing. Deposits Susquehanna's deposit base is consumer-oriented, consisting of time deposits, primarily certificates of deposit of various terms, interest-bearing demand accounts, savings accounts, and demand deposits. The average amounts of deposits by type are summarized in Table 12. Susquehanna does not rely upon time deposits of $100,000 or more as a principal source of funds, as they represent 8% of total deposits. Table 13 presents a breakdown by maturity of time deposits of $100,000 or more as of December 31, 2001. Market Risks The types of market risk exposures generally faced by banking entities include interest rate risk, liquidity risk, equity market price risk, foreign currency risk, and commodity price risk. Due to the nature of its operations, only interest rate risk and liquidity risk are significant to Susquehanna. Liquidity and interest rate risk are related but distinctly different from one another. The maintenance of adequate liquidity--the ability to meet the cash requirements of its customers and other financial commitments--is a fundamental aspect of Susquehanna's asset/liability management strategy. Susquehan-na's policy of diversifying its funding sources--purchased funds, repurchase agreements, and deposit accounts--allows it to avoid undue concentration in any single financial market and also to avoid heavy funding requirements within short periods of time. At December 31, 2001, Susquehanna's subsidiary banks and savings bank have unused lines of credit available to them from various FHLBs of $559 million. However, liquidity is not entirely dependent on increasing Susquehanna's liability balances. Liquidity can also be generated from maturing or readily marketable assets. The carrying value of investment securities maturing within one year amounted to $34 million at December 31, 2001. These maturing investments represented 3% of total investment securities. Cash and due from banks amounted to $149 million and unrestricted short-term investments amounted to $47 million for the year ended December 31, 2001, both of which represent additional sources of liquidity. 23 TABLE 7 - Investment Securities
-------------------------------------------------------------------------------------------------------- Dollars in thousands Within After 1 Year but After 5 Years but After 1 Year Within 5 Years Within 10 Years 10 Years Total -------------------------------------------------------------------------------------------------------- Available-for-Sale U.S. Treasury Fair value $ 1,302 $ 1,302 Amortized cost 1,201 1,201 Yield 7.01% 7.01% U.S. Government agencies Fair value $ 2,904 $ 67,962 $ 16,209 $ 1,214 $ 88,289 Amortized cost 2,900 66,261 15,943 1,225 86,329 Yield 3.41% 6.18% 5.84% 5.52% 6.01% Corporate debt securities Fair value $ 2,017 $ 17,833 $ 4 $ 990 $ 20,844 Amortized cost 2,004 17,082 5 982 20,073 Yield 5.97% 6.54% 2.63% 3.83% 6.35% Mortgage-backed securities Fair value $17,775 $ 994 $ 75,325 $714,887 $ 808,981 Amortized cost 18,040 984 74,543 705,699 799,266 Yield 5.28% 6.42% 5.47% 6.01% 5.94% State and municipal securities Fair value $11,169 $ 40,734 $ 6,991 $ 5,818 $ 64,712 Amortized cost 11,097 39,830 6,765 5,642 63,334 Yield 6.84% 6.54% 8.83% 8.46% 7.01% Equity securities Fair value $ 35,185 Amortized cost 33,373 Yield 5.61% Held-to-Maturity Mortgage-backed securities Fair value $ 310 $ 1,468 $ 1,778 Amortized cost 310 1,468 1,778 Yield 4.46% 4.90% 4.82% Total Securities Fair value $33,865 $129,135 $ 98,529 $724,377 $1,021,091 Amortized cost 34,041 125,668 97,256 715,016 1,005,354 Yield 5.67% 6.35% 5.76% 6.02% 6.01% ========================================================================================================
Closely related to the management of liquidity is the management of interest rate risk. Interest rate risk focuses on maintaining stability in the net interest margin, an important factor in earnings growth. Interest rate sensitivity is the matching or mismatching of the maturity and rate structure of the interest-bearing assets and liabilities. It is the objective of management to control the difference in the timing of the rate changes for these assets and liabilities to preserve a satisfactory net interest margin. In doing so, Susquehanna endeavors to maximize earnings in an environment of changing interest rates. However, there is a lag in maintaining the desired matching because the repricing of products occurs at varying time intervals. Susquehanna employs a variety of methods to monitor interest rate risk. By dividing the assets and liabilities into three groups--fixed rate, floating rate, and those which reprice only at management's discretion--strategies are developed which are designed to minimize exposure to interest rate fluctuations. Management also utilizes gap analysis to evaluate rate sensitivity at a given point in time. Table 14 illustrates Susquehanna's estimated interest rate sen sitivity and periodic and cumulative gap positions as calculated at December 31, 2001 and 2000. These estimates include anticipated paydowns on commercial and residential loans, mortgage-backed securities, and certain assumptions regarding core deposits. Traditionally, an institution with more assets repricing than liabilities over a given time frame is considered asset sensitive, and one with more liabilities repricing than assets is considered liability sensitive. An asset sensitive institution will generally benefit from rising rates, and a liability sensitive institution will generally benefit from declining rates. However, imbedded options, such as a call feature on a bond or a prepayment option on a loan, may impact the magnitude and direction of interest rate sensitivity. In addition to periodic gap reports comparing the sensitivity of interest-earning assets and interest-bearing liabilities to changes in interest rates, management also utilizes an in-house simulation model that measures Susquehanna's exposure to interest rate risk. This model calculates the income effect and the economic value of assets, liabilities, and equity at current and forecasted interest rates, and at hypothetical higher and lower 24 Table 8 - Loan and Lease Portfolio
--------------------------------------------------------------------------------------------- At December 31 2001 2000 --------------------------------------------------------------------------------------------- Percentage Percentage of Loans to of Loans to Dollars in thousands Amount Total Loans Amount Total Loans --------------------------------------------------------------------------------------------- Commercial, financial, and agricultural $ 434,780 12.4% $ 371,320 10.8% Real estate--construction 359,445 10.2 264,182 7.7 Real estate--mortgage 1,963,094 55.8 1,933,772 56.3 Consumer 325,170 9.2 350,707 10.2 Leases 437,009 12.4 513,629 15.0 --------------------------------------------------------------------------------------------- Total $3,519,498 100.0% $3,433,610 100.0% =============================================================================================
Table 9 - Loan Maturity and Interest Sensitivity
--------------------------------------------------------------------------------------------------------------- Dollars in thousands --------------------------------------------------------------------------------------------------------------- At December 31 --------------------------------------------------------------------------------------------------------------- Under One One to Five Over Five Maturity Year Years Years Total --------------------------------------------------------------------------------------------------------------- Commercial, financial, and agricultural $ 199,932 $129,282 $105,566 $434,780 Real estate--construction 183,832 145,545 30,068 359,445 --------------------------------------------------------------------------------------------------------------- $ 383,764 $274,827 $135,634 $794,225 =============================================================================================================== Rate sensitivity of loans with maturities greater than 1 year: Variable rate $240,063 Fixed rate 170,398 --------------------------------------------------------------------------------------------------------------- $410,461 ===============================================================================================================
Table 10 - Allocation of Allowance for Loan and Lease Losses
----------------------------------------------------------------------------------------- Dollars in thousands ----------------------------------------------------------------------------------------- At December 31 2001 2000 1999 1998 1997 ----------------------------------------------------------------------------------------- Commercial, financial, and agricultural $ 8,783 $ 7,518 $ 5,773 $ 5,212 $ 5,184 Real estate--construction 10,388 7,632 6,018 5,937 5,994 Real estate--mortgage 8,545 8,064 8,000 8,014 7,698 Consumer 6,423 6,187 6,981 5,500 5,225 Leases 1,923 2,276 9,113 4,657 3,960 Unused commitments 1,110 2,211 2,937 2,366 2,558 Unallocated 526 3,299 5,643 7,754 8,697 ----------------------------------------------------------------------------------------- Total $37,698 $37,187 $44,465 $39,440 $39,316 =========================================================================================
interest rates at one percent intervals. The income effect and economic value of defined categories of financial instruments is calculated by the model using estimated cash flows based on imbedded options, prepayments, early withdrawals, and weighted average contractual rates and terms. For economic value calculations, the model also considers discount rates for similar financial instruments. The economic value of longer-term fixed-rate financial instruments are generally more sensitive to changes in interest rates. Adjustable-rate and variable-rate financial instruments largely reflect only a change in economic value representing the difference between the contractual and discounted rates until the next contractual interest rate repricing date, unless subject to rate caps and floors. A substantial portion of Susquehanna's loans consists of commercial and residential mortgage loans containing significant imbedded options which permit the borrower to repay the principal balance of the loan prior to maturity ("prepayments") without penalty. A loan's susceptibility for prepayment is dependent upon a number of factors, including the current interest rate versus the contractual interest rate of the loan, the financial ability of the borrower to refinance, and the economic benefit and availability of refinancing at attractive terms. Also, refinancing may depend upon economic and other factors in specific geographic areas that affect the sales and price levels of residential property. In a changing interest rate environment, prepayments may increase or decrease depending on the current relative levels and expectations of future short- and long-term interest rates. Since a significant portion of Susquehanna's loan portfolio has adjustable or variable rates, prepayments on such loans generally increase when long-term interest rates fall or are at historically low levels relative to short-term interest rates and fixed rate loans are economically more desirable. 25 ------------------------------------------------------------------------------ 1999 1998 1997 ------------------------------------------------------------------------------ Percentage Percentage Percentage of Loans to of Loans to of Loans to Amount Total Loans Amount Total Loans Amount Total Loans ------------------------------------------------------------------------------ $ 327,670 9.4% $ 301,385 9.3% $ 327,598 10.7% 255,054 7.4 256,451 7.9 231,120 7.5 1,850,375 53.3 1,821,485 56.0 1,761,763 57.4 395,566 11.4 346,180 10.7 329,876 10.7 640,996 18.5 523,317 16.1 422,328 13.7 ------------------------------------------------------------------------------ $3,469,661 100.0% $3,248,818 100.0% $3,072,685 100.0% ============================================================================== Table 11 - Loan Concentrations Substantially all of Susquehanna's loans and leases are to enterprises and individuals in Pennsylvania, Maryland, New Jersey, and New York. At December 31, 2001, Susquehanna's portfolio included the following concentrations:
------------------------------------------------------------------------------------------------------------------- Total As a % of % Nonperforming Dollars in thousands Permanent Construction All Other Amount Total Loans in each category ------------------------------------------------------------------------------------------------------------------- Housing developments $ 99,821 $ 173,560 $ 1,238 $ 274,619 7.8 0.7 Office buildings and warehouses 137,285 5,559 57,873 200,717 5.7 1.7 Retailing 113,695 36,875 1,574 152,144 4.3 0.0 Manufacturing 46,023 3,114 66,882 116,020 3.3 1.8 Hotels/motels 61,905 4,443 4,237 70,585 2.0 0.1 Agriculture 36,598 130 19,150 55,879 1.6 0.6 Wholesalers 14,406 200 30,379 44,985 1.3 0.6 ===================================================================================================================
Investment securities, other than those with early call provisions and mortgage-backed securities, generally do not have significant imbedded options and repay pursuant to specific terms until maturity. While savings and checking deposits generally may be withdrawn upon the customer's request without prior notice, a continuing relationship with customers resulting in future deposits and withdrawals is generally predictable, resulting in a dependable source of funds. Time deposits generally have early withdrawal penalties, while term FHLB borrowings and subordinated notes have prepayment penalties which discourage customer withdrawal of time deposits and prepayment of FHLB borrowings and subordinated notes prior to maturity. Susquehanna's loans are primarily indexed to national interest indices. When such loans are funded by interest-bearing liabilities which are determined by other indices, primarily deposits and FHLB borrowings, a changing interest rate environment may result in different levels of changes in the different indices, resulting in disproportionate changes in the value of, and the net earnings generated from, such financial instruments. Each index is unique and is influenced by different external factors; therefore, the historical relationships in various indices may not be indicative of the actual change which may result in a changing interest rate environment. Tables 15 and 16 reflect the estimated income effect and economic value of assets, liabilities, and equity calculated using certain assumptions determined by Susquehanna as of Decem-ber 31, 2001 and 2000, at current interest rates and at hypothetical higher and lower interest rates in one- and two-percent increments. As noted in Table 15, the economic value of equity at risk as of December 31, 2001, is four percent at an interest rate change of plus two percent, while Table 16 discloses that net interest income at risk as of December 31, 2001, is eight percent at an interest rate change of minus two percent. At December 31, 2001, Susquehanna was an asset-sensitive institution and should benefit from a rise in interest rates in 2002, if that should occur. Securitizations and Off-Balance Sheet Financings Assets securitizations and other off-balance sheet financings can further impact liquidity and interest rate risk. Hann's automobile lease originations are financed primarily in four ways: agency arrangements with other financial institutions; securitization Table 12 - Average Deposit Balances --------------------------------------------------------------- Dollars in thousands --------------------------------------------------------------- Year ended December 31 2001 2000 1999 --------------------------------------------------------------- Demand deposits $ 468,319 $ 441,894 $ 421,055 Interest-bearing demand deposits 834,950 773,552 785,175 Savings deposits 420,818 420,512 444,938 Time deposits 1,568,646 1,552,939 1,519,267 --------------------------------------------------------------- Total $3,292,733 $3,188,897 $3,170,435 =============================================================== Table 13 - Deposit Maturity --------------------------------------------------------------- Maturity of time deposits of $100 or more at December 31, 2001 --------------------------------------------------------------- Dollars in thousands --------------------------------------------------------------- Three months or less $ 84,592 Over three months through six months 50,011 Over six months through twelve months 58,646 Over twelve months 88,387 --------------------------------------------------------------- Total $281,636 =============================================================== 26 Table 14 - Balance Sheet Gap Analysis
----------------------------------------------------------------------------------------------------------------- Dollars in thousands 1-3 3-12 1-3 Over 3 At December 31, 2001 months months years years Total ----------------------------------------------------------------------------------------------------------------- Assets Short-term investments $ 88,565 $ 0 $ 0 $ 0 $ 88,565 Investments 151,439 226,343 337,733 305,576 1,021,091 Loans and leases, net of unearned income 1,063,376 611,940 942,470 901,712 3,519,498 ----------------------------------------------------------------------------------------------------------------- Total $1,303,380 $ 838,283 $1,280,203 $1,207,288 $4,629,154 ----------------------------------------------------------------------------------------------------------------- Liabilities Interest-bearing demand $ 131,747 $ 216,516 $ 425,113 $ 141,704 $ 915,080 Savings 26,832 80,496 246,473 82,158 435,959 Time 313,317 545,543 374,956 88,678 1,322,494 Time in denominations of $100 or more 84,592 108,657 69,035 19,352 281,636 Total borrowings 176,424 44,314 568,226 227,882 1,016,846 ----------------------------------------------------------------------------------------------------------------- Total $ 732,912 $ 995,526 $1,683,803 $ 559,774 $3,972,015 ================================================================================================================= Interest Sensitivity Gap: Periodic $ 570,468 $ (157,243) $ (403,600) $ 647,514 Cumulative 413,225 9,625 657,139 Cumulative gap as a percentage of earning assets 12% 9% 0% 14%
----------------------------------------------------------------------------------------------------------------- 1-3 3-12 1-3 Over 3 At December 31, 2000 months months years years Total ----------------------------------------------------------------------------------------------------------------- Assets Short-term investments $ 59,035 $ 0 $ 0 $ 0 $ 59,035 Investments 88,763 109,253 311,141 389,447 898,604 Loans and leases, net of unearned income 1,123,486 702,439 1,010,264 597,421 3,433,610 ----------------------------------------------------------------------------------------------------------------- Total $1,271,284 $ 811,692 $1,321,405 $986,868 $4,391,249 ================================================================================================================= Liabilities Interest-bearing demand $ 105,639 $ 283,614 $ 139,208 $289,405 $ 817,866 Savings 47,068 137,135 85,505 144,170 413,878 Time 257,419 588,876 403,902 53,100 1,303,297 Time in denominations of $100 or more 80,757 107,577 50,256 13,085 251,675 Total borrowings 447,448 110,710 312,875 159,779 1,030,812 ----------------------------------------------------------------------------------------------------------------- Total $ 938,331 $1,227,912 $ 991,746 $659,539 $3,817,528 ================================================================================================================= Interest Sensitivity Gap: Periodic $ 332,953 $ (416,220) $ 329,659 $327,329 Cumulative (83,267) 246,392 573,721 Cumulative gap as a percentage of earning assets 8% -2% 6% 13% =================================================================================================================
transactions; sale-leaseback transactions; and other sources of funds, including internally generated sources. Assets financed in the first three of these manners generally are not reflected on Susquehanna's consolidated balance sheet. As of December 31, 2001, Hann's off-balance sheet, managed portfolio was funded in the following manners: agency arrangements, $555 million; asset securitization transactions, $111 million; and sale-leaseback transactions, $168 million. Agency arrangements generally occur on similar economic terms and generally result in no accounting gains or losses to Hann and no retention of credit, residual value, or interest rate risk with respect to the sold assets. Agency arrangements involve the origination and servicing by Hann of automobile leases for other financial institutions. Hann generally is entitled to receive all of the administrative fees collected from obligors, a servicing fee, and an origination fee per lease. Lease sales are generally accounted for as sales under SFAS 140. In asset securitization transactions, Hann generally sells or contributes the beneficial interest in fixed-rate automobile leases and related vehicles to a wholly-owned, special purpose entity, or SPE. The SPE finances the purchase by borrowing funds from a non-related, asset-backed commercial paper issuer. Hann continues to act as servicer for the sold portfolio and Hann is entitled to receive all of the administrative fees collected from obligors. In addition, Hann also receives a servicing fee based upon a percentage of the dollar amount of assets serviced. These transactions are generally accounted for as sales under the guidelines of SFAS 140. Neither Hann nor Susquehanna provides recourse for credit losses. The debt issued bears a floating rate of interest, and Susquehanna either obtains interest rate protec- 27 Table 15 - Balance Sheet Shock Analysis
--------------------------------------------------------------------------------------------------------------- Base Dollars in thousands Present At December 31, 2001 -2% -1% Value 1% 2% --------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 149,233 $ 149,233 $ 149,233 $ 149,233 $ 149,233 Short-term investments 88,565 88,565 88,565 88,565 88,565 Investment securities: Held-to-maturity 1,967 1,878 1,794 1,716 1,642 Available-for-sale 1,040,905 1,031,544 1,019,313 998,072 973,117 Loans and leases, net of unearned income 3,703,282 3,641,837 3,581,492 3,522,580 3,465,534 Other assets 310,403 310,403 310,403 310,403 310,403 --------------------------------------------------------------------------------------------------------------- Total assets $ 5,294,355 $ 5,223,460 $ 5,150,800 $ 5,070,569 $ 4,988,494 =============================================================================================================== Liabilities Deposits: Non-interest bearing $ 533,436 $ 518,195 $ 503,398 $ 488,601 $ 474,248 Interest-bearing 3,034,639 2,994,820 2,955,774 2,917,138 2,879,842 Total borrowings 1,062,516 1,045,342 1,028,653 1,012,494 998,316 Other liabilities 56,380 56,380 56,380 56,380 56,380 --------------------------------------------------------------------------------------------------------------- Total liabilities 4,686,971 4,614,737 4,544,205 4,474,613 4,408,786 Total economic equity 607,384 608,723 606,595 595,956 579,708 --------------------------------------------------------------------------------------------------------------- Total liabilities and equity $ 5,294,355 $ 5,223,460 $ 5,150,800 $ 5,070,569 $ 4,988,494 =============================================================================================================== Economic equity ratio 11% 12% 12% 12% 12% Value at risk 789 2,128 0 (10,639) (26,887) %Value at risk 0% 0% 0% -2% -4%
--------------------------------------------------------------------------------------------------------------- Base Dollars in thousands Present At December 31, 2000 -2% -1% Value 1% 2% --------------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 129,101 $ 129,101 $ 129,101 $ 129,101 $ 129,101 Short-term investments 59,042 59,039 59,035 59,032 59,029 Investment securities: Held-to-maturity 17,132 16,786 16,658 16,239 15,851 Available-for-sale 896,185 882,902 882,285 860,489 837,309 Loans and leases, net of unearned income 3,519,374 3,471,013 3,423,848 3,377,646 3,331,302 Other assets 309,693 309,693 309,693 309,693 309,693 --------------------------------------------------------------------------------------------------------------- Total assets 4,930,527 4,868,534 4,820,620 4,752,200 4,682,285 =============================================================================================================== Liabilities Deposits: Non-interest bearing 469,153 455,854 442,943 430,032 417,507 Interest-bearing 2,889,481 2,854,384 2,820,494 2,786,565 2,753,565 Total borrowings 1,058,580 1,040,424 1,022,746 1,005,507 988,673 Other liabilities 59,594 59,594 59,594 59,594 59,594 --------------------------------------------------------------------------------------------------------------- Total liabilities 4,476,808 4,410,256 4,345,777 4,281,698 4,219,339 Total economic equity 453,719 458,278 474,843 470,502 462,946 --------------------------------------------------------------------------------------------------------------- Total liabilities and equity $ 4,930,527 $ 4,868,534 $ 4,820,620 $ 4,752,200 $ 4,682,285 =============================================================================================================== Economic equity ratio 9% 9% 10% 10% 10% Value at risk (21,124) (16,565) 0 (4,341) (11,897) % Value at risk -4% -3% 0% -1% -3% ===============================================================================================================
28 Table 16 - Net Interest Income Shock Analysis
--------------------------------------------------------------------------------------------------------------- Base Dollars in thousands Present At December 31, 2001 -2% -1% Value 1% 2% --------------------------------------------------------------------------------------------------------------- Interest income: Short-term investments $ 1,883 $ 3,290 $ 4,790 $ 6,318 $ 7,881 Investments 52,758 55,777 58,844 60,969 62,842 Loans and leases 238,593 250,661 262,647 274,458 286,301 --------------------------------------------------------------------------------------------------------------- Total interest income 293,234 309,728 326,281 341,745 357,024 --------------------------------------------------------------------------------------------------------------- Interest expense: Interest-bearing demand and savings 15,162 15,890 17,252 20,953 24,653 Time 51,429 57,444 63,659 69,931 76,268 Total borrowings 49,017 50,406 52,449 54,562 57,269 --------------------------------------------------------------------------------------------------------------- Total interest expense 115,608 123,740 133,360 145,446 158,190 --------------------------------------------------------------------------------------------------------------- Net interest income $ 177,626 $ 185,988 $ 192,921 $ 196,299 $ 198,834 =============================================================================================================== Net interest income at risk $ (15,295) $ (6,933) 0 $ 3,378 $ 5,913 % Net interest income at risk -8% -4% 0% 2% 3% ===============================================================================================================
Base Dollars in thousands Present At December 31, 2000 -2% -1% Value 1% 2% --------------------------------------------------------------------------------------------------------------- Interest income: Short-term investments $ 3,287 $ 4,111 $ 4,934 $ 5,757 $ 6,518 Investments 44,494 47,978 55,608 56,700 57,850 Loans and leases 268,590 280,778 292,895 307,709 323,988 --------------------------------------------------------------------------------------------------------------- Total interest income 316,371 332,867 353,437 370,166 388,356 --------------------------------------------------------------------------------------------------------------- Interest expense: Interest-bearing demand and savings 27,372 29,243 33,407 36,502 39,665 Time 73,063 79,009 84,958 90,906 96,855 Total borrowings 56,901 61,423 65,945 70,467 74,989 --------------------------------------------------------------------------------------------------------------- Total interest expense $ 157,336 $ 169,675 $ 184,310 $ 197,875 $ 211,509 --------------------------------------------------------------------------------------------------------------- Net interest income $ 159,035 $ 163,192 $ 169,127 $ 172,291 $ 176,847 =============================================================================================================== Net interest income at risk $ (10,092) $ (5,935) 0 $ 3,164 $ 7,720 % Net interest income at risk -6% -4% 0% 2% 5%
Table 17 - Capital Adequacy
----------------------------------------------------------------------------------- At December 31, 2001 ----------------------------------------------------------------------------------- Tier I Capital Total Capital Leverage Ratio (A) Ratio (B) Ratio (C) ----------------------------------------------------------------------------------- Required Ratio 4.00% 8.00% 4.00% Citizens Bank of Southern Pennsylvania 10.78 11.75 6.82 Equity Bank 9.41 10.53 7.24 Farmers First Bank 10.44 11.69 8.32 Farmers & Merchants Bank and Trust 8.54 11.09 6.44 First American Bank of Pennsylvania 14.74 15.51 9.95 First Susquehanna Bank & Trust 10.65 11.90 7.38 Founders' Bank 9.17 10.41 7.50 Susquehanna Bank 8.91 11.45 7.13 WNB Bank 14.24 15.48 9.71 Total Susquehanna 10.81% 12.53% 8.68% ===================================================================================
(A) Tier I capital divided by year-end risk-adjusted assets, as defined by the risk-based capital guidelines. (B) Total capital divided by year-end risk-adjusted assets. (C) Tier I capital divided by average total assets less disallowed intangible assets. 29 tion agreements or retains the related interest rate risk. Although neither Hann nor Susquehanna has retained residual risk in the vehicle leases and related vehicles, in the event of a breach by Auto Lenders of its obligation under the Servicing Agreement, described earlier in the discussion titled "Related Party Transaction and Residual Value Risk," Susquehanna would be required to reimburse up to $20.5 million under a letter of credit facility for losses suffered by the investors to the extent of amounts not paid by Auto Lenders. As of December 31, 2001, Hann had one outstanding asset securitization transaction. The transaction documents contain several requirements, obligations, liabilities, provisions, and consequences, including events of default, which become applicable upon, among other conditions, the failure of the sold and pledged portfolios to meet certain performance tests. The SPE generally retains the right to receive excess cash flows from the sold portfolio and, under SFAS 140, Hann is required to recognize a receivable representing the present value of these excess cash flows, which is subordinate to the investors' interests. The value of this recorded interest is subject to credit, prepayment, and interest rate risks. At Decem-ber 31, 2001, this recorded interest was $4.5 million of which $1.3 million represents the remaining interest-only asset and $3.2 million is a valuation adjustment which is recognized as other comprehensive income, net of taxes. In December 2000, Hann sold and leased back the beneficial interest in $190 million of automobiles subject to operating leases under a Master Lease Agreement that has an eight-year term with an early buyout option on January 14, 2007. For accounting purposes, the transaction is treated as a sale and an operating lease. To support its obligations under the Master Lease Agreement, Hann pledges the beneficial interest in an additional $31.6 million of automobile leases and related vehicles. Hann is expected to earn approximately $11.7 million in other income over the term of the Master Lease Agreement, which includes $27.1 million of estimated net rental income, or the difference between the operating lease payments received by Hann and the payments made by Hann under the Master Lease Agreement. The estimated net rental income will be partially offset by the amortization of transaction costs of approximately $15.4 million, which includes a $14.0 million deferred loss on an interest rate swap. Susquehanna entered into an interest rate swap in order to fix the return on the transaction, while leases originated for the sale-leaseback were being held in a warehouse facility during the ten-month production period. The transaction documents contain several requirements, obligations, liabilities, provisions, and consequences which become applicable upon the occurrence of an "Early Amortization Event." An Early Amortization Event includes the failure of the sold and pledged portfolios to meet certain performance tests or the failure of Susquehanna to continue to maintain its investment-grade senior unsecured long-term debt ratings. This rating provision can be cured by Susque-hanna by obtaining a $32.7 million letter of credit from an eligible financial institution for the benefit of the equity participants in the transaction. This is referred to in Table 18 as Contingent Cash Collateral. For example, after an Early Amortization Event, substitutions are no longer permitted, which means that the sales proceeds from the sold vehicles following termination of the related auto leases may not be used to purchase replacement vehicles and leases. Instead, these proceeds are required to make termination and other payments under the Master Lease Agreement. As of December 31, 2001, the obligation to make these termination and other payments is collateralized by a cash deposit of $6.4 million. Table 18 presents certain contractual obligations and commercial commitments, including the guarantees of Susquehanna on behalf of its subsidiaries, and their expected year of payment or expiration. Capital Adequacy Risk-based capital ratios, based upon guidelines adopted by bank regulators in 1989, focus upon credit risk. Assets and certain off-balance sheet items are segmented into one of four broad-risk categories and weighted according to the relative percentage of credit risk assigned by the regulatory authorities. Off-balance sheet instruments are converted into a balance sheet credit equivalent before being assigned to one of the four risk-weighted categories. To supplement the risk-based capital ratios, the regulators issued a minimum leverage ratio guideline (Tier 1 capital as a percentage of average assets less excludable intangibles). Capital elements are segmented into two tiers. Tier 1 capital represents stockholders' equity reduced by excludable intangibles, while Tier 2 capital represents certain allowable long-term debt, the portion of the allowance for loan and lease losses equal to 1.25% of risk-adjusted assets, and 45% of the unrealized gain on equity securities. The sum of Tier 1 capital and Tier 2 capital is "total risk-based capital." The maintenance of a strong capital base at both the parent company level as well as at each bank affiliate is an important aspect of Susquehanna's philosophy. Table 17 illustrates these capital ratios for each bank and savings bank subsidiary and Susquehanna on a consolidated basis. Susquehanna and each of its banking and savings bank subsidiaries have leverage and risk-weighted ratios well in excess of regulatory minimums, and each entity is considered "well capitalized" under regulatory guidelines. Recent Accounting Pronouncements On July 20, 2001, the FASB issued SFAS No. 141, ("SFAS 141") "Business Combinations," and SFAS No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets." SFAS 141 supercedes Accounting Principles Board Opinion ("APB") No. 16, "Business Combinations." The most significant changes made by SFAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001; (2) establishing specific criteria for the recognition of intangible assets separately from goodwill; and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain. Management has reviewed SFAS 141 and has determined that the statement has no effect on its current financial position or results of operations. SFAS 142 supercedes APB 17, "Intangible Assets." SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. The most significant changes made by SFAS 142 are: (1) goodwill and indefinite-lived intangible assets will no longer be amortized; (2) goodwill will be tested for impairment at least annually at the reporting unit level; (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually; and (4) the amortization period of intangible assets with finite 30 TABLE 18--Contractual Obligations and Commercial Commitments
-------------------------------------------------------------------------------------- Payments Due by Period -------------------------------------------------------------------------------------- Less than 1-3 4-5 Over 5 Contractual Obligations Total 1 Year Years Years Years -------------------------------------------------------------------------------------- Long-term debt $ 105,000 $ 0 $ 55,000 $ 50,000 $ 0 Operating leases 211,544 27,147 53,425 61,567 69,405 Contingent cash collateral 32,739 0 0 0 32,739 --------------------------------------------------------------------------------------
Commitment Expiration -------------------------------------------------------------------------------------- Less than 1-3 4-5 Over 5 Other Commercial Commitments Total 1 Year Years Years Years -------------------------------------------------------------------------------------- Stand-by letters of credit $ 86,161 $ 54,180 $ 31,981 $ 0 $ 0 Guarantees 20,000 0 20,000 0 0 Other commercial commitments, principally lines of credit 424,945 328,588 96,357 0 0 ======================================================================================
lives will no longer be limited to forty years. The provision of SFAS 142 will be effective for fiscal years beginning after De-cember 15, 2001. Management estimates that amortization expense for 2002 will be reduced by approximately $3.3 million. Management has not yet performed an impairment test of goodwill. Critical Accounting Policies Susquehanna has established various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. The significant accounting policies of Susquehanna are described in the footnotes to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experiences and other factors which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, 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 operations of Susquehanna. Susquehanna believes that the allowance for loan and lease losses, which is discussed in the section titled "Provision and Allowance for Loan and Lease Losses," and the treatment of securitizations and off-balance sheet financing, which is discussed in the section titled "Securitizations and Off-Balance Sheet Financing," both require the most significant judgments and estimates used in the preparation of its consolidated financial statements. See "Footnote 1. Summary of Significant Accounting Policies" for a detailed description of Suquehanna's estimation process and methodology related to the allowance for loan and lease losses and treatment of recorded interests in securitized assets, and "Footnote 10. Financial Instruments with Off-Balance Sheet Risk." Summary of 2000 Compared to 1999 Several significant transactions occurred which affected the comparability of Susquehanna's financial performance for theyears ended December 31, 2001 and 2000. These transactions are described in the following paragraphs. On March 3, 2000, Susquehanna completed the acquisition of Valley Forge Asset Management Corp., a Pennsylvania asset management corporation registered both as a broker/dealer and as an investment advisor, and Valley Forge Investment Company, Inc., its parent corporation, in cash transactions. The acquisition was accounted for under the purchase method of accounting for business combinations. Goodwill of $9.4 million was recognized in the acquisition and was being amortized to other operating expense on a straight-line basis over 25 years. In this transaction, there was a contingent earn-out paid, totaling $6.0 million in 2001. On February 1, 2000, Susquehanna completed the acquisition of Hann, a closely held consumer automobile financing company that services more than $1.0 billion in lease receivables. Susquehanna issued 2,360,000 shares of common stock to the stockholders of Hann for the outstanding common shares of Hann. The acquisition was accounted for under the pooling-of-interest method of accounting for business combinations; accordingly, the consolidated financial statements have been restated to include the consolidated accounts of Hann for all periods presented. Susquehanna's net income for the year ended December 31, 2000, increased $11.5 million, or 26%, from the 1999 net income of $43.5 million. Net income for 1999 included $10.8 million of special charges relating to the consolidation of Susquehanna's back office operations and a special bonus. The restructuring charge of $7.4 million represents severance, employee and employment assistance services, consulting, and asset write-offs related to a reduction in the work force. This work force reduction should result in an estimated net annual savings of approximately $6.0 million, of which $1.0 million was realized in the year 2000, with an anticipated 100% realization in 2001 and each succeeding year. A special bonus of $3.4 million was awarded to Susquehanna employees (excluding executive and senior management) for extraordinary efforts in 1999. Susquehanna's earnings performance in 2000 was also affected by significant growth in non-interest income resulting primarily from increases in vehicle origination and servicing fees and merchant credit card fees. Non-interest income increased 31 $20.6 million, or 38%, in 2000 over 1999. Diluted EPS increased 27% from $1.10 per share for the year ended 1999 to $1.40 per share for the year ended 2000. Excluding the special charges noted above, annual 2000 diluted EPS increased 9% over 1999. ROA and ROE finished at 1.15% and 13.01% for the year 2000, compared with 0.94% and 10.45% for 1999. Excluding the special charges noted above, Susque-hanna's ROA and ROE for 1999 would have been 1.09% and 12.13%, respectively. For 2000, tangible net income, earnings per share, ROA, and ROE were $58.1 million, $1.48, 1.23%, and 15.08%, respectively, compared to actual net income, basic earnings per share, ROA, and ROE of $55.0 million, $1.40, 1.15%, and 13.01%, respectively. Tangible net income, earnings per share, ROA, and ROE for 1999 were $46.5 million, $1.18, 1.01%, and 12.13%, respectively. Excluding special charges, tangible net income, EPS, ROA, and ROE were $53.5 million, $1.36, 1.16%, and 13.96%, respectively. 32 Item 8. Financial Statements and Supplementary Data ------ ------------------------------------------- The following consolidated financial statements of Susquehanna are submitted herewith:
Page Reference -------------- Consolidated Balance Sheets at December 31, 2001 and 2000.................... 34 Consolidated Statements of Income for the years ended December 31, 2001, 2000, and 1999................................... 35 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999................................... 36 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2001, 2000, and 1999............... 37 Notes to Consolidated Financial Statements................................... 38 Report of Independent Accountants............................................ 52 Summary of Quarterly Financial Data.......................................... 53
33 Consolidated Balance Sheets SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------------------------------- Dollars in thousands --------------------------------------------------------------------------------------------------------- Year ended December 31 2001 2000 --------------------------------------------------------------------------------------------------------- Assets Cash and due from banks $ 149,233 $ 129,101 Short-term investments: Restricted 41,584 32,731 Unrestricted 46,981 26,304 --------------------------------------------------------------------------------------------------------- Total short-term investments 88,565 59,035 --------------------------------------------------------------------------------------------------------- Investment securities available for sale, at fair value 1,019,313 882,285 Investment securities held to maturity, at amortized cost (Fair values of $1,778 and $16,658) 1,778 16,319 Loans and leases, net of unearned income 3,519,498 3,433,610 Less: Allowance for loan and lease losses 37,698 37,187 --------------------------------------------------------------------------------------------------------- Net loans and leases 3,481,800 3,396,423 --------------------------------------------------------------------------------------------------------- Premises and equipment (net) 60,063 58,303 Accrued income receivable 21,268 26,775 Bank-owned life insurance 120,174 113,865 Other assets 108,898 110,750 --------------------------------------------------------------------------------------------------------- Total assets $ 5,051,092 $ 4,792,856 ========================================================================================================= Liabilities Deposits: Noninterest-bearing $ 529,162 $ 462,297 Interest-bearing 2,955,169 2,786,716 --------------------------------------------------------------------------------------------------------- Total deposits 3,484,331 3,249,013 --------------------------------------------------------------------------------------------------------- Short-term borrowings 169,803 205,336 FHLB borrowings 570,580 367,954 Vehicle financing 171,462 357,522 Long-term debt 105,000 100,000 Accrued interest, taxes, and expenses payable 36,652 42,382 Other liabilities 19,728 17,212 --------------------------------------------------------------------------------------------------------- Total liabilities 4,557,556 4,339,419 --------------------------------------------------------------------------------------------------------- Commitments and contingencies (Note 16) Stockholders' Equity Common stock Authorized: 100,000,000 ($2.00 par value) Issued: 39,398,190 78,796 78,796 Surplus 57,986 57,872 Retained earnings 345,508 320,020 Accumulated other comprehensive income, net of taxes of $6,928 and 12,009 (757) ($408), respectively Less: Treasury stock (54,115 and 176,798 common shares at cost,respectively) 763 2,494 --------------------------------------------------------------------------------------------------------- Total stockholders' equity 493,536 453,437 --------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 5,051,092 $ 4,792,856 =========================================================================================================
The accompanying notes are an integral part of these financial statements. 34 Consolidated Statements of Income SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
----------------------------------------------------------------------------------------------- Dollars in thousands, except per share ----------------------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 ----------------------------------------------------------------------------------------------- Interest Income Interest and fees on loans and leases $283,212 $293,046 $276,280 Interest on investment securities: Taxable 51,247 53,238 50,485 Tax-exempt 3,297 4,195 5,232 Interest on short-term investments 3,539 2,937 3,089 ----------------------------------------------------------------------------------------------- Total interest income 341,295 353,416 335,086 ----------------------------------------------------------------------------------------------- Interest Expense Interest on deposits: Interest-bearing demand 18,144 22,080 20,359 Savings 6,324 7,709 8,166 Time 84,222 85,216 77,487 Interest on short-term borrowings 7,976 11,597 4,336 Interest on FHLB borrowings 23,656 23,139 19,600 Interest on vehicle financing 20,886 30,961 34,679 Interest on long-term debt 7,843 7,762 8,899 ----------------------------------------------------------------------------------------------- Total interest expense 169,051 188,464 173,526 ----------------------------------------------------------------------------------------------- Net interest income 172,244 164,952 161,560 Provision for loan and lease losses 7,310 3,726 11,203 ----------------------------------------------------------------------------------------------- Net interest income after provision for loan and lease losses 164,934 161,226 150,357 ----------------------------------------------------------------------------------------------- Other Income Service charges on deposit accounts 13,735 10,867 10,054 Vehicle origination and servicing fees 22,435 22,053 13,480 Merchant credit card fees 10,489 10,130 3,086 Asset management fees 9,072 6,610 0 Income from fiduciary-related activities 5,084 4,734 4,028 Gain on sale of loans and leases 4,198 3,936 3,427 Income from bank-owned life insurance 6,509 5,909 4,528 Other operating income 11,995 9,784 13,878 Investment security gains/(losses) 649 (13) 978 ----------------------------------------------------------------------------------------------- Total other income 84,166 74,010 53,459 ----------------------------------------------------------------------------------------------- Other Expenses Salaries and employee benefits 73,850 68,110 64,218 Net occupancy expense 11,498 9,933 9,349 Furniture and equipment expense 8,185 8,308 8,088 Amortization of intangible assets 3,645 3,294 3,476 Vehicle residual value expense 4,850 8,068 2,102 Vehicle delivery and preparation expense 6,168 2,166 1,181 Merchant credit card servicing expense 9,820 9,514 3,122 Restructuring charge 0 (900) 7,412 Other operating expenses 49,747 47,088 42,840 ----------------------------------------------------------------------------------------------- Total other expenses 167,763 155,581 141,788 ----------------------------------------------------------------------------------------------- Income before income taxes 81,337 79,655 62,028 Provision for income taxes 25,621 24,693 18,505 ----------------------------------------------------------------------------------------------- Net Income $ 55,716 $ 54,962 $ 43,523 =============================================================================================== Per share information: Basic earnings $ 1.42 $ 1.40 $ 1.11 Diluted earnings 1.41 1.40 1.10 Cash dividends 0.77 0.70 0.62 Average shares outstanding: Basic 39,263 39,262 39,320 Diluted 39,593 39,365 39,497 ===============================================================================================
The accompanying notes are an integral part of these financial statements. 35 Consolidated Statements of Cash Flows SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------- Dollars in thousands ------------------------------------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 ------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 55,716 $ 54,962 $ 43,523 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization, and accretion 12,814 14,248 11,857 Provision for loan and lease losses 7,310 3,726 11,203 Gain on sale of branch offices 0 0 (3,352) (Gain)/loss on securities transactions (649) 13 (978) Gain on sale of loans (4,198) (3,936) (3,427) Loss on sale of other real estate owned 16 15 6 Mortgage loans originated for resale (118,652) (117,328) (187,017) Sale of mortgage loans originated for resale 118,177 114,530 203,158 Leases acquired/originated for resale (116,643) (222,376) 0 Sale of leases acquired/originated for resale 118,392 200,709 0 (Increase)/decrease in accrued interest receivable 5,757 (3,012) (989) (Decrease)/increase in accrued interest payable (5,782) 3,471 734 (Decrease)/increase in accrued expenses and taxes payable (146) 4,165 2,635 Other, net (3,718) 3,900 1,832 ------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 68,394 53,087 79,185 ------------------------------------------------------------------------------------------------------------- Investing Activities Net increase in restricted short-term investments (8,853) (25,427) (3,713) Proceeds from the sale of available-for-sale securities 21,889 4,482 47,719 Proceeds from the maturity of investment securities 457,528 120,204 264,783 Purchase of available-for-sale securities (584,286) (84,412) (302,763) Purchase of held-to-maturity securities 0 (7,887) 0 Proceeds from sale of credit card portfolio 0 12,373 0 Net (increase)/decrease in loans and leases (39,730) 19,670 (192,610) Transfer of allowance for loan and lease losses to third-party guarantor 0 (3,057) 0 Capital expenditures (4,207) (9,709) (5,400) Net cash and cash equivalents received/(paid) in acquisitions 6,224 (12,707) (22,381) Purchase of insurance products 0 0 (50,000) ------------------------------------------------------------------------------------------------------------- Net cash provided by/(used for) investing activities (151,435) 13,530 (264,365) ------------------------------------------------------------------------------------------------------------- Financing Activities Net increase/(decrease) in deposits 166,200 68,493 (13,978) Net increase/(decrease) in short-term borrowings (35,533) (2,171) 102,976 Net increase/(decrease) in FHLB borrowings 202,626 (4,460) 58,778 Net increase/(decrease) in vehicle financing (186,060) (124,582) 25,191 Proceeds from issuance of long-term debt 5,000 5,000 0 Repayment of long-term debt 0 0 (10) Proceeds from issuance of common stock 1,845 772 1,372 Cash paid for treasury stock 0 (3,097) (287) Dividends paid (30,228) (27,092) (22,918) ------------------------------------------------------------------------------------------------------------- Net cash provided by/(used for) financing activities 123,850 (87,137) 151,124 ------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents 40,809 (20,520) (34,056) Cash and cash equivalents at January 1 155,405 175,925 209,981 ------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at December 31 $ 196,214 $ 155,405 $ 175,925 ============================================================================================================= Cash and cash equivalents: Cash and due from banks $ 149,233 $ 129,101 $ 146,576 Unrestricted short-term investments 46,981 26,304 29,349 ------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at December 31 $ 196,214 $ 155,405 $ 175,925 =============================================================================================================
The accompanying notes are an integral part of these financial statements. 36 Consolidated Statements of Changes in Stockholders' Equity SUSQUEHANNA BANCSHARES, INC. AND SUBSIDIARIES
----------------------------------------------------------------------------------------------------------------------------- Years ended December 31, 2001, 2000, and 1999 ----------------------------------------------------------------------------------------------------------------------------- Accumulated Other Dollars in thousands, Common Retained Comprehensive Treasury Total except per share data Stock Surplus Earnings Income Stock Equity ----------------------------------------------------------------------------------------------------------------------------- Balance, January 1, 1999 $ 78,655 $ 57,166 $271,545 $ 6,004 $ (783) $412,587 Comprehensive income: Net income 43,523 43,523 Change in unrealized gain/(loss) on securities, net of taxes of ($10,186) and reclassification adjustment of $978 (19,620) (19,620) ----------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 43,523 (19,620) 23,903 Common stock issued under employee benefit plans (including related tax benefits of $365) 133 707 897 1,737 Purchase/conversion of treasury stock (287) (287) Cash dividends paid: Per common share of $0.62 (22,918) (22,918) ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1999 78,788 57,873 292,150 (13,616) (173) 415,022 Comprehensive income: Net income 54,962 54,962 Change in unrealized gain/(loss) on securities, net of taxes of ($6,553) and reclassification adjustment of ($13) 12,859 12,859 ----------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 54,962 12,859 67,821 Common stock issued under employee benefit plans (including related tax benefit of $11) 8 (1) 776 783 Purchase/conversion of treasury stock (3,097) (3,097) Cash dividends paid: Per common share of $0.70 (27,092) (27,092) ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2000 78,796 57,872 320,020 (757) (2,494) 453,437 Comprehensive income: Net income 55,716 55,716 Change in unrealized gain/(loss) on securities, net of taxes of $5,578 and reclassification adjustment of $649 10,862 10,862 Unrealized gain on recorded interest in securitized assets, net of taxes of $1,296 1,904 1,904 ----------------------------------------------------------------------------------------------------------------------------- Total comprehensive income 55,716 12,766 68,482 Common stock issued under employee benefit plans (includes related tax benefit of $278) 114 1,731 1,845 Cash dividends paid: Per common share of $0.77 (30,228) (30,228) ----------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001 $ 78,796 $ 57,986 $345,508 $ 12,009 $ (763) $493,536 =============================================================================================================================
The accompanying notes are an integral part of these financial statements. 37 Notes to Consolidated Financial Statements YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999 (Dollars in thousands, except as noted and per share data) -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Susquehanna Banc-shares, Inc. and subsidiaries ("Susquehanna") conform to accounting principles generally accepted in the United States of America and to general practices in the banking industry. The more significant policies follow: Principles of Consolidation. The accompanying consolidated financial statements include the accounts of Susquehanna and its wholly-owned subsidiaries: Boston Service Company, Inc. (t/a Hann Financial Service Corporation) ("Hann"), Conestoga Management Company, Farmers First Bank and subsidiaries ("Farmers"), Farmers & Merchants Bank and Trust and subsidiaries ("F&M"), First American Bank of Pennsylvania ("FAB"), First Susquehanna Bank & Trust ("First Susquehanna"), WNB Bank ("WNB"), Citizens Bank of Southern Pennsylvania ("Citizens"), Susquehanna Bancshares East, Inc. and subsidiaries ("East"), Susquehanna Bancshares South, Inc. and subsidiaries ("South"), Susque-Bancshares Life Insurance Co. ("SBLIC"), Susque-Bancshares Leasing Company, Inc. and subsidiary ("SBLC"), and Valley Forge Asset Management Corporation ("VFAM"), as of and for the years ended December 31, 2001, 2000, and 1999. All significant inter-company transactions have been eliminated. Income and expenses are recorded on the accrual basis of accounting except for trust and certain other fees, which are recorded principally on the cash basis. This does not materially affect the results of operations or financial position of Susque-hanna. Nature of Operations. Susquehanna is a financial holding company which operates nine commercial banks based upon the sound principles of super-community banking. These subsidiaries provide financial services from 146 branches located in central and southeastern Pennsylvania, Maryland, northeastern West Virginia, and southern New Jersey. In addition, Susque-hanna operates four non-bank subsidiaries that provide leasing, credit insurance, and asset management services. Susquehanna's primary source of revenue is derived from loans to customers, who are predominately small- and middle-market businesses and middle-income individuals. Use of Estimates in the Preparation of Financial Statements.The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Purchase Method of Accounting. Net assets of companies acquired in purchase transactions are recorded at the fair value at the date of acquisition. Core deposit and other intangible assets are amortized on a straight-line basis generally over 10 years. The excess of purchase price over the fair value of net assets acquired, or goodwill, is amortized on a straight-line basis generally over 15 to 40 years. The unamortized amount of goodwill was $43,496 and $38,934 at December 31, 2001 and 2000, respectively. Periodically, management reevaluates goodwill and other intangibles based on undiscounted operating cash flows whenever significant events or changes occur which might impair recovery of recorded asset costs. Consolidated Statement of Cash Flows. Interest paid on deposits, short-term borrowings, and long-term debt was $174,635 in 2001, $184,993 in 2000, and $178,734 in 1999. Income taxes paid were $8,784 in 2001, $422 in 2000, and $16,409 in 1999. Amounts transferred to other real estate owned were $3,836 in 2001, $2,795 in 2000, and $7,342 in 1999. On February 1, 2000, Susquehanna acquired Hann, using the pooling-of-interests method of accounting for business combinations; accordingly, consolidated results for all periods have been restated. On March 3, 2000, Susquehanna completed its acquisition of VFAM, using the purchase method of accounting for business combinations. Cash and Cash Equivalents. For purposes of reporting cash flows, cash and cash equivalents includes cash, due from banks, and unrestricted short-term investments. Unrestricted short-term investments consist of interest-bearing deposits in other banks, federal funds sold, and money market funds with an original maturity of three months or less. Investment Securities. Susquehanna classifies debt and equity securities as either "held-to-maturity" or "available-for-sale." Susquehanna does not have any securities classified as "trading" at December 31, 2001, or 2000. Investments for which management has the intent and Susquehanna has the ability to hold to maturity are carried at the lower of cost or market adjusted for amortization of premium and accretion of discount. Amortization and accretion are calculated principally on the interest method. All other securities are classified as "available-for-sale" and reported at fair value. Changes in unrealized gains and losses for "available-for-sale" securities are recorded as a component of stockholders' equity. Securities classified as "available-for-sale" include investments management intends to use as part of its asset/liability management strategy, and that may be sold in response to changes in interest rates, resultant prepayment risk, and other factors. Realized gains and losses on the sale of securities are recognized using the specific identification method and are included in Other Income in the Consolidated Statements of Income. Allowance for Loan and Lease Losses. The allowance for loan and lease losses is established, as losses are estimated to have occurred, through a provision for loan and lease losses charged to earnings. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed, and recoveries on previously charged-off loans and leases are credited to the allowance. The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management's 38 periodic review of the collectibility of the loans and leases in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Susquehanna considers a loan to be impaired, based upon current information and events, if it is probable that Susque-hanna will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. Larger groups of small-balance loans, such as residential mortgage and installment loans, are collectively evaluated for impairment. Only commercial loans exceeding $100 are individually evaluated for impairment. An insignificant delay or shortfall in the amounts of payments, when considered independent of other factors, would not cause a loan to be rendered impaired. Insignificant delays or shortfalls may include, depending on specific facts and circumstances, those that are associated with temporary operational downturns or seasonal delays. Management performs periodic reviews of Susquehanna's loan portfolio to identify impaired loans. Measurement of impaired loans is based on present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on fair value of the collateral. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When an impaired loan or portion of an impaired loan is determined to be uncollectible, the portion deemed uncollectible is charged against the related valuation allowance and subsequent recoveries, if any, are credited to the valuation allowance. Depreciable Assets. Buildings, leasehold improvements, and furniture and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily by the straight-line method over the estimated useful lives of the related property as follows: Buildings, 40 years, and furniture and equipment, 3 to 20 years. Leasehold improvements are amortized over the shorter of the lease term, or 10 to 20 years. Maintenance and normal repairs are charged to operations as incurred, while additions and improvements to buildings and furniture and equipment are capitalized. Gain or loss on disposition is reflected in operations. Long-lived assets are evaluated for impairment by management on an ongoing basis. An impairment may occur whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Other Real Estate. Other real estate property acquired through foreclosure or other means is recorded at the lower of its carrying value or fair value of the property at the transfer date less estimated selling costs. Costs to maintain other real estate are expensed as incurred. Interest Income on Loans and Leases. Interest income on commercial, consumer, and mortgage loans is recorded on the interest method. Interest income on installment loans and leases is recorded on the interest method and the actuarial method. Loan fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment to the related loan yield on the interest method, generally over the contractual life of the related loans. Nonaccrual loans are those on which the accrual of interest has ceased and where all previously accrued but not collected interest is reversed. Loans, other than consumer loans, are placed on nonaccrual status when principal or interest is past due 90 days or more and the loan is not well collateralized and in the process of collection or immediately, if, in the opinion of management, full collection is doubtful. Interest accrued but not collected as of the date of placement on nonaccrual status is reversed and charged against current income. Susquehanna does not accrue interest on impaired loans. While a loan is considered impaired or on nonaccrual status, subsequent cash interest payments received either are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of the ultimate collectibility of principal and interest. In any case, the deferral or non-recognition of interest does not constitute forgiveness of the borrower's obligation. Consumer loans are recorded in accordance with the Uniform Retail Classification regulation. Generally, the regulation requires that consumer loans are charged off to the allowance for loan losses when they become 120 days or more past due. Segment Reporting. Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), requires that public business enterprises report financial and descriptive information about its reportable operating segments. Based on the guidance provided by the statement, Susquehanna has determined its only reportable segment is Community Banking. Comprehensive Income. Susquehanna reports comprehensive income in accordance with Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." Components of comprehensive income, as detailed in the Consolidated Statements of Changes in Stockholders' Equity, are net of tax. Comprehensive income includes a reclassification adjustment for net realized gains/(losses) included in net income of $649, $(13), and $978 for the years ended December 31, 2001, 2000, and 1999, respectively. Recorded Interests in Securitized Assets. In accordance with Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125)," recorded interests in securitized assets, including debt securities and interest-only strips, are initially recorded at their allocated carrying amounts based on the relative fair value of assets sold and retained. Recorded interests are subsequently carried at fair value, which is generally estimated based on the present value of expected cash flows, calculated using management's best estimates of key assumptions, including credit losses, loan repayment speeds, and discount rates commensurate with the risks involved. Gains on sale and servicing fees are recorded in non-interest income. During 2001, Susquehanna repurchased and sold approximately $117 million of auto leases, and realized $1.7 million of pre-tax gain on the sale. Susquehanna receives annual servicing fees as compensation for servicing the outstanding balances on the auto leases. Susquehanna's recorded interests are subordinate to purchasers' interests. The value of these recorded interests is subject to credit, prepayment, and interest rate risks re- 39 lated to the transferred assets. At December 31, 2001, Susque-hanna's recorded interests were $4.5 million. Key economic assumptions used in measuring the initial recorded interests resulting from the securitization completed in 2001 were weighted average life of 30 months, expected credit losses of 1.72%, and discount rate of 4%. Federal Income Taxes. Deferred income taxes reflect the temporary tax consequences on future years of differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse. Earnings Per Share. Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by Susquehanna relate solely to outstanding stock options, and are determined using the treasury stock method. Consolidated Statements of Changes in Stockholders' Equity ----------------------------------------------------------------------- Common Shares Outstanding ----------------------------------------------------------------------- Balance, January 1, 1999 29,262,522 Stock issued under employee benefit plans 134,931 Purchase of treasury stock (15,000) ----------------------------------------------------------------------- Balance, December 31, 1999 39,262,522 Stock issued under employee benefit plans 59,156 Purchase of treasury stock (220,217) ----------------------------------------------------------------------- Balance, December 31, 2000 39,221,392 Stock issued under employee benefit plans 122,683 ----------------------------------------------------------------------- Balance, December 31, 2001 39,344,075 ======================================================================= Recent Accounting Pronouncements. On July 20, 2001, the FASB issued Statements of Accounting Standards No. 141 ("SFAS 141"), Business Combinations, and No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets. SFAS 141 supercedes Accounting Principles Board Opinion No. 16, Business Combinations. The most significant changes made by SFAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001; (2) establishing specific criteria for the recognition of intangible assets separately from goodwill; and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain. Management has reviewed SFAS 141 and has determined that the statement has no effect on its current financial position or results of operations. SFAS 142 supercedes Accounting Principles Board Opinion No. 17, Intangible Assets. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. The most significant changes made by SFAS 142 are: (1) goodwill and indefinite-lived intangible assets will no longer be amortized; (2) goodwill will be tested for impairment at least annually at the reporting unit level; (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually; and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. As required, Susquehanna adopted this new standard on Janu-ary 1, 2002. The $43 million in goodwill outstanding at Decem-ber 31, 2001, will no longer be amortized going forward pursuant to the new pronouncement. Management estimates that amortization expense for 2002 will be reduced by approximately $3.3 million. Management has not yet performed an impairment test of goodwill. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), Accounting for Asset Retirement Obligations. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible, long-lived assets and the associated asset retirement costs. This Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred by capitalizing it as part of the carrying amount of the long-lived assets. As required by SFAS 143, Susquehanna will adopt this new accounting standard on January 1, 2003. Management believes the adoption of SFAS 143 will not have a material impact on our financial statements. SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, was issued by FASB on October 3, 2001, and is effective for fiscal years beginning after December 15, 2001. This statement establishes a single accounting model for impairment related to disposal of long-lived assets, including discontinued operations. SFAS 144 superseded Statement of Financial Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS 121), and APB Opinion No. 30, Reporting the results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. The provisions of SFAS 144 are effective in fiscal years beginning after December 15, 2001, with early adoption permitted, and in general are to be applied prospectively. This statement is not expected to have a material impact on Susque-hanna's financial position or results of operations. -------------------------------------------------------------------------------- 2. SHORT-TERM INVESTMENTS The book value of short-term investments and weighted average interest rates on December 31, 2001 and 2000, were as follows: --------------------------------------------------------------------------- 2001 2000 --------------------------------------------------------------------------- Book Book Value Rates Value Rates --------------------------------------------------------------------------- Interest-bearingdeposits in other banks $ 45,455 1.22% $40,463 5.42% Federal funds sold 8,500 1.63 291 6.50 Money market funds 34,610 1.79 18,281 5.84 --------------------------------------------------------------------------- Total $ 88,565 $59,035 =========================================================================== 40 -------------------------------------------------------------------------------- 3. INVESTMENT SECURITIES The amortized cost and fair values of investment securities at December 31, 2001 and 2000, are as follows:
------------------------------------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Fair At December 31, 2001 Cost Gains Losses Value ------------------------------------------------------------------------------------------------------------ Available-for-Sale: U.S. Treasury $ 1,201 $ 101 $ 0 $ 1,302 U.S. Government agencies 86,329 1,960 0 88,289 Obligations of states and political subdivisions 63,334 1,400 22 64,712 Corporate debt securities 20,073 772 1 20,844 Mortgage-backed securities 799,266 10,718 1,003 808,981 Equity securities 33,373 1,812 0 35,185 ------------------------------------------------------------------------------------------------------------ $ 1,003,576 $ 16,763 $ 1,026 $1,019,313 ------------------------------------------------------------------------------------------------------------ Held-to-Maturity: State and municipal $ 1,778 $ 0 $ 0 $ 1,778 ------------------------------------------------------------------------------------------------------------ $ 1,778 $ 0 $ 0 $ 1,778 ------------------------------------------------------------------------------------------------------------ Total investment securities $ 1,005,354 $ 16,763 $ 1,026 $1,021,091 ============================================================================================================ At December 31, 2000 ------------------------------------------------------------------------------------------------------------ Available-for-Sale: U.S. Treasury $ 3,249 $ 68 $ 10 $ 3,307 U.S. Government agencies 360,276 870 1,373 359,773 Obligations of states and political subdivisions 63,674 381 133 63,922 Corporate debt securities 16,499 169 27 16,641 Mortgage-backed securities 405,678 884 3,468 403,094 Equity securities 34,074 1,474 0 35,548 ------------------------------------------------------------------------------------------------------------ $ 883,450 $ 3,846 $ 5,011 $ 882,285 ------------------------------------------------------------------------------------------------------------ Held-to-Maturity: State and municipal $ 15,833 $ 343 $ 0 $ 16,176 Mortgage-backed securities 486 0 4 482 ------------------------------------------------------------------------------------------------------------ $ 16,319 $ 343 $ 4 $ 16,658 ------------------------------------------------------------------------------------------------------------ Total investment securities $ 899,769 $ 4,189 $ 5,015 $ 898,943 ============================================================================================================
At December 31, 2001 and 2000, investment securities with a carrying value of $611,065 and $475,725, respectively, were pledged to secure public funds and for other purposes as required by law. There were no invesment securities whose ratings were less than investment grade at December 31, 2001 and 2000. The amortized cost and fair value of U.S. Treasury, U.S. Gov- ernment agencies, obligations of states and political subdivisions, corporate debt securities, and mortgage-backed securities, at December 31, 2001, by contractual maturity, are shown following. 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. 41 ---------------------------------------------------------------------- Amortized Fair Cost Value ---------------------------------------------------------------------- Securities Available-for-Sale: Within one year $ 34,041 $ 33,865 After one year but within five years 125,358 128,825 After five years but within ten years 97,256 98,529 After ten years 713,548 722,909 ---------------------------------------------------------------------- $ 970,203 $ 984,128 ---------------------------------------------------------------------- Securities Held-to-Maturity: Within one year $ 0 $ 0 After one year but within five years 310 310 After five years but within ten years 0 0 After ten years 1,468 1,468 ---------------------------------------------------------------------- $ 1,778 $ 1,778 ---------------------------------------------------------------------- Total debt securities $ 971,981 $ 985,906 ====================================================================== The gross realized gains and gross realized losses on investment securities transactions are summarized following. During 2001, 2000, and 1999, certain securities classified as held-to-maturity were called for early redemption by the issuer. The results of those transactions are recorded in the corresponding category. ----------------------------------------------------------------------------- Available-for-Sale Held-to-Maturity ----------------------------------------------------------------------------- For the year ended December 31, 2001 ----------------------------------------------------------------------------- Gross gains $ 652 $ 0 Gross losses 3 0 ----------------------------------------------------------------------------- Net gains/(losses) $ 649 $ 0 ============================================================================= ----------------------------------------------------------------------------- For the year ended December 31, 2000 ----------------------------------------------------------------------------- Gross gains $ 4 $ 0 Gross losses 17 0 ----------------------------------------------------------------------------- Net gains/(losses) $ (13) $ 0 ============================================================================= ----------------------------------------------------------------------------- For the year ended December 31, 1999 ----------------------------------------------------------------------------- Gross gains $ 998 $ 1 Gross losses 18 3 ----------------------------------------------------------------------------- Net gains/(losses) $ 980 $(2) ============================================================================= Interest earned on investment securities for the years ended December 31 was as follows: -------------------------------------------------------------------- 2001 2000 1999 -------------------------------------------------------------------- Taxable $ 51,247 $ 53,238 $ 50,485 Tax-advantaged 3,297 4,195 5,232 -------------------------------------------------------------------- Total $ 54,544 $ 57,433 $ 55,717 ==================================================================== 42 -------------------------------------------------------------------------------- 4. LOANS AND LEASES At December 31, loans and leases, net of unearned income ($20,381 at December 31, 2001, and $53,239 at December 31, 2000), were as follows: ------------------------------------------------------------------ 2001 2000 ------------------------------------------------------------------ Commercial, financial, and agricultural $ 434,780 $ 371,320 Real estate--construction 359,445 264,182 Real estate--mortgage 1,963,094 1,933,772 Consumer 325,170 350,707 Leases 437,009 513,629 ------------------------------------------------------------------ Total $ 3,519,498 $ 3,433,610 ================================================================== ------------------------------------------------------------------ Net investment in direct financing leases is as follows: ------------------------------------------------------------------ Minimum lease payments receivable $ 175,893 $ 172,775 Estimated residual value of leases 299,433 391,625 Unearned income under lease contracts (38,317) (50,771) ------------------------------------------------------------------ Total leases $ 437,009 $ 513,629 ================================================================== During 2000, Hann originated $209 million in leases for resale. On December 29, 2000, Hann sold $190 million of operating leases in a sale-leaseback transaction. The remaining $19 million are held by Hann as collateral in the transaction and are recorded as lease financing receivables. Under the structure of the sale of the automobile leases, Hann sells the ownership of the automobiles and leases the vehicles back from the investors in a sale-leaseback transaction. The original term of the leaseback transaction is approximately eight years, with an early buyout option on January 14, 2007. The difference in lease payments received from the consumer and paid to the investor, net of amortized costs, is recognized in vehicle origination and servicing fees on the statements of income. In conjunction with the transaction, Susquehanna entered into an interest rate swap agreement to fix the return to Susquehanna and Hann. A deferred loss of $14 million was recognized on the swap and will be amortized over the estimated life of the transaction. Listed below are Hann's minimum future lease payments under this arrangement. --------------------------------------- 2002 $ 23,713 2003 23,713 2004 23,713 2005 27,665 2006 30,035 Subsequent years 63,905 --------------------------------------- $ 192,744 ======================================= Certain directors and executive officers of Susquehanna and its affiliates, including their immediate families and companies in which they are principal owners (more than 10%), were indebted to banking subsidiaries. In the opinion of management, such loans are consistent with sound banking practices and are within applicable regulatory bank lending limitations. Susque-hanna relies on the directors and executive officers for the identification of their associates. The activity of loans to such persons whose balance exceeded $60 during 2001, 2000, and 1999 follows: -------------------------------------------------------- 2001 2000 1999 -------------------------------------------------------- Balance--January 1 $ 35,246 $ 35,975 $ 27,225 -------------------------------------------------------- Additions 22,587 48,735 28,273 Deductions: Amounts collected 19,258 46,599 24, 657 Other changes (10,075) (2,865) 5,134 -------------------------------------------------------- Balance--December 31 $ 28,500 $ 35,246 $ 35,975 ======================================================== Substantially all of Susquehanna's loans and leases are to enterprises and individuals in Pennsylvania, New Jersey, New York, Maryland, and West Virginia. Susquehanna, as shown in Table 11, has no concentration of loans to borrowers in any one industry, or related industry, which exceeds 10% of total loans. An analysis of impaired loans at December 31, 2001 and 2000, is presented as follows: --------------------------------------------------------------- 2001 2000 --------------------------------------------------------------- Impaired loans without a related reserve $ 7,252 $ 4,379 Impaired loans with a reserve 2,111 2,970 --------------------------------------------------------------- Total impaired loans $ 9,363 $ 7,349 =============================================================== Reserve for impaired loans $ 560 $ 866 =============================================================== An analysis of impaired loans for the years ended December 31, 2001 and 2000, is presented as follows: --------------------------------------------------------------- 2001 2000 --------------------------------------------------------------- Average balance of impaired loans $11,865 $10,645 Interest income on impaired loans (cash basis) $ 420 $ 76 =============================================================== 43 -------------------------------------------------------------------------------- 5. ALLOWANCE FOR LOAN AND LEASE LOSSES Changes in the allowance for loan and lease losses were as follows: ------------------------------------------------------------------------------- 2001 2000 1999 ------------------------------------------------------------------------------- Balance--January 1 $37,187 $44,465 $39,440 Reserve acquired or (transferred) 539 (3,057) 0 Provision charged to operating expenses 7,310 3,726 11,203 ------------------------------------------------------------------------------- 45,036 45,134 50,643 ------------------------------------------------------------------------------- Charge-offs 9,424 9,700 8,419 Recoveries 2,086 1,753 2,241 ------------------------------------------------------------------------------- Net charge-offs 7,338 7,947 6,178 ------------------------------------------------------------------------------- Balance--December 31 $37,698 $37,187 $44,465 =============================================================================== -------------------------------------------------------------------------------- 6. PREMISES AND EQUIPMENT Property, buildings, and equipment, at December 31, were as follows: -------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------- Land $ 10,377 $ 9,706 Buildings 50,871 48,222 Furniture and equipment 61,282 60,462 Leasehold improvements 7,447 6,027 Land improvements 925 738 -------------------------------------------------------------------------------- $130,902 $125,155 -------------------------------------------------------------------------------- Less: accumulated depreciation and amortization 70,839 66,852 -------------------------------------------------------------------------------- $ 60,063 $ 58,303 ================================================================================ Depreciation and amortization expense charged to operations amounted to $8,357 in 2001, $7,594 in 2000, and $6,881 in 1999. All subsidiaries lease certain banking branches and equipment under operating leases which expire on various dates through 2015. Renewal options are available for periods up to 20 years. Minimum future rental commitments under non-cancellable leases, as of December 31, 2000, are as follows: -------------------------------------------------------------------------------- Operating Leases -------------------------------------------------------------------------------- 2002 $ 3,434 2003 3,142 2004 2,857 2005 2,278 2006 1,589 Subsequent years 5,500 -------------------------------------------------------------------------------- $ 18,800 ================================================================================ Total rent expense charged to operations amounted to $4,468 in 2001, $3,887 in 2000, and $3,475 in 1999. -------------------------------------------------------------------------------- 7. DEPOSITS Deposits at December 31 were as follows: -------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------- Noninterest-bearing: Demand $ 529,162 $ 462,297 Interest-bearing: Interest-bearing demand 915,080 817,866 Savings 435,959 413,878 Time 1,322,494 1,303,297 Time of $100 or more 281,636 251,675 -------------------------------------------------------------------------------- Total deposits $3,484,331 $3,249,013 ================================================================================ 44 -------------------------------------------------------------------------------- 8. BORROWINGS Short-Term Borrowings Short-term borrowings and weighted average interest rates, at December 31, were as follows: -------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------- Amount Rate Amount Rate -------------------------------------------------------------------------------- Securities sold under repurchase agreements $158,140 3.28% $198,573 5.72% Treasury tax and loan notes 11,663 1.50 6,763 6.25 -------------------------------------------------------------------------------- $169,803 $205,336 ================================================================================ Federal Home Loan Bank Borrowings -------------------------------------------------------------------------------- December 31 2001 2000 -------------------------------------------------------------------------------- Due 2001, 5.27% to 6.76% $ 0 $ 111,250 Due 2002, 0.00% to 4.12% 28,800 1,500 Due 2003, 2.99% to 5.98% 145,800 114,700 Due 2004, 3.56% to 4.95% 180,200 15,000 Due 2006, 4.73% to 6.65% 30,580 691 Due 2008, 5.43% to 5.50% 75,000 75,000 Due 2009, 5.34% 3,000 3,000 Due 2010, 6.01% to 6.17% 42,750 42,750 Due 2011, 3.25% to 5.33% 60,080 83 Due 2012, 3.25% 144 150 Due 2013, 5.94% 188 199 Due 2014, 5.00% to 6.51% 1,021 1,041 Due 2018, 6.00% 339 343 Due 2019, 4.50% to 5.40% 245 194 Due 2020, 4.50% to 6.00% 2,433 2,053 -------------------------------------------------------------------------------- $ 570,580 $ 367,954 ================================================================================ Vehicle Financing Prior to 2000, Hann originated leases for other investors and financial institutions that contained Hann's guarantee for the residual values and any credit losses. Accounting principles generally accepted in the United States of America require Hann to reflect the entire amount of the lease obligation, on the balance sheet. Accordingly, an obligation under the lease contract with the same terms as the lease assets is recorded as vehicle financing in the borrowings section of the balance sheet. The contractual runoff of these obligations is projected to be $47,058 in 2002, $50,811 in 2003, $54,844 in 2004, and $18,709 in 2005 and beyond. Susquehanna subsidiary banks are members of the Federal Home Loan Banks ("FHLB") of Atlanta, New York, and Pittsburgh, and, as such, can take advantage of the FHLB program for overnight and term advances at published daily rates. Under the terms of a blanket collateral agreement, advances from the FHLB are collateralized by qualifying first mortgages. In addition, all of the subsidiaries' stock in the FHLB is pledged as collateral for such debt. Advances available under this agreement are limited by available and qualifying collateral and the amount of FHLB stock held by the borrower. Under this program Susquehanna subsidiaries have lines of credit available to them totalling $1.130 billion and $934 million, of which $571 million and $368 million were outstanding at December 31, 2001 and 2000, respectively. At December 31, 2001, Susquehanna subsidiaries could borrow an additional $559 million based on qualifying collateral. Such additional borrowings would require the subsidiaries to increase their investment in FHLB stock by approximately $25 million. Long-Term Debt -------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------- Amount Rate Amount Rate -------------------------------------------------------------------------------- Senior notes due February 1, 2003 $ 35,000 6.30% $ 35,000 6.30% Term note due July 19, 2003 10,000 6.09 10,000 6.09 Term note due July 19, 2003 5,000 7.35 5,000 7.35 Term note due July 19, 2004 5,000 4.48 -- -- Subordinate notes due February 1, 2005 50,000 9.00 50,000 9.00 -------------------------------------------------------------------------------- $105,000 $100,000 ================================================================================ The notes require interest-only payments throughout their term with the entire principal balance paid at maturity. Susquehanna guarantees the $20 million in term notes for the holder of these instruments. 45 -------------------------------------------------------------------------------- 9. INCOME TAXES The components of the provision for income taxes are as follows: ------------------------------------------------------------------------------- 2001 2000 1999 ------------------------------------------------------------------------------- Current $ 11,197 $ 464 $ 19,009 Deferred 14,424 24,229 (504) ------------------------------------------------------------------------------- Total $ 25,621 $ 24,693 $ 18,505 =============================================================================== The provision for income taxes differs from the amount derived from applying the statutory income tax rate to income before income taxes as follows: ------------------------------------------------------------------------------- 2001 2000 1999 ------------------------------------------------------------------------------- Provision for statutory rates $ 28,468 $ 27,879 $ 21,710 Tax-advantaged income (2,033) (2,595) (2,857) Other, net (814) (591) (348) ------------------------------------------------------------------------------- Total $ 25,621 $ 24,693 $ 18,505 =============================================================================== Accounting for income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax return. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The components of the net deferred tax asset/(liability) as of December 31 were as follows: ------------------------------------------------------------------------------- 2001 2000 1999 ------------------------------------------------------------------------------- Deferred tax assets: Reserve for loan losses $ 13,690 $ 13,991 $ 16,539 Accrued pension expense 872 904 1,180 Deferred directors' fees 570 564 564 Deferred compensation 1,005 1,103 775 Nonaccrual loan interest 1,096 996 1,398 Core deposit intangible 0 0 101 Purchase accounting 442 537 493 Suspended losses 4,085 18,665 38,311 Alternative minimum tax credit carryover 1,091 0 0 Other assets 1,436 2,696 4,835 Deferred tax liabilities: Deferred loan costs (1,474) (2,328) (1,310) FHLB stock dividends (372) (395) (395) Premises and equipment (2,532) (2,359) (2,208) Operating lease income, net (50,975) (54,993) (56,116) Recapture of savings banks' bad debt reserve 0 (90) (344) Unrealized investment securities (gains)/losses (5,632) 408 6,961 Unrealized gain on recorded interest in securitized assets (1,296) 0 0 Deferred intercompany gain (4,798) 0 0 Other liabilities (1,517) (2,248) (2,551) ------------------------------------------------------------------------------- Net deferred income tax asset/(liability) $(44,309) $(22,549) $ 8,233 =============================================================================== -------------------------------------------------------------------------------- 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Susquehanna is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to orginate loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statement of condition. The contract or notional amount of those instruments reflects the extent of involvement Susque-hanna has in particular classes of financial instruments. Susquehanna's exposure to credit loss in the event of nonper-formance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the contractual amount of these instruments. Susquehanna uses the same credit policies for these instruments as it does for on-balance sheet instruments. Standby letters of credit are conditional commitments issued by Susquehanna to guarantee the performance by a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Commitments to originate loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment does not necessarily represent future cash requirements. Susquehanna evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by Susquehanna upon extension of credit, is based on management's credit evaluation of the borrower. Financial instruments with off-balance sheet risk at December 31, 2001 and 2000, are as follows: -------------------------------------------------------------------------------- Contractual 2001 2000 -------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk: Standby letters of credit $ 86,161 $ 37,313 Commitments to originate loans 360,690 175,929 Unused portion of home equity and credit card lines 164,714 171,836 Other unused commitments, principally commercial lines of credit 424,945 517,463 46 -------------------------------------------------------------------------------- 11. FAIR VALUE OF FINANCIAL INSTRUMENTS Susquehanna's estimated fair value information about financial instruments is presented below. Some of this information is presented whether it is recognized in the Consolidated Balance Sheets or not, and if it is practicable to estimate that value. Fair value is best determined by values quoted through active trading markets. Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using present value discounted cash flow or other valuation techniques. As a result, Susquehanna's ability to actually realize these derived values cannot be assured. The estimated fair values disclosed herewith may vary significantly between institutions based on the estimates and assumptions used in the various valuation methodologies. The disclosure requirements exclude disclosure of nonfinancial assets such as buildings as well as certain financial instruments such as leases. Susquehanna also has several intangible assets which are not included in the fair value disclosures such as mortgage servicing rights, customer lists, and core deposit intangibles. Accordingly, the aggregate estimated fair values presented do not represent the underlying value of Susquehanna. The following methods and assumptions were used to estimate the fair value of each class of financial instrument. Cash and Due from Banks and Short-Term Investments. The fair value of cash and due from banks and short-term investments is deemed to be the same as their carrying value. Investment Securities. The fair value of investment securities is estimated based on quoted market prices, where available. When quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans and Leases. Variable rate loans which do not expose Susquehanna to interest rate risk have a fair value that equals their carrying value, discounted for estimated future credit losses. The fair value of fixed rate loans was based upon the present value of projected cash flows. The discount rate was based upon the U.S. Treasury yield curve, adjusted for credit risk. Deposits. The fair values of demand, interest-bearing demand, and savings deposits are the amounts payable on demand at the balance sheet date. The carrying value of variable rate time deposits represents a reasonable estimate of fair value. The fair value of fixed rate time deposits is based upon the discounted value of future cash flows expected to be paid at maturity. Discount rates are calculated off the U.S. Treasury yield curve. Short-term Borrowings. The carrying amounts reported in the balance sheet represent a reasonable estimate of fair value since these liabilities mature in less than one year. FHLB Borrowings, Vehicle Financing, and Long-Term Debt. Fairvalues were based upon quoted rates of similar instruments, issued by banking companies with similar credit ratings. Off-Balance Sheet Items. The fair value of unused commitments to lend and standby letters is deemed to be the same as their carrying value. The following table represents the carrying amount and estimated fair value of Susquehanna's financial instruments at December 31:
----------------------------------------------------------------------------------------------- 2001 2000 ----------------------------------------------------------------------------------------------- Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ----------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 149,233 $ 149,233 $ 129,101 $ 129,101 Short-term investments 88,565 88,565 59,035 59,035 Investment securities 1,021,091 1,021,091 898,604 898,943 Loans and leases, net of unearned income 3,519,498 3,581,495 3,433,610 3,423,848 Liabilities: Deposits 3,484,331 3,520,173 3,249,013 3,263,437 Short-term borrowings 169,803 169,803 205,336 205,336 FHLB borrowings 570,580 578,333 367,954 364,851 Vehicle financing 171,462 170,587 357,522 352,891 Long-term debt 105,000 109,919 100,000 99,668
47 -------------------------------------------------------------------------------- 12. BENEFIT PLANS Susquehanna maintains a single non-contributory pension plan that covers substantially all full-time employees. In addition, Susquehanna offers life insurance and other benefits to its retirees. A summary of the plans at December 31 is as follows:
-------------------------------------------------------------------------------------- Pension Benefits Other Benefits -------------------------------------------------------------------------------------- 2001 2000 2001 2000 -------------------------------------------------------------------------------------- Change in Benefit Obligation Benefit obligation at beginning of year $ 38,436 $ 35,151 $ 3,604 $ 3,099 Service cost 2,015 1,790 137 141 Interest cost 2,788 2,737 273 250 Plan participants' contributions 0 0 147 0 Amendments 402 96 0 70 Actuarial (gain)/loss (501) 614 (64) 131 Benefits paid (2,392) (1,952) (220) (87) -------------------------------------------------------------------------------------- Benefit obligation at end of year $ 40,748 $ 38,436 $ 3,877 $ 3,604 -------------------------------------------------------------------------------------- Change in Plan Assets Fair value of plan assets at beginning of year $ 44,870 $ 47,352 $ 0 $ 0 Actual return on plan assets (2,043) (534) 0 0 Employer contributions 71 4 73 87 Plan participants' contributions 0 0 147 0 Benefits paid (2,392) (1,952) (220) (87) -------------------------------------------------------------------------------------- Fair value of plan assets at end of year $ 40,506 $ 44,870 $ 0 $ 0 -------------------------------------------------------------------------------------- Funded status $ (241) $ 6,434 $(3,877) $(3,604) Unrecognized net actuarial gain (1,329) (7,163) (1,009) (954) Unrecognized prior service cost (1,561) (2,197) 364 410 Unrecognized transition asset (345) (413) 1,251 1,364 -------------------------------------------------------------------------------------- Accrued benefit cost $ (3,476) $ (3,339) $(3,271) $(2,784) ======================================================================================
---------------------------------------------------------------------------------------------- Pension Benefits Other Benefits ---------------------------------------------------------------------------------------------- 2001 2000 1999 2001 2000 1999 ---------------------------------------------------------------------------------------------- Components of Net Periodic Benefit Expense/(Income) Service cost $ 2,015 $ 1,790 $ 1,916 $ 137 $ 141 $ 146 Interest cost 2,788 2,737 2,505 273 250 212 Expected return on plan assets (3,967) (4,202) (3,962) 0 0 0 Amortization of prior service cost (235) (269) (277) 46 46 41 Amortization of transition asset (68) (68) (68) 113 113 113 Amortization of net actuarial gain (324) (796) (305) (9) (46) (28) ---------------------------------------------------------------------------------------------- Net periodic benefit expense/(income) $ 209 $ (808) $ (191) $ 560 $ 504 $ 484 ============================================================================================== Weighted-Average Assumptions at Year-End Discount rate 7.25% 8.00% 8.00% 7.25% 7.50% 8.00% Expected return on plan assets 9.00% 9.00% 9.00% 0.00% 0.00% 0.00% Rate of compensation increase 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%
The plan assets were invested principally in U.S. Government securities and listed stocks and bonds including 56,231 and 54,078 shares of Susquehanna common stock at December 31, 2001 and 2000, respectively. Susquehanna maintains a 401(k) savings plan which allows employees to invest a percentage of their earnings, matched up to a certain amount specified by Susquehanna. Contributions to the savings plan which are included in salaries and benefits expense amounted to $1,253 in 2001, $1,169 in 2000, and $1,192 in 1999. Susquehanna offers an Employee Stock Purchase Plan ("ESPP"), which allows employees to purchase Susquehanna common stock up to 5% of their salary at a discount to the market price, through payroll deductions. On December 16, 1998, Susquehanna acquired Cardinal Bancorp, Inc. ("Cardinal"), a Pennsylvania bank holding company. Cardinal, prior to the merger with Susquehanna, had issued 135,099 Stock Purchase Options to the members of Cardinal's Board of Directors. Susquehanna succeeded Cardinal as a party to the options as a result of the merger. The option prices range from a low of $6.44 to a high of $10.25. Susquehanna implemented an Equity Compensation Plan ("Compensation Plan") in 1997 under which Susquehanna may grant options to its employees and directors for up to 2,462,500 48 shares of common stock. Under the Compensation Plan, the exercise price of each nonqualified option equals the market price of the company's stock on the date of grant, and an option's maximum term is 10 years. Options are granted upon approval of the Board of Directors and typically vest one-third at the end of years three, four, and five. The option prices range from a low of $13.00 to a high of $24.75. On January 1, 1996, Susquehanna adopted SFAS 123 and as permitted by SFAS 123, Susquehanna has chosen to apply APB Opinion No.25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for the Compensation Plan. Accordingly, no compensation cost has been recognized for options granted under the Compensation Plan. For purposes of disclosure, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-valuation model based upon the assumptions noted below. The pro forma effects on net income include both the Compensation Plan and the ESPP.
---------------------------------------------------------------------------------------------------------------------- 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year: 1,470,529 $ 15.90 1,094,625 $ 16.76 892,870 $ 15.36 Granted 242,251 17.25 382,500 13.31 294,117 18.19 Forfeited 34,209 15.89 2,500 13.31 0 0 Exercised 75,824 11.08 4,096 6.90 92,362 7.81 ---------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 1,602,747 $ 16.33 1,470,529 $ 15.90 1,094,625 $ 16.76 ====================================================================================================================== Outstanding at end of year: Granted prior to 1999 722,847 $ 16.83 572,193 $ 12.96 576,289 $ 12.92 Granted 1999 278,774 18.19 224,219 24.75 224,219 24.75 Granted 2000 363,750 13.31 294,117 18.19 294,117 18.19 Granted 2001 237,376 17.25 380,000 13.31 0 0 ---------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 1,602,747 $ 16.33 1,470,529 $ 15.90 1,094,625 $ 16.76 ====================================================================================================================== Options exercisable at year-end: Granted prior to 1999 758,807 $ 15.64 427,599 $ 12.62 302,848 $ 12.16 Granted 1999 0 0 0 0 0 0 Granted 2000 0 0 0 0 0 0 Granted 2001 0 0 0 0 0 0 ---------------------------------------------------------------------------------------------------------------------- Options exercisable at year-end 758,807 $ 15.64 427,599 $ 12.62 302,848 $ 12.16 ====================================================================================================================== Weighted average remaining contractual maturity of options outstanding at year-end: Granted prior to 1999 5.1 years Granted 1999 7.4 years Granted 2000 8.4 years Granted 2001 9.4 years ---------------------------------------------------------------------------------------------------------------------- Total 6.9 years
---------------------------------------------------------------------------------------------------------- 2001 2000 1999 ---------------------------------------------------------------------------------------------------------- Dollars Per Share Dollars Per Share Dollars Per Share ---------------------------------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $ 1,096 $ 4.52 $ 1,290 $ 3.36 $ 1,321 $ 4.49 Fair value disclosures pro forma effect on: Net income (746) (797) (328) Basic earnings per share (0.02) (0.02) (0.01) Diluted earnings per share N/A* N/A* 0.00 ---------------------------------------------------------------------------------------------------------- Weighted-average fair value assumptions: Dividend yield 3.5% 3.5% 3.0% Expected volatility 23.5% 23.0% 22.0% Risk-free interest rate 5.5% 6.6% 5.7% Expected term 7 years 7 years 7 years
* For the years ended December 31, 2001 and 2000, the application of SFAS 123 would have an anti-dilutive effect. 49 ------------------------------------------------------------------------------- 13. SUSQUEHANNA BANCSHARES, INC. (Parent Only) CONDENSED BALANCE SHEETS ------------------------------------------------------------------------------- December 31 2001 2000 ------------------------------------------------------------------------------- Assets Cash in subsidiary bank $ 2,117 $ 1,037 Investment in consolidated subsidiaries at equity in net assets 567,277 526,150 Other investment securities 2,690 2,414 Premises and equipment (net) 2,703 2,649 Other assets 9,592 11,070 ------------------------------------------------------------------------------- Total assets $584,379 $ 543,320 =============================================================================== Liabilities Long-term debt $ 85,000 $ 85,000 Accrued taxes and expenses payable 5,843 4,883 ------------------------------------------------------------------------------- Total liabilities 90,843 89,883 ------------------------------------------------------------------------------- Equity ------------------------------------------------------------------------------- Common stock ($2 par value) 78,796 78,796 Surplus 57,986 57,872 Retained earnings 345,508 320,020 ------------------------------------------------------------------------------- Accumulated other comprehensive income, net of taxes 12,009 (757) Less: Treasury stock at cost 763 2,494 ------------------------------------------------------------------------------- Total stockholders' equity 493,536 453,437 ------------------------------------------------------------------------------- Total liabilities and stockholders' equity $584,379 $ 543,320 =============================================================================== -------------------------------------------------------------------------------- SUSQUEHANNA BANCSHARES, INC. (Parent only) CONDENSED STATEMENTS OF INCOME ------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 ------------------------------------------------------------------------------- Income Dividends from subsidiaries $ 68,821 $ 71,581 $ 35,814 Interest, dividends, and gains on sales of investment securities 419 3,145 959 Interest and management fee from subsidiaries 37,506 22,840 3,408 ------------------------------------------------------------------------------- Total income 106,746 97,566 40,181 ------------------------------------------------------------------------------- Expenses Interest expense 6,864 6,863 6,864 Restructuring charges 0 0 3,410 Other expenses 36,786 31,872 7,145 ------------------------------------------------------------------------------- Total expenses 43,650 38,735 17,419 ------------------------------------------------------------------------------- Income before taxes, and equity in undistributed income of subsidiaries 63,096 58,831 22,762 Income tax provision/(benefit) 421 (125) (1,470) Equity in undistributed income of subsidiaries (6,959) (3,994) 19,291 ------------------------------------------------------------------------------- Net Income $ 55,716 $ 54,962 $ 43,523 =============================================================================== ------------------------------------------------------------------------------- SUSQUEHANNA BANCSHARES, INC. (Parent only) CONDENSED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------- Year ended December 31 2001 2000 1999 ------------------------------------------------------------------------------- Operating Activities Net income $ 55,716 $ 54,962 $ 43,523 Adjustment to reconcile net income to cash provided by operating activities: Depreciation and amortization 666 1,409 357 Equity in undistributed income of subsidiaries and income of subsidiaries accrued not received 6,959 3,994 (19,291) Decrease/(increase) in other assets (282) (3,553) (651) Increase/(decrease) in accrued expenses payable 960 (2,604) (278) Other, net (956) 4,585 (959) ------------------------------------------------------------------------------- Net cash provided from operating activities 63,063 58,793 22,701 ------------------------------------------------------------------------------- Investing Activities Purchase of investment securities 0 (8) (500) Proceeds from the sale/maturities of investment securities 72 0 1,089 Capital expenditures (547) (2,699) (204) Net infusion of investment in subsidiaries (33,125) (25,879) (1,814) ------------------------------------------------------------------------------- Net cash used for investing activities (33,600) (28,586) (1,429) ------------------------------------------------------------------------------- Financing Activities Proceeds from issuance of common stock 1,845 772 1,372 Dividends paid (30,228) (27,092) (22,918) Cash paid for treasury stock 0 (3,097) (287) ------------------------------------------------------------------------------- Net cash (used for)/provided from financing activities (28,383) (29,417) (21,833) ------------------------------------------------------------------------------- Net (decrease)/increase in cash and cash equivalents 1,080 790 (561) Cash and cash equivalents at January 1 1,037 247 808 ------------------------------------------------------------------------------- Cash and cash equivalents at December 31 $ 2,117 $ 1,037 $ 247 =============================================================================== Cash in subsidiary bank at December 31 $ 2,117 $ 1,037 $ 247 =============================================================================== 50 -------------------------------------------------------------------------------- 14. EARNING PER SHARE The following table sets forth the calculation of basic and diluted earnings per share for the years ended below:
----------------------------------------------------------------------------------------------------------------------------- December 31 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------------- Per Share Per Share Per Share Income Shares Amount Income Shares Amount Income Shares Amount ----------------------------------------------------------------------------------------------------------------------------- Basic Earnings per Share: Income available to common stockholders $ 55,716 39,263 $ 1.42 $ 54,962 39,262 $ 1.40 $ 43,523 39,320 $ 1.11 Effect of Diluted Securities: Stock options outstanding 330 103 177 ----------------------------------------------------------------------------------------------------------------------------- Diluted Earnings per Share: Income available to common stockholders and assuming conversion $ 55,716 39,593 $ 1.41 $ 54,962 39,365 $ 1.40 $ 43,523 39,497 $ 1.10
-------------------------------------------------------------------------------- 15. REGULATORY RESTRICTIONS OF BANKING SUBSIDIARIES Susquehanna is limited by regulatory provisions in the amount it can receive in dividends from its banking subsidiaries. Accordingly, at December 31, 2001, $13,340 is available for dividend distribution to Susquehanna in 2002 from its banking subsidiaries. Included in cash and due from banks are balances required to be maintained by banking subsidiaries on deposit with the Federal Reserve. The amounts of such reserves are based on percentages of certain deposit types and totalled $3,075 and $1,427 at December 31, 2001 and 2000, respectively. In accordance with certain lease and retail loan financing arrangements, Hann maintains prescribed amounts of cash in accounts with the respective financial institutions. The total of such amounts represents restricted cash of $41,584 and $32,731 at December 31, 2001 and 2000, respectively. -------------------------------------------------------------------------------- 16. CONTINGENT LIABILITIES Susquehanna is party to various legal proceedings incidental to its business. Certain claims, suits, and complaints arising in the ordinary course of business have been filed or are pending against Susquehanna. In the opinion of management, all such matters are adequately covered by insurance or, if not covered, are without merit or are of such kind, or involve such amounts, as would not have a material effect on the financial position, results of operations, and cash flows of Susquehanna, if disposed of unfavorably. 51 PricewaterhouseCoopers LLP One South Market Square Harrisburg, PA 17101-9916 Telephone (717) 231-5900 Facsimile (717) 232-5672 Report of Independent Accountants To the Board of Directors and Stockholders of Susquehanna Bancshares, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in stockholders' equity, and cash flows present fairly, in all material respects, the financial position of Susquehanna Bancshares, Inc. (Susquehanna) and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Susquehanna's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP January 22, 2002 52 Summary of Quarterly Financial Data The unaudited quarterly results of operations for the years ended December 31, 2001 and 2000, are as follows:
---------------------------------------------------------------------------------------------------------------------- Dollars in thousands, except per share 2001 2000 ---------------------------------------------------------------------------------------------------------------------- Quarter Ended Dec31 Sep30 Jun30 Mar31 Dec31 Sep30 Jun30 Mar31 ---------------------------------------------------------------------------------------------------------------------- Interest income $83,386 $86,683 $84,833 $86,393 $89,360 $89,263 $88,050 $86,743 ---------------------------------------------------------------------------------------------------------------------- Interest expense 38,517 42,756 42,296 45,482 48,290 47,846 46,406 45,922 ---------------------------------------------------------------------------------------------------------------------- Net interest income 44,869 43,927 42,537 40,911 41,070 41,417 41,644 40,821 ---------------------------------------------------------------------------------------------------------------------- Provision for loan and lease losses 1,891 1,740 1,833 1,846 1,453 766 643 864 ---------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan and lease losses 42,978 42,187 40,704 39,065 39,617 40,651 41,001 39,957 ---------------------------------------------------------------------------------------------------------------------- Other income 21,660 20,796 21,191 20,519 19,399 19,072 18,476 17,063 ---------------------------------------------------------------------------------------------------------------------- Other expenses 43,215 42,054 41,287 41,207 39,141 39,159 39,693 37,588 ---------------------------------------------------------------------------------------------------------------------- Income before income taxes 21,423 20,929 20,608 18,377 19,875 20,564 19,784 19,432 ---------------------------------------------------------------------------------------------------------------------- Applicable income taxes 6,748 6,592 6,400 5,881 6,161 6,375 6,133 6,024 ---------------------------------------------------------------------------------------------------------------------- Net income $14,675 $14,337 $14,208 $12,496 $13,714 $14,189 $13,651 $13,408 ====================================================================================================================== Earnings per common share: Basic $ 0.37 $ 0.36 $ 0.36 $ 0.32 $ 0.35 $ 0.36 $ 0.35 $ 0.34 Diluted 0.37 0.36 0.36 0.32 0.35 0.36 0.35 0.34
Market for Susquehanna Bancshares, Inc., Capital Stock Since November 5, 1985, Susquehanna common stock has been listed for quotation on the National Association of Securities Dealers National Market System. Set forth below are the high and low sales prices of Susquehanna's common stock as reported on the Nasdaq National Market System for the years 2001 and 2000. -------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------- Quarterly Quarterly Market Price Dividend Market Price Dividend -------------------------------------------------------------------------- First Quarter $18.88-$15.00 $0.19 $15.88-$11.25 $0.17 Second Quarter $20.81-$16.25 $0.19 $15.00-$12.38 $0.17 Third Quarter $22.83-$18.15 $0.19 $15.44-$12.00 $0.17 Fourth Quarter $22.24-$19.95 $0.20 $17.98-$12.88 $0.19 53 Item 9. Changes in and Disagreements on Accounting and Financial Disclosure. ------ -------------------------------------------------------------------- There has been no change in Susquehanna's principal accountants in over two years. There have been no disagreements with such principal accountants on any matters of accounting principles, practices, financial statement disclosure, auditing scope or procedures. 54 PART III Item 10. Directors and Executive Officers of Susquehanna. ------- ----------------------------------------------- The information required by this Item will be included in Susquehanna's Proxy Statement for its 2002 Annual Meeting of Shareholders (the "2002 Proxy Statement") in the Election of Directors section and the Director and Executive Officer Compensation section, each of which sections is incorporated herein by reference. Item 11. Executive Compensation ------- ---------------------- The information required by this Item will be included in the 2002 Proxy Statement in the Director and Executive Officer Compensation section, and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management ------- -------------------------------------------------------------- The information required by this Item will be included in the 2002 Proxy Statement in the Principal Holders of Voting Securities and Holdings of Management section, and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions ------- ---------------------------------------------- The information required by this Item will be included in the 2002 Proxy Statement in the Certain Relationships and Related Transaction section, and is incorporated herein by reference. 55 PART IV ------- Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K. ------- --------------------------------------------------------------- (a) The following documents are filed as part of this report: (1) Financial Statements. See Item 8 of this report for the consolidated financial statements of Susquehanna and its subsidiaries (including the index to financial statements). (2) Financial Statement Schedules. Not Applicable. (3) Exhibits. A list of the Exhibits to this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits. (b) Report on Form 8-K. None. (c) Exhibits. The exhibits required to be filed as part of this report pursuant to Item 601 of Regulation S-K are filed herewith or incorporated by reference. (d) Financial Statement Schedule. None Required. 56 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. SUSQUEHANNA BANCSHARES, INC. By: /s/ William J. Reuter -------------------------------- William J. Reuter, President and Chief Executive Officer Dated: March 18, 2002 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ William J. Reuter President, Chief Executive March 18, 2002 --------------------------- Officer and Director (William J. Reuter) /s/ Drew K. Hostetter Executive Vice President, March 18, 2002 --------------------------- Treasurer and Chief (Drew K. Hostetter) Financial Officer /s/ Robert S. Bolinger Director March 18, 2002 --------------------------- (Robert S. Bolinger) /s/ Chloe R. Eichelberger Director March 21, 2002 --------------------------- (Chloe R. Eichelberger) /s/ James G. Apple Director March 21, 2002 --------------------------- (James G. Apple) /s/ Wayne E. Alter, Jr. Director March 20, 2002 --------------------------- (Wayne E. Alter, Jr.) /s/ John M. Denlinger Director March 18, 2002 --------------------------- (John M. Denlinger) /s/ Owen O. Freeman, Jr. Director March 18, 2002 --------------------------- (Owen O. Freeman, Jr.) /s/ Henry H. Gibbel Director March 18, 2002 --------------------------- (Henry H. Gibbel) /s/ William B. Zimmerman Director March 18, 2002 --------------------------- (William B. Zimmerman) /s/ T. Max Hall Director March 19, 2002 --------------------------- (T. Max Hall) 57 SECURITIES AND EXCHANGE COMMISSION SUSQUEHANNA BANCSHARES, INC. Form 10-K, December 31, 2001 [SIGNATURES CONTINUED] Signature Title Date --------- ----- ---- /s/ Michael J. Wimmer Director March 20, 2002 --------------------------- (Michael J. Wimmer) /s/ C. William Hetzer, Jr. Director March 18, 2002 --------------------------- (C. William Hetzer, Jr.) /s/ Guy W. Miller, Jr. Director March 18, 2002 --------------------------- (Guy W. Miller, Jr.) /s/ George J. Morgan Director March 18, 2002 --------------------------- (George J. Morgan) /s/ Roger V. Wiest Director March 18, 2002 --------------------------- (Roger V. Wiest) [END OF SIGNATURE PAGES] 58 EXHIBIT INDEX Exhibit Numbers Description and Method of Filing --------------- -------------------------------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession. Not Applicable. (3) (i) Articles of Incorporation. Incorporated by reference to Attachment E to Susquehanna's Joint Proxy Statement/Prospectus on Susquehanna's Registration Statement on Form S-4, Registration No. 33-13276 and to Exhibit 3.3 of Susquehanna's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998. (ii) By-laws. Incorporated by reference to Exhibit 3 of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (4) Instruments defining the rights of security holders including indentures. The rights of the holders of Susquehanna's Common Stock and the rights of Susquehanna's note holders are contained in the following documents or instruments, which are incorporated herein by reference. (i) Articles of Incorporation. Incorporated by reference to Attachment E to Susquehanna's Joint Proxy Statement/Prospectus on Susquehanna's Registration Statement on Form S-4, Registration No. 33-76319 and to Exhibit 3.3 of Susquehanna's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1998. (iii) By-laws. Incorporated by reference to Exhibit 3 of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (iv) Form of Subordinated Note/Indenture incorporated by reference to Exhibit 4.1 to Susquehanna's Registration Statement on Form S-3, Registration No. 33-87624. (9) Voting trust agreement. Not Applicable (10) Material Contracts. (i) Susquehanna's Key Employee Severance Pay Plan, adopted in 1999 and amended on May 26, 2000 and on February 22, 2001, is incorporated by reference to Exhibit 10 of Susquehanna's Annual Report on Form 10-K for fiscal year ended December 31, 1999 and to Exhibit 10(i) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. (ii) Susquehanna's Executive Deferred Income Plan, effective January 1, 1999, is incorporated by reference to Exhibit 10(a) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. (iii) Susquehanna's Equity Compensation Plan, as amended on May 25, 2001, is filed herewith as Exhibit 10(iii). (iv) Susquehanna's Supplemental Executive Retirement Plan as amended and restated effective January 1, 1998 is filed herewith as Exhibit 10(iv). (v) Forms of The Insurance Trust for Susquehanna Bancshares Banks and Affiliates Split Dollar Agreement and Split Dollar Policy Endorsement are filed herewith as Exhibit 10(v). 59 (vi) 2002 Amended Servicing Agreement dated January 1, 2002 between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Auto Lenders Liquidation Center, Inc. is filed herewith as Exhibit 10(vi). (vii) Guaranty Agreement dated December 31, 2001 by Michael J. Wimmer in favor of Boston Service Company, Inc. is filed herewith as Exhibit 10(vii). (viii) Employment Agreement between Susquehanna and William J. Reuter, dated March 21, 2001, is incorporated by reference to Exhibit 10(vi) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Amendment dated February 28, 2002 is filed herewith as Exhibit 10(viii). (ix) Employment Agreement between Susquehanna and Gregory A. Duncan, dated March 14, 2001, is incorporated by reference to Exhibit 10(vii) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Amendment dated February 28, 2002, is filed herewith as Exhibit 10(ix). (x) Employment Agreement between Susquehanna and Drew K. Hostetter, dated March 12, 2001, is incorporated by reference to Exhibit 10(viii) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Amendment dated February 28, 2002, is filed herewith as Exhibit 10(x). (xi) Employment Agreement between Susquehanna and Williamsport National Bank and Charles W. Luppert, dated March 20, 2001, is incorporated by reference to Exhibit 10(ix) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Amendment dated February 28, 2002, is filed herewith as Exhibit 10(xi). (xii) Employment Agreement between Boston Service Company, Inc. t/a Hann Financial Service Corp. and Michael J. Wimmer, dated February 1, 2000, is incorporated by reference to Exhibit 10(x) of Susquehanna's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. (xiii) Consulting Agreement between Susquehanna and Robert S. Bolinger, dated June 4, 2001, is filed herewith as Exhibit 10(xiii). (xiv) Guaranty Agreement dated March 11, 2002 by Michael J. Wimmer in favor of Boston Service Company, Inc. is filed herewith as Exhibit 10(xiv). (11) Statement re: computation of per share earnings. Not Applicable. (12) Statements re: computation of ratios. Not Applicable. (13) Annual report to security holders, Form 10-Q or quarterly report to security holders. Not applicable. (16) Letter re: change in certified accountant. Not applicable. (18) Letter re: change in accounting principles. Not Applicable. (19) Report furnished to security holders. Not Applicable. (21) Subsidiaries of the registrant. Filed herewith. (22) Published report regarding matters submitted to vote of security holders. Not Applicable. 60 (23) Consents of experts and counsel. Filed herewith. (24) Power of Attorney. Not Applicable. (99) Additional Exhibits. Not Applicable. 61