** **

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC  20549**

** **

**FORM 10-K**

 

**(Mark One)**

**ý****Annual Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

**[Fee Required]**

**For the fiscal year ended December 31, 2002**

 

**or**

**o****Transition Report Pursuant to Section 13 or 15(d) of theSecurities ExchangeAct of 1934**

**[No Fee Required]**

**For thetransition period from                             to**

 

**CommissionFile Number 0-14745**

 

**Sun Bancorp, Inc.**

(Exactname of registrant as specified in its charter)

 
| **Pennsylvania**                                                                                                                            |   | **23-2233584**       |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|
| (State  or other jurisdiction of                                                                                                            |   | (I.R.S.  Employer    |
| incorporation  or organization)                                                                                                             |   | Identification  No.) |
|                                                                                                                                        |   |                 |
| **155 North 15th Street, Lewisburg, PA**                                                                                                    |   | **17837**            |
| (Address  of principal executive offices)                                                                                                   |   | (Zip  Code)          |
|                                                                                                                                        |   |                 |
| Registrant’s  telephone number, including area code            **570-374-1131** |
|                                                                                                                                        |   |                 |

 

Securities registered pursuantto Section 12(b) of the Act:

                                                         

 

 
| Title  of each class |   | Name  of each exchange on   which registered |
|----------------------|--------|----------------------------------------------|
| **None**             |   | **None**                                     |

 

 

Securities registered pursuantto Section 12(g) of the Act:

 
| **Common stock, No Par Value** |
|--------------------------------|
| (Title  of Class)              |

 

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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. [ X] Yes  [    ] No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section229.405 of this Chapter) is not contained herein, and will not be contained, tothe best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in PART III of this Form 10-K or anyamendment to this Form 10-K.  [ X ]

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) [X ] Yes  [    ] No

 

As of March 7, 2002, theRegistrant had 7,162,799 shares of common stock outstanding with a no parvalue.  Based on the closing price of$18.70 on the same date, the aggregate market value of the voting stock held bynonaffiliates of the Registrant was $133,944,341.

 

Portions of the 2002 AnnualReport to Shareholders are incorporated by reference in Parts I, II, and IIIhereof.

 

Portions of the 2003 ProxyStatement for the Annual Shareholders’ Meeting to be held on April 24, 2003 areincorporated by reference in Part III hereof.

 

The index to exhibits includedin this filing appears on page 5.

 

 

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PART I

ITEM 1 - BUSINESS

 

SUNBANCORP, INC. (SUN) is a holding company incorporated under the laws ofPennsylvania and registered under the Bank Holding Company Act of 1956, asamended, on November 26, 1982.  SUNacquired the Snyder County Trust Company in June 1983 and The WatsontownNational Bank in November 1987.  OnDecember 1, 1993, the two banks merged into one bank under the legal title ofSun Bank (Bank).  SUN also owns theBeacon Life Insurance Company, a credit life and disability insurancecompany.  SUN is a limited partner in fivepartnerships for the purpose of building, owning, and operating an affordableelderly apartment complex in SUN’s market area.  SUN is also a partner in two partnerships that provide officespace in areas designated empowerment zones by the Commonwealth ofPennsylvania.  As part of the agreement,SUN is able to recognize tax credits from these economic developmentprojects.  On June 30, 1997, SUNacquired Bucktail Bank and Trust Company (Bucktail) from FNB Corporation.  Concurrently, Bucktail was merged into SunBank.  On October 4, 2000, Sun Bankbegan conducting business as SunBank and discontinued using the trade namesSnyder County Trust Company, Watsontown Bank, Central Pennsylvania Bank, andBucktail Bank and Trust Company.  OnOctober 30, 2000, SUN acquired seventy-five percent of Sun Abstract andSettlement Services for the sum of $15,000 which represents the totalinvestment.  During 2001, SUN’sinvestment percentage was reduced to thirty percent due to the addition ofadditional partners. On January 28, 2001, SUN formed Sun Bancorp StatutoryTrust I for the purpose of issuing trust preferred securities.  On January 30, 2001, SUN formed SunInvestment Services, Inc. to offer SUN’s customers mutual fund and annuityproducts.  On May 31, 2001, SUN acquiredGuaranty Bank, N.A., which was concurrently merged into SunBank.  On December 28, 2002, SUN formed SUBIInvestment Company, a Delaware corporation formed to hold certaininvestments.  On December 19, 2002, SUNformed SUBI Services, LLC, an employee services company, solely owned by SunBank.

 

SunBank,a state-chartered bank regulated by Pennsylvania Banking Law, provides fullservice commercial and retail banking services primarily in northeastern andcentral Pennsylvania.  SunBank operates23 banking offices and one trust services office serving Snyder, Union,Northumberland, Lycoming, Clinton, and Luzerne Counties.  At December 31, 2002, SunBank had totalassets of $948,039,000 and total shareholders’ equity of $97,636,000.  Net income for 2002 was $7,983,000.

 

SunBankoffers a wide range of services including demand deposit accounts, savingsaccounts, Christmas and all-purpose clubs, time certificates of deposit, andindividual retirement accounts, as well as commercial loans, consumer loans,mortgage loans, auto leases, equipment leases, investment products, and safedeposit services.  SunBank also operatesa trust department that provides full fiduciary services.  Also, 45 Automated Teller Machines (ATMs)and cash dispensing units throughout the service area provide 24-hour bankingservice.  SunBank’s activities are suchthat the loss of one single customer or a few customers would not have amaterial adverse effect on its operations. Additionally, SunBank’s business is not seasonal in nature and does notengage in foreign transactions.  Themajority of the loan portfolio is comprised of real estate loans (mortgage andcommercial) and consumer loans/leases (predominately automobiles).  SunBank’s deposits are insured by theFederal Deposit Insurance Corporation (FDIC) to the maximum extent allowed bylaw.

 

Competitioncontinues to heighten in the financial services industry in northeastern andcentral Pennsylvania not only among banks but also with savings and loanassociations, credit unions, discount brokerage firms, insurance companies, andother nonbank financial service providers. Changing regulatory and economic conditions affect SUN’s ability tocompete effectively in its market area. Most of the competition is centered around the setting of interest ratesto be charged on loans and rates paid on deposits, fees on deposit accounts,and customer service.  SUN’s managementfeels it competes effectively in its market area.

 

SUN issubject to regulation and supervision by the Board of Governors of the FederalReserve Bank and the Pennsylvania Department of Banking.  SUN files quarterly and annual reports withthe Federal Reserve Bank (FRB) of Philadelphia and periodic 

 

2

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on-site exams of SUN are doneby the FRB.  Regular examinations ofSunBank are conducted by the FDIC and the Pennsylvania Department of Banking.

 

SUN andthe Beacon Life Insurance Company do not have any employees.  At December 31, 2002, SunBank and itssubsidiaries employed 299 persons. SunBank and its subsidiaries offer a variety of benefit programs and feelsits relationship with its employees is good.

 

*USA Patriot Act.*In the wake of the tragic events, of September 11th, on October 26, 2001,President Bush signed the Uniting and Strengthening America by ProvidingAppropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT)Act of 2001. Under the USA PATRIOT Act, financial institutions are subject toprohibitions against specified financial transactions and account relationshipsas well as enhanced due diligence and “know your customer” standards in theirdealings with foreign financial institutions and foreign customers.  For example, the enhanced due diligencepolicies, procedures, and controls generally require financial institutions totake reasonable steps:

 

•       to conduct enhanced scrutiny of account relationships to guardagainst money laundering and report any suspicious transaction;

•       to ascertain the identity of the nominal and beneficial ownersof, and the source of funds deposited into, each account as needed to guardagainst money laundering and report any suspicious transactions;

•       to ascertain for any foreign bank, the shares of which are notpublicly traded, the identity of the owners of the foreign bank, and the natureand extent of the ownership interest of each such owner; and

•       to ascertain whether any foreign bank provides correspondentaccounts to other foreign banks and, if so, the identity of those foreign banksand related due diligence information.

 

Under the USA PATRIOT Act, financial institutions were required to establishanti-money laundering programs by April 25, 2002.  The USA PATRIOT Act sets forth minimum standards for theseprograms, including:

 

•       the development of internal policies, procedures, endcontrols;

•       the designation of a compliance officer;

•       an ongoing employee training program; and

•       an independent audit function, to test, the programs.

 

In addition, the USA PATRIOT Act authorizes the Secretary of theTreasury to adopt rules increasing the cooperation and information sharingbetween financial institutions, regulators, and law enforcement authoritiesregarding individuals, entities and organizations engaged in, or reasonablysuspected based on credible evidence of engaging in, terrorist acts or moneylaundering activities.  Any financialinstitutions complying with these rules will not be deemed to have violated theprivacy provisions of the Gramm-Leach-Bliley Act.  SUN does not have any significant international bankingrelationships, and does not anticipate that the USA PATRIOT Act will have amaterial effect on its business or operations.

 

 

3

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*Sarbanes-OxleyAct of 2002*. On July 30, 2002, President Bush signed into lawthe Sarbanes-Oxley Act of 2002.  TheSarbanes-Oxley Act represents a comprehensive revision of laws affectingcorporate governance, accounting obligations and corporate reporting.  The Sarbanes-Oxley Act is applicable to allcompanies with equity or debt securities registered or that file reports underthe Securities Exchange Act of 1934.  Inparticular, the Sarbanes-Oxley Act establishes: (i) new requirements for auditcommittees, including independence, expertise, and responsibilities; (ii)additional responsibilities regarding financial statements for the ChiefExecutive Officer and Chief Financial Officer of the reporting company; (iii)new standards for auditors and regulation of audits; (iv) increased disclosureand reporting obligations for the reporting company and its directors andexecutive officers; and (v) new and increased civil and criminal penalties forviolations of the securities laws.  Manyof the provisions were effective immediately while other provisions becomeeffective over a period of time and are subject to rulemaking by the SEC.Because SUN’s common stock is registered with the SEC, SUN is currently subjectto this Act.

 

 

 

 

SUN’swebsite address is www.sunbankpa.com. SUN makes available free of charge its annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments tothose reports as soon as reasonably practicable after it electronically filessuch reports with the SEC.  Copies ofsuch reports are available at no charge by contacting Sun Bancorp, Inc.,Shareholder Services, 155 North 15th Street, Lewisburg, PA17837.  The information found on SUN’swebsite does not constitute a part of this or any other report.

 

ITEM 2 - PROPERTIES

 

SUN’scorporate office is located in Lewisburg, Pennsylvania at its corporateheadquarters and training facility.  SUNowns all of its properties with the exception of an off-site ATM at 700 NorthBroad Street; Selinsgrove; and bank offices in Loyalsock and Lewisburg; whichare leased.  In 1995, SUN purchasedparcels of land in Liverpool for the purpose of building a branch in thefuture. In 2001, SunBank opened an office in Lewisburg.  In addition, SunBank purchased three MellonBank branches: Lewisburg, Lock Haven, and Mill Hall.  SUN acquired Guaranty Bank, N.A. in 2001, and after the banksmerged, had additional offices in Mountain Top, Pikes Creek, Wilkes-Barre, GlenLyon, Shamokin, and Nanticoke. In 2002, SUN purchased a building in Lewisburgto be used as the corporate headquarters and training facility.  All properties are in good condition andadequate for SunBank’s purposes.  Thefollowing is a list of banking offices, ATM locations, their addresses, and abrief description of each office.

 

 

|   | Office         |   | Address                                 |   | Description     |
|--------|----------------|--------|-----------------------------------------|--------|-----------------|
| 1.     | Selinsgrove    |   | 2 South Market Street                   |   | Brick structure |
|   |           |   | Selinsgrove, Pennsylvania  17870        |   |            |
|   |           |   |                                    |   |            |
| 2.     | Shamokin Dam   |   | 200 Susquehanna Trail                   |   | Brick structure |
|   |           |   | Shamokin Dam,  Pennsylvania  17876 |   |            |
|   |           |   |                                    |   |            |
| 3.     | New Berlin     |   | Market & Plum Streets               |   | Brick structure |
|   |           |   | New Berlin, Pennsylvania  17855    |   |            |
|   |           |   |                                    |   |            |
| 4.     | Sunbury        |   | 11 South Second Street                  |   | Brick structure |
|   |           |   | Sunbury, Pennsylvania  17801       |   |            |
|   |           |   |                                    |   |            |
| 5.     | Middleburg     |   | Route 522 & Dock Hill  Road         |   | Brick structure |
|   |           |   | Middleburg, Pennsylvania  17842    |   |            |
|   |           |   |                                    |   |            |
| 6.     | Trust Division |   | 100 West Pine Street                    |   | Brick structure |
|   |           |   | Selinsgrove,  Pennsylvania  17870  |   |            |

 

 

4

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|   | Office                   |   | Address                                    |   | Description               |
|--------|--------------------------|--------|--------------------------------------------|--------|---------------------------|
| 7.     | Automated Teller Machine |   | 108 West Pine Street                       |   | Brick structure           |
|   |                     |   | Selinsgrove,  Pennsylvania  17870     |   |                      |
|   |                     |   |                                       |   |                      |
| 8.     | Automated Teller Machine |   | 700 North Broad Street                     |   | Brick structure           |
|   |                     |   | Selinsgrove,  Pennsylvania  17870     |   |                      |
|   |                     |   |                                       |   |                      |
| 9.     | Watsontown               |   | 300 Main Street                            |   | Brick structure           |
|   |                     |   | Watsontown,  Pennsylvania  17777 |   |                      |
|   |                     |   |                                       |   |                      |
| 10.    | Northumberland           |   | 96 Duke Street                             |   | Brick structure           |
|   |                     |   | Northumberland,  Pennsylvania  17857  |   |                      |
|   |                     |   |                                       |   |                      |
| 11.    | Liverpool                |   | Rts. 11 & 15 South                     |   | Land                      |
|   |                     |   | Liverpool, Pennsylvania  17045        |   |                      |
|   |                     |   |                                       |   |                      |
| 12.    | Hughesville              |   | 2 South Main Street                        |   | Brick structure           |
|   |                     |   | Hughesville, PA  17737                |   |                      |
|   |                     |   |                                       |   |                      |
| 13.    | Newberry                 |   | 2131 W. Fourth Street                      |   | Brick structure           |
|   |                     |   | Williamsport, PA  17701               |   |                      |
|   |                     |   |                                       |   |                      |
| 14.    | Montoursville            |   | 301 Broad Street                           |   | Brick structure           |
|   |                     |   | Montoursville, PA  17754              |   |                      |
|   |                     |   |                                       |   |                      |
| 15.    | Squire Hays              |   | 3155 Lycoming Creek Road                   |   | Stone and frame structure |
|   |                     |   | Williamsport, PA  17701               |   |                      |
|   |                     |   |                                       |   |                      |
| 16.    | Maynard Street           |   | 90 Maynard Street                          |   | Brick structure           |
|   |                     |   | Williamsport, PA  17701               |   |                      |
|   |                     |   |                                       |   |                      |
| 17.    | Loyalsock                |   | 814 Westminster Drive                      |   | Masonry Block             |
|   |                     |   | Williamsport, PA  17701               |   |                      |
|   |                     |   |                                       |   |                      |
| 18.    | Lewisburg                |   | 141 Plaza 15                               |   | Brick structure           |
|   |                     |   | Lewisburg, PA  17837                  |   |                      |
|   |                     |   |                                       |   |                      |
| 19.    | Lewisburg                |   | 311 Market Street                          |   | Brick and stone structure |
|   |                     |   | Lewisburg, PA  17837                  |   |                      |
|   |                     |   |                                       |   |                      |
| 20.    | Lock Haven               |   | Bellefonte Ave & East  Church Street   |   | Frame structure           |
|   |                     |   | Lock Haven, PA  17745                 |   |                      |
|   |                     |   |                                       |   |                      |
| 21.    | Mill Hall                |   | 349 Main Street                            |   | Brick structure           |
|   |                     |   | Mill Hall, PA  17751                  |   |                      |
|   |                     |   |                                       |   |                      |
| 22.    | Mountain Top             |   | 46 South Mountain Boulevard                |   | Frame structure           |
|   |                     |   | Mountain Top, PA  18707               |   |                      |
|   |                     |   |                                       |   |                      |
| 23.    | Pikes Creek              |   | Routes 118 & 29                        |   | Frame structure           |
|   |                     |   | Pikes Creek, PA  18621                |   |                      |
|   |                     |   |                                       |   |                      |
| 24.    | Wilkes-Barre             |   | 639 South Main Street                      |   | Brick and stone structure |
|   |                     |   | Wilkes-Barre, PA  18702               |   |                      |
|   |                     |   |                                       |   |                      |
| 25.    | Glen Lyon                |   | 18 East Main Street                        |   | Brick and stone structure |
|   |                     |   | Glen Lyon, PA  18617                  |   |                      |
|   |                     |   |                                       |   |                      |
| 26.    | Shamokin                 |   | 10 South Market Street                     |   | Brick structure           |
|   |                     |   | Shamokin, PA  17872                   |   |                      |
|   |                     |   |                                       |   |                      |
| 27.    | Nanticoke                |   | 35 East Main Street                        |   | Brick and stone structure |
|   |                     |   | Nanticoke, PA  18634                  |   |                      |

 

 

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ITEM 3 - LEGAL PROCEEDINGS

 

Variouslegal actions arise against the corporation in the normal course ofbusiness.  In the opinion of managementwhen the actions that are currently pending or threatened against thecorporation are resolved, they should not have a material adverse effect on thebusiness or financial condition of the corporation.

 

 

ITEM 4 - SUBMISSION OF MATTERSTO A VOTE OF SHAREHOLDERS

 

Notapplicable

 

 

 

 

 

 

6

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PART II

 

ITEM 5 - MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATEDSHAREHOLDER      MATTERS

 

Thecommon stock of SUN BANCORP, INC. trades on the NASDAQ national market systemunder the symbol SUBI.  As of March 7,2002, SUN had approximately 2,222 holders of its common stock.  SUN offers its shareholders a DividendReinvestment Plan whereby holders of stock may have their quarterly cashdividends automatically invested in additional shares of common stock.

 

The paymentof dividends by SUN is made at the discretion of the Board of Directors and tothe extent funds are legally available for that purpose.  SUN may not pay dividends in any year inexcess of the total of the current year’s net income and the retained netincome of the prior two years without the approval of the Federal ReserveBank.  Additionally, bank regulationslimit the amount of dividends that may be paid to SUN by the subsidiary bankwithout prior approval from the regulatory agencies.

 

Additionalstock information is incorporated by reference to Shareholder Information foundon page 56 of the 2002 Annual Report to Shareholders.

 

ITEM 6 - SELECTED FINANCIALDATA

 

Thisitem is incorporated by reference to information under the heading Five YearFinancial Highlights on page 39 of the 2002 Annual Report to Shareholders.

 

 

ITEM 7- MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

 

Thisitem is incorporated by reference to Management’s Discussion and Analysis onpages 40 through 55 of the 2002 Annual Report to Shareholders.

 

ITEM 7A - QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Thisitem is incorporated by reference to Management’s Discussion and Analysis onpages 53 and 54 of the 2002 Annual Report to Shareholders.

 

                Disclosure of the Corporation’s significant accounting policies is included in Note 1 to the consolidated financial statements on pages 18 through 20 of the Annual Report to Stockholders (Exhibit 13). Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions to be made by management. Additional information is contained in Management’s Discussion and Analysis for the most sensitive of these issues, including the provision and allowance for loan and lease losses, which are located on pages 45 and 46, and in Note 6 located on page 24 of Exhibit 13.

 

                Significantestimates are made by management in determining the allowance for loan andlease losses.  Consideration is given toa variety of factors in establishing this estimate. In estimating the allowancefor loan and lease losses, management considers current economic conditions,diversification of the loan portfolio, delinquency statistics, results ofinternal loan reviews, financial and managerial strengths of borrowers,adequacy of collateral, if collateral dependent, or present value of futurecash flows and other relevant factors.

 

ITEM 8 - FINANCIAL STATEMENTSAND SUPPLEMENTARY DATA

 

Thisitem is incorporated by reference to the Consolidated Financial Statements,Notes to Consolidated Financial Statements and Independent Auditors’ Report setforth on pages 14 through 38 of the 2002 Annual Report to Shareholders.

 

 

7

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ITEM 9 - CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND

         FINANCIAL DISCLOSURE

 

On May 14, 2002, the Audit Committee of the Board ofDirectors of the corporation approved a change in the corporation’s independentaccountants. The Board of Directors ratified the Audit Committee’s engagementof PricewaterhouseCoopers LLP to serve as the corporation’s independentaccountants and the Committee’s replacement of Parente Randolph, P.C. as thecorporation’s independent accountants.

 

                Parente Randolph, P.C.’s reportson the consolidated financial statements of the corporation and itssubsidiaries for the two most recent fiscal years ended December 31, 2001, didnot contain any adverse opinion or disclaimer of opinion, nor were theyqualified or modified as to uncertainty, audit scope or accounting principles.

 

                During the corporation’s twofiscal years ended December 31, 2001, and the subsequent interim period throughMay 14, 2002, there were no disagreements between the corporation and ParenteRandolph, P.C. on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure, which disagreements, ifnot resolved to Parente Randolph, P.C. ‘s satisfaction, would have caused themto make reference to the subject matter of the disagreement in connection withtheir reports on the corporation’s consolidated financial statements for suchyears; and there were no reportable events as described in Item 304(a)(1)(v) ofRegulation S-K.

 

                The corporation requested thatParente Randolph, P.C. furnish a letter addressed to the SEC stating itsagreement with the statements set forth above. A copy of the letter, dated May23, 2002, was filed as Exhibit 16 to the corporation’s amended Current Reporton Form 8-K/A dated May 23, 2002.

 

                During the corporation’s twofiscal years ended December 31, 2001, and the subsequent interim period throughMay 14, 2002, the corporation did not consult with PricewaterhouseCoopers LLPwith respect to the application of accounting principles to a specified transaction,either completed or proposed, or with respect to the audit opinion that mightbe rendered on the corporation’s consolidated financial statements, or anyother matters or reportable events as set forth in Items 304(a)(2)(i) and (ii)of Regulation S-K.

 

8

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PARTIII

 

ITEM 10 - DIRECTORS ANDEXECUTIVE OFFICERS OF REGISTRANT

 

Informationconcerning directors and executive officers of the Registrant is incorporatedherein by reference to Board of Directors on pages 5 and 6 of Sun’s 2003 ProxyStatement.

 

     Section 16(a) of the Securities ExchangeAct of 1934, as amended, requires the corporation’s officers and directors, andpersons who own more than ten percent of the registered class of thecorporation’s equity securities, to file reports of ownership and changes inownership with the Securities and Exchange Commission.  Officers, directors and greater than tenpercent shareholders are required by SEC regulation to furnish the corporationwith copies of all Section 16(a) forms they file.

 

     Based on its reviewof the copies of such forms received by SUN, and/or written statements receivedfrom the respective individuals, SUN believes that during the period January 1,2002 through December 31, 2002, its officers and directors were in compliancewith all filing requirements applicable to them.

 

 

ITEM 11 - EXECUTIVECOMPENSATION

 

Informationrelating to management remuneration and compensation is incorporated herein byreference to Executive Compensation and Other Information on page 11 of the2003 Proxy Statement.

 

 

ITEM 12 - SECURITY OWNERSHIP ORCERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Thisinformation is incorporated by reference to Security Ownership of Directors andExecutive Officers of the Corporation on pages 28 and 29 of the 2002 ProxyStatement.

 

                Information related to the Equity Compensation Planis incorporated by reference to the Equity Compensation Plan table on page 14of the 2003 Proxy Statement.

 

ITEM 13 - CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS

 

Thisinformation is incorporated by reference to footnote 15 on page 32 of the 2002Annual Report to Shareholders and under the heading of Transactions withManagement on pages 20 and 21 of the 2003 Proxy Statement.

 

ITEM 14 — CONTROLS AND PROCEDURES

 

(a)Evaluation of disclosure controls and procedures

 

        Under the supervision and with theparticipation of management, including the Chief Executive Officer and ChiefFinancial Officer, the effectiveness of the design and operation of SUN’s disclosurecontrols and procedures (as defined in Rule 13a-14(c) under the Exchange Act)was evaluated as of a date(the “Evaluation Date”) within 90 days prior to thefiling date of this report.  Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, SUN’s disclosure controls andprocedures were effective in timely alerting them to the material informationrelating to SUN’s (or SUN’s consolidated subsidiaries) required to be includedin its periodic SEC filings.

 

(a)Changes in internal controls

 

Therewere no significant changes made in SUN’s internal controls during the periodcovered by this report or, to their knowledge, in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation.

 

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PART IV

 

ITEM 15 - EXHIBITS, FINANCIALSTATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 

   (a)(1) The following consolidated financial statements and independent accountantsreport of SUN BANCORP, INC. and subsidiaries included in the Annual Report toShareholders for the year ended December 31, 2002 are incorporated by referencein Part II, Item 8:

 

ConsolidatedBalance Sheets - December 31, 2002 and 2001

 

ConsolidatedStatements of Income - Years Ended December 31, 2002,

2001,and 2000

 

ConsolidatedStatements of Changes in Shareholders’ Equity - Years

EndedDecember 31, 2002, 2001, and 2000

 

ConsolidatedStatements of Cash Flows - Years Ended December 31, 2002, 2001, and 2000

 

Notesto Consolidated Financial Statements

 

IndependentAccountants Report

 

(2) All schedules applicable to the Registrant are shown in therespective financial statements or the notes thereto.  Financial statement schedules not included are omitted becausethe information is not required under the related instructions or it isinapplicable.

 

(3)  Exhibits

3(i)                     The Articles of Incorporationof the Corporation are incorporated herein by reference to Exhibit 3 to theCorporation’s Registration Statement on Form S-8 filed with the Securities andExchange Commission on August 12, 1998 (Commission File Number 0-14745).

 

3(ii)                  The By-Laws, as amended andrestated, are incorporated herein by reference to Exhibit 3 to theCorporation’s Annual Report on Form 10-K for the year ended December 31, 1993(Commission File Number 0-14745).

 

10                          Employment agreements betweenRobert J. McCormack and Sun Bancorp, Inc. and SunBank dated October 31, 2002,Sandra Miller and Sun Bancorp, Inc. and SunBank dated October 24, 2002, ThomasW. Bixler and Sun Bancorp, Inc. and SunBank dated November 3, 2002, and MaureenM. Bufalino and Sun Bancorp, Inc. and SunBank dated May 31, 2001, areincorporated by reference to Form 8-K filed March, 20, 2003 (Commission FileNumber 0-14745).

 

13                          Annual Report to Shareholdersof SUN BANCORP, INC. for the year ended December 31, 2002 is filedherewith.  The report, except for thoseportions thereof which are expressly incorporated by reference herein, is furnishedfor information of the Securities and Exchange Commission only and it is notconsidered “filed” as part of the Form 10-K filing.

 

21                          Subsidiaries of the Registrant.

 

22                          Published Report RegardingMatters Submitted To Vote Of Shareholders is incorporated by reference to the2003 Definitive Proxy Statement of SUN BANCORP, INC.

 

23                          Consent of IndependentAccountants.

 

 

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(b)  On December 23, 2002 Form 8-K was filedregarding the acquisition of Mid-Penn Insurance Associates, Inc.

 

       On December 23, 2002 Form 8-K was filedregarding the acquisition of Steelton Bancorp, Inc.

 

(c)  Exhibits - the required exhibits are includedunder Item 14(a) (3) of the Form 10-K.

 

(d)  Financial statement schedules are omittedbecause the required information is not applicable or is included elsewhereherein.

 

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SIGNATURES

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, SUN BANCORP, INC.has duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 

 

 
|   |    | Sun  Bancorp, Inc.                     |
|--------|---------|----------------------------------------|
|   |    | (Registrant)                           |
|   |    |                                   |
|   |    |                                   |
| Date:  | 3/21/03 |                                   | By: | /s/ Robert J. McCormack |
|   |    | Robert J. McCormack                    |
|   |    | President and Chief Executive  Officer |
|   |    | (Principal Executive Officer)          |
|   |    |                                   |
| Date:  | 3/21/03 |                                   | By: | /s/Wilmer D. Leinbach |
|   |    | Wilmer D.  Leinbach                    |
|   |    | Exec. VP, Chief  Financial Officer     |
|   |    | (Principal  Financial Officer and      |
|   |    | Principal Accounting Officer)          |
|        |         |                                        |  |  |  |

 

 

 

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed on behalf ofthe Registrant and in the capacities and on the dates indicated.

 

 

 

12

----

 
|                                              |   |     |
|---------------------------------------------------|--------|----------|
| **Name**                                          |   | **Date** |
| /s/ Robert A. Hormell                             |   | 3/21/03  |
| Robert A. Hormell                                 |   |     |
| Chairman of the Board                             |   |     |
|                                              |   |     |
| /s/ Robert J. McCormack                           |   | 3/21/03  |
| Robert J. McCormack                               |   |     |
| President, Chief Executive  Officer, and Director |   |     |
|                                              |   |     |
| /s/ Martha A. Barrick                             |   | 3/21/03  |
| Martha A. Barrick, Director                       |   |     |
|                                              |   |     |
| /s/ Max E. Bingaman                               |   | 3/21/03  |
| Max E. Bingaman, Director                         |   |     |
|                                              |   |     |
| /s/ Maureen M. Bufalino                           |   | 3/21/03  |
| Maureen M. Bufalino, Director                     |   |     |
|                                              |   |     |
| /s/ David R. Dieck                                |   | 3/21/03  |
|  David R. Dieck, Director                    |   |     |
|                                              |   |     |
| /s/ Louis A. Eaton                                |   | 3/21/03  |
| Louis A. Eaton, Director                          |   |     |
|                                              |   |     |
| /s/ M. Mitchell Fetterolf                         |   | 3/21/03  |
| M. Mitchell Fetterolf,  Director                  |   |     |
|                                              |   |     |
| /s/ Stephen J. Gurgovits                          |   | 3/21/03  |
| Stephen J. Gurgovits,  Director                   |   |     |
|                                              |   |     |
| /s/ Paul R. John                                  |   | 3/21/03  |
| Paul R. John, Director                            |   |     |
|                                              |   |     |
| /s/ George F. Keller                              |   | 3/21/03  |
| George F. Keller, Director                        |   |     |
|                                              |   |     |
| /s/ George E. Logue, Jr.                          |   | 3/21/03  |
| George E. Logue, Jr., Director                    |   |     |
|                                              |   |     |
| /s/ Marlin T. Sierer                              |   | 3/21/03  |
| Marlin T. Sierer, Director                        |   |     |
|                                              |   |     |
| /s/ Gary L. Tice                                  |   | 3/21/03  |
| Gary L. Tice, Director                            |   |     |
|                                              |   |     |
| /s/ Dennis J. Van                                 |   | 3/21/03  |
| Dennis J. Van, Director                           |   |     |

 

13

----

 

 

Subsidiariesof Sun Bancorp, Inc.

 

The following table sets forththe subsidiaries of the Registrant at December 31, 2001.

 
| Name                                  |   | Organized  Under the Laws of  |
|---------------------------------------|--------|-------------------------------|
| SunBank                               |   | Commonwealth  of Pennsylvania |
| Lewisburg,  PA                        |   |                          |
| Wholly  Owned                         |   |                          |
|                                  |   |                          |
| Beacon Life Insurance Company         |   | State  of Arizona             |
| Phoenix,  AZ                          |   |                          |
| Wholly  Owned                         |   |                          |
|                                  |   |                          |
| Sun Bancorp Statutory Trust I         |   | State  of Connecticut         |
| Hartford,  CT                         |   |                          |
| Wholly  Owned                         |   |                          |
|                                  |   |                          |
| SUBI Investment Company               |   | State  of Delaware            |
| Wilmington,  DE                       |   |                          |
| Wholly  Owned                         |   |                          |
|                                  |   |                          |
| Sun Abstract and Settlement  Services |   | Commonwealth  of Pennsylvania |
| Lewisburg,  PA                        |   |                          |
| Thirty  Percent Owned                 |   |                          |
|                                  |   |                          |
| Sun Investment Services, Inc.         |   | Commonwealth  of Pennsylvania |
| Lewisburg,  PA                        |   |                          |
| Wholly  Owned                         |   |                          |
|                                  |   |                          |
| SUBI Services, Inc.                   |   | Commonwealth  of Pennsylvania |
| Lewisburg,  PA                        |   |                          |
| Wholly  Owned                         |   |                          |

 

 

 

 

 

 

14

----

 

 

CONSENTOF INDEPENDENT ACCOUNTANTS

 

 

We hereby consent to theincorporation by reference in the Registration Statements on Form S-8 (No.  333-61249, No.  333-61241,  No. 333-40266 and No.  333-61237)  of Sun Bancorp,Inc. of our report dated February 11, 2003 relating to the financialstatements, which appears in the Annual Report to Shareholders, which is incorporatedin this Annual Report on Form 10-K.

 

 

/s/ PricewaterhouseCoopers LLP

 

Harrisburg, Pennsylvania

March 21, 2003

 

CONSENT OF INDEPENDENT ACCOUNTANTS

 

We hereby consent to theincorporation by reference in the Registration Statements on Forms S-8 (Nos.333-61249, 333-61241, 333-40266 and 333-61237) of Sun Bancorp, Inc. of our reportdated February 19, 2002, which is incorporated by reference to the 2001 AnnualReport.

 

 

/s/ Parente Randolph, PC

 

Williamsport, Pennsylvania

March 21, 2003

 

15

----

**CERTIFICATION**

 

I, Robert J. McCormack, President and Chief Executive Officer, certify, that:

 

1.                    I have reviewed this annual report on Form 10-K of Sun Bancorp, Inc.

 

2.                    Based on my knowledge, the annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the period covered by this annual report.

 

3.                    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

 

4.                    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

(a)               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

(b)              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

 

(c)               presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.

 

5.                    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

(a)               all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

(b)              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

 

6.                    The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant  changes in internal controls or in other factors that could significantly affect the internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 
| 7.     | Date:  | March 21, 2003 |   | By:                                     |  /s/ Robert J. McCormack   |
|--------|--------|----------------|--------|-----------------------------------------|-------------------------------------------|
|   |   |           |   | President & Chief Executive Officer |

 

 

16

 

**CERTIFICATION**

 

I, Wilmer D. Leinbach, Executive Vice President and Chief Financial Officer, certify, that:

 

1.                    I have reviewed this annual report on Form 10-K of Sun Bancorp, Inc.

 

2.                    Based on my knowledge, the annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the period covered by this annual report.

 

3.                    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

 

4.                    The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

(a)               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

(b)              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

 

(c)               presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.

 

5.                    The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

(a)               all significant deficiencies in the design or operation of the internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

(b)              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

 

8.                    The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant  changes in internal controls or in other factors that could significantly affect the internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 
| 7.     | Date:  | March 21, 2003 |   | By:                                                  | /s/ Wilmer D. Leinbach |
|--------|--------|----------------|--------|------------------------------------------------------|------------------------|
|   |   |           |   | Executive Vice President and Chief Financial Officer |

 

 

17

----

 

 
| Financial Contents                           |   |
|----------------------------------------------|--------|
| Consolidated  Financial Statements           |   |
| Notes to  Consolidated Financial Statements  |   |
| Report of Independent  Accountants           |   |
| Five-Year Financial  Highlights              |   |
| Management’s  Discussion & Analysis |   |

 

18

----

 

**Consolidated Balance Sheets**

 

(In Thousands, Except for Share Data)

 
| **December 31,**                                                                                                    |   | **2002** |    | **2001** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Assets                                                                                                              |   |     |    |     |   |
| Cash and due from banks                                                                                             |   | $        | 21,399  |     | $      | 24,125 |   |
| Interest-bearing deposits in banks                                                                                  |   | 20,170   |    | 20,858   |   |
| Total cash and cash equivalents                                                                                     |   | 41,569   |    | 44,983   |   |
| Investment securities, available for sale                                                                           |   | 219,438  |    | 305,612  |   |
| Loans, net                                                                                                          |   | 583,519  |    | 515,520  |   |
| Bank premises and equipment, net                                                                                    |   | 15,809   |    | 14,462   |   |
| Goodwill                                                                                                            |   | 22,924   |    | 22,924   |   |
| Accrued interest                                                                                                    |   | 3,501    |    | 5,063    |   |
| Bank owned life insurance                                                                                           |   | 30,800   |    | —   |   |
| Other assets                                                                                                        |   | 33,614   |    | 13,486   |   |
| Total assets                                                                                                        |   | $        | 951,174 |     | $      | 922,050 |   |
|                                                                                                                |   |     |    |     |   |
| Liabilities and Shareholders’ Equity                                                                           |   |     |    |     |   |
| Deposits:                                                                                                           |   |     |    |     |   |
| Non-interest-bearing                                                                                                |   | $        | 59,181  |     | $      | 57,990 |   |
| Interest-bearing                                                                                                    |   | 528,299  |    | 515,887  |   |
| Total deposits                                                                                                      |   | 587,480  |    | 573,877  |   |
| Short-term borrowings                                                                                               |   | 29,682   |    | 22,138   |   |
| Other borrowed funds                                                                                                |   | 220,000  |    | 222,000  |   |
| Subordinated debentures                                                                                             |   | 19,655   |    | 20,444   |   |
| Accrued interest and other liabilities                                                                              |   | 13,110   |    | 6,080    |   |
| Total liabilities                                                                                                   |   | 869,927  |    | 844,539  |   |
|                                                                                                                |   |     |    |     |   |
| Shareholders’ equity:                                                                                          |   |     |    |     |   |
| Common stock, no par value per share; 20,000,000 authorized shares;  issued 7,299,446 in 2002 and 7,236,251 in 2001 |   | 84,591   |    | 83,565   |   |
| Retained earnings (deficit)                                                                                         |   | (5,159   | )       | (6,961   | )      |
| Accumulated other comprehensive income                                                                              |   | 3,578    |    | 2,069    |   |
| Less: Treasury stock at cost, 126,717 shares in 2002 and 93,417 shares  in 2001                                     |   | (1,763   | )       | (1,162   | )      |
| Total shareholders’ equity                                                                                     |   | 81,247   |    | 77,511   |   |
| Total liabilities and shareholders’ equity                                                                     |   | $        | 951,174 |     | $      | 922,050 |   |

 

19

----

 

**Consolidated Statements of Income**

 

(In Thousands, Except for Net Income Per Share)

 
| **Years Ended December 31,**                                   |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Interest and dividend income:                                  |   |     |   |     |   |     |   |
| Interest and fees on loans                                     |   | $        | 40,310 |     | $      | 38,603   |   | $ | 33,964 |   |
| Income from available for sale securities:                     |   |     |   |     |   |     |   |
| Taxable                                                        |   | 12,380   |   | 17,089   |   | 16,805   |   |
| Tax exempt                                                     |   | 1,015    |   | 1,137    |   | 967      |   |
| Dividends                                                      |   | 475      |   | 1,520    |   | 1,396    |   |
| Interest on deposits in banks and other financial institutions |   | 363      |   | 1,345    |   | 428      |   |
| Total interest and dividend income                             |   | 54,543   |   | 59,694   |   | 53,560   |   |
| Interest expense:                                              |   |     |   |     |   |     |   |
| Interest on deposits                                           |   | 14,733   |   | 21,164   |   | 18,075   |   |
| Interest on short-term borrowings                              |   | 325      |   | 430      |   | 853      |   |
| Interest on other borrowed funds                               |   | 12,698   |   | 12,787   |   | 12,897   |   |
| Interest on subordinated debentures                            |   | 1,892    |   | 1,578    |   | —   |   |
| Total interest expense                                         |   | 29,648   |   | 35,959   |   | 31,825   |   |
| Net interest income                                            |   | 24,895   |   | 23,735   |   | 21,735   |   |
| Provision for loan and lease losses                            |   | 1,460    |   | 1,500    |   | 2,500    |   |
| Net interest income after provision for loan and lease losses  |   | 23,435   |   | 22,235   |   | 19,235   |   |
| Non-interest income:                                           |   |     |   |     |   |     |   |
| Service charges on deposit accounts                            |   | 3,041    |   | 1,903    |   | 1,315    |   |
| Trust income                                                   |   | 759      |   | 745      |   | 897      |   |
| Net securities gains (losses)                                  |   | 616      |   | 844      |   | (1,955   | )      |
| Income from investment product sales                           |   | 406      |   | 309      |   | —   |   |
| Bank owned life insurance                                      |   | 720      |   | —   |   | —   |   |
| Income from insurance subsidiary                               |   | 77       |   | 183      |   | 270      |   |
| Gain on sale of branches                                       |   | —   |   | 4,892    |   | —   |   |
| Gain on sale of loans                                          |   | 255      |   | 130      |   | 25       |   |
| Other income                                                   |   | 794      |   | 502      |   | 432      |   |
| Total non-interest income                                      |   | 6,668    |   | 9,508    |   | 984      |   |
| Non-interest expense:                                          |   |     |   |     |   |     |   |
| Salaries and employee benefits                                 |   | 11,800   |   | 9,680    |   | 7,319    |   |
| Net occupancy expenses                                         |   | 1,083    |   | 995      |   | 660      |   |
| Furniture and equipment expenses                               |   | 1,790    |   | 1,745    |   | 1,184    |   |
| Pennsylvania shares tax                                        |   | 800      |   | 699      |   | 600      |   |
| Amortization of intangibles                                    |   | —   |   | 1,567    |   | 755      |   |
| Expenses of insurance subsidiary                               |   | 117      |   | 110      |   | 190      |   |
| Other expenses                                                 |   | 7,032    |   | 5,253    |   | 3,387    |   |
| Total non-interest expense                                     |   | 22,622   |   | 20,049   |   | 14,095   |   |
| Income before income tax provision                             |   | 7,481    |   | 11,694   |   | 6,124    |   |
| Income tax provision                                           |   | 1,065    |   | 3,344    |   | 1,526    |   |
| Net income                                                     |   | $        | 6,416  |     | $      | 8,350    |   | $ | 4,598 |   |
| Net income per share — Basic                              |   | $        | 0.90   |     | $      | 1.20     |   | $ | 0.68 |   |
| Net income per share — Diluted                            |   | $        | 0.89   |     | $      | 1.20     |   | $ | 0.68 |   |

 

20

----

 

**Consolidated Statements of Changes inShareholders’ Equity**

 

(In Thousands, Except for Share Data)

Years Ended December 31, 2002, 2001 and 2000

 
|                                                                                                    |   | **Common  Stock  Shares** |   | **Amount** |   | **Retained  Earnings  (Deficit)** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Treasury  Stock** |    | **Total  Shareholders’  Equity** |   |
|---------------------------------------------------------------------------------------------------------|--------|---------------------------|--------|------------|--------|-----------------------------------|--------|------------------------------------------------------|--------|---------------------|---------|---------------------------------------|--------|
| Balance, January 1, 2000                                                                                |   | 7,219                     |   | $          | 81,520 |                              | $      | (10,498                                              | )      | $                   | (10,667 | )                                     | $      | (4,342 | ) | $ | 56,013 |   |
| Comprehensive income:                                                                                   |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Net income                                                                                              |   | —                    |   | —     |   | 4,598                             |   | —                                               |   | —              |    | 4,598                                 |   |
| Unrealized gains on securities available for sale, net of  reclassification adjustments and tax effects |   | —                    |   | —     |   | —                            |   | 9,076                                                |   | —              |    | 9,076                                 |   |
| Total comprehensive income                                                                              |   |                      |   |       |   |                              |   |                                                 |   |                |    | 13,674                                |   |
| Stock issued:                                                                                           |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Employee benefit plans                                                                                  |   | 8                         |   | 112        |   | —                            |   | —                                               |   | —              |    | 112                                   |   |
| Purchase of treasury stock (140,391 shares)                                                             |   | —                    |   | —     |   | —                            |   | —                                               |   | (1,995              | )       | (1,995                                | )      |
| Cash dividends declared, $.78 per share                                                                 |   | —                    |   | —     |   | (5,277                            | )      | —                                               |   | —              |    | (5,277                                | )      |
| Balance, December 31, 2000                                                                              |   | 7,227                     |   | 81,632     |   | (11,177                           | )      | (1,591                                               | )      | (6,337              | )       | 62,527                                |   |
| Comprehensive income:                                                                                   |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Net income                                                                                              |   | —                    |   | —     |   | 8,350                             |   | —                                               |   | —              |    | 8,350                                 |   |
| Unrealized gains on securities available for sale, net of  reclassification adjustments and tax effects |   | —                    |   | —     |   | —                            |   | 3,660                                                |   | —              |    | 3,660                                 |   |
| Total comprehensive income                                                                              |   |                      |   |       |   |                              |   |                                                 |   |                |    | 12,010                                |   |
| Stock issued:                                                                                           |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Employee benefit plans                                                                                  |   | 9                         |   | 123        |   | —                            |   | —                                               |   | —              |    | 123                                   |   |
| Purchase of Guaranty Bank, N.A. (553,558 treasury shares)                                               |   | —                    |   | 1,810      |   | —                            |   | —                                               |   | 6,388               |    | 8,198                                 |   |
| Purchase of treasury stock (80,535 shares)                                                              |   | —                    |   | —     |   | —                            |   | —                                               |   | (1,213              | )       | (1,213                                | )      |
| Cash dividends declared, $.60 per share                                                                 |   | —                    |   | —     |   | (4,134                            | )      | —                                               |   | —              |    | (4,134                                | )      |
| Balance, December 31, 2001                                                                              |   | 7,236                     |   | 83,565     |   | (6,961                            | )      | 2,069                                                |   | (1,162              | )       | 77,511                                |   |
| Comprehensive income:                                                                                   |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Net income                                                                                              |   | —                    |   | —     |   | 6,416                             |   | —                                               |   | —              |    | 6,416                                 |   |
| Unrealized gains on securities available for sale, net of  reclassification adjustments and tax effects |   | —                    |   | —     |   | —                            |   | 1,509                                                |   | —              |    | 1,509                                 |   |
| Total comprehensive income                                                                              |   |                      |   |       |   |                              |   |                                                 |   |                |    | 7,925                                 |   |
| Stock issued:                                                                                           |   |                      |   |       |   |                              |   |                                                 |   |                |    |                                  |   |
| Employee benefit plans, net of tax benefit                                                              |   | 63                        |   | 1,026      |   | —                            |   | —                                               |   | —              |    | 1,026                                 |   |
| Purchase of treasury stock (33,300 shares)                                                              |   | —                    |   | —     |   | —                            |   | —                                               |   | (601                | )       | (601                                  | )      |
| Cash dividends declared, $0.645 per share                                                               |   | —                    |   | —     |   | (4,614                            | )      | —                                               |   | —              |    | (4,614                                | )      |
| Balance, December 31, 2002                                                                              |   | 7,299                     |   | $          | 84,591 |                              | $      | (5,159                                               | )      | $                   | 3,578   |                                  | $      | (1,763 | ) | $ | 81,247 |   |

 

21

----

 

**Consolidated Statements of Cash Flows(In Thousands)**

 
| **Years Ended December 31,**                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                                                        |   |     |   |     |   |     |   |
| Net income                                                                                   |   | $        | 6,416  |     | $      | 8,350    |   | $ | 4,598 |   |
| Adjustments to reconcile net income to net cash (used in) provided by  operating activities: |   |     |   |     |   |     |   |
| Provision for loan and lease losses                                                          |   | 1,460    |   | 1,500    |   | 2,500    |   |
| Depreciation                                                                                 |   | 1,049    |   | 977      |   | 812      |   |
| Amortization of intangibles                                                                  |   | —   |   | 1,567    |   | 755      |   |
| Amortization and accretion of premium and discounts on securities                            |   | 1,081    |   | 418      |   | 90       |   |
| Deferred income tax                                                                          |   | —   |   | (305     | )      | (349     | )      |
| Net securities (gains) losses                                                                |   | (616     | )      | (844     | )      | 1,955    |   |
| Gain on sale of branches                                                                     |   | —   |   | (4,892   | )      | —   |   |
| Gain on sale of bank premises and equipment                                                  |   | (6       | )      | (71      | )      | —   |   |
| Net change in other assets and liabilities                                                   |   | (12,654  | )      | (7,016   | )      | (2,217   | )      |
| Net cash (used in) provided by operating activities                                          |   | (3,270   | )      | (316     | )      | 8,144    |   |
| Cash flows from investing activities:                                                        |   |     |   |     |   |     |   |
| Proceeds from sales of available for sale securities                                         |   | 26,417   |   | 43,252   |   | 71,024   |   |
| Proceeds from maturities, calls, and prepayments of securities                               |   | 156,665  |   | 109,051  |   | 31,622   |   |
| Purchase of bank owned life insurance                                                        |   | (30,000  | )      | —   |   | —   |   |
| Cash acquired from branch acquisitions                                                       |   | —   |   | 92,852   |   | —   |   |
| Cash paid from sale of branches                                                              |   | —   |   | (32,431  | )      | —   |   |
| Purchases of investment securities                                                           |   | (95,087  | )      | (135,464 | )      | (98,836  | )      |
| Issuance of loans, net of repayment                                                          |   | (69,918  | )      | (59,981  | )      | (30,472  | )      |
| Proceeds from sale of branches                                                               |   | —   |   | 4,892    |   | —   |   |
| Proceeds from sale of bank premises and equipment                                            |   | 6        |   | 222      |   | —   |   |
| Capital expenditures                                                                         |   | (2,396   | )      | (596     | )      | (1,165   | )      |
| Net cash (used in) provided by investing activities                                          |   | (14,313  | )      | 21,797   |   | (27,827  | )      |
| Cash flows from financing activities:                                                        |   |     |   |     |   |     |   |
| Net increase (decrease) in deposits                                                          |   | 13,603   |   | (8,557   | )      | 44,445   |   |
| Net increase (decrease) in short-term borrowings                                             |   | 7,544    |   | 5,506    |   | (26,384  | )      |
| Proceeds from other borrowed funds                                                           |   | —   |   | —   |   | 100,000  |   |
| Repayments of other borrowed funds                                                           |   | (2,000   | )      | —   |   | (92,000  | )      |
| Proceeds from issuance of subordinated debentures                                            |   | —   |   | 16,500   |   | —   |   |
| Repayments of subordinated debentures                                                        |   | (789     | )      | —   |   | —   |   |
| Cash dividends paid                                                                          |   | (4,614   | )      | (4,134   | )      | (5,277   | )      |
| Proceeds from sale of stock for employee benefits program                                    |   | 1,026    |   | 123      |   | 112      |   |
| Purchase of treasury stock                                                                   |   | (601     | )      | (1,213   | )      | (1,995   | )      |
| Net cash provided by financing activities                                                    |   | 14,169   |   | 8,225    |   | 18,901   |   |
| Net (decrease) increase in cash and cash equivalents                                         |   | (3,414   | )      | 29,706   |   | (782     | )      |
| Cash and cash equivalents at beginning of year                                               |   | 44,983   |   | 15,277   |   | 16,059   |   |
| Cash and cash equivalents at end of year                                                     |   | $        | 41,569 |     | $      | 44,983   |   | $ | 15,277 |   |
| Supplemental disclosure of cash flow information:                                            |   |     |   |     |   |     |   |
| Interest paid                                                                                |   | $        | 29,650 |     | $      | 34,598   |   | $ | 31,825 |   |
| Income taxes paid                                                                            |   | $        | 1,950  |     | $      | 2,450    |   | $ | 2,239 |   |

 

Supplemental schedule of noncash investing and financing activities:

• Loans with anestimated value of $459 in 2002 and $837 in 2001, were reclassified toforeclosed assets held for sale.

 

22

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**Notesto Consolidated Financial Statements****(For the Years Ended December 31, 2002,2001 and 2000)**

 

**1. Basisof Presentation and Summary of Significant Accounting Policies**

 

Sun Bancorp, Inc. and subsidiaries (“Sun”) accounting and financialreporting policies conform with accounting principles generally accepted in theUnited States of America and with general financial industry practices. Certainprior year amounts were reclassified to conform to current yearclassifications. The net effect of the reclassifications had no impact on theoverall financial position or net income. The following summary addresses themost significant policies:

 

**ConsolidationBasis**

Consolidated financial statements include the accounts of Sun Bancorp,Inc. (parent company) and its wholly owned subsidiaries: SunBank (Bank), SUBIInvestment Company, Sun Trust I, Beacon Life Insurance Company (Beacon), andSUBI Services LLC. Sun also holds thirty percent ownership in Sun Abstract andSettlement Services (Sun Abstract). Beacon’s, Sun Abstract’s, and SUBI ServicesLLC transactions are not material to the consolidated financial statements. Allsignificant intercompany balances and transactions have been eliminated inconsolidation.

 

**Operations**

Sun provides a full-range of community and commercial banking servicesthrough 23 SunBank offices in northeast and central Pennsylvania. SunBank’sprimary deposit products include checking, savings, money market, andcertificate of deposit accounts. SunBank’s primary loan products includecommercial loans, consumer loans, and single-family residential mortgages.

 

**Use ofEstimates**

In preparing the financial statements, management is required to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the balance sheets, the disclosed amounts ofcontingent assets and liabilities as of the date of the balance sheets, and thereported amounts of revenues and expenses for the periods presented. Actualresults could differ significantly from those estimates. In particular,management relies on estimates and assumptions when determining an adequate allowancefor loan and lease losses. Refer to the heading “Allowance for Loan and LeaseLosses (ALLL)” in Note 1 for additional information. In addition, managementrelies on estimates and assumptions when determining the residual value forSunBank’s auto and equipment leasing business. Refer to the heading “ResidualValue” in Note 1 for additional information. Deferred tax assets andliabilities also represent significant estimates (see Note 14).

 

**InvestmentSecurities**

Sun reports all securities, including debt instruments, restrictedequities, and unrestricted equities as available for sale. Except forrestricted equities, Sun reports all securities at fair value. Unrealized gainsor losses, net of tax, are excluded from earnings and reported as a component ofaccumulated other comprehensive income within shareholders’ equity. Restrictedequities consist primarily of Federal Home Loan Bank of Pittsburgh (FHLB)stock. Management estimates fair values based on observable market prices. Whenbid prices are not available, management relies on standard economic valuemodels. When neither bid prices or economic value models are available,management estimates fair value based on observable market prices forinstruments with similar cash flow and risk characteristics.

Premium amortization and discount accretion are recorded using the levelyield method over each security’s remaining contractual or expected life(whichever is shorter), adjusted for actual prepayment experience. Realizedgains and losses from securities sales are computed based on each security’sspecific carrying value.

 

**InterestIncome on Loans and Leases**

Interest income on commercial, consumer, and mortgage loans isrecognized on an accrual basis. Interest income on installment loans and leasesis recognized on an accrual basis and the actuarial method. Loan fees andcertain direct loan origination costs are being deferred and the net amountamortized 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 ceasedand where all previously accrued but not collected interest is reversed. Loans,other than consumer loans, are placed on nonaccrual status when principal orinterest is past due 90 days or more and the loan is not well-collateralizedand in the process of collection or immediately, if, in the opinion ofmanagement, full collection is doubtful. Interest accrued but not collected asof the date of placement on nonaccrual status is reversed and charged againstcurrent income. Sun does not accrue interest on impaired loans. While a loan isconsidered impaired or on nonaccrual status, subsequent cash interest paymentsreceived either are applied to the outstanding principal balance or recorded asinterest income, depending upon management’s assessment of the ultimatecollectibility of principal and interest. In any case, the deferral ornon-recognition of interest does not constitute forgiveness of the borrower’sobligation. Consumer loans are recorded in accordance with the Uniform RetailClassification regulation. Generally, the regulation requires that consumerloans are charged off to the allowance for loan losses when they become 120days or more past due.

 

**Loan Servicing**

Mortgage loans serviced are not included in Sun’s consolidated balancesheets. Unpaid principal of mortgage loans serviced for others totaled$18,132,000 at December 31, 2002, and $20,769,000 at December 31, 2001.Capitalized mortgage servicing rights (MSRs), included with other assets in theconsolidated balance sheets, totaled approximately $38,000 at December 31, 2002and $36,000 at December 31, 2001.

Sun records MSRs at fair value and amortizes the balance over the periodof estimated net servicing income or loss. Sun relies on a valuation model tocalculate the net present value of expected future cash flows that determinesthe MSRs fair value. Sun’s valuation model incorporates assumptions marketparticipants might use to estimate future net servicing income, including loantypes, interest rates, servicing costs, prepayment speeds, and discount rates.Sun periodically evaluates the MSR’s value for impairment.

 

23

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**Allowancefor Loan and Lease Losses (ALLL)**

Sun’s ALLL reflects periodic provisions for loan and lease losses, andthat provision is reported as an expense. Loan losses are charged against theALLL in the period in which they have been determined to be uncollectible.Recoveries of previously charged off loans are credited to the allowance asthey are received. Management maintains the ALLL at a level it believes will beadequate to absorb probable losses in the existing loan portfolio. Sun’s loanportfolio consists primarily of residential mortgage loans and commercial loansconcentrated in northeast and central Pennsylvania (Lycoming, Snyder, Union,Northumberland, Clinton and Luzerne counties). These regions’ economy depend onthe manufacturing and service industries. Management’s analysis incorporatesmany factors, including current economic conditions, loss experience, loanportfolio composition, and anticipated losses. For significant real estateproperties, management obtains independent value appraisals. Management alsoretains consultants to periodically review loan quality. However, unforeseendevelopments may require management to increase the ALLL. Such developmentscould include changing economic conditions or negative developments withborrowers. In addition, bank regulators periodically assess Sun’s ALLL and may,consistent with examination guidelines and current information, require anincreased ALLL. As a result, any number of factors may materially changemanagement’s analysis in the future.

 

**ResidualValue – Auto**

Sun’s residual value represents the estimated wholesale market value ofa leased auto at the end of the lease term, which is established at thebeginning of the lease term by the Automotive Lease Guide (ALG). Residualvalues which are above the wholesale market value at the end of the lease termcould lead to financial losses. To mitigate the possible loss, Sun has enteredinto an insurance policy that limits Sun’s loss to $500 per vehicle, based onthe realized value and Black Book value. The Black Book value is determined bythe national wholesale value of each auto accumulated and published by BlackBook.

 

**ForeclosedAssets**

Sun classifies all foreclosed assets as held for sale and reportsforeclosed assets at the lower of cost or fair value (less estimated sellingcosts). Foreclosed assets, which are included with other assets in theconsolidated balance sheets, totaled $912,000 at December 31, 2002, and$940,000 at December 31, 2001.

 

**Premises andEquipment**

Sun reports premises and equipment at cost less accumulated depreciation.Depreciation expense is computed and recognized using the straight-line method.Sun generally expenses repair and maintenance expenditures as incurred, andcapitalizes such expenditures only when they extend an asset’s useful life.When Sun retires or sells premises or equipment, remaining cost and accumulateddepreciation are removed from the account and any gain or loss is reported incurrent income.

 

**IntangibleAssets**

Sun’s goodwill resulted from the acquisition of Bucktail Bank and TrustCompany (Bucktail) in 1997, Guaranty Bank N.A. in 2001, and three Mellonbranches during 2001, which represents the excess cost of acquired assetsrelative to those assets’ fair value at time of purchase. Sun adopted SFAS 147,Acquisition of Certain Financial Institutions in 2002 as described in Note8.  Prior to 2002, Sun amortizedgoodwill and unidentifiable intangible assets using the straight-line methodand 15-20 year lives. Under the provisions of SFAS 142, goodwill arising fromthe acquisitions during 2001 by Sun will no longer be amortized. Sunperiodically evaluates the goodwill carrying value for impairment based on fairvalue of undiscounted operating cash flows. Amortization of intangibles totaled$1,567,000 in 2001 and $755,000 in 2000. Based on impairment evaluation,management believes no material impairment of intangibles existed at December31, 2002 and December 31, 2001.

 

**Investmentsin Limited Partnerships**

Sun is a limited partner in five partnerships at December 31, 2002 thatprovide low income elderly housing in Sun’s market. Sun’s book value of theseinvestments was $3,922,000 at December 31, 2002 and $4,070,000 at December 31,2001. Sun is amortizing the investment in each partnership over the life of thetax credits generated by the investment, based on an annual impairmentevaluation. The amortization of the limited partnership investments totaled$236,000 in 2002, $ 177,000 in 2001, and $127,000 in 2000.

Sun is also a partner in two partnerships at December 31, 2002 thatprovide office space in areas designated empowerment zones by the Commonwealthof Pennsylvania. These partnerships provide Sun with Pennsylvania Shares Taxcredits and had a book value of $2,901,000 at December 31, 2002.

 

**Income Taxes**

Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to the differences between the financial reportingand income tax accounting methods, using enacted tax rates in effect for theyear in which the difference is expected to reverse. These differences primarilyinvolve timing differences for recognition of loan and lease losses,depreciation, deferred compensation, and loan fee income.

 

**Off-BalanceSheet Financial Instruments**

In the ordinary course of business, Sun enters into off-balance sheetfinancial instruments. Those instruments consist of commitments to extendcredit and standby letters of credit. When those instruments are funded orbecome payable, Sun reports the amounts in its financial statements. Sun hasnot entered into any other off-balance sheet derivative instruments.

 

**Cash andCash Equivalents**

Cash equivalents include cash and due from banks and interest-bearingdeposits in banks. Federal funds and other overnight borrowings are purchasedand sold within a one-day period. Deposits maintained at each financialinstitution are insured by the Federal Deposit Insurance Corporation (FDIC) upto $100,000. Sun maintains cash and cash equivalents with financialinstitutions in excess of the insured amount.

 

**Trust Assetsand Income**

Assets held in a fiduciary or agency capacity are not Sun’s assets andare excluded from Sun’s consolidated financial statements. Trust income isreported on the accrual basis.

 

24

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**2. NetIncome Per Share**

 

Net income per share is computed based on the weighted average number ofshares of stock outstanding for each year presented. Statement of FinancialAccounting Standards (SFAS) No. 128, “Earnings Per Share,” requirespresentation of two amounts; basic and diluted net income per share.

The following data shows the amounts used in computing net income pershare and the weighted average number of shares of dilutive stock options:

 
|                                                                  |   | **Income** |      | **Weighted  Average  Common Shares** |      | **Net Income  Per Share** |   |
|-----------------------------------------------------------------------|--------|------------|-----------|--------------------------------------|-----------|---------------------------|--------|
| 2002                                                                  |   |       |      |                                 |      |                      |   |
| Net income per share — Basic                                     |   | $          | 6,416,000 |                                 | 7,154,107 |                      | $      | 0.90 |   |
| Dilutive effect of potential common stock arising from stock options: |   |       |      |                                 |      |                      |   |
| Exercise of options outstanding                                       |   |       |      | 250,207                              |      |                      |   |
| Hypothetical share repurchase at $19.63                               |   |       |      | (207,780                             | )         |                      |   |
| Net income per share — Diluted                                   |   | $          | 6,416,000 |                                 | 7,196,534 |                      | $      | 0.89 |   |
|                                                                  |   |       |      |                                 |      |                      |   |
| 2001                                                                  |   |       |      |                                 |      |                      |   |
| Net income per share — Basic                                     |   | $          | 8,350,000 |                                 | 6,942,122 |                      | $      | 1.20 |   |
| Dilutive effect of potential common stock arising from stock options: |   |       |      |                                 |      |                      |   |
| Exercise of options outstanding                                       |   |       |      | 236,334                              |      |                      |   |
| Hypothetical share repurchase at $15.63                               |   |       |      | (232,952                             | )         |                      |   |
| Net income per share — Diluted                                   |   | $          | 8,350,000 |                                 | 6,945,504 |                      | $      | 1.20 |   |
|                                                                  |   |       |      |                                 |      |                      |   |
| 2000                                                                  |   |       |      |                                 |      |                      |   |
| Net income per share — Basic                                     |   | $          | 4,598,000 |                                 | 6,769,924 |                      | $      | 0.68 |   |
| Dilutive effect of potential common stock arising from stock options: |   |       |      |                                 |      |                      |   |
| Exercise of options outstanding                                       |   |       |      | 112,952                              |      |                      |   |
| Hypothetical share repurchase at $15.13                               |   |       |      | (98,614                              | )         |                      |   |
| Net income per share — Diluted                                   |   | $          | 4,598,000 |                                 | 6,784,262 |                      | $      | 0.68 |   |

 

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**3.Comprehensive Income**

 

Generally accepted accounting principles require recognized revenues,expenses, gains, and losses be included in net income. Certain changes inassets and liabilities, including unrealized gains and losses on available forsale securities, are reported as a separate equity component and as componentsof comprehensive income. Other comprehensive income components and related taxeffects were:

(In Thousands)

 
| **Years Ended December 31,**                                             |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Unrealized holding gains on available for sale securities                |   | $        | 2,902  |     | $      | 6,389    |   | $ | 11,797 |   |
| Less: Reclassification adjustment for (gains) losses realized in  income |   | (616     | )      | (844     | )      | 1,955    |   |
| Net unrealized gains                                                     |   | 2,286    |   | 5,545    |   | 13,752   |   |
| Income tax expense                                                       |   | (777     | )      | (1,885   | )      | (4,676   | )      |
| Net                                                                      |   | $        | 1,509  |     | $      | 3,660    |   | $ | 9,076 |   |

 

**4.Restrictions on Cash and Due From Bank Accounts**

 

Based on deposit levels, Sun must maintain cash and other reserves withthe Federal Reserve Bank of Philadelphia (FRB). Those reserves averaged$1,284,000 in 2002, $1,186,000 in 2001, and $800,000 in 2000. Sun hasimplemented account analysis systems, which enable reclassification oftransaction accounts to non-transaction accounts. These reserves were$1,356,000 at December 31, 2002 and $1,175,000 at December 31, 2001.

 

**5.Investment Securities**

 

Sun’s entire investment portfolio is classified as available for sale.The amortized cost and fair value of investment securities at December 31, 2002and 2001 are shown below:

(In Thousands)

 
|                                             |   | **Amortized  Cost** |    | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Fair  Value** |   |
|--------------------------------------------------|--------|---------------------|---------|-----------------------|--------|------------------------|--------|-----------------|--------|
| December 31, 2002                                |   |                |    |                  |   |                   |   |            |   |
| Debt securities:                                 |   |                |    |                  |   |                   |   |            |   |
| Obligations of U.S. government agencies          |   | $                   | 173,552 |                  | $      | 4,584                  |   | $               | (133   | ) | $ | 178,003 |   |
| Obligations of states and political subdivisions |   | 19,767              |    | 836                   |   | —                 |   | 20,603          |   |
| Other corporate                                  |   | 5,575               |    | 388                   |   | (75                    | )      | 5,888           |   |
| Total debt securities                            |   | 198,894             |    | 5,808                 |   | (208                   | )      | 204,494         |   |
| Equity securities:                               |   |                |    |                  |   |                   |   |            |   |
| Marketable equity securities                     |   | 3,111               |    | 136                   |   | (315                   | )      | 2,932           |   |
| Restricted equity securities                     |   | 12,012              |    | —                |   | —                 |   | 12,012          |   |
| Total equity securities                          |   | 15,123              |    | 136                   |   | (315                   | )      | 14,944          |   |
| Total                                            |   | $                   | 214,017 |                  | $      | 5,944                  |   | $               | (523   | ) | $ | 219,438 |   |
|                                             |   |                |    |                  |   |                   |   |            |   |
| December 31, 2001                                |   |                |    |                  |   |                   |   |            |   |
| Debt securities:                                 |   |                |    |                  |   |                   |   |            |   |
| Obligations of U.S. government agencies          |   | $                   | 258,234 |                  | $      | 3,982                  |   | $               | (557   | ) | $ | 261,659 |   |
| Obligations of states and political subdivisions |   | 22,054              |    | 312                   |   | (161                   | )      | 22,205          |   |
| Other corporate                                  |   | 7,239               |    | 253                   |   | (40                    | )      | 7,452           |   |
| Total debt securities                            |   | 287,527             |    | 4,547                 |   | (758                   | )      | 291,316         |   |
| Equity securities:                               |   |                |    |                  |   |                   |   |            |   |
| Marketable equity securities                     |   | 3,836               |    | 13                    |   | (667                   | )      | 3,182           |   |
| Restricted equity securities                     |   | 11,114              |    | —                |   | —                 |   | 11,114          |   |
| Total equity securities                          |   | 14,950              |    | 13                    |   | (667                   | )      | 14,296          |   |
| Total                                            |   | $                   | 302,477 |                  | $      | 4,560                  |   | $               | (1,425 | ) | $ | 305,612 |   |

 

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The amortized cost and estimated fair value of Sun’s securities atDecember 31, 2002 and 2001, by contractual maturity, are shown below. Expectedmaturities will differ from contractual maturities because borrowers may havethe right to call or prepay obligations with or without prepayment penalties.

Securities by Contractual Maturity*:

(In Thousands)

 
| **December 31,**                       |   | **2002  Amortized Cost** |    | **Fair Value** |   | **2001  Amortized Cost** |   | **Fair Value** |    |
|----------------------------------------|--------|--------------------------|---------|----------------|--------|--------------------------|--------|----------------|---------|
| Debt securities:                       |   |                     |    |           |   |                     |   |           |    |
| Due in one year or less                |   | $                        | 2,148   |           | $      | 2,177                    |   | $              | 2,742   |   | $ | 2,757 |   |
| Due after one year through five years  |   | 14,683                   |    | 14,909         |   | 20,821                   |   | 21,234         |    |
| Due after five years through ten years |   | 18,107                   |    | 19,240         |   | 36,315                   |   | 37,907         |    |
| Due after ten years                    |   | 15,555                   |    | 16,110         |   | 14,922                   |   | 15,317         |    |
| Mortgage-backed securities             |   | 148,401                  |    | 152,058        |   | 212,727                  |   | 214,101        |    |
| Total debt securities                  |   | 198,894                  |    | 204,494        |   | 287,527                  |   | 291,316        |    |
| Equity securities                      |   | 15,123                   |    | 14,944         |   | 14,950                   |   | 14,296         |    |
| Total                                  |   | $                        | 214,017 |           | $      | 219,438                  |   | $              | 302,477 |   | $ | 305,612 |   |

 

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*Actual principal cash flows may differ due to individual securities’call, prepayment, and other options.

Securities with a carrying value of $174,991,000 at December 31, 2002and $205,215,000 at December 31, 2001 were pledged to secure public deposits,trust deposits, securities sold under agreements to repurchase, FHLBborrowings, and other balances required by law.

Sun’s securities do not include any concentrations exceeding 10% ofshareholders’ equity from any individual issuer (excluding those guaranteed bythe U.S. government or its agencies).

Sales of Securities:

(In Thousands)

 
| **For the Years Ended December 31,** |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Realized Gains                       |   | $        | 1,286  |     | $      | 1,044    |   | $ | 964 |   |
| Realized Losses                      |   | (670     | )      | (200     | )      | (2,919   | )      |
| Net Realized Gains (Losses)          |   | $        | 616    |     | $      | 844      |   | $ | (1,955 | ) |

 

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**6. Loans**

 

Loan activity is well diversified and focused within Sun’s definedmarket area. However, borrowers’ ability to repay loans depends in part oneconomic conditions in Sun’s market area.

Loan Portfolio Composition:

(In Thousands)

 
| **December 31,**                                            |   | **2002** |    | **2001** |   |
|-------------------------------------------------------------|--------|----------|---------|----------|--------|
| Real estate – Mortgages                                |   | $        | 205,885 |     | $      | 206,109 |   |
| Real estate – Commercial                               |   | 198,465  |    | 170,936  |   |
| Real estate – Construction                             |   | 17,721   |    | 6,893    |   |
| Agricultural                                                |   | 138      |    | 503      |   |
| Commercial and industrial                                   |   | 54,624   |    | 34,914   |   |
| Lease – Auto                                           |   | 29,698   |    | 8,489    |   |
| Lease – Equipment                                      |   | 4,955    |    | 2,287    |   |
| Individual                                                  |   | 85,920   |    | 93,200   |   |
| Other                                                       |   | 328      |    | 1,619    |   |
| Total                                                       |   | 597,734  |    | 524,950  |   |
|                                                        |   |     |    |     |   |
| Less: Deferred fees and unearned income on loans and leases |   | (7,945   | )       | (3,089   | )      |
| Unamortized net discount on purchased loans                 |   | (64      | )       | (137     | )      |
| ALLL                                                        |   | (6,206   | )       | (6,204   | )      |
| Net                                                         |   | $        | 583,519 |     | $      | 515,520 |   |

 

Loans held for sale at December 31, 2002 were $1,309,000.

 

**NetInvestment in Direct Financing Leases:**

(In Thousands)

 
| **Years Ended December 31,**          |   | **2002** |   | **2001** |   |
|---------------------------------------|--------|----------|--------|----------|--------|
| Minimum lease payments receivable     |   | $        | 34,653 |     | $      | 10,776 |   |
| Unearned income under lease contracts |   | (7,874   | )      | (2,669   | )      |
| Net investment                        |   | $        | 26,779 |     | $      | 8,107 |   |
| Residual                              |   | $        | 18,876 |     | $      | 4,885 |   |

 

The net investment in direct financing leases is reported as loans inthe consolidated balance sheet. Residual values are reported as other assets inthe consolidated balance sheet.

 

The following table shows the expected lease payments over the next fiveyears.

 

**LeasePayment Receivable:**

(In Thousands)

 
| **Years Ending December 31:** |   |   |   |
|-------------------------------|--------|--------|--------|
| 2003                          |   | $      | 8,315  |   |
| 2004                          |   | 9,580  |   |
| 2005                          |   | 8,720  |   |
| 2006                          |   | 6,555  |   |
| 2007                          |   | 1,483  |   |
| Thereafter                    |   | — |   |
| Total                         |   | $      | 34,653 |   |

 

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Transactions in the ALLL were as follows:

**Allowancefor Loan and Lease Losses (ALLL):**

(In Thousands)

 
| **Years Ended December 31,**              |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Balance, beginning of year                |   | $        | 6,204  |     | $      | 5,074    |   | $ | 3,857 |   |
| Provision for loan and lease losses       |   | 1,460    |   | 1,500    |   | 2,500    |   |
| ALLL assumed upon acquisition of Guaranty |   | —   |   | 572      |   | —   |   |
| Recoveries                                |   | 455      |   | 341      |   | 270      |   |
| Loans charged off                         |   | (1,913   | )      | (1,283   | )      | (1,553   | )      |
| Balance, end of year                      |   | $        | 6,206  |     | $      | 6,204    |   | $ | 5,074 |   |

** **

**ImpairedLoans and Past Due Loans:**

(In Thousands)

 
| **At December 31,**                                                  |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Impaired loans                                                       |   | $        | 4,775  |     | $      | 5,592    |   | $ | 3,482 |   |
| Accruing loans past due 90 days or more as to principal and interest |   | 315      |   | 560      |   | 1,429    |   |
| Amount of impaired loans with a related allowance for possible loss  |   | 4,775    |   | 5,592    |   | 3,482    |   |
| Amount of impaired loans with no related allowance                   |   | —   |   | —   |   | —   |   |
| Total allowance for impaired loans                                   |   | 2,831    |   | 2,339    |   | 410      |   |
|                                                                      |        |          |        |          |        |          |        |  |  |  |

 
| **For Years Ended December 31,**                              |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Average investment in impaired loans                          |   | $        | 5,161  |     | $      | 4,977    |   | $ | 3,518 |   |
| Interest income recognized on impaired loans (all cash basis) |   | $        | 387    |     | $      | 437      |   | $ | 271 |   |

 

**7. BankPremises and Equipment**

 

Bank premises and equipment at December 31:

(In Thousands)

 
| **December 31,**                 |   | **2002** |   | **2001** |   |
|----------------------------------|--------|----------|--------|----------|--------|
| Land                             |   | $        | 2,046  |     | $      | 1,906 |   |
| Bank premises                    |   | 13,175   |   | 12,308   |   |
| Furniture and equipment          |   | 6,954    |   | 6,977    |   |
| Total cost                       |   | 22,175   |   | 21,191   |   |
|                             |   |     |   |     |   |
| Less: Accumulated depreciation   |   | (6,366   | )      | (6,729   | )      |
| Bank premises and equipment, net |   | $        | 15,809 |     | $      | 14,462 |   |

 

Depreciation expense was $1,049,000 in 2002, $977,000 in 2001, and$812,000 in 2000.

 

29

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**8.Goodwill**

 

Upon the adoption of SFAS 142 on January 1, 2002, Sun ceased amortizingits goodwill, which decreased non-interest expense and increased net income for2002 as compared to 2001 and 2000. Sun also adopted SFAS 147 in October 2002which allowed Sun to reclassify previously recorded unidentifiable intangibleassets to goodwill and to cease amortizing this intangible asset effectiveJanuary 1, 2002. The following table shows the proforma effects of applyingSFAS 142 and SFAS 147 to the 2001 and 2000 periods.

(In Thousands, Except for Net Income Per Share)

 
| **Years Ending December 31,**        |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Goodwill amortization:               |   |     |   |     |   |     |   |
| Pre-tax                              |   | $        | — |     | $      | 1,567    |   | $ | 755 |   |
| After-tax                            |   | —   |   | 1,034    |   | 498      |   |
| Net income:                          |   |     |   |     |   |     |   |
| Reported                             |   | 6,416    |   | 8,350    |   | 4,598    |   |
| Add: after-tax goodwill amortization |   | —   |   | 1,034    |   | 498      |   |
| Adjusted                             |   | $        | 6,416  |     | $      | 9,384    |   | $ | 5,096 |   |
| Basic net income per share           |   |     |   |     |   |     |   |
| Reported                             |   | $        | 0.90   |     | $      | 1.20     |   | $ | 0.68 |   |
| Add: goodwill amortization per share |   | —   |   | 0.15     |   | 0.07     |   |
| Adjusted                             |   | $        | 0.90   |     | $      | 1.35     |   | $ | 0.75 |   |
| Diluted net income per share         |   |     |   |     |   |     |   |
| Reported                             |   | $        | 0.89   |     | $      | 1.20     |   | $ | 0.68 |   |
| Add: goodwill amortization per share |   | —   |   | 0.15     |   | 0.07     |   |
| Adjusted                             |   | $        | 0.89   |     | $      | 1.35     |   | $ | 0.75 |   |

 

As of December 31, 2002, Sun had goodwill assets of $22,924,000.Effective January 1, 2002, in conjunction with the adoption of SFAS 147,unidentifiable intangible assets of $8,756,000 were reclassified as goodwill.

 

30

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**9.Deposits**

 

Deposits as of December 31, 2002 and 2001 included:

(In Thousands)

 
| **December 31**                                  |   | **2002** |    | **2001** |   |
|--------------------------------------------------|--------|----------|---------|----------|--------|
| Demand deposits                                  |   | $        | 59,181  |     | $      | 58,063 |   |
| NOW accounts                                     |   | 155,144  |    | 146,339  |   |
| Insured Money Market Accounts                    |   | 29,827   |    | 18,058   |   |
| Savings deposits                                 |   | 76,712   |    | 70,422   |   |
| Time certificates of deposit of $100,000 or more |   | 46,630   |    | 49,484   |   |
| Other time deposits                              |   | 220,016  |    | 231,511  |   |
| Total deposits                                   |   | $        | 587,480 |     | $      | 573,877 |   |

 

The following table reflects certificates of deposit and other timedeposits and their remaining maturities as of December 31, 2002:

(In Thousands)

 
| **Years Ending December 31:** |   |   |    |
|-------------------------------|--------|--------|---------|
| 2003                          |   | $      | 147,354 |   |
| 2004                          |   | 56,056 |    |
| 2005                          |   | 24,403 |    |
| 2006                          |   | 15,538 |    |
| 2006                          |   | 23,135 |    |
| Thereafter                    |   | 160    |    |
| Total                         |   | $      | 266,646 |   |

 

Accounts of $100,000 or More:

The totals above include certificates of deposit and other time depositsissued in amounts of $100,000 or more. These deposits and their remainingmaturities, at December 31, 2002 were:

(In Thousands)

 
| **December 31,**          |   | **2002** |   |
|---------------------------|--------|----------|--------|
| Three months or less      |   | $        | 6,301  |   |
| Three through six months  |   | 4,593    |   |
| Six through twelve months |   | 14,248   |   |
| Over twelve months        |   | 21,488   |   |
| Total                     |   | $        | 46,630 |   |

 

Interest on deposits of $100,000 or more amounted to approximately$2,087,000 in 2002, $3,179,000 in 2001, and $2,691,000 in 2000.

 

31

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**10.Borrowed Funds**

 

At December 31, 2002, Sun’s maximum borrowing capacity at the FHLB was$315,206,000, with $94,968,000 in unused capacity. At December 31, 2001, Sun’smaximum borrowing capacity at the FHLB was $273,979,000, with $51,706,000 inunused capacity. Sun also maintains a line of credit with another financialinstitution of $5,000,000 which was not used at December 31, 2002.

Borrowed funds as of December 31, 2002 and 2001 included:

(In Thousands)

 
| **December 31,**                                   |   | **2002** |    | **2001** |   |
|----------------------------------------------------|--------|----------|---------|----------|--------|
| Short-term Borrowings:                             |   |     |    |     |   |
| Securities sold under agreements to repurchase (1) |   | $        | 29,557  |     | $      | 22,013 |   |
| Treasury Tax and Loan Note Option (2)              |   | 125      |    | 125      |   |
| Total Short-term Borrowings                        |   | 29,682   |    | 22,138   |   |
| FHLB advances (3)                                  |   | 220,000  |    | 222,000  |   |
| Total Borrowed Funds                               |   | $        | 249,682 |     | $      | 244,138 |   |

 

----

(1) Securities sold under agreements to repurchase represent depositcustomers’ cash management accounts. These repurchase agreements arecollateralized by a blanket agreement with the FHLB in which the actualownership of the securities is not transferred. The maximum month end amount ofsecurities sold under agreements to repurchase was $29,557,000 in 2002,$22,673,000 in 2001, and $17,563,000 in 2000.

The average daily amount of such borrowings was $22,107,000 in 2002,$17,101,000 in 2001, and $11,438,000 in 2000, and the weighted average interestrates were 1.91% in 2002, 2.47% in 2001, and 4.66% in 2000.

(2) Borrowings on the Treasury Tax and Loan Note Option (TT&L)represent tax funds deposited and held until the U.S. Treasury calls thebalance.  At December 31, 2002, themaximum amount available to borrow through the Note Options was $125,000. Themaximum month end amount of such borrowings was $125,000 in 2002, $125,000 in2001, and $25,000 in 2000. The average daily amount of such borrowings was$125,000 in 2002, $125,000 in 2001, and $25,000 in 2000, and the weightedaverage interest rates were 1.41% in 2002, 3.46% in 2001, and 5.88% in 2000.

(3) FHLB advances represent variable and fixed rate borrowingscollateralized by first-lien residential mortgages and investment securitiesissued by U.S. government agencies. Stated maturities are shown below:

 

(In Thousands)

 
| **December 31,**                                                             |   | **2002** |    | **2001** |   |
|------------------------------------------------------------------------------|--------|----------|---------|----------|--------|
| Variable rates between 5.04% and 5.41%, at December 31, 2001, maturity  2008 |   | $        | 70,000  |     | $      | 70,000 |   |
| Variable rates between 4.93% and 5.88%, at December 31, 2001, maturity  2009 |   | 50,000   |    | 50,000   |   |
| Variable rates between 5.86% and 6.36%, at December 31, 2001, maturity  2010 |   | 100,000  |    | 100,000  |   |
| Fixed rates between 7.80% and 7.88%, maturity 2002                           |   | —   |    | 2,000    |   |
| Total                                                                        |   | $        | 220,000 |     | $      | 222,000 |   |

 

32

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**11.Estimated Fair Value of Financial Instruments**

 

SFAS 107, “Disclosures about Fair Value of Financial Instruments”, requiresSun to disclose estimated fair values for its financial instruments. Fair valueestimates are made at a specific point in time, based on relevant market andfinancial instrument information. These estimates do not reflect any premium ordiscount that could result from a sale of any particular financial instrumentor group of instruments. Fair value estimates are based on judgments regardingcurrent economic conditions, return rates, and anticipated riskcharacteristics. These estimates are highly subjective, involve considerableuncertainty, and cannot be precisely determined. Changes to those assumptionscan significantly affect the estimated fair values.

Sun determines estimated fair value using historical data and reasonableestimation methodology for each financial instrument category. Estimated fairvalue for Sun’s investment securities is detailed in Note 5. All other fairvalue estimates, methods, and assumptions are set forth below:

 

**Cash and duefrom banks:**

The carrying amounts for cash and due from banks represent approximatefair value.

 

**Loans:**

Management segregates loans into categories with homogeneous types,financial structure, and risk characteristics. For performing loans, expectedcash flows until full repayment are discounted at a rate which managementbelieves fairly reflects credit, interest rate, and other risks. Cash flows andmaturities are estimated based on Sun’s historical experience with each loancategory.

Management estimates fair value for significant nonperforming loans basedon current external appraisals. If appraisals are not available, estimated cashflows are discounted using a rate commensurate with the risk associated withthe estimated cash flows. Credit risk, cash flows, and discount rateassumptions are determined using market information using methods managementbelieves to be reasonable.

(In Thousands)

 
| **December 31,** |   | **Book Value** |    | **2002  Fair Value** |   | **Book Value** |   | **2001  Fair Value** |    |
|------------------|--------|----------------|---------|----------------------|--------|----------------|--------|----------------------|---------|
| Total loans, net |   | $              | 583,519 |                 | $      | 600,238        |   | $                    | 515,520 |   | $ | 589,025 |   |
|                  |        |                |         |                      |        |                |        |                      |         |  |  |  |  |

 

**Deposits:**

Fair value of deposits with no stated maturity, such as demand deposits,NOW accounts, savings deposits, and Insured Money Market Accounts, areestimated at carrying value. Fair value of deposits with frequently resetadjustable rates or managed rates are estimated at carrying value (suchdeposits are generally priced at market). Fair value of time deposits is basedon the discounted value of contractual cash flows discounted at observed marketrates for time deposits with similar characteristics and remaining maturities.Fair value estimates for deposits are not based on market rates for borrowingsor other higher cost alternatives.

(In Thousands)

 
| **December 31,** |   | **Book Value** |    | **2002  Fair Value** |   | **Book Value** |   | **2001  Fair Value** |    |
|------------------|--------|----------------|---------|----------------------|--------|----------------|--------|----------------------|---------|
| Total deposits   |   | $              | 587,480 |                 | $      | 570,149        |   | $                    | 573,877 |   | $ | 588,301 |   |
|                  |        |                |         |                      |        |                |        |                      |         |  |  |  |  |

 

**BorrowedFunds:**

Current available borrowing rates from similar sources are used to valueexisting borrowings.

(In Thousands)

 
| **December 31,** |   | **Book Value** |    | **2002  Fair Value** |   | **Book Value** |   | **2001  Fair Value** |    |
|------------------|--------|----------------|---------|----------------------|--------|----------------|--------|----------------------|---------|
| Total borrowings |   | $              | 269,337 |                 | $      | 282,294        |   | $                    | 264,582 |   | $ | 251,093 |   |
|                  |        |                |         |                      |        |                |        |                      |         |  |  |  |  |

 

**Off-balanceSheet Items:**

There is no material difference between the notional amount and theestimated fair value of off-balance sheet items. Those items totaled$139,373,000 at December 31, 2002, and $112,443,000 at December 31, 2001. Thoseitems primarily consist of unfunded loan commitments, which are generallypriced at market when funded.

 

33

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**12. Common Stock Plans**

 

Sun has three common stock plans for employees and directors. The 1998Stock Incentive Plan, administered by a Board of Directors committee ofindependent directors, allows 716,625 shares of common stock for key officersand other management employees in the form of qualified options, nonqualifiedoptions, stock appreciation rights, or restrictive stock. The 1998 IndependentDirectors Stock Option Plan allows 115,763 shares of common stock to be issuedto non-employee directors. Options under those plans expire ten years after thegrant date. Both of these plans terminate in 2008.

The 1998 Employee Stock Purchase Plan, which permits all employees topurchase common stock at an option price per share not less than 85% of themarket value on the exercise date was allocated 248,063 shares. Options grantedto date have been awarded at 90% of the market value on the exercise date. Eachoption under the 1998 Employee Stock Purchase Plan expires no later than 5years from the grant date. This plan terminates in 2008.

Sun applies Accounting Principles Board Opinion 25 and relatedinterpretations to account for its common stock plans. Accordingly, Sun has notrecognized compensation expense for the plans. Had compensation costs beendetermined based on fair values at the grant dates (pursuant to SFAS 123),Sun’s net income and earnings per share for 2002, 2001, and 2000 would havebeen adjusted to the pro forma amounts indicated below:

 
|                             |   | **2002** |      | **2001** |   | **2000**  |   |
|----------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
| Net income:                      |   |     |      |     |   |      |   |
| As reported                      |   | $        | 6,416,000 |     | $      | 8,350,000 |   | $ | 4,598,000 |   |
| Pro forma                        |   | $        | 6,316,000 |     | $      | 8,158,000 |   | $ | 4,434,000 |   |
| Earnings per share – Basic: |   |     |      |     |   |      |   |
| As reported                      |   | $        | 0.90      |     | $      | 1.20      |   | $ | 0.68 |   |
| Pro forma                        |   | $        | 0.88      |     | $      | 1.18      |   | $ | 0.65 |   |

 

For the pro forma calculations above, each option grant’s fair value wasestimated on the grant date using the Black-Scholes option-pricing model andthe following weighted-average assumptions for grants issued in 2002, 2001, and2000:

 
|                         |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Dividend yield               |   | 4        | %      | 4        | %      | 5        | %      |
| Volatility                   |   | 24       | %      | 24       | %      | 24       | %      |
| Risk-free interest rates:    |   |     |   |     |   |     |   |
| Stock Incentive Plan         |   | 3.77     | %      | 4.50     | %      | 6.13     | %      |
| Independent Directors Plan   |   | 4.19     | %      | 4.88     | %      | 6.55     | %      |
| Employee Stock Purchase Plan |   | 4.59     | %      | 4.51     | %      | 6.38     | %      |
|                         |   |     |   |     |   |     |   |
| Expected option lives        |   | 4  years |   | 4  years |   | 4  years |   |

 

34

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The common stock plans are summarized below:

 
| **Shares**                                    |   | **2002  Weighted-average  Exercise Price** |   | **Shares** |   | **2001  Weighted-average  Exercise Price** |    | **Shares** |   | **2000  Weighted-average  Exercise Price** |   |    |   |
|-----------------------------------------------|--------|--------------------------------------------|--------|------------|--------|--------------------------------------------|---------|------------|--------|--------------------------------------------|--------|---------|--------|
| Outstanding, beginning of year                |   | 503,846                                    |   | $          | 22.79  |                                       | 510,887 |       | $      | 22.35                                      |   | 436,358 |   | $ | 23.25 |   |
| Granted                                       |   | 110,409                                    |   | 23.38      |   | 117,105                                    |    | 16.53      |   | 117,356                                    |   | 15.64   |   |
| Exercised                                     |   | (65,879                                    | )      | 14.99      |   | (9,085                                     | )       | 14.53      |   | (7,504                                     | )      | 13.20   |   |
| Forfeited                                     |   | (61,643                                    | )      | 20.09      |   | (115,061                                   | )       | 15.11      |   | (35,323                                    | )      | 13.17   |   |
| Outstanding, end of year                      |   | 486,733                                    |   | $          | 24.32  |                                       | 503,846 |       | $      | 22.79                                      |   | 510,887 |   | $ | 22.35 |   |
| Options exercisable at year end               |   | 420,633                                    |   |       |   | 417,264                                    |    |       |   | 428,387                                    |   |    |   |
| Fair value of options granted during the year |   | $                                          | 3.24   |       |   |                                       | $       | 2.48       |   |                                       |   | $       | 2.12   |   |   |   |
|                                               |        |                                            |        |            |        |                                            |         |            |        |                                            |        |         |        |  |  |  |  |  |  |

 

The following table summarizes the fixed stock options outstanding underthe Stock Incentive Plan, Independent Directors Plan, and the Employee StockPurchase Plan at December 31, 2002:

 
| **Exercise  Prices** |   | **Number  Outstanding  at December 31, 2002** |   | **Remaining  Contractual Life** |   | **Number  Exercisable  at December 31, 2002** |   |
|----------------------|--------|-----------------------------------------------|--------|---------------------------------|--------|-----------------------------------------------|--------|
| $16.43               |   | 6,137                                         |   | 1  years                        |   | 6,137                                         |   |
| $10.76               |   | 5,770                                         |   | 2  years                        |   | 5,770                                         |   |
| $16.43               |   | 10,563                                        |   | 2  years                        |   | 10,563                                        |   |
| $11.22               |   | 1,646                                         |   | 3  years                        |   | 1,646                                         |   |
| $13.71               |   | 6,314                                         |   | 3  years                        |   | 6,314                                         |   |
| $16.43               |   | 11,058                                        |   | 3  years                        |   | 11,058                                        |   |
| $16.24               |   | 4,684                                         |   | 4  years                        |   | 4,684                                         |   |
| $16.43               |   | 14,690                                        |   | 4  years                        |   | 14,690                                        |   |
| $18.43               |   | 24,688                                        |   | 4  years                        |   | 24,688                                        |   |
| $19.19               |   | 6,584                                         |   | 5  years                        |   | 6,584                                         |   |
| $16.43               |   | 18,554                                        |   | 5  years                        |   | 18,554                                        |   |
| $21.89               |   | 39,930                                        |   | 5  years                        |   | 39,930                                        |   |
| $33.70               |   | 9,053                                         |   | 6  years                        |   | 9,053                                         |   |
| $34.29               |   | 53,020                                        |   | 6  years                        |   | 53,020                                        |   |
| $22.28               |   | 8,657                                         |   | 7  years                        |   | 8,657                                         |   |
| $25.71               |   | 54,066                                        |   | 7  years                        |   | 54,066                                        |   |
| $16.56               |   | 7,870                                         |   | 8  years                        |   | 7,870                                         |   |
| $16.00               |   | 48,400                                        |   | 8  years                        |   | 48,400                                        |   |
| $16.00               |   | 10,231                                        |   | 9  years                        |   | 10,231                                        |   |
| $16.83               |   | 67,700                                        |   | 9  years                        |   | 67,700                                        |   |
| $18.00               |   | 11,018                                        |   | 10  years                       |   | 11,018                                        |   |
| $26.38               |   | 66,100                                        |   | 10  years                       |   | —                                        |   |
|                 |   | 486,733                                       |   | 6.8  years                      |   | 420,633                                       |   |

 

**13.Employee Benefit Plans**

 

Sun provides a defined contribution pension plan that coverssubstantially all employees. Sun’s contributions are based on employeecontributions and compensation. In addition to the defined contribution plan,Sun also provides supplemental payments to certain key employees uponretirement. With the Guaranty acquisition in 2001, Sun will also providesupplemental payments to certain former directors. Life insurance contracts arebeing used to fund this supplemental payment to the former directors. Expensesrelated to these plans were:

 
| **(In Thousands)**            |   | **2002** |   | **2001** |   | **2000** |   |
|-------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Defined pension contributions |   | $        | 653    |     | $      | 482      |   | $ | 350 |   |
| Supplemental payment expense  |   | $        | 33     |     | $      | 36       |   | $ | 40 |   |

 

35

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**14.Income Taxes**

 

Temporary differences produced a deferred tax liability at December 31,2002 and a deferred tax asset at 2001, which is summarized below:

(In Thousands)

 
| **December 31,**                          |   | **2002** |   | **2001** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|
| Deferred tax assets:                      |   |     |   |     |   |
| Loan loss provisions                      |   | $        | 2,110  |     | $      | 1,892 |   |
| Discount on loans acquired from Bucktail  |   | 83       |   | 116      |   |
| Loan fees and costs                       |   | 135      |   | 86       |   |
| Nonaccrual interest                       |   | 81       |   | 68       |   |
| Supplemental compensation plan            |   | 120      |   | 109      |   |
| Tax credit carryover                      |   | 602      |   | —   |   |
| Other                                     |   | 112      |   | 71       |   |
| Total                                     |   | $        | 3,243  |     | $      | 2,342 |   |
| Deferred tax liabilities:                 |   |     |   |     |   |
| Bank premises and equipment               |   | $        | 723    |     | $      | 706 |   |
| Unrealized gains on investment securities |   | 1,843    |   | 1,066    |   |
| Auto leases                               |   | 4,923    |   | —   |   |
| Intangibles                               |   | 142      |   | —   |   |
| Other                                     |   | 202      |   | 57       |   |
| Total                                     |   | 7,833    |   | 1,829    |   |
| Deferred tax (liability) asset, net       |   | $        | (4,590 | )        | $      | 513 |   |

 

Sun’s income tax provision for 2002, 2001, and 2000 consists of thefollowing:

(In Thousands)

 
| **Years Ended December 31,** |   | **2002** |   | **2001** |   | **2000** |   |
|------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Current provision            |   | $        | (3,261 | )        | $      | 3,649    |   | $ | 1,875 |   |
| Deferred income tax benefit  |   | 4,326    |   | (305     | )      | (349     | )      |
| Income tax provision         |   | $        | 1,065  |     | $      | 3,344    |   | $ | 1,526 |   |

 

Actual income tax expense reconciles to the tax amount, which would havebeen recognized at the federal statutory rate as follows:

(In Thousands)

 
| **Years Ended December 31,**          |   | **2002  Amount** |   | **2001  Amount** |   | **2000  Amount** |   |
|---------------------------------------|--------|------------------|--------|------------------|--------|------------------|--------|
| Federal income tax at statutory rate  |   | $                | 2,546  |             | $      | 4,093            |   | $ | 2,143 |   |
| Tax exempt income                     |   | (595             | )      | (834             | )      | (668             | )      |
| Amortization of goodwill              |   | (48              | )      | 328              |   | 264              |   |
| Tax credits from limited partnerships |   | (602             | )      | (443             | )      | (225             | )      |
| CSV officers’ life insurance     |   | (245             | )      | (443             | )      | (225             | )      |
| Other items                           |   | 9                |   | 200              |   | 12               |   |
| Income tax provision                  |   | $                | 1,065  |             | $      | 3,344            |   | $ | 1,526 |   |

 

36

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**15.Related Party Transactions**

 

Certain executive officers, corporate directors, or companies in whichthe individuals have 10 percent or more beneficial ownership were indebted toSun or held deposit accounts with the Bank during 2002. All transactions weremade in the ordinary course of business on substantially the same terms,including interest rates and collateral, as those prevailing at the time forcomparable transactions with other persons and do not involve more than normalcollection risk. Other changes represent transfers in and out of the relatedparty category.

Related Party Indebtedness:

(In Thousands)

 
| **Year Ended December 31,**             |   | **Beginning  Balance** |   | **Loans** |   | **Repayments** |   | **Other  Changes** |    | **Ending  Balance** |   |
|-----------------------------------------|--------|------------------------|--------|-----------|--------|----------------|--------|--------------------|---------|---------------------|--------|
| 15 Directors, 4 Executive Officers 2002 |   | $                      | 10,846 |      | $      | 27,085         |   | $                  | (25,069 | )                   | $      | (2,382 | ) | $ | 10,480 |   |
| 9 Directors, 3 Executive Officers 2001  |   | 6,468                  |   | 23,173    |   | (24,706        | )      | 5,911              |    | 10,846              |   |
|                                         |        |                        |        |           |        |                |        |                    |         |                     |        |  |  |  |  |  |

 

Related Party Deposits:

(In Thousands)

 
| **December 31,** |   | **2002** |   | **2001** |   |
|------------------|--------|----------|--------|----------|--------|
| Deposit Balances |   | $        | 6,119  |     | $      | 4,184 |   |
|                  |        |          |        |          |        |  |  |

 

**16.Off-Balance Sheet Risk**

 

Sun is a party to financial instruments with off-balance sheet risk inthe normal course of business to meet customers’ financing needs. Thesefinancial instruments include commitments to extend credit and standby lettersof credit containing, in varying degrees, credit and interest rate riskexceeding the amount recognized in the balance sheet.

Credit risk from nonperformance by counterparties to commitments toextend credit and standby letters of credit is represented by the contractualamount of those instruments. Sun uses the same credit policies to guidecommitments and conditional obligations as it does for direct, funded loans.

Commitments to extend credit are agreements to lend to a customer aslong as no contract conditions are violated. Commitments generally includefixed expiration dates or other termination clauses and certain fee payments.Since many commitments are expected to expire without being drawn upon, thetotal commitment amounts do not necessarily represent future cash requirements.Each customer’s creditworthiness is evaluated on a case-by-case basis. Thecollateral amount obtained, if deemed necessary, is based on management’scredit evaluation of the customer. Collateral types vary but may includeaccounts receivable, inventory, property, equipment, and income-producingcommercial properties.

Standby letters of credit are conditional commitments that guarantee acustomer’s performance to a third party. Those guarantees are primarily issuedto support borrowing arrangements and related transactions. Terms vary from onemonth to 24 months and may have renewal features. Credit risk differs littlefrom direct loans to customers. When warranted, Sun holds collateral againstthose commitments.

(In Thousands)

 
| **December 31,**                                   |   | **2002** |    | **2001** |   |
|----------------------------------------------------|--------|----------|---------|----------|--------|
| Commitments to extend credit (binding)             |   | $        | 128,796 |     | $      | 110,193 |   |
| Standby letters of credit and financial guarantees |   | 10,577   |    | 2,250    |   |
| Total credit extension commitments                 |   | $        | 139,373 |     | $      | 112,443 |   |

 

37

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**17.Regulatory Matters**

 

Sun and the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies. The Bank is also subject to theregulatory framework for prompt corrective action (“PCA”). Failure to meetminimum capital requirements can initiate certain mandatory, and possiblyadditional discretionary, actions by regulators that, if undertaken, could havea direct material effect on the Bank’s financial statements. Capital adequacyguidelines and the regulatory framework for prompt corrective action definespecific capital requirements that involve quantitative measures of Sun and theBank’s assets, liabilities, and certain off-balance-sheet items as calculatedunder regulatory accounting practices. Sun and the Bank’s capital amounts andthe Bank’s PCA classification are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capitaladequacy require the Bank to maintain minimum amounts and ratios (set forth inthe table below) of total and Tier I capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier I capital (as defined) toaverage assets (as defined). Management believes, as of December 31, 2002, thatSun and the Bank meet all capital adequacy requirements to which they aresubject.

As of December 31, 2001, and December 31, 2002, the most recentnotification from the Bank’s primary federal regulator, Federal DepositInsurance Corporation (FDIC), categorized the Bank as well capitalized underthe regulatory framework for prompt corrective action. To be categorized aswell capitalized the Bank must maintain minimum total risk-based, Tier Irisk-based, Tier I leverage ratios as set forth in the table. There are noconditions or events since that notification that management believes havechanged the Bank’s category.

 

 
| **(In  Thousands)**       |   | **Actual  Amount** |   |       |   | **For Capital  Adequacy Purposes** |   | **To Be Well  Capitalized  Under Prompt Corrective  Action Provisions** |   |
|---------------------------|--------|--------------------|--------|------------|--------|------------------------------------|--------|-------------------------------------------------------------------------|--------|
|                      |   | **Ratio**          |   | **Amount** |   | **Ratio**                          |   | **Amount**                                                              |   | **Ratio** |   |
| As of December 31, 2002:  |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Tier 1 capital:           |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 71,123 |       | 11.1   | %                                  | $      | 25,661                                                                  |   | 4.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 70,969 |       | 11.1   | %                                  | $      | 25,558                                                                  |   | 4.0 | % | $ | 38,337 |   | 6.0 | % |
|                      |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Total risk based capital: |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 80,484 |       | 12.6   | %                                  | $      | 51,322                                                                  |   | 8.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 77,175 |       | 12.1   | %                                  | $      | 51,116                                                                  |   | 8.0 | % | $ | 63,895 |   | 10.0 | % |
|                      |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Leverage ratio:           |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 71,123 |       | 7.8    | %                                  | $      | 37,598                                                                  |   | 4.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 70,969 |       | 7.9    | %                                  | $      | 36,168                                                                  |   | 4.0 | % | $ | 45,210 |   | 5.0 | % |
|                      |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| As of December 31, 2001:  |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Tier 1 capital:           |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 68,582 |       | 13.0   | %                                  | $      | 21,116                                                                  |   | 4.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 62,577 |       | 11.9   | %                                  | $      | 21,042                                                                  |   | 4.0 | % | $ | 31,563 |   | 6.0 | % |
|                      |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Total risk based capital: |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 78,730 |       | 14.9   | %                                  | $      | 42,233                                                                  |   | 8.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 68,781 |       | 13.1   | %                                  | $      | 42,085                                                                  |   | 8.0 | % | $ | 52,606 |   | 10.0 | % |
|                      |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Leverage ratio:           |   |               |   |       |   |                               |   |                                                                    |   |   |   |   |   |
| Sun                       |   | $                  | 68,582 |       | 7.1    | %                                  | $      | 38,507                                                                  |   | 4.0 | % | N/A |   | N/A |   |
| Bank                      |   | $                  | 62,577 |       | 6.7    | %                                  | $      | 37,541                                                                  |   | 4.0 | % | $ | 46,926 |   | 5.0 | % |
|                           |        |                    |        |            |        |                                    |        |                                                                         |        |  |  |  |  |  |  |  |  |

 

**Payment ofDividends**

Sun is a legal entity separate and distinct from its subsidiaries. Themajority of Sun’s revenue is from dividends paid to Sun by its bankingsubsidiary.  Sun’s banking subsidiary issubject to laws and regulations that limit the amount of dividends it can pay.In addition, both Sun and its banking subsidiary are subject to variousregulatory restrictions relating to the payment of dividends, includingrequirements to maintain capital at or above regulatory minimums. Bankingregulators have indicated that banking organizations should generally paydividends only if (1) the organization’s net income available to common shareholdersover the past year has been sufficient to fully fund the dividends and (2) theprospective rate of earnings retention appears consistent with theorganization’s capital needs, asset quality and overall financial condition.Sun does not expect that any of these laws, regulations or policies willmaterially affect the ability of the Bank to pay dividends. During the yearended December 31, 2002, Sun’s subsidiaries declared $7,331,000 in dividendspayable to Sun.

 

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**18.Condensed Financial Information – Parent Company Only**

** **

**CONDENSEDBALANCE SHEETS**

(In Thousands)

 
| **December 31,**                                |   | **2002** |    | **2001** |   |
|-------------------------------------------------|--------|----------|---------|----------|--------|
| Assets:                                         |   |     |    |     |   |
| Cash                                            |   | $        | 105     |     | $      | 150 |   |
| Securities available for sale                   |   | 500      |    | —   |   |
| Subsidiary investments:                         |   |     |    |     |   |
| SunBank                                         |   | 97,636   |    | 88,188   |   |
| SUBI Investment Company                         |   | 2,064    |    | 9,304    |   |
| Beacon Life Insurance Company                   |   | 528      |    | 542      |   |
| Sun Trust I                                     |   | 511      |    | 511      |   |
| Sun Abstract & Settlement Services          |   | 15       |    | 14       |   |
| Receivable from Sun Trust I                     |   | 19       |    | 19       |   |
| Subordinated debenture issuance costs           |   | 397      |    | 446      |   |
| Other assets                                    |   | 593      |    | 56       |   |
| Total assets                                    |   | $        | 102,368 |     | $      | 99,230 |   |
| Liabilities:                                    |   |     |    |     |   |
| Subordinated debentures                         |   | $        | 20,166  |     | $      | 20,955 |   |
| Subordinated debenture interest payable         |   | 633      |    | 755      |   |
| Accounts payable                                |   | 322      |    | 9        |   |
| Total Liabilities                               |   | 21,121   |    | 21,719   |   |
| Shareholders’ Equity:                      |   |     |    |     |   |
| Common stock                                    |   | 84,591   |    | 83,565   |   |
| Retained earnings (deficit)                     |   | (5,159   | )       | (6,961   | )      |
| Accumulated other comprehensive income          |   | 3,578    |    | 2,069    |   |
| Treasury stock                                  |   | (1,763   | )       | (1,162   | )      |
| Total shareholders’ equity                 |   | 81,247   |    | 77,511   |   |
| Total liabilities and shareholders’ equity |   | $        | 102,368 |     | $      | 99,230 |   |

 

**CONDENSEDSTATEMENTS OF INCOME**

(In Thousands)

 
| **Years Ended December 31,**                                                            |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Income:                                                                                 |   |     |   |     |   |     |   |
| Dividends from subsidiaries                                                             |   | $        | 7,331  |     | $      | 1,059    |   | $ | 6,506 |   |
| Interest and other income                                                               |   | 69       |   | 75       |   | 19       |   |
| Total income                                                                            |   | 7,400    |   | 1,134    |   | 6,525    |   |
| Expenses:                                                                               |   |     |   |     |   |     |   |
| Subordinated debenture interest                                                         |   | 1,944    |   | 1,623    |   | —   |   |
| Stationery and printing                                                                 |   | 51       |   | 61       |   | 17       |   |
| Professional fees                                                                       |   | 288      |   | 197      |   | 82       |   |
| Other expenses                                                                          |   | 243      |   | 260      |   | 221      |   |
| Total expenses                                                                          |   | 2,526    |   | 2,141    |   | 320      |   |
| Income (loss) before income taxes and equity in undistributed earnings  of subsidiaries |   | 4,874    |   | (1,007   | )      | 6,205    |   |
| Income tax benefit                                                                      |   | (855     | )      | (698     | )      | (107     | )      |
| Income (loss) before equity in undistributed earnings of subsidiaries                   |   | 5,729    |   | (309     | )      | 6,312    |   |
| Equity in undistributed earnings (losses) of subsidiaries                               |   | 687      |   | 8,659    |   | (1,714   | )      |
| Net income                                                                              |   | $        | 6,416  |     | $      | 8,350    |   | $ | 4,598 |   |

 

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CONDENSED STATEMENTS OF CASH FLOWS

(In Thousands)

 
| **Years Ended December 31,**                                                                 |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                                                        |   |     |   |     |   |     |   |
| Net income                                                                                   |   | $        | 6,416  |     | $      | 8,350    |   | $ | 4,598 |   |
| Adjustments to reconcile net income to net cash (used in) provided by  operating activities: |   |     |   |     |   |     |   |
| Equity in undistributed (earnings) losses of subsidiaries                                    |   | (687     | )      | (8,659   | )      | 1,714    |   |
| (Increase) decrease in other assets                                                          |   | (487     | )      | (487     | )      | 989      |   |
| Increase (decrease) in liabilities                                                           |   | 191      |   | 642      |   | 117      |   |
| Net cash provided by (used in) operating activities                                          |   | 5,433    |   | (154     | )      | 7,418    |   |
| Cash flows from investing activities:                                                        |   |     |   |     |   |     |   |
| Purchases of investment securities                                                           |   | (500     | )      | (7       | )      | (240     | )      |
| Purchase of investment in SUBI Investment Company                                            |   | —   |   | (8,460   | )      | —   |   |
| Purchase of investment in Sun Trust I                                                        |   | —   |   | (511     | )      | —   |   |
| Purchase of investment in Sun Abstract                                                       |   | —   |   | —   |   | (15      | )      |
| Proceeds from return of capital of investment in Sun Abstract                                |   | —   |   | 7        |   | —   |   |
| Net cash used in investing activities                                                        |   | (500     | )      | (8,971   | )      | (255     | )      |
| Cash flows from financing activities:                                                        |   |     |   |     |   |     |   |
| Proceeds from issuance of subordinated debentures                                            |   | —   |   | 17,011   |   | —   |   |
| Repayment of subordinated debentures                                                         |   | (789     | )      | —   |   | —   |   |
| Cash dividends                                                                               |   | (4,614   | )      | (4,134   | )      | (5,277   | )      |
| Return of capital, Sun Abstract                                                              |   | —   |   | 4        |   | —   |   |
| Purchase of Guaranty Bank, N.A.                                                              |   | —   |   | (2,544   | )      | —   |   |
| Purchase of treasury stock                                                                   |   | (601     | )      | (1,213   | )      | (1,995   | )      |
| Proceeds from sale of stock for employee benefit program                                     |   | 1,026    |   | 123      |   | 112      |   |
| Net cash (used in) provided by financing activities                                          |   | (4,978   | )      | 9,247    |   | (7,160   | )      |
| Net (decrease) increase in cash and cash equivalents                                         |   | (45      | )      | 122      |   | 3        |   |
| Cash and cash equivalents at beginning of year                                               |   | 150      |   | 28       |   | 25       |   |
| Cash and cash equivalents at end of year                                                     |   | $        | 105    |     | $      | 150      |   | $ | 28 |   |

 

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**19.Consolidated Quarterly Financial Data (Unaudited)**

(Dollars in Thousands, Except for Per Share Data)

 
| **2002**                            |   | **1st Qtr.** |   | **2nd Qtr.** |   | **3rd Qtr.** |   | **4th Qtr.** |   | **Total** |   |
|-------------------------------------|--------|--------------|--------|--------------|--------|--------------|--------|--------------|--------|-----------|--------|
| Interest income                     |   | $            | 13,741 |         | $      | 14,144       |   | $            | 13,727 |      | $      | 12,931 |   | $ | 54,543 |   |
| Interest expense                    |   | (7,705       | )      | (7,411       | )      | (7,351       | )      | (7,181       | )      | (29,648   | )      |
| Net interest income                 |   | 6,036        |   | 6,733        |   | 6,376        |   | 5,750        |   | 24,895    |   |
| Provision for loan and lease losses |   | (405         | )      | (405         | )      | (450         | )      | (200         | )      | (1,460    | )      |
| Net security gains                  |   | 95           |   | 45           |   | 3            |   | 473          |   | 616       |   |
| Non-interest income                 |   | 1,025        |   | 1,531        |   | 1,627        |   | 1,869        |   | 6,052     |   |
| Non-interest expenses               |   | (4,900       | )      | (5,428       | )      | (5,651       | )      | (6,643       | )      | (22,622   | )      |
| Income before income taxes          |   | 1,851        |   | 2,476        |   | 1,905        |   | 1,249        |   | 7,481     |   |
| Income tax provision                |   | (299         | )      | (535         | )      | (210         | )      | (21          | )      | (1,065    | )      |
| Net income                          |   | $            | 1,522  |         | $      | 1,941        |   | $            | 1,695  |      | $      | 1,228 |   | $ | 6,416 |   |
| Net income per share – Basic   |   | $            | 0.22   |         | $      | 0.27         |   | $            | 0.24   |      | $      | 0.17 |   | $ | 0.90 |   |
| Net income per share – Diluted |   | $            | 0.22   |         | $      | 0.27         |   | $            | 0.24   |      | $      | 0.16 |   | $ | 0.89 |   |

 

Quarterly information has been restated to reflect the adoption of SFAS142 and SFAS 147 as described in Note 8.

 
| **2002**                                  |   | **1st Qtr.** |   | **2nd Qtr.** |   | **3rd Qtr.** |   | **4th Qtr.** |   | **Total** |   |
|-------------------------------------------|--------|--------------|--------|--------------|--------|--------------|--------|--------------|--------|-----------|--------|
| Previously reported non-interest expenses |   | $            | 5,134  |         | $      | 5,662        |   | $            | 5,885  |      | $      | 6,643 |   | $ | 23,324 |   |
| Less: reversal of amortization            |   | (234         | )      | (234         | )      | (234         | )      | —       |   | (702      | )      |
| Restated non-interest expenses            |   | $            | 4,900  |         | $      | 5,428        |   | $            | 5,651  |      | $      | 6,643 |   | $ | 22,622 |   |

 
| **2001**                            |   | **1st Qtr.** |   | **2nd Qtr.** |   | **3rd Qtr.** |   | **4th Qtr.** |   | **Total** |   |
|-------------------------------------|--------|--------------|--------|--------------|--------|--------------|--------|--------------|--------|-----------|--------|
| Interest income                     |   | $            | 13,692 |         | $      | 14,723       |   | $            | 16,198 |      | $      | 15,081 |   | $ | 59,694 |   |
| Interest expense                    |   | (8,518       | )      | (9,142       | )      | (9,593       | )      | (8,706       | )      | (35,959   | )      |
| Net interest income                 |   | 5,174        |   | 5,581        |   | 6,605        |   | 6,375        |   | 23,735    |   |
| Provision for loan and lease losses |   | (300         | )      | (300         | )      | (325         | )      | (575         | )      | (1,500    | )      |
| Net security (losses) gains         |   | 798          |   | 38           |   | 62           |   | (54          | )      | 844       |   |
| Non-interest income                 |   | 810          |   | 893          |   | 1,235        |   | 834          |   | 3,772     |   |
| Gain on sale of branches            |   | —       |   | —       |   | —       |   | 4,892        |   | 4,892     |   |
| Non-interest expenses               |   | (4,096       | )      | (4,833       | )      | (5,413       | )      | (5,707       | )      | (20,049   | )      |
| Income before income taxes          |   | 2,386        |   | 1,379        |   | 2,164        |   | 5,765        |   | 11,694    |   |
| Income tax provision                |   | (613         | )      | (285         | )      | (613         | )      | (1,833       | )      | (3,344    | )      |
| Net income                          |   | $            | 1,773  |         | $      | 1,094        |   | $            | 1,551  |      | $      | 3,932 |   | $ | 8,350 |   |
| Net income per share – Basic   |   | $            | 0.27   |         | $      | 0.16         |   | $            | 0.22   |      | $      | 0.55 |   | $ | 1.20 |   |
| Net income per share – Diluted |   | $            | 0.27   |         | $      | 0.16         |   | $            | 0.22   |      | $      | 0.55 |   | $ | 1.20 |   |

 

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**20.Recent Accounting Pronouncements**

** **

**Goodwill andOther Intangible Assets:**

On January 1, 2002, the Corporation adopted SFAS 142, Goodwill and OtherIntangible Assets, which addresses the accounting and reporting for acquiredgoodwill and other intangible assets and supersedes APB Opinion 17, IntangibleAssets. Notes 1 and 8 provide further detail on the accounting for goodwill andintangible assets under the standard and the impact of the adoption on thefinancial statements. The standard’s adoption had no impact on liquidity.

 

**Rescissionof FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, andTechnical Corrections (SFAS 145):**

In April 2002, the FASB issued SFAS 145, which updates, clarifies, andsimplifies certain existing accounting pronouncements beginning at variousdates in 2002 and 2003. The statement rescinds SFAS 4 and SFAS 64, whichrequired net gains or losses from the extinguishment of debt to be classifiedas an extraordinary item in the income statement. These gains and losses will nowbe classified as extraordinary only if they meet the criteria for suchclassification as outlined in APB Opinion 30, which allows for extraordinarytreatment if the item is material and both unusual and infrequent in nature.The statement also rescinds SFAS 44 related to the accounting for intangibleassets for motor carriers and amends SFAS 13 to require certain leasemodifications that have economic effects similar to sale-leaseback transactionsto be accounted for as such. The changes required by SFAS 145 are not expectedto have a material impact on results of operations, financial position, orliquidity.

 

**Accountingfor Stock-Based Compensation:**

In December 2002, the FASB issued SFAS 148, Accounting for Stock-BasedCompensation — Transition and Disclosure, which provides guidance on how totransition from the intrinsic value method of accounting for stock-basedemployee compensation under APB 25 to SFAS 123’s fair value method ofaccounting, if a company so elects.

As permitted, Sun will continue to account for these plans under APBOpinion 25, and the pro forma impact of accounting for these plans will bedisclosed in the consolidated financial statements.

Acquisitions of Certain Financial Institutions:

In October 2002, the FASB issued SFAS 147, Acquisitions of CertainFinancial Institutions, which provides guidance on the accounting for theacquisition of a financial institution and supersedes the specializedaccounting guidance provided in SFAS 72, Accounting for Certain Acquisitions ofBanking or Thrift Institutions. SFAS 147 became effective upon issuance andrequires companies to cease amortization of unidentified intangible assetsassociated with certain branch acquisitions and reclassify these assets togoodwill. SFAS 147 also modifies SFAS 144 to include in its scope long-termcustomer-relationship intangible assets and thus subject those intangibleassets to the same undiscounted cash flow recoverability test and impairmentloss recognition and measurement provisions required for other long-livedassets.

 

**Guarantees:**

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others. This interpretation expands thedisclosures to be made by a guarantor in its financial statements about itsobligations under certain guarantees and requires the guarantor to recognize aliability for the fair value of an obligation assumed under a guarantee.

FIN 45 clarifies the requirements of SFAS 5, Accounting forContingencies, relating to guarantees. In general, FIN 45 applies to contractsor indemnification agreements that contingently require the guarantor to makepayments to the guaranteed party based on changes in an underlying that isrelated to an asset, liability, or equity security of the guaranteed party.Certain guarantee contracts are excluded from both the disclosure andrecognition requirements of this interpretation, including, among others,guarantees relating to employee compensation, residual value guarantees undercapital lease arrangements, commercial letters of credit, loan commitments,subordinated interests in an SPE, and guarantees of a company’s own futureperformance. Other guarantees are subject to the disclosure requirements of FIN45 but not to the recognition provisions and include, among others, a guaranteeaccounted for as a derivative instrument under SFAS 133, a parent’s guaranteeof debt owed to a third party by its subsidiary or vice versa, and a guaranteewhich is based on performance not price. The disclosure requirements of FIN 45are effective for Sun as of December 31, 2002, and require disclosure of thenature of the guarantee, the maximum potential amount of future payments thatthe guarantor could be required to make under the guarantee, and the currentamount of the liability, if any, for the guarantor’s obligations under theguarantee. The recognition requirements of FIN 45 are to be appliedprospectively to guarantees issued or modified after December 31, 2002.Sun does not expect the requirements of FIN 45 to have a material impact onresults of operations, financial position, or liquidity.

 

**Consolidationof Variable Interest Entities:**

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),Consolidation of Variable Interest Entities. The objective of thisinterpretation is to provide guidance on how to identify a variable interestentity (VIE) and determine when the assets, liabilities, noncontrollinginterests, and results of operations of a VIE need to be included in acompany’s consolidated financial statements. A company that holds variableinterests in an entity will need to consolidate the entity if the company’sinterest in the VIE is such that the company will absorb a majority of theVIE’s expected losses and/or receive a majority of the entity’s expectedresidual returns, if they occur. FIN 46 also requires additional disclosures byprimary beneficiaries and other significant variable interest holders. Theprovisions of this interpretation became effective upon issuance. Managementdoes not believe the interpretation will have a material impact on theconsolidated financial statements.

 

42

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**21.Subsequent Events**

 

On January 23, 2003, the Board of Directors declared a quarterly cashdividend of $0.165 per common share. The dividend will be payable March 7, 2003to shareholders of record on February 23, 2003.

Effective January 1, 2003, Sun acquired Bank Capital ServicesCorporation (Bank Capital), a lease broker, in exchange for stock and cash inthe amount of $590,000. Bank Capital was approximately $216,000 in assets atDecember 31, 2002 and will operate as a subsidiary of SunBank.

In December 2002, Sun announced that an agreement has been signed forSun to purchase Mid-Penn Insurance (Mid-Penn) as its foundation agency.  Mid-Penn will operate as a subsidiary of SunBancorp, Inc.  Management and the Boardof Directors expect to execute the final documents during March 2003.

In December 2002, Sun announced that an agreement has been signed forSun to purchase Steelton Bancorp (Steelton). Steelton’s two branches will bemerged into SunBank and will operate under the name of SunBank. Steeltonprovides Sun with its entrance into the Harrisburg, PA market. Management andthe Board of Directors expect to execute the final documents during April 2003.

On March 27, 2003, the Board of Directors elected to apply for FinancialHolding Company status, which will expand the permissible activities of Sun.

 

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**Reportof Independent Accountants**

 

**To theShareholders and Board of Directors of SUN BANCORP, INC:**

 

In our opinion, the accompanying consolidated balance sheet as ofDecember 31, 2002 and the related consolidated statements of income, changes inshareholders’ equity and cash flows present fairly, in all material respects,the financial position of Sun Bancorp, Inc. and its subsidiaries (Company) atDecember 31, 2002, and the results of their operations and their cash flows forthe year then ended in conformity with accounting principles generally acceptedin the United States of America. These financial statements are theresponsibility of the Company’s management; our responsibility is to express anopinion on these financial statements based on our audit. We conducted ouraudit of these statements in accordance with auditing standards generallyaccepted in the United States of America, which require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion. The financial statements of the Company as of December 31, 2001 andfor each of the two years in the period ended December 31, 2001 were audited byother independent accountants whose report dated February 19, 2002 expressed anunqualified opinion on those statements.

As discussed in notes 1 and 8 to the consolidated financial statements,on January 1, 2002 the Company adopted Statement of Financial AccountingStandard No. 142, Goodwill and Other Intangible Assets, and No. 147,Acquisition of Certain Financial Institutions.

 

PricewaterhouseCoopers LLP

Harrisburg, Pennsylvania

February 11, 2003

 

44

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**Five-YearFinancial Highlights**

 

**SelectedFinancial Data**

 
| **Balance Sheet Data (In Thousands)**       |   | **2002**  |    | **2001**  |   | **2000**  |   | **1999**  |    | **1998**  |   |
|---------------------------------------------|--------|-----------|---------|-----------|--------|-----------|--------|-----------|---------|-----------|--------|
| Assets                                      |   | $         | 951,174 |      | $      | 922,050   |   | $         | 743,588 |      | $      | 710,921 |   | $ | 623,577 |   |
| Deposits                                    |   | 587,480   |    | 573,877   |   | 444,566   |   | 400,121   |    | 363,886   |   |
| Loans                                       |   | 583,519   |    | 515,520   |   | 406,775   |   | 377,485   |    | 326,928   |   |
| Securities available for sale               |   | 219,438   |    | 305,612   |   | 290,513   |   | 282,616   |    | 254,780   |   |
| Shareholders’ equity                   |   | 81,247    |    | 77,511    |   | 62,527    |   | 56,013    |    | 67,801    |   |
| Average equity                              |   | 79,966    |    | 68,207    |   | 57,768    |   | 63,537    |    | 67,063    |   |
| Average assets                              |   | 931,320   |    | 866,053   |   | 724,435   |   | 661,099   |    | 575,797   |   |
|                                        |   |      |    |      |   |      |   |      |    |      |   |
| Earnings Data (In Thousands)                |   |      |    |      |   |      |   |      |    |      |   |
| Interest income                             |   | $         | 54,543  |      | $      | 59,694    |   | $         | 53,360  |      | $      | 47,454 |   | $ | 42,677 |   |
| Interest expense                            |   | 29,648    |    | 35,959    |   | 31,825    |   | 26,230    |    | 22,467    |   |
| Net interest income                         |   | 24,895    |    | 23,735    |   | 21,735    |   | 21,224    |    | 20,210    |   |
| Provision for loan and lease losses         |   | 1,460     |    | 1,500     |   | 2,500     |   | 1,925     |    | 1,200     |   |
| Net interest income after provision         |   |      |    |      |   |      |   |      |    |      |   |
| for loan and lease losses                   |   | 23,435    |    | 22,235    |   | 19,235    |   | 19,299    |    | 19,010    |   |
| Net security gains (losses)                 |   | 616       |    | 844       |   | (1,955    | )      | 1,962     |    | 1,403     |   |
| Non-interest income                         |   | 6,052     |    | 3,772     |   | 2,939     |   | 2,998     |    | 2,687     |   |
| Gain on sale of branches                    |   | —    |    | 4,892     |   | —    |   | —    |    | —    |   |
| Non-interest expenses                       |   | 22,622    |    | 20,049    |   | 14,095    |   | 12,079    |    | 11,295    |   |
| Income before income tax provision          |   | 7,481     |    | 11,694    |   | 6,124     |   | 12,180    |    | 11,805    |   |
| Income tax provision                        |   | 1,065     |    | 3,344     |   | 1,526     |   | 3,425     |    | 3,079     |   |
| Net income                                  |   | 6,416     |    | 8,350     |   | 4,598     |   | 8,755     |    | 8,726     |   |
| Dividends paid                              |   | 4,613     |    | 4,134     |   | 5,277     |   | 6,135     |    | 5,369     |   |
|                                        |   |      |    |      |   |      |   |      |    |      |   |
| Ratios                                      |   |      |    |      |   |      |   |      |    |      |   |
| Return on average assets                    |   | 0.69      | %       | 0.93      | %      | 0.63      | %      | 1.32      | %       | 1.51      | %      |
| Return on average equity                    |   | 8.02      | %       | 12.24     | %      | 7.96      | %      | 13.78     | %       | 13.01     | %      |
| Efficiency ratio                            |   | 73.10     | %       | 57.04     | %      | 54.07     | %      | 46.75     | %       | 46.03     | %      |
| Net interest margin                         |   | 3.09      | %       | 3.12      | %      | 3.46      | %      | 3.57      | %       | 4.00      | %      |
| Equity to assets (year end)                 |   | 8.54      | %       | 8.42      | %      | 8.41      | %      | 7.88      | %       | 10.87     | %      |
| Loans to deposits (year end)                |   | 99.33     | %       | 89.83     | %      | 91.50     | %      | 94.34     | %       | 89.84     | %      |
| Loans to assets (year end)                  |   | 61.35     | %       | 55.98     | %      | 54.70     | %      | 53.10     | %       | 52.43     | %      |
| Dividend payout  (percentage of net income) |   | 71.90     | %       | 49.51     | %      | 114.77    | %      | 70.07     | %       | 61.53     | %      |
|                                        |   |      |    |      |   |      |   |      |    |      |   |
| Per Share Data                              |   |      |    |      |   |      |   |      |    |      |   |
| Net income per share — Basic           |   | $         | 0.90    |      | $      | 1.20      |   | $         | 0.68    |      | $      | 1.28 |   | $ | 1.27 |   |
| Net income per share — Diluted         |   | $         | 0.89    |      | $      | 1.20      |   | $         | 0.68    |      | $      | 1.28 |   | $ | 1.26 |   |
| Cash dividends per share                    |   | $         | 0.645   |      | $      | 0.60      |   | $         | 0.78    |      | $      | 0.90 |   | $ | 0.78 |   |
| Book value per share                        |   | $         | 11.33   |      | $      | 10.85     |   | $         | 9.39    |      | $      | 8.25 |   | $ | 9.89 |   |
| Average shares outstanding — Basic     |   | 7,154,107 |    | 6,942,122 |   | 6,769,924 |   | 6,813,956 |    | 6,856,955 |   |
| Average shares outstanding — Diluted   |   | 7,196,534 |    | 6,945,504 |   | 6,784,262 |   | 6,860,114 |    | 6,923,366 |   |
| Approximate number of shareholders          |   | 2,236     |    | 2,207     |   | 2,159     |   | 2,105     |    | 1,977     |   |

 

45

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**Management’sDiscussion and Analysis**

 

**ForwardLooking Statements (FLSs)**

 

This report contains FLSs that reflect Sun’s current views regardingfuture events and financial performance for Sun and its subsidiaries. FLSs maygenerally, but not always, be identified by words such as “estimate,”“believe,” “forecast” and other indications of future events and trends. FLSsare subject to considerable uncertainties and risks, including factors beyondSun’s control that could cause actual results to differ materially fromhistorical or anticipated results. Such factors include, but are not limited to(1) customer and deposit attrition or revenue loss following announced mergersmay be greater than expected; (2) financial industry competition may increasesignificantly; (3) changing economic, interest rate, and regulatoryenvironments; (4) announced mergers do not consummate as anticipated; (5) otherfactors that may not be identifiable at this time. Further, Sun’s historicalperformance does not guarantee and may not indicate future results.

The list of important factors is not complete or exclusive. Additionalinformation regarding factors that may cause actual results to differmaterially from those considered by FLSs is included in Sun’s current andsubsequent filings with the Securities and Exchange Commission (SEC). Sun doesnot update any FLS that may be made from time to time by or on behalf of Sun.

 

**Operations**

 

Sun provides community-based commercial banking and wealth managementservices through 23 SunBank offices in Lycoming, Snyder, Union, Northumberland,Clinton, and Luzerne counties in northeast and central Pennsylvania. Theoffices are located in diversified local economies with solid manufacturing andservice bases. Those local economies have not been subjected to observablesignificant adverse effects during 2002. During the fourth quarter of 2001, Sunsold its two branches in Elk and Cameron counties in part due to management’sassessment that local economic conditions were not consistent with Sun’sobjectives.

Sun’s business is focused in community banking, commercial banking,wealth management, leasing and treasury. Through community banking, Sundelivers financial products and services to retail customers via its branchnetwork, telephone systems, and internet systems. Community banking productsand services include a wide range of deposit products, residential mortgageloans, vehicle and personal loans, auto leasing, and other services. Sun’scommercial banking business line provides credit, deposit, cash management, andother services to businesses, municipalities, and nonprofit organizations. Thewealth management group provides asset management and trust services to retailand corporate customers. The treasury area manages Sun’s investment securitiesportfolio and overall asset/liability strategy. In addition, Sun hassubsidiaries and ownership interests in partnerships that engage in variousbusiness activities, including credit life and disability insurance, titleinsurance and settlement services, equipment leasing, consumer auto leasing,and affordable housing for senior citizens.

 

**Applicationof Critical Accounting Policies**

 

Sun’s consolidated financial statements are prepared in accordance withaccounting principles generally accepted in the United States and followgeneral practices within the industry in which it operates. Application ofthese principles requires management to make estimates, assumptions, andjudgments that affect the amounts reported in the financial statements andaccompanying notes. These estimates, assumptions, and judgments are based oninformation available as of the date of the financial statements; accordingly,as this information changes, the financial statements could reflect differentestimates, assumptions, and judgments. Certain policies inherently have agreater reliance on the use of estimates, assumptions, and judgments and assuch have a greater possibility of producing results that could be materiallydifferent than originally reported. Estimates, assumptions, and judgments arenecessary when assets and liabilities are required to be recorded at fairvalue, when a decline in the value of an asset not carried on the financialstatements at fair value warrants an impairment write-down or valuation reserveto be established, or when an asset or liability needs to be recordedcontingent upon a future event. Carrying assets and liabilities at fair valueinherently results in more financial statement volatility. The fair values andthe information used to record valuation adjustments for certain assets andliabilities are based either on quoted market prices or are provided by otherthird-party sources, when available. When third-party information is notavailable, valuation adjustments are estimated in good faith by managementprimarily through the use of internal cash flow modeling techniques.

The most significant accounting policies followed by Sun are presentedin Note 1 to the consolidated financial statements. These policies, along withthe disclosures presented in the other financial statement notes and in thisfinancial review, provide information on how significant assets and liabilitiesare valued in the financial statements and how those values are determined. Basedon the valuation techniques used and the sensitivity of financial statementamounts to the methods, assumptions, and estimates underlying those amounts,management has identified the determination of the allowance for loan losses,and the valuation of leased asset residuals to be the accounting areas thatrequire the most subjective or complex judgments, and as such could be mostsubject to revision as new information becomes available.

The allowance for loan losses represents management’s estimate of probablecredit losses inherent in the loan portfolio. Determining the amount of theallowance for loan losses is considered a critical accounting estimate becauseit requires significant judgment and the use of estimates related to the amountand timing of expected future cash flows on impaired loans, estimated losses onpools of homogeneous loans based on historical loss experience, andconsideration of current economic trends and conditions, all of which may besusceptible to significant change. The loan portfolio also represents thelargest asset type on the consolidated balance sheet. Note 1 to theconsolidated financial statements describes the methodology used to determinethe allowance for loan losses and a discussion of the factors driving changes inthe amount of the allowance for loan losses is included in the Allowance forLoan and Lease Losses section of this financial review.

Lease financing receivables include a residual value component, whichrepresents the estimated wholesale market value of the leased asset upon theexpiration of the lease. Sun leases various types of equipment under commerciallease financing arrangements and also has a portfolio of automobile

lease financings. The valuation of residual assets is consideredcritical due to the sensitivity in forecasting the impact of product andtechnology changes, consumer behavior, competitor initiatives, shifts in supplyand demand, and economic conditions, among other factors, on the fair value ofresidual assets.

 

46

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**OperatingPerformance**

** **

**Summary:**

Sun reported net income of $6,416,000 for the year ended December 31,2002, or $0.90 basic per share as compared to $8,350,000 for the year endedDecember 31, 2001, or $1.20 basic per share. Excluding the sale of two branchesduring 2001 and the adoption of SFAS 142 and 147 during 2002, net income wouldhave increased $212,000 for the year ended December 31, 2002 as compared to theyear ended December 31, 2001.

During 2002, management implemented many new strategies and programsexpected to begin improving Sun’s performance. Management’s 2002 efforts wereconcentrated on strengthening credit quality, establishing Sun’s brand ofcommunity-focused commercial banking, expanding core markets, building aneffective sales culture, and introducing new products and services to increasefee income. Management’s efforts have been largely successful and will continuein 2003.

Sun’s 2002 financial results illustrate both the potential for growthand improved performance, but also show the lingering effects of past leveragestrategies. Management believes Sun’s strategies, culture, and services arealigned to enable continued improvement. Sun’s 2002 announced acquisitions ofBank Capital Services Corp., Mid-Penn Insurance, and Steelton Bancorp haveprovided attractive new markets with significant growth potential. Managementintends to vigorously pursue improved performance in 2003 and beyond throughits focus on credit quality, core deposit growth, effective risk management,fee income growth, and market expansion.

 

**InterestEarning Assets**

** **

**Loans**

** **

Loans represent Sun’s largest interest earning asset component. Nettotal loans increased $67,999,000 to $583,519,000 at December 31, 2002, from$515,520,000 at December 31, 2001, which represents 13.2% growth. The largestincreases occurred in commercial loans and in auto leasing, which reflectedSun’s strategic plan to grow those portfolios. Management believes the loanportfolio is adequately diversified and no credit concentration exceeds 50% ofthe Bank’s tier 1 capital as shown in Note 17.

Sun extends credit principally to customers in its core market areas,including Lycoming, Snyder, Union, Northumberland, Clinton, and Luzernecounties in Pennsylvania. Sun’s lending activity focuses on three segments:commercial, residential mortgage, and consumer loans. Commercial creditproducts include demand notes, variable rate notes, credit lines, equipmentleasing, and real estate financing. Residential mortgage lending includes avariety of programs and terms consistent with the national and local markets.Consumer loans are primarily direct and indirect vehicle financing. Bypreference, Sun lends predominately on a secured basis.

The following table identifies loan portfolio composition, net ofunearned income, unamortized discounts on purchased loans, deferred loan fees,and ALLL, for the five years ended December 31:

 
| **(In Thousands)**                          |   | **2002** |    | **2001** |   | **2000** |   | **1999** |    | **1998** |   |
|---------------------------------------------|--------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
| Real estate — Mortgage                 |   | $        | 404,350 |     | $      | 377,045  |   | $        | 203,371 |     | $      | 178,876 |   | $ | 192,592 |   |
| Real estate — Construction             |   | 17,721   |    | 6,893    |   | 5,340    |   | 3,318    |    | 3,353    |   |
| Agricultural                                |   | 138      |    | 503      |   | 617      |   | 1,059    |    | 971      |   |
| Commercial and industrial                   |   | 54,624   |    | 34,914   |   | 117,096  |   | 114,193  |    | 52,823   |   |
| Individual                                  |   | 85,920   |    | 93,200   |   | 86,123   |   | 85,255   |    | 83,343   |   |
| Lease — Auto                           |   | 29,698   |    | 8,489    |   | —   |   | —   |    | —   |   |
| Lease — Equipment                      |   | 4,955    |    | 2,287    |   | —   |   | —   |    | —   |   |
| Other                                       |   | 328      |    | 1,619    |   | 54       |   | 104      |    | 383      |   |
| Deferred fees and unearned income on loans  |   | (7,945   | )       | (3,089   | )      | (538     | )      | (955     | )       | (1,940   | )      |
| Unamortized net discount on purchased loans |   | (64      | )       | (137     | )      | (214     | )      | (508     | )       | (1,270   | )      |
| ALLL                                        |   | (6,206   | )       | (6,204   | )      | (5,074   | )      | (3,857   | )       | (3,327   | )      |
| Total loans, net                            |   | $        | 583,519 |     | $      | 515,520  |   | $        | 406,775 |     | $      | 377,485 |   | $ | 326,928 |   |

 

The following tables report gross loan balances by maturities andinterest rate repricing for agricultural, commercial and industrial, and realestate – construction loans at December 31, 2002.

 
| **(In Thousands)**                      |   | **Within  One Year** |   | **After One  But  Within Five Years** |   | **After  Five Years** |   | **Total** |   |
|-----------------------------------------|--------|----------------------|--------|---------------------------------------|--------|-----------------------|--------|-----------|--------|
| Agricultural, commercial and industrial |   | $                    | 30,795 |                                  | $      | 12,737                |   | $         | 11,092 |   | $ | 54,624 |   |
| Real estate — Construction         |   | 8,983                |   | 7,474                                 |   | 1,263                 |   | 17,721    |   |
| Total                                   |   | $                    | 39,778 |                                  | $      | 20,211                |   | $         | 12,355 |   | $ | 72,345 |   |

 
|                |   | **Interest  Rate Sensitivity** |   |
|---------------------|--------|--------------------------------|--------|
|                |   | **Fixed  Rate**                |   | **Variable  Rate** |   | **Total** |   |
| Due within one year |   | $                              | 1,173  |   | $ | 29,622 |   | $ | 30,795 |   |
| Due after one year  |   | 19,519                         |   | 4,310 |   | 23,829 |   |
| Total               |   | $                              | 20,692 |   | $ | 33,932 |   | $ | 54,624 |   |

 

All construction loans are written with fixed rate terms.

 

47

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**CreditQuality**

 

Despite adverse national economic developments, Sun’s credit qualityremained healthy during 2002. As 2002 progressed, some banks began reportingcredit difficulties and bank regulatory agencies cautioned that overall bankcredit quality might be pressured. Contrary to industry trends, Sun’s creditquality remained solid and loan demand remained strong.

Net loans grew $67,999,000, or 13.2%, to $583,519,000 from $515,520,000at December 31, 2001. While net loans increased substantially, past due andnonperforming loans remained stable. At December 31, 2002, past due andnonperforming loans totalled $7,174,000 (1.23% of net loans) compared to$7,289,000 (1.41% of net loans) as of December 31, 2001.

Management continued to strengthen the credit culture and control environment.Sun extends primarily secured credit, and management closely evaluatescollateral both prior to extending credit and periodically thereafter. Aconsistent credit-scoring system, tailored for each loan segment, enablesmanagement to carefully evaluate each borrower’s credit risk. Risk-basedpricing enables management to price loans based on each credit’s unique riskcharacteristics. Management’s efforts have been successful, but improvement iscontinually sought.

Sun relies on a matrix approval system to evaluate and approve newcredits. In addition, Sun’s credit quality committee meets regularly to focusexclusively on potential credit issues. This senior management committee alsoincludes representatives from the Board of Directors. Larger loans arepresented directly to the Board of Directors for consideration. Managementprovides the credit quality committee and the Board of Directors with regularreports that illustrate the bank’s current and anticipated credit quality.

Sun’s formal loan review process provides management with independentcredit assessments. In addition, Sun periodically retains an independentconsultant to review all credits $250,000 and greater. Equally important,management uses those reviews to evaluate internal loan review effectiveness.Sun believes its loan review program provides adequate coverage and independentanalysis for management’s credit quality assessments.

Past due and nonperforming loans include past due, nonaccrual, andrestructured loans. Sun places loans on nonaccrual status when managementconcludes collection of interest income appears doubtful, or once the loanreaches 90 days past due (unless well-secured and in the process ofcollection). Interest on loans classified nonaccrual is recognized as it is received.Restructured loans have terms renegotiated to reduce or defer interest orprincipal.

 

**Nonaccrual,past due, and restructured loans for the five years ended December 31, 2001:**

 
| **(In Thousands)**                     |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|----------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Loans past due 30 to 89 days           |   | $        | 3,662  |     | $      | 3,520    |   | $        | 3,185  |     | $      | 4,954 |   | $ | 8,545 |   |
| Loans past due 90 days or more         |   | 315      |   | 560      |   | 1,429    |   | 1,015    |   | 2,867    |   |
| Nonaccrual loans                       |   | 2,934    |   | 2,851    |   | 837      |   | 1,965    |   | 635      |   |
| Restructured loans                     |   | 263      |   | 358      |   | 368      |   | 320      |   | 243      |   |
| Total past due and nonperforming loans |   | $        | 7,174  |     | $      | 7,289    |   | $        | 5,819  |     | $      | 8,254 |   | $ | 12,290 |   |

 

Total past due and nonperforming loans above include “impaired” loans ofapproximately $4,775,000 at December 31, 2002, and $5,592,000 at December 31,2001. In accordance with SFAS 114, a loan is considered impaired when, based oncurrent information and events, it appears probable all amounts due will not becollected according to the loan’s contractual terms. This category does notapply to large groups of smaller balance loans collectively evaluated forimpairment, such as residential mortgage and consumer loans. Refer to Note 6for information on interest reported on the cash basis.

 

48

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**Allowancefor Loan and Lease Losses (ALLL)**

 

Sun’s ALLL reflects periodic provisions for loan and lease losses, andthat provision is reported as an expense in current income. Loan losses arecharged against the ALLL in the period in which they have been determineduncollectible. Recoveries of previously charged off loans are credited to theALLL when received. Management maintains the ALLL at a level it believes willbe adequate to absorb probable credit losses in the existing loan portfolio.Management believes the ALLL is adequate as of December 31, 2002.

Management’s analysis incorporates many factors, including current andanticipated economic conditions, loss experience, loan portfolio composition,anticipated losses, and unfunded commitments. For significant real estateproperties, management obtains independent value appraisals. Sun’s internalloan review function provides independent credit assessments and managementalso retains consultants to conduct periodic loan quality reviews, whichmanagement incorporates into its ALLL analysis.

Sun segregates the ALLL into specific allocations and other components.Management determines specific allocations based on criteria and analysisdeveloped to evaluate credit risk within each loan category. Each loancategory’s unique risk characteristics guides management’s analysis anddetermination of an adequate specific reserve for that category. For realestate loans, management considers factors that include historical andprojected loss rates, past due levels, collateral values, and anticipatedeconomic conditions. For commercial and industrial loans, management evaluatesseveral factors including: historical loss experience, current loan grades,expected future cash flows, individual loan reviews, internal and externalanalysis, and anticipated economic conditions. For individual (consumer) loans,management evaluates factors such as historical and projected loss rates, pastdue levels, collateral values, and anticipated economic conditions.

Sun’s other ALLL components are based on loss rates by loan grade,economic trends, and other risk factors. Management determines estimated lossrates by loan grade based on current loan grade, remaining term, loan type,periodic quantification of actual losses over a period of time, and otherfactors. Management believes its methodology reasonably measures the creditrisk not captured in specific allocations and provides for an adequateaggregate ALLL.

Management closely monitored the ALLL during 2002 concurrently withother efforts that produced improved credit quality (refer to Credit Qualitysubsection). Management held the provision for loan and lease losses (PLLL)constant at $1,460,000 during 2002. The ALLL decreased to 1.05% at December 31,2002 from 1.20% of total loans at December 31, 2001. The decrease is primarilythe result of the charge off of a commercial loan, which Sun is pursuingrecovery through the legal system and insurance claim.

Management has continued to enhance its methodology for analyzing theALLL and for allocating reserves. The ALLL represents management’s estimate ofan amount adequate to absorb probable loan losses due to credit quality andeconomic factors. Management cannot precisely quantify that amount due to manyuncertainties, including future global, national, and local economic conditionsand other factors. As a result, unforeseen developments may require managementto increase the ALLL. Such developments could include changing economicconditions or negative developments with borrowers. In addition, bankregulators periodically assess Sun’s ALLL and may, consistent with examinationguidelines and current information, require an increased ALLL. As a result, anynumber of factors may materially change management’s analysis in the future.

 

49

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**ALLL Allocationand ALLL Changes for the five years ended December 31, 2001:**

 
| **(In  Thousands)**       |   | **Allowance** |   | **2002  % of  Total  Allowance** |   | **•Allowance** |   | **2001  % of  Total  Allowance** |   | **•Allowance** |   | **2000  % of  Total  Allowance** |   | **•Allowance** |   | **1999  % of  Total  Allowance** |   | **•Allowance** |   | **1998  % of  Total  Allowance** |   |
|---------------------------|--------|---------------|--------|----------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------|--------|----------------------------------|--------|---------------------|--------|----------------------------------|--------|
| Real estate               |   | $             | 1,107  |                             | 17.84  | %                   | $      | 2,357                            |   | 37.99               | %      | $                                | 1,870  |                | 36.85  | %                                | $      | 844                 |   | 47.59                            | %      | $ | 1,408 |   | 58.76 | % |
| Commercial and industrial |   | 2,849         |   | 45.91                            |   | 1,922               |   | 30.98                            |   | 1,990               |   | 39.22                            |   | 908                 |   | 30.13                            |   | 479                 |   | 16.25                            |   |
| Individual                |   | 2,250         |   | 36.25                            |   | 1,925               |   | 31.03                            |   | 1,214               |   | 23.93                            |   | 2,105               |   | 22.28                            |   | 1,440               |   | 24.99                            |   |
| Total ALLL                |   | $             | 6,206  |                             | 100.00 | %                   | $      | 6,204                            |   | 100.00              | %      | $                                | 5,074  |                | 100.00 | %                                | $      | 3,857               |   | 100.00                           | %      | $ | 3,327 |   | 100.00 | % |

 
| **(In Thousands)**                               |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|--------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
| Balance, beginning of year                       |   | $        | 6,204  |     | $      | 5,074    |   | $        | 3,857  |     | $      | 3,327 |   | $ | 3,130 |   |
| Loans and leases charged off:                    |   |     |   |     |   |     |   |     |   |     |   |
| Real estate                                      |   | (231     | )      | (303     | )      | (223     | )      | (389     | )      | (271     | )      |
| Commercial and industrial                        |   | (1,140   | )      | (321     | )      | (618     | )      | (169     | )      | (276     | )      |
| Individual                                       |   | (542     | )      | (659     | )      | (712     | )      | (1,048   | )      | (704     | )      |
| Total loans and leases charged off               |   | (1,913   | )      | (1,283   | )      | (1,553   | )      | (1,606   | )      | (1,251   | )      |
| Recoveries:                                      |   |     |   |     |   |     |   |     |   |     |   |
| Real estate                                      |   | 230      |   | 63       |   | 40       |   | 36       |   | 95       |   |
| Commercial and industrial                        |   | 41       |   | 139      |   | 37       |   | 26       |   | 32       |   |
| Individual                                       |   | 184      |   | 139      |   | 193      |   | 149      |   | 121      |   |
| Total recoveries of loans and leases charged off |   | 455      |   | 341      |   | 270      |   | 211      |   | 248      |   |
| Net loans charged off                            |   | (1,458   | )      | (942     | )      | (1,283   | )      | (1,395   | )      | (1,003   | )      |
| Provision for loan and lease losses              |   | 1,460    |   | 1,500    |   | 2,500    |   | 1,925    |   | 1,200    |   |
| ALLL assumed upon acquisition of Guaranty        |   | —   |   | 572      |   | —   |   | —   |   | —   |   |
| Balance, end of year                             |   | $        | 6,206  |     | $      | 6,204    |   | $        | 5,074  |     | $      | 3,857 |   | $ | 3,327 |   |
| Ratios:                                          |   |     |   |     |   |     |   |     |   |     |   |
| Net charge-offs to average loans                 |   | .34      | %      | .19      | %      | .32      | %      | .40      | %      | .32      | %      |
| ALLL to total loans at December 31               |   | 1.05     | %      | 1.20     | %      | 1.23     | %      | 1.01     | %      | 1.00     | %      |
| ALLL to total nonperforming loans                |   | 183.56   | %      | 164.61   | %      | 192.63   | %      | 116.88   | %      | 88.84    | %      |

 

50

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**InvestmentSecurities**

 

Sun’s securities portfolio traditionally was composed almost entirely oflong-term mortgage pass-through securities. However, those instruments carrysignificant market risk and extension risk due to prepayment volatility.Management now maintains the investment portfolio to serve as a stable sourceof supplemental liquidity and earnings.

Thus, management’s portfolio strategy focuses on maximizingrisk-adjusted return through effective analysis of cash flows and embeddedoptions. Generally, Sun does not take material credit risk in its securitiesportfolio. Sun’s investment activities emphasize instruments withwell-structured cash flows, competitive returns, and moderate market risk.Through careful monitoring and transaction timing, management has reduced thesecurities portfolio’s embedded market risk without a substantial decline inaggregate yield. Management intends to pursue further risk reduction strategiesduring 2003 whenever warranted.

Investment securities contractual maturities as of December 31, 2002:

 
|                                                |   | **Within  One Year Amortized** |   | **After One But  Within Five Years Amortized** |   | **After Five But  Within Ten Years Amortized** |   | **After  Ten Years Amortized** |   | **Total Amortized** |   |
|-----------------------------------------------------|--------|--------------------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|--------------------------------|--------|---------------------|--------|
| **(In Thousands)**                                  |   | **Cost**                       |   | **Yield (3)**                                  |   | **Cost**                                       |   | **Yield (3)**                  |   | **Cost**            |   | **Yield (3)** |   | **Cost** |   | **Yield (3)** |   | **Cost** |   | **Yield (3)** |   |
| Obligations of U.S. government agencies             |   | $                              | 5,514  |                                           | 2.91   | %                                              | $      | 10,546                         |   | 4.95                | %      | $ | 27,697 |   | 6.13 | % | $ | 129,795 |   | 5.15 | % | $ | 173,552 |   | 5.22 | % |
| Obligations of states and political subdivisions(1) |   | 1,062                          |   | 5.54                                           |   | 3,446                                          |   | 6.15                           |   | 2,500               |   | 7.34 |   | 12,759 |   | 8.14 |   | 19,767 |   | 7.55 |   |
| Corporate                                           |   | 1,187                          |   | 5.77                                           |   | 1,005                                          |   | 6.01                           |   | 2,181               |   | 8.82 |   | 1,202 |   | 8.70 |   | 5,575 |   | 7.67 |   |
| Total $7,763                                        |   | 3.70                           | %      | $14,997                                        |   | 5.30                                           | %      | $32,378                        |   | 6.41                | %      | $143,756 |   | 5.44 | % | $198,894 |   | 5.52 | % |   |   |
|                                                |   |                           |   |                                           |   |                                           |   |                           |   |                |   |   |   |   |   |   |   |   |   |   |   |
| Equity securities(2)                                |   |                           |   |                                           |   |                                           |   |                           |   |                |   |   |   |   |   |   |   | 15,123 |   |   |   |
| Total investment securities                         |   |                           |   |                                           |   |                                           |   |                           |   |                |   |   |   |   |   |   |   | $ | 214,017 |   | 5.13 | % |
|                                                     |        |                                |        |                                                |        |                                                |        |                                |        |                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) Tax-equivalent income calculated using a 34% federal income taxrate.

(2) Equity securities have no stated maturity or dividend rate.

(3) Yields based on 360/360 calculation.

 

51

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**Funding**

 

**Deposits:**

Sun’s total deposits increased $13,603,000, or 2.37%, to $587,480,000 atDecember 31, 2002, compared to $573,877,000 at December 1, 2001.

In 2001, total deposits increased $129,311,000 or 29.09%, includingcertain non cash transactions of $137,868,000 related to acquisition anddisposal activities. During 2001, Sun began to concentrate its depositgathering efforts on core deposits to reduce the reliance on higher costcertificates of deposit and borrowed funds, which increased interest expense,decreased net interest income, and compressed the net interest margin. Sunconsiders core funding to be only deposit accounts without stated maturities.Such transaction and savings products generally represent more lasting, lowercost relationships. At December 31, 2002, Sun had $320,967,000 in coredeposits, an increase of $28,157 or 9.62%, from $292,810 at December 31, 2001.This increase is attributable to the decline in the stock market and thecustomer relationship program.

(In Thousands)

 
| **December 31,**                                 |   | **% of  2002** |    | **% Change  Total** |   | **from Prior  Year** |   |
|--------------------------------------------------|--------|----------------|---------|---------------------|--------|----------------------|--------|
| Demand deposits                                  |   | $              | 59,181  |                | 10.07  | %                    | 1.93   | % |
| NOW accounts                                     |   | 155,114        |    | 26.40               |   | 6.00                 |   |
| Insured Money Market Accounts                    |   | 29,827         |    | 5.08                |   | 65.17                |   |
| Savings deposits                                 |   | 76,712         |    | 13.06               |   | 8.90                 |   |
| Time Certificates of Deposit of $100,000 or more |   | 46,630         |    | 7.94                |   | (5.77                | )      |
| Other time deposits                              |   | 220,016        |    | 37.45               |   | (5.00                | )      |
| Total deposits                                   |   | $              | 587,480 |                | 100.00 | %                    | 2.37   | % |

 
| **December 31,**                                 |   | **% of  2001** |    | **% Change  Total** |   | **from Prior  Year** |   |
|--------------------------------------------------|--------|----------------|---------|---------------------|--------|----------------------|--------|
| Demand deposits                                  |   | $              | 58,063  |                | 10.12  | %                    | 46.02  | % |
| NOW accounts                                     |   | 146,339        |    | 25.50               |   | 32.66                |   |
| Insured Money Market Accounts                    |   | 18,058         |    | 3.15                |   | 14.22                |   |
| Savings deposits                                 |   | 70,422         |    | 12.27               |   | 74.54                |   |
| Time Certificates of Deposit of $100,000 or more |   | 49,484         |    | 8.62                |   | 11.24                |   |
| Other time deposits                              |   | 231,511        |    | 40.34               |   | 19.43                |   |
| Total deposits                                   |   | $              | 573,877 |                | 100.00 | %                    | 29.09  | % |

 

**OtherFunding:**

Sun continued using borrowed funds to supplement deposits during 2002.At December 31, 2002, the $220,000 in FHLB term advances were variable rateadvances that mature between 2008 and 2010.

FHLB advances are collateralized by pledged investment securities (U.S.government agency debt) and first lien residential mortgage loans. Otherfunding sources include deposit customers’ cash management accounts (classifiedas securities sold under agreements to repurchase) and the Treasury Tax andLoan Note Option. Sun continually monitors its borrowed funds positions andmarket conditions in order to maintain an effective funding structure. Whenappropriate, Sun may take future action to modify its borrowed funds structure.

 

**NetInterest Income and Net Interest Margin**

 

Net interest income, the difference between interest income and interestexpense, is the largest component of Sun’s earnings. Net interest margin (NIM)measures the difference between the interest earning assets yield and theaggregate funding cost. The NIM is calculated as taxable equivalent netinterest income divided by average interest earning assets.

NIM narrowed by 3 basis points to 3.09% for 2002 compared to 3.12% for2001. The compression resulted principally from the prepayment of loans andinvestments as caused by the rate reductions by the Federal Reserve over thepast two years.

Net interest income was $24,895,000 for 2002, compared with $23,735,000for the prior year. On a taxable equivalent basis, net interest incomedecreased $360,000 to $25,913,000 for 2002 versus $26,273,000 for the prioryear. The following table provides additional information related to netinterest income.

 

52

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**ConsolidatedStatements of Income**

 

**AverageBalances and Net Interest Income**

 

This table presents average daily balance composition and net interestincome on a fully taxable equivalent basis:

 
| **(In Thousands)**                                              |   | **2002**             |    | **2001**     |   | **2000** |   |
|-----------------------------------------------------------------|--------|----------------------|---------|--------------|--------|----------|--------|
|                                                            |   | **Average  Balance** |    | **Interest** |   | **Rate** |   | **Average  Balance** |   | **Interest** |   | **Rate** |   | **Average  Balance** |   | **Interest** |   | **Rate** |   |
| ASSETS                                                          |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets:                                        |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits                                       |   | $                    | 17,195  |         | $      | 363      |   | 2.11 | % | $ | 37,753 |   | $ | 1,345 |   | 3.56 | % | $ | 7,092 |   | $ | 428 |   | 6.03 | % |
| Loans (net of unearned income)(1)(2)                            |   | 568,154              |    | 40,806       |   | 7.18     |   | 483,817 |   | 40,555 |   | 8.38 |   | 399,517 |   | 35,399 |   | 8.86 |   |
| Investments:                                                    |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                         |   | 232,911              |    | 12,855       |   | 5.52     |   | 298,346 |   | 18,609 |   | 6.24 |   | 260,337 |   | 18,201 |   | 6.99 |   |
| Tax exempt(2)                                                   |   | 21,009               |    | 1,537        |   | 7.32     |   | 21,950 |   | 1,723 |   | 7.85 |   | 17,823 |   | 1,465 |   | 8.22 |   |
| Total interest-earning assets                                   |   | 839,269              |    | 55,561       |   | 6.62     |   | 841,866 |   | 62,232 |   | 7.39 |   | 684,769 |   | 55,493 |   | 8.10 |   |
|                                                            |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning assets:                                    |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                                         |   | 19,444               |    |         |   |     |   | 15,082 |   |   |   |   |   | 12,267 |   |   |   |   |   |
| Bank premises & equipment                                   |   | 14,783               |    |         |   |     |   | 13,604 |   |   |   |   |   | 10,659 |   |   |   |   |   |
| Intangible assets                                               |   | 22,924               |    |         |   |     |   | 18,000 |   |   |   |   |   | 9,041 |   |   |   |   |   |
| Accrued interest and other assets                               |   | 41,618               |    |         |   |     |   | 13,298 |   |   |   |   |   | 12,059 |   |   |   |   |   |
| Less:                                                           |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ALLL                                                            |   | (6,840               | )       |         |   |     |   | (5,807 | ) |   |   |   |   | (4,410 | ) |   |   |   |   |
| Unamortized loan fees                                           |   | 122                  |    |         |   |     |   | 10 |   |   |   |   |   | 50 |   |   |   |   |   |
| Total assets                                                    |   | $                    | 931,320 |         |   |     |   |   | $ | 896,053 |   |   |   |   |   | $ | 724,435 |   |   |   |   |   |
|                                                            |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                       |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                   |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW Accounts                                                    |   | $                    | 151,004 |         | $      | 1,974    |   | 1.31 | % | $ | 136,075 |   | $ | 3,285 |   | 2.41 | % | $ | 94,374 |   | 3,601 |   | 3.82 | % |
| Insured Money Market Accounts                                   |   | 22,329               |    | 412          |   | 1.85     |   | 20,945 |   | 568 |   | 2.71 |   | 18,624 |   | 724 |   | 3.89 |   |
| Savings deposits                                                |   | 76,656               |    | 1,200        |   | 1.57     |   | 63,090 |   | 1,241 |   | 1.97 |   | 43,849 |   | 880 |   | 2.01 |   |
| Time deposits                                                   |   | 275,373              |    | 11,147       |   | 4.05     |   | 291,327 |   | 16,070 |   | 5.52 |   | 224,690 |   | 12,870 |   | 5.73 |   |
| Short-term borrowings                                           |   | 22,897               |    | 325          |   | 1.42     |   | 17,270 |   | 430 |   | 2.49 |   | 16,729 |   | 853 |   | 5.10 |   |
| Subordinated debentures                                         |   | 20,083               |    | 1,892        |   | 9.42     |   | 16,051 |   | 1,578 |   | 9.83 |   | — |   | — |   | — |   |
| Other borrowed funds                                            |   | 220,849              |    | 12,698       |   | 5.75     |   | 222,000 |   | 12,787 |   | 5.76 |   | 223,785 |   | 12,897 |   | 5.76 |   |
| Total interest-bearing liabilities                              |   | 789,191              |    | 29,648       |   | 3.76     |   | 766,758 |   | 35,959 |   | 4.69 |   | 622,051 |   | 31,825 |   | 5.12 |   |
| Non-interest-bearing liabilities and shareholders’ equity: |   |                 |    |         |   |     |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                 |   | 57,310               |    |         |   |     |   | 57,478 |   |   |   |   |   | 40,840 |   |   |   |   |   |
| Accrued interest and other liabilities                          |   | 4,853                |    |         |   |     |   | 3,610 |   |   |   |   |   | 3,776 |   |   |   |   |   |
| Shareholders’ equity                                       |   | 79,966               |    |         |   |     |   | 68,207 |   |   |   |   |   | 57,768 |   |   |   |   |   |
| Total liabilities and shareholders’ equity                 |   | $                    | 931,320 |         |   |     |   |   | $ | 896,053 |   |   |   |   |   | $ | 724,435 |   |   |   |   |   |
| Interest rate spread                                            |   |                 |    |         |   | 2.86     | %      |   |   |   |   | 2.70 | % |   |   |   |   | 2.98 | % |
| Net interest income/margin                                      |   |                 |    | $            | 25,913 |     | 3.09   | % |   |   | $ | 26,273 |   | 3.12 | % |   |   | $ | 23,668 |   | 3.46 | % |

 

----

(1) Average loan balances include non-accrual loans and interest incomeincludes fees on loans.

(2) Yields on tax exempt loans and investments have been adjusted to afully taxable equivalent basis using a 34% federal income tax rate.

 

**Management’s Discussion and Analysis**

 

**Volumeand Rates**

Changes in interest income and interest expense can result fromvariances in both volume and rates. The following table shows an analysis ofthe effect of volume and rate variances on taxable equivalent interest income,interest expense, and net interest income.

 

53

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| **(In Thousands)**                 |   | **2002  Compared to 2001  Increase (Decrease)** |   | **2001  Compared to 2000  Increase (Decrease)** |   |
|------------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|
|                               |   | **Volume**                                      |   | **Rate**                                        |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** |   |
| Interest earned on:                |   |                                            |   |                                            |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits          |   | $                                               | (733   | )                                               | $      | (249 | ) | $ | (982 | ) | $ | 1,688 |   | $ | (771 | ) | $ | 917 |   |
| Loans                              |   | 7,061                                           |   | (6,810                                          | )      | 251 |   | 7,467 |   | (2,311 | ) | 5,156 |   |
| Investments:                       |   |                                            |   |                                            |   |   |   |   |   |   |   |   |   |
| Taxable                            |   | (4,077                                          | )      | (1,677                                          | )      | (5,754 | ) | 2,653 |   | (2,245 | ) | 408 |   |
| Tax exempt                         |   | (74                                             | )      | (112                                            | )      | (186 | ) | 339 |   | (81 | ) | 258 |   |
| Total interest-earning assets      |   | 2,177                                           |   | (8,848                                          | )      | (6,671 | ) | 12,147 |   | (5,408 | ) | 6,739 |   |
| Interest paid on:                  |   |                                            |   |                                            |   |   |   |   |   |   |   |   |   |
| NOW Accounts                       |   | 359                                             |   | (1,670                                          | )      | (1,311 | ) | 1,597 |   | (1,913 | ) | (316 | ) |
| Insured Money Market Accounts      |   | 38                                              |   | (194                                            | )      | (156 | ) | 91 |   | (247 | ) | (156 | ) |
| Savings deposits                   |   | 268                                             |   | (309                                            | )      | (41 | ) | 388 |   | (27 | ) | 361 |   |
| Time deposits                      |   | (879                                            | )      | (4,044                                          | )      | (4,923 | ) | 3,823 |   | (623 | ) | 3,200 |   |
| Short-term borrowings              |   | 140                                             |   | (245                                            | )      | (105 | ) | 28 |   | (451 | ) | (423 | ) |
| Subordinated debentures            |   | 396                                             |   | (82                                             | )      | 314 |   | 1,578 |   | — |   | 1,578 |   |
| Other borrowed funds               |   | (66                                             | )      | (23                                             | )      | (89 | ) | (110 | ) | — |   | (110 | ) |
| Total interest-bearing liabilities |   | 256                                             |   | (6,567                                          | )      | (6,311 | ) | 7,395 |   | (3,261 | ) | 4,134 |   |
| Net interest income                |   | $                                               | 1,921  |                                            | $      | (2,281 | ) | $ | (360 | ) | $ | 4,752 |   | $ | (2,147 | ) | $ | 2,605 |   |

 

Income on tax exempt loans and investments have been adjusted to a fullytaxable equivalent basis using a 34% federal income tax rate.

Changes in interest income and interest expense attributable to thecombined impact of both volume and rate were allocated proportionately to thechanges due to volume and the changes due to rate.

 

54

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**Income and Expense Changes**

 

The table below presents the consolidated comparative changes in incomeand expense, and it reflects changes in average asset and liability volumes.Tax exempt income is not shown on a tax equivalent basis.

(In Thousands)    2002 Compared to 20012001 Compared to 2000

 
|                                                          |   | **Average  $ Change** |   | **Volumes  % Change** |   | **Income/  Expense  $ Change** |   | **% Change** |   | **Average  • $ Change** |   | **Volumes  % Change** |    | **Income/  Expense  $ Change** |   | **% Change** |    |
|---------------------------------------------------------------|--------|-----------------------|--------|-----------------------|--------|--------------------------------|--------|--------------|--------|------------------------------|--------|-----------------------|---------|--------------------------------|--------|--------------|---------|
| Loans, net                                                    |   | $                     | 84,337 |                  | 17.43  | %                              | $      | 1,707        |   | 4.42                         | %      | $                     | 84,300  |                           | 21.10  | %            | $       | 4,639 |   | 13.67 | % |
| Investment securities                                         |   | (66,376               | )      | (20.72                | )      | (5,876                         | )      | (29.76       | )      | 42,136                       |   | 15.15                 |    | 578                            |   | 3.02         |    |
| Interest-bearing deposits                                     |   | (20,558               | )      | (54.45                | )      | (982                           | )      | (73.01       | )      | 30,661                       |   | 394.81                |    | 917                            |   | 214.25       |    |
| Total interest-earning assets                                 |   | $                     | (2,597 | )                     | (0.31  | )%                             | $      | (5,151       | )      | (8.63                        | )%     | $                     | 157,097 |                           | 22.94  | %            | $       | 6,134 |   | 11.45 | % |
| NOW Accounts                                                  |   | $                     | 14,929 |                  | 10.97  | %                              | $      | (1,311       | )      | (39.91                       | )%     | $                     | 41,701  |                           | 44.19  | %            | $       | (316 | ) | (8.78 | )% |
| Insured Money Market Accounts                                 |   | 1,384                 |   | 6.61                  |   | (156                           | )      | (27.46       | )      | 2,321                        |   | 12.46                 |    | (156                           | )      | (21.55       | )       |
| Savings deposits                                              |   | 13,566                |   | 21.50                 |   | (41                            | )      | (3.30        | )      | 19,241                       |   | 43.88                 |    | 361                            |   | 41.02        |    |
| Time deposits                                                 |   | (15,954               | )      | (5.48                 | )      | (4,923                         | )      | (30.63       | )      | 66,637                       |   | 29.66                 |    | 3,200                          |   | 24.86        |    |
| Short-term borrowings                                         |   | 5,627                 |   | 32.58                 |   | (105                           | )      | (24.42       | )      | 541                          |   | 3.23                  |    | (423                           | )      | (49.59       | )       |
| Subordinated debentures                                       |   | 4,032                 |   | 25.12                 |   | 314                            |   | 19.90        |   | 16,051                       |   | 100.00                |    | 1,578                          |   | 100.00       |    |
| Other borrowed funds                                          |   | (1,151                | )      | (0.52                 | )      | (89                            | )      | (0.70        | )      | (1,785                       | )      | .80                   |    | (110                           | )      | (.85         | )       |
| Total interest-bearing liabilities                            |   | $                     | 22,433 |                  | 2.93   | %                              | $      | (6,311       | )      | (17.55                       | )%     | $                     | 144,707 |                           | 23.26  | %            | $       | 4,134 |   | 12.99 | % |
| Net interest income                                           |   |                  |   |                  |   | $                              | 1,160  |         | 4.89   | %                            |   |                  |    |                           | $      | 2,000        |    | 9.20 | % |
| Provision for loan and lease losses                           |   |                  |   |                  |   | (40                            | )      | (2.67        | )      |                         |   |                  |    | (1,000                         | )      | 40.00        |    |
| Net interest income after provision for loan and lease losses |   |                  |   |                  |   | 1,200                          |   | 5.40         |   |                         |   |                  |    | 3,000                          |   | 15.60        |    |
| Service charges on deposit accounts                           |   |                  |   |                  |   | 1,138                          |   | 59.80        |   |                         |   |                  |    | 588                            |   | 44.71        |    |
| Trust income                                                  |   |                  |   |                  |   | 14                             |   | 1.88         |   |                         |   |                  |    | (152                           | )      | (16.95       | )       |
| Net securities gains                                          |   |                  |   |                  |   | (228                           | )      | (27.01       | )      |                         |   |                  |    | 2,799                          |   | 143.17       |    |
| Income from investment sales                                  |   |                  |   |                  |   | 97                             |   | 31.39        |   |                         |   |                  |    | 309                            |   | 100.00       |    |
| Bank owned life insurance                                     |   |                  |   |                  |   | 720                            |   | 100.00       |   |                         |   |                  |    |                           |   |         |    |
| Income from insurance subsidiary                              |   |                  |   |                  |   | (106                           | )      | (57.92       | )      |                         |   |                  |    | (87                            | )      | (32.22       | )       |
| Gain on sale of branches                                      |   |                  |   |                  |   | (4,892                         | )      | (100.00      | )      |                         |   |                  |    | 4,892                          |   | 100.00       |    |
| Gain on sale of loans                                         |   |                  |   |                  |   | 125                            |   | 96.15        |   |                         |   |                  |    | 105                            |   | 420.00       | %       |
| Other income                                                  |   |                  |   |                  |   | 292                            |   | 58.17        |   |                         |   |                  |    | 70                             |   | 16.20        |    |
| Total non-interest income                                     |   |                  |   |                  |   | (2,840                         | )      | (29.87       | )      |                         |   |                  |    | 8,524                          |   | 866.29       |    |
| Salaries and employee benefits                                |   |                  |   |                  |   | 2,120                          |   | 21.90        |   |                         |   |                  |    | 2,361                          |   | 32.26        |    |
| Net occupancy and equipment expenses                          |   |                  |   |                  |   | 133                            |   | 4.85         |   |                         |   |                  |    | 896                            |   | 48.59        |    |
| Pennsylvania shares tax                                       |   |                  |   |                  |   | 101                            |   | 12.63        |   |                         |   |                  |    | 99                             |   | 16.50        |    |
| Amortization of intangibles                                   |   |                  |   |                  |   | (1,567                         | )      | (100.00      | )      |                         |   |                  |    | 812                            |   | 107.55       |    |
| Expenses of insurance subsidiary                              |   |                  |   |                  |   | 7                              |   | 6.36         |   |                         |   |                  |    | (80                            | )      | (42.11       | )  |
| Other expenses                                                |   |                  |   |                  |   | 1,779                          |   | 33.87        |   |                         |   |                  |    | 1,866                          |   | 55.09        |    |
| Total non-interest expenses                                   |   |                  |   |                  |   | 2,573                          |   | 12.83        |   |                         |   |                  |    | 5,954                          |   | 42.24        |    |
| Income before income tax provision                            |   |                  |   |                  |   | (4,213                         | )      | (36.03       | )      |                         |   |                  |    | 5,570                          |   | 90.95        |    |
| Income tax provision                                          |   |                  |   |                  |   | (2,279                         | )      | (68.15       | )      |                         |   |                  |    | 1,818                          |   | 119.13       |    |
| Net income                                                    |   |                  |   |                  |   | $                              | (1,934 | )            | (23.16 | )%                           |   |                  |    |                           |   | $            | 3,752   |   | 81.60 | % |
|                                                               |        |                       |        |                       |        |                                |        |              |        |                              |        |                       |         |                                |        |              |         |  |  |  |  |  |  |  |

 

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**Non-InterestIncome**

 

Non-interest income, excluding gain on sale of branches, increased$2,052,000 or 44.5%, from 2001 to 2002. This increase resulted largely from therecognition of $720,000 in fee income from bank owned life insurance and anincrease of $1,138,000 in service charge on deposits.

Service charges on deposit accounts demonstrated continued growth andincreased 59.8% in 2002. This growth resulted from an overdraft honor program,increased transaction account fee income, and increased ATM usage fees.Management will continue pursuing ATM expansion in high volume locations. Trustincome increased 1.9% during 2002 as the stock market remained stagnant whichcaused the fair market value of the accounts to remain stable which has adirect result on fees generated.

Gains on loan sales increased $125,000 from 2002 to 2001. Other incomeincreased $292,000 or 58.2%, from 2001 to 2002 as a result of increasedmiscellaneous income and non-yield related loan fees.

Changes in non-interest income for the years ended December 31:

 
| **(In Thousands)**                  |   | **2002** |   | **% Change** |   | **2001** |   | **% Change** |   | **2000** |   |
|-------------------------------------|--------|----------|--------|--------------|--------|----------|--------|--------------|--------|----------|--------|
| Service charges on deposit accounts |   | $        | 3,041  |         | 59.80  | %        | $      | 1,903        |   | 44.71    | %      | $ | 1,315 |   |
| Trust income                        |   | 759      |   | 1.88         |   | 745      |   | (16.95       | )      | 897      |   |
| Net securities gains (losses)       |   | 616      |   | (27.01       | )      | 844      |   | 143.17       |   | (1,955   | )      |
| Income from insurance subsidiary    |   | 77       |   | (57.92       | )      | 183      |   | (32.22       | )      | 270      |   |
| Income from investment sales        |   | 406      |   | 31.39        |   | 309      |   | 100.00       |   | —   |   |
| Bank owned life insurance           |   | 720      |   | 100.00       |   | —   |   | —       |   | —   |   |
| Gain on sale of branches            |   | —   |   | (100.00      | )      | 4,892    |   | 100.00       |   | —   |   |
| Gain on sale of loans               |   | 255      |   | 96.15        |   | 130      |   | 420.00       |   | 25       |   |
| Other income                        |   | 794      |   | 58.17        |   | 502      |   | 16.20        |   | 432      |   |
| Total non-interest income           |   | $        | 6,668  |         | (29.87 | )%       | $      | 9,508        |   | 866.26   | %      | $ | 984 |   |

 

**Non-InterestExpenses**

 

Non-interest expenses increased $2,573,000 or 12.8 %, from 2001 to 2002.That increase resulted primarily from the outsourcing of the daily processingfunctions which has required parallel systems to be run during the period ofconversion. Cost savings associated with the outsourcing have not yet been realizedas parallel systems are being run during the conversion. Salaries and employeebenefits increased $2,120,000 or 21.9%, from 2001 to 2002. The increase is theresult of a full year’s impact of the Guaranty Bank and three branch purchasesduring 2001 and Sun continuing to attract key individuals to provide increasedmarket coverage. Occupancy and furniture and equipment expenses remained steadyfrom 2001 to 2002. Other expenses increased $1,779,000 from 2001 to 2002. Inaddition, Sun incurred a significant increase in consulting fees related toinfrastructure improvements. Amortization of intangibles declined $1,567,000 asunder SFAS 147 and SFAS 142 as described in Note 8, Sun is no longer requiredto amortize goodwill.

Changes in non-interest expense for the years ended December 31:

 
| **(In Thousands)**               |   | **2002** |   | **% Change** |   | **2001** |   | **% Change** |   | **2000** |   |
|----------------------------------|--------|----------|--------|--------------|--------|----------|--------|--------------|--------|----------|--------|
| Salaries and employee benefits   |   | $        | 11,800 |         | 21.90  | %        | $      | 9,680        |   | 32.26    | %      | $ | 7,319 |   |
| Net occupancy expenses           |   | 1,083    |   | 8.84         |   | 995      |   | 50.78        |   | 660      |   |
| Furniture and equipment expenses |   | 1,790    |   | 2.58         |   | 1,745    |   | 47.38        |   | 1,184    |   |
| Pennsylvania shares tax          |   | 800      |   | 14.45        |   | 699      |   | 16.50        |   | 600      |   |
| Amortization of intangibles      |   | —   |   | (100.00      | )      | 1,567    |   | 107.55       |   | 755      |   |
| Expenses of insurance subsidiary |   | 117      |   | 6.36         |   | 110      |   | (42.11       | )      | 190      |   |
| Other expenses                   |   | 7,032    |   | 33.87        |   | 5,253    |   | 55.09        |   | 3,387    |   |
| Total non-interest expenses      |   | $        | 22,622 |         | 12.83  | %        | $      | 20,049       |   | 42.24    | %      | $ | 14,095 |   |

 

**Liquidity**

 

Management must ensure sufficient liquidity to meet current and futurebusiness needs, including customer cash withdrawals and loan fundings. Inaddition, management must maintain additional contingency liquidity sources tomeet unexpected needs.

Sun’s liquidity depends on its ability to acquire funds or convertassets to cash without material loss. Sun’s primary liquidity sources includeregular principal and interest payments on loans and securities, short-termsecurities, and various borrowing sources. Supplemental liquidity sourcesinclude longer-term securities, lines of credit, and additional sources for newdeposits. Notably, management does not consider cash and due from banks amountsto be liquidity sources. Those amounts are typically needed by banks for dailyoperations. Refer to Note 10, Borrowed Funds, for detail regarding Sun’sborrowing capacity.

Management believes there are no identified trends, demands,commitments, or uncertainties that negatively impact liquidity.

 

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**MarketRisk**

 

For Sun, market risk results predominantly from interest rate risk andequity price risk. Although Sun’s market risks may change in the future,management currently focuses its risk management efforts on those twocomponents.

 

**InterestRate Risk (IRR):**

IRR represents the potential current or future earnings and capitalvolatility due to interest rate changes. Interest rate fluctuations affectearnings by changing net interest income and other interest-sensitive incomeand expense levels. Interest rate changes affect capital by altering banks’economic value of equity (EVE). EVE represents the net present value of allasset, liability, and off-balance sheet cash flows. Interest rate fluctuationschange the present values of those cash flows.

As financial intermediaries, banks cannot completely avoid IRR. However,excessive IRR can threaten earnings, capital, liquidity, and solvency. IRR hasmany components, including repricing risk, basis risk, yield curve risk, optionrisk, and price risk. Sun’s primary, but not sole, IRR source is balance sheetoptionality from residential mortgages and mortgage-backed securities. Thoseassets may prepay principal at changing speeds depending on interest ratelevels and other factors beyond Sun’s control. When prepayments occur,management must reinvest those cash flows at current market rates (in loans orsecurities). Thus, future interest levels and paths may negatively (orpositively) affect Sun’s net interest income.

Sun seeks to minimize net interest income volatility by carefullymeasuring, monitoring, and controlling IRR. Sun is implementing a comprehensivemarket risk management program to dramatically enhance management’s ability tomeasure, monitor, and control risk. Market risk can result in fluctuating netinterest income due to interest rate and other economic changes. Usingsimulation models, Sun can measure market risk by forecasting net interestincome volatility under various interest rate scenarios. However, these modelsdepend on many significant assumptions that may not accurately reflect futureconditions.

 

**Rate ShockForecast at December 31, 2002:**

(In Thousands)

 
|                |   | **Parallel  rate shock in basis points (bp)** |   |
|---------------------|--------|-----------------------------------------------|--------|
|                |   | **-200bp***                                   |   | **-100bp*** |   | **0bp** |   | **+100bp** |   | **+200bp** |   |
| Interest income:    |   | $                                             | 43,852 |   | $ | 47,145 |   | $ | 50,810 |   | $ | 53,955 |   | $ | 57,191 |   |
| Interest expense:   |   | $                                             | 22,220 |   | $ | 23,308 |   | $ | 25,072 |   | $ | 26,837 |   | $ | 28,603 |   |
| Net interest income |   | $                                             | 21,632 |   | $ | 23,837 |   | $ | 25,738 |   | $ | 27,118 |   | $ | 28,588 |   |

 

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*Given low current levels for certain short-term interest rates,applying declining rate shocks would result in some negative interest rates.

In order to avoid unrealistic conditions and results, floors were set at0.50%.

 

**Equity PriceRisk:**

Sun’s equity securities consist of marketable equities and restrictedstock. Marketable equities consist entirely of common stocks, primarily of bankand bank holding companies. Restricted stock consists almost entirely of FHLBstock. Since FHLB stock is redeemable at par, Sun carries it at cost andperiodically evaluates the stock for impairment. Possible impairment factorsinclude potential dramatic changes to the housing and residential mortgageindustry or the related regulatory environment. Management currently does notbelieve any factors exist to suggest potential impairment.

Bank and bank holding company stocks are subject to general industryrisks, including competition from non-bank entities, credit risk, interest raterisk, and other factors. Individual stocks could suffer price decreases due tocircumstances at specific banks. In addition, Sun’s bank stock investments areconcentrated in Pennsylvania entities, so these investments could decline invalue if there were a downturn in the state’s economy. Other marketable stocksare comprised of non-bank, exchange-traded stocks that are subject to typicalequity risks.

(In Thousands)

 
| **December 31,**    |   | **2002  Cost** |   | **Fair Value** |   | **2001  Cost** |   | **Fair Value** |   |
|---------------------|--------|----------------|--------|----------------|--------|----------------|--------|----------------|--------|
| Marketable equities |   | $              | 3,111  |           | $      | 2,932          |   | $              | 3,836  |   | $ | 3,102 |   |
| Restricted stock    |   | 12,012         |   | 12,012         |   | 11,114         |   | 11,114         |   |
| Total               |   | $              | 15,123 |           | $      | 14,944         |   | $              | 14,950 |   | $ | 14,216 |   |

Until 2000, Sun had actively invested in both bank and non-bank marketableequities. In 2000, management began a long-term program to gradually reduceequity investments and risk exposure to a nominal amount. Management hassuccessfully reduced Sun’s marketable equity price risk exposure, as shown inthe table below:

 

(In Thousands)

 
| **December 31,** |   | **2002** |   | **2001** |   |
|------------------|--------|----------|--------|----------|--------|
| Cost             |   | $        | 3,111  |     | $      | 3,836 |   |
| Fair Value       |   | 2,932    |   | 3,182    |   |
| Unrealized Loss  |   | $        | (179   | )        | $      | (654 | ) |

 

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**CapitalAdequacy**

 

Sun and the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capitalrequirements could prompt regulatory action that, if undertaken, mightmaterially affect Sun’s financial statements. Under regulatory capital adequacyguidelines, Sun and the Bank must meet specific capital requirements involvingquantitative measures of assets, liabilities, and certain off-balance sheetitems (calculated using regulatory accounting practices). All related factorsare subject to qualitative judgments by the regulators.

Sun is currently, and has been in the past, designated awell-capitalized institution. Shareholders’ equity increased $3,736,000 to$81,247,000 at December 31, 2002, from $77,511,000 at December 31, 2001.Unrealized gains or losses, net of taxes, on securities available for sale arereported as accumulated other comprehensive income (loss) within shareholders’equity. Sun had unrealized gains, net of tax, of $3,578,000 at December 31,2002, and unrealized gains, net of tax, of $2,069,000 at December 31, 2001.During 2002, Sun paid $4,614,000 in cash dividends. Management is not aware ofany events or regulatory restrictions that would have a material effect onSun’s capital adequacy.

 

**Regulation**

 

Various federal and state laws and regulations apply to banks and governbusiness scope, lending, investments, reserves, capital, and other activities.Banking laws and regulations have been developed primarily to protectdepositors rather than shareholders. The Bank’s deposits are insured by theFDIC to the extent provided by law, for which the Bank must pay a quarterlyassessment determined by the FDIC. The Bank is also subject to numerous stateand federal statutes and regulations that affect its business and operations,and is supervised and examined by one or more state or federal bank regulatoryagencies. The federal state bank regulatory agencies are empowered withconsiderable supervisory, examination, and enforcement discretion. Any changein banking law, regulation, policies, examination procedures, or correctiveaction remedies could have a material impact on Sun or the Bank.

On July 30, 2002, the Senate and the House of Representatives of theUnited States (Congress) enacted the Sarbanes-Oxley Act of 2002, a law thataddresses, among other issues, corporate governance, auditing and accounting,executive compensation, and enhanced and timely disclosure of corporateinformation. The New York Stock Exchange has also proposed corporate governancerules that were presented to the Securities and Exchange Commission for reviewand approval. The proposed changes are intended to allow stockholders to moreeasily and efficiently monitor the performance of companies and directors.

Effective August 29, 2002, as directed by Section 302(a) of Sarbanes-Oxley,Sun’s chief executive officer and chief financial officer are each required tocertify that Sun’s Quarterly and Annual Reports do not contain any untruestatement of a material fact. The rules have several requirements, includinghaving these officers certify that: they are responsible for establishing,maintaining and regularly evaluating the effectiveness of Sun’s internalcontrols; they have made certain disclosures to Sun’s auditors and the auditcommittee of the Board of Directors about Sun’s internal controls; and theyhave included information in Sun’s Quarterly and Annual Reports about theirevaluation and whether there have been significant changes in Sun’s internalcontrols or in other factors that could significantly affect internal controlssubsequent to the evaluation.

During 2002, the Board of Directors of Sun approved a series of actionsto strengthen and improve its already strong corporate governance practices.Included in those actions was the adoption of new Corporate Governance Guidelinesand new charters for the Audit, Compensation, and Nominating and Board ofDirectors’ Governance Committees and the drafting of a Code of Ethics and aCode of Ethics for Senior Financial Officers.

The Gramm-Leach-Bliley Act (GLBA) was enacted in November 1999 and mostprovisions became effective in March 2000. The GLBA permits greater affiliationamong banks, securities firms, insurance companies, and other companies under anew type of financial services company known as a “financial holding company.”Financial holding companies may engage in a number of financial activitiespreviously impermissible or subject to regulatory limitations for bank holdingcompanies, including securities underwriting; dealing and market making;sponsoring mutual funds and investment companies; insurance underwriting andagency; and merchant banking activities (see Note 21).

 

**Outlook**

In last year’s annual report we outlined our customer relationshipmanagement strategy. We mentioned a focus on growing quality loans, growingcore deposits, increasing fee income, market expansion and improved operationalefficiencies. Our goals were very aggressive in all areas and we exceeded thosegoals, loans up 12%, with record loan quality, core deposits up 10%, fee incomeup 59%, while we also had significant technological advances.

We ended the year with the announced acquisitions of Bank Capital andMid-Penn Insurance Associates, Inc, both who will provide needed solutions toour clients but also diversify our revenue sources. We also announced ouracquisition of Steelton Bancorp, Inc, our entry into the capital region.Together, these lay the foundation for future success.

Entering 2003, we have made significant progress in transforming Sun tobecoming a financial service provider, becoming that trusted advisor for ourclients. We have outlined aggressive goals for 2003. It starts withorganizational excellence beginning with our people. For us to be that trustedadvisor, to provide value for our clients, we need the right people, trainedand equipped with the right tools, doing the right things short and long termfor our clients.

In 2003, we expect to exceed the aggressive goals we previously outlinedbut also an organization recognized for its commitment to all stakeholdergroups, our shareholders, customers, employees and communities. Much progresshas been made these last 2 years, we expect much more in 2003.

 

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**ShareholderInformation**

 

**CommonStock Market Prices and Dividends Per Share**

 

The common stock of Sun Bancorp, Inc. is traded publicly on the NASDAQnational market system under the symbol SUBI. The high and low bid informationdoes not include retail mark-ups or mark-downs or any commission to thebroker-dealer.

 
| **Quarter Ended** |   | **2002  Bid Information  High** |   | **Low** |   | **Cash  Dividends  Paid** |   | **2001  Bid Information  High** |   | **Low** |   | **Cash  Dividends  Paid** |   |
|-------------------|--------|---------------------------------|--------|---------|--------|---------------------------|--------|---------------------------------|--------|---------|--------|---------------------------|--------|
| March 31          |   | $                               | 18.05  |    | $      | 16.28                     |   | $                               | .150   |    | $      | 15.73                     |   | $ | 13.38 |   | $ | .15 |   |
| June 30           |   | 24.49                           |   | 17.65   |   | .165                      |   | 16.50                           |   | 14.85   |   | .15                       |   |
| September 30      |   | 23.98                           |   | 21.85   |   | .165                      |   | 17.50                           |   | 14.65   |   | .15                       |   |
| December 31       |   | 22.44                           |   | 17.84   |   | .165                      |   | 17.50                           |   | 15.50   |   | .15                       |   |
|                   |        |                                 |        |         |        |                           |        |                                 |        |         |        |                           |        |  |  |  |  |  |  |

 

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**MarketMakers Include:**

 

Janney Montgomery Scott, Inc.

Wolfe Plaza

309 N. Fifth Street, Suite C

Sunbury, PA  17801

1-800-831-2741

 

F.J. Morrissey & Co., Inc.

1700 Market Street, Suite 1420

Philadelphia, PA  19103

1-215-563-8500

 

Ferris, Baker, Watts

3100 Market Street

Camp Hill, PA  17011

1-717-737-5800

 

First Tennessee Securities Corp.

845 Crossover Lane

Memphis, TN  38117

1-800-456-5460

 

Legg Mason

The Stadium Office Park, Suite 201

330 Montage Mountain Road

Scranton, PA  18507

1-800-346-4346

 

Sandler O’Neill & Partners, LP

919 Third Avenue

Sixth Floor

New York, NY 10022

1-800-635-6860

 

Wachovia Securities

P.O. Box 1357

Richmond, VA  23218

1-800-627-8625

 

Keefe, Bruyette & Woods

787 7th Avenue, 8th Floor

New York, NY  10019

1-212-887-8950

 

Ryan, Beck & Co.

Millennium 1

20 Ash Street

Conshohocken, PA  19428

1-800-342-2325

 

Ferris, Baker, Watts

100 Light Street

Baltimore, MD 21202

1-410-659-4616

 

Herzog, Heine & Geduld, Inc.

2 Penn Center, Suite 1708

Philadelphia, PA  19102

1-215-972-0813

 

Boenning & Scattergood, Inc.

Four Tower Bridge

200 Barr Harbor Drive, Suite 300

West Conshohocken, PA  19428

1-800-883-8383

 

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Spear, Leads & Kellog

1900 Market Street

Philadelphia, PA  19103

1-212-422-2405

 

Knight Securities

525 Washington Boulevard

Newport Tower

Jersey City, NJ  07310

1-800-544-7508

 

Goldman, Sachs & Company

10 Exchange Place

11th Floor

Jersey City, NJ  07302

1-212-902-1000

 

**Availabilityof Form 10-K**

Upon written request of any shareholder, a copy of the Corporation’sAnnual Report on Form 10-K for its fiscal year ended December 31, 2002,including the financial statements, and schedules thereto required to be filedwith the Securities and Exchange Commission pursuant to Rule 13a-l under theSecurities Exchange Act of 1934, as amended, may be obtained, without charge,from Shareholder Services, 155 North 15th Street, Lewisburg, PA 17837.

 

**Informationon Dividend Reinvestment Plan**

A voluntary Dividend Reinvestment Plan is available to Sun shareholders.Participants may elect full dividend reinvestment and/or optional cash paymentsto purchase additional shares. Information about the plan may be obtained bycontacting Registrar and Transfer Company, 10 Commerce Drive, Cranford, NJ07016-3572, Attn: Dividend Reinvestment Department, 1-800-368-5948.

The Annual Report and other Company reports are also filed electronicallythrough the Electronic Data Gathering Analysis and Retrieval System (EDGAR)which performs automated collection, validation, indexing, acceptance, andforwarding of submissions to the Securities and Exchange Commission (SEC) andis accessible by the public using the Internet at http://www.sec.gov/edgarhp

The Annual Report, other Company reports, and news releases areavailable on Sun’s website at http://www.sunbankpa.com

 

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