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|                                                 |          
|------------------------------------------------ | ---------
|UNITED STATES SECURITIES AND EXCHANGE COMMISSION | FORM 10-K

Washington, D. C. 20549


(Mark One)

| |                                                                                                     
| | ----------------------------------------------------------------------------------------------------
| | x      ANNUAL
    REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
| | For the fiscal year ended December 31, 2003                                                         

OR



| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | o      TRANSITION
    REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

For the transition period
from  to

Commission file number 0-16276



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STERLING FINANCIAL CORPORATION




|                                                                                                   |  |                                                   
|-------------------------------------------------------------------------------------------------- |  | --------------------------------------------------
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|Pennsylvania(State or other jurisdiction of
    incorporation or organization)                     |  | 23-2449551(I.R.S. Employer
    Identification No.)
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|101 North Pointe Boulevard
    Lancaster, Pennsylvania(Address of principal executive
    offices) |  | 17601-4133(Zip Code)                              

Registrants Telephone number, including area code:
(717) 581-6030

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, Par Value $5.00 Per Share



Indicated by a check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of the
Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.
o

Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes x No
o

Indicate by check mark whether the registrant is an accelerated
filer (as defined in Exchange Act Rule 126-2). Yes
x No
o

The aggregate market value of the voting stock held by
non-affiliates of the Registrant at June 30, 2003, was
approximately $379,370,000.

The number of shares of Registrants Common Stock
outstanding on February 27, 2004, was 21,678,293.

Documents Incorporated by Reference

Portions of the 2004 Proxy Statement for the Registrant are
incorporated by reference into Part III of this report.



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##### 



Sterling Financial Corporation

Table of Contents

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|Part I     |  |                                                                                                                          |  |     
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|Item 1.    |  | Business                                                                                                                 |  |      | 3  | 
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|Item 2.    |  | Properties                                                                                                               |  |      | 10 | 
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|Item 3.    |  | Legal Proceedings                                                                                                        |  |      | 10 | 
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|Item 4.    |  | Submission of Matters to a Vote of Security                                                                              |  |      | 10 | 
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|Part II    |  |                                                                                                                          |  |     
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|Item 5.    |  | Market for the Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities |  |      | 10 | 
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|Item 6.    |  | Selected Financial Data                                                                                                  |  |      | 12 | 
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|Item 7.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                |  |      | 13 | 
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|Item 7A.   |  | Quantitative and Qualitative Disclosure About
    Market Risk                                                            |  |      | 38 | 
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|Item 8.    |  | Financial Statements and Supplementary Data                                                                              |  |      | 40 | 
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|Item 9.    |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure                                 |  |      | 84 | 
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|Item 9A.   |  | Controls and Procedures                                                                                                  |  |      | 84 | 
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|Part III   |  |                                                                                                                          |  |     
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|Item 10.   |  | Directors and Executive Officers of the Registrant                                                                       |  |      | 84 | 
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|Item 11.   |  | Executive Compensation                                                                                                   |  |      | 84 | 
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|Item 12.   |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters                       |  |      | 84 | 
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|Item 13.   |  | Certain Relationships and Related Transactions                                                                           |  |      | 84 | 
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|Item 14.   |  | Principal Accountant Fees and Services                                                                                   |  |      | 84 | 
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|Part IV    |  |                                                                                                                          |  |     
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|Item 15.   |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                                      |  |      | 85 | 
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|Signatures |  |                                                                                                                          |  |      | 87 | 

2



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Part I

The management of Sterling Financial Corporation has made
forward-looking statements in this Annual Report on
Form 10-K. These forward-looking statements may be subject
to risks and uncertainties. Forward-looking statements include
the information concerning possible or assumed future results of
operations of Sterling Financial Corporation and its
wholly-owned subsidiaries, Bank of Lancaster County, N.A., First
National Bank of North East, Bank of Hanover and Trust Company,
Church Capital Management LLC, Bainbridge Securities Inc.,
T&C Leasing, Inc., HOVB Investment Co. and Sterling Mortgage
Services, Inc. (inactive). The consolidated financial statements
also include Town & Country Leasing, LLC, Sterling
Financial Trust Company and Equipment Finance, LLC, all
wholly-owned subsidiaries of Bank of Lancaster County, N.A. When
words such as believes, expects,
anticipates, may, could,
should, estimates or similar expressions
occur in this annual report, management is making
forward-looking statements.

Shareholders should note that many factors, some of which are
discussed elsewhere in this report, could affect the future
financial results of Sterling Financial Corporation and its
subsidiaries, both individually and collectively, and could
cause those results to differ materially from those expressed in
this report. These risk factors include the following:



| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Operating, legal and regulatory risks;                                                                                                                     
|
| |  | Economic, political and competitive forces impacting our various
    lines of business;                                                                    
|
| |  | The risk that our analysis of these risks and forces could be
    incorrect and/or that the strategies developed to address them
    could be unsuccessful;
|
| |  | The possibility that increased demand or prices for
    Sterlings financial services and products may not occur;                                          
|
| |  | Volatility in interest rates; and                                                                                                                          
|
| |  | Other risks and uncertainties.                                                                                                                             

Sterling undertakes no obligation to publicly revise or update
these forward-looking statements to reflect events or
circumstances that arise after the date of this report. Readers
should carefully review the risk factors described in other
documents Sterling files periodically with the Securities and
Exchange Commission, including Quarterly Reports on
Form 10-Q and any Current Reports on Form 8-K.




Item 1  Business

Sterling Financial Corporation is a $2.344 billion
financial holding company headquartered in Lancaster,
Pennsylvania. Through its banking and nonbanking subsidiaries,
Sterling provides a full range of banking and financial services
to individuals and businesses, through its five business
segments: Community Banking and Related Services; Leasing;
Commercial Finance; Trust and Investment Services; and Insurance
and Related Services.

Community Banking and Related Services

The Community Banking and Related Services segment provides
financial services to consumers, businesses, financial
institutions and governmental units in southern Pennsylvania and
northern Maryland. These services include providing various
types of loans to customers, accepting deposits, mortgage
banking and other typical banking services. Parent company and
treasury function income is included in the community-banking
segment, as the majority of effort of these functions is related
to this segment. Major revenue sources include net interest
income and service fees on deposit accounts. Expenses include
personnel and branch network support charges.

3



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Our Community Banking and Related Services segment is comprised
of our banking affiliates, summarized below (dollars in
millions).

|                                  |  |         |    |                |  |                                                                                                                     |  |          |     |        |  |   |       |  |  |       
|--------------------------------- |  | ------- | -- | -------------- |  | ------------------------------------------------------------------------------------------------------------------- |  | -------- | --- | ------ |  | - | ----- |  |  | ------
|                                  |  | # of    |    |                |  |                                                                                                                     |  |          |     |       
|Bank Name                         |  | Offices |    | Markets Served |  | Loans                                                                                                               |  | Deposits |     | Assets
|                                  |  |         |    |                |  |                                                                                                                     |  |          |     |       
|Bank of Lancaster County, N.A.    |  |         | 37 |                |  | Lancaster County, PA
    Chester County, PA
    Berks County, PA(1)
    Lebanon County, PA(2)
    New Castle, DE(3) |  | $        | 965 |        |  | $ | 1,141 |  |  | $1,463
|                                 
|                                 
|                                 
|                                 
|Bank of Hanover and Trust Company |  |         | 16 |                |  | York County, PA
    Adams County, PA
    Carroll County, MD                                                         |  |          | 426 |        |  |   | 537   |  |  | 687   
|                                 
|                                 
|                                 
|                                 
|First National Bank of North East |  |         | 4  |                |  | Cecil County, MD                                                                                                    |  |          | 72  |        |  |   | 112   |  |  | 122   



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|    |                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------
|(1) | Bank of Lancaster County conducts business through its
    PennSterling Bank division office.          
|   
|(2) | Bank of Lancaster County conducts business through its two Bank
    of Lebanon County division offices.
|   
|(3) | Bank of Lancaster County conducts business through its Delaware
    Sterling Bank division office.     

In addition to its network of 57 office locations, the Community
Banking and Related Services segment delivers its services
through alternative delivery channels, including the ATM
network, internet and telephone banking.

The Community Banking and Related Services segments
geographic market is among the strongest and most stable
economies in Pennsylvania and Maryland, with agriculture,
industry and tourism all contributing to the overall strength of
the economy. No single sector dominates the regions
economy.

The affiliate banks are subject to regulation and periodic
examination by their regulators, including the Office of the
Comptroller of the Currency for the national banks, and the
Federal Deposit Insurance Corporation and Pennsylvania
Department of Banking for the state chartered bank, Bank of
Hanover. The Federal Deposit Insurance Corporation, as provided
by law, insures the banks deposits.

At December 31, 2003, the Community Banking and Related
Services segment represented approximately 83% of
Sterlings consolidated assets, and contributed
approximately 67% of Sterlings net income for the year
ended December 31, 2003.

Leasing

The Leasing Segment provides vehicle and equipment financing
alternatives to commercial businesses. Sterling has two
affiliates that comprise the leasing segment, including Town
& Country Leasing LLC, a wholly owned subsidiary of Bank of
Lancaster County, and T&C Leasing, Inc., a direct subsidiary
of Sterling.

The Leasing segment provides fleet management and equipment
financing and leasing alternatives to customers headquartered
primarily in Pennsylvania and surrounding states. Through its
customers branch offices, the Leasing segment conducts
business in 46 of the 48 continental United States.

At December 31, 2003, the Leasing segment represented
approximately 9% of Sterlings consolidated assets, and
contributed approximately 3% of Sterlings net income for
the year ended December 31, 2003. Major revenue sources
include net interest income and rental income on operating
leases. Expenses include personnel, support and depreciation
charges on operating leases.

Commercial Finance

Equipment Finance LLC, which was acquired by Sterling in
February 2002, represents the sole affiliate within the
commercial finance segment. Equipment Finance specializes in
financing forestry and land-clearing equipment through more than
150 equipment dealer locations ranging from Maine to Florida.

At December 31, 2003, the Commercial Finance Segment
represented approximately 7% of Sterlings consolidated
assets, and contributed approximately 28% of Sterlings net
income for the year ended

4



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Trust and Investment Services

The Trust and Investment Services segment includes both
corporate asset and personal wealth management services. The
corporate asset management business provides retirement planning
services, investment management, custody and other corporate
trust services to small to medium size businesses in
Sterlings market area. Personal wealth management services
include investment management, brokerage, estate and tax
planning, as well as trust management and administration for
high net worth individuals and their families.

Prior to October 2003, Sterling Financial Trust Company, a
wholly owned subsidiary of Bank of Lancaster County, and its
predecessor wealth management and investment services divisions
at Bank of Lancaster County and Bank of Hanover were the only
units within this segment. In 2002, the wealth management and
investment services divisions of the two banks were combined
into the newly created Trust Company to increase revenue
generation opportunities, while increasing operating
efficiencies.

In the fourth quarter of 2003, Sterling acquired Church Capital
Management LLC and Bainbridge Securities, Inc. These
acquisitions result in our ability to offer a wider array of
financial services within the Trust and Investment Services
segment. Church Capital is a SEC Registered Investment Advisor
and Bainbridge Securities is a National Association of
Securities Dealers (NASD) broker/ dealer that offers
complementary products to the more traditional wealth management
services. Sterling expects that this acquisition will enhance
earnings and provide financial product diversification.

At December 31, 2003, the Trust and Investment Services
Segment represented approximately 1% of consolidated assets, and
contributed approximately 2% of Sterlings net income for
the year ended December 31, 2003. In addition, the Trust
and Investment Services segment had assets under management of
approximately $1.7 billion. Major revenue sources include
management and estate fees and commissions on security
transactions. Expenses primarily consist of personnel and
support charges, as well as amortization of intangible assets.

Insurance and Related Services

Presently, Sterlings affiliates offer insurance and
related services to its customers including credit life and
disability, through its Pennbanks Insurance Company,
comprehensive personal insurance and coverages through a joint
venture that it has established with a local insurance agency
(Lancaster Insurance Group), and Sterling Financial Settlement
Services, a settlement and title insurance agency joint venture
that it has established with a local realtor agency.

As of December 31, 2003, the Insurance and Related Services
segment is not considered significant to Sterlings
financial position or results of operations. In future periods,
we expect this segment is expected to represent a more
significant portion of our business, with the pending
acquisition of Corporate Healthcare Strategies, which is
scheduled to close early in the second quarter of 2004.

Corporate Healthcare Strategies, doing business as
StoudtAdvisors, is located in Lancaster Pennsylvania, and
provides benefit products and consulting services to medium and
large-sized businesses in the Central Pennsylvania region.
StoudtAdvisors annual revenues are approximately $6,600,000.

For more detailed financial information pertaining to our
operating segments, please refer to Note 23 of the Consolidated
Financial Statements.

Sterlings major sources of operating funds, as a parent
company, are dividends received from its subsidiary banks and
reimbursement of operating expenses from the affiliates.
Sterlings expenses are primarily operating expenses.
Dividends that Sterling pays to shareholders are funded, in
part, by dividends paid to Sterling by its subsidiary banks.

5



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Sterling and its subsidiaries do not have any portion of their
businesses dependent on a single or limited number of customers,
the loss of which would have a material adverse effect on their
businesses. No substantial portion of their loans or investments
are concentrated within a single industry or group of related
industries, although a significant amount of loans are secured
by real estate located in south central Pennsylvania, and
northern Maryland. Loan exposure to the forestry industry is
approximately 10%. The businesses of Sterling and its
subsidiaries are not seasonal in nature.

The common stock of Sterling is listed on The NASDAQ Stock
Market under the symbol SLFI.

Competition

The financial services industry in Sterlings market area
is highly competitive, including competition from commercial
banks, savings banks, credit unions, finance companies and
nonbank providers of financial services. Several of
Sterlings competitors have legal lending limits that
exceed Sterlings subsidiaries, as well as funding sources
in the capital markets that exceeds Sterlings
availability. The increased competition has resulted from a
changing legal and regulatory climate, as well as from the
economic climate.

Environmental Compliance

Sterlings and its subsidiaries compliance with
federal, state and local environmental protection laws had no
material effect on capital expenditures, earnings or their
competitive position in 2003, and is not expected to have a
material effect on such expenditures, earnings or competitive
position in 2004.

Supervision and Regulation

Bank holding companies and banks operate in a highly regulated
environment and are regularly examined by Federal and State
regulatory authorities.

The following discussion concerns various Federal and State laws
and regulations and the potential impact of such laws and
regulations on Sterling and its subsidiaries.

To the extent that the following information describes statutory
or regulatory provisions, it is qualified in its entirety by
reference to the particular statutory or regulatory provisions
themselves. Proposals to change laws and regulations are
frequently introduced in Congress, the state legislatures, and
before the various bank regulatory agencies. Sterling cannot
determine the likelihood or timing of any such proposals or
legislation or the impact they may have on Sterling and its
subsidiaries. A change in law, regulations or regulatory policy
may have a material effect on the business of Sterling and its
subsidiaries.

Bank
Holding Company Regulation

Sterling is a financial holding company and, as such, is subject
to the regulations of the Board of Governors of the Federal
Reserve System under the Bank Holding Company Act of 1956, as
amended (BHC Act). Bank holding companies are required to
file periodic reports with and are subject to examination by the
Federal Reserve. The BHC Act requires a financial holding
company to serve as a source of financial and managerial
strength to its banking subsidiaries, which may result in
providing adequate capital funds to the banks during periods of
financial stress or adversity.

The BHC Act prohibits Sterling from acquiring direct or indirect
control of more than 5% of the outstanding voting stock of any
bank, or substantially all of the assets of any bank, or merger
with another bank holding company, without the prior approval of
the Federal Reserve. The BHC Act allows interstate bank
acquisitions and interstate branching by acquisition and
consolidation in those states that had not elected out by the
required deadline. The Pennsylvania Department of Banking also
must approve any similar consolidation. Pennsylvania law permits
Pennsylvania financial holding companies to control an unlimited
number of banks.

6



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In addition, the BHC Act restricts our nonbanking activities to
those that are determined by the Federal Reserve Board to be
financial in nature, incidental to such financial activity, or
complementary to a financial activity. The BHC Act does not
place territorial restrictions on the activities of nonbank
subsidiaries of financial holding companies.

The Federal Deposit Insurance Corporation Improvement Act
requires a bank holding company to guarantee the compliance of
any insured depository institution subsidiary that may become
undercapitalized, as defined by regulations, with
the terms of any capital restoration plan filed by such
subsidiary with its appropriate federal banking agency, up to
specified limits.

Financial
Services Modernization Legislation

In November 1999, the Gramm-Leach-Bliley Act of 1999, or the
GLB, was enacted. As a result of GLB new opportunities became
available to financial institution holding companies as it
removed the restrictions that resulted from a regulatory
framework that had its origin in the Great Depression of the
1930s. In addition, the GLB also contains provisions that
expressly preempt any state law restricting the establishment of
financial affiliations, primarily related to insurance.

The general effect of GLB is to permit banks, other depository
institutions, insurance companies and securities firms to enter
into combinations that result in a single financial services
organization to offer customers a wider array of financial
services and products, through a new entity known as a
financial holding company. Financial
activities is broadly defined to include not only banking,
insurance and securities activities, but other activities
incidental to such financial activities or complementary
activities that do not pose a substantial risk to the safety and
soundness of depository institutions or the financial system
generally.

The GLB also permits national banks to engage in expanded
activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity
authorized for national banks directly or any financial
activity, except for insurance underwriting, insurance
investments, real estate investment or development, or merchant
banking, which may only be conducted through a subsidiary of a
financial holding company. Financial activities include all
activities permitted under new sections of the BHC Act or
permitted by regulation.

To the extent that the GLB permits banks, securities firms and
insurance companies to affiliate, the financial services
industry may experience further consolidation. The GLB is
intended to grant to community banks certain powers as a matter
of right that larger institutions have accumulated on an ad hoc
basis and which unitary savings and loan holding companies
already possess. Nevertheless, the GLB may have the result of
increasing the amount of competition that Sterling faces from
larger institutions and other types of companies offering
financial products, many of which may have substantially more
financial resources than does Sterling.

Sarbanes-Oxley
Act of 2002

On July 30, 2002, the Sarbanes-Oxley Act of 2002 was
enacted. The Sarbanes-Oxley Act represents a comprehensive
revision of laws affecting corporate governance, accounting
obligations and corporate reporting. The Sarbanes-Oxley Act is
applicable to all companies with equity securities registered or
that file reports under the Securities Exchange Act of 1934. In
particular, the Sarbanes-Oxley Act established: (i) new
requirements for audit committees, including independence,
expertise and responsibilities; (ii) additional
responsibilities regarding financial statements for the Chief
Executive Officer and Chief Financial Officer of the reporting
company; (iii) new standards for auditors and regulation of
audits; (iv) increased disclosure and reporting obligations
for the reporting company and its directors and executive
officers; and (v) new and increased civil and criminal
penalties for violations of the securities laws. Many of the
provisions were effective immediately while other provisions
became effective over a period of time and are subject to
rulemaking by the SEC. Because Sterlings common stock is
registered with the SEC, it is currently subject to this Act.

Throughout 2002 and 2003, the SEC and Nasdaq Stock Market issued
new regulations affecting our corporate governance and
heightening our disclosure requirements. Among the many new
changes this year

7



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We cannot predict what legislation might be enacted or what
regulations might be adopted, or if enacted or adopted, the
effect thereof on our operations.

USA
Patriot Act of 2001

On October 26, 2001, the USA Patriot Act of 2001 was
enacted. This act contains the International Money Laundering
Abatement and Financial Anti-Terrorism Act of 2001, which sets
forth anti-money laundering measures affecting insured
depository institutions, broker-dealers and other financial
institutions. The Act requires U.S. financial institutions to
adopt new policies and procedures to combat money laundering and
grants the Secretary of the Treasury broad authority to
establish regulations and to impose requirements and
restrictions on the operations of financial institutions.

Regulation W

Sterling and its banking affiliates are subject to
Regulation W, which provides guidance on permissible
activities and transactions between affiliated companies. In
general, subject to certain specified exemptions, a bank or its
subsidiaries are limited in their ability to engage in
covered transactions with affiliates:



| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | to an amount equal to 10% of the banks capital and
    surplus, in the case of covered transactions with any one
    affiliate; and
|
| |  | to an amount equal to 20% of the banks capital and
    surplus, in the case of covered transactions with all affiliates.           

In addition, a bank and its subsidiaries may engage in covered
transactions and other specified transactions only on terms and
under circumstances that are substantially the same, or at least
as favorable to the bank or its subsidiary, as those prevailing
at the time for comparable transactions with nonaffiliated
companies. A covered transaction includes:



| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | a loan or extension of credit to an affiliate;                                                                           
|
| |  | a purchase of, or an investment in, securities issued by an
    affiliate;                                               
|
| |  | a purchase of assets from an affiliate, with some exceptions;                                                            
|
| |  | the acceptance of securities issued by an affiliate as
    collateral for a loan or extension of credit to any party; and
|
| |  | the issuance of a guarantee, acceptance or letter of credit on
    behalf of an affiliate.                               

In addition, under Regulation W:



| |   |                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a bank and its subsidiaries may not purchase a low-quality asset
    from an affiliate;                                                                                                                                                                         
|
| |  | covered transactions and other specified transactions between a
    bank or its subsidiaries and an affiliate must be on terms and
    conditions that are consistent with safe and sound banking
    practices; and                                            
|
| |  | with some exceptions, each loan or extension of credit by a bank
    to an affiliate must be secured by collateral with a market
    value ranging from 100% to 130%, depending on the type of
    collateral, of the amount of the loan or extension of credit.

Dividends

Sterling is a legal entity separate and distinct from the
subsidiary banks and nonbank subsidiaries. Our revenues, on a
parent company only basis, result almost entirely from dividends
paid to the corporation by its

8



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Further, it is the policy of the Federal Reserve that bank
holding companies should pay dividends only out of current
earnings. Federal banking regulators also have the authority to
prohibit banks and bank holding companies from paying a dividend
if they should deem such payment to be an unsafe or unsound
practice.

FDIC
Insurance

The subsidiary banks are subject to Federal Deposit Insurance
Corporation assessments. The FDIC has adopted a risk-related
premium assessment system for both the Bank Insurance Fund for
banks and the Savings Association Insurance Fund for savings
associations. Under this system, FDIC insurance premiums are
assessed based on capital and supervisory measures.

Under the risk-related premium assessment system, the FDIC, on a
semiannual basis, assigns each institution to one of three
capital groups, well capitalized, adequately
capitalized, or undercapitalized, and further
assigns such institution to one of three subgroups within a
capital group corresponding to the FDICs judgment of its
strength based on supervisory evaluations, including examination
reports, statistical analysis, and other information relevant to
gauging the risk posed by the institution. Only institutions
with a total risk-based capital to risk-adjusted assets ratio of
10% or greater, a Tier 1 capital to risk-adjusted assets
ratio of 6% or greater, and a Tier 1 leverage ratio of 5%
or greater, are assigned to the well-capitalized group. Sterling
and its subsidiary banks, at December 31, 2003, qualify as
well capitalized under these regulatory standards.

Regulation
of Banks

The operations of our banking subsidiaries are subject to the
federal and state statutes, and are subject to the regulations
of the Office of the Comptroller of the Currency, the Federal
Reserve, the FDIC, and the Pennsylvania Department of Banking.

The Office of the Comptroller of the Currency, the primary
supervisory authority over national banks, and the FDIC, the
primary regulator of the state chartered bank, regularly
examines banks in such areas as reserves, loans, investments,
management practices, and other aspects of operations. These
examinations are designed for the protection of the banks
depositors rather than our shareholders. The subsidiary banks
must file quarterly and annual reports with the FDIC.

The National Bank Act requires the subsidiary national banks to
obtain the prior approval of the Office of the Comptroller of
the Currency for the payment of dividends if the total of all
dividends declared by the banks in one year would exceed the
banks net profits, as defined and interpreted by
regulation, for the two preceding years, less any required
transfers to surplus. In addition, the banks may only pay
dividends to the extent that their retained net profits,
including the portion transferred to surplus, exceed statutory
bad debts, as defined by regulation. Under Pennsylvania
statutes, state chartered banks are restricted, unless prior
regulatory approval is obtained, in the amount of dividends,
which it may declare in relation to its accumulated profits,
less any required transfer to surplus. These restrictions have
not had, nor are they expected to have any impact on our
dividend policy.

Sterling and our subsidiary banks are affected by the monetary
and fiscal policies of government agencies, including the
Federal Reserve and FDIC. Through open market securities
transactions and changes in its discount rate and reserve
requirements, the Board of Governors of the Federal Reserve
exerts considerable influence over the cost and availability of
funds for lending and investment. The nature of monetary and
fiscal policies on future business and earnings of Sterling
cannot be predicted at this time.

Other

From time to time, various federal and state legislation is
proposed that could result in additional regulation of, and
restrictions on, the business of Sterling and its subsidiaries,
or otherwise change the business

9



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##### 





Products and Services with Reputation Risk

Sterling and its subsidiaries offer a diverse range of financial
and banking products and services. In the event one or more
customers and/or governmental agencies become dissatisfied or
object to any product or service offered by Sterling or any of
its subsidiaries, negative publicity with respect to any such
product or service, whether legally justified or not, could have
a negative impact on Sterlings reputation. The
discontinuance of any product or service, whether or not any
customer or governmental agency has challenged any such product
or service, could have a negative impact on Sterlings
reputation.

Employees

As of December 31, 2003, Sterling had 835 full-time
equivalent employees. None of these employees are represented by
a collective bargaining agreement, and Sterling believes it
enjoys good relations with its personnel.




Item 2  Properties

As of December 31, 2003, Sterling and its affiliates occupy
57 office locations in Lancaster, York, Adams, Lebanon, Berks,
Chester and Bucks Counties, Pennsylvania, Cecil and Carroll
Counties, Maryland and New Castle County, Delaware. The majority
of these offices are utilized by the banking affiliates to
service the needs of their retail and business customers.
Offices at 34 locations are occupied under leases, and at
three locations the affiliate owns the building, but leases the
land. The remainder of the locations are owned by one of the
bank affiliates.

In addition to the banking locations, the corporate
headquarters, located in Lancaster, Pennsylvania, and operations
centers located in East Petersburg, and Hanover, Pennsylvania,
are owned by the bank affiliates. A certain amount of space in
the Lancaster and East Petersburg buildings are leased to third
parties.

All real estate owned by the subsidiary banks is free and clear
of encumbrances. The leases of the subsidiary banks expire
intermittently over the years through 2024 and most are subject
to one or more renewal options. During 2003, aggregate annual
rentals for real estate paid did not exceed 2% of our operating
expenses.




Item 3  Legal Proceedings

As of December 31, 2003, there were no material pending
legal proceedings, other than ordinary routine litigation
incidental to the business, to which Sterling or its
subsidiaries are a party or by which any of their property is
the subject.

Various actions and proceedings arise out of routine operations
and, in managements opinion, will not have a material
adverse effect on Sterlings consolidated financial
position or results of operations.




Item 4  Submission of Matters to a Vote of
Security Holders

There were no matters submitted to a vote of security holders
during the fourth quarter of 2003.




Part II




Item 5  Market for the Registrants
Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities

Sterling Financial Corporations common stock trades on the
NASDAQ Stock Market under the symbol SLFI. There were
70,000,000 shares of common stock authorized at
December 31, 2003, and 21,477,239

10



---



##### 





Sterling is restricted as to the amount of dividends that it can
pay to stockholders by virtue of the restrictions on the
subsidiaries ability to pay dividends to Sterling.

The following table reflects the quarterly high and low prices
of Sterlings common stock for the periods indicated and
the cash dividends declared on the common stock for the periods
indicated.

|               |  |                       |       |           |  |          |       |  |  |   |       | 
|-------------- |  | --------------------- | ----- | --------- |  | -------- | ----- |  |  | - | ----- | 
|               |  |                       |       |          
|               |  | Price Range Per Share |       |          
|               |  |                       |       | Per Share
|2003           |  | High                  |       | Low       |  | Dividend
|               |  |                       |       |           |  |         
|First Quarter  |  | $                     | 19.66 |           |  | $        | 17.38 |  |  | $ | 0.136 | 
|              
|              
|              
|              
|Second Quarter |  |                       | 20.40 |           |  |          | 18.12 |  |  |   | 0.136 | 
|              
|              
|              
|              
|Third Quarter  |  |                       | 23.06 |           |  |          | 18.80 |  |  |   | 0.144 | 
|              
|              
|              
|              
|Fourth Quarter |  |                       | 23.54 |           |  |          | 21.02 |  |  |   | 0.144 | 
|              
|              
|              
|              
|2002           |  |                       |       |           |  |          |       |  |  |   |       | 
|               |  |                       |       |           |  |          |       |  |  |   |       | 
|              
|First Quarter  |  | $                     | 16.16 |           |  | $        | 14.40 |  |  | $ | 0.128 | 
|              
|              
|              
|              
|Second Quarter |  |                       | 20.03 |           |  |          | 15.10 |  |  |   | 0.128 | 
|              
|              
|              
|              
|Third Quarter  |  |                       | 21.38 |           |  |          | 18.12 |  |  |   | 0.136 | 
|              
|              
|              
|              
|Fourth Quarter |  |                       | 20.80 |           |  |          | 18.40 |  |  |   | 0.136 | 

All per share information has been restated for the 5-for-4
stock split, effected in the form of a 25% stock dividend
declared in January 2004.

11



---



##### 






Item 6  Selected Financial Data

|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |           |        | 
|--------------------------------------------- | ------------------------------------------------------- | ------------------------ | - | --------- | ------ | ---- | - | --------- | ------ | ---- | - | --------- | ------ |  | - | --------- | ------ |  | - | --------- | ------ | 
|                                              |                                                         |                         
|                                              |                                                         | Years Ended December 31,
|                                              |                                                         |                         
|(Dollars in thousands, except per share data) |                                                         | 2003(5)                  |   | 2002(5)   |        | 2001 |   | 2000      |        | 1999
|                                              |                                                         |                          |   |           |        |      |   |           |        |     
|Summaries of Income                           |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Interest income                                         |                          | $ | 127,074   |        |      | $ | 123,591   |        |      | $ | 115,916   |        |  | $ | 113,319   |        |  | $ | 101,626   |       
|                                             
|                                             
|                                             
|                                             
|                                              | Interest expense                                        |                          |   | 41,156    |        |      |   | 48,643    |        |      |   | 57,274    |        |  |   | 58,501    |        |  |   | 47,404    |       
|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                              | Net interest income                                     |                          |   | 85,918    |        |      |   | 74,948    |        |      |   | 58,642    |        |  |   | 54,818    |        |  |   | 54,222    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Provision for loan losses                               |                          |   | 3,697     |        |      |   | 2,095     |        |      |   | 1,217     |        |  |   | 605       |        |  |   | 1,060     |       
|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                              | Net interest income after provision for loan
    losses |                          |   | 82,221    |        |      |   | 72,853    |        |      |   | 57,425    |        |  |   | 54,213    |        |  |   | 53,162    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Noninterest income                                      |                          |   | 49,721    |        |      |   | 44,832    |        |      |   | 43,925    |        |  |   | 37,508    |        |  |   | 33,539    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Noninterest expense                                     |                          |   | 92,568    |        |      |   | 85,922    |        |      |   | 75,172    |        |  |   | 70,203    |        |  |   | 62,459    |       
|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                              | Income before income taxes                              |                          |   | 39,374    |        |      |   | 31,763    |        |      |   | 26,178    |        |  |   | 21,518    |        |  |   | 24,242    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Applicable income taxes                                 |                          |   | 10,315    |        |      |   | 7,018     |        |      |   | 5,844     |        |  |   | 4,951     |        |  |   | 6,257     |       
|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                              |                                                         | Net income               |   | $         | 29,059 |      |   | $         | 24,745 |      |   | $         | 20,334 |  |   | $         | 16,567 |  |   | $         | 17,985 | 
|                                              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|Financial Condition at Year End               |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Assets                                                  |                          | $ | 2,343,517 |        |      | $ | 2,156,928 |        |      | $ | 1,861,439 |        |  | $ | 1,726,138 |        |  | $ | 1,556,323 |       
|                                             
|                                             
|                                             
|                                             
|                                              | Loans, net                                              |                          |   | 1,481,369 |        |      |   | 1,283,075 |        |      |   | 1,087,102 |        |  |   | 1,021,499 |        |  |   | 946,583   |       
|                                             
|                                             
|                                             
|                                             
|                                              | Deposits                                                |                          |   | 1,778,587 |        |      |   | 1,702,302 |        |      |   | 1,535,649 |        |  |   | 1,420,300 |        |  |   | 1,288,814 |       
|                                             
|                                             
|                                             
|                                             
|                                              | Borrowed money                                          |                          |   | 296,342   |        |      |   | 217,717   |        |      |   | 141,378   |        |  |   | 139,506   |        |  |   | 125,997   |       
|                                             
|                                             
|                                             
|                                             
|                                              | Stockholders equity                                    |                          |   | 220,011   |        |      |   | 196,833   |        |      |   | 152,111   |        |  |   | 139,347   |        |  |   | 122,760   |       
|                                             
|                                             
|                                             
|                                             
|Per Common Share Data (3)                     |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Earnings per share  basic                              |                          |   | 1.37      |        |      |   | 1.19      |        |      |   | 1.04      |        |  |   | 0.85      |        |  |   | 0.91      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Earnings per share  diluted                            |                          |   | 1.35      |        |      |   | 1.18      |        |      |   | 1.03      |        |  |   | 0.85      |        |  |   | 0.91      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Cash dividends declared                                 |                          |   | 0.56      |        |      |   | 0.53      |        |      |   | 0.50      |        |  |   | 0.48      |        |  |   | 0.46      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Book value                                              |                          |   | 10.24     |        |      |   | 9.31      |        |      |   | 7.78      |        |  |   | 7.11      |        |  |   | 6.26      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Realized book value (2)                                 |                          |   | 9.60      |        |      |   | 8.64      |        |      |   | 7.50      |        |  |   | 6.98      |        |  |   | 6.59      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average number of common shares:               |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |           |       
|                                             
|                                             
|                                             
|                                             
|                                              |                                                         | Basic                    |   |           | 21,224 |      |   |           | 20,849 |      |   |           | 19,576 |  |   |           | 19,601 |  |   |           | 19,624 | 
|                                             
|                                             
|                                             
|                                             
|                                              |                                                         | Diluted                  |   |           | 21,448 |      |   |           | 21,028 |      |   |           | 19,656 |  |   |           | 19,620 |  |   |           | 19,719 | 
|                                             
|                                             
|                                             
|                                             
|                                              | Dividend payout ratio (1)                               |                          |   | 40.9      | %      |      |   | 44.5      | %      |      |   | 48.1      | %      |  |   | 56.5      | %      |  |   | 50.5      | %     
|                                             
|                                             
|                                             
|                                             
|Profitability Ratios on Earnings              |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Return on average assets                                |                          |   | 1.33      | %      |      |   | 1.22      | %      |      |   | 1.14      | %      |  |   | 1.02      | %      |  |   | 1.19      | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Return on average equity                                |                          |   | 14.02     | %      |      |   | 13.70     | %      |      |   | 13.74     | %      |  |   | 12.99     | %      |  |   | 14.43     | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Return on average realized equity (2)                   |                          |   | 15.10     | %      |      |   | 14.47     | %      |      |   | 14.41     | %      |  |   | 12.36     | %      |  |   | 14.46     | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Average equity to average assets                        |                          |   | 9.38      | %      |      |   | 8.87      | %      |      |   | 8.33      | %      |  |   | 7.83      | %      |  |   | 8.23      | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Efficiency ratio (4)                                    |                          |   | 59.20     | %      |      |   | 60.20     | %      |      |   | 64.50     | %      |  |   | 63.10     | %      |  |   | 62.30     | %     
|                                             
|                                             
|                                             
|                                             
|Selected Asset Quality Ratios                 |                                                         |                          |   |           |        |      |   |           |        |      |   |           |        |  |   |           |        |  |   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Nonperforming loans to total loans                      |                          |   | 0.31      | %      |      |   | 0.90      | %      |      |   | 0.80      | %      |  |   | 0.59      | %      |  |   | 0.38      | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Net charge-offs to average loans outstanding            |                          |   | 0.14      | %      |      |   | 0.08      | %      |      |   | 0.17      | %      |  |   | 0.08      | %      |  |   | 0.07      | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Allowance for loan losses to total loans                |                          |   | 0.98      | %      |      |   | 1.00      | %      |      |   | 1.01      | %      |  |   | 1.13      | %      |  |   | 1.24      | %     
|                                             
|                                             
|                                             
|                                             
|                                              | Allowance for loan losses to nonperforming loans        |                          |   | 315.25    | %      |      |   | 110.62    | %      |      |   | 125.80    | %      |  |   | 192.10    | %      |  |   | 328.60    | %     



---



|    |                                                                                                                                                                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Dividends per share divided by basic earnings per share.                                                                                                                                                                                                                      
|   
|(2) | Excludes accumulated other comprehensive income (loss).                                                                                                                                                                                                                       
|   
|(3) | All per share information reflects the 5-for-4 stock split,
    effected in the form of a 25% stock dividend, declared in
    January 2004.                                                                                                                                   
|   
|(4) | Calculated after netting depreciation on operating leases with
    related rental income.                                                                                                                                                                                     
|   
|(5) | Financial information reflects the acquisition of Equipment
    Finance LLC on March 1, 2002 and Church Capital Management
    LLC and Bainbridge Securities, Inc. on October 15, 2003.
    These acquisitions were accounted for under the purchase method
    of accounting.

12



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##### 






Item 7  Managements Discussion and
Analysis of Financial Condition and Results of Operations

The following discussion provides managements analysis of
the consolidated financial condition and results of operations
of Sterling Financial Corporation and its wholly-owned
subsidiaries, Bank of Lancaster County, N.A., First National
Bank of North East, Bank of Hanover and Trust Company, HOVB
Investment Co., T&C Leasing, Inc. (T&C), Pennbanks
Insurance Company, SPC, Church Capital Management LLC,
Bainbridge Securities Inc. and Sterling Mortgage Services, Inc.
(inactive). The consolidated financial statements also include
Town & Country Leasing, LLC, Sterling Financial Trust
Company and Equipment Finance, LLC, all wholly-owned
subsidiaries of Bank of Lancaster County.

Managements discussion and analysis should be read in
conjunction with the audited financial statements and footnotes
appearing elsewhere in this report and is intended to assist in
understanding and evaluating the major changes in the financial
condition and results of operations of the company with a
primary focus in Sterlings performance.

Critical Accounting Policies

Sterlings consolidated financial statements are prepared
in accordance with accounting principles generally accepted in
the United States and follow general practices within the
industries in which it operates. Application of these principles
require management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and
accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the
financial statements; accordingly, as this information changes,
the financial statements could reflect different estimates,
assumptions, and judgments. Certain policies inherently have a
greater reliance on the use of estimates, assumptions, and
judgments and as such have a greater possibility of producing
results that could be materially different than originally
reported. Estimates, assumptions, and judgments are necessary
when assets and liabilities are required to be recorded at fair
value, when a decline in the value of an asset not carried on
the financial statements at fair value warrants an impairment
write-down or valuation reserve to be established, or when an
asset or liability needs to be recorded contingent upon a future
event. Carrying assets and liabilities at fair value inherently
results in more financial statement volatility. The fair values
and the information used to record valuation adjustments for
certain assets and liabilities are based either on quoted market
prices or are provided by other third-party sources, when
available. When third-party information is not available,
valuation adjustments are estimated in good faith by management
primarily through the use of internal cash flow modeling
techniques.

The most significant accounting policies followed by Sterling
are presented in Note 1 to the consolidated financial
statements. These policies, along with the disclosures presented
in the other financial statement notes and in this financial
review, provide information on how significant assets and
liabilities are valued in the financial statements and how those
values are determined. Based on the valuation techniques used
and the sensitivity of financial statement amounts to the
methods, assumptions, and estimates underlying those amounts,
management has identified the determination of the allowance for
loan losses and the evaluation of goodwill impairment to be the
accounting areas that require the most subjective or complex
judgments, and as such could be most subject to revision as new
information becomes available.

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

13



---



##### 





With the adoption of SFAS No. 142 on January 1,
2002, Sterling is no longer required to amortize goodwill
resulting from business acquisitions. Goodwill is now subject to
impairment testing at least annually to determine whether
write-downs of the recorded balances are necessary. Sterling
tests for impairment based on the goodwill maintained at each
defined reporting unit. An independent party using various
market valuation methodologies determines a fair value. If the
fair values of the reporting units exceed their book values, no
write-downs of recorded goodwill are necessary. If the fair
value of the reporting unit is less than its book value, an
impairment expense may be required to be recorded to write down
the related goodwill to the proper carrying value. Sterling
completed its annual impairment testing and determined that no
impairment write-offs were necessary. No assurance can be given
that future impairment tests will not result in a charge to
earnings.

Any material effect on the financial statements related to these
critical accounting areas is also discussed in this management
discussion and analysis.

Non-GAAP Presentations

This managements discussion and analysis refers to the
efficiency ratio, that is a non-GAAP financial measure that we
believe provides readers with important information regarding
Sterlings operational efficiency. Comparison of
Sterlings efficiency ratio with other companies may
not be appropriate, as they may calculate their efficiency ratio
in a different manner.

The efficiency ratio is computed by dividing noninterest
expense, less depreciation on operating leases, by the sum of
tax equivalent net interest income and noninterest income, less
depreciation on operating leases. Sterling nets the depreciation
on operating leases against related income, as it is consistent
with utilizing net interest income presentation for comparable
capital leases, which nets interest expense against interest
income. The efficiency ratio excludes unusual items, including
gains/losses on securities activities, interest collected on
charged-off loans, etc.

Sterling, in referring to its net income, is referring to income
determined in conformity with accounting principles generally
accepted in the United States (GAAP).

Inflation and Interest Rates

The majority of assets and liabilities of a financial
institution are monetary in nature and, therefore, differ
greatly from most commercial and industrial companies that have
significant investments in fixed assets or inventories. However,
inflation does have an important impact on the growth of total
assets and on noninterest expenses, which tend to rise during
periods of general inflation. Inflationary pressures over the
last few years have been modest, although the potential for
future inflationary pressure is always present given changing
trends in the economy.

Fluctuations in interest rates impact financial institutions far
more than inflationary factors. During the past two years, the
Federal Reserve has lowered interest rates only twice, a
25 basis point reduction in June 2003 and a 50 basis
point reduction in November 2002. The stability in interest
rates throughout 2002-2003 was in sharp contrast to 2001, in
which interest rates were cut eleven times, resulting in a
reduction of the prime-lending rate by 475 b.p.

Management recognizes that asset/liability management, including
the effect of rate changes on interest earning assets and
interest bearing liabilities, is of critical importance.

14



---



##### 



RESULTS OF OPERATIONS

(All dollar amounts presented within tables are in thousands,
except per share data.)

Executive Overview

Sterlings executive management team and board of directors
have identified three performance measurements that they feel
are key elements of enhancing shareholder value. These include:
a) increase in earnings per share; b) return on
realized equity; and c) efficiency ratio.

The primary source of Sterlings revenues, are net interest
income derived from investments, which would include loans and
investments, less their deposit and borrowing funding costs, as
well as fees from financial services provided to customers,
including rental income on operating leases. Revenues are
influenced by general economic factors, including market
interest rates, the economy of the markets served, stock market
conditions, as well as competitive forces within the markets.

Despite a low interest rate environment and overall decline in
the financial services industrys net interest margin,
Sterling was able to improve its net interest margin, from 3.95%
and 4.38% in 2001 and 2002, to 4.65% in 2003. The improvement
was primarily the result of a shift in the composition of
Sterlings interest earning assets, away from lower
yielding federal funds and securities to higher yielding loans,
particularly commercial loans and finance receivables. Net
interest income increased to $85,918,000 in 2003, compared to
$74,948,000 in 2002 and $58,642,000 in 2001.

Noninterest income, excluding securities gains and losses, has
also benefited from the present market conditions as noted by
the growth experience, and was $49,210,000, $45,292,000 and
$41,215,000 in 2003, 2002 and 2001. As a result of the low
interest rate environment, Sterling experienced an unprecedented
volume of mortgage loan originations which contributed to growth
in mortgage banking income, including mortgage servicing income
and the gain on sale of loans, to $4,037,000 in 2003, compared
to $3,103,000 in 2002 and $2,222,000 in 2001. In addition,
improvement in the equity market supported growth in income from
fiduciary activities and commissions and fees. Supplementing the
improvement in the equity market was the acquisition of Church
Capital Management LLC, a Registered Investment Advisor, and
Bainbridge Securities, Inc., a NASD registered broker/dealer in
the fourth quarter of 2003, which generated additional
non-margin related fees. Industry projections are that mortgage
loan originations are projected to fall off during 2004, which
will adversely impact Sterlings future mortgage banking
revenues. A full year of fees and commissions at Church and
Bainbridge should partially offset the lost mortgage production
revenues.

As a result of the growth Sterling has experienced in its
revenues over the past three years, noninterest expense has also
increased to $92,568,000 in 2003, compared to $85,922,000 in
2002 and $75,172,000 in 2001. The increase in revenues that
Sterling has experienced can be attributed to our relationship
management model, which has resulted in new customer
relationships, new financial services products being offered to
meet their needs, and expansion of our market in to new
geographic regions. These efforts have resulted in increases in
salaries and employee benefits, higher occupancy and equipment
charges, and other noninterest expenses.

Sterlings overall strategy is to enhance growth in
existing markets and affiliates, and complement this with new
products and services, through the leveraging of existing
resources. This has resulted in net income of $29,059,000, or
$1.35 per diluted share in 2003, compared to $24,745,000, or
$1.18 per diluted share in 2002, and $20,334,000, or $1.03 per
diluted share in 2001. This represents an 14.4% increase in
diluted earnings per diluted share in 2003, over 2002 results,
and a 14.6% increase in 2002 over 2001 results. Sterlings
efficiency ratio, which expresses noninterest expenses a
percentage of tax-equivalent net interest income and noninterest
income, improved to 59.2% in 2003, compared to 60.2% and 64.5%
in 2002 and 2001.

As a result of the increased earnings levels and improved
efficiency ratio, returns on average realized equity also
demonstrated improvement, and were 15.10%, 14.47% and 14.41% in
2003, 2002 and 2001.

A more thorough discussion of Sterlings results of
operations is included in the following pages.

15



---



##### 



Net Interest Income

The primary component of Sterlings revenue is net interest
income, which is the difference between interest income and fees
on interest-earning assets and interest expense on
interest-bearing funds. Earning assets include loans, securities
and federal funds sold. Interest-bearing funds include deposits
and borrowed funds. To compare the tax-exempt yields to taxable
yields, amounts are adjusted to pretax equivalents based on a
35% federal corporate income tax rate.

Net interest income is affected by changes in interest rates,
volume of interest-bearing assets and liabilities and the
composition. The interest rate spread and net
interest margin are two common statistics related to
changes in net interest income. The interest rate spread
represents the difference between the yields earned on
interest-earning assets and the rates paid for interest-bearing
liabilities. The net interest margin is defined as the
percentage of taxable equivalent net interest income to average
earning assets. Due mainly to demand deposits and
stockholders equity, the net interest margin exceeds the
interest rate spread, as these funding sources are non-interest
bearing.

Table 1 presents net interest income on a fully taxable
equivalent basis, interest rate spread and net interest margin
for the years ending December 31, 2003, 2002, and 2001.
Table 2 analyzes the changes in net interest income for the
periods broken down by their rate and volume components.

Net interest income, on a tax equivalent basis, totaled
$92,394,000 in 2003 compared to $80,492,000 for 2002 (excluding
the interest recovery on a charged-off loan) and $64,295,000 in
2001.

The increase in net interest income of $11,902,000 from 2002 to
2003 reflects both an 8.2% increase in the average balance of
interest-earning assets as well as a shift in the mix of
interest-earning assets that led to a 27 b.p. increase in
net interest margin.

The increase in interest-earning assets came primarily in the
form of loans. In fact, the growth in loans exceeded the growth
in earning assets, reflecting the funding of a portion of the
loan growth with securities portfolio cash flow and overnight
fed funds over the past year. Strong growth in the commercial
loan and finance receivable portfolios as well as consumer loans
and leases contributed to the increase in total loans.
Year-over-year, average loans increased $161 million,
increasing the percentage of loans to interest-earning assets
from 68% in 2002 to 71% in 2003. Generally, loans carry a higher
yield than alternative interest-earning assets, primarily
securities and other investments.

Funding for the growth in assets came from deposits, borrowings,
and earnings retained in stockholders equity. Strong
growth was experienced in demand and savings deposits while the
average balance of time deposits for the year increased at a
relatively modest amount. Over the past year, Sterling
experienced a significant volume of maturing CDs at high
interest rates. During that time, current CD rates were
consciously held at the now lower market levels.

During 2003, Sterling issued $35,000,000 of trust preferred
redeemable equity securities through Sterling Capital
Trust II, which qualified as regulatory capital. As a
result, Sterling could leverage the increased capital by
borrowing $75,000,000 from the Federal Home Loan Bank to
purchase investment securities and were used for maturities of
other FHLB borrowings and the continued pay-downs of third-party
borrowings that had been used to fund both finance receivables
and operating leases.

The increase in net interest margin from 2002 to 2003 continued
for the second consecutive year, a reversal of a declining trend
from the previous years. Driving this improvement was both the
improving mix of earning assets in the balance sheet to higher
yielding assets as well as the positive impact of generally
declining interest rates. During the two and a half years from
January 2001 to June of 2003, the Federal Reserve Bank lowered
the federal funds rate thirteen times totaling 5.50%. This
dramatic decrease in short-term interest rates resulted in a
significant decrease in the cost of funds for Sterling.

16



---



##### 



Table 1  Distribution of Assets, Liabilities
and Stockholders Equity Interest Rates and Interest
Differential-Tax Equivalent Yields

|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |      |  
|---------------------------------------------- | ------------------------ | ------------------------ | --------- | --------- |  | ------ | ------- | ------- |  | -------- | ---- | ------ | - | ------- | --------- | --------- |  | ------ | ------- | ------ |  |  | ---- | ----- | - | - | --------- | --------- |  | - | ------- | ------ |  |  | ---- | ---- | -
|                                               |                          |                         
|                                               |                          | Years Ended December 31,
|                                               |                          |                         
|                                               |                          |                          |           |           |  |       
|                                               |                          | 2003                     |           | 2002      |  | 2001  
|                                               |                          |                          |           |           |  |       
|                                               |                          | Average                  |           |           |  | Annual |         | Average |  |          |      | Annual |   | Average |           |           |  | Annual
|                                               |                          | Balance                  |           | Interest  |  | Rate   |         | Balance |  | Interest |      | Rate   |   | Balance |           | Interest  |  | Rate  
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |       
|Assets:                                        |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Federal funds sold                             |                          | $                        | 21,281    |           |  | $      | 232     |         |  |          | 1.09 | %      |   | $       | 51,561    |           |  | $      | 850     |        |  |  | 1.65 | %     |   | $ | 63,070    |           |  | $ | 2,040   |        |  |  | 3.23 | %   
|                                              
|                                              
|                                              
|                                              
|Other short-term investments                   |                          |                          | 8,605     |           |  |        | 81      |         |  |          | 0.94 | %      |   |         | 4,079     |           |  |        | 49      |        |  |  | 1.20 | %     |   |   | 1,664     |           |  |   | 61      |        |  |  | 3.68 | %   
|                                              
|                                              
|                                              
|                                              
|Securities:                                    |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|                                               | U.S. Treasury            |                          |           | 8,742     |  |        |         | 366     |  |          |      | 4.19   | % |         |           | 14,542    |  |        |         | 779    |  |  |      | 5.36  | % |   |           | 25,374    |  |   |         | 1,322  |  |  |      | 5.21 | %
|                                              
|                                              
|                                              
|                                              
|                                               | U.S. Government agencies |                          |           | 177,913   |  |        |         | 8,204   |  |          |      | 4.61   | % |         |           | 158,126   |  |        |         | 8,823  |  |  |      | 5.58  | % |   |           | 138,173   |  |   |         | 8,726  |  |  |      | 6.32 | %
|                                              
|                                              
|                                              
|                                              
|                                               | State and Municipal      |                          |           | 226,802   |  |        |         | 16,364  |  |          |      | 7.22   | % |         |           | 201,552   |  |        |         | 15,028 |  |  |      | 7.46  | % |   |           | 191,773   |  |   |         | 14,336 |  |  |      | 7.48 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Other                    |                          |           | 138,343   |  |        |         | 7,553   |  |          |      | 5.46   | % |         |           | 162,685   |  |        |         | 9,305  |  |  |      | 5.72  | % |   |           | 138,271   |  |   |         | 8,755  |  |  |      | 6.33 | %
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                               | Total securities         |                          |           | 551,800   |  |        |         | 32,487  |  |          |      | 5.89   | % |         |           | 536,905   |  |        |         | 33,935 |  |  |      | 6.32  | % |   |           | 493,591   |  |   |         | 33,139 |  |  |      | 6.71 | %
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Loans:                                         |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|                                               | Commercial               |                          |           | 762,278   |  |        |         | 47,738  |  |          |      | 6.26   | % |         |           | 683,497   |  |        |         | 47,049 |  |  |      | 6.88  | % |   |           | 552,534   |  |   |         | 43,527 |  |  |      | 7.88 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Consumer                 |                          |           | 304,167   |  |        |         | 19,383  |  |          |      | 6.37   | % |         |           | 284,469   |  |        |         | 21,149 |  |  |      | 7.43  | % |   |           | 279,057   |  |   |         | 23,346 |  |  |      | 8.37 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Residential mortgages    |                          |           | 98,347    |  |        |         | 7,044   |  |          |      | 7.16   | % |         |           | 109,929   |  |        |         | 8,152  |  |  |      | 7.42  | % |   |           | 154,083   |  |   |         | 12,147 |  |  |      | 7.88 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Leases                   |                          |           | 101,638   |  |        |         | 7,571   |  |          |      | 7.45   | % |         |           | 83,498    |  |        |         | 6,906  |  |  |      | 8.27  | % |   |           | 85,483    |  |   |         | 7,309  |  |  |      | 8.55 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Finance receivables      |                          |           | 140,600   |  |        |         | 19,014  |  |          |      | 13.52  | % |         |           | 84,513    |  |        |         | 11,045 |  |  |      | 13.07 | % |   |           |          |  |   |         |       |  |  |      |     |  
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                               | Total loans              |                          |           | 1,407,030 |  |        |         | 100,750 |  |          |      | 7.16   | % |         |           | 1,245,906 |  |        |         | 94,301 |  |  |      | 7.57  | % |   |           | 1,071,157 |  |   |         | 86,329 |  |  |      | 8.06 | %
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Total interest earning assets                  |                          |                          | 1,988,716 |           |  |        | 133,550 |         |  |          | 6.72 | %      |   |         | 1,838,451 |           |  |        | 129,135 |        |  |  | 7.02 | %     |   |   | 1,629,482 |           |  |   | 121,569 |        |  |  | 7.46 | %   
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Allowance for loan losses                      |                          |                          | (13,688   | )         |  |        |         |         |  |          |      |        |   |         | (12,423   | )         |  |        |         |        |  |  |      |       |   |   | (11,374   | )         |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Cash and due from banks                        |                          |                          | 55,553    |           |  |        |         |         |  |          |      |        |   |         | 54,057    |           |  |        |         |        |  |  |      |       |   |   | 47,915    |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Other noninterest earning assets               |                          |                          | 177,874   |           |  |        |         |         |  |          |      |        |   |         | 156,106   |           |  |        |         |        |  |  |      |       |   |   | 111,390   |           |  |   |         |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|TOTAL ASSETS                                   |                          | $                        | 2,208,455 |           |  |        |         |         |  |          |      |        |   | $       | 2,036,191 |           |  |        |         |        |  |  |      |       |   | $ | 1,777,413 |           |  |   |         |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Liabilities and Stockholders
    Equity:      |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Interest-bearing liabilities:                  |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|                                               | Demand deposits          |                          | $         | 558,425   |  |        | $       | 3,461   |  |          |      | 0.62   | % |         | $         | 494,778   |  |        | $       | 5,038  |  |  |      | 1.02  | % |   | $         | 435,199   |  |   | $       | 8,606  |  |  |      | 1.98 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Saving deposits          |                          |           | 205,373   |  |        |         | 1,262   |  |          |      | 0.61   | % |         |           | 186,403   |  |        |         | 1,973  |  |  |      | 1.06  | % |   |           | 167,978   |  |   |         | 3,520  |  |  |      | 2.10 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Time deposits            |                          |           | 746,421   |  |        |         | 24,720  |  |          |      | 3.31   | % |         |           | 742,198   |  |        |         | 31,163 |  |  |      | 4.20  | % |   |           | 689,797   |  |   |         | 37,486 |  |  |      | 5.43 | %
|                                              
|                                              
|                                              
|                                              
|                                               | Borrowed funds           |                          |           | 246,101   |  |        |         | 11,713  |  |          |      | 4.76   | % |         |           | 209,968   |  |        |         | 10,469 |  |  |      | 4.99  | % |   |           | 143,216   |  |   |         | 7,662  |  |  |      | 5.35 | %
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Total interest-bearing liabilities             |                          |                          | 1,756,320 |           |  |        | 41,156  |         |  |          | 2.34 | %      |   |         | 1,633,347 |           |  |        | 48,643  |        |  |  | 2.98 | %     |   |   | 1,436,190 |           |  |   | 57,274  |        |  |  | 3.99 | %   
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Demand deposits                                |                          |                          | 206,372   |           |  |        |         |         |  |          |      |        |   |         | 186,860   |           |  |        |         |        |  |  |      |       |   |   | 168,678   |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Other liabilities                              |                          |                          | 38,552    |           |  |        |         |         |  |          |      |        |   |         | 35,355    |           |  |        |         |        |  |  |      |       |   |   | 24,533    |           |  |   |         |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Stockholders equity                           |                          |                          | 207,211   |           |  |        |         |         |  |          |      |        |   |         | 180,629   |           |  |        |         |        |  |  |      |       |   |   | 148,012   |           |  |   |         |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY     |                          | $                        | 2,208,455 |           |  |        |         |         |  |          |      |        |   | $       | 2,036,191 |           |  |        |         |        |  |  |      |       |   | $ | 1,777,413 |           |  |   |         |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Net interest rate spread                       |                          |                          |           |           |  |        |         |         |  |          | 4.38 | %      |   |         |           |           |  |        |         |        |  |  | 4.04 | %     |   |   |           |           |  |   |         |        |  |  | 3.47 | %   
|                                              
|                                              
|                                              
|                                              
|Net interest income (FTE)/ net interest margin |                          |                          |           |           |  |        | 92,394  |         |  |          | 4.65 | %      |   |         |           |           |  |        | 80,492  |        |  |  | 4.38 | %     |   |   |           |           |  |   | 64,295  |        |  |  | 3.95 | %   
|                                              
|                                              
|                                              
|                                              
|Interest recovery on charged-off loan          |                          |                          |           |           |  |        |        |         |  |          |      |        |   |         |           |           |  |        | 419     |        |  |  |      |       |   |   |           |           |  |   |        |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|                                               |                          |                          |           |           |  |        | 92,394  |         |  |          |      |        |   |         |           |           |  |        | 80,911  |        |  |  |      |       |   |   |           |           |  |   | 64,295  |        |  |  |      |     
|                                              
|                                              
|                                              
|                                              
|Taxable-equivalent adjustment                  |                          |                          |           |           |  |        | (6,476  | )       |  |          |      |        |   |         |           |           |  |        | (5,963  | )      |  |  |      |       |   |   |           |           |  |   | (5,653  | )      |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     
|Net interest income                            |                          |                          |           |           |  | $      | 85,918  |         |  |          |      |        |   |         |           |           |  | $      | 74,948  |        |  |  |      |       |   |   |           |           |  | $ | 58,642  |        |  |  |      |     
|                                               |                          |                          |           |           |  |        |         |         |  |          |      |        |   |         |           |           |  |        |         |        |  |  |      |       |   |   |           |           |  |   |         |        |  |  |      |     

Yields on tax-exempt assets have been computed on
a fully taxable equivalent basis assuming a 35% tax rate.

For yield calculation purposes, nonaccruing loans
are included in the average loan balance.

17



---



##### 



The rate paid on interest bearing liabilities declined
64 b.p. from 2002 to 2003 resulting from:



| |   |                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------
| |  | The reduction of rates paid on deposit accounts;                                                            
|
| |  | The maturing of higher rate time deposits and borrowings;                                                   
|
| |  | Deposit growth and additional borrowings at relatively low rates
    of interest; and                       
|
| |  | Less reliance on third-party borrowings to fund growth in both
    finance receivables and operating leases.

At the same time, the rate earned on interest earning assets
declined only 30 b.p. reflecting:



| |   |                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Growth in the loan portfolio, shifting the mix of earning
    assets. This growth also included the relatively higher margin
    finance receivables from EFI; and          
|
| |  | A general lag in the effect of rapidly declining rates on loan
    and securities portfolio yields due to the proportion of fixed
    rates of interest in these portfolios.

During the second half of 2003, the downward repricing of assets
accelerated relative to the repricing of liabilities, resulting
in a diminishing benefit from the prolonged decline in interest
rates. In addition, while the leveraging of the trust preferred
proceeds increased net interest income, it reduced net interest
margin.

The increase in net interest income of $16,197,000 from 2001 to
2002 reflects both a 12.8% increase in the average balance of
interest-earning assets as well as a 43 b.p. increase in
net interest margin.

Several factors had an impact on 2002s results:



| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | Strong growth in the commercial loan portfolio;                                                        
|
| |  | The acquisition of EFI and subsequent growth in finance
    receivables;                               
|
| |  | General decline in interest rates resulting in the reduction of
    rates paid on deposit accounts; and
|
| |  | The maturing of higher rate deposits and borrowings.                                                   

Table 2  Analysis of Changes in Net
Interest Income

The rate-volume variance analysis set forth in the table below,
which is computed on a taxable equivalent basis, compares
changes in net interest income for the periods indicated by
their rate and volume components. The change in interest
income/expense due to both volume and rate has been allocated to
change in rate.

|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |        |  
|------------------- | ---------------------------- | ----------------- | ------ | ----------------- | - | ----- | ---- | ------- | - | ---- | ------ | ------ | - | - | ----- | ------ | - | - | ----- | ------- | - | - | ------ | ------ | -
|                    |                              |                   |        |                  
|                    |                              | 2003 Versus 2002  |        | 2002 Versus 2001 
|                    |                              | Due to Changes in |        | Due to Changes in
|                    |                              |                   |        |                  
|                    |                              | Volume            |        | Rate              |   | Total |      | Volume  |   | Rate |        | Total 
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |       
|Interest income:    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|                   
|                   
|                   
|                   
|                    | Federal funds sold           |                   | $      | (499              | ) |       | $    | (118    | ) |      | $      | (617   | ) |   | $     | (372   | ) |   | $     | (818    | ) |   | $      | (1,190 | )
|                   
|                   
|                   
|                   
|                    | Other short-term investments |                   |        | 54                |   |       |      | (22     | ) |      |        | 32     |   |   |       | 89     |   |   |       | (101    | ) |   |        | (12    | )
|                   
|                   
|                   
|                   
|                    | Securities                   |                   |        | 1,284             |   |       |      | (2,732  | ) |      |        | (1,448 | ) |   |       | 2,908  |   |   |       | (2,112  | ) |   |        | 796    |  
|                   
|                   
|                   
|                   
|                    | Loans                        |                   |        | 14,858            |   |       |      | (8,409  | ) |      |        | 6,449  |   |   |       | 14,084 |   |   |       | (6,112  | ) |   |        | 7,972  |  
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|                    | Total interest income        |                   |        | 15,697            |   |       |      | (11,281 | ) |      |        | 4,416  |   |   |       | 16,709 |   |   |       | (9,143  | ) |   |        | 7,566  |  
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|Interest expense:   |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|                   
|                   
|                   
|                   
|                    | Interest-bearing demand      |                   |        | 648               |   |       |      | (2,225  | ) |      |        | (1,577 | ) |   |       | 1,178  |   |   |       | (4,746  | ) |   |        | (3,568 | )
|                   
|                   
|                   
|                   
|                    | Savings deposits             |                   |        | 201               |   |       |      | (912    | ) |      |        | (711   | ) |   |       | 386    |   |   |       | (1,933  | ) |   |        | (1,547 | )
|                   
|                   
|                   
|                   
|                    | Time deposits                |                   |        | 177               |   |       |      | (6,620  | ) |      |        | (6,443 | ) |   |       | 2,848  |   |   |       | (9,171  | ) |   |        | (6,323 | )
|                   
|                   
|                   
|                   
|                    | Borrowed funds               |                   |        | 1,802             |   |       |      | (558    | ) |      |        | 1,244  |   |   |       | 3,581  |   |   |       | (774    | ) |   |        | 2,807  |  
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|                    | Total interest expense       |                   |        | 2,828             |   |       |      | (10,315 | ) |      |        | (7,487 | ) |   |       | 7,993  |   |   |       | (16,624 | ) |   |        | (8,631 | )
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       
|Net interest income |                              | $                 | 12,869 |                   |   | $     | (966 | )       |   | $    | 11,903 |        |   | $ | 8,716 |        |   | $ | 7,481 |         |   | $ | 16,197 |       
|                    |                              |                   |        |                   |   |       |      |         |   |      |        |        |   |   |       |        |   |   |       |         |   |   |        |       

18



---



##### 



Provision for Loan Losses

The provision for loan losses charged against earnings was
$3,697,000 in 2003, compared to $2,095,000 in 2002 and
$1,217,000 in 2001. Despite the improvements in non-performing
assets, Sterling increased its provision for loan losses during
the last two years due to increases in net charge-offs during
the period, combined with the growth in the loan portfolio and
the increase in potential problem loans. Certain qualitative
factors have also led to the increase in provision for loan
losses, including our customer base, in which we have observed
cash flows being negatively impacted by the national and local
economic conditions, Sterlings entry into new geographic
markets resulting in the employment of new relationship
managers, as well as turnover of experienced relationship
managers. See further discussion in Asset Quality
below.

Noninterest Income

Details of noninterest income follow:

Table 3  Noninterest Income

|                                            |  |      |        |                  |  |   |       |                  |  |        |        |    |  |      |        |   |  |   |        |   |  |  |        |    |  |   |        | 
|------------------------------------------- |  | ---- | ------ | ---------------- |  | - | ----- | ---------------- |  | ------ | ------ | -- |  | ---- | ------ | - |  | - | ------ | - |  |  | ------ | -- |  | - | ------ | 
|                                            |  |      |        |                  |  |   |       |                  |  |       
|                                            |  |      |        | 2003 Versus 2002 |  |   |       | 2002 Versus 2001 |  |       
|                                            |  |      |        |                  |  |   |       |                  |  |       
|                                            |  | 2003 |        | Amount           |  | % |       | 2002             |  | Amount |        | %  |  | 2001
|                                            |  |      |        |                  |  |   |       |                  |  |        |        |    |  |     
|Income from fiduciary activities            |  | $    | 4,954  |                  |  | $ | 727   |                  |  |        | 17.2   | %  |  | $    | 4,227  |   |  | $ | 61     |   |  |  | 1.5    | %  |  | $ | 4,166  | 
|                                           
|                                           
|                                           
|                                           
|Service charges on deposit accounts         |  |      | 5,797  |                  |  |   | 221   |                  |  |        | 4.0    | %  |  |      | 5,576  |   |  |   | 209    |   |  |  | 3.9    | %  |  |   | 5,367  | 
|                                           
|                                           
|                                           
|                                           
|Other service charges, commissions and fees |  |      | 5,658  |                  |  |   | 1,088 |                  |  |        | 23.8   | %  |  |      | 4,570  |   |  |   | 852    |   |  |  | 22.9   | %  |  |   | 3,718  | 
|                                           
|                                           
|                                           
|                                           
|Mortgage banking income                     |  |      | 4,037  |                  |  |   | 934   |                  |  |        | 30.1   | %  |  |      | 3,103  |   |  |   | 881    |   |  |  | 39.6   | %  |  |   | 2,222  | 
|                                           
|                                           
|                                           
|                                           
|Rental income on operating property         |  |      | 25,799 |                  |  |   | 47    |                  |  |        | 0.2    | %  |  |      | 25,752 |   |  |   | 1,433  |   |  |  | 5.9    | %  |  |   | 24,319 | 
|                                           
|                                           
|                                           
|                                           
|Other operating income                      |  |      | 2,965  |                  |  |   | 901   |                  |  |        | 43.7   | %  |  |      | 2,064  |   |  |   | 641    |   |  |  | 45.0   | %  |  |   | 1,423  | 
|                                           
|                                           
|                                           
|                                           
|Securities gains (losses)                   |  |      | 511    |                  |  |   | 971   |                  |  |        | (211.1 | )% |  |      | (460   | ) |  |   | (3,170 | ) |  |  | (117.0 | )% |  |   | 2,710  | 
|                                            |  |      |        |                  |  |   |       |                  |  |        |        |    |  |      |        |   |  |   |        |   |  |  |        |    |  |   |        | 
|Total                                       |  | $    | 49,721 |                  |  | $ | 4,889 |                  |  |        | 10.9   | %  |  | $    | 44,832 |   |  | $ | 907    |   |  |  | 2.1    | %  |  | $ | 43,925 | 
|                                            |  |      |        |                  |  |   |       |                  |  |        |        |    |  |      |        |   |  |   |        |   |  |  |        |    |  |   |        | 

Income from fiduciary activities, which includes both
institutional trust and personal wealth management services,
grew to $4,954,000 for the year ended December 31, 2003, up
from $4,227,000, or 17.2% in 2002 and $4,166,000 in 2001. At
December 31, 2003, Sterling had total assets under
administration of approximately $1.058 billion compared to
$918 million at the end of 2002 and $980 million at
the end of 2001. These numbers include assets under management
of $796 million, $671 million, and $737 million
at December 31, 2003, 2002, and 2001. The positive effects
of new business development, which increased the number of trust
customers and related fees, combined with favorable market
conditions over the past year all contributed to the overall
increase in fee-based income.

Management believes that wealth management business represents a
continued growth opportunity for the corporation. Through the
formation of a separate trust company, Sterling Financial Trust
Company, along with the acquisition of Church Capital Management
LLC and Bainbridge Securities Inc. in October 2003, Sterling
believes it will be able to increase revenue generation
opportunities, while increasing operating efficiencies.

Other service charges, commissions and fees were $5,658,000 in
2003, a 23.8% increase over 2002s total of $4,570,000. The
acquisition of Church Capital Management and Bainbridge
Securities in October 2003 contributed $905,000 of fee revenue,
and is the primary reason for the increase. In addition, other
service charges and fees have increased due to an increase in
mutual fund and annuity commissions, as well as continued growth
in customer debit card usage. The increase in income noted
during 2002 and 2001 resulted from an increase in mutual fund
and annuity commissions as a result of a more concentrated sales
effort combined with a more competitive commission fee structure.

Mortgage banking income was $4,037,000 in 2003, compared to
$3,103,000 in 2002 and $2,222,000 in 2001. Mortgage banking
income has been favorably influenced by the trend noted in the
financial services industry, which has seen an increased volume
of mortgage loan originations/refinancings during the past three
years, as interest rates have dropped significantly to 40-year
lows. As a result of the rate environment,

19



---



##### 





Rental income on operating leases was $25,799,000 in 2003,
compared to $25,752,000 in 2002, or a minor increase from year
to year. This follows an increase of 5.9% in 2002 over 2001
results. The trend in rental income is consistent with the
number of units under operating leases, which were 6,178, 6,214,
and 5,864 as of December 31, 2003, 2002, and 2001. The
decrease in the number of operating units during 2003 is
primarily due to customers entering into more traditional
financing arrangements such as commercial loans and finance
leases, given the current interest rate environment combined
with favorable tax treatment related to the depreciation of the
assets leased/purchased.

Other operating income was $2,965,000 for the year ended
December 31, 2003, an increase of $901,000 or 43.7% over
2002s other operating income of $2,064,000. The increase
in other income is primarily the result of the continued growth
in insurance related revenues, which increased $140,000 over
2002, as well as increased handling charges on the lease
portfolio. The 2002 increase is the result of the continued
growth in insurance related revenues, as well as increased
handling charges on the lease portfolio.

Securities gains and losses, all from the available-for-sale
portfolio, are summarized as follows:

|                   |        |      |     |      |   |      |      |        |   |   |       |       |  
|------------------ | ------ | ---- | --- | ---- | - | ---- | ---- | ------ | - | - | ----- | ----- | -
|                   |        | 2003 |     | 2002 |   | 2001
|                   |        |      |     |      |   |     
|Debt securities:   |        |      |     |      |   |      |      |        |   |   |       |      
|                  
|                  
|                  
|                  
|                   | Gains  |      | $   | 468  |   |      | $    | 706    |   |   | $     | 728   |  
|                  
|                  
|                  
|                  
|                   | Losses |      |     | (153 | ) |      |      | (766   | ) |   |       | (51   | )
|                   |        |      |     |      |   |      |      |        |   |   |       |      
|                   |        |      | 315 |      |   |      | (60  | )      |   |   | 677   |      
|                   |        |      |     |      |   |      |      |        |   |   |       |      
|Equity securities: |        |      |     |      |   |      |      |        |   |   |       |      
|                  
|                  
|                  
|                  
|                   | Gains  |      |     | 379  |   |      |      | 814    |   |   |       | 2,442 |  
|                  
|                  
|                  
|                  
|                   | Losses |      |     | (183 | ) |      |      | (1,214 | ) |   |       | (409  | )
|                   |        |      |     |      |   |      |      |        |   |   |       |      
|                   |        |      | 196 |      |   |      | (400 | )      |   |   | 2,033 |      
|                   |        |      |     |      |   |      |      |        |   |   |       |      
|                   |        | $    | 511 |      |   | $    | (460 | )      |   | $ | 2,710 |      
|                   |        |      |     |      |   |      |      |        |   |   |       |      

Gains and losses on debt securities are realized as part of
ongoing investment portfolio and balance sheet management
strategies. In 2003, Sterling experienced net gains on the debt
security portfolio of $315,000, versus net losses of $60,000 in
2002 and net gains of $677,000 in 2001.

Equity security gains and losses are generated primarily through
Sterlings equity portfolio of financial institution sector
stocks. Net securities gains on equities were $196,000 for the
year ended December 31, 2003 versus securities losses of
$400,000 in 2002 and net gains of $2,033,000 in 2001. Gains are
taken as the result of ongoing asset liability management
strategies, and capitalizing on appreciated values on certain
equity security portfolio positions. During 2003, 2002 and 2001
Sterling recorded approximately $130,000, $1,160,000 and
$224,000 in other than temporary impairment charges in the
financial institution portfolio, which are included in losses
above.

20



---



##### 



Noninterest Expense

Details of noninterest expense follow:

Table 4  Noninterest Expense

|                                       |  |      |        |                  |  |   |       |                  |  |        |      |   |  |      |        |  |  |   |        |  |  |  |      |   |  |   |        | 
|-------------------------------------- |  | ---- | ------ | ---------------- |  | - | ----- | ---------------- |  | ------ | ---- | - |  | ---- | ------ |  |  | - | ------ |  |  |  | ---- | - |  | - | ------ | 
|                                       |  |      |        |                  |  |   |       |                  |  |       
|                                       |  |      |        | 2003 Versus 2002 |  |   |       | 2002 Versus 2001 |  |       
|                                       |  |      |        |                  |  |   |       |                  |  |       
|                                       |  | 2003 |        | Amount           |  | % |       | 2002             |  | Amount |      | % |  | 2001
|                                       |  |      |        |                  |  |   |       |                  |  |        |      |   |  |     
|Salaries and employee benefits         |  | $    | 39,436 |                  |  | $ | 2,576 |                  |  |        | 7.0  | % |  | $    | 36,860 |  |  | $ | 5,870  |  |  |  | 18.9 | % |  | $ | 30,990 | 
|                                      
|                                      
|                                      
|                                      
|Net occupancy                          |  |      | 4,926  |                  |  |   | 717   |                  |  |        | 17.0 | % |  |      | 4,209  |  |  |   | 383    |  |  |  | 10.0 | % |  |   | 3,826  | 
|                                      
|                                      
|                                      
|                                      
|Furniture & equipment                  |  |      | 6,368  |                  |  |   | 606   |                  |  |        | 10.5 | % |  |      | 5,762  |  |  |   | 681    |  |  |  | 13.4 | % |  |   | 5,081  | 
|                                      
|                                      
|                                      
|                                      
|Professional services                  |  |      | 3,154  |                  |  |   | 309   |                  |  |        | 10.9 | % |  |      | 2,845  |  |  |   | 433    |  |  |  | 18.0 | % |  |   | 2,412  | 
|                                      
|                                      
|                                      
|                                      
|Depreciation on operating lease assets |  |      | 21,438 |                  |  |   | 536   |                  |  |        | 2.6  | % |  |      | 20,902 |  |  |   | 1,685  |  |  |  | 8.8  | % |  |   | 19,217 | 
|                                      
|                                      
|                                      
|                                      
|Other                                  |  |      | 17,246 |                  |  |   | 1,902 |                  |  |        | 12.4 | % |  |      | 15,344 |  |  |   | 1,698  |  |  |  | 12.4 | % |  |   | 13,646 | 
|                                       |  |      |        |                  |  |   |       |                  |  |        |      |   |  |      |        |  |  |   |        |  |  |  |      |   |  |   |        | 
|Total                                  |  | $    | 92,568 |                  |  | $ | 6,646 |                  |  |        | 7.7  | % |  | $    | 85,922 |  |  | $ | 10,750 |  |  |  | 14.3 | % |  | $ | 75,172 | 
|                                       |  |      |        |                  |  |   |       |                  |  |        |      |   |  |      |        |  |  |   |        |  |  |  |      |   |  |   |        | 

The largest component of noninterest expense is salaries and
employee benefits, which increased $2,576,000 or 7.0%, to
$39,436,000 in 2003, after increasing $5,870,000 or 18.9% in
2002. In order to better understand the change in this expense
category, infrequent charges of $1,785,000 should be excluded
from the prior year total of $36,860,000. The infrequent charges
consist of $1,140,000 in severance packages, $270,000 in the
termination of the qualified non-contributory pension plan, and
$375,000 in compensation expense related to the modification of
terms on stock options granted to severed employees. Excluding
these infrequent charges, the increase in salaries and employee
benefits for the year ended December 31, 2003 is $4,361,000
or 12.4%. The increase is attributable to the following factors:



| |   |                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Normal merit increases to existing employees, coupled with
    replacing positions at higher wages than previously earned;                                                                  
|
| |  | Increased number of employees, the result of branch expansion
    including the addition of PennSterling Bank and Delaware
    Sterling Bank, as well as the Church/ Bainbridge acquisition;
|
| |  | A full year of EFI salaries and benefits compared to ten months
    in 2002;                                                                                                                
|
| |  | Additions to staff required to continue to serve our customers
    in light of the increased transaction volumes;                                                                           
|
| |  | Higher incentive accruals resulting from the corporations
    performance levels during 2003 exceeding that achieved in 2002.                                                              

The $5,870,000 increase in salary and employee benefits in 2002
over 2001 was the result of normal merit increases; additional
staffing needs for branch expansion; increases in employee
benefit costs; and $1,785,000 of infrequent charges discussed
above.

Furniture and equipment charges were $6,368,000, $5,762,000 and
$5,081,000 for the years ended December 31, 2003, 2002 and
2001. The steady upward trend in furniture and equipment expense
is the result of enhancements to the delivery channels available
to deliver products to customers. Additionally, certain
equipment charges are based on the number of accounts opened and
their transaction volume. As Sterlings customer base
continues to grow, these types of charges grow as well. The
increase in number of branch offices, and renovations made to
existing branches also contributed to the increase in charges
over the last two years.

Professional service expense was $3,154,000 for the year ended
December 31, 2003, which represented a $309,000, or 10.9%,
increase over 2002s results. This increase followed a
$433,000, or 18.0% increase, experienced in 2002 over
2001s results. Increased professional service charges are
due to increased auditor and attorney fees and expenses to
ensure that Sterling continues to meet the requirements of the
Sarbanes-Oxley Act of 2002. In addition, professional service
expenses have increased as a result of long-term strategic

21



---



##### 





Depreciation on operating lease assets increased to $21,438,000
in 2003, compared to $20,902,000 in 2002 and $19,217,000 in
2001. Depreciation expense on leased property as a percent of
related rental income has increased from 79.0% in 2001, to 81.2%
in 2002 and 83.1% in 2003. The higher depreciation as a percent
of rental income is the result of the declining interest rate
environment in 2002 and 2003. A correlation exists between
interest rates, and the rental income charged to customers. In a
lower interest rate environment, the rental income will decrease
in order to compete with alternative financing sources
(i.e. finance leases, commercial loans, etc.). Depreciation
charges are more closely correlated to the units cost,
which is not impacted as much by interest rates, but rather
inflation.

Other non-interest expenses were $17,246,000 in 2003, compared
to $15,344,000 in 2002 and $13,646,000 in 2001. Expenses in this
category consist of marketing, advertising, promotions, taxes
other than income, postage, lending related expenses and
telephone expenses. The largest fluctuation noted was in lending
related expenses, as mortgage origination volumes during the
past two years have increased the related expenses associated
with this production. Additional reasons for the increase can be
attributed to problem loan expense, particularly in 2003, as
Sterling was able to decrease its non-performing asset balances.
Marketing and advertising expenditures have increased, as
Sterling entered new geographic markets and capitalized on the
market disruption that occurred from larger bank mergers. The
remaining increase in other non-interest expense is a function
of Sterlings overall growth, which results in higher
expenses.

Operating expenses levels are often measured by the efficiency
ratio, which expresses noninterest expense, excluding merger
related and restructuring charges, as a percentage of
tax-equivalent net interest income and other income. In
calculating its efficiency ratio, Sterling nets depreciation on
operating leases with the related rental income to more
consistently present operating results with the banking industry.

Sterlings efficiency ratio, excluding unusual items such
as securities activities, restructuring charges, severance and
other infrequent items, was 59.2%, 60.2%, and 64.5% for the
years ended December 31, 2003, 2002 and 2001. The
improvement noted in Sterlings efficiency ratio is driven
by the increase in net interest income experienced over the past
two years. 2002s improvement over 2001 was further
enhanced by the centralization of various operations functions,
which allowed for the elimination of redundant costs associated
with running the three bank affiliates on different operating
systems. The centralized operations functions allows for better
utilization of fixed costs, such as premises and equipment, and
variable costs, which includes employee resources.

Income
Taxes

Sterling recognized income taxes of $10,315,000, $7,018,000 and
$5,844,000 for the years ended December 31, 2003, 2002 and
2001. The increase in income tax expense is consistent with the
higher levels of pre-tax income.

A more meaningful comparison is the effective tax rate, a
measurement of income tax expense as a percent of pre-tax
income, which was 26.2%, 22.1% and 22.3% for the years ended
December 31, 2003, 2002, and 2001. Sterlings
effective tax rate is less than the 35% federal statutory rate,
primarily due to tax-exempt loan and security income, and tax
credits associated with low-income housing projects, offset by
certain non-deductible expenses and state income taxes.

In order to understand the fluctuation, three events need to be
considered. In March 2002, Sterling acquired Equipment Finance
Inc. (EFI), a Pennsylvania C-corporation subject to state income
taxes until April 1, 2003, when it converted to a single
member limited liability company, which significantly reduced
their state income tax expense. Also, effective July 1,
2002, Town and Country Leasing, a C-corporation at the time,
converted to a single-member limited liability company which
resulted in the reversal of a $1,200,000 deferred state tax
liability. Excluding the $1,200,000 reversal, 2002s
effective tax rate would have been approximately 25.9%, an
increase over 2001s effective tax rate of 22.3%,
reflective of the EFI acquisition. In 2003, tax-exempt income
represented a smaller portion of pre-tax income, and therefore
resulted in a higher

22



---



##### 





FINANCIAL
CONDITION

Average assets were $2,208,455,000 in 2003, representing 8.5%
growth compared to 2002s average assets of $2,036,291,000.
Assets grew by 14.5% from 2001 to 2002. Loans experienced the
most growth, as further outlined below.

Growth in average deposits funded a significant portion of the
loan growth, and increased to $1,510,219,000 in 2003, compared
to $1,423,379,000 in 2002 and $1,292,974,000 in 2001.

As part of an overall strategy to increase the return on equity
of the corporation, the remaining growth in assets and more
specifically loans, was funded by a reduction in the average
level of federal funds sold and the cash flows from the
investment securities portfolio. While investment securities on
average increased from 2002 to 2003 by $14,895,000, this was the
result of securities purchased through additional borrowed funds
as part of a leveraging strategy to offset the incremental
interest associated with trust preferred securities.

Investment
Securities

Sterling utilizes investment securities as a primary tool for
managing interest rate risk, to generate interest and dividend
income and to provide liquidity to the parent company and
affiliates. During 2003, the cash flows from investment
securities were generally used to fund the strong loan growth
generated by Sterling. Proceeds from maturities, sales, and
calls totaled $195,006,000. Purchases of $183,779,000 included
$80,000,000 related to the leveraging of trust-preferred
proceeds. The $80,000,000 was funded by trust preferred proceeds
and incremental borrowings from the Federal Home Loan Bank.

Overall, this activity shifted the mix of the portfolio by
increasing agency and municipal securities and decreasing
mortgage-backed and corporate securities. This shift was a
result of a number of factors, including the generally low
interest rate environment, a continued effort to reduce the
credit risk associated with corporate securities, and a need to
maintain a sufficient level of securities that are qualified to
serve as collateral for public fund and other deposits requiring
pledged securities.

At December 31, 2003, the securities balance included net
unrealized gains on available-for-sale securities of $22,747,000
versus net unrealized gains of $23,695,000 at December 31,
2002. The continued low level of interest rates led to
maintaining or even increasing the unrealized gains on a
majority of the holdings in the portfolio. However, the
relatively significant level of cash flow and reinvestment
resulted in a greater portion of the portfolio carrying yields
closer to the current level of market interest rates.

Table 5  Investment Securities

The following table shows the amortized cost of the
held-to-maturity securities owned by Sterling as of the dates
indicated. Securities are stated at cost adjusted for
amortization of premiums and accretion of discounts.

|                                 |          |              |        |        |  |      |        |        |  |   |        |        | 
|-------------------------------- | -------- | ------------ | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                                 |          |             
|                                 |          | December 31,
|                                 |          |             
|                                 |          | 2003         |        | 2002   |  | 2001
|                                 |          |              |        |        |  |     
|U.S. Government agencies         |          | $            |       |        |  | $    |       |        |  | $ | 109    |       
|                                
|                                
|                                
|                                
|States and political subdivision |          |              | 23,320 |        |  |      | 27,123 |        |  |   | 33,757 |       
|                                
|                                
|                                
|                                
|Mortgage-backed securities       |          |              | 172    |        |  |      | 450    |        |  |   | 497    |       
|                                
|                                
|                                
|                                
|Corporate securities             |          |              | 622    |        |  |      | 1,126  |        |  |   | 1,540  |       
|                                 |          |              |        |        |  |      |        |        |  |   |        |       
|                                 | Subtotal |              |        | 24,114 |  |      |        | 28,699 |  |   |        | 35,903 | 
|                                
|                                
|                                
|                                
|Non-marketable equity securities |          |              | 11,842 |        |  |      | 7,897  |        |  |   | 5,885  |       
|                                 |          |              |        |        |  |      |        |        |  |   |        |       
|                                 | Total    |              | $      | 35,956 |  |      | $      | 36,596 |  |   | $      | 41,788 | 
|                                 |          |              |        |        |  |      |        |        |  |   |        |       

23



---



##### 



Included in held-to-maturity equity securities are Federal
Reserve Bank stock, Federal Home Loan Bank of Pittsburgh stock,
and Atlantic Central Bankers Bank stock.

The following table shows the amortized cost and fair value of
the available-for-sale securities owned as of the dates
indicated.

|                                  |  |              |         |       |  |           |         |       |  |           |         |       |  |   |         |  |  |   |         |  |  |   |         | 
|--------------------------------- |  | ------------ | ------- | ----- |  | --------- | ------- | ----- |  | --------- | ------- | ----- |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                  |  |             
|                                  |  | December 31,
|                                  |  |             
|                                  |  |              |         |       |  |          
|                                  |  | 2003         |         | 2002  |  | 2001     
|                                  |  |              |         |       |  |          
|                                  |  | Amortized    |         | Fair  |  | Amortized |         | Fair  |  | Amortized |         | Fair 
|                                  |  | Cost         |         | Value |  | Cost      |         | Value |  | Cost      |         | Value
|                                  |  |              |         |       |  |           |         |       |  |           |         |      
|U.S. Treasury securities          |  | $            | 6,923   |       |  | $         | 7,099   |       |  | $         | 11,825  |       |  | $ | 12,176  |  |  | $ | 15,188  |  |  | $ | 15,685  | 
|                                 
|                                 
|                                 
|                                 
|U.S. Government agencies          |  |              | 166,436 |       |  |           | 165,529 |       |  |           | 106,792 |       |  |   | 110,024 |  |  |   | 87,714  |  |  |   | 89,569  | 
|                                 
|                                 
|                                 
|                                 
|States and political subdivisions |  |              | 217,256 |       |  |           | 228,271 |       |  |           | 191,383 |       |  |   | 200,497 |  |  |   | 164,357 |  |  |   | 164,746 | 
|                                 
|                                 
|                                 
|                                 
|Mortgage-backed securities        |  |              | 22,814  |       |  |           | 23,669  |       |  |           | 74,317  |       |  |   | 76,603  |  |  |   | 57,232  |  |  |   | 57,781  | 
|                                 
|                                 
|                                 
|                                 
|Corporate securities              |  |              | 95,125  |       |  |           | 100,378 |       |  |           | 135,270 |       |  |   | 140,535 |  |  |   | 148,734 |  |  |   | 151,044 | 
|                                  |  |              |         |       |  |           |         |       |  |           |         |       |  |   |         |  |  |   |         |  |  |   |         | 
|Subtotal                          |  |              | 508,554 |       |  |           | 524,946 |       |  |           | 519,587 |       |  |   | 539,835 |  |  |   | 473,225 |  |  |   | 478,825 | 
|                                 
|                                 
|                                 
|                                 
|Equity securities                 |  |              | 8,748   |       |  |           | 15,103  |       |  |           | 8,414   |       |  |   | 11,861  |  |  |   | 9,373   |  |  |   | 12,130  | 
|                                  |  |              |         |       |  |           |         |       |  |           |         |       |  |   |         |  |  |   |         |  |  |   |         | 
|Total                             |  | $            | 517,302 |       |  | $         | 540,049 |       |  | $         | 528,001 |       |  | $ | 551,696 |  |  | $ | 482,598 |  |  | $ | 490,955 | 
|                                  |  |              |         |       |  |           |         |       |  |           |         |       |  |   |         |  |  |   |         |  |  |   |         | 

All mortgage-backed securities are those of U.S. Government
agencies.

The available-for-sale equity securities are comprised of the
following:

|                                            |  |              |       |       |  |           |        |       |  |           |       |       |  |   |        |  |  |   |       |  |  |   |        | 
|------------------------------------------- |  | ------------ | ----- | ----- |  | --------- | ------ | ----- |  | --------- | ----- | ----- |  | - | ------ |  |  | - | ----- |  |  | - | ------ | 
|                                            |  |             
|                                            |  | December 31,
|                                            |  |             
|                                            |  |              |       |       |  |          
|                                            |  | 2003         |       | 2002  |  | 2001     
|                                            |  |              |       |       |  |          
|                                            |  | Amortized    |       | Fair  |  | Amortized |        | Fair  |  | Amortized |       | Fair 
|                                            |  | Cost         |       | Value |  | Cost      |        | Value |  | Cost      |       | Value
|                                            |  |              |       |       |  |           |        |       |  |           |       |      
|Government sponsored enterprise stock       |  | $            | 2     |       |  | $         | 3,462  |       |  | $         | 2     |       |  | $ | 3,196  |  |  | $ | 3     |  |  | $ | 2,911  | 
|                                           
|                                           
|                                           
|                                           
|Community bank stocks                       |  |              | 2,045 |       |  |           | 2,919  |       |  |           | 1,697 |       |  |   | 1,924  |  |  |   | 1,378 |  |  |   | 1,445  | 
|                                           
|                                           
|                                           
|                                           
|Large cap financial services company stocks |  |              | 6,701 |       |  |           | 8,722  |       |  |           | 6,715 |       |  |   | 6,741  |  |  |   | 7,992 |  |  |   | 7,774  | 
|                                            |  |              |       |       |  |           |        |       |  |           |       |       |  |   |        |  |  |   |       |  |  |   |        | 
|Total                                       |  | $            | 8,748 |       |  | $         | 15,103 |       |  | $         | 8,414 |       |  | $ | 11,861 |  |  | $ | 9,373 |  |  | $ | 12,130 | 
|                                            |  |              |       |       |  |           |        |       |  |           |       |       |  |   |        |  |  |   |       |  |  |   |        | 

These holdings are maintained for long-term appreciation in
these segments of the market.

As of December 31, 2003, amortized cost reflects a
write-down for other than temporary impairment charges totaling
$872,000. These charges were recognized when the market value of
a specific holding had not exceeded cost at any time in the
prior six months.

Sterling recognized other than temporary impairment charges of
$130,000, $1,160,000 and $224,000 in 2003, 2002, and 2001.

24



---



##### 



Table 6  Investment Securities (Yields)

The following table shows the maturities of held-to-maturity
debt securities at amortized cost as of December 31, 2003,
and approximate weighted average yields of such securities.
Yields on states and political subdivision securities are shown
on a tax equivalent basis, assuming a 35% federal income tax
rate.

|                                  |  |                 |     |               |  |                |      |               |  |        |        |       |  |        |      |       |  |        |       |       |  |  |      |   |  |   |       |  |  |  |      |   |  |   |        |  |  |  |      |  
|--------------------------------- |  | --------------- | --- | ------------- |  | -------------- | ---- | ------------- |  | ------ | ------ | ----- |  | ------ | ---- | ----- |  | ------ | ----- | ----- |  |  | ---- | - |  | - | ----- |  |  |  | ---- | - |  | - | ------ |  |  |  | ---- | -
|                                  |  |                 |     |               |  |                |      |               |  |        |        |       |  |        |      |      
|                                  |  |                 |     | Over 1 thru 5 |  | Over 5 thru 10 |      |               |  |       
|                                  |  | 1 Year and Less |     | Years         |  | Years          |      | Over 10 Years |  | Total 
|                                  |  |                 |     |               |  |                |      |               |  |       
|                                  |  | Amount          |     | Yield         |  | Amount         |      | Yield         |  | Amount |        | Yield |  | Amount |      | Yield |  | Amount |       | Yield
|                                  |  |                 |     |               |  |                |      |               |  |        |        |       |  |        |      |       |  |        |       |      
|States and political subdivisions |  | $               | 555 |               |  |                | 7.06 | %             |  | $      | 15,111 |       |  |        | 7.42 | %     |  | $      | 7,059 |       |  |  | 7.14 | % |  | $ | 595   |  |  |  | 8.95 | % |  | $ | 23,320 |  |  |  | 7.37 | %
|                                 
|                                 
|                                 
|                                 
|Mortgage-backed securities        |  |                 |    |               |  |                |     |               |  |        | 42     |       |  |        | 6.20 | %     |  |        | 112   |       |  |  | 6.27 | % |  |   | 18    |  |  |  | 3.05 | % |  |   | 172    |  |  |  | 5.92 | %
|                                 
|                                 
|                                 
|                                 
|Corporate securities              |  |                 | 115 |               |  |                | 2.00 | %             |  |        |       |       |  |        |     |       |  |        |      |       |  |  |     |   |  |   | 507   |  |  |  | 4.73 | % |  |   | 622    |  |  |  | 4.23 | %
|                                  |  |                 |     |               |  |                |      |               |  |        |        |       |  |        |      |       |  |        |       |       |  |  |      |   |  |   |       |  |  |  |      |   |  |   |        |  |  |  |      |  
|Total                             |  | $               | 670 |               |  |                | 6.19 | %             |  | $      | 15,153 |       |  |        | 7.42 | %     |  | $      | 7,171 |       |  |  | 7.13 | % |  | $ | 1,120 |  |  |  | 6.94 | % |  | $ | 24,114 |  |  |  | 7.27 | %
|                                  |  |                 |     |               |  |                |      |               |  |        |        |       |  |        |      |       |  |        |       |       |  |  |      |   |  |   |       |  |  |  |      |   |  |   |        |  |  |  |      |  

The following table shows the maturities of available-for-sale
debt securities at fair value as of December 31, 2003, and
approximate weighted average yields of such securities. Yields
on states and political subdivision securities are shown on a
tax equivalent basis assuming a 35% federal income tax rate.

|                                  |  |                 |        |               |  |                |      |               |  |        |         |       |  |        |      |       |  |        |         |       |  |  |      |   |  |   |         |  |  |  |      |   |  |   |         |  |  |  |      |  
|--------------------------------- |  | --------------- | ------ | ------------- |  | -------------- | ---- | ------------- |  | ------ | ------- | ----- |  | ------ | ---- | ----- |  | ------ | ------- | ----- |  |  | ---- | - |  | - | ------- |  |  |  | ---- | - |  | - | ------- |  |  |  | ---- | -
|                                  |  |                 |        |               |  |                |      |               |  |        |         |       |  |        |      |      
|                                  |  |                 |        | Over 1 thru 5 |  | Over 5 thru 10 |      |               |  |       
|                                  |  | 1 Year and Less |        | Years         |  | Years          |      | Over 10 Years |  | Total 
|                                  |  |                 |        |               |  |                |      |               |  |       
|                                  |  | Amount          |        | Yield         |  | Amount         |      | Yield         |  | Amount |         | Yield |  | Amount |      | Yield |  | Amount |         | Yield
|                                  |  |                 |        |               |  |                |      |               |  |        |         |       |  |        |      |       |  |        |         |      
|U.S. Treasury securities          |  | $               | 2,278  |               |  |                | 3.98 | %             |  | $      | 4,821   |       |  |        | 3.33 | %     |  | $      |        |       |  |  |     |   |  | $ |        |  |  |  |     |   |  | $ | 7,099   |  |  |  | 3.53 | %
|                                 
|                                 
|                                 
|                                 
|U.S. Government agencies          |  |                 | 29,893 |               |  |                | 2.71 | %             |  |        | 45,563  |       |  |        | 4.32 | %     |  |        | 90,073  |       |  |  | 4.14 | % |  |   |        |  |  |  |     |   |  |   | 165,529 |  |  |  | 3.93 | %
|                                 
|                                 
|                                 
|                                 
|States and political subdivisions |  |                 | 4,028  |               |  |                | 4.77 | %             |  |        | 25,148  |       |  |        | 5.96 | %     |  |        | 52,110  |       |  |  | 6.54 | % |  |   | 146,985 |  |  |  | 6.40 | % |  |   | 228,271 |  |  |  | 6.35 | %
|                                 
|                                 
|                                 
|                                 
|Mortgage-backed securities        |  |                 | 65     |               |  |                | 6.08 | %             |  |        | 3,584   |       |  |        | 4.74 | %     |  |        | 4,053   |       |  |  | 3.97 | % |  |   | 15,967  |  |  |  | 6.01 | % |  |   | 23,669  |  |  |  | 5.47 | %
|                                 
|                                 
|                                 
|                                 
|Corporate securities              |  |                 | 18,829 |               |  |                | 6.50 | %             |  |        | 78,917  |       |  |        | 5.32 | %     |  |        | 1,630   |       |  |  | 6.54 | % |  |   | 1,002   |  |  |  | 9.23 | % |  |   | 100,378 |  |  |  | 5.60 | %
|                                  |  |                 |        |               |  |                |      |               |  |        |         |       |  |        |      |       |  |        |         |       |  |  |      |   |  |   |         |  |  |  |      |   |  |   |         |  |  |  |      |  
|Total                             |  | $               | 55,093 |               |  |                | 4.21 | %             |  | $      | 158,033 |       |  |        | 5.06 | %     |  | $      | 147,866 |       |  |  | 5.01 | % |  | $ | 163,954 |  |  |  | 6.38 | % |  | $ | 524,946 |  |  |  | 5.37 | %
|                                  |  |                 |        |               |  |                |      |               |  |        |         |       |  |        |      |       |  |        |         |       |  |  |      |   |  |   |         |  |  |  |      |   |  |   |         |  |  |  |      |  

There is no issuer of securities in which the aggregate book
value of that issuer, other than securities of the U.S.
Treasury, U.S. Government agencies, exceeds 10% of
stockholders equity.

Loans

Loans outstanding increased $199,997,000, or 15.4% in 2003,
compared to 18.0% growth experienced in 2002. The overall growth
in loans is consistent with a stable local economy, and
continued demand for loans to support existing customers
growth. Sterling experienced growth in every loan category
except real estate mortgage, which is attributable to the
following factors:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Commercial and agricultural loans increased $37,266,000, or
    13.1% from December 31, 2002. Sterling has experienced
    increased business loan demand during 2003 as customers
    capitalized on the low interest rate environment to fund their
    capital expenditures. Growth has also come from Sterlings
    newer markets, including Berks County, Pennsylvania, and Carroll
    County, Maryland. Sterling expects to see continued growth in
    these two new markets, as it expands its geographic footprint.
|
| |  | Commercial real estate loans have increased $53,638,000 or 13.4%
    since December 31, 2002. The low interest rate environment,
    entrance to the new markets, and increased emphasis on
    commercial real estate lending has generated additional real
    estate lending opportunities.                                                                                                                                                                                                                                
|
| |  | Loans to financial institutions totaled $19,488,000 at
    December 31, 2003, a $14,788,000 increase over
    December 31, 2002. This is a direct result of the
    Correspondent Services Group, a division of Bank of Lancaster
    County, N.A. started in the latter half of 2002 to serve the
    needs of financial institutions in the Mid-Atlantic region.                                                                                                                                                            

25



---



##### 





| |   |                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Consumer loans have also benefited from the low interest rate
    environment and reported a $32,174,000 increase. Customers are
    using home equity loans to make improvements to their homes, buy
    new vehicles, and make other discretionary purchases. In
    addition, Sterling has been utilizing advertising campaigns in
    target markets to increase its retail relationships.
|
| |  | Despite the historic lows in mortgage rates and the resulting
    origination volume, Sterlings real estate mortgage loan
    balance has decreased $22,217,000 or 21.6% since
    December 31, 2002. As a result of the low interest rate
    environment, Sterling has experienced higher levels of early
    payoffs, as customers are refinancing at lower interest rates.               
|
| |  | Finance receivables have increased $56,533,000 from
    December 31, 2002 to December 31, 2003, and lease
    financing receivables increased $23,848,000 during the same
    period. This growth is the result of Sterlings two
    specialty lending subsidiaries, Equipment Finance and
    Town & Country Leasing, which have generated a
    significant volume of new business.        

A primary reason for Equipment Finances decision to be
affiliated with Sterling was the funding that Sterling could
provide in order to increase its market share. Since
Sterlings acquisition in February 2002, Equipment Finance
has been able to capture new business and increase its finance
receivables outstanding.

Town & Country has also generated growth in its lease
financings, as additions to the sales force have led to new
business opportunities, and similar to the growth in commercial
loans, customers have made capital expenditures to benefit from
the low interest rate environment. A portion of the growth
experienced in lease financing receivables is the result of
certain customers, who in the past would prefer an operating
lease, now favoring finance leases to capitalize on bonus
accelerated tax depreciation. As a result, Town & Country
has experienced a decline in its operating lease balances on
personal property.

Table 7  Loan Portfolio

The following table sets forth the composition of
Sterlings loan portfolio as of the dates indicated:

|                                             |  |              |           |      |  |      |           |      |  |      |           |  |  |   |           |  |  |   |         | 
|-------------------------------------------- |  | ------------ | --------- | ---- |  | ---- | --------- | ---- |  | ---- | --------- |  |  | - | --------- |  |  | - | ------- | 
|                                             |  |             
|                                             |  | December 31,
|                                             |  |             
|                                             |  | 2003         |           | 2002 |  | 2001 |           | 2000 |  | 1999
|                                             |  |              |           |      |  |      |           |      |  |     
|Commercial and agricultural                  |  | $            | 321,728   |      |  | $    | 284,462   |      |  | $    | 271,348   |  |  | $ | 250,483   |  |  | $ | 220,791 | 
|                                            
|                                            
|                                            
|                                            
|Commercial real estate                       |  |              | 453,456   |      |  |      | 399,818   |      |  |      | 326,826   |  |  |   | 272,230   |  |  |   | 236,167 | 
|                                            
|                                            
|                                            
|                                            
|Financial                                    |  |              | 19,488    |      |  |      | 4,700     |      |  |      |          |  |  |   |          |  |  |   |        | 
|                                            
|                                            
|                                            
|                                            
|Real estate-construction                     |  |              | 23,471    |      |  |      | 19,504    |      |  |      | 19,710    |  |  |   | 9,665     |  |  |   | 9,127   | 
|                                            
|                                            
|                                            
|                                            
|Real estate-mortgage                         |  |              | 80,674    |      |  |      | 102,891   |      |  |      | 117,293   |  |  |   | 142,534   |  |  |   | 155,894 | 
|                                            
|                                            
|                                            
|                                            
|Consumer                                     |  |              | 316,190   |      |  |      | 284,016   |      |  |      | 279,139   |  |  |   | 279,645   |  |  |   | 263,356 | 
|                                            
|                                            
|                                            
|                                            
|Finance receivables (net of unearned income) |  |              | 171,733   |      |  |      | 115,200   |      |  |      |          |  |  |   |          |  |  |   |        | 
|                                            
|                                            
|                                            
|                                            
|Lease financing (net of unearned income)     |  |              | 109,285   |      |  |      | 85,437    |      |  |      | 83,857    |  |  |   | 78,658    |  |  |   | 73,123  | 
|                                             |  |              |           |      |  |      |           |      |  |      |           |  |  |   |           |  |  |   |         | 
|Total                                        |  | $            | 1,496,025 |      |  | $    | 1,296,028 |      |  | $    | 1,098,173 |  |  | $ | 1,033,215 |  |  | $ | 958,458 | 
|                                             |  |              |           |      |  |      |           |      |  |      |           |  |  |   |           |  |  |   |         | 

26



---



##### 



Table 8  Loan Maturity and Interest Sensitivity

The following table sets forth the maturity of the commercial
loan portfolio as of December 31, 2003.

|                                                                      |  |          |        |            |  |            |         |       |  |   |         |  |  |   |         | 
|--------------------------------------------------------------------- |  | -------- | ------ | ---------- |  | ---------- | ------- | ----- |  | - | ------- |  |  | - | ------- | 
|                                                                      |  |          |        | After One  |  |            |         |      
|                                                                      |  | Within   |        | but Within |  | After Five |         |      
|                                                                      |  | One Year |        | Five Years |  | Years      |         | Total
|                                                                      |  |          |        |            |  |            |         |      
|Commercial and agricultural, financial and
    commercial real estate |  | $        | 42,125 |            |  | $          | 175,788 |       |  | $ | 576,759 |  |  | $ | 794,672 | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Real estate  construction                                            |  |          | 18,503 |            |  |            | 146     |       |  |   | 4,822   |  |  |   | 23,471  | 
|                                                                      |  |          |        |            |  |            |         |       |  |   |         |  |  |   |         | 
|                                                                      |  | $        | 60,628 |            |  | $          | 175,934 |       |  | $ | 581,581 |  |  | $ | 818,143 | 
|                                                                      |  |          |        |            |  |            |         |       |  |   |         |  |  |   |         | 

Commercial loans due after one year totaling $332,337,000 have
variable interest rates. The remaining $435,178,000 in loans
have fixed rates.

Asset Quality

Sterlings loan portfolios are subject to varying degrees
of credit risk. Credit risk is mitigated through prudent
underwriting standards, on-going credit review, and monitoring
and reporting asset quality measures. Additionally, loan
portfolio diversification, limiting exposure to a single
industry or borrower, and requiring collateral also reduces
Sterlings credit risk.

Sterlings commercial, consumer and residential mortgage
loans are principally to borrowers in south central
Pennsylvania, northern Maryland, and northern Delaware. As the
majority of Sterlings loans are located in this area, a
substantial portion of the debtors ability to honor their
obligations may be affected by the level of economic activity in
the market area. Sterlings finance receivables are
primarily to customers in the eastern part of the United States
to finance forestry and land clearing equipment.

Non-performing assets include nonaccrual and restructured loans,
accruing loans past due 90 days or more and other
foreclosed assets. Sterlings general policy has been to
cease accruing interest on loans when management determines that
a reasonable doubt exists as to the collectibility of additional
interest. When management places a loan on nonaccrual status, it
reverses unpaid interest credited to income in the current year,
and charges unpaid interest accrued in prior years to the
allowance for loan losses. Sterling recognizes income on these
loans only to the extent that it receives cash payments.
Sterling typically returns nonaccrual loans to performing status
when the borrower brings the loan current and performs in
accordance with contractual terms for a reasonable period of
time. Sterling categorizes a loan as restructured if it changes
the terms of the loan such as interest rate, repayment schedule
or both, to terms that it otherwise would not have granted
originally.

27



---



##### 



Table 9  Nonaccrual, Past Due and Restructured
Loans

The following table presents information concerning the
aggregate amount of nonaccrual, past due and restructured loans:

|                                         |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |       |  
|---------------------------------------- | ---------------------------------------------------------------------- | ------------ | ----- | ----- | - | ---- | ------ | ------ | - | ---- | ----- | ----- | - | - | ----- | ----- | - | - | ----- | ----- | -
|                                         |                                                                        |             
|                                         |                                                                        | December 31,
|                                         |                                                                        |             
|                                         |                                                                        | 2003         |       | 2002  |   | 2001 |        | 2000   |   | 1999
|                                         |                                                                        |              |       |       |   |      |        |        |   |     
|Nonaccrual loans                         |                                                                        | $            | 3,136 |       |   | $    | 10,643 |        |   | $    | 6,707 |       |   | $ | 3,102 |       |   | $ | 771   |      
|                                        
|                                        
|                                        
|                                        
|Accruing loans, past due 90 days or more |                                                                        |              | 1,513 |       |   |      | 545    |        |   |      | 1,562 |       |   |   | 1,145 |       |   |   | 882   |      
|                                        
|                                        
|                                        
|                                        
|Restructured loans                       |                                                                        |              |      |       |   |      | 521    |        |   |      | 531   |       |   |   | 1,851 |       |   |   | 1,961 |      
|                                         |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |      
|                                         | Total non-performing loans                                             |              |       | 4,649 |   |      |        | 11,709 |   |      |       | 8,800 |   |   |       | 6,098 |   |   |       | 3,614 |  
|                                        
|                                        
|                                        
|                                        
|Foreclosed assets                        |                                                                        |              | 601   |       |   |      | 293    |        |   |      | 74    |       |   |   | 469   |       |   |   | 504   |      
|                                         |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |      
|                                         | Total non-performing assets                                            |              | $     | 5,250 |   |      | $      | 12,002 |   |      | $     | 8,874 |   |   | $     | 6,567 |   |   | $     | 4,118 |  
|                                         |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |      
|Nonaccrual loans:                        |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |      
|                                        
|                                        
|                                        
|                                        
|                                         | Interest income that would have been recorded
    under original terms |              | $     | 433   |   |      | $      | 458    |   |      | $     | 429   |   |   | $     | 196   |   |   | $     | 98    |  
|                                        
|                                        
|                                        
|                                        
|                                         | Interest income recorded                                               |              |       | 139   |   |      |        | 60     |   |      |       | 43    |   |   |       | 94    |   |   |       | 8     |  
|                                        
|                                        
|                                        
|                                        
|Ratios:                                  |                                                                        |              |       |       |   |      |        |        |   |      |       |       |   |   |       |       |   |   |       |      
|                                        
|                                        
|                                        
|                                        
|                                         | Non-performing loans to total loans                                    |              |       | 0.31  | % |      |        | 0.90   | % |      |       | 0.80  | % |   |       | 0.59  | % |   |       | 0.38  | %
|                                        
|                                        
|                                        
|                                        
|                                         | Non-performing assets to total loans and
    foreclosed assets         |              |       | 0.35  | % |      |        | 0.93   | % |      |       | 0.81  | % |   |       | 0.64  | % |   |       | 0.43  | %
|                                        
|                                        
|                                        
|                                        
|                                         | Non-performing assets to total assets                                  |              |       | 0.22  | % |      |        | 0.48   | % |      |       | 0.48  | % |   |       | 0.38  | % |   |       | 0.26  | %

As of December 31, 2003, non-performing assets were
$5,250,000, a decrease of $6,752,000 or 56.3% from
December 31, 2002. Restructured loans included in
non-performing loans, represented a series of loans to one
borrower in the real estate business, which were fully secured
with real estate collateral and were current as to modified
contractual obligations. In 2003, these loans were removed from
restructured status as they remained current and met contractual
obligations as required by the loan agreements.

During 2003, several favorable developments occurred, which
contributed to the $7,507,000 reduction in nonaccrual loans.
These developments were as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | An agreement was reached with two large commercial relationships
    that were classified as nonaccrual loans at December 31,
    2002, which resulted in the liquidation of business assets,
    foreclosure by Sterling on certain remaining assets, and the
    charge-off of the remaining principal balance. As a result of
    these agreements, $3,050,000 was transferred from loans to
    foreclosed assets, $900,000 in business assets were liquidated
    by the borrower and used to reduce outstanding loan balances,
    and $620,000 was charged off on these loans. Subsequent to
    foreclosure, $2,500,000 in real estate foreclosed in 2003 was
    sold to a third party with external financing sources. The
    settlement of this transaction resulted in a minor gain on sale
    of real estate.
|
| |  | Two large commercial relationships in nonaccrual status had
    substantial principal payments during the year, including a
    $1,500,000 relationship that was paid off in its entirety, and a
    reduction of $600,000 in nonaccrual loans on a second
    relationship.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

Potential problem loans are defined as performing loans, which
have characteristics that cause management to have serious
doubts as to the ability of the borrower to perform under
present loan repayment terms and which may result in the
reporting of these loans as nonperforming loans in the future.
Total potential problem loans were approximately
$7.1 million at December 31, 2003 and
$1.2 million at December 31, 2002. Additionally,
outstanding letter of credit commitments totaling approximately
$2.3 million could result in potential problem loans, if
drawn upon. The majority of these loans are secured by a
combination of business assets and/or real estate with
acceptable loan-to-value ratios.

28



---



##### 



Allowance for Loan Losses

Sterling maintains the allowance for loan losses at a level that
management believes adequate to absorb potential losses inherent
in the loan portfolio and is established through a provision for
loan losses charged to earnings. Additionally, when Sterling
acquires a company in a purchase business combination, the
acquired allowance is combined with Sterlings existing
allowance. Quarterly, the company utilizes a defined methodology
in determining the adequacy of the allowance for loan losses.
This methodology considers specific credit reviews, past loan
loss historical experience, and qualitative factors.

Management assigns internal risk ratings to all commercial
relationships with aggregate borrowings or commitments to extend
credit in excess of $100,000. Using migration analysis for the
previous eight quarters, management develops a loss factor test,
which it then uses to estimate losses on impaired loans,
potential problem loans and non-classified loans. When
management finds loans with uncertain collectibility of
principal and interest, it places those loans on the
problem list, and evaluates them on a quarterly
basis in order to estimate potential losses. Managements
analysis considers:



| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | Adverse situations that may affect the borrowers ability
    to repay;
|
| |  | Estimated value of underlying collateral; and                          
|
| |  | Prevailing market conditions.                                          

If management determines that a specific reserve allocation is
not required, it assigns the general loss factor based on
historical performance to determine the reserve. For homogeneous
loan types, such as consumer and residential mortgage loans,
management bases specific allocations on the average loss ratio
for the previous two years for each specific loan pool.
Additionally, management adjusts projected loss ratios for other
factors, including the following:



| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | Trends in delinquency levels;                                         
|
| |  | Trends in non-performing and potential problem loans;                 
|
| |  | Trends in composition, volume and terms of loans;                     
|
| |  | Effects in changes in lending policies or underwriting
    procedures;
|
| |  | Experience ability and depth of management;                           
|
| |  | National and local economic conditions;                               
|
| |  | Concentrations in lending activities; and                             
|
| |  | Other factors as management may deem appropriate.                     

Management determines the unallocated portion of the allowance
for loan losses based on the following criteria:



| |   |                                                                                          
| | - | -----------------------------------------------------------------------------------------
| |  | Risk of error in the specific and general reserve allocations;                           
|
| |  | Other potential exposure in the loan portfolio;                                          
|
| |  | Variances in managements assessment of national and local
    economic conditions; and  
|
| |  | Other internal or external factors that management believes
    appropriate at that time.

Management believes this methodology accurately reflects losses
inherent in the portfolio. Management charges actual loan losses
to the allowance for loan losses. Management periodically
updates this methodology, which reduces the difference between
actual losses and estimated losses.

Management bases the provision for loan losses on the overall
analysis taking the methodology into account.

29



---



##### 



A summary of the activity in the allowance for loan losses is as
follows:

Table 10  Summary of Loan Loss Experience

|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |       | 
|--------------------------------------------------------------------- | --------------------------- | ------------------------ | ------ | ----- |  | ---- | ------ | ----- |  | ---- | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                                                      |                             |                         
|                                                                      |                             | Years Ended December 31,
|                                                                      |                             |                         
|                                                                      |                             | 2003                     |        | 2002  |  | 2001 |        | 2000  |  | 1999
|                                                                      |                             |                          |        |       |  |      |        |       |  |     
|Beginning balance                                                     |                             | $                        | 12,953 |       |  | $    | 11,071 |       |  | $    | 11,716 |       |  | $ | 11,875 |       |  | $ | 11,475 |      
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Allowance acquired in acquisition                                     |                             |                          |       |       |  |      | 837    |       |  |      |       |       |  |   |       |       |  |   |       |      
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Loans charged off during year:                                        |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Commercial and agricultural |                          |        | 556   |  |      |        | 485   |  |      |        | 1,152 |  |   |        | 45    |  |   |        | 58    | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Commercial real estate      |                          |        | 399   |  |      |        |      |  |      |        |      |  |   |        | 523   |  |   |        | 292   | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Financial                   |                          |        |      |  |      |        |      |  |      |        |      |  |   |        |      |  |   |        |      | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Real estate mortgage        |                          |        | 142   |  |      |        | 210   |  |      |        | 1     |  |   |        | 53    |  |   |        | 107   | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Consumer                    |                          |        | 1,138 |  |      |        | 961   |  |      |        | 864   |  |   |        | 459   |  |   |        | 661   | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Lease financing             |                          |        | 504   |  |      |        | 429   |  |      |        | 577   |  |   |        | 101   |  |   |        | 31    | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Finance receivables         |                          |        | 37    |  |      |        | 85    |  |      |        |      |  |   |        |      |  |   |        |      | 
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                      | Total charge-offs           |                          |        | 2,776 |  |      |        | 2,170 |  |      |        | 2,594 |  |   |        | 1,181 |  |   |        | 1,149 | 
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Recoveries:                                                           |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Commercial and agricultural |                          |        | 187   |  |      |        | 819   |  |      |        | 8     |  |   |        | 37    |  |   |        | 169   | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Commercial real estate      |                          |        | 234   |  |      |        | 4     |  |      |        | 428   |  |   |        | 58    |  |   |        | 29    | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Financial                   |                          |        |      |  |      |        |      |  |      |        |      |  |   |        |      |  |   |        |      | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Real estate mortgage        |                          |        | 1     |  |      |        | 2     |  |      |        |      |  |   |        | 10    |  |   |        |      | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Consumer                    |                          |        | 255   |  |      |        | 269   |  |      |        | 269   |  |   |        | 301   |  |   |        | 247   | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Lease financing             |                          |        | 86    |  |      |        | 24    |  |      |        | 27    |  |   |        | 11    |  |   |        | 44    | 
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|                                                                      | Finance receivables         |                          |        | 19    |  |      |        | 2     |  |      |        |      |  |   |        |      |  |   |        |      | 
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|                                                                      | Total recoveries            |                          |        | 782   |  |      |        | 1,120 |  |      |        | 732   |  |   |        | 417   |  |   |        | 489   | 
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Net loans charged off                                                 |                             |                          | 1,994  |       |  |      | 1,050  |       |  |      | 1,862  |       |  |   | 764    |       |  |   | 660    |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Provision for loan losses                                             |                             |                          | 3,697  |       |  |      | 2,095  |       |  |      | 1,217  |       |  |   | 605    |       |  |   | 1,060  |      
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Balance at end of year                                                |                             | $                        | 14,656 |       |  | $    | 12,953 |       |  | $    | 11,071 |       |  | $ | 11,716 |       |  | $ | 11,875 |      
|                                                                      |                             |                          |        |       |  |      |        |       |  |      |        |       |  |   |        |       |  |   |        |      
|Ratio of net loans charged off to average loans
    outstanding       |                             |                          | 0.14   | %     |  |      | 0.08   | %     |  |      | 0.17   | %     |  |   | 0.08   | %     |  |   | 0.07   | %    
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Ending allowance for loan losses to net loans
    charged off         |                             |                          | 7.4x   |       |  |      | 12.3x  |       |  |      | 5.9x   |       |  |   | 15.3x  |       |  |   | 18.0x  |      
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Net loans charged off to provision for loan losses                    |                             |                          | 53.9   | %     |  |      | 50.1   | %     |  |      | 152.9  | %     |  |   | 126.2  | %     |  |   | 62.3   | %    
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Allowance for loan losses as a percent of total
    loans outstanding |                             |                          | 0.98   | %     |  |      | 1.00   | %     |  |      | 1.01   | %     |  |   | 1.13   | %     |  |   | 1.24   | %    
|                                                                     
|                                                                     
|                                                                     
|                                                                     
|Allowance for loan losses as a percent of
    non-performing loans    |                             |                          | 315.2  | %     |  |      | 110.6  | %     |  |      | 125.8  | %     |  |   | 192.1  | %     |  |   | 328.6  | %    

The allowance for loan losses increased $1,703,000 from
$12,953,000 at December 31, 2002, to $14,656,000 at
December 31, 2003. The allowance represents 0.98% of loans
outstanding at December 31, 2003, and continued a trend in
lower reserve levels to outstanding loans.

Despite the improvements in non-performing assets, Sterling
increased its provision for loan losses to $3,697,000 for 2003,
as compared to $2,095,000 for 2002. The increase in the
provision is consistent with the increase in net charge-offs
during the period, combined with the growth in the loan
portfolio and the increase in potential problem loans. Certain
qualitative factors have also led to the increase in provision
for loan losses, including our customer base, in which we have
observed cash flows being negatively impacted by the national

30



---



##### 





Table 11  Allocation of Allowance for Loan
Losses

|                                        |  |                          |        |       |  |        |     |       |  |        |        |       |  |        |     |       |  |        |        |       |  |  |     |   |  |   |        |  |  |  |     |   |  |   |        |  |  |  |     |  
|--------------------------------------- |  | ------------------------ | ------ | ----- |  | ------ | --- | ----- |  | ------ | ------ | ----- |  | ------ | --- | ----- |  | ------ | ------ | ----- |  |  | --- | - |  | - | ------ |  |  |  | --- | - |  | - | ------ |  |  |  | --- | -
|                                        |  |                         
|                                        |  | Years Ended December 31,
|                                        |  |                         
|                                        |  |                          |        |       |  |        |     |       |  |       
|                                        |  | 2003                     |        | 2002  |  | 2001   |     | 2000  |  | 1999  
|                                        |  |                          |        |       |  |        |     |       |  |       
|                                        |  |                          |        | Loans |  |        |     | Loans |  |        |        | Loans |  |        |     | Loans |  |        |        | Loans
|                                        |  |                          |        | % to  |  |        |     | % to  |  |        |        | % to  |  |        |     | % to  |  |        |        | % to 
|                                        |  |                          |        | Total |  |        |     | Total |  |        |        | Total |  |        |     | Total |  |        |        | Total
|                                        |  | Amount                   |        | Loans |  | Amount |     | Loans |  | Amount |        | Loans |  | Amount |     | Loans |  | Amount |        | Loans
|                                        |  |                          |        |       |  |        |     |       |  |        |        |       |  |        |     |       |  |        |        |      
|Commercial, financial and agricultural  |  | $                        | 9,337  |       |  |        | 53  | %     |  | $      | 8,355  |       |  |        | 53  | %     |  | $      | 6,751  |       |  |  | 54  | % |  | $ | 7,816  |  |  |  | 50  | % |  | $ | 6,821  |  |  |  | 48  | %
|                                       
|                                       
|                                       
|                                       
|Real estate  mortgage and construction |  |                          | 218    |       |  |        | 5   | %     |  |        | 138    |       |  |        | 9   | %     |  |        | 188    |       |  |  | 13  | % |  |   | 255    |  |  |  | 15  | % |  |   | 256    |  |  |  | 17  | %
|                                       
|                                       
|                                       
|                                       
|Consumer                                |  |                          | 1,443  |       |  |        | 20  | %     |  |        | 962    |       |  |        | 22  | %     |  |        | 791    |       |  |  | 25  | % |  |   | 1,283  |  |  |  | 27  | % |  |   | 1,649  |  |  |  | 27  | %
|                                       
|                                       
|                                       
|                                       
|Leases                                  |  |                          | 1,856  |       |  |        | 13  | %     |  |        | 1,032  |       |  |        | 7   | %     |  |        | 617    |       |  |  | 8   | % |  |   | 512    |  |  |  | 8   | % |  |   | 638    |  |  |  | 8   | %
|                                       
|                                       
|                                       
|                                       
|Finance receivables                     |  |                          | 807    |       |  |        | 9   | %     |  |        | 854    |       |  |        | 9   | %     |  |        |       |       |  |  |    |   |  |   |       |  |  |  |    |   |  |   |       |  |  |  |    |  
|                                       
|                                       
|                                       
|                                       
|Unallocated                             |  |                          | 995    |       |  |        | 0   | %     |  |        | 1,612  |       |  |        | 0   | %     |  |        | 2,724  |       |  |  | 0   | % |  |   | 1,850  |  |  |  | 0   | % |  |   | 2,511  |  |  |  | 0   | %
|                                        |  |                          |        |       |  |        |     |       |  |        |        |       |  |        |     |       |  |        |        |       |  |  |     |   |  |   |        |  |  |  |     |   |  |   |        |  |  |  |     |  
|Total                                   |  | $                        | 14,656 |       |  |        | 100 | %     |  | $      | 12,953 |       |  |        | 100 | %     |  | $      | 11,071 |       |  |  | 100 | % |  | $ | 11,716 |  |  |  | 100 | % |  | $ | 11,875 |  |  |  | 100 | %
|                                        |  |                          |        |       |  |        |     |       |  |        |        |       |  |        |     |       |  |        |        |       |  |  |     |   |  |   |        |  |  |  |     |   |  |   |        |  |  |  |     |  

The allocation of the allowance for loan losses between the
various loan portfolios has changed over the past few years,
consistent with the historical net loss experience in each of
the portfolios. Additionally, management enhanced the
application of the allowance methodology in 2002, which served
to more appropriately reflect the risk associated with the
factors and resulted in a more refined allocation methodology.
Consequently, a portion of the unallocated reserve was
reclassified to the allocated reserve, without an increase in
probable loan losses.

The largest reserve allocation is to the commercial, financial
and agricultural loan portfolio, which represents approximately
53% of the reserve balance. This reflects the increase in net
charge-offs, increases in loans, entering new markets with new
lenders, and changes in other factors that impact the inherent
risks in the portfolio. This non-homogeneous loan portfolio,
along with leases, continues to represent the greatest risk
exposure to Sterling. The loans, generally, are larger than the
remainder of the portfolio and the related collateral is not as
marketable. Additionally, other external factors, such as
competition for high rated credits, is also considered in
allocating this reserve balance.

During 1998, Sterling sold its credit card portfolio, which was
included in the consumer loan category in determining the
allocation of the allowance for loan losses. As a result of the
sale of this portfolio, Sterling has seen an improvement in
charge-offs in consumer loans in 1998 through 2000, which
resulted in lower historical charge-off percentages used in
developing the quantitative portion of the reserve allocation.
As a result, the allocation of the allowance for loan losses to
the consumer loan portfolio generally lowered from
1998  2001. As a result of the recent downturn
in the economy and managements approach in more
aggressively charging off consumer loans, Sterling has
experienced a steady increase in net charge-offs during the last
three years. This increase, which led to higher historical
charge-off percentages, combined with an increased qualitative
adjustment, resulted in an increase in the consumer loan
allocation in 2002.

During 2003, the reserve allocation related to the lease
portfolio has increased consistent with the trends noted in
lease charge-offs during the last two years and continued
uncertainty as to the impact of the economy on the slumping
transportation industry and other factors that impact the
inherent risks in the portfolio.

The unallocated portion of the allowance reflects estimated
inherent losses within the portfolio that have not been
detected. The unallocated portion of the reserve results due to
risk of error in the specific and general reserve allocations,
other potential exposure in the loan portfolio, variances in
managements assessment of national and local economic
conditions, and other internal or external factors that
management believes appropriate at the time.

31



---



##### 



While management believes Sterlings allowance for loan
losses is adequate based on information currently available,
future adjustments to the reserve may be necessary due to
changes in economic conditions, and managements
assumptions as to future delinquencies or loss rates.

Assets Held for Operating Leases

After several years of steady growth, Sterlings assets
held for operating leases portfolio experienced a decline during
2003. Assets held for operating leases were $57,891,000 at
December 31, 2003, compared to $63,291,000 at
December 31, 2002, an 8.5% decrease. The decrease can be
attributed to economic conditions, in which the low interest
rate environment and bonus tax depreciation on personal property
has resulted in a greater willingness of customers to enter into
finance leases, or more traditional commercial lending
arrangements.

Operating leases have residual value risk associated with them.
Operating lease terms, including monthly rental payment and
length of the lease, are established based upon the residual
value, or the estimate of fair value of the leased asset at the
end of the lease term. If, at the end of the lease term, the
fair value of the leased property is less than the residual
value calculated at lease origination, a loss on disposal could
result. Sterling mitigates this risk through use of anticipated
values published by various industries, and in some instances,
discussions with industry experts. Further, the lease terms
include provisions that the lessee shares the risk of loss on
disposal of equipment, up to 50% of the residual value.

Deposits

Sterling continues to rely heavily on deposit growth as a
primary source of funds for lending activities. Total deposits
at December 31, 2003 were $1,778,587,000, compared to
$1,702,302,000 at December 31, 2002, an increase of 4.5%.
Sterling has experienced growth in its demand deposit and
savings accounts, while seeing a decline in its certificate of
deposit portfolio.

During the past two years, the banking industry has seen
customers migrate their investment funds from the equity market
to safer and more liquid investments. Banks have benefited from
this shift in consumer preference and have been able to grow
their deposit base, particularly in the money-market indexed
funds. The decrease in certificates of deposits from 2002 to
2003 is due to its reduced attractiveness in a low interest rate
environment. With the recent improvement in the equity market,
management anticipates it will not be able to continue to
generate the deposit growth it has seen in the past two years,
as investors will migrate back to the equity market. Sterling
will continue to explore new products to meet the needs of its
customers in order to grow its deposit balances.

Table 12  Average Deposit Balances and Rates
Paid

The following table summarizes the average amounts of deposits
and rates paid for the years indicated:

|                                    |  |                          |           |      |  |        |      |      |  |        |           |      |  |  |      |   |  |   |           |  |  |  |      |  
|----------------------------------- |  | ------------------------ | --------- | ---- |  | ------ | ---- | ---- |  | ------ | --------- | ---- |  |  | ---- | - |  | - | --------- |  |  |  | ---- | -
|                                    |  |                         
|                                    |  | Years Ended December 31,
|                                    |  |                         
|                                    |  |                          |           |      |  |       
|                                    |  | 2003                     |           | 2002 |  | 2001  
|                                    |  |                          |           |      |  |       
|                                    |  | Amount                   |           | Rate |  | Amount |      | Rate |  | Amount |           | Rate
|                                    |  |                          |           |      |  |        |      |      |  |        |           |     
|Noninterest-bearing demand deposits |  | $                        | 206,372   |      |  |        |     |      |  | $      | 186,860   |      |  |  |     |   |  | $ | 168,678   |  |  |  |     |  
|                                   
|                                   
|                                   
|                                   
|Interest-bearing demand deposits    |  |                          | 558,425   |      |  |        | 0.62 | %    |  |        | 494,778   |      |  |  | 1.02 | % |  |   | 435,199   |  |  |  | 1.98 | %
|                                   
|                                   
|                                   
|                                   
|Savings deposits                    |  |                          | 205,373   |      |  |        | 0.61 | %    |  |        | 186,403   |      |  |  | 1.06 | % |  |   | 167,978   |  |  |  | 2.10 | %
|                                   
|                                   
|                                   
|                                   
|Time deposits                       |  |                          | 746,421   |      |  |        | 3.31 | %    |  |        | 742,198   |      |  |  | 4.20 | % |  |   | 689,797   |  |  |  | 5.43 | %
|                                    |  |                          |           |      |  |        |      |      |  |        |           |      |  |  |      |   |  |   |           |  |  |  |      |  
|Total                               |  | $                        | 1,716,591 |      |  |        |      |      |  | $      | 1,610,239 |      |  |  |      |   |  | $ | 1,461,652 |  |  |  |      |  
|                                    |  |                          |           |      |  |        |      |      |  |        |           |      |  |  |      |   |  |   |           |  |  |  |      |  

32



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##### 



Table 13  Deposit Maturity

The following table summarizes the maturities of time deposits
of $100,000 or more as of the dates indicated:

|                               |  |              |         |      |  |   |         | 
|------------------------------ |  | ------------ | ------- | ---- |  | - | ------- | 
|                               |  |             
|                               |  | December 31,
|                               |  |             
|                               |  | 2003         |         | 2002
|                               |  |              |         |     
|Three months or less           |  | $            | 32,420  |      |  | $ | 25,798  | 
|                              
|                              
|                              
|                              
|Over three through six months  |  |              | 23,881  |      |  |   | 17,754  | 
|                              
|                              
|                              
|                              
|Over six through twelve months |  |              | 21,134  |      |  |   | 20,495  | 
|                              
|                              
|                              
|                              
|Over twelve months             |  |              | 62,815  |      |  |   | 77,333  | 
|                               |  |              |         |      |  |   |         | 
|Total                          |  | $            | 140,250 |      |  | $ | 141,380 | 
|                               |  |              |         |      |  |   |         | 

Short-Term Borrowings

Short-term borrowings are comprised primarily of securities sold
under agreements to repurchase, U.S. Treasury demand notes,
borrowings from other financial institutions and lines of
credit. As of December 31, 2003, short-term borrowings were
$43,878,000, an increase of $2,258,000 from the
December 31, 2002 balance of $41,620,000. This increase is
primarily attributable to Sterling borrowing $5,000,000 under a
line of credit to fund finance receivables, offset by a decrease
of approximately $2,326,000 of securities sold under repurchase
agreements.

Long-Term Debt

Long-term debt totaled $195,762,000 at December 31, 2003,
an increase of $40,284,000 over December 31, 2002s
balance of $155,478,000.

In the third quarter of 2003, Sterling entered into a leveraging
strategy, in which it borrowed $75,038,000 from the Federal Home
Loan Bank of Pittsburgh, and invested the proceeds in
U.S. Agency and tax-free securities. The incremental
borrowings have a weighted average rate of 2.46%, and weighted
average maturity of 39 months.

Prior to the leveraging strategy, Sterling was meeting its
scheduled maturities of long-term debt obligations with funding
obtained from deposit growth. This reduction in third party
borrowings offset the incremental borrowings that resulted from
the leveraging strategy. In addition, the prepayment of two FHLB
advances totaling, $5,000,000 occurred in December 2003, and
resulted in a prepayment fee of $258,000.

Subordinated Notes Payable

In the third quarter of 2003, Sterling deconsolidated its
investment in Sterling Financial Statutory Trusts I and II
in accordance with the provisions of FIN 46. As permitted
by the provisions of FIN 46, the December 31, 2002
balance sheet was restated as well for consistent presentation.

Sterling Financial Statutory Trusts I and II are special
purpose subsidiary trusts that issued trust preferred capital
securities. The proceeds from the trust preferred securities
were invested in junior subordinated deferrable interest
debentures of Sterling, at terms consistent with the trust
preferred capital securities.

Prior to the third quarter, Sterling presented company
obligated mandatorily redeemable preferred securities of a
subsidiary trust on its balance sheet, which was the trust
preferred securities being consolidated in Sterlings
balance sheet. With the adoption of FIN 46, the subsidiary
trusts are no longer consolidated, and as a result, the balance
sheet now presents junior subordinated debt on its balance sheet.

In June 2003, Sterling entered into a $36,083,000 junior
subordinated note payable with Sterling Financial Statutory
Trust II, at a fixed interest rate of 5.55%. This debenture
was in addition to Sterlings first junior subordinated
debt with Sterling Financial Statutory Trust I, at a
variable interest rate of 3-month

33



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##### 





Derivative Financial Instruments

Sterling is a party to derivative instruments in the normal
course of business to reduce its own exposure to fluctuations in
interest rates and to meet the financing needs of its customers.



| |                           
| | --------------------------
| | Asset Liability Management

Sterling uses derivative instruments to assist in asset
liability management to manage its exposure to earnings
volatility caused by fluctuations in interest rates. Interest
rate swaps are used to hedge cash flow variability related to
floating rate liabilities, through the use of pay-fixed
instruments. Gains and losses on derivative instruments
reclassified from accumulated other comprehensive income to
current-period earnings are included in the line item in which
the hedged cash flows are recorded. At December 31, 2003
other comprehensive income included a deferred after-tax loss of
$942,000 consisting of a loss on a pay-fixed interest rate swap
used to hedge future cash flows on floating rate liabilities,
versus $1,078,000 at December 31, 2002. A portion of the
amount in other comprehensive income is reclassified from other
comprehensive income to interest expense as net settlements
occur. For the year end December 31, 2003, Sterling
recognized interest expense of $918,000 related to interest rate
swaps accounted for as cash flow hedges, versus $543,000 for the
year ended December 31, 2002. At December 31, 2003,
the notional amount of the interest rate swap was $25,000,000,
and had a negative gross carrying value of $1,480 ,000. The
interest rate swap matures in 2006.

Interest rate options, which include caps, are contracts that
transfer, modify, or reduce interest rate risk in exchange for
the payment of a premium when the contract is initiated. A
premium is paid for the right, but not the obligation, to buy or
sell a financial instrument at predetermined terms in the
future. At December 31, 2003, the notional amount of an
interest rate cap purchased was $5,000,000, and its carrying
value was reduced to zero.

In May 2003, Sterling entered into two equity put options as
fair value hedges to protect the company from risk that the fair
value of its SLM Corporation stock might be adversely impacted
by changes in market price. The two equity put options each
cover 30,000 shares of SLMs stock, one with a valuation
date in May 2004 and the second with a valuation date of May
2006. If, at the valuation date, the stock price is below the
reference price (May 2004  $31.93; May
2006  $33.81), the counter-party will pay the
difference between the stocks price on the valuation date
and its reference price to Sterling. Sterling paid $258,000 for
these put options, and as of December 31, 2003 their fair
value was $84,000. The difference was charged to other
noninterest expense and totaled $174,000 for the year ended
December 31, 2003. At December 31, 2003, the trading
price of the SLM Corporation stock was $37.68.



| |                 
| | ----------------
| | Customer Related

In the third quarter of 2003, Sterling entered into interest
rate contracts; including interest rate caps and interest rate
swap agreements to facilitate customer transactions in order to
meet their financing needs. A summary of the customer related
interest rate contracts at December 31, 2003 is as follows
(in thousands):

|                                                                 |  |          |       |          |  |   |     |  
|---------------------------------------------------------------- |  | -------- | ----- | -------- |  | - | --- | -
|                                                                 |  | Notional |       | Carrying
|                                                                 |  | Amount   |       | Value   
|                                                                 |  |          |       |         
|Interest rate swap agreements (pay
    fixed/receiving floating) |  | $        | 7,000 |          |  | $ | (33 | )
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate swap agreements (pay
    floating/received fixed)  |  |          | 7,000 |          |  |   | 33  |  
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate caps written                                       |  |          | 6,000 |          |  |   | (27 | )
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate caps purchased                                     |  |          | 6,000 |          |  |   | 27  |  

The interest rate contract portfolio is actively managed and
hedged with offsetting contracts, with identical terms, with
third-party counterparties. Changes in the estimated fair value
of customer related contracts and related interest settlements,
net of the offsetting counterparty contracts, are recorded in

34



---



##### 





Sterling believes it has reduced market risk on its customer
related derivative contracts, through offsetting contractual
relationships with counterparties. However, if a customer or
counterparty fails to perform, credit risk is equal to the
extent of the fair value gain in a derivative. When the fair
value of a derivative instrument contract is positive, this
generally indicates that the counterparty or customer owes
Sterling, and results in credit risk to Sterling. When the fair
value of a credit risk is negative, Sterling owes the customer
or counterparty, and therefore, has no credit risk. Sterling
minimizes the credit risk in derivative instruments by including
derivative credit risk in its credit underwriting procedures,
and by entering into transactions with high-quality
counterparties that are reviewed periodically by Sterlings
treasury function.

Capital

The management of capital in a regulated financial services
industry must properly balance return on equity to stockholders
while maintaining sufficient capital levels and related
risk-based capital ratios to satisfy regulatory requirements.
Additionally, capital management must also consider acquisition
opportunities that may exist, and the resulting accounting
treatment.

Sterlings capital management strategies have been
developed to provide attractive rates of returns to
stockholders, while maintaining its well-capitalized
position at each of the banking subsidiaries.

One capital management strategy that Sterling has employed is
the use of trust preferred capital securities through its wholly
owned special purpose subsidiary trusts, Sterling Financial
Statutory Trust I and II. The proceeds from the preferred
securities were invested in junior subordinated deferrable
interest debentures of Sterling, at terms consistent with the
trust preferred capital securities. Sterlings treatment of
the preferred capital securities is consistent with long-term
debt, and the related dividends being presented as interest
expense. Sterlings obligations under the debentures and
related documents, taken together, constitute a full and
unconditional guarantee by Sterling of the Statutory
Trusts obligations under the preferred capital securities.
As of this writing, the preferred capital securities continue to
qualify for Tier 1 capital treatment for Sterling.

FIN 46 has been the subject of much debate among accounting
professionals, regulators, Financial Accounting Standards Board
and the SEC staff. While the primary intention of FIN 46
was to require consolidation of certain off balance
sheet special purpose affiliates for generally accepted
accounting principles, one consequence is to require
deconsolidation of trust subsidiaries used for purposes of
issuing Trust Preferred Securities. This deconsolidation could
jeopardize Tier 1 capital treatment of the trust preferred
securities in regulatory capital calculations, when final
clarification of the guidance is issued. In June 2003, the Board
of Governors of the Federal Reserve issued interim guidance,
which instructs institutions with trust preferred securities to
continue reporting in their Tier 1 capital for regulatory
purposes.

Sterling has $55,000,000 in trust preferred securities as of
December 31, 2003, which has been included as Tier 1
capital in its regulatory capital calculations. In the event of
an unfavorable outcome, which would prohibit inclusion of the
trust preferred securities as Tier 1 capital in the future,
Sterlings Tier 1 ratio would be negatively impacted.
However, Sterling expects its Tier 1 and total capital
ratios will remain above the well-capitalized thresholds.

Earnings retention, which represents net income less dividends
declared, is a primary source of additional capital to Sterling.
During 2003, Sterling retained $17,130,000, or 58.9%, of its net
income. The acquisition of Church and Bainbridge has provided
additional capital of $7,315,000.

During the second quarter of 2003, Sterling announced that its
Board of Directors authorized a plan to purchase, in open market
and privately negotiated transactions, up to
1,000,000 shares of its outstanding common stock. This
newly approved repurchase plan, when combined with
42,692 shares remaining to be purchased under
Sterlings repurchase plan announced in February 2001,
represents approximately 4.9% of the outstanding shares of
Sterlings common stock. Through December 31, 2003,
93,750 shares have been repurchased under this program at an
average price of $21.37.

35



---



##### 



Sterling and its banking subsidiaries are subject to various
regulatory capital requirements administered by the federal and
state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on Sterling and
the subsidiary banks financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt
corrective action, Sterling and its banking subsidiaries must
meet specific capital guidelines that involve quantitative
measures of their assets, liabilities and certain off-balance
sheet items as calculated under regulatory accounting practices.
The capital amounts and reclassifications are also subject to
qualitative judgments by the regulators about components, risk
weightings, and other factors. Prompt corrective action
provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure
capital adequacy require Sterling and its banking subsidiaries
to maintain minimum amounts and ratios of total and Tier 1
capital to average assets. Management believes, as of
December 31, 2003 and 2002 that Sterling and the subsidiary
banks met all minimum capital adequacy requirements to which
they are subject.

As of December 31, 2003, the most recent notification from
the Federal Deposit Insurance Corporation categorized the banks
as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well
capitalized institutions must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage
ratios as set forth in the following tables. There are no
conditions or events since the notification that management
believes have changed the banks category. Sterlings
and the banks actual capital amounts and ratios as of
December 31, 2003, and 2002 are also presented in the table.

Table 14  Risked-Based Capital

Sterlings actual capital amount and ratios are as follows:

|                  |                                          |                |   |                 |  |        |  |       |   |  |   |         |  |  |  |     |  
|----------------- | ---------------------------------------- | -------------- | - | --------------- |  | ------ |  | ----- | - |  | - | ------- |  |  |  | --- | -
|                  |                                          |                |   |                 |  |       
|                  |                                          |                |   | Minimum Capital
|                  |                                          | Actual Capital |   | Requirement    
|                  |                                          |                |   |                
|                  |                                          | Amount         |   | Ratio           |  | Amount |  | Ratio
|                  |                                          |                |   |                 |  |        |  |      
|December 31, 2003 |                                          |                |   |                 |  |        |  |       |   |  |   |         |  |  |  |    
|                 
|                 
|                 
|                 
|                  | Total capital to risked weighted assets  |                | $ | 244,621         |  |        |  | 13.4  | % |  | $ | 145,952 |  |  |  | 8.0 | %
|                 
|                 
|                 
|                 
|                  | Tier 1 capital to risked weighted assets |                |   | 227,106         |  |        |  | 12.4  | % |  |   | 72,976  |  |  |  | 4.0 | %
|                 
|                 
|                 
|                 
|                  | Tier 1 capital to average assets         |                |   | 227,106         |  |        |  | 10.0  | % |  |   | 90,546  |  |  |  | 4.0 | %
|December 31, 2002 |                                          |                |   |                 |  |        |  |       |   |  |   |         |  |  |  |    
|                 
|                 
|                 
|                 
|                  | Total capital to risked weighted assets  |                | $ | 198,476         |  |        |  | 12.2  | % |  | $ | 129,853 |  |  |  | 8.0 | %
|                 
|                 
|                 
|                 
|                  | Tier 1 capital to risked weighted assets |                |   | 183,848         |  |        |  | 11.3  | % |  |   | 64,927  |  |  |  | 4.0 | %
|                 
|                 
|                 
|                 
|                  | Tier 1 capital to average assets         |                |   | 183,848         |  |        |  | 8.7   | % |  |   | 84,376  |  |  |  | 4.0 | %

The improvement in the capital ratios at December 31, 2003
from 2002, are principally attributable to the $35,000,000 trust
preferred securities, issued in June 2003, which presently
qualifies for Tier 1 Capital treatment.

Liquidity

Effective liquidity management ensures the cash flow
requirements of depositors and borrowers, as well as the
operating cash needs of Sterling are met.

Sterlings funds are available from a variety of sources,
including assets that are readily convertible to cash (federal
funds sold, short-term investments), securities portfolio,
scheduled repayments of loans receivable, core deposit base,
short-term borrowing capacity with a number of correspondent
banks and the Federal Home Loan Bank (FHLB), and the ability to
package residential mortgage loans originated for sale. As of
December 31, 2003, Sterling has unused funding commitments
from these financial institutions and the FHLB totaling
$316,900,000.

The liquidity of the parent company also represents an important
aspect of liquidity management. The parent companys net
cash outflows consist principally of dividends to shareholders
and unallocated corporate

36



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##### 





Sterling manages liquidity by monitoring projected cash inflows
and outflows on a daily basis, and believes it has sufficient
funding sources to maintain sufficient liquidity under varying
degrees of business conditions.



| |                                                                            
| | ---------------------------------------------------------------------------
| | Contractual Obligations, Commitments and Off-balance Sheet
    Arrangements

Sterling enters into contractual obligations in its normal
course of business to fund loan growth, for asset/ liability
management purposes, to meet required capital needs and for
other corporate purposes. The following table presents
significant fixed and determinable contractual obligations by
payment date. Further discussion of the nature of each
obligation is included in the referenced note to the
consolidated financial statements.

|                                                              |  |           |    |           |  |                 |           |             |  |            |           |           |  |   |         |  |  |   |         |  |  |   |         | 
|------------------------------------------------------------- |  | --------- | -- | --------- |  | --------------- | --------- | ----------- |  | ---------- | --------- | --------- |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                              |  |           |    |           |  |                
|                                                              |  |           |    |           |  | Payments Due In
|                                                              |  |           |    | Total     |  |                
|                                                              |  | Note      |    | Amount    |  | One Year or     |           | One to      |  | Three to   |           | Over Five
|                                                              |  | Reference |    | Committed |  | Less            |           | Three Years |  | Five Years |           | Years    
|                                                              |  |           |    |           |  |                 |           |             |  |            |           |          
|Deposits without a stated maturity                            |  |           |    |           |  | $               | 1,037,952 |             |  | $          | 1,037,952 |           |  | $ |        |  |  | $ |        |  |  | $ |        | 
|                                                             
|                                                             
|                                                             
|                                                             
|Time deposits                                                 |  |           | 10 |           |  |                 | 740,635   |             |  |            | 358,238   |           |  |   | 144,596 |  |  |   | 233,189 |  |  |   | 4,612   | 
|                                                             
|                                                             
|                                                             
|                                                             
|Securities sold under repurchase agreements                   |  |           | 11 |           |  |                 | 7,794     |             |  |            | 7,794     |           |  |   |        |  |  |   |        |  |  |   |        | 
|                                                             
|                                                             
|                                                             
|                                                             
|Interest-bearing demand notes issued to the U.S.
    Treasury |  |           | 11 |           |  |                 | 6,084     |             |  |            | 6,084     |           |  |   |        |  |  |   |        |  |  |   |        | 
|                                                             
|                                                             
|                                                             
|                                                             
|Lines of credit                                               |  |           | 11 |           |  |                 | 30,000    |             |  |            | 30,000    |           |  |   |        |  |  |   |        |  |  |   |        | 
|                                                             
|                                                             
|                                                             
|                                                             
|Long-term debt                                                |  |           | 12 |           |  |                 | 195,762   |             |  |            | 30,312    |           |  |   | 36,726  |  |  |   | 73,418  |  |  |   | 55,306  | 
|                                                             
|                                                             
|                                                             
|                                                             
|Subordinated notes payable                                    |  |           | 13 |           |  |                 | 56,702    |             |  |            |          |           |  |   |        |  |  |   |        |  |  |   | 56,702  | 
|                                                             
|                                                             
|                                                             
|                                                             
|Operating leases                                              |  |           | 7  |           |  |                 | 11,576    |             |  |            | 1,479     |           |  |   | 2,327   |  |  |   | 1,704   |  |  |   | 6,066   | 
|                                                              |  |           |    |           |  |                 |           |             |  |            |           |           |  |   |         |  |  |   |         |  |  |   |         | 
|                                                              |  |           |    |           |  | $               | 2,086,505 |             |  | $          | 1,471,859 |           |  | $ | 183,649 |  |  | $ | 308,311 |  |  | $ | 122,686 | 
|                                                              |  |           |    |           |  |                 |           |             |  |            |           |           |  |   |         |  |  |   |         |  |  |   |         | 

Sterling is a party to derivative instruments in the normal
course of business, to assist in asset liability management and
reduce exposure in earnings volatility caused by fluctuations in
interest and market conditions and to meet the financing needs
of its customers. Derivative contracts are carried at fair value
on the consolidated balance sheet with the fair value
representing the net present value of the expected future cash
receipts or payments based on market and interest rate
conditions as of the balance sheet date. The fair values of the
contracts can change daily as market and interest rate
conditions fluctuate. These derivative contracts require monthly
cash settlement. As the derivative liabilities recorded on the
balance sheet do not represent the amounts that will ultimately
be paid under the contract, they are not included in the table
of contractual obligations discussed above. Further discussion
of derivative instruments is included in Notes 1 and 15 to the
consolidated financial statements.

A schedule of significant commitments at December 31, 2003
is as follows:

Commitments to extend credit:

|                          |                                    |   |         |         | 
|------------------------- | ---------------------------------- | - | ------- | ------- | 
|                         
|                         
|                         
|                         
|                          | Unused home equity lines of credit |   | $       | 59,550  | 
|                         
|                         
|                         
|                         
|                          | Other commitments to extend credit |   |         | 264,329 | 
|                         
|                         
|                         
|                         
|Standby letters of credit |                                    |   | 67,557  |        
|                          |                                    |   |         |        
|                          |                                    | $ | 391,436 |        
|                          |                                    |   |         |        

37



---



##### 



Further discussion of these commitments to extend credit is
included in Note 15 to the consolidated financial
statements. In addition, Sterling has commitments and
obligations under employee benefit plans as discussed in
Note 17 to the consolidated financial statements.

Sterling has no off-balance sheet arrangements through the use
of special-purpose entities.

New Financial Accounting Standards

Note 1 to the consolidated financial statements discusses the
expected impact on Sterlings financial condition or
results of operations for recently issued or proposed accounting
standards that have not been adopted. To the extent we
anticipate a significant impact to Sterlings financial
condition or results of operations, appropriate discussion takes
place in the applicable note to the consolidated financial
statements.




Item 7A  Quantitative and Qualitative
Disclosures About Market Risk

Financial institutions can be exposed to several market risks
that may impact the value or future earnings capacity of an
organization. These risks involve interest rate risk, foreign
currency exchange risk, commodity price risk and equity market
price risk. Sterlings primary market risk is interest rate
risk. Interest rate risk is inherent because as a financial
institution, Sterling derives a significant amount of its
operating revenue from purchasing funds (customer
deposits and borrowings) at various terms and rates. These funds
are then invested into earning assets (loans, leases,
investments, etc.) at various terms and rates. This risk is
further discussed below.

Equity market risk is not a significant risk to the corporation,
as equity investments on a cost basis comprise less than 1% of
corporate assets. Sterling does not have any exposure to foreign
currency exchange risk or commodity price risk.

Interest Rate Risk

Interest rate risk is the exposure to fluctuations in the
corporations future earnings (earnings at risk) and value
(value at risk) resulting from changes in interest rates. This
exposure results from differences between the amounts of
interest earning assets and interest bearing liabilities that
reprice within a specified time period as a result of scheduled
maturities and repayment, contractual interest rate changes, or
the exercise of explicit or embedded options.

The primary objective of the corporations asset/liability
management process is to maximize current and future net
interest income within acceptable levels of interest rate risk
while satisfying liquidity and capital requirements. Management
recognizes that a certain amount of interest rate risk is
inherent and appropriate yet is not essential to the
corporations profitability. Thus the goal of interest rate
risk management is to maintain a balance between risk and reward
such that net interest income is maximized while risk is
maintained at a tolerable level.

Management endeavors to control the exposures to changes in
interest rates by understanding, reviewing and making decisions
based on its risk position. The corporate asset/liability
committee is responsible for these decisions. The corporation
primarily uses the securities portfolios and borrowings to
manage its interest rate risk position. Additionally, pricing,
promotion and product development activities are directed in an
effort to emphasize the loan and deposit term or repricing
characteristics that best meet current interest rate risk
objectives. At present, the use of off-balance sheet instruments
is not significant.

The committee operates under management policies defining
guidelines and limits on the level of risk. These policies are
approved by the Boards of Directors.

The corporation uses simulation analysis to assess earnings at
risk and net present value analysis to assess value at risk.
These methods allow management to regularly monitor both the
direction and magnitude of the corporations interest rate
risk exposure. These modeling techniques involve assumptions and
estimates that inherently cannot be measured with complete
precision. Key assumptions in the analyses include maturity and
repricing characteristics of both assets and liabilities,
prepayments on amortizing assets, other imbedded

38



---



##### 





Earnings at Risk

Simulation analysis evaluates the effect of upward and downward
changes in market interest rates on future net interest income.
The analysis involves changing the interest rates used in
determining net interest income over the next twelve months. The
resulting percentage change in net interest income in various
rate scenarios is an indication of the corporations
shorter-term interest rate risk. The analysis utilizes a
static balance sheet approach. The measurement date
balance sheet composition (or mix) is maintained over the
simulation time period, with maturing and repayment dollars
being rolled back into like instruments for new terms at current
market rates. Additional assumptions are applied to modify
volumes and pricing under the various rate scenarios. These
include prepayment assumptions on mortgage assets, the
sensitivity of non-maturity deposit rates, and other factors
deemed significant.

The simulation analysis results are presented in Table 15a.
These results indicate that the corporation would expect net
interest income to increase over the next twelve months by 3.9%
assuming an immediate upward shift in market interest rates of
2.00% and to decrease by 5.3% if rates shifted downward in the
same manner. This profile reflects an asset sensitive short-term
rate risk position and is within the guidelines set by policy.
At December 31, 2002, annual net interest income was
expected to increase by 1.9% in the upward scenario and to
decrease by 3.3% in the downward scenario. The risk position has
changed from the prior year-end to a more asset sensitive
position primarily due to an increase in the volume of variable
commercial and consumer loans as well as fed funds sold.

Value at Risk

The net present value analysis provides information on the risk
inherent in the balance sheet that might not be taken into
account in the simulation analysis due to the shorter time
horizon used in that analysis. The net present value of the
balance sheet is defined as the discounted present value of
expected asset cash flows minus the discounted present value of
the expected liability cash flows. The analysis involves
changing the interest rates used in determining the expected
cash flows and in discounting the cash flows. The resulting
percentage change in net present value in various rate scenarios
is an indication of the longer term repricing risk and options
embedded in the balance sheet.

The net present value analysis results are presented in
Table 15b. These results indicate that the net present
value would be unchanged assuming an immediate upward shift in
market interest rates of 2.00% and to decrease 1.7% if rates
shifted downward in the same manner. The risk position of
Sterling is within the guidelines set by policy. At
December 31, 2002, the analysis indicated that the net
present value would decrease 0.3% assuming an immediate upward
shift in market interest rates of 2.00% and to decrease 1.1% if
rates shifted downward in the same manner.

|                      |      |                     |  |                       |      |                     |  |      |      |      |  |  |      |  |  |  |      |   |  |  |      |  
|--------------------- | ---- | ------------------- |  | --------------------- | ---- | ------------------- |  | ---- | ---- | ---- |  |  | ---- |  |  |  | ---- | - |  |  | ---- | -
|                      |      |                    
|Table15a              |      | Table15b           
|                      |      |                    
|                      |      |                     |  |                       |      |                    
|Change in             |      | % Change in         |  | Change in             |      | % Change in Present
|Market Interest Rates |      | Net Interest income |  | Market Interest Rates |      | Value of Equity    
|                      |      |                     |  |                       |      |                    
|                      |      | 2003                |  | 2002                  |      |                     |  | 2003 |      | 2002
|                      |      |                     |  |                       |      |                     |  |      |      |     
|                      | -200 |                     |  |                       | -5.3 | %                   |  |      | -3.3 | %    |  |  | -200 |  |  |  | -1.7 | % |  |  | -1.1 | %
|                     
|                     
|                     
|                     
|                      | -100 |                     |  |                       | -2.0 | %                   |  |      | -1.1 | %    |  |  | -100 |  |  |  | -0.7 | % |  |  | -0.3 | %
|                     
|                     
|                     
|                     
|                      | 0    |                     |  |                       | 0.0  | %                   |  |      | 0.0  | %    |  |  | 0    |  |  |  | 0.0  | % |  |  | 0.0  | %
|                     
|                     
|                     
|                     
|                      | +100 |                     |  |                       | 2.0  | %                   |  |      | 1.0  | %    |  |  | +100 |  |  |  | 0.1  | % |  |  | 0.1  | %
|                     
|                     
|                     
|                     
|                      | +200 |                     |  |                       | 3.9  | %                   |  |      | 1.9  | %    |  |  | +200 |  |  |  | 0.0  | % |  |  | -0.3 | %

39



---



##### 






Item 8  Financial Statements

(a) The following audited consolidated financial statements
and related documents are set forth in the Annual Report on
Form 10-K on the following pages:

|                                                               |  |      |    | 
|-------------------------------------------------------------- |  | ---- | -- | 
|                                                               |  | Page
|                                                               |  |     
|Report of Independent Auditors                                 |  |      | 41 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Consolidated Balance Sheets                                    |  |      | 42 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Consolidated Statements of Income                              |  |      | 43 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Consolidated Statements of Changes in
    Stockholders Equity |  |      | 44 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Consolidated Statements of Cash Flows                          |  |      | 45 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Notes to Consolidated Financial Statements                     |  |      | 46 | 

40



---



##### 



Report of Independent Auditors

The Board of Directors and Shareholders



We have audited the accompanying consolidated balance sheets of
Sterling Financial Corporation as of December 31, 2003 and
2002, and the related consolidated statements of income,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2003. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require
that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Sterling Financial Corporation at
December 31, 2003 and 2002, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United
States.

As discussed in Note 1 to the Consolidated Financial Statements,
in 2002, Sterling Financial Corporation changed its method of
accounting for goodwill.



| |                    
| | -------------------
| | (ERNST & YOUNG LLP)

Philadelphia, Pennsylvania



41



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets


|                                                                                                                                |                           |              |           |           |  |   |           |           | 
|------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ------------ | --------- | --------- |  | - | --------- | --------- | 
|                                                                                                                                |                           |             
|                                                                                                                                |                           | December 31,
|                                                                                                                                |                           |             
|(Dollars in thousands)                                                                                                          |                           | 2003         |           | 2002     
|                                                                                                                                |                           |              |           |          
|Assets                                                                                                                          |                           |              |           |           |  |   |           |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Cash and due from banks                                                                                                         |                           | $            | 64,996    |           |  | $ | 82,208    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Federal funds sold                                                                                                              |                           |              | 19,102    |           |  |   | 25,131    |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|                                                                                                                                | Cash and cash equivalents |              |           | 84,098    |  |   |           | 107,339   | 
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Interest-bearing deposits in banks                                                                                              |                           |              | 4,102     |           |  |   | 3,412     |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Short-term investments                                                                                                          |                           |              | 11,275    |           |  |   | 11,200    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Mortgage loans held for sale                                                                                                    |                           |              | 11,520    |           |  |   | 16,784    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Securities held-to-maturity (fair value
    2003  $37,405; 2002  $38,368)                                                     |                           |              | 35,956    |           |  |   | 36,596    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Securities available-for-sale                                                                                                   |                           |              | 540,049   |           |  |   | 551,696   |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Loans, net of allowance for loan losses
    (2003  $14,656; 2002  $12,953)                                                    |                           |              | 1,481,369 |           |  |   | 1,283,075 |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Premises and equipment, net                                                                                                     |                           |              | 38,720    |           |  |   | 35,212    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Assets held for operating lease, net                                                                                            |                           |              | 57,891    |           |  |   | 63,291    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Other real estate owned                                                                                                         |                           |              | 520       |           |  |   | 207       |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Goodwill                                                                                                                        |                           |              | 30,490    |           |  |   | 18,360    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Intangible assets                                                                                                               |                           |              | 5,083     |           |  |   | 121       |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Accrued interest receivable                                                                                                     |                           |              | 11,236    |           |  |   | 11,770    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Other assets                                                                                                                    |                           |              | 31,208    |           |  |   | 17,865    |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Total assets                                                                                                                    |                           | $            | 2,343,517 |           |  | $ | 2,156,928 |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Liabilities                                                                                                                     |                           |              |           |           |  |   |           |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Deposits:                                                                                                                       |                           |              |           |           |  |   |           |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                                | Noninterest-bearing       |              | $         | 250,119   |  |   | $         | 208,119   | 
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                                | Now and money market      |              |           | 577,486   |  |   |           | 544,055   | 
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                                | Savings                   |              |           | 210,347   |  |   |           | 189,534   | 
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                                | Time                      |              |           | 740,635   |  |   |           | 760,594   | 
|                                                                                                                                |                           |              |           |           |  |   |           |          
|                                                                                                                                | Total deposits            |              |           | 1,778,587 |  |   |           | 1,702,302 | 
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Short-term borrowings                                                                                                           |                           |              | 43,878    |           |  |   | 41,620    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Long-term debt                                                                                                                  |                           |              | 195,762   |           |  |   | 155,478   |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Subordinated notes payable                                                                                                      |                           |              | 56,702    |           |  |   | 20,619    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Accrued interest payable                                                                                                        |                           |              | 6,273     |           |  |   | 7,981     |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Other liabilities                                                                                                               |                           |              | 42,304    |           |  |   | 32,095    |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Total liabilities                                                                                                               |                           |              | 2,123,506 |           |  |   | 1,960,095 |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Stockholders equity                                                                                                            |                           |              |           |           |  |   |           |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Preferred stock, no par value, 10,000,000 shares
    authorized; no shares issued and outstanding                               |                           |              |          |           |  |   |          |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Common stock  $5.00 par value,
    70,000,000 shares authorized; issued 2003  21,776,551
    shares; 2002  16,923,069 shares |                           |              | 108,883   |           |  |   | 84,615    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Capital surplus                                                                                                                 |                           |              | 44,615    |           |  |   | 34,949    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Escrowed shares (2003  240,002 shares;
    2002  0 shares)                                                                    |                           |              | (4,877    | )         |  |   |          |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Retained earnings                                                                                                               |                           |              | 58,874    |           |  |   | 63,521    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Accumulated other comprehensive income                                                                                          |                           |              | 13,827    |           |  |   | 14,299    |          
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|                                                                                                                               
|Common stock in treasury, at cost
    (2003  59,310 shares; 2002  22,500 shares)                                              |                           |              | (1,311    | )         |  |   | (551      | )        
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Total stockholders equity                                                                                                      |                           |              | 220,011   |           |  |   | 196,833   |          
|                                                                                                                                |                           |              |           |           |  |   |           |          
|Total liabilities and stockholders
    equity                                                                                  |                           | $            | 2,343,517 |           |  | $ | 2,156,928 |          
|                                                                                                                                |                           |              |           |           |  |   |           |          

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

42



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income


|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |        |         | 
|--------------------------------------------- | -------------------------- | ------------------------------------------------------- | ------ | ------ | ------- | ---- | ------ | ------ | ------- | - | ------ | ------ | ------- | 
|                                              |                            |                                                        
|                                              |                            | Years Ended December 31,                               
|                                              |                            |                                                        
|(Dollars in thousands, except per share data) |                            | 2003                                                    |        | 2002   |         | 2001
|                                              |                            |                                                         |        |        |         |     
|Interest and dividend income                  |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|Loans, including fees                         |                            | $                                                       | 99,657 |        |         | $    | 93,635 |        |         | $ | 85,283 |       
|Debt securities                               |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|                                              | Taxable                    |                                                         |        | 16,482 |         |      |        | 19,484 |         |   |        | 19,245 |        
|                                             
|                                             
|                                             
|                                             
|                                              | Tax-exempt                 |                                                         |        | 9,990  |         |      |        | 9,059  |         |   |        | 8,556  |        
|                                             
|                                             
|                                             
|                                             
|Dividends                                     |                            |                                                         | 632    |        |         |      | 514    |        |         |   | 731    |       
|                                             
|                                             
|                                             
|                                             
|Federal funds sold                            |                            |                                                         | 232    |        |         |      | 850    |        |         |   | 2,040  |       
|                                             
|                                             
|                                             
|                                             
|Short-term investments                        |                            |                                                         | 81     |        |         |      | 49     |        |         |   | 61     |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                              |                            | Total interest and dividend income                      |        |        | 127,074 |      |        |        | 123,591 |   |        |        | 115,916 | 
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Interest expense                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|Deposits                                      |                            |                                                         | 29,443 |        |         |      | 38,174 |        |         |   | 49,612 |       
|                                             
|                                             
|                                             
|                                             
|Short-term borrowings                         |                            |                                                         | 1,599  |        |         |      | 1,531  |        |         |   | 617    |       
|                                             
|                                             
|                                             
|                                             
|Long-term debt                                |                            |                                                         | 8,044  |        |         |      | 8,044  |        |         |   | 7,045  |       
|                                             
|                                             
|                                             
|                                             
|Subordinated debt                             |                            |                                                         | 2,070  |        |         |      | 894    |        |         |   |       |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                              |                            | Total interest expense                                  |        |        | 41,156  |      |        |        | 48,643  |   |        |        | 57,274  | 
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Net interest income                           |                            |                                                         | 85,918 |        |         |      | 74,948 |        |         |   | 58,642 |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Provision for loan losses                     |                            |                                                         | 3,697  |        |         |      | 2,095  |        |         |   | 1,217  |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                              |                            | Net interest income after provision for loan
    losses |        |        | 82,221  |      |        |        | 72,853  |   |        |        | 57,425  | 
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Noninterest income                            |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|Income from fiduciary activities              |                            |                                                         | 4,954  |        |         |      | 4,227  |        |         |   | 4,166  |       
|                                             
|                                             
|                                             
|                                             
|Service charges on deposit accounts           |                            |                                                         | 5,797  |        |         |      | 5,576  |        |         |   | 5,367  |       
|                                             
|                                             
|                                             
|                                             
|Other service charges, commissions and fees   |                            |                                                         | 5,658  |        |         |      | 4,570  |        |         |   | 3,718  |       
|                                             
|                                             
|                                             
|                                             
|Mortgage banking income                       |                            |                                                         | 4,037  |        |         |      | 3,103  |        |         |   | 2,222  |       
|                                             
|                                             
|                                             
|                                             
|Rental income on operating leases             |                            |                                                         | 25,799 |        |         |      | 25,752 |        |         |   | 24,319 |       
|                                             
|                                             
|                                             
|                                             
|Other operating income                        |                            |                                                         | 2,965  |        |         |      | 2,064  |        |         |   | 1,423  |       
|                                             
|                                             
|                                             
|                                             
|Securities gains (losses)                     |                            |                                                         | 511    |        |         |      | (460   | )      |         |   | 2,710  |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                              |                            | Total noninterest income                                |        |        | 49,721  |      |        |        | 44,832  |   |        |        | 43,925  | 
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Noninterest expenses                          |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|Salaries and employee benefits                |                            |                                                         | 39,436 |        |         |      | 36,860 |        |         |   | 30,990 |       
|                                             
|                                             
|                                             
|                                             
|Net occupancy                                 |                            |                                                         | 4,926  |        |         |      | 4,209  |        |         |   | 3,826  |       
|                                             
|                                             
|                                             
|                                             
|Furniture and equipment                       |                            |                                                         | 6,368  |        |         |      | 5,762  |        |         |   | 5,081  |       
|                                             
|                                             
|                                             
|                                             
|Professional services                         |                            |                                                         | 3,154  |        |         |      | 2,845  |        |         |   | 2,412  |       
|                                             
|                                             
|                                             
|                                             
|Depreciation on operating lease assets        |                            |                                                         | 21,438 |        |         |      | 20,902 |        |         |   | 19,217 |       
|                                             
|                                             
|                                             
|                                             
|Other                                         |                            |                                                         | 17,246 |        |         |      | 15,344 |        |         |   | 13,646 |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                              |                            | Total noninterest expenses                              |        |        | 92,568  |      |        |        | 85,922  |   |        |        | 75,172  | 
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Income before income taxes                    |                            |                                                         | 39,374 |        |         |      | 31,763 |        |         |   | 26,178 |       
|                                             
|                                             
|                                             
|                                             
|Income tax expenses                           |                            |                                                         | 10,315 |        |         |      | 7,018  |        |         |   | 5,844  |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Net income                                    |                            | $                                                       | 29,059 |        |         | $    | 24,745 |        |         | $ | 20,334 |       
|                                              |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|Per share information                         |                            |                                                         |        |        |         |      |        |        |         |   |        |       
|                                             
|                                             
|                                             
|                                             
|                                              | Basic earnings per share   |                                                         | $      | 1.37   |         |      | $      | 1.19   |         |   | $      | 1.04   |        
|                                             
|                                             
|                                             
|                                             
|                                              | Diluted earnings per share |                                                         |        | 1.35   |         |      |        | 1.18   |         |   |        | 1.03   |        
|                                             
|                                             
|                                             
|                                             
|                                              | Dividends declared         |                                                         |        | 0.56   |         |      |        | 0.53   |         |   |        | 0.50   |        

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

43



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders
Equity


|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |        |     | 
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------ | ----------------------------- | ---------- | --------- |  | ------- | ------- | -------- |  | ------------- | ------ | -------- | --- | ----- | ------- | ------- | - | - | ------ | ------ | - | - | ------ | ------ | --- | - | ------- | ------ | --- | 
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  | Accumulated   |        |          |     |      
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  | Other         |        | Treasury |     |      
|                                                                            |                                                                                                                    | Shares                        |            |           |  |         |         |          |  | Comprehensive |        | and      |     |      
|                                                                            |                                                                                                                    | Common                        |            | Common    |  | Capital |         | Retained |  | Income        |        | Escrowed |     |      
|(Dollars in thousands)                                                      |                                                                                                                    | Stock                         |            | Stock     |  | Surplus |         | Earnings |  | (Loss)        |        | Shares   |     | Total
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |      
|Balance, January 1, 2001                                                    |                                                                                                                    |                               | 12,546,477 |           |  | $       | 62,732  |          |  | $             | 17,856 |          |     | $     | 56,261  |         |   | $ | 2,498  |        |   | $ |       |        |     | $ | 139,347 |       
|Comprehensive income                                                        |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Net Income                                                                                                         |                               |            |           |  |         |         |          |  |               |        |          |     |       |         | 20,334  |   |   |        |        |   |   |        |        |     |   |         | 20,334 |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Change in net unrealized gain (loss) on
    securities AFS, net of reclassification adjustment and tax
    effects |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        | 2,935  |   |   |        |        |     |   |         | 2,935  |    
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Total comprehensive income                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 23,269  |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Common stock issued                                                         |                                                                                                                    |                               | 186        |           |  |         | 1       |          |  |               | 2      |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 3       |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Cash dividends declared                                                     |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       | (9,772  | )       |   |   |        |        |   |   |        |        |     |   | (9,772  | )     
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Purchase of treasury stock (53,077)                                         |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   | (1,061 | )      |     |   | (1,061  | )     
|Issuance of treasury stock                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Directors compensation plan (3,000 shares)                                                                        |                               |            |           |  |         |         |          |  |               |        | 12       |     |       |         |         |   |   |        |        |   |   |        | 54     |     |   |         | 66     |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            |                                                                                                                    | Stock options (15,367 shares) |            |           |  |         |         |          |  |               |        |          | (21 | )     |         |         |   |   |        |        |   |   |        |        | 280 |   |         |        | 259 | 
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Balance, December 31, 2001                                                  |                                                                                                                    |                               | 12,546,663 |           |  |         | 62,733  |          |  |               | 17,849 |          |     |       | 66,823  |         |   |   | 5,433  |        |   |   | (727   | )      |     |   | 152,111 |       
|Comprehensive income                                                        |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Net income                                                                                                         |                               |            |           |  |         |         |          |  |               |        |          |     |       |         | 24,745  |   |   |        |        |   |   |        |        |     |   |         | 24,745 |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Change in net unrealized gain (loss) on
    securities AFS, net of reclassification adjustment and tax
    effects |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        | 9,944  |   |   |        |        |     |   |         | 9,944  |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Change in unrealized loss on interest rate swap                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        | (1,078 | ) |   |        |        |     |   |         | (1,078 | )  
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Total comprehensive income                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 33,611  |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Common stock issued:                                                        |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Acquisition of Equipment Finance, Inc                                                                              |                               |            | 954,452   |  |         |         | 4,772    |  |               |        | 16,226   |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         | 20,998 |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Stock options                                                                                                      |                               |            | 48,093    |  |         |         | 241      |  |               |        | 404      |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         | 645    |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | 5-for-4 stock split effected in the form of a 25%
    common stock dividend                                        |                               |            | 3,373,861 |  |         |         | 16,869   |  |               |        |          |     |       |         | (16,901 | ) |   |        |        |   |   |        |        |     |   |         | (32    | )  
|Issuance of treasury stock                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Directors compensation plan (3,900 shares)                                                                        |                               |            |           |  |         |         |          |  |               |        | 33       |     |       |         |         |   |   |        |        |   |   |        | 65     |     |   |         | 98     |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Stock options (32,654 shares)                                                                                      |                               |            |           |  |         |         |          |  |               |        | (109     | )   |       |         |         |   |   |        |        |   |   |        | 662    |     |   |         | 553    |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Purchase of treasury stock (22,500 shares)                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   | (551   | )      |     |   | (551    | )     
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Cash dividends declared                                                     |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       | (11,146 | )       |   |   |        |        |   |   |        |        |     |   | (11,146 | )     
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Income tax benefit of nonqualified stock options                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               | 171    |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 171     |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Compensation expense on modification of stock
    option awards             |                                                                                                                    |                               |            |           |  |         |         |          |  |               | 375    |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 375     |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Balance, December 31, 2002                                                  |                                                                                                                    |                               | 16,923,069 |           |  |         | 84,615  |          |  |               | 34,949 |          |     |       | 63,521  |         |   |   | 14,299 |        |   |   | (551   | )      |     |   | 196,833 |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Comprehensive income:                                                       |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Net Income                                                                                                         |                               |            |           |  |         |         |          |  |               |        |          |     |       |         | 29,059  |   |   |        |        |   |   |        |        |     |   |         | 29,059 |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Other comprehensive income:                                                                                        |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |        |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Change in net unrealized gain/loss on securities
    AFS, net of reclassification adjustment and tax effects       |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        | (608   | ) |   |        |        |     |   |         | (608   | )  
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Change in unrealized loss on interest rate swap                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        | 136    |   |   |        |        |     |   |         | 136    |    
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Total comprehensive income                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 28,587  |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Common stock issued:                                                        |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Acquisition of Church/ Bainbridge                                                                                  |                               |            | 480,000   |  |         |         | 2,400    |  |               |        | 9,792    |     |       |         |         |   |   |        |        |   |   |        | (4,877 | )   |   |         | 7,315  |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Stock options                                                                                                      |                               |            | 17,947    |  |         |         | 90       |  |               |        | 225      |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         | 315    |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Directors compensation plan                                                                                       |                               |            | 225       |  |         |         | 1        |  |               |        | 20       |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         | 21     |    
|Issuance of treasury stock                                                  |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Dividend Reinvestment Plan (29,548 shares)                                                                         |                               |            |           |  |         |         |          |  |               |        | (20      | )   |       |         |         |   |   |        |        |   |   |        | 720    |     |   |         | 700    |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Directors compensation plan (6,725) shares)                                                                       |                               |            |           |  |         |         |          |  |               |        | 5        |     |       |         |         |   |   |        |        |   |   |        | 150    |     |   |         | 155    |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|                                                                            | Stock options (78,267 shares)                                                                                      |                               |            |           |  |         |         |          |  |               |        | (563     | )   |       |         |         |   |   |        |        |   |   |        | 1,829  |     |   |         | 1,266  |    
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Purchase of treasury stock (139,500 shares)                                 |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   | (3,459 | )      |     |   | (3,459  | )     
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Cash dividends declared                                                     |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       | (11,929 | )       |   |   |        |        |   |   |        |        |     |   | (11,929 | )     
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Income tax benefit of nonqualified stock options                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               | 207    |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   | 207     |       
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|5-for-4 stock split effected in the form of a 25%
    common stock dividend |                                                                                                                    |                               | 4,355,310  |           |  |         | 21,777  |          |  |               |        |          |     |       | (21,777 | )       |   |   |        |        |   |   |        |        |     |   |        |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       
|Balance, December 31, 2003                                                  |                                                                                                                    |                               | 21,776,551 |           |  | $       | 108,883 |          |  | $             | 44,615 |          |     | $     | 58,874  |         |   | $ | 13,827 |        |   | $ | (6,188 | )      |     | $ | 220,011 |       
|                                                                            |                                                                                                                    |                               |            |           |  |         |         |          |  |               |        |          |     |       |         |         |   |   |        |        |   |   |        |        |     |   |         |       

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

44



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows


|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |          |        |  
|------------------------------------------------------------------------------------- | ------------------------------------------------------------ | --------------------------------------------------- | -------- | -------- | ------ | ---- | -------- | -------- | ---- | - | -------- | -------- | ------ | -
|                                                                                      |                                                              |                                                    
|                                                                                      |                                                              | Years Ended December 31,                           
|                                                                                      |                                                              |                                                    
|(Dollars in thousands)                                                                |                                                              | 2003                                                |          | 2002     |        | 2001
|                                                                                      |                                                              |                                                     |          |          |        |     
|Cash Flows from Operating Activities                                                  |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net income                                                                            |                                                              | $                                                   | 29,059   |          |        | $    | 24,745   |          |      | $ | 20,334   |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Depreciation                                                 |                                                     |          | 25,708   |        |      |          | 24,926   |      |   |          | 23,001   |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Accretion and amortization of investment
    securities      |                                                     |          | 741      |        |      |          | 762      |      |   |          | 38       |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Amortization of intangible assets                            |                                                     |          | 236      |        |      |          | 167      |      |   |          | 189      |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Provision for loan losses                                    |                                                     |          | 3,697    |        |      |          | 2,095    |      |   |          | 1,217    |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Provision for deferred income taxes                          |                                                     |          | 887      |        |      |          | 936      |      |   |          | (1,113   | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | (Gains) losses on sales of securities
    available-for-sale |                                                     |          | (511     | )      |      |          | 460      |      |   |          | (2,710   | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Gains on sale of mortgage loans                              |                                                     |          | (2,122   | )      |      |          | (1,393   | )    |   |          | (898     | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Proceeds from sales of mortgage loans                        |                                                     |          | 263,740  |        |      |          | 177,381  |      |   |          | 142,242  |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Originations of mortgage loans held for sale                 |                                                     |          | (256,354 | )      |      |          | (171,748 | )    |   |          | (160,390 | )     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Change in operating assets and liabilities:                  |                                                     |          |          |        |      |          |          |      |   |          |          |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                              | (Increase) decrease in accrued interest receivable  |          |          | 534    |      |          |          | 346  |   |          |          | (129   | )
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                              | (Increase) decrease in other assets                 |          |          | (7,951 | )    |          |          | (139 | ) |          |          | (3,779 | )
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                              | Increase (decrease) in accrued interest
    payable |          |          | (1,708 | )    |          |          | (771 | ) |          |          | (1,333 | )
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                              | Increase (decrease) in other liabilities            |          |          | 7,846  |      |          |          | 755  |   |          |          | 6,071  |  
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                              | Other                                               |          |          | (100   | )    |          |          | 375  |   |          |          |       |  
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|Net cash provided by operating activities                                             |                                                              |                                                     | 63,702   |          |        |      | 58,897   |          |      |   | 22,740   |         
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|Cash Flows From Investing Activities                                                  |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net increase in interest-bearing deposits in
    other banks                          |                                                              |                                                     | (690     | )        |        |      | (1,045   | )        |      |   | (1,851   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net increase in short-term investments                                                |                                                              |                                                     | (75      | )        |        |      | (9,923   | )        |      |   | (674     | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from sales of securities
    available-for-sale                              |                                                              |                                                     | 74,907   |          |        |      | 29,150   |          |      |   | 28,107   |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from maturities or calls of securities
    held-to-maturity                  |                                                              |                                                     | 5,522    |          |        |      | 7,617    |          |      |   | 13,784   |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from maturities or calls of securities
    available-for-sale                |                                                              |                                                     | 114,577  |          |        |      | 94,619   |          |      |   | 141,010  |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchases of securities held-to-maturity                                              |                                                              |                                                     | (4,874   | )        |        |      | (2,420   | )        |      |   | (4,737   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchases of securities available-for-sale                                            |                                                              |                                                     | (178,905 | )        |        |      | (170,400 | )        |      |   | (217,346 | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net loans and direct finance leases made to
    customers                             |                                                              |                                                     | (202,304 | )        |        |      | (118,678 | )        |      |   | (66,820  | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchases of equipment acquired for operating
    leases, net                         |                                                              |                                                     | (16,038  | )        |        |      | (25,197  | )        |      |   | (23,920  | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchases of premises and equipment (net)                                             |                                                              |                                                     | (7,738   | )        |        |      | (6,974   | )        |      |   | (6,162   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net cash paid for business combination                                                |                                                              |                                                     | (8,282   | )        |        |      | (8,783   | )        |      |   |         |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash placed in escrow related to business
    combination                             |                                                              |                                                     | (5,280   | )        |        |      |         |          |      |   |         |         
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                      | Net cash used by investing activities                        |                                                     |          | (229,180 | )      |      |          | (212,034 | )    |   |          | (138,609 | )     
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|Cash Flows From Financing Activities                                                  |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net increase in deposits                                                              |                                                              |                                                     | 76,285   |          |        |      | 166,653  |          |      |   | 115,349  |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net increase (decrease) in short-term
    borrowings                                  |                                                              |                                                     | 2,258    |          |        |      | (45,655  | )        |      |   | (5,371   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from issuance of long-term debt                                              |                                                              |                                                     | 75,038   |          |        |      | 65,250   |          |      |   | 56,000   |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Repayment of long-term debt                                                           |                                                              |                                                     | (34,754  | )        |        |      | (30,865  | )        |      |   | (48,757  | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from issuance of trust preferred
    securities                              |                                                              |                                                     | 36,083   |          |        |      | 20,619   |          |      |   |         |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from issuance of common stock                                                |                                                              |                                                     | 336      |          |        |      | 645      |          |      |   | 3        |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash dividends                                                                        |                                                              |                                                     | (11,671  | )        |        |      | (10,771  | )        |      |   | (9,654   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash paid in lieu of fractional shares                                                |                                                              |                                                     |         |          |        |      | (32      | )        |      |   |         |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchase of treasury stock                                                            |                                                              |                                                     | (3,459   | )        |        |      | (551     | )        |      |   | (1,061   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from issuance of treasury stock                                              |                                                              |                                                     | 2,121    |          |        |      | 651      |          |      |   | 325      |         
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                      | Net cash provided by financing activities                    |                                                     |          | 142,237  |        |      |          | 165,944  |      |   |          | 106,834  |       
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|Net change in cash and cash equivalents                                               |                                                              |                                                     | (23,241  | )        |        |      | 12,807   |          |      |   | (9,035   | )       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash and cash equivalents:                                                            |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Beginning of year                                            |                                                     |          | 107,339  |        |      |          | 94,532   |      |   |          | 103,567  |       
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                      | End of year                                                  |                                                     | $        | 84,098   |        |      | $        | 107,339  |      |   | $        | 94,532   |       
|                                                                                      |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|Supplemental Disclosure of Cash Flow
    Information:                                 |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash payments for:                                                                    |                                                              |                                                     |          |          |        |      |          |          |      |   |          |         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Interest                                                     |                                                     | $        | 55,410   |        |      | $        | 49,383   |      |   | $        | 58,607   |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Income taxes                                                 |                                                     |          | 9,224    |        |      |          | 6,457    |      |   |          | 6,660    |       

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

45



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements



Note 1  Summary of Significant Accounting
Policies

Basis of Presentation and Consolidation  The
consolidated financial statements include the accounts of
Sterling Financial Corporation (Sterling) and its wholly-owned
subsidiaries, Bank of Lancaster County, N.A. (Bank of Lancaster
County), First National Bank of North East (First National),
Bank of Hanover and Trust Company (Bank of Hanover), HOVB
Investment Co., T&C Leasing, Inc. (T&C), Pennbanks
Insurance Company, SPC, Church Capital Management, LLC,
Bainbridge Securities Inc., and Sterling Mortgage Services, Inc.
(inactive). The consolidated financial statements also include
Town & Country Leasing, LLC (Town & Country), Sterling
Financial Trust Company, and Equipment Finance, LLC, all
wholly-owned subsidiaries of Bank of Lancaster County. All
significant intercompany balances and transactions have been
eliminated in consolidation.

Use of Estimates  In preparing consolidated
financial statements in conformity with generally accepted
accounting principles, management is required to make estimates
and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and reported
amounts of revenues and expenses during the period. Actual
results could differ from those estimates.

Business  Sterling, through its subsidiaries,
provides a full range of financial services to individual and
corporate customers located in south central Pennsylvania,
northern Maryland and Delaware. Additionally, with its
acquisition of Equipment Finance, LLC in 2002, Sterling finances
forestry and land clearing equipment to customers on the east
coast of the United States.

Concentration of Credit Risk  Sterling
operates primarily in its defined market area and, accordingly,
the banks have extended credit primarily to commercial entities
and individuals in this area whose ability to honor their
contracts is influenced by the regions economy. The loan
portfolio is well diversified and Sterling does not have any
significant concentrations of credit risk. Sterlings
exposure to the forestry industry at December 31, 2003 was
$141 million. The banks are limited in extending credit by
legal lending limits to any single group of borrowers.

Cash and Cash Equivalents  For purposes of the
consolidated statements of cash flows, cash and cash equivalents
include cash and balances due from banks and federal funds sold,
generally which mature in one day.

Interest-bearing Deposits in Banks 
Interest-bearing deposits in banks mature within one year and
are carried at cost.

Securities  Debt securities that management
has the positive intent and ability to hold to maturity are
classified as held-to-maturity and recorded at
amortized cost. Securities not classified as held to maturity,
including equity securities with readily determinable fair
values, are classified as available-for-sale and
recorded at fair value, with unrealized gains and losses
excluded from earnings and reported in other comprehensive
income.

Purchase premiums and discounts are recognized in interest
income using the interest method over terms of the securities
using the constant yield method. Declines in the fair value of
held-to-maturity and available-for-sale securities below their
cost that are deemed to be other-than-temporary are reflected in
earnings in the period that management concludes that other than
temporary impairment occurs. Sterling uses various indicators in
determining whether a security is other-than-temporarily
impaired, including for equity securities, if the market value
is below its cost for an extended period of time or for debt
securities, when it is probable that the contractual interest
and principal will not be collected.

Gains and losses on the sale of securities are recorded on the
trade date and are determined using the specific identification
method.

46



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Mortgage Loans Held for Sale  Loans originated
and intended for sale in the secondary market are carried at the
lower of cost or estimated fair value in aggregate. Net
unrealized losses, if any, are recognized through a valuation
allowance by charges to income.

Loans  Sterling grants mortgage, commercial
and consumer loans and leasing alternatives to customers. The
ability of Sterlings debtors to honor their contracts is
dependent upon the real estate and general economic conditions
in the market area.

Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off, generally are
reported at their outstanding principal balance adjusted for
charge-offs, the allowance for loan losses and any deferred fees
or costs on originated loans. Interest income is accrued on the
unpaid principal balance.

Lease contracts which meet the appropriate criteria specified in
Statement of Financial Accounting Standards No. 13,
Accounting for Leases, are classified as direct finance
leases. Direct finance leases are recorded upon acceptance of
the equipment by the customer. Unearned lease income represents
the excess of the gross lease investment over the cost of the
leased equipment, which is recognized over the lease term at a
constant rate of return on the net investment in the lease.

Loan and lease origination fees and loan origination costs are
deferred and recognized as an adjustment of the related loan
yield using the interest method.

The accrual of interest on loans is generally discontinued at
the time the loan is 90 days delinquent unless the credit
is well secured and in the process of collection. Loans are
placed on nonaccrual status or charged-off at an earlier date if
collection of principal or interest is considered doubtful. All
interest accrued, but not collected for loans that are placed on
nonaccrual status or charged-off is reversed against interest
income. The interest received on these loans is applied to
reduce the carrying value of the loan or, if principal is
considered fully collectible, recognized as interest income
until qualifying for return to accrual status. Loans are
returned to accrual status when all the principal and interest
amounts contractually due are brought current and future
payments are reasonably assured.

Allowance for Loan Losses  Sterling maintains
the allowance for loan losses at a level believed adequate by
management to absorb potential losses inherent in the loan
portfolio. It is established and maintained through a provision
for loan losses charged to earnings. Quarterly, the company
utilizes a defined methodology in determining the adequacy of
the allowance for loan losses, which considers specific credit
reviews, past loan loss historical experience, and qualitative
factors. This methodology which has remained consistent for the
past several years, results in an allowance consisting of two
components, allocated and unallocated.

Management assigns internal risk ratings to all commercial
relationships with aggregate borrowings or commitments to extend
credit in excess of $100,000. Utilizing migration analysis for
the previous eight quarters, management develops a loss factor
test, which it then uses to estimate losses on impaired loans,
potential problem loans and non-classified loans. When
management finds loans with uncertain collectibility of
principal and interest, it places those loans on the
problem list, and evaluates them on a quarterly
basis in order to estimate potential losses. Managements
analysis considers adverse situations that may affect the
borrowers ability to repay, estimated value of underlying
collateral, and prevailing market conditions. If management
determines that a specific reserve allocation is not required,
it assigns a general loss factor based on historical performance
to determine the reserve necessary for each loan. For
homogeneous loan types, such as consumer and residential
mortgage loans, management bases specific allocations on the
average loss ratio for the previous two years for each specific
loan pool. Additionally, management projects loss ratios for
other factors, including trends in delinquency levels, trends in
non-performing and potential problem loans, trends in
composition, volume and terms of loans, effects of changes in
lending policies or underwriting procedures,

47



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

experience ability and depth of management, national and local
economic conditions, concentrations in lending activities, and
other factors that management may deem appropriate.

Management determines the unallocated portion of the allowance
for loan losses based on the following criteria: risk of error
in the specific and general reserve allocations; other potential
exposure in the loan portfolio; variances in managements
assessment of national and local economic conditions; and other
internal or external factors that management believes
appropriate at that time.

Management believes the above methodology accurately reflects
losses inherent in the portfolio. Management charges actual
losses to the allowance for loan losses. Management periodically
updates the methodology discussed above, which reduces the
difference between actual losses and estimated losses.

A loan is considered impaired when, based on current information
and events, it is probable that Sterling will be unable to
collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan agreement.
Factors considered by management in determining impairment
include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration
all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay,
the borrowers prior payment record, and the amount of the
shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial
and construction loans by either the present value of expected
future cash flows discounted at the loans effective
interest rate, the loans obtainable market price, or the
fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. Accordingly, Sterling
does not separately identify individual consumer and residential
loans for impairment disclosures.

Servicing  Servicing assets are recognized as
separate assets when rights are retained through the sale of
financial assets. Capitalized servicing rights are reported in
other assets and are amortized into noninterest income in
proportion to, and over the period of, the estimated future net
servicing income of the underlying financial assets. Servicing
assets are evaluated for impairment based upon the fair value of
the rights as compared to amortized cost. Impairment is
determined by stratifying rights by predominant characteristics,
such as interest rate and terms. Fair value is determined using
prices for similar assets with similar characteristics, when
available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a
valuation allowance for individual stratum, to the extent the
fair value is less than the capitalized amount for the stratum.

Financial Instruments

Credit Related Financial Instruments  In the
ordinary course of business, Sterling has entered into
commitments to extend credit, commercial letters of credit and
standby letters of credit. Such financial instruments are
recorded when they are funded.

Derivative Financial Instruments  As part of
Sterlings asset/liability management, it uses interest
rate contracts, which include swaps and cap agreements, to hedge
various exposures or to modify interest rate characteristics of
various balance sheet accounts. Derivatives that are used as
part of the asset/liability management process are linked to
specific assets or liabilities and have high correlation between
the contract and the underlying item being hedged, both at
inception and throughout the hedge period. Sterling formally
documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and
strategy for undertaking each hedge transaction.

48



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging
Activities, as amended, requires all derivative instruments
to be carried at fair value on the balance sheet. Statement
No. 133 provides special hedge accounting provisions, which
permit the change in fair value of the hedged item related to
risk being hedged to be recognized in earnings in the same
period and in the same income statement line as the change in
fair value of the derivative.

Sterlings derivatives consist of cash flow hedges, which
are designed to mitigate exposures to variability in expected
cash flows. Cash flow hedges are accounted for by recording the
fair value of the derivative instrument on the balance sheet as
either a freestanding asset or liability, with a corresponding
offset recorded in other comprehensive income within
stockholders equity, net of tax. Amounts are reclassified
from other comprehensive income to the income statement in
period or periods the hedged forecasted transaction effects
earnings. Under the cash flow hedge method, derivative gains and
losses not effective in hedging the change in expected cash
flows of the hedged item are recognized immediately in income in
the interest expense line. At the hedges inception and at
least quarterly thereafter, an assessment is performed to
determine whether changes in the cash flows of the derivative
instruments have been highly effective in offsetting changes in
the cash flows of the hedged items and whether they are expected
to be highly effective in the future. If it is determined a
derivative instrument has not been or will not continue to be
highly effective as a hedge, hedge accounting is discontinued
prospectively.

Foreclosed Assets  Assets acquired through, or
in lieu of, loan foreclosure are held for sale and are initially
recorded at the lower of fair value or carrying value at the
date of foreclosure. Any initial charge necessary is reflected
as a charge to the allowance for loan losses. Subsequent to
foreclosure, valuations are periodically performed by management
and the assets are carried at the lower of carrying amount or
fair value less cost to sell. Revenues and expenses from
operations and changes in the valuation allowance are included
in other non-interest expenses.

Premises and Equipment  Land is carried at
cost. Buildings, furniture, equipment and leasehold improvements
are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed primarily on the
straight-line method over the estimated useful lives of the
asset.

Assets Held for Operating Leases  Leases that
do not meet the criteria of direct finance leases are accounted
for as operating leases. Leased equipment is recorded at cost
and depreciated over the lease term, to the estimated residual
value at the expiration of the lease term, generally on a
straight-line basis. Sterling periodically reviews estimated net
realizable values and records losses in current earnings if the
estimated residual balance indicates impairment.

Goodwill  Goodwill represents the excess of
the cost of an acquisition over the fair value of the assets
acquired. Sterling segments goodwill into two different
categories, goodwill associated with business acquisitions and
goodwill associated with branch purchases. As a result of the
adoption of Statement No. 142, Goodwill and Other
Intangible Assets, business acquisition goodwill is no
longer ratably amortized into the income statement over an
estimated life, but rather is tested at least annually for
impairment. Consistent with the provisions of Statement
No. 147,Sterling continues to amortize its branch
purchase goodwill over a twenty-year period.

Intangible Assets  Intangible assets represent
purchased assets that lack physical substance but can be
distinguished from goodwill because of contractual or other
legal rights. Sterlings intangible assets have finite
lives and are amortized over their estimated useful lives.
Intangible assets are also subject to impairment testing.

Income Taxes  Deferred income tax assets and
liabilities are determined using the liability (or balance
sheet) method. Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the
temporary differences between the book and tax bases of the
various balance sheet assets and liabilities and gives current
recognition to changes in tax rates and laws.

49



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Advertising  Sterling expenses advertising
costs as incurred. The expenses for 2003, 2002, and 2001 were
$1,379,000, $1,545,000, and $1,172,000.

Stock Compensation Plan Statement of
Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, encourages all entities to adopt a
fair value-based method of accounting for employee stock
compensation plans, whereby compensation cost is measured at the
grant date based on the value of the award and is recognized
over the vesting period. However, it also allows an entity to
continue to measure compensation cost for those plans using the
intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, whereby compensation cost is
the excess, if any, of the quoted market price of the stock at
the grant date over the amount an employee must pay to acquire
the stock. Stock options issued under Sterlings stock
incentive plan have no intrinsic value at the grant date, and
under Opinion No. 25, no compensation cost is recognized
for them. Sterling has elected to continue with the accounting
methodology in Opinion No. 25 and, as a result, has
provided pro forma disclosures of net income, earnings per share
and other disclosures, as if the fair value based method of
accounting had been applied.

Earnings Per Share  Basic earnings per share
represents income available to common stockholders divided by
the weighted-average number of common shares outstanding during
the period. Diluted earnings per share reflect additional common
shares that would have been outstanding if potential dilutive
common shares had been issued. Potential common shares that may
be issued by Sterling consist solely of outstanding stock
options and are determined using the treasury stock method.

Earnings per common share have been computed based on the
following:

|                                                                                             |                            |                          |            |      |  |      |            |      |  |   |            |      | 
|-------------------------------------------------------------------------------------------- | -------------------------- | ------------------------ | ---------- | ---- |  | ---- | ---------- | ---- |  | - | ---------- | ---- | 
|                                                                                             |                            |                         
|                                                                                             |                            | Years Ended December 31,
|                                                                                             |                            |                         
|                                                                                             |                            | 2003                     |            | 2002 |  | 2001
|                                                                                             |                            |                          |            |      |  |     
|Net income available to stockholders                                                         |                            | $                        | 29,059     |      |  | $    | 24,745     |      |  | $ | 20,334     |     
|                                                                                             |                            |                          |            |      |  |      |            |      |  |   |            |     
|Average number of shares outstanding                                                         |                            |                          | 21,224,302 |      |  |      | 20,849,318 |      |  |   | 19,575,848 |     
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|Effect of dilutive stock options                                                             |                            |                          | 223,969    |      |  |      | 179,180    |      |  |   | 80,631     |     
|                                                                                             |                            |                          |            |      |  |      |            |      |  |   |            |     
|Average number of shares outstanding used to
    calculate diluted earnings per common share |                            |                          | 21,448,271 |      |  |      | 21,028,498 |      |  |   | 19,656,479 |     
|                                                                                             |                            |                          |            |      |  |      |            |      |  |   |            |     
|Per share information:                                                                       |                            |                          |            |      |  |      |            |      |  |   |            |     
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Basic earnings per share   |                          | $          | 1.37 |  |      | $          | 1.19 |  |   | $          | 1.04 | 
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                            
|                                                                                             | Diluted earnings per share |                          |            | 1.35 |  |      |            | 1.18 |  |   |            | 1.03 | 

All share and per share amounts have been properly restated to
reflect the 5-for-4 stock split effected in the form of a 25%
stock dividend declared in January 2004, which will be paid in
February 2004.

Comprehensive Income  Accounting principles
generally require that recognized revenue, expenses, gains and
losses be included in net income. Although certain changes in
assets and liabilities, such as unrealized gains and losses on
available-for-sale securities and interest rate derivatives are
reported as separate components of the equity section of the
balance sheet, such items, along with net income, are components
of comprehensive income.

50



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The components of other comprehensive income and related tax
effects are as follows:

|                                                                                   |  |      |      |      |  |      |        |   |  |   |        |  
|---------------------------------------------------------------------------------- |  | ---- | ---- | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                                   |  | 2003 |      | 2002 |  | 2001
|                                                                                   |  |      |      |      |  |     
|Unrealized holding gains (losses) on
    available-for-sale securities             |  | $    | (436 | )    |  | $    | 14,876 |   |  | $ | 7,216  |  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Reclassification adjustment for securities
    (gains) losses realized in income   |  |      | (511 | )    |  |      | 460    |   |  |   | (2,710 | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Unrealized (gains) loss on derivatives used
    in cash flow hedging relationships |  |      | 395  |      |  |      | (1,875 | ) |  |   |       |  
|                                                                                   |  |      |      |      |  |      |        |   |  |   |        |  
|Net unrealized gains (losses)                                                      |  |      | (552 | )    |  |      | 13,461 |   |  |   | 4,506  |  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Income tax (expense) benefit                                                       |  |      | 81   |      |  |      | (4,595 | ) |  |   | (1,571 | )
|                                                                                   |  |      |      |      |  |      |        |   |  |   |        |  
|Net-of-tax amount                                                                  |  | $    | (471 | )    |  | $    | 8,866  |   |  | $ | 2,935  |  
|                                                                                   |  |      |      |      |  |      |        |   |  |   |        |  

The ending accumulated balances for each item included in
accumulated other comprehensive income, net of related income
taxes, were as follows:

|                                                                                         |  |              |        |      |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                                                                         |  |             
|                                                                                         |  | December 31,
|                                                                                         |  |             
|                                                                                         |  | 2003         |        | 2002
|                                                                                         |  |              |        |     
|Accumulated unrealized gains on securities
    available-for-sale                        |  | $            | 14,769 |      |  | $ | 15,377 |  
|                                                                                        
|                                                                                        
|                                                                                        
|                                                                                        
|Accumulated unrealized losses on derivatives used
    in cash flow hedging relationships |  |              | (942   | )    |  |   | (1,078 | )
|                                                                                         |  |              |        |      |  |   |        |  
|                                                                                         |  | $            | 13,827 |      |  | $ | 14,299 |  
|                                                                                         |  |              |        |      |  |   |        |  

Reclassifications  Certain items in the 2002
and 2001 consolidated financial statements have been
reclassified to conform to the 2003 presentation format. Such
reclassifications had no impact on net income.

Recent Accounting Pronouncements  On
December 11, 2003, the Securities and Exchange Commission
(SEC) staff announced its intention to release a Staff
Accounting Bulletin that would require all registrants to
account for mortgage loan interest rate lock commitments related
to loans held for sale as written options, effective no later
than for commitments entered into after March 31, 2004.
This guidance, if issued, would require Sterling to recognize a
liability on its balance sheet equal to the fair value of the
commitment at the time the loan commitment is issued, and not
recognize revenue related to these commitments until such time
as the loan is sold. The Corporation is currently assessing the
impact of this pending guidance on its results of operations and
financial position. In the quarter of adoption, Sterling does
not anticipate a significant impact to its financial condition
or results of operations.

In December 2003, the Financial Accounting Standards Board
(FASB) revised Statement No. 132, Employers
Disclosures about Pensions and Other Postretirement Benefits.This Statement retains the disclosures required by the
original Statement No. 132 and requires additional
disclosures about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension and
postretirement plans. In addition, this Statement requires
interim period disclosure of the components of net period
benefit cost and contributions if significantly different from
previously reported amounts. Sterling adopted the provisions of
this Statement as of December 31, 2003. See Note 16
for the additional pension and other postretirement benefit
disclosures.

In May 2003, the FASB issued Statement No. 150,
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. This
Statement establishes standards for classifying and measuring
certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity.
The provisions of SFAS 150 became effective June 1,
2003, for all financial instruments created or modified after
May 31, 2003, and otherwise became effective as of
July 1, 2003. The adoption of this standard did not have a
material impact on financial condition, the results of
operations, or liquidity.

51



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

In April 2003, the FASB issued Statement No. 149,
Amendment of Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities.This
statement clarifies the definition of a derivative and
incorporates certain decisions made by the Board as part of the
Derivatives Implementation Group process. This statement is
effective for contracts entered into or modified, and for
hedging relationships designated after June 30, 2003 and
should be applied prospectively. The provisions of the Statement
that relate to implementation issues addressed by the
Derivatives Implementation Group that have been effective should
continue to be applied in accordance with their respective
effective dates. Adoption of this standard is not expected to
have a significant impact on Sterlings financial condition
or results of operations.

In January 2003, the FASB issued Interpretation No. 46
(FIN 46), Consolidation of Variable Interest Entities,FIN 46 provides guidance on how to identify a variable
interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations
of a VIE are to be included in an entitys consolidated
financial statements. A VIE exists when either the total equity
investment at risk is not sufficient to permit the entity to
finance its activities by itself, or the equity investors lack
one of three characteristics associated with owning a
controlling financial interest. Those characteristics include
the direct or indirect ability to make decisions about an
entitys activities through voting rights or similar
rights, the obligation to absorb the expected losses of an
entity if they occur, or the right to receive the expected
residual returns of the entity if they occur.

During the third quarter of 2003, Sterling applied the
provisions of FIN 46 to two wholly-owned special purpose
subsidiary trusts, Sterling Financial Statutory Trust I and
II that have issued preferred capital securities to third-party
investors. The application of FIN 46 resulted in the
deconsolidation of the two wholly-owned subsidiary trusts. The
assets, which consisted entirely of a subordinated debenture in
Sterling, and liabilities, which consisted solely of preferred
securities held by third parties and common securities held by
Sterling, of the subsidiary trusts that were deconsolidated
totaled $20.633 million and $36.111 million,
respectively. As allowed by the transition provisions of
FIN 46, Sterling restated all previous periods presented as
if FIN 46 had been adopted as of the date of the
establishment of the subsidiary trusts. There was no material
impact to results of operations or liquidity as of and for the
year ended December 31, 2003 and 2002 as a result of
applying these provisions of FIN 46. See Note 12 for
further discussion of these trusts and Sterlings related
obligations.

In December 2003 the FASB made certain modifications to clarify
FIN 46. Application of this guidance was effective for
interests in certain VIEs commonly referred to as
special-purpose entities (SPEs) as of December 31, 2003.
Application for all other types of entities is required for
periods ending after March 15, 2004, unless previously
applied.

In November 2002, the FASB issued Interpretation No. 45
(FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This Interpretation expands the
disclosures to be made by a guarantor in its financial
statements about its obligations under certain guarantees and
requires the guarantor to recognize a liability for the fair
value of an obligation assumed under certain specified
guarantees. FIN 45 clarifies the requirements of FASB
Statement No. 5, Accounting for
Contingencies.In general, FIN 45 applies to
contracts or indemnification agreements that contingently
require the guarantor to make payments to the guaranteed party
based on changes in an underlying that is related to an asset,
liability or equity security of the guaranteed party, which
would include financial standby letters of credit. Certain
guarantee contracts are excluded from both the disclosure and
recognition of this Interpretation, including, among others,
guarantees related to commercial letters of credit and loan
commitments. The disclosure requirements of FIN 45 require
disclosure of the nature of the guarantee, the maximum potential
amount of future payments that the guarantor could be required
to make under the guarantee and the current amount of the
liability, if any, for the guarantors obligations under
the guarantee. The accounting recognition requirements of
FIN 45 are to be applied prospectively to guarantees

52



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

issued or modified after December 31, 2002. Significant
guarantees are disclosed in Note 15. Adoption of
FIN 45 did not have a significant impact on Sterlings
financial condition or results of operations.

Standby letters of credit written are conditional commitments
issued by Sterling to guarantee the performance of a customer to
a third party. Those letters of credit are primarily issued to
support public and private borrowing arrangements. Essentially
all letters of credit issued have expiration dates within one
year. The credit risk involved in issuing letters of credit is
essentially the same as those that are involved in extending
loan facilities to customers. Sterling generally holds
collateral and/or guarantees supporting these commitments, if
deemed necessary.

Sterling has $67,557,000 of standby letters of credit as of
December 31, 2003. Management believes that the proceeds
obtained through a liquidation of collateral and the enforcement
of guarantees would be sufficient to cover the potential amount
of future payments required under the corresponding guarantees.
The current amount of the liability as of December 31, 2003
for guarantees under standby letters of credit issued after
December 31, 2002 is not material.

Note 2  Business Combinations

Equipment Finance, LLC  On February 28,
2002, Sterling acquired 100 percent of the outstanding common
shares of Equipment Finance, Inc. (EFI), a Lancaster-based
commercial finance company. The results of EFIs operations
have been included in the consolidated financial statements
since that date. EFI specializes in financing forestry and land
clearing equipment through more than 150 equipment dealer
locations ranging from Maine to Florida. As a result of the
acquisition, Sterling has enhanced earnings and provided
financial product diversification.

The transaction was accounted for under the provisions of
Statement No. 141, Business Combinations, which
requires assets acquired and liabilities assumed to be recorded
at their fair value on the date of the acquisition. The carrying
amounts of the assets acquired, primarily loans receivables, and
the liabilities assumed, primarily borrowings, on
February 28, 2002, approximated their fair value. The
excess of the acquisition cost over the fair value of the net
assets acquired has been recorded as goodwill. Goodwill
recognized in this transaction was approximately $17,220,000,
which was assigned to the commercial finance segment.

The aggregate purchase price was $30,500,000 including
$9,502,000 of cash and common stock valued at $20,998,000. The
value of the 954,452 common shares issued was based on the
closing price of Sterling common stock at the time the Agreement
and Plan of Reorganization (Merger Agreement) was entered into.
In accordance with the items of the Merger Agreement, there is
no contingent consideration associated with this transaction. An
escrow account of $1,065,000 has been established and will be
released in three years after the acquisition date, upon
determination that no unknown claims or liabilities existed as
of the acquisition date.

Church Capital Management Inc. and Bainbridge Securities,
Inc.  On October 15, 2003, Sterling acquired
100 percent of the outstanding common shares of Church
Capital Management, Inc. and its affiliate, Bainbridge
Securities Inc. Church Capital Management is a SEC Registered
Investment Advisor with assets under management of approximately
$690,000,000. Bainbridge Securities is a National Association of
Securities Dealers (NASD) securities broker/dealer offering
a wide array of investment services. As a result of the
acquisition, Sterling plans to enhance earnings and provide
financial product diversification.

In connection with the completion of the acquisition of Church
and Bainbridge, Sterling issued 359,998 shares of its common
stock and paid $7,920,000. In addition, 240,002 shares of
Sterlings common stock and $5,280,000 were placed in
escrow, which will be released over the next five years based
upon Church and Bainbridge reaching specified performance
criteria and the settlement, if any, of outstanding litigation
at the date of acquisition. Based on the closing price of
Sterlings common stock at the time the agreement was

53



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

entered into, the 600,000 shares of common shares are valued at
$12,192,000. The share information has been restated to reflect
the 5-for-4 stock split effected in the form of a 25% stock
dividend.

The transaction was accounted for under the provisions of
Statement No. 141, Business Combinations.The
purchase price allocation included $38,000 to premises and
equipment and $5,110,000 to finite-lived intangible assets,
including $3,700,000 to customer list, $480,000 to trademark,
and $930,000 to covenants not to compete. The intangible assets
have a weighted average life of approximately 7 years. The
remaining portion of the purchase price, or $12,218,000, was
assigned to goodwill, within the Trust and Investment Services
segment. This transaction will generate additional goodwill, as
the cash and shares held in escrow are released upon the
satisfying of the specified performance criteria. The goodwill
is not expected to be written off for tax purposes.

Note 3  Restrictions on Cash and Due from Banks

Sterlings subsidiary banks are required to maintain
reserves, in the form of cash and balances with the Federal
Reserve Bank, against their deposit liabilities. The average
amount of these reserve balances for the year ended
December 31, 2003 were approximately $8,370,000. Balances
maintained at the Federal Reserve Bank are included in cash and
due from banks.

Note 4  Securities

The amortized cost and fair values of securities were as follows:

|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|------------------ | -------------------------------- | --------- | - | ---------- |  | ---------- | - | ---------- |  |  | - | ----- |  |  | - | ------- | 
|                   |                                  |           |   | Gross      |  | Gross      |   |           
|                   |                                  | Amortized |   | Unrealized |  | Unrealized |   |           
|                   |                                  | Cost      |   | Gains      |  | Losses     |   | Fair Value
|                   |                                  |           |   |            |  |            |   |           
|December 31, 2003: |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                  
|                  
|                  
|                  
|                   | Available-for sale:              |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|                  
|                  
|                  
|                  
|                   | U.S. Treasury securities         |           | $ | 6,923      |  |            | $ | 176        |  |  | $ |      |  |  | $ | 7,099   | 
|                  
|                  
|                  
|                  
|                   | U.S. Government agencies         |           |   | 166,436    |  |            |   | 1,912      |  |  |   | 2,819 |  |  |   | 165,529 | 
|                  
|                  
|                  
|                  
|                   | State and political subdivision  |           |   | 217,256    |  |            |   | 11,861     |  |  |   | 846   |  |  |   | 228,271 | 
|                  
|                  
|                  
|                  
|                   | Mortgage-backed securities       |           |   | 22,814     |  |            |   | 860        |  |  |   | 5     |  |  |   | 23,669  | 
|                  
|                  
|                  
|                  
|                   | Corporate securities             |           |   | 95,125     |  |            |   | 5,253      |  |  |   |      |  |  |   | 100,378 | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Subtotal                         |           |   | 508,554    |  |            |   | 20,062     |  |  |   | 3,670 |  |  |   | 524,946 | 
|                  
|                  
|                  
|                  
|                   | Equity securities                |           |   | 8,748      |  |            |   | 6,370      |  |  |   | 15    |  |  |   | 15,103  | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Total                            |           | $ | 517,302    |  |            | $ | 26,432     |  |  | $ | 3,685 |  |  | $ | 540,049 | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Held-to-maturity:                |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|                  
|                  
|                  
|                  
|                   | State and political subdivisions |           | $ | 23,320     |  |            | $ | 1,442      |  |  | $ |      |  |  | $ | 24,762  | 
|                  
|                  
|                  
|                  
|                   | Mortgage-backed securities       |           |   | 172        |  |            |   | 7          |  |  |   |      |  |  |   | 179     | 
|                  
|                  
|                  
|                  
|                   | Corporate securities             |           |   | 622        |  |            |   |           |  |  |   |      |  |  |   | 622     | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Subtotal                         |           |   | 24,114     |  |            |   | 1,449      |  |  |   |      |  |  |   | 25,563  | 
|                  
|                  
|                  
|                  
|                   | Equity securities                |           |   | 11,842     |  |            |   |           |  |  |   |      |  |  |   | 11,842  | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Total                            |           | $ | 35,956     |  |            | $ | 1,449      |  |  | $ |      |  |  | $ | 37,405  | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        

54



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|------------------ | -------------------------------- | --------- | - | ---------- |  | ---------- | - | ---------- |  |  | - | ----- |  |  | - | ------- | 
|                   |                                  |           |   | Gross      |  | Gross      |   |           
|                   |                                  | Amortized |   | Unrealized |  | Unrealized |   |           
|                   |                                  | Cost      |   | Gains      |  | Losses     |   | Fair Value
|                   |                                  |           |   |            |  |            |   |           
|December 31, 2002: |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                  
|                  
|                  
|                  
|                   | Available-for sale:              |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|                  
|                  
|                  
|                  
|                   | U.S. Treasury securities         |           | $ | 11,825     |  |            | $ | 351        |  |  | $ |      |  |  | $ | 12,176  | 
|                  
|                  
|                  
|                  
|                   | U.S. Government agencies         |           |   | 106,792    |  |            |   | 3,235      |  |  |   | 3     |  |  |   | 110,024 | 
|                  
|                  
|                  
|                  
|                   | State and political subdivision  |           |   | 191,383    |  |            |   | 9,217      |  |  |   | 103   |  |  |   | 200,497 | 
|                  
|                  
|                  
|                  
|                   | Mortgage-backed securities       |           |   | 74,317     |  |            |   | 2,293      |  |  |   | 7     |  |  |   | 76,603  | 
|                  
|                  
|                  
|                  
|                   | Corporate securities             |           |   | 135,270    |  |            |   | 5,997      |  |  |   | 732   |  |  |   | 140,535 | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Subtotal                         |           |   | 519,587    |  |            |   | 21,093     |  |  |   | 845   |  |  |   | 539,835 | 
|                  
|                  
|                  
|                  
|                   | Equity securities                |           |   | 8,414      |  |            |   | 3,738      |  |  |   | 291   |  |  |   | 11,861  | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Total                            |           | $ | 528,001    |  |            | $ | 24,831     |  |  | $ | 1,136 |  |  | $ | 551,696 | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Held-to-maturity:                |           |   |            |  |            |   |            |  |  |   |       |  |  |   |         | 
|                  
|                  
|                  
|                  
|                   | State and political subdivisions |           | $ | 27,123     |  |            | $ | 1,742      |  |  | $ |      |  |  | $ | 28,865  | 
|                  
|                  
|                  
|                  
|                   | Mortgage-backed securities       |           |   | 450        |  |            |   | 16         |  |  |   |      |  |  |   | 466     | 
|                  
|                  
|                  
|                  
|                   | Corporate securities             |           |   | 1,126      |  |            |   | 14         |  |  |   |      |  |  |   | 1,140   | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Subtotal                         |           |   | 28,699     |  |            |   | 1,772      |  |  |   |      |  |  |   | 30,471  | 
|                  
|                  
|                  
|                  
|                   | Equity securities                |           |   | 7,897      |  |            |   |           |  |  |   |      |  |  |   | 7,897   | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        
|                   | Total                            |           | $ | 36,596     |  |            | $ | 1,772      |  |  | $ |      |  |  | $ | 38,368  | 
|                   |                                  |           |   |            |  |            |   |            |  |  |   |       |  |  |   |        

Included in held-to-maturity equity securities are Federal
Reserve Bank stock, Federal Home Loan Bank of Pittsburgh stock
and Atlantic Central Bankers Bank stock.

The amortized cost and fair value of securities at
December 31, 2003, by contractual maturity, are shown
below. Expected maturities may differ from contractual
maturities or call dates because borrowers may have the right to
call or prepay obligations with or without call or prepayment
penalties.

|                                      |  |                    |         |                  |  |           |         |       |  |   |        |  |  |   |        | 
|------------------------------------- |  | ------------------ | ------- | ---------------- |  | --------- | ------- | ----- |  | - | ------ |  |  | - | ------ | 
|                                      |  |                    |         |                 
|                                      |  | Securities         |         | Securities      
|                                      |  | Available-for-Sale |         | Held-to-Maturity
|                                      |  |                    |         |                 
|                                      |  | Amortized          |         | Fair             |  | Amortized |         | Fair 
|                                      |  | Cost               |         | Value            |  | Cost      |         | Value
|                                      |  |                    |         |                  |  |           |         |      
|Due in one year or less               |  | $                  | 54,334  |                  |  | $         | 55,028  |       |  | $ | 670    |  |  | $ | 679    | 
|                                     
|                                     
|                                     
|                                     
|Due after one year through five years |  |                    | 147,202 |                  |  |           | 154,449 |       |  |   | 15,111 |  |  |   | 15,983 | 
|                                     
|                                     
|                                     
|                                     
|Due in five years through ten years   |  |                    | 142,871 |                  |  |           | 143,813 |       |  |   | 7,059  |  |  |   | 7,594  | 
|                                     
|                                     
|                                     
|                                     
|Due after ten years                   |  |                    | 141,333 |                  |  |           | 147,987 |       |  |   | 1,102  |  |  |   | 1,128  | 
|                                      |  |                    |         |                  |  |           |         |       |  |   |        |  |  |   |        | 
|                                      |  |                    | 485,740 |                  |  |           | 501,277 |       |  |   | 23,942 |  |  |   | 25,384 | 
|                                     
|                                     
|                                     
|                                     
|Mortgage-backed securities            |  |                    | 22,814  |                  |  |           | 23,669  |       |  |   | 172    |  |  |   | 179    | 
|                                      |  |                    |         |                  |  |           |         |       |  |   |        |  |  |   |        | 
|                                      |  | $                  | 508,554 |                  |  | $         | 524,946 |       |  | $ | 24,114 |  |  | $ | 25,563 | 
|                                      |  |                    |         |                  |  |           |         |       |  |   |        |  |  |   |        | 

55



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The following table presents a breakdown by consecutive months
of gross unrealized losses and fair value by investment category.

|                                 |  |                     |        |                   |  |       |       |            |  |       |       |            |  |   |    |  |  |   |        |  |  |   |       | 
|-------------------------------- |  | ------------------- | ------ | ----------------- |  | ----- | ----- | ---------- |  | ----- | ----- | ---------- |  | - | -- |  |  | - | ------ |  |  | - | ----- | 
|                                 |  |                     |        |                   |  |      
|                                 |  | Less Than 12 Months |        | 12 Months or More |  | Total
|                                 |  |                     |        |                   |  |      
|                                 |  | Fair                |        | Unrealized        |  | Fair  |       | Unrealized |  | Fair  |       | Unrealized
|                                 |  | Value               |        | Losses            |  | Value |       | Losses     |  | Value |       | Losses    
|                                 |  |                     |        |                   |  |       |       |            |  |       |       |           
|U.S. Government agencies         |  | $                   | 64,883 |                   |  | $     | 2,819 |            |  | $     |      |            |  | $ |   |  |  | $ | 64,883 |  |  | $ | 2,819 | 
|                                
|                                
|                                
|                                
|State and political subdivisions |  |                     | 17,100 |                   |  |       | 824   |            |  |       | 858   |            |  |   | 22 |  |  |   | 17,958 |  |  |   | 846   | 
|                                
|                                
|                                
|                                
|Mortgage-backed securities       |  |                     | 27     |                   |  |       |      |            |  |       | 217   |            |  |   | 5  |  |  |   | 244    |  |  |   | 5     | 
|                                
|                                
|                                
|                                
|Corporate securities             |  |                     |       |                   |  |       |      |            |  |       | 2     |            |  |   |   |  |  |   | 2      |  |  |   |      | 
|                                 |  |                     |        |                   |  |       |       |            |  |       |       |            |  |   |    |  |  |   |        |  |  |   |       | 
|Subtotal                         |  |                     | 82,010 |                   |  |       | 3,643 |            |  |       | 1,077 |            |  |   | 27 |  |  |   | 83,087 |  |  |   | 3,670 | 
|                                
|                                
|                                
|                                
|Equity securities                |  |                     | 59     |                   |  |       | 15    |            |  |       |      |            |  |   |   |  |  |   | 59     |  |  |   | 15    | 
|                                 |  |                     |        |                   |  |       |       |            |  |       |       |            |  |   |    |  |  |   |        |  |  |   |       | 
|Total                            |  | $                   | 82,069 |                   |  | $     | 3,658 |            |  | $     | 1,077 |            |  | $ | 27 |  |  | $ | 83,146 |  |  | $ | 3,685 | 
|                                 |  |                     |        |                   |  |       |       |            |  |       |       |            |  |   |    |  |  |   |        |  |  |   |       | 

Various indicators are used in determining whether a security is
other-than-temporarily impaired, including for equity
securities, if the market value is below its cost for an
extended period of time or for debt securities, when it is
probable that the contractual interest and principal will not be
collected. The unrealized losses as of December 31, 2003
are primarily attributable to changes in interest rates (i.e.
increase in rates since the date of acquiring the debt
security). Management does not believe any individual unrealized
loss represents an other-than-temporary impairment.

Securities pledged to secure government and other public
deposits, trust deposits, short-term borrowings, and other
balances as required or permitted by law were carried at
$184,688,000 in 2003 and $157,199,000 in 2002.

Proceeds from sales of securities available-for-sale were
$74,907,000, $29,150,000, and $28,107,000 for the years ended
December 31, 2003, 2002, and 2001. Gross gains of $847,000,
$1,520,000, and $3,170,000 were realized on these sales for the
years ended December 31, 2003, 2002, and 2001. Gross losses
of $336,000, $1,980,000, and $460,000 were recognized for the
years ended December 31, 2003, 2002, and 2001. Gross losses
include impairment charges of $130,000, $1,160,000 and $224,000
for years ended December 31, 2003, 2002 and 2001.

Note 5  Loans

A summary of the balances of loans follows:

|                                                                                        |  |              |           |      |  |   |           | 
|--------------------------------------------------------------------------------------- |  | ------------ | --------- | ---- |  | - | --------- | 
|                                                                                        |  |             
|                                                                                        |  | December 31,
|                                                                                        |  |             
|                                                                                        |  | 2003         |           | 2002
|                                                                                        |  |              |           |     
|Commercial and agricultural                                                             |  | $            | 321,728   |      |  | $ | 284,462   | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Commercial real estate                                                                  |  |              | 453,456   |      |  |   | 399,818   | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Financial                                                                               |  |              | 19,488    |      |  |   | 4,700     | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Real estate  construction                                                              |  |              | 23,471    |      |  |   | 19,504    | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Real estate  mortgage                                                                  |  |              | 80,674    |      |  |   | 102,891   | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Consumer                                                                                |  |              | 316,190   |      |  |   | 284,016   | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Finance receivables, (net of unearned income
    2003  $23,088; 2002  $14,948)        |  |              | 171,733   |      |  |   | 115,200   | 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Lease financing receivables (net of unearned
    income 2003  $13,822; 2002  $11,872) |  |              | 109,285   |      |  |   | 85,437    | 
|                                                                                        |  |              |           |      |  |   |           | 
|Total loans                                                                             |  | $            | 1,496,025 |      |  | $ | 1,296,028 | 
|                                                                                        |  |              |           |      |  |   |           | 

56



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Changes in the allowance for loan losses are as follows:

|                       |                                            |                          |        |        |   |      |        |        |   |   |        |        |  
|---------------------- | ------------------------------------------ | ------------------------ | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------ | -
|                       |                                            |                         
|                       |                                            | Years Ended December 31,
|                       |                                            |                         
|                       |                                            | 2003                     |        | 2002   |   | 2001
|                       |                                            |                          |        |        |   |     
|Balance at January 1   |                                            | $                        | 12,953 |        |   | $    | 11,071 |        |   | $ | 11,716 |       
|                      
|                      
|                      
|                      
|                       | Allowance acquired in acquisition          |                          |        |       |   |      |        | 837    |   |   |        |       |  
|                      
|                      
|                      
|                      
|                       | Provisions for loan losses                 |                          |        | 3,697  |   |      |        | 2,095  |   |   |        | 1,217  |  
|                      
|                      
|                      
|                      
|                       | Loans charged off                          |                          |        | (2,776 | ) |      |        | (2,170 | ) |   |        | (2,594 | )
|                      
|                      
|                      
|                      
|                       | Recoveries of loans previously charged off |                          |        | 782    |   |      |        | 1,120  |   |   |        | 732    |  
|                       |                                            |                          |        |        |   |      |        |        |   |   |        |       
|Balance at December 31 |                                            | $                        | 14,656 |        |   | $    | 12,953 |        |   | $ | 11,071 |       
|                       |                                            |                          |        |        |   |      |        |        |   |   |        |       

Information concerning impaired loans is as follows:

|                                              |                      |              |       |       |  |   |        |        | 
|--------------------------------------------- | -------------------- | ------------ | ----- | ----- |  | - | ------ | ------ | 
|                                              |                      |             
|                                              |                      | December 31,
|                                              |                      |             
|                                              |                      | 2003         |       | 2002 
|                                              |                      |              |       |      
|Impaired loans with a valuation allowance     |                      | $            | 3,136 |       |  | $ | 11,164 |       
|                                             
|                                             
|                                             
|                                             
|Impaired loans without a valuation allowance  |                      |              |      |       |  |   |       |       
|                                              |                      |              |       |       |  |   |        |       
|                                              | Total impaired loans |              |       | 3,136 |  |   |        | 11,164 | 
|                                              |                      |              |       |       |  |   |        |       
|Valuation allowance related to impaired loans |                      | $            | 292   |       |  | $ | 1,917  |       
|                                              |                      |              |       |       |  |   |        |       

|                                                                 |  |                          |       |      |  |      |       |  |  |   |       | 
|---------------------------------------------------------------- |  | ------------------------ | ----- | ---- |  | ---- | ----- |  |  | - | ----- | 
|                                                                 |  |                         
|                                                                 |  | Years Ended December 31,
|                                                                 |  |                         
|                                                                 |  | 2003                     |       | 2002 |  | 2001
|                                                                 |  |                          |       |      |  |     
|Average investment in impaired loans                             |  | $                        | 4,666 |      |  | $    | 8,381 |  |  | $ | 7,298 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Interest income recognized on impaired loans                     |  |                          | 433   |      |  |      | 88    |  |  |   | 72    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Interest income recognized on a cash basis on
    impaired loans |  |                          | 139   |      |  |      | 88    |  |  |   | 72    | 

Impaired loans included $0 and $521,000 of loans that were
considered troubled debt restructurings at December 31,
2003 and 2002. The remainder of the impaired loan balance
consisted of nonaccrual loans at December 31, 2003 and
2002. Loans over 90 days past due still accruing interest
were $1,513,000 and $545,000 at December 31, 2003 and 2002.

Note 6  Mortgage Banking Activities

Loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal mortgage loans
serviced for others were $499,202,000, $403,559,000 and
$325,030,000 at December 31, 2003, 2002, and 2001.
Sterlings bank affiliates maintain sufficient levels of
capital to meet its investors net worth requirements.

Changes in the mortgage servicing right asset is as follows:

|                       |                                     |                          |       |        |   |      |       |       |   |   |       |       |  
|---------------------- | ----------------------------------- | ------------------------ | ----- | ------ | - | ---- | ----- | ----- | - | - | ----- | ----- | -
|                       |                                     |                         
|                       |                                     | Years Ended December 31,
|                       |                                     |                         
|                       |                                     | 2003                     |       | 2002   |   | 2001
|                       |                                     |                          |       |        |   |     
|Balance at January 1   |                                     | $                        | 2,339 |        |   | $    | 1,881 |       |   | $ | 1,467 |      
|                      
|                      
|                      
|                      
|                       | Mortgage service rights capitalized |                          |       | 2,512  |   |      |       | 1,389 |   |   |       | 1,147 |  
|                      
|                      
|                      
|                      
|                       | Mortgage service rights amortized   |                          |       | (1,501 | ) |      |       | (931  | ) |   |       | (733  | )
|                       |                                     |                          |       |        |   |      |       |       |   |   |       |      
|Balance at December 31 |                                     | $                        | 3,350 |        |   | $    | 2,339 |       |   | $ | 1,881 |      
|                       |                                     |                          |       |        |   |      |       |       |   |   |       |      

57



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Information concerning the activity in the related mortgage
servicing rights valuation allowance is as follows:

|                                          |  |              |     |      |  |      |     |  |  |   |     | 
|----------------------------------------- |  | ------------ | --- | ---- |  | ---- | --- |  |  | - | --- | 
|                                          |  |             
|                                          |  | Years Ended 
|                                          |  | December 31,
|                                          |  |             
|                                          |  | 2003         |     | 2002 |  | 2001
|                                          |  |              |     |      |  |     
|Balance at January 1                      |  | $            | 301 |      |  | $    | 198 |  |  | $ | 16  | 
|                                         
|                                         
|                                         
|                                         
|Additional valuation allowance recognized |  |              | 141 |      |  |      | 103 |  |  |   | 182 | 
|                                          |  |              |     |      |  |      |     |  |  |   |     | 
|Balance at December 31                    |  | $            | 442 |      |  | $    | 301 |  |  | $ | 198 | 
|                                          |  |              |     |      |  |      |     |  |  |   |     | 

For valuation purposes, at December 31, 2003, Sterling
assumed a weighted average discount rate of 8.5% and assumed
prepayments speeds consistent with published rates for
Sterlings market area. Additional factors such as economic
data, market trading information, credit risk and professional
judgment were used in determining the valuation allowance.

Note 7  Premises and Equipment

A summary of the cost and accumulated depreciation of premises
and equipment follows:

|                                  |  |              |         |      |  |   |         |  
|--------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                  |  |             
|                                  |  | December 31,
|                                  |  |             
|                                  |  | 2003         |         | 2002
|                                  |  |              |         |     
|Land                              |  | $            | 5,962   |      |  | $ | 6,026   |  
|                                 
|                                 
|                                 
|                                 
|Buildings                         |  |              | 28,171  |      |  |   | 25,946  |  
|                                 
|                                 
|                                 
|                                 
|Leasehold improvements            |  |              | 3,135   |      |  |   | 3,033   |  
|                                 
|                                 
|                                 
|                                 
|Equipment, furniture and fixtures |  |              | 39,508  |      |  |   | 34,601  |  
|                                  |  |              |         |      |  |   |         |  
|                                  |  |              | 76,776  |      |  |   | 69,606  |  
|                                 
|                                 
|                                 
|                                 
|Less: Accumulated depreciation    |  |              | (38,056 | )    |  |   | (34,394 | )
|                                  |  |              |         |      |  |   |         |  
|                                  |  | $            | 38,720  |      |  | $ | 35,212  |  
|                                  |  |              |         |      |  |   |         |  

The subsidiaries of Sterling lease certain facilities under
operating leases which expire on various dates through 2024.
Renewal options are available on these leases. Minimum future
rental payments as of December 31, 2003, under
non-cancelable real estate leases, are payable as follows:

|                                     |  |   |        | 
|------------------------------------ |  | - | ------ | 
|                                    
|                                    
|                                    
|                                    
|Due in 2004                          |  | $ | 1,479  | 
|                                    
|                                    
|                                    
|                                    
|Due in 2005                          |  |   | 1,307  | 
|                                    
|                                    
|                                    
|                                    
|Due in 2006                          |  |   | 1,020  | 
|                                    
|                                    
|                                    
|                                    
|Due in 2007                          |  |   | 907    | 
|                                    
|                                    
|                                    
|                                    
|Due in 2008                          |  |   | 797    | 
|                                    
|                                    
|                                    
|                                    
|Thereafter                           |  |   | 6,066  | 
|                                     |  |   |        | 
|Total minimum future rental payments |  | $ | 11,576 | 
|                                     |  |   |        | 

Total rent expense charged to operations amounted to $1,517,000,
$1,288,000 and $1,096,000 for the years ended December 31,
2003, 2002, and 2001.

58



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 8  Leases

Information concerning net investment in direct financing
leases, included in loans receivable:

|                                 |  |              |         |      |  |   |         |  
|-------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                 |  |             
|                                 |  | December 31,
|                                 |  |             
|                                 |  | 2003         |         | 2002
|                                 |  |              |         |     
|Minimum lease payment receivable |  | $            | 122,438 |      |  | $ | 96,696  |  
|                                
|                                
|                                
|                                
|Lease origination costs          |  |              | 669     |      |  |   | 613     |  
|                                
|                                
|                                
|                                
|Unearned income                  |  |              | (13,822 | )    |  |   | (11,872 | )
|                                 |  |              |         |      |  |   |         |  
|                                 |  | $            | 109,285 |      |  | $ | 85,437  |  
|                                 |  |              |         |      |  |   |         |  

The allowance for uncollectible lease payments, included in the
allowance for loan losses, was $2,021,000 and $1,094,000 at
December 31, 2003 and 2002.

Investments in property on operating lease and property held for
lease by major classes is as follows:

|                                |  |              |         |      |  |   |         |  
|------------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                                |  |             
|                                |  | December 31,
|                                |  |             
|                                |  | 2003         |         | 2002
|                                |  |              |         |     
|Automobiles                     |  | $            | 30,364  |      |  | $ | 31,155  |  
|                               
|                               
|                               
|                               
|Heavy truck, trailers and buses |  |              | 19,745  |      |  |   | 19,870  |  
|                               
|                               
|                               
|                               
|Trucks, light and medium duty   |  |              | 45,691  |      |  |   | 45,100  |  
|                               
|                               
|                               
|                               
|Other                           |  |              | 31,337  |      |  |   | 30,659  |  
|                                |  |              |         |      |  |   |         |  
|                                |  |              | 127,137 |      |  |   | 126,784 |  
|                               
|                               
|                               
|                               
|Less: Accumulated depreciation  |  |              | (69,246 | )    |  |   | (63,493 | )
|                                |  |              |         |      |  |   |         |  
|                                |  | $            | 57,891  |      |  | $ | 63,291  |  
|                                |  |              |         |      |  |   |         |  

Minimum future rentals on noncancelable finance and operating
leases as of December 31, 2003, are as follows:

|                             |  |         |         |           |  |   |        | 
|---------------------------- |  | ------- | ------- | --------- |  | - | ------ | 
|                             |  | Finance |         | Operating
|                             |  |         |         |          
|Due in 2004                  |  | $       | 45,069  |           |  | $ | 22,674 | 
|                            
|                            
|                            
|                            
|Due in 2005                  |  |         | 34,654  |           |  |   | 11,988 | 
|                            
|                            
|                            
|                            
|Due in 2006                  |  |         | 23,932  |           |  |   | 5,967  | 
|                            
|                            
|                            
|                            
|Due in 2007                  |  |         | 14,231  |           |  |   | 2,309  | 
|                            
|                            
|                            
|                            
|Due in 2008                  |  |         | 4,522   |           |  |   | 153    | 
|                            
|                            
|                            
|                            
|Thereafter                   |  |         | 30      |           |  |   |       | 
|                             |  |         |         |           |  |   |        | 
|Total minimum future rentals |  | $       | 122,438 |           |  | $ | 43,091 | 
|                             |  |         |         |           |  |   |        | 

59



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 9  Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the two years
ended December 31, 2003, are as follows:

|                           |                                               |           |       |            |   |            |        |        |  |   |        |        |  |   |        |        |  
|-------------------------- | --------------------------------------------- | --------- | ----- | ---------- | - | ---------- | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | -
|                           |                                               |           |       |            |   | Trust &    |        |       
|                           |                                               | Community |       | Commercial |   | Investment |        |       
|                           |                                               | Banking   |       | Finance    |   | Services   |        | Total 
|                           |                                               |           |       |            |   |            |        |       
|Balance, January 1, 2002   |                                               | $         | 1,228 |            |   | $          |       |        |  | $ |       |        |  | $ | 1,228  |       
|                          
|                          
|                          
|                          
|                           | Goodwill acquired                             |           |       |           |   |            |        | 17,220 |  |   |        |       |  |   |        | 17,220 |  
|                          
|                          
|                          
|                          
|                           | Impairment losses                             |           |       |           |   |            |        |       |  |   |        |       |  |   |        |       |  
|                          
|                          
|                          
|                          
|                           | Amortization of goodwill from branch purchase |           |       | (88        | ) |            |        |       |  |   |        |       |  |   |        | (88    | )
|                           |                                               |           |       |            |   |            |        |        |  |   |        |        |  |   |        |       
|Balance, December 31, 2002 |                                               |           | 1,140 |            |   |            | 17,220 |        |  |   |       |        |  |   | 18,360 |       
|                          
|                          
|                          
|                          
|                           | Goodwill acquired                             |           |       |           |   |            |        |       |  |   |        | 12,218 |  |   |        | 12,218 |  
|                          
|                          
|                          
|                          
|                           | Impairment losses                             |           |       |           |   |            |        |       |  |   |        |       |  |   |        |       |  
|                          
|                          
|                          
|                          
|                           | Amortization of goodwill from branch purchase |           |       | (88        | ) |            |        |       |  |   |        |       |  |   |        | (88    | )
|                           |                                               |           |       |            |   |            |        |        |  |   |        |        |  |   |        |       
|Balance, December 31, 2003 |                                               | $         | 1,052 |            |   | $          | 17,220 |        |  | $ | 12,218 |        |  | $ | 30,490 |       
|                           |                                               |           |       |            |   |            |        |        |  |   |        |        |  |   |        |       

A summary of finite-lived intangible assets are as follows:

|                            |                          |                   |       |                   |  |          |        |              |   |   |     |     |  |   |      |      |  
|--------------------------- | ------------------------ | ----------------- | ----- | ----------------- |  | -------- | ------ | ------------ | - | - | --- | --- |  | - | ---- | ---- | -
|                            |                          |                   |       |                  
|                            |                          | December 31, 2003 |       | December 31, 2002
|                            |                          |                   |       |                  
|                            |                          | Gross             |       |                   |  | Gross    |        |             
|                            |                          | Carrying          |       | Accumulated       |  | Carrying |        | Accumulated 
|                            |                          | Amount            |       | Amortization      |  | Amount   |        | Amortization
|                            |                          |                   |       |                   |  |          |        |             
|Amortized intangible assets |                          |                   |       |                   |  |          |        |              |   |   |     |     |  |   |      |     
|                           
|                           
|                           
|                           
|                            | Core deposit intangible  |                   | $     | 981               |  |          | $      | (917         | ) |   | $   | 981 |  |   | $    | (860 | )
|                           
|                           
|                           
|                           
|                            | Customer list            |                   |       | 3,700             |  |          |        | (55          | ) |   |     |    |  |   |      |     |  
|                           
|                           
|                           
|                           
|                            | Trademark                |                   |       | 480               |  |          |        | (11          | ) |   |     |    |  |   |      |     |  
|                           
|                           
|                           
|                           
|                            | Covenants not to compete |                   |       | 930               |  |          |        | (25          | ) |   |     |    |  |   |      |     |  
|                            |                          |                   |       |                   |  |          |        |              |   |   |     |     |  |   |      |     
|                            |                          | $                 | 6,091 |                   |  | $        | (1,008 | )            |   | $ | 981 |     |  | $ | (860 | )   
|                            |                          |                   |       |                   |  |          |        |              |   |   |     |     |  |   |      |     

Amortization expense of finite-lived intangible assets was
$148,000, $79,000, and $101,000 for the years ended
December 31, 2003, 2002, and 2001. Amortization expense on
finite-lived intangible assets is estimated to be $813,000,
$760,000, $754,000, $747,000 and $744,000 for the years ended
December 31, 2004, 2005, 2006, 2007, and 2008.

Note 10  Deposits

The aggregate amount of time deposits in denominations of
$100,000 or more at December 31, 2003 and 2002 was
$140,250,000 and $141,380,000.

60



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

At December 31, 2003, the scheduled maturities of time
deposits are as follows:

|            |  |   |         | 
|----------- |  | - | ------- | 
|           
|           
|           
|           
|Due in 2004 |  | $ | 358,238 | 
|           
|           
|           
|           
|Due in 2005 |  |   | 144,596 | 
|           
|           
|           
|           
|Due in 2006 |  |   | 137,641 | 
|           
|           
|           
|           
|Due in 2007 |  |   | 72,959  | 
|           
|           
|           
|           
|Due in 2008 |  |   | 22,589  | 
|           
|           
|           
|           
|Thereafter  |  |   | 4,612   | 
|            |  |   |         | 
|Total       |  | $ | 740,635 | 
|            |  |   |         | 

Note 11  Short-Term Borrowings

Short-term borrowings and weighted average interest rates
consist of the following:

|                                                              |  |              |        |      |  |        |       |      |  |   |        |  |  |  |       | 
|------------------------------------------------------------- |  | ------------ | ------ | ---- |  | ------ | ----- | ---- |  | - | ------ |  |  |  | ----- | 
|                                                              |  |             
|                                                              |  | December 31,
|                                                              |  |             
|                                                              |  |              |        |     
|                                                              |  | 2003         |        | 2002
|                                                              |  |              |        |     
|                                                              |  | Amount       |        | Rate |  | Amount |       | Rate
|                                                              |  |              |        |      |  |        |       |     
|Securities sold under repurchase agreements                   |  | $            | 7,794  |      |  |        | 0.73% |      |  | $ | 10,120 |  |  |  | 0.74% | 
|                                                             
|                                                             
|                                                             
|                                                             
|Interest-bearing demand notes issued to the
    U.S. Treasury |  |              | 6,084  |      |  |        | 0.73% |      |  |   | 6,500  |  |  |  | 1.00% | 
|                                                             
|                                                             
|                                                             
|                                                             
|Lines of credit                                               |  |              | 30,000 |      |  |        | 2.14% |      |  |   | 25,000 |  |  |  | 2.31% | 
|                                                              |  |              |        |      |  |        |       |      |  |   |        |  |  |  |       | 
|Total                                                         |  | $            | 43,878 |      |  |        |       |      |  | $ | 41,620 |  |  |  |       | 
|                                                              |  |              |        |      |  |        |       |      |  |   |        |  |  |  |       | 

The securities sold under repurchase agreements represent
collateral to the lending party and are obligations of U.S.
agencies and corporations. These securities are maintained under
Sterlings control. As of December 31, 2003, Sterling
had unused short-term funding commitments totaling $93,500,000.

61



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 12  Long-Term Debt

Long-term debt consisted of the following:

|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |              |         |         |  |   |         |        | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | ------- | ------- |  | - | ------- | ------ | 
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |             
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        | December 31,
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |             
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        | 2003         |         | 2002   
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |              |         |        
|FHLB advances:                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                        |              |         |         |  |   |         |       
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                            | Redeemable advances, 3.13%-6.99%, due 2007-2014,
    with a weighted average interest rate of 5.50% and 5.88% at
    December 31, 2003 and 2002                                                                                        |              | $       | 60,000  |  |   | $       | 60,000 | 
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                            | Nonredeemable fixed rate advances, 1.74%-6.75%,
    due 2004-2008, with a weighted average interest rate of 3.12%
    and 4.13% at December 31, 2003 and 2002                                                                          |              |         | 106,288 |  |   |         | 37,450 | 
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                            | Nonredeemable fixed rate, amortizing advances,
    3.00%-4.33%, due 2007-2011, with a weighted average interest
    rate of 4.29% and 4.30% at December 31, 2003 and 2002                                                              |              |         | 9,936   |  |   |         | 12,807 | 
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                            | Nonredeemable advance due in 2003 with a variable
    rate of interest based on the 3 month LIBOR rate plus
    41 b.p. The rate reset quarterly with a cap of 7.50% and a
    floor of 6.25%. At December 31, 2002 the rate was 6.25% |              |         |        |  |   |         | 5,000  | 
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|Notes payable to two financial institutions,
    generally with an original maturity of 36 months. Interest
    rates on the notes range from 3.84% to 7.93%, with a weighted
    average interest rate of 4.50% and 4.98% at December 31,
    2003 and 2002. The notes mature through 2005 |                                                                                                                                                                                                                                        |              | 12,869  |         |  |   | 32,220  |       
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|Note payable with an original term of
    36 months due in 2005 with even quarterly principal
    payments and a fixed rate of interest of 5.25%                                                                                                                                            |                                                                                                                                                                                                                                        |              | 1,669   |         |  |   | 3,001   |       
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                           
|Note payable with an original term of
    24 months due in 2004 and a variable rate of interest based
    on the 30 day LIBOR rate. The rate resets monthly and was
    2.52% at December 31, 2003                                                                                          |                                                                                                                                                                                                                                        |              | 5,000   |         |  |   | 5,000   |       
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |              |         |         |  |   |         |       
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        | $            | 195,762 |         |  | $ | 155,478 |       
|                                                                                                                                                                                                                                                                                            |                                                                                                                                                                                                                                        |              |         |         |  |   |         |       

The contractual maturities of long-term debt as of
December 31, 2003, are shown below. Actual maturities may
differ from contractual maturities due to the convertible
features of the FHLB advances, which may be prepaid by Sterling,
in the event the FHLB converts them to adjustable rate.

|            |  |   |         | 
|----------- |  | - | ------- | 
|           
|           
|           
|           
|Due in 2004 |  | $ | 30,312  | 
|           
|           
|           
|           
|Due in 2005 |  |   | 36,726  | 
|           
|           
|           
|           
|Due in 2006 |  |   | 33,750  | 
|           
|           
|           
|           
|Due in 2007 |  |   | 29,668  | 
|           
|           
|           
|           
|Due in 2008 |  |   | 10,000  | 
|           
|           
|           
|           
|Thereafter  |  |   | 55,306  | 
|            |  |   |         | 
|Total       |  | $ | 195,762 | 
|            |  |   |         | 

Under the terms of the notes payable to financial institutions,
Sterling is required to meet certain conditions, including
specific financial ratios, as measured on a periodic basis.
Sterling was in compliance with these covenants during the
periods presented. As of December 31, 2003, Sterling has
unused funding commitments from these financial institutions and
the FHLB totaling $223,400,000.

62



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 13  Junior Subordinated Debentures Owed
to Unconsolidated Subsidiary Trusts and Corporation-Obligated
Mandatorily Redeemable Capital Securities of Subsidiary Trusts
Holding Solely Debentures of the Corporation

Sterling has two non-consolidated subsidiary trusts, Sterling
Financial Statutory Trust I and Sterling Financial
Statutory Trust II, of which 100% of the common equity is
owned by Sterling. The trusts were formed for the purpose of
issuing corporation-obligated mandatorily redeemable capital
securities (the capital securities) to third-party investors and
investing the proceeds from the sale of such capital securities
solely in junior subordinated debt securities of Sterling (the
debentures). The debentures held by each trust are the sole
assets of that trust. Distributions on the capital securities
issued by each trust are payable semi-annually at a rate per
annum equal to the interest rate being earned by the trust on
the debentures held by that trust. The capital securities are
subject to mandatory redemption, in whole or in part, upon
repayment of the debentures. Sterling has entered into
agreements which, taken collectively, fully and unconditionally
guarantee the capital securities subject to the terms of each of
the guarantees. The debentures held by the Statutory
Trust I and II capital trusts are first redeemable, in
whole or in part, by the Corporation on March 26, 2007 and
June 26, 2008, respectively.

In 2003, as a result of applying the provisions of FIN 46,
which represents new accounting guidance governing when an
equity interest should be consolidated, Sterling was required to
deconsolidate these subsidiary trusts from its financial
statements. The deconsolidation of the net assets and results of
operations of the trusts had virtually no impact on
Sterlings financial statements or liquidity position since
Sterling continues to be obligated to repay the debentures held
by the trusts and guarantees repayment of the capital securities
issued by the trusts. Sterlings total debt obligation
related to the trusts did increase however from $55,000,000 to
$56,702,000 upon deconsolidation with the difference
representing Sterlings common ownership interest in the
trusts.

The junior subordinated debentures from Sterling to the two
subsidiary trusts consist of two notes, $20,619,000 which is at
a floating rate of interest of LIBOR plus 360 basis points, and
matures in 2032. The second note of $36,083,000 is at a fixed
rate of interest of 5.55%, and matures in 2033.

The debentures held by the trusts qualify as Tier 1 capital
for Sterling under Federal Reserve Board guidelines. As a result
of the issuance of FIN 46, the Federal Reserve Board is
currently evaluating whether deconsolidation of the trusts will
affect the qualification of the debentures as Tier 1
capital. If in the future it is determined that the debentures
can no longer qualify as Tier 1 capital, it is anticipated
that Sterling will continue to meet its minimum capital
requirements.

63



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 14  Income Taxes

The allocation of income taxes between current and deferred is
as follows:

|         |         |                          |        |       |  |      |       |        |   |   |        |        |  
|-------- | ------- | ------------------------ | ------ | ----- |  | ---- | ----- | ------ | - | - | ------ | ------ | -
|         |         |                         
|         |         | Years Ended December 31,
|         |         |                         
|         |         | 2003                     |        | 2002  |  | 2001
|         |         |                          |        |       |  |     
|Current: |         |                          |        |       |  |      |       |        |   |   |        |       
|        
|        
|        
|        
|         | Federal |                          | $      | 8,813 |  |      | $     | 5,151  |   |   | $      | 6,805  |  
|        
|        
|        
|        
|         | State   |                          |        | 615   |  |      |       | 931    |   |   |        | 152    |  
|         |         |                          |        |       |  |      |       |        |   |   |        |       
|         |         |                          | 9,428  |       |  |      | 6,082 |        |   |   | 6,957  |       
|         |         |                          |        |       |  |      |       |        |   |   |        |       
|Deferred |         |                          |        |       |  |      |       |        |   |   |        |       
|        
|        
|        
|        
|         | Federal |                          |        | 840   |  |      |       | 2,046  |   |   |        | (1,250 | )
|        
|        
|        
|        
|         | State   |                          |        | 47    |  |      |       | (1,110 | ) |   |        | 137    |  
|         |         |                          |        |       |  |      |       |        |   |   |        |       
|         |         |                          | 887    |       |  |      | 936   |        |   |   | (1,113 | )     
|         |         |                          |        |       |  |      |       |        |   |   |        |       
|Total    |         | $                        | 10,315 |       |  | $    | 7,018 |        |   | $ | 5,844  |       
|         |         |                          |        |       |  |      |       |        |   |   |        |       

On June 28, 2002, a nonbanking affiliate of Sterling
organized as a C-corporation was converted to a single member
limited liability company. As a result of this conversion, the
need for approximately $1.2 million in state deferred tax
liabilities was eliminated and resulted in a reduction of income
tax expense for the period. On March 31, 2003 a second
nonbanking affiliate also organized as a C-corporation converted
to a single member limited liability company, with no
significant impact to deferred taxes.

The reason for the differences between the federal statutory
income tax rate and the effective tax rates are summarized as
follows:

|                                    |                                            |                          |      |       |    |      |      |       |    |  |      |       |   
|----------------------------------- | ------------------------------------------ | ------------------------ | ---- | ----- | -- | ---- | ---- | ----- | -- |  | ---- | ----- | --
|                                    |                                            |                         
|                                    |                                            | Years Ended December 31,
|                                    |                                            |                         
|                                    |                                            | 2003                     |      | 2002  |    | 2001
|                                    |                                            |                          |      |       |    |     
|Pretax income                       |                                            |                          | 35.0 | %     |    |      | 35.0 | %     |    |  | 35.0 | %    
|                                   
|                                   
|                                   
|                                   
|Increase (decrease) resulting from: |                                            |                          |      |       |    |      |      |       |    |  |      |      
|                                   
|                                   
|                                   
|                                   
|                                    | Tax-exempt interest income                 |                          |      | (10.7 | )% |      |      | (12.2 | )% |  |      | (14.0 | )%
|                                   
|                                   
|                                   
|                                   
|                                    | Disallowed interest                        |                          |      | 0.8   | %  |      |      | 1.2   | %  |  |      | 1.8   | % 
|                                   
|                                   
|                                   
|                                   
|                                    | Low-income housing credits                 |                          |      | (0.3  | )% |      |      | (0.4  | )% |  |      | (0.8  | )%
|                                   
|                                   
|                                   
|                                   
|                                    | State tax (benefit), net of federal impact |                          |      | 1.1   | %  |      |      | (1.4  | )% |  |      | 0.7   | % 
|                                   
|                                   
|                                   
|                                   
|                                    | Other, net                                 |                          |      | 0.3   | %  |      |      |      |    |  |      | (0.4  | )%
|                                    |                                            |                          |      |       |    |      |      |       |    |  |      |      
|Effective tax rates                 |                                            |                          | 26.2 | %     |    |      | 22.2 | %     |    |  | 22.3 | %    
|                                    |                                            |                          |      |       |    |      |      |       |    |  |      |      

The income tax provision (benefit) includes $179,000,
($161,000), and $949,000 of income taxes relating to realized
securities gains (losses) for the years ended December 31,
2003, 2002, and 2001.

64



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The significant components of Sterlings deferred tax
assets and liabilities are as follows:

|                           |                                        |              |         |         |   |   |         |         |  
|-------------------------- | -------------------------------------- | ------------ | ------- | ------- | - | - | ------- | ------- | -
|                           |                                        |             
|                           |                                        | December 31,
|                           |                                        |             
|                           |                                        | 2003         |         | 2002   
|                           |                                        |              |         |        
|Deferred tax assets        |                                        |              |         |         |   |   |         |        
|                          
|                          
|                          
|                          
|                           | Allowance for loan losses              |              | $       | 5,198   |   |   | $       | 4,634   |  
|                          
|                          
|                          
|                          
|                           | Employee benefit plans                 |              |         | 649     |   |   |         | 619     |  
|                          
|                          
|                          
|                          
|                           | Accrued directors fees                 |              |         | 569     |   |   |         | 580     |  
|                          
|                          
|                          
|                          
|                           | State net operating loss carryforwards |              |         | 57      |   |   |         | 57      |  
|                          
|                          
|                          
|                          
|                           | Restructuring charge reserve           |              |         | 221     |   |   |         | 368     |  
|                          
|                          
|                          
|                          
|                           | Securities impairment reserve          |              |         | 305     |   |   |         | 465     |  
|                          
|                          
|                          
|                          
|                           | Others                                 |              |         | 183     |   |   |         | 169     |  
|                           |                                        |              |         |         |   |   |         |        
|                           |                                        |              | 7,182   |         |   |   | 6,892   |        
|                           |                                        |              |         |         |   |   |         |        
|Deferred tax liabilities   |                                        |              |         |         |   |   |         |        
|                          
|                          
|                          
|                          
|                           | Leasing                                |              |         | (11,607 | ) |   |         | (10,905 | )
|                          
|                          
|                          
|                          
|                           | Premises and equipment                 |              |         | (737    | ) |   |         | (473    | )
|                          
|                          
|                          
|                          
|                           | Deferred loan fees                     |              |         | (353    | ) |   |         | (403    | )
|                          
|                          
|                          
|                          
|                           | Securities accretion                   |              |         | (188    | ) |   |         | (104    | )
|                          
|                          
|                          
|                          
|                           | Accumulated other comprehensive income |              |         | (7,440  | ) |   |         | (7,521  | )
|                          
|                          
|                          
|                          
|                           | Purchase accounting amortization       |              |         | (1,757  | ) |   |         |        |  
|                          
|                          
|                          
|                          
|                           | Other                                  |              |         | (222    | ) |   |         | (82     | )
|                           |                                        |              |         |         |   |   |         |        
|                           |                                        |              | (22,304 | )       |   |   | (19,488 | )      
|                           |                                        |              |         |         |   |   |         |        
|Net deferred tax liability |                                        | $            | (15,122 | )       |   | $ | (12,596 | )      
|                           |                                        |              |         |         |   |   |         |        

The net deferred tax liability is included in other liabilities.

Note 15  Commitments and Contingent Liabilities

Credit-Related Financial Instruments 
Sterlings credit-related financial instruments include
commitments to extend credit and letters of credit. Such
commitments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amounts recognized in the
consolidated balance sheets.

Sterlings exposure to credit loss is represented by the
contractual amount of these commitments. Sterling follows the
same credit policies in making commitments as it does for
on-balance sheet instruments.

The following outstanding instruments have contract amounts that
represent credit risk.

|                              |                                    |              |        |         |  |  |        |         | 
|----------------------------- | ---------------------------------- | ------------ | ------ | ------- |  |  | ------ | ------- | 
|                              |                                    |             
|                              |                                    | December 31,
|                              |                                    |             
|                              |                                    | 2003         |        | 2002   
|                              |                                    |              |        |        
|Commitments to extend credit: |                                    |              |        |         |  |  |        |        
|                             
|                             
|                             
|                             
|                              | Unused home equity lines of credit |              | $      | 59,550  |  |  | $      | 50,754  | 
|                             
|                             
|                             
|                             
|                              | Other commitments to extend credit |              |        | 264,329 |  |  |        | 273,683 | 
|                             
|                             
|                             
|                             
|Standby letters of credit     |                                    |              | 67,557 |         |  |  | 58,231 |        

Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition
established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require
the payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. Each

65



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

customers creditworthiness is evaluated on a case-by-case
basis. The amount of collateral obtained, if deemed necessary
upon extension of credit, is based on managements credit
evaluation of the customer and generally consists of real
estate. Excluded from these amounts are commitments to extend
credit in the form of check credit or related plans.

Standby letters of credit are conditional commitments issued by
Sterling to guarantee the performance of a customer to a third
party. Those letters of credit are primarily issued to support
public and private borrowing arrangements. Essentially all
letters of credit issued have expiration dates within one year.
The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan
facilities to customers. Sterling generally holds collateral
supporting those commitments if deemed necessary.

Derivative Financial Instruments  Sterling is
a party to derivative instruments in the normal course of
business to manage its own exposure to fluctuations in interest
rates and to meet the financing needs of its customers.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Asset liability management  Sterling uses derivative
    instruments to assist in asset liability management to manage
    its exposure to earnings volatility caused by fluctuations in
    interest rates. Interest rate swaps are used to hedge cash flow
    variability related to floating rate liabilities, through the
    use of pay-fixed instruments. Gains and losses on derivative
    instruments reclassified from accumulated other comprehensive
    income to current-period earnings are included in the line item
    in which the hedged cash flows are recorded. At
    December 31, 2003, other comprehensive income included a
    deferred after-tax loss of $942,000 consisting of a loss on
    pay-fixed interest rate swap used to hedge future cash flows on
    floating rate liabilities. A portion of the amount in other
    comprehensive income is reclassified from other comprehensive
    income to interest expense as net settlements occur. For the
    year ended December 31, 2003, Sterling recognized interest
    expense of $918,000 related to interest rate swaps accounted for
    as cash flow hedges, versus $543,000 for the year ended
    December 31, 2002. At December 31, 2003, the notional
    amount of the interest rate swap was $25,000,000, and had a
    negative gross carrying value of $1,480,000. The interest rate
    swap matures in 2006.
|
| | Interest rate options, which include caps, are contracts that
    transfer, modify, or reduce interest rate risk in exchange for
    the payment of a premium when the contract is initiated. A
    premium is paid for the right, but not the obligation, to buy or
    sell a financial instrument at predetermined terms in the
    future. At December 31, 2003, the notional amount of an
    interest rate cap purchased was $5,000,000, and its carrying
    value was reduced to zero.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | In May 2003, Sterling entered into two equity put options as
    fair value hedges to protect the company from risk that the fair
    value of its SLM Corporation stock might be adversely impacted
    by changes in market price. The two equity put options each
    cover 30,000 shares of SLMs stock, one with a valuation
    date in May 2004 and the second with a valuation date of May
    2006. If, at the valuation date, the stock price is below the
    reference price (May 2004  $31.93; May
    2006  $33.81), the counter-party will pay the
    difference between the stocks price on the valuation date
    and the reference price to Sterling. Sterling paid $258,000 for
    these put options, and as of December 31, 2003 their fair
    value was $84,000. The difference was charged to other
    noninterest expense and totaled $174,000 for the year ended
    December 31, 2003. At December 31, 2003, the trading
    price of the SLM Corporation stock was $37.68.                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Customer Related  In the third quarter of 2003,
    Sterling entered into interest rate contracts; including
    interest rate caps and interest rate swap agreements to
    facilitate customer transactions in order                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

66



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)



| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | to meet their financing needs. A summary of the customer related
    interest rate contracts at December 31, 2003 is as follows:

|                                                                 |  |          |       |          |  |   |     |  
|---------------------------------------------------------------- |  | -------- | ----- | -------- |  | - | --- | -
|                                                                 |  | Notional |       | Carrying
|                                                                 |  | Amount   |       | Value   
|                                                                 |  |          |       |         
|Interest rate swap agreements (pay
    fixed/receiving floating) |  | $        | 7,000 |          |  | $ | (33 | )
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate swap agreements (pay
    floating/received fixed)  |  |          | 7,000 |          |  |   | 33  |  
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate caps written                                       |  |          | 6,000 |          |  |   | (27 | )
|                                                                
|                                                                
|                                                                
|                                                                
|Interest rate caps purchased                                     |  |          | 6,000 |          |  |   | 27  |  

The interest rate contract portfolio is actively managed and
hedged with offsetting contracts, with identical terms, with
counterparties. Changes in the estimated fair value of customer
related contracts and related interest settlements, net of the
offsetting counterparty contracts, are recorded in noninterest
income. Through December 31, 2003, net fees of $28,000 are
included in other noninterest income.

Sterling believes it has reduced market risk on its customer
related derivative contracts, through offsetting contractual
relationships with counterparties. However, if a customer or
counterparty fails to perform, credit risk is equal to the
extent of the fair value gain in a derivative. When the fair
value of a derivative instrument contract is positive, this
generally indicates that the counterparty or customer owes
Sterling, and results in credit risk to Sterling. When the fair
value of a credit risk is negative, Sterling owes the customer
or counterparty, and therefore, has no credit risk. Sterling
minimizes the credit risk in derivative instruments by including
derivative credit risk in its credit underwriting procedures,
and by entering into transactions with high-quality
counterparties that are reviewed periodically by Sterlings
treasury function.

Other Contingent Liabilities  From time to
time, Sterling and its subsidiaries may be named as defendants
in legal proceedings that arise during the normal course of
business. While any litigation has an element of uncertainty,
management is of the opinion that the liability, if any,
resulting from these actions will not have a material effect on
the consolidated financial condition or results of operations of
Sterling.

Note 16  Stockholders Equity and Regulatory
Matters

Sterling maintains a dividend reinvestment and stock purchase
plan. Under the Plan, shareholders may purchase additional
shares of Sterlings common stock at the prevailing market
prices with reinvested dividends and voluntary cash payments.
Sterling has reserved 2,153,320 shares of the corporations
common stock to be issued under the dividend reinvestment and
stock purchase plan. As of December 31, 2003, 1,659,307
shares were available to be issued under the plan.

Sterling also maintains a directors stock compensation
plan (Directors Plan). Under the Directors Plan,
each non-employee director is entitled to receive shares of
Sterlings common stock each July 1. Sterling has
reserved 49,219 shares of the corporations common
stock to be issued under the directors stock compensation
plan. As of December 31, 2003, 14,406 shares were
available to be issued under the plan.

During the second quarter of 2003, Sterling announced that its
Board of Directors authorized a plan to purchase, in open market
and privately negotiated transactions, up to 1,000,000 shares of
its outstanding common stock. This newly approved repurchase
plan, when combined with 42,692 shares remaining to be purchased
under Sterlings repurchase plan announced in February
2001, represents approximately 4.9% of the outstanding shares of
Sterlings common stock. Through December 31, 2003,
93,750 shares have been repurchased under this program at
an average price of $21.37.

Sterling (on a consolidated basis) and its banking subsidiaries
are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on
Sterlings and the banks financial statements. Under
capital adequacy

67



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

guidelines and the regulatory framework for prompt corrective
action, Sterling and its banking subsidiaries must meet specific
capital guidelines that involve quantitative measures of their
assets, liabilities and certain off-balance sheet items as
calculated under regulatory accounting practices. The capital
amounts and reclassifications are also subject to qualitative
judgments by the regulators about components, risk weightings,
and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.

Quantitative measures established by regulation to ensure
capital adequacy require Sterling and its banking subsidiaries
to maintain minimum amounts and ratios (set forth in the
following table) of Total and Tier 1 capital (as defined)
to average assets (as defined in the Regulations). Management
believes, as of December 31, 2003, and 2002, that Sterling
and the banks met all minimum capital adequacy requirements to
which they are subject.

As of December 31, 2003, the most recent notification from
the Federal Deposit Insurance Corporation categorized the banks
as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well
capitalized institutions must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage
ratios as set forth in the following tables. There are no
conditions or events since the notification that management
believes have changed the banks category. Sterlings
and the banks actual capital amounts and ratios as of
December 31, 2003, and 2002 are also presented in the table.

|                                       |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |      |  
|-------------------------------------- | --------------------------------- | ------ | - | ------- |  | ----------------- |  | ----- | - | ---------------- | - | ------- |  |  |  | --- | - |  | - | ------- |  |  |  | ---- | -
|                                       |                                   |        |   |         |  |                   |  |       |   |                 
|                                       |                                   |        |   |         |  |                   |  |       |   | Minimum To Be   
|                                       |                                   |        |   |         |  |                   |  |       |   | Well Capitalized
|                                       |                                   |        |   |         |  |                   |  |       |   | Under Prompt    
|                                       |                                   |        |   |         |  | Corrective Action
|                                       |                                   | Actual |   | Minimum |  | Provisions       
|                                       |                                   |        |   |         |  |                  
|                                       |                                   | Amount |   | Ratio   |  | Amount            |  | Ratio |   | Amount           |   | Ratio  
|                                       |                                   |        |   |         |  |                   |  |       |   |                  |   |        
|December 31, 2003                      |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|Total capital to risk weighted assets  |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        | $ | 244,621 |  |                   |  | 13.4  | % |                  | $ | 145,952 |  |  |  | 8.0 | % |  | $ | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 156,863 |  |                   |  | 12.3  | % |                  |   | 101,630 |  |  |  | 8.0 | % |  |   | 127,037 |  |  |  | 10.0 | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 55,875  |  |                   |  | 12.6  | % |                  |   | 35,468  |  |  |  | 8.0 | % |  |   | 44,335  |  |  |  | 10.0 | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 10,124  |  |                   |  | 13.5  | % |                  |   | 5,986   |  |  |  | 8.0 | % |  |   | 7,482   |  |  |  | 10.0 | %
|Tier 1 capital to risk weighted assets |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        |   | 227,106 |  |                   |  | 12.4  | % |                  |   | 72,976  |  |  |  | 4.0 | % |  |   | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 144,523 |  |                   |  | 11.4  | % |                  |   | 50,815  |  |  |  | 4.0 | % |  |   | 76,222  |  |  |  | 6.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 52,538  |  |                   |  | 11.9  | % |                  |   | 17,734  |  |  |  | 4.0 | % |  |   | 26,601  |  |  |  | 6.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 9,528   |  |                   |  | 12.7  | % |                  |   | 2,993   |  |  |  | 4.0 | % |  |   | 4,489   |  |  |  | 6.0  | %
|Tier 1 capital to average assets       |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        |   | 227,106 |  |                   |  | 10.0  | % |                  |   | 90,546  |  |  |  | 4.0 | % |  |   | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 144,523 |  |                   |  | 9.8   | % |                  |   | 59,281  |  |  |  | 4.0 | % |  |   | 74,101  |  |  |  | 5.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 52,538  |  |                   |  | 7.9   | % |                  |   | 26,672  |  |  |  | 4.0 | % |  |   | 33,340  |  |  |  | 5.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 9,528   |  |                   |  | 7.9   | % |                  |   | 4,833   |  |  |  | 4.0 | % |  |   | 6,041   |  |  |  | 5.0  | %

68



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

|                                       |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |      |  
|-------------------------------------- | --------------------------------- | ------ | - | ------- |  | ----------------- |  | ----- | - | ---------------- | - | ------- |  |  |  | --- | - |  | - | ------- |  |  |  | ---- | -
|                                       |                                   |        |   |         |  |                   |  |       |   |                 
|                                       |                                   |        |   |         |  |                   |  |       |   | Minimum To Be   
|                                       |                                   |        |   |         |  |                   |  |       |   | Well Capitalized
|                                       |                                   |        |   |         |  |                   |  |       |   | Under Prompt    
|                                       |                                   |        |   |         |  | Corrective Action
|                                       |                                   | Actual |   | Minimum |  | Provisions       
|                                       |                                   |        |   |         |  |                  
|                                       |                                   | Amount |   | Ratio   |  | Amount            |  | Ratio |   | Amount           |   | Ratio  
|                                       |                                   |        |   |         |  |                   |  |       |   |                  |   |        
|December 31, 2002                      |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|Total capital to risk weighted assets  |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        | $ | 198,476 |  |                   |  | 12.2  | % |                  | $ | 129,853 |  |  |  | 8.0 | % |  | $ | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 131,027 |  |                   |  | 11.6  | % |                  |   | 90,122  |  |  |  | 8.0 | % |  |   | 112,652 |  |  |  | 10.0 | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 47,336  |  |                   |  | 11.6  | % |                  |   | 32,692  |  |  |  | 8.0 | % |  |   | 40,865  |  |  |  | 10.0 | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 9,742   |  |                   |  | 12.7  | % |                  |   | 6,152   |  |  |  | 8.0 | % |  |   | 7,690   |  |  |  | 10.0 | %
|Tier 1 capital to risk weighted assets |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        |   | 183,848 |  |                   |  | 11.3  | % |                  |   | 64,927  |  |  |  | 4.0 | % |  |   | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 120,123 |  |                   |  | 10.7  | % |                  |   | 45,061  |  |  |  | 4.0 | % |  |   | 67,591  |  |  |  | 6.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 44,445  |  |                   |  | 10.9  | % |                  |   | 16,346  |  |  |  | 4.0 | % |  |   | 24,519  |  |  |  | 6.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 9,129   |  |                   |  | 11.9  | % |                  |   | 3,076   |  |  |  | 4.0 | % |  |   | 4,614   |  |  |  | 6.0  | %
|Tier 1 capital to average assets       |                                   |        |   |         |  |                   |  |       |   |                  |   |         |  |  |  |     |   |  |   |         |  |  |  |     
|                                      
|                                      
|                                      
|                                      
|                                       | Sterling (consolidated)           |        |   | 183,848 |  |                   |  | 8.7   | % |                  |   | 84,376  |  |  |  | 4.0 | % |  |   | n/a     |  |  |  | n/a  |  
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Lancaster County, N.A.    |        |   | 120,123 |  |                   |  | 8.7   | % |                  |   | 55,062  |  |  |  | 4.0 | % |  |   | 68,827  |  |  |  | 5.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | Bank of Hanover and Trust Company |        |   | 44,445  |  |                   |  | 6.8   | % |                  |   | 26,110  |  |  |  | 4.0 | % |  |   | 32,637  |  |  |  | 5.0  | %
|                                      
|                                      
|                                      
|                                      
|                                       | First National Bank of North East |        |   | 9,129   |  |                   |  | 8.3   | % |                  |   | 4,381   |  |  |  | 4.0 | % |  |   | 5,476   |  |  |  | 5.0  | %

Note 17  Employee Benefit Plans

In December 2000, Bank of Lancaster Countys Board of
Directors approved a resolution that terminated its qualified
non-contributory pension plan in 2001, including the freezing of
benefits effective February 28, 2001. All excess funds that
remain after satisfaction of all liabilities of the plan will be
provided to eligible active participants to provide additional
retirement income benefits. As a result of the boards
action, plan assets were converted to cash equivalents in the
first quarter of 2001, thereby causing the expected return on
plan assets to be lowered from 9.0% to 5.5%. Further, the
discount rate used in calculating the projected benefit
obligation was lowered from 7.00% in 1999 to 5.50% in 2000, to
more closely match the short-term nature of the settlement.

The Bank of Lancaster County also sponsored a retirement
restoration plan for any officer whose compensation exceeded
mandated levels. The plan was designed to restore
the level of benefits that is lost to these employees under the
qualified retirement plans because of Internal Revenue Code
restrictions. Consistent with termination of the qualified
non-contributory plan, the Board of Directors also terminated in
2001 the retirement restoration plan.

Sterling accounted for the settlement and termination of the
qualified non-contributory and retirement restoration plans in
accordance with FASB Statement No. 88, Employers
Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits. The settlement
included lump-sum payments and the purchase of annuity contracts
that benefited the participants.

Sterling sponsors a qualified postretirement benefit plan that
provides certain health care insurance benefits for retired
employees who have reached minimum age and years of service
eligibility requirements.

69



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The change in benefit obligation and the change in fair value of
plan assets related to the qualified pension plans, nonqualified
pension and other postretirement benefits for each of the years
in the two-year period ended December 31, 2003, is as
follows:

|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|------------------------------------------------------------------- |  | --------------------- | ------ | --------- |  | --------- | ------ | ---- |  | - | ------- | - |  | - | ---- | -
|                                                                    |  |                       |        |           |  | Non      
|                                                                    |  | Other Post-retirement |        | Qualified |  | Qualified
|                                                                    |  | Benefits              |        | Pension   |  | Pension  
|                                                                    |  |                       |        |           |  |          
|                                                                    |  | 2003                  |        | 2002      |  | 2002      |        | 2002
|                                                                    |  |                       |        |           |  |           |        |     
|Change in benefit obligation                                        |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Benefit obligation at beginning of year                             |  | $                     | 1,561  |           |  | $         | 1,244  |      |  | $ | 14,011  |   |  | $ | 407  |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Effect of plan curtailment                                          |  |                       |       |           |  |           |       |      |  |   |        |   |  |   | (145 | )
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Effect of plan settlement                                           |  |                       |       |           |  |           |       |      |  |   | (14,065 | ) |  |   | (269 | )
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Service cost                                                        |  |                       | 85     |           |  |           | 66     |      |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Interest cost                                                       |  |                       | 94     |           |  |           | 79     |      |  |   | 385     |   |  |   | 7    |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Benefit payments                                                    |  |                       | (65    | )         |  |           | (115   | )    |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Actuarial (gains) losses                                            |  |                       |       |           |  |           |       |      |  |   | (331    | ) |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Change in discount rate and plan amendments                         |  |                       | 302    |           |  |           | 287    |      |  |   |        |   |  |   |     |  
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Benefit obligation at end of year                                   |  |                       | 1,977  |           |  |           | 1,561  |      |  |   |        |   |  |   |     |  
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Change in plan assets                                               |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Fair value of plan assets at beginning of year                      |  |                       |       |           |  |           |       |      |  |   | 14,011  |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Return on plan assets                                               |  |                       |       |           |  |           |       |      |  |   | 54      |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Employer contributions                                              |  |                       | 65     |           |  |           | 115    |      |  |   |        |   |  |   | 269  |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Benefit payments                                                    |  |                       | (65    | )         |  |           | (115   | )    |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Effect of plan settlement                                           |  |                       |       |           |  |           |       |      |  |   | (14,065 | ) |  |   | (269 | )
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Fair value of plan assets at end of year                            |  |                       |       |           |  |           |       |      |  |   |        |   |  |   |     |  
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Reconciliation of funded status                                     |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Funded status of plans                                              |  |                       | (1,977 | )         |  |           | (1,561 | )    |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Unrecognized net transition obligation                              |  |                       | 83     |           |  |           | 91     |      |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Unrecognized prior service costs                                    |  |                       | 143    |           |  |           | 157    |      |  |   |        |   |  |   |     |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Unrecognized net (gains) losses                                     |  |                       | 184    |           |  |           | (117   | )    |  |   |        |   |  |   |     |  
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Accrued benefit expense                                             |  | $                     | (1,567 | )         |  | $         | (1,430 | )    |  | $ |        |   |  | $ |     |  
|                                                                    |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|Assumptions                                                         |  |                       |        |           |  |           |        |      |  |   |         |   |  |   |      |  
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Discount rate                                                       |  |                       | 6.00   | %         |  |           | 6.25   | %    |  |   | 5.50    | % |  |   | 5.50 | %
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Expected return on plan assets                                      |  |                       |       |           |  |           |       |      |  |   | 5.50    | % |  |   | 5.50 | %
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Weighted average rate of increase in future
    compensation levels |  |                       |       |           |  |           |       |      |  |   | 4.50    | % |  |   | 4.50 | %

70



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The components of the retirement benefits cost are presented
below.

|                                   |                                        |                   |      |              |  |      |      |      |  |   |      |     |   |   |    |    | 
|---------------------------------- | -------------------------------------- | ----------------- | ---- | ------------ |  | ---- | ---- | ---- |  | - | ---- | --- | - | - | -- | -- | 
|                                   |                                        |                   |      |              |  |     
|                                   |                                        |                   |      | Nonqualified
|                                   |                                        | Qualified Pension |      | Pension     
|                                   |                                        | Years Ended       |      | Years Ended 
|                                   |                                        | December 31,      |      | December 31,
|                                   |                                        |                   |      |             
|                                   |                                        | 2002              |      | 2001         |  | 2002 |      | 2001
|                                   |                                        |                   |      |              |  |      |      |     
|Retirement benefit costs           |                                        |                   |      |              |  |      |      |      |  |   |      |     |   |   |    |   
|                                  
|                                  
|                                  
|                                  
|Service cost                       |                                        | $                 |     |              |  | $    |     |      |  | $ |     |     |   | $ | 16 |   
|                                  
|                                  
|                                  
|                                  
|Interest cost                      |                                        |                   | 385  |              |  |      | 757  |      |  |   | 7    |     |   |   | 21 |   
|                                  
|                                  
|                                  
|                                  
|Return on plan assets              |                                        |                   | (54  | )            |  |      | (557 | )    |  |   |     |     |   |   |   |   
|                                  
|                                  
|                                  
|                                  
|Amortization of transition gains   |                                        |                   |     |              |  |      |     |      |  |   |     |     |   |   |   |   
|                                  
|                                  
|                                  
|                                  
|Amortization of prior service cost |                                        |                   |     |              |  |      |     |      |  |   | 66   |     |   |   | 20 |   
|                                  
|                                  
|                                  
|                                  
|Actuarial gains (losses)           |                                        |                   | (331 | )            |  |      | (200 | )    |  |   | 53   |     |   |   |   |   
|                                  
|                                  
|                                  
|                                  
|Effect of plan curtailment         |                                        |                   | (85  | )            |  |      |     |      |  |   | (145 | )   |   |   |   |   
|                                  
|                                  
|                                  
|                                  
|Effect of plan settlement          |                                        |                   | 397  |              |  |      |     |      |  |   |     |     |   |   |   |   
|                                   |                                        |                   |      |              |  |      |      |      |  |   |      |     |   |   |    |   
|                                   | Net retirement benefits costs (income) |                   | $    | 312          |  |      | $    |     |  |   | $    | (19 | ) |   | $  | 57 | 
|                                   |                                        |                   |      |              |  |      |      |      |  |   |      |     |   |   |    |   

|                                                |                               |                               |    |      |  |      |     |     |  |   |     |     | 
|----------------------------------------------- | ----------------------------- | ----------------------------- | -- | ---- |  | ---- | --- | --- |  | - | --- | --- | 
|                                                |                               |                              
|                                                |                               | Other Postretirement Benefits
|                                                |                               | Years Ended December 31,     
|                                                |                               |                              
|                                                |                               | 2003                          |    | 2002 |  | 2001
|                                                |                               |                               |    |      |  |     
|Retirement benefit costs                        |                               |                               |    |      |  |      |     |     |  |   |     |    
|                                               
|                                               
|                                               
|                                               
|Service cost                                    |                               | $                             | 85 |      |  | $    | 66  |     |  | $ | 50  |    
|                                               
|                                               
|                                               
|                                               
|Interest cost                                   |                               |                               | 94 |      |  |      | 80  |     |  |   | 69  |    
|                                               
|                                               
|                                               
|                                               
|Amortization of transition losses               |                               |                               | 8  |      |  |      | 9   |     |  |   | 9   |    
|                                               
|                                               
|                                               
|                                               
|Amortization of unrecognized prior service cost |                               |                               | 14 |      |  |      | 14  |     |  |   | 14  |    
|                                               
|                                               
|                                               
|                                               
|Actuarial losses                                |                               |                               |   |      |  |      | (20 | )   |  |   | (31 | )  
|                                                |                               |                               |    |      |  |      |     |     |  |   |     |    
|                                                | Net retirement benefits costs |                               | $  | 201  |  |      | $   | 149 |  |   | $   | 111 | 
|                                                |                               |                               |    |      |  |      |     |     |  |   |     |    

Health care cost trend rates assumed with respect to other
postretirement benefits in measuring the accumulated
postretirement benefit were 5.0% at December 31, 2003. The
health care cost trend rate assumption has a significant effect
on the amounts reported. The following table reflects the effect
of a 1% point increase and a 1% point decrease in the health
care cost trend rates.

The measurement date for the post retirement benefits is
October 31 of each year.

|                                                            |  |          |     |          |  |   |     | 
|----------------------------------------------------------- |  | -------- | --- | -------- |  | - | --- | 
|                                                            |  | 1% Point |     | 1% Point
|                                                            |  | Increase |     | Decrease
|                                                            |  |          |     |         
|Effect on total of service and interest cost
    components |  | $        | 24  |          |  | $ | 21  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Effect on postretirement benefit obligation                 |  |          | 184 |          |  |   | 161 | 

In December 2003, President Bush signed into law a bill that
expands Medicare benefits, primarily adding a prescription drug
benefit for Medicare-eligible retirees beginning in 2006. The
law also provides a federal subsidy to companies which sponsor
postretirement benefit plans that provide prescription drug
coverage. FASB Staff Position 106-1, Accounting
and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003permits deferring the recognition of the new Medicare
provisions impact due to lack of specific authoritative
guidance on accounting for the federal subsidy. Sterling has
elected to defer accounting for the effects of this new
legislation until the specific authoritative guidance is issued.
Accordingly, the postretirement benefit obligations and net
periodic costs reported in the accompanying financial statements
and notes do not reflect the impact of this legislation. The

71



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

accounting guidance, when issued, could require changes to
previously reported financial information. Sterling anticipates
its benefit costs after 2006 will be somewhat lower as a result
of the new Medicare provisions, however, the adoption of this
standard is not expected to have a material impact on results of
operations, financial position, or liquidity.

Sterling Financial Corporation sponsors a 401(k) retirement
plan for its eligible employees. Under the salary deferral
feature of the plan, a participant may contribute up to 20% of
their compensation. Sterling matches contributions equal to 100%
of the first 2%, 50% on the next 2% and 25% on the next 4% of
the employees contributions, which the employees may
direct the investment of those contributions to one or all of
the several funds available. Matching contributions are fully
vested and are invested based on the employees direction.

Under the performance incentive feature of the plan, additional
contributions are made to participant accounts for each plan
year for an amount determined by the Board of Directors based on
achieving certain performance objectives. The performance
incentive feature is paid entirely in Sterling common stock.
Total expense for the performance incentive feature and employer
contributions were $1,596,000, $1,340,000 and $1,105,000 for the
years ended December 31, 2003, 2002 and 2001.

The number of shares owned at December 31, 2003, in the
Sterling Financial 401(k) Retirement Plan total
1,181,280 shares, with an approximate market value of
$26,224,000. Dividends totaling $692,000 were reinvested in
additional shares of Sterling common stock.

Note 18  Stock Compensation

Sterling has an omnibus stock incentive plan under which
incentive and nonqualified stock options, stock appreciation
rights, or restricted stock may be issued. To date, only
incentive and nonqualified stock options have been issued under
the plan. The options are granted periodically to key employees
at a price not less than the fair value of the shares at the
date of grant, and have a term of ten years. As of
December 31, 2003, Sterling had approximately
958,228 shares of common stock reserved for issuance under
the stock incentive plans. All options issued were in connection
with the omnibus stock incentive plan, which was approved by
shareholders.

Sterling accounts for its stock incentive plan under the
recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees,
and related Interpretations. No stock-based employee
compensation cost for option grants are reflected in net income,
as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net
income and earnings per share if Sterling had applied the fair

72



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based
employee compensation.

|                            |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |        |  
|--------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | - | ------ | - | ---- | - | ------ | - |  | - | ------ | -
|                            |                                                                                                                                              |                         
|                            |                                                                                                                                              | Years Ended December 31,
|                            |                                                                                                                                              |                         
|                            |                                                                                                                                              | 2003                     |   | 2002   |   | 2001
|                            |                                                                                                                                              |                          |   |        |   |     
|Net income:                 |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |       
|                           
|                           
|                           
|                           
|                            | As reported                                                                                                                                  |                          | $ | 29,059 |   |      | $ | 24,745 |   |  | $ | 20,334 |  
|                           
|                           
|                           
|                           
|                            | Total stock-based employee compensation expense
    determined under fair value based methods for all awards, net of
    related tax effects |                          |   | (1,006 | ) |      |   | (917   | ) |  |   | (763   | )
|                            |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |       
|                            | Proforma                                                                                                                                     |                          | $ | 28,053 |   |      | $ | 23,828 |   |  | $ | 19,571 |  
|                            |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |       
|Basic earnings per share:   |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |       
|                           
|                           
|                           
|                           
|                            | As reported                                                                                                                                  |                          | $ | 1.37   |   |      | $ | 1.19   |   |  | $ | 1.04   |  
|                           
|                           
|                           
|                           
|                            | Proforma                                                                                                                                     |                          |   | 1.32   |   |      |   | 1.14   |   |  |   | 1.00   |  
|                           
|                           
|                           
|                           
|Diluted earnings per share: |                                                                                                                                              |                          |   |        |   |      |   |        |   |  |   |       
|                           
|                           
|                           
|                           
|                            | As reported                                                                                                                                  |                          | $ | 1.35   |   |      | $ | 1.18   |   |  | $ | 1.03   |  
|                           
|                           
|                           
|                           
|                            | Proforma                                                                                                                                     |                          |   | 1.31   |   |      |   | 1.13   |   |  |   | .99    |  

The fair value of each option granted is estimated on the date
of grant using the Black-Scholes option-pricing model with the
following weighted average assumptions:

|                        |  |                          |      |      |  |      |      |   |  |  |      |  
|----------------------- |  | ------------------------ | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                        |  |                         
|                        |  | Years Ended December 31,
|                        |  |                         
|                        |  | 2003                     |      | 2002 |  | 2001
|                        |  |                          |      |      |  |     
|Dividend yield          |  |                          | 3.04 | %    |  |      | 3.40 | % |  |  | 4.47 | %
|                       
|                       
|                       
|                       
|Risk-free interest rate |  |                          | 3.70 | %    |  |      | 4.90 | % |  |  | 4.96 | %
|                       
|                       
|                       
|                       
|Expected life           |  |                          | 7    |      |  |      | 7    |   |  |  | 10   |  
|                       
|                       
|                       
|                       
|Expected volatility     |  |                          | 41.4 | %    |  |      | 45.3 | % |  |  | 49.0 | %

A summary of the status of Sterlings stock option plans is
presented below:

|                                                                 |           |        |         |          |   |        |       |          |  |        |         |          |   |   |       |       |  |  |         |         |   |   |       |       | 
|---------------------------------------------------------------- | --------- | ------ | ------- | -------- | - | ------ | ----- | -------- |  | ------ | ------- | -------- | - | - | ----- | ----- |  |  | ------- | ------- | - | - | ----- | ----- | 
|                                                                 |           |        |         |          |   |       
|                                                                 |           | 2003   |         | 2002     |   | 2001  
|                                                                 |           |        |         |          |   |       
|                                                                 |           |        |         | Weighted |   |        |       | Weighted |  |        |         | Weighted
|                                                                 |           |        |         | Average  |   |        |       | Average  |  |        |         | Average 
|                                                                 |           |        |         | Exercise |   |        |       | Exercise |  |        |         | Exercise
|                                                                 |           | Shares |         | Price    |   | Shares |       | Price    |  | Shares |         | Price   
|                                                                 |           |        |         |          |   |        |       |          |  |        |         |         
|Outstanding at January 1                                         |           |        | 811,476 |          |   | $      | 14.80 |          |  |        | 695,906 |          |   | $ | 14.13 |       |  |  | 517,483 |         |   | $ | 15.30 |      
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Granted   |        |         | 304,156  |   |        |       | 17.95    |  |        |         | 230,000  |   |   |       | 14.95 |  |  |         | 206,875 |   |   |       | 10.88 | 
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Exercised |        |         | (119,536 | ) |        |       | 13.13    |  |        |         | (109,430 | ) |   |       | 10.93 |  |  |         | (24,301 | ) |   |       | 10.78 | 
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Forfeited |        |         | (16,375  | ) |        |       | 17.49    |  |        |         | (5,000   | ) |   |       | 11.93 |  |  |         | (4,151  | ) |   |       | 11.02 | 
|                                                                 |           |        |         |          |   |        |       |          |  |        |         |          |   |   |       |       |  |  |         |         |   |   |       |      
|Outstanding at December 31                                       |           |        | 979,721 |          |   |        | 15.94 |          |  |        | 811,476 |          |   |   | 14.80 |       |  |  | 695,906 |         |   |   | 14.13 |      
|                                                                 |           |        |         |          |   |        |       |          |  |        |         |          |   |   |       |       |  |  |         |         |   |   |       |      
|Options exercisable at December 31                               |           |        | 484,673 |          |   |        | 15.51 |          |  |        | 497,083 |          |   |   | 15.63 |       |  |  | 438,995 |         |   |   | 15.32 |      
|                                                                
|                                                                
|                                                                
|                                                                
|Weighted average fair value of options granted
    during period |           |        |         |          |   | $      | 6.20  |          |  |        |         |          |   | $ | 5.66  |       |  |  |         |         |   | $ | 3.98  |      

73



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Information pertaining to options outstanding at
December 31, 2003, is as follows:

|                |  |                     |         |                     |  |                 |       |             |  |          |     |                 |  |  |         |  |  |   |       |  |  |  |     | 
|--------------- |  | ------------------- | ------- | ------------------- |  | --------------- | ----- | ----------- |  | -------- | --- | --------------- |  |  | ------- |  |  | - | ----- |  |  |  | --- | 
|                |  |                     |         |                    
|                |  | Options Outstanding |         | Options Exercisable
|                |  |                     |         |                    
|                |  |                     |         | Weighted            |  |                 |       | Weighted   
|                |  |                     |         | Weighted            |  | Average         |       |             |  | Weighted |     | Average        
|                |  |                     |         | Average             |  | Remaining       |       |             |  | Average  |     | Remaining      
|Range of        |  | Number              |         | Exercise            |  | Contractual     |       | Number      |  | Exercise |     | Contractual    
|Exercise Prices |  | Outstanding         |         | Price               |  | Life (in years) |       | Outstanding |  | Price    |     | Life (in years)
|                |  |                     |         |                     |  |                 |       |             |  |          |     |                
|$10.00-10.99    |  |                     | 180,948 |                     |  | $               | 10.77 |             |  |          | 7.0 |                 |  |  | 130,517 |  |  | $ | 10.73 |  |  |  | 6.9 | 
|11.00-11.99     |  |                     | 43,671  |                     |  |                 | 11.84 |             |  |          | 4.0 |                 |  |  | 43,671  |  |  |   | 11.84 |  |  |  | 4.0 | 
|14.00-14.99     |  |                     | 255,148 |                     |  |                 | 14.83 |             |  |          | 7.5 |                 |  |  | 111,031 |  |  |   | 14.68 |  |  |  | 6.7 | 
|17.00-17.99     |  |                     | 225,500 |                     |  |                 | 17.50 |             |  |          | 9.2 |                 |  |  |        |  |  |   |      |  |  |  |    | 
|18.00-18.99     |  |                     | 155,939 |                     |  |                 | 18.41 |             |  |          | 6.9 |                 |  |  | 112,189 |  |  |   | 18.56 |  |  |  | 6.0 | 
|19.00-19.99     |  |                     | 12,500  |                     |  |                 | 19.25 |             |  |          | 9.3 |                 |  |  |        |  |  |   |      |  |  |  |    | 
|21.00-22.30     |  |                     | 106,015 |                     |  |                 | 21.75 |             |  |          | 5.8 |                 |  |  | 87,265  |  |  |   | 21.63 |  |  |  | 5.0 | 
|                |  |                     |         |                     |  |                 |       |             |  |          |     |                 |  |  |         |  |  |   |       |  |  |  |     | 
|                |  |                     | 979,721 |                     |  | $               | 15.94 |             |  |          | 7.4 |                 |  |  | 484,673 |  |  | $ | 15.51 |  |  |  | 6.0 | 
|                |  |                     |         |                     |  |                 |       |             |  |          |     |                 |  |  |         |  |  |   |       |  |  |  |     | 

Compensation expense of $375,000 was recorded in 2002 related to
the fair value of stock options from former employees whose
option terms were modified upon the change in employment status.

Note 19  Related Party Transactions

Certain directors and officers of Sterling Financial Corporation
and its subsidiaries, their immediate families and companies in
which they are principal owners (more than 10%), were indebted
to the subsidiary banks during 2003 and 2002. All loans were
made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable
transactions with other persons and, in the opinion of the
management of the banks, do not involve more than a normal risk
of collectibility or present other unfavorable features. Total
loans to these persons at December 31, 2003, and 2002
amounted to $4,942,000 and $6,678,000. During 2003, $1,800,000
of new loans were made and repayments totaled $3,536,000.

Note 20  Restrictions on Dividends, Loans and
Advances

Federal and state banking regulations place certain restrictions
on dividends paid and loans or advances made to Sterling by its
subsidiary banks. The amount of dividends that may be paid from
the subsidiary banks to Sterling totals $61,390,000 at
December 31, 2003. However, dividends paid by the
subsidiary banks would be prohibited if the effect thereof would
cause the banks capital to be reduced below applicable
minimum capital requirements.

Under current Federal Reserve regulations, the subsidiary banks
are limited to the amounts they may loan to their affiliates,
including Sterling. Loans to a single affiliate may not exceed
10%, and the aggregate of loans to all affiliates may not exceed
20% of each bank subsidiarys capital and surplus (as
defined by regulation). At December 31, 2003, the maximum
amount available for loans to Sterling totaled $22,286,000.

Note 21  Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount
that would be exchanged between willing parties, other than in a
forced liquidation. Fair value is best determined based upon
quoted market prices. However, in many instances, there are no
quoted market prices for Sterlings various financial
instruments. In cases where quoted market prices are not
available, fair values are based on estimates using present
value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. Accordingly,
the fair value estimates may not be realized in an immediate
settlement of the instrument. FASB Statement No. 107,
Disclosures about Fair Value of

74



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Financial Instruments, excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair
value of Sterling.

The following methods and assumptions were used by Sterling in
estimating fair value disclosures for financial instruments.

Cash and cash equivalents:The carrying amounts of cash,
due from banks and federal funds sold approximate fair value.

Interest-bearing deposits in banks and short-term
investments:The carrying amounts of interest-bearing
deposits and short-term investments maturing within 90 days
approximate their fair values. Fair values of other
interest-bearing deposits and short-term investments are
estimated using discounted cash flow analyses based on current
rates for similar type instruments.

Securities:Fair values for securities, excluding
restricted equity securities, are based on quoted market prices,
if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar
securities. The carrying value of restricted stock approximates
fair value based on the redemption provisions of the security.

Mortgage loans held for sale:Fair values of mortgage
loans held for sale are based on commitments on hand from
investors or prevailing market prices.

Loans receivable:Fair values for loans are estimated
using discounted cash flow analyses, using interest rates
currently being offered for loans with similar terms to
borrowers of similar credit quality. Lease contracts are
specifically exempt from fair value reporting and are not
included in this table.

Deposit liabilities:The fair values disclosed for demand
deposits (e.g., interest and non-interest checking, passbook
savings and certain types of money market accounts) are, by
definition, equal to the amount payable on demand at the
reporting date (i.e. their carrying amount). Fair values for
fixed-rate certificates of deposits are estimated using a
discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of
aggregated expected monthly maturities on time deposits.

Short-term borrowings:The carrying amounts of short-term
borrowings maturing within 90 days and floating rate
short-term borrowings approximate their fair values. Fair values
of other short-term borrowings are estimated using discounted
cash flow analyses based on Sterlings current incremental
borrowing rates for similar types of borrowing arrangements.

Long-term debt and subordinated notes payable:The fair
values of Sterlings long-term debt are estimated using
discounted cash flow analyses based on current borrowing rates
for similar types of borrowing arrangements.

Accrued interest:The carrying amounts of accrued
interest approximate fair value.

Derivative assets and liabilities:The fair values for
derivative instruments are based on cash flow projection models
obtained from third parties.

Off-balance sheet instruments:Fair values for
off-balance sheet, credit-related financial instruments are
based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the
agreements and the counterparties credit standing. The
fair values of off-balance sheet instruments are not significant
at December 31, 2003 and 2002.

75



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

The estimated fair values and related carrying or notional
amounts of Sterlings financial instruments are as follows:

|                       |                                          |              |   |           |  |          |   |           |  |  |   |           |  |  |   |           | 
|---------------------- | ---------------------------------------- | ------------ | - | --------- |  | -------- | - | --------- |  |  | - | --------- |  |  | - | --------- | 
|                       |                                          |             
|                       |                                          | December 31,
|                       |                                          |             
|                       |                                          |              |   |          
|                       |                                          | 2003         |   | 2002     
|                       |                                          |              |   |          
|                       |                                          | Carrying     |   | Fair      |  | Carrying |   | Fair     
|                       |                                          | Amount       |   | Value     |  | Amount   |   | Value    
|                       |                                          |              |   |           |  |          |   |          
|Financial Assets:      |                                          |              |   |           |  |          |   |           |  |  |   |           |  |  |   |          
|                      
|                      
|                      
|                      
|                       | Cash and cash equivalents                |              | $ | 84,098    |  |          | $ | 84,098    |  |  | $ | 107,339   |  |  | $ | 107,339   | 
|                      
|                      
|                      
|                      
|                       | Interest-bearing deposits in banks       |              |   | 4,102     |  |          |   | 4,102     |  |  |   | 3,412     |  |  |   | 3,412     | 
|                      
|                      
|                      
|                      
|                       | Short-term investments                   |              |   | 11,275    |  |          |   | 11,275    |  |  |   | 11,200    |  |  |   | 11,200    | 
|                      
|                      
|                      
|                      
|                       | Mortgage loans held for sale             |              |   | 11,520    |  |          |   | 11,520    |  |  |   | 16,784    |  |  |   | 16,784    | 
|                      
|                      
|                      
|                      
|                       | Securities held-to-maturity              |              |   | 35,956    |  |          |   | 37,405    |  |  |   | 36,596    |  |  |   | 38,368    | 
|                      
|                      
|                      
|                      
|                       | Securities available-for-sale            |              |   | 540,049   |  |          |   | 540,049   |  |  |   | 551,696   |  |  |   | 551,696   | 
|                      
|                      
|                      
|                      
|                       | Loans (net of allowance for loan losses) |              |   | 1,374,105 |  |          |   | 1,410,953 |  |  |   | 1,198,732 |  |  |   | 1,256,011 | 
|                      
|                      
|                      
|                      
|                       | Accrued interest receivable              |              |   | 11,236    |  |          |   | 11,236    |  |  |   | 11,770    |  |  |   | 11,770    | 
|                      
|                      
|                      
|                      
|                       | Derivative assets                        |              |   | 144       |  |          |   | 144       |  |  |   | 13        |  |  |   | 13        | 
|                      
|                      
|                      
|                      
|Financial Liabilities: |                                          |              |   |           |  |          |   |           |  |  |   |           |  |  |   |          
|                      
|                      
|                      
|                      
|                       | Deposits                                 |              | $ | 1,778,587 |  |          | $ | 1,795,289 |  |  | $ | 1,702,302 |  |  | $ | 1,722,580 | 
|                      
|                      
|                      
|                      
|                       | Short-term borrowings                    |              |   | 43,878    |  |          |   | 43,878    |  |  |   | 41,620    |  |  |   | 41,620    | 
|                      
|                      
|                      
|                      
|                       | Long-term debt                           |              |   | 195,762   |  |          |   | 208,756   |  |  |   | 155,478   |  |  |   | 169,364   | 
|                      
|                      
|                      
|                      
|                       | Subordinated notes payable               |              |   | 56,702    |  |          |   | 54,677    |  |  |   | 20,619    |  |  |   | 20,619    | 
|                      
|                      
|                      
|                      
|                       | Accrued interest payable                 |              |   | 6,273     |  |          |   | 6,273     |  |  |   | 7,981     |  |  |   | 7,981     | 
|                      
|                      
|                      
|                      
|                       | Derivative liabilities                   |              |   | 1,540     |  |          |   | 1,540     |  |  |   | 1,875     |  |  |   | 1,875     | 

76



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 22  Condensed Financial Statements of Parent
Company

Financial information pertaining only to Sterling Financial
Corporation is as follows:

|                     |                               |                      |                                            |        |         |         |         |        |         |         | 
|-------------------- | ----------------------------- | -------------------- | ------------------------------------------ | ------ | ------- | ------- | ------- | ------ | ------- | ------- | 
|                     |                               |                     
|                     |                               | December 31,        
|                     |                               |                     
|                     |                               | 2003                 |                                            | 2002  
|                     |                               |                      |                                            |       
|Assets               |                               |                      |                                            |        |         |         |         |       
|                    
|                    
|                    
|                    
|                     | Cash and cash equivalents     |                      | $                                          | 8,633  |         |         | $       | 7,256  |        
|                    
|                    
|                    
|                    
|                     | Securities available for sale |                      |                                            | 3,010  |         |         |         | 2,004  |        
|                    
|                    
|                    
|                    
|                     | Investment in:                |                      |                                            |        |         |         |         |        |        
|                    
|                    
|                    
|                    
|                     |                               | Bank subsidiaries    |                                            |        | 237,249 |         |         |        | 206,537 |        
|                    
|                    
|                    
|                    
|                     |                               | Nonbank subsidiaries |                                            |        | 27,637  |         |         |        | 8,925   |        
|                    
|                    
|                    
|                    
|                     | Due from affiliates           |                      |                                            | 39     |         |         |         | 2,215  |        
|                    
|                    
|                    
|                    
|                     | Other assets                  |                      |                                            | 10,998 |         |         |         | 2,670  |        
|                     |                               |                      |                                            |        |         |         |         |       
|                     |                               |                      | Total assets                               |        | $       | 287,566 |         |        | $       | 229,607 | 
|                     |                               |                      |                                            |        |         |         |         |       
|Liabilities          |                               |                      |                                            |        |         |         |         |       
|                    
|                    
|                    
|                    
|                     | Long-term debt                |                      | $                                          | 6,669  |         |         | $       | 8,001  |        
|                    
|                    
|                    
|                    
|                     | Subordinated debentures       |                      |                                            | 56,702 |         |         |         | 20,619 |        
|                    
|                    
|                    
|                    
|                     | Other liabilities             |                      |                                            | 4,184  |         |         |         | 4,154  |        
|                     |                               |                      |                                            |        |         |         |         |       
|                     |                               |                      | Total liabilities                          |        |         | 67,555  |         |        |         | 32,774  | 
|                     |                               |                      |                                            |        |         |         |         |       
|Stockholders equity |                               |                      | 220,011                                    |        |         |         | 196,833 |       
|                     |                               |                      |                                            |        |         |         |         |       
|                     |                               |                      | Total liabilities and stockholders equity |        | $       | 287,566 |         |        | $       | 229,607 | 
|                     |                               |                      |                                            |        |         |         |         |       

77



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |        |        | 
|------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------ | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                                      |                                            |                         
|                                                                                      |                                            | Years Ended December 31,
|                                                                                      |                                            |                         
|                                                                                      |                                            | 2003                     |        | 2002   |        | 2001
|                                                                                      |                                            |                          |        |        |        |     
|Statements of Income                                                                  |                                            |                          |        |        |        |      |        |        |        |   |        |       
|Income                                                                                |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Dividends from banking subsidiaries        |                          | $      | 10,630 |        |      | $      | 9,530  |        |   | $      | 9,780  |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Dividends from nonbanking subsidiaries     |                          |        | 60     |        |      |        | 376    |        |   |        | 1,350  |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Dividends on securities available-for-sale |                          |        | 56     |        |      |        | 47     |        |   |        | 27     |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Gains on securities available-for-sale     |                          |        | 31     |        |      |        | 16     |        |   |        | 180    |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Management fees from subsidiaries          |                          |        | 19,869 |        |      |        | 18,723 |        |   |        |       |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Other                                      |                          |        | 311    |        |      |        | 5      |        |   |        | 3      |       
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                      |                                            | Total income             |        |        | 30,957 |      |        |        | 28,697 |   |        |        | 11,340 | 
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Expenses                                                                              |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Interest expense                           |                          |        | 2,333  |        |      |        | 1,195  |        |   |        |       |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Operating expenses                         |                          |        | 22,862 |        |      |        | 17,572 |        |   |        | 548    |       
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                      |                                            | Total expense            |        |        | 25,195 |      |        |        | 18,767 |   |        |        | 548    | 
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       
|Income before income taxes and equity in
    undistributed net income of subsidiaries |                                            |                          | 5,762  |        |        |      | 9,930  |        |        |   | 10,792 |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Income tax expense (benefit)                                                          |                                            |                          | (1,780 | )      |        |      | 24     |        |        |   | (83    | )     
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                      |                                            |                          | 7,542  |        |        |      | 9,906  |        |        |   | 10,875 |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Equity in undistributed income of:                                                    |                                            |                          |        |        |        |      |        |        |        |   |        |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Banking subsidiaries                       |                          |        | 21,085 |        |      |        | 15,485 |        |   |        | 10,015 |       
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Other subsidiaries                         |                          |        | 432    |        |      |        | (646   | )      |   |        | (556   | )     
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       
|Net Income                                                                            |                                            | $                        | 29,059 |        |        | $    | 24,745 |        |        | $ | 20,334 |       
|                                                                                      |                                            |                          |        |        |        |      |        |        |        |   |        |       

78



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |        |        |        |         |  
|------------------------------------ | ---------- | ------------------------------------------------------------------------------------ | -------------------------------------------------- | ----------------------------------------- | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------ | ------ | ------ | ------- | -
|                                     |            |                                                                                     
|                                     |            | Years Ended December 31,                                                            
|                                     |            |                                                                                     
|                                     |            | 2003                                                                                 |                                                    | 2002                                      |         | 2001   
|                                     |            |                                                                                      |                                                    |                                           |         |        
|Statements of Cash Flows             |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|Cash flows from operating activities |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                    
|                                    
|                                    
|                                    
|                                     | Net income |                                                                                      | $                                                  | 29,059                                    |         |         | $       | 24,745 |         |         | $       | 20,334 |       
|                                     |            | Adjustments to reconcile net income to net cash
    provided by operating activities |                                                    |                                           |         |         |         |        |         |         |         |        |        |       
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | Depreciation                                       |                                           |         | 267     |         |        |         |        |         |        |        |       |        
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | Equity in undistributed net income of subsidiaries |                                           |         | (21,517 | )       |        |         | (14,839 | )       |        |        | (9,459 | )      
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | Gains on securities available-for-sale             |                                           |         | (31     | )       |        |         | (16     | )       |        |        | (180   | )      
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | (Increase) decrease in other assets                |                                           |         | (3,255  | )       |        |         | (4,570  | )       |        |        | 87     |        
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | Increase (decrease) in other liabilities           |                                           |         | (259    | )       |        |         | 1,771   |         |        |        | 609    |        
|                                    
|                                    
|                                    
|                                    
|                                     |            |                                                                                      | Other                                              |                                           |         | (67     | )       |        |         | 375     |         |        |        |       |        
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                     |            |                                                                                      |                                                    | Net cash provided by operating activities |         |         | 4,197   |        |         |         | 7,466   |        |        |        | 11,391  |  
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|Cash flows investing activities      |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Purchases of securities available-for-sale                                           |                                                    |                                           | (300    | )       |         |        | (447    | )       |         |        | (493   | )     
|                                    
|                                    
|                                    
|                                    
|                                     |            | Proceeds from sales and maturities of securities
    available-for-sale              |                                                    |                                           | 72      |         |         |        | 140     |         |         |        | 512    |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Investment in and advances to banking subsidiaries                                   |                                                    |                                           | (11,750 | )       |         |        | (21,764 | )       |         |        |       |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Investment in nonbanking subsidiaries                                                |                                                    |                                           | (9,756  | )       |         |        | (619    | )       |         |        | (70    | )     
|                                    
|                                    
|                                    
|                                    
|                                     |            | Return of capital from nonbanking subsidiaries                                       |                                                    |                                           |        |         |         |        | 500     |         |         |        | 750    |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Purchase of premises and equipment                                                   |                                                    |                                           | (3,164  | )       |         |        |        |         |         |        |       |       
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                     |            |                                                                                      |                                                    | Net cash used in investing activities     |         |         | (24,898 | )      |         |         | (22,190 | )      |        |        | 699     |  
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|Cash flows from financing activities |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Proceeds from subordinated note from subsidiary                                      |                                                    |                                           | 36,083  |         |         |        | 20,619  |         |         |        |       |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Proceeds from long-term debt                                                         |                                                    |                                           |        |         |         |        | 9,000   |         |         |        |       |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Repayment of long-term debt                                                          |                                                    |                                           | (1,332  | )       |         |        | (999    | )       |         |        |       |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Proceeds from issuance of common stock                                               |                                                    |                                           | 336     |         |         |        | 645     |         |         |        | 3      |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Cash dividends on common stock                                                       |                                                    |                                           | (11,671 | )       |         |        | (10,771 | )       |         |        | (9,654 | )     
|                                    
|                                    
|                                    
|                                    
|                                     |            | Cash paid in lieu of fractional shares                                               |                                                    |                                           |        |         |         |        | (32     | )       |         |        |       |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Purchases of treasury stock                                                          |                                                    |                                           | (3,459  | )       |         |        | (551    | )       |         |        | (1,061 | )     
|                                    
|                                    
|                                    
|                                    
|                                     |            | Proceeds from issuance of treasury stock                                             |                                                    |                                           | 2,121   |         |         |        | 651     |         |         |        | 325    |       
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                     |            |                                                                                      |                                                    | Net cash used in financing activities     |         |         | 22,078  |        |         |         | 18,562  |        |        |        | (10,387 | )
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|Increase in cash                     |            |                                                                                      | 1,377                                              |                                           |         |         | 3,838   |        |         |         | 1,703   |       
|Cash                                 |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                    
|                                    
|                                    
|                                    
|                                     |            | Beginning of year                                                                    |                                                    |                                           | 7,256   |         |         |        | 3,418   |         |         |        | 1,715  |       
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       
|                                     |            | End of year                                                                          |                                                    | $                                         | 8,633   |         |         | $      | 7,256   |         |         | $      | 3,418  |       
|                                     |            |                                                                                      |                                                    |                                           |         |         |         |        |         |         |         |       

Note 23  Segment Reporting

Sterling operates four major lines of business: Community
Banking and Related Services; Leasing; Commercial Finance; and
Trust and Investment Services. A fifth line of business,
Insurance Related Services

79



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

does not presently meet the thresholds for reportable segment
reporting; therefore it is included in the all other category.

The Community Banking and Related Services segment provides
financial services to consumers, businesses, financial
institutions and governmental units in southern Pennsylvania and
northern Maryland. These services include providing various
types of loans to customers, accepting deposits, mortgage
banking and other typical banking services. Parent company and
treasury function income is included in the community-banking
segment, as the majority of effort of these functions is related
to this segment. Major revenue sources include net interest
income and service fees on deposit accounts. Expenses include
personnel and branch support network support charges.

The Leasing segment provides vehicle and equipment financing
alternatives to businesses primarily located in south central
Pennsylvania and northeastern Maryland, although assets are
located throughout the United States. Major revenue sources
include net interest income and rental income on operating
leases. Expenses include personnel, support and depreciation
charges on operating leases.

The Commercial Finance segment specializes in financing forestry
and land-clearing equipment through more than 150 equipment
dealer locations ranging from Maine to Florida. Major revenue
sources include net interest income. Expenses include personnel
and support charges.

The Trust and Investment Services segment includes both
corporate asset and personal wealth management services. The
corporate asset management business provides retirement planning
services, investment management, custody and other corporate
trust services to small to medium size business in Sterling
market area. Personal wealth management services include
investment management, brokerage, estate and tax planning, as
well as trust management and administration for high net worth
individuals and their families. Major revenue sources include
management and estate fees and commissions on security
transactions. Expenses primarily consist of personnel and
support charges, as well as amortization of intangible assets.
Prior year information for this segment has been segregated from
the all other segment for consistent presentation with 2003.

The accounting policies of the segments are the same as those
described in the summary of significant accounting policies.
Transactions between segments, principally loans, were at terms
consistent with that which would be obtained from a third party.

Sterlings reportable segments are strategic business units
that offer different products and services. They are managed
separately because each segment appeals to different markets
and, accordingly, requires different technology and marketing
strategies. Sterlings chief operating decision maker
utilizes interest income, interest expense, non-interest income,
non-interest expense, and the provision for income taxes in
making decisions and determining resources to be allocated to
the segments.

80



---



##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Information about reportable segments, and reconciliation of
such information to the consolidated financial statements
follows (in thousands):

|                              |  |           |           |         |  |            |         |            |  |           |         |               |  |              |        |   |  |   |       |   |  |   |          |   |  |   |           | 
|----------------------------- |  | --------- | --------- | ------- |  | ---------- | ------- | ---------- |  | --------- | ------- | ------------- |  | ------------ | ------ | - |  | - | ----- | - |  | - | -------- | - |  | - | --------- | 
|                              |  | Community |           |         |  |            |         |            |  |           |         |               |  |             
|                              |  | Banking & |           |         |  |            |         | Trust and  |  |           |         |               |  |             
|                              |  | Related   |           |         |  | Commercial |         | Investment |  |           |         | Inter-Segment |  | Consolidated
|                              |  | Services  |           | Leasing |  | Finance    |         | Services   |  | All Other |         | Elimination   |  | Totals      
|                              |  |           |           |         |  |            |         |            |  |           |         |               |  |             
|Year ended December 31, 2003  |  |           |           |         |  |            |         |            |  |           |         |               |  |              |        |   |  |   |       |   |  |   |          |   |  |   |           | 
|                             
|                             
|                             
|                             
|Interest and dividend income  |  | $         | 107,344   |         |  | $          | 9,085   |            |  | $         | 19,469  |               |  | $            | 29     |   |  | $ | 26    |   |  | $ | (8,879   | ) |  | $ | 127,074   | 
|                             
|                             
|                             
|                             
|Interest expense              |  |           | 38,570    |         |  |            | 7,330   |            |  |           | 4,128   |               |  |              | 7      |   |  |   |      |   |  |   | (8,879   | ) |  |   | 41,156    | 
|                             
|                             
|                             
|                             
|Provision for loan losses     |  |           | 2,352     |         |  |            | 1,345   |            |  |           |        |               |  |              |       |   |  |   |      |   |  |   |         |   |  |   | 3,697     | 
|                             
|                             
|                             
|                             
|Noninterest income            |  |           | 15,333    |         |  |            | 26,869  |            |  |           | 255     |               |  |              | 6,945  |   |  |   | 319   |   |  |   |         |   |  |   | 49,721    | 
|                             
|                             
|                             
|                             
|Noninterest expenses          |  |           | 57,930    |         |  |            | 25,867  |            |  |           | 2,479   |               |  |              | 6,034  |   |  |   | 258   |   |  |   |         |   |  |   | 92,568    | 
|                             
|                             
|                             
|                             
|Income before income taxes    |  |           | 23,825    |         |  |            | 1,412   |            |  |           | 13,117  |               |  |              | 933    |   |  |   | 87    |   |  |   |         |   |  |   | 39,374    | 
|                             
|                             
|                             
|                             
|Income tax expenses (benefit) |  |           | 4,387     |         |  |            | 530     |            |  |           | 4,881   |               |  |              | 385    |   |  |   | 132   |   |  |   |         |   |  |   | 10,315    | 
|                             
|                             
|                             
|                             
|Net income                    |  |           | 19,438    |         |  |            | 882     |            |  |           | 8,236   |               |  |              | 548    |   |  |   | (45   | ) |  |   |         |   |  |   | 29,059    | 
|                             
|                             
|                             
|                             
|Assets                        |  |           | 2,246,298 |         |  |            | 203,906 |            |  |           | 160,142 |               |  |              | 19,385 |   |  |   | 3,387 |   |  |   | (289,601 | ) |  |   | 2,343,517 | 
|                             
|                             
|                             
|                             
|Year ended December 31, 2002  |  |           |           |         |  |            |         |            |  |           |         |               |  |              |        |   |  |   |       |   |  |   |          |   |  |   |           | 
|                             
|                             
|                             
|                             
|Interest and dividend income  |  | $         | 111,113   |         |  | $          | 7,394   |            |  | $         | 11,857  |               |  | $            | 19     |   |  | $ | 22    |   |  | $ | (6,814   | ) |  | $ | 123,591   | 
|                             
|                             
|                             
|                             
|Interest expense              |  |           | 45,422    |         |  |            | 7,401   |            |  |           | 2,630   |               |  |              | 4      |   |  |   |      |   |  |   | (6,814   | ) |  |   | 48,643    | 
|                             
|                             
|                             
|                             
|Provision for loan losses     |  |           | 1,131     |         |  |            | 685     |            |  |           | 279     |               |  |              |       |   |  |   |      |   |  |   |         |   |  |   | 2,095     | 
|                             
|                             
|                             
|                             
|Noninterest income            |  |           | 12,594    |         |  |            | 26,566  |            |  |           | 121     |               |  |              | 5,201  |   |  |   | 350   |   |  |   |         |   |  |   | 44,832    | 
|                             
|                             
|                             
|                             
|Noninterest expenses          |  |           | 53,981    |         |  |            | 24,722  |            |  |           | 1,947   |               |  |              | 4,989  |   |  |   | 283   |   |  |   |         |   |  |   | 85,922    | 
|                             
|                             
|                             
|                             
|Income before income taxes    |  |           | 23,173    |         |  |            | 1,152   |            |  |           | 7,122   |               |  |              | 227    |   |  |   | 89    |   |  |   |         |   |  |   | 31,763    | 
|                             
|                             
|                             
|                             
|Income tax expenses (benefit) |  |           | 4,576     |         |  |            | (645    | )          |  |           | 2,990   |               |  |              | 97     |   |  |   |      |   |  |   |         |   |  |   | 7,018     | 
|                             
|                             
|                             
|                             
|Net income                    |  |           | 18,597    |         |  |            | 1,797   |            |  |           | 4,132   |               |  |              | 130    |   |  |   | 89    |   |  |   |         |   |  |   | 24,745    | 
|                             
|                             
|                             
|                             
|Assets                        |  |           | 2,073,176 |         |  |            | 165,385 |            |  |           | 121,224 |               |  |              | 2,137  |   |  |   | 1,776 |   |  |   | (206,770 | ) |  |   | 2,156,928 | 
|                             
|                             
|                             
|                             
|Year ended December 31, 2001  |  |           |           |         |  |            |         |            |  |           |         |               |  |              |        |   |  |   |       |   |  |   |          |   |  |   |           | 
|                             
|                             
|                             
|                             
|Interest and dividend income  |  | $         | 114,045   |         |  | $          | 7,309   |            |  | $         |        |               |  | $            |       |   |  | $ | 38    |   |  | $ | (5,476   | ) |  | $ | 115,916   | 
|                             
|                             
|                             
|                             
|Interest expense              |  |           | 54,970    |         |  |            | 7,780   |            |  |           |        |               |  |              |       |   |  |   |      |   |  |   | (5,476   | ) |  |   | 57,274    | 
|                             
|                             
|                             
|                             
|Provision for loan losses     |  |           | 620       |         |  |            | 597     |            |  |           |        |               |  |              |       |   |  |   |      |   |  |   |         |   |  |   | 1,217     | 
|                             
|                             
|                             
|                             
|Noninterest income            |  |           | 14,601    |         |  |            | 24,912  |            |  |           |        |               |  |              | 4,161  |   |  |   | 251   |   |  |   |         |   |  |   | 43,925    | 
|                             
|                             
|                             
|                             
|Noninterest expenses          |  |           | 48,376    |         |  |            | 22,211  |            |  |           |        |               |  |              | 4,398  |   |  |   | 187   |   |  |   |         |   |  |   | 75,172    | 
|                             
|                             
|                             
|                             
|Income before income taxes    |  |           | 24,680    |         |  |            | 1,633   |            |  |           |        |               |  |              | (237   | ) |  |   | 102   |   |  |   |         |   |  |   | 26,178    | 
|                             
|                             
|                             
|                             
|Income tax expenses (benefit) |  |           | 5,242     |         |  |            | 685     |            |  |           |        |               |  |              | (83    | ) |  |   |      |   |  |   |         |   |  |   | 5,844     | 
|                             
|                             
|                             
|                             
|Net income                    |  |           | 19,438    |         |  |            | 948     |            |  |           |        |               |  |              | (154   | ) |  |   | 102   |   |  |   |         |   |  |   | 20,334    | 
|                             
|                             
|                             
|                             
|Assets                        |  |           | 1,800,246 |         |  |            | 148,000 |            |  |           |        |               |  |              |       |   |  |   |      |   |  |   | (86,807  | ) |  |   | 1,861,439 | 

81



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Note 24  Quarterly Financial Data
(Unaudited)

The following is a summary of the quarterly results of
operations:

|                             |                            |                    |        |              |  |         |        |          |  |   |        |      |  |   |        |      | 
|---------------------------- | -------------------------- | ------------------ | ------ | ------------ |  | ------- | ------ | -------- |  | - | ------ | ---- |  | - | ------ | ---- | 
|                             |                            |                   
|                             |                            | Three Months Ended
|                             |                            |                   
|                             |                            | December 31        |        | September 30 |  | June 30 |        | March 31
|                             |                            |                    |        |              |  |         |        |         
|2003                         |                            |                    |        |              |  |         |        |          |  |   |        |      |  |   |        |     
|                            
|                            
|                            
|                            
|Interest and dividend income |                            | $                  | 32,473 |              |  | $       | 32,157 |          |  | $ | 31,267 |      |  | $ | 31,177 |     
|                            
|                            
|                            
|                            
|Interest expense             |                            |                    | 10,306 |              |  |         | 10,153 |          |  |   | 10,095 |      |  |   | 10,602 |     
|                            
|                            
|                            
|                            
|Provision for loan losses    |                            |                    | 881    |              |  |         | 872    |          |  |   | 909    |      |  |   | 1,035  |     
|                            
|                            
|                            
|                            
|Securities gains             |                            |                    | 121    |              |  |         | 346    |          |  |   | 40     |      |  |   | 4      |     
|                            
|                            
|                            
|                            
|Noninterest income           |                            |                    | 13,681 |              |  |         | 12,381 |          |  |   | 11,723 |      |  |   | 11,425 |     
|                            
|                            
|                            
|                            
|Noninterest expense          |                            |                    | 24,135 |              |  |         | 23,774 |          |  |   | 22,746 |      |  |   | 21,913 |     
|                            
|                            
|                            
|                            
|Income before income taxes   |                            |                    | 10,953 |              |  |         | 10,085 |          |  |   | 9,280  |      |  |   | 9,056  |     
|                            
|                            
|                            
|                            
|Income tax expense           |                            |                    | 2,960  |              |  |         | 2,588  |          |  |   | 2,336  |      |  |   | 2,431  |     
|                            
|                            
|                            
|                            
|Net income                   |                            |                    | 7,993  |              |  |         | 7,497  |          |  |   | 6,944  |      |  |   | 6,625  |     
|                            
|                            
|                            
|                            
|Per share informative:       |                            |                    |        |              |  |         |        |          |  |   |        |      |  |   |        |     
|                            
|                            
|                            
|                            
|                             | Basic earnings per share   |                    | $      | 0.37         |  |         | $      | 0.35     |  |   | $      | 0.33 |  |   | $      | 0.31 | 
|                            
|                            
|                            
|                            
|                             | Diluted earnings per share |                    |        | 0.37         |  |         |        | 0.35     |  |   |        | 0.33 |  |   |        | 0.31 | 
|                            
|                            
|                            
|                            
|                             | Dividends declared         |                    |        | 0.14         |  |         |        | 0.14     |  |   |        | 0.14 |  |   |        | 0.14 | 
|                            
|                            
|                            
|                            
|2002                         |                            |                    |        |              |  |         |        |          |  |   |        |      |  |   |        |     
|                            
|                            
|                            
|                            
|Interest and dividend income |                            | $                  | 31,548 |              |  | $       | 31,646 |          |  | $ | 31,172 |      |  | $ | 29,225 |     
|                            
|                            
|                            
|                            
|Interest expense             |                            |                    | 11,639 |              |  |         | 12,423 |          |  |   | 12,503 |      |  |   | 12,078 |     
|                            
|                            
|                            
|                            
|Provision for loan losses    |                            |                    | 1,077  |              |  |         | 218    |          |  |   | 582    |      |  |   | 218    |     
|                            
|                            
|                            
|                            
|Securities gains             |                            |                    | 20     |              |  |         | (89    | )        |  |   | (407   | )    |  |   | 16     |     
|                            
|                            
|                            
|                            
|Noninterest income           |                            |                    | 12,252 |              |  |         | 10,878 |          |  |   | 11,238 |      |  |   | 10,924 |     
|                            
|                            
|                            
|                            
|Noninterest expense          |                            |                    | 21,803 |              |  |         | 21,206 |          |  |   | 22,217 |      |  |   | 20,696 |     
|                            
|                            
|                            
|                            
|Income before income taxes   |                            |                    | 9,301  |              |  |         | 8,588  |          |  |   | 6,701  |      |  |   | 7,173  |     
|                            
|                            
|                            
|                            
|Income tax expense           |                            |                    | 2,502  |              |  |         | 2,323  |          |  |   | 542    |      |  |   | 1,651  |     
|                            
|                            
|                            
|                            
|Net income                   |                            |                    | 6,799  |              |  |         | 6,265  |          |  |   | 6,159  |      |  |   | 5,522  |     
|                            
|                            
|                            
|                            
|Per share informative:       |                            |                    |        |              |  |         |        |          |  |   |        |      |  |   |        |     
|                            
|                            
|                            
|                            
|                             | Basic earnings per share   |                    | $      | 0.32         |  |         | $      | 0.30     |  |   | $      | 0.29 |  |   | $      | 0.28 | 
|                            
|                            
|                            
|                            
|                             | Diluted earnings per share |                    |        | 0.32         |  |         |        | 0.29     |  |   |        | 0.29 |  |   |        | 0.27 | 
|                            
|                            
|                            
|                            
|                             | Dividends declared         |                    |        | 0.14         |  |         |        | 0.14     |  |   |        | 0.13 |  |   |        | 0.13 | 

Note 25  Subsequent Events

On January 12, 2004, Sterling entered into a definitive
agreement to purchase Corporate Healthcare Strategies, Inc.,
doing business as The Stoudt Companies, a Lancaster,
Pennsylvania, based firm that provides benefit products and
benefit consulting services to medium and large-sized businesses
in the Central Pennsylvania region. Stoudt consists of three
divisions, StoudtAdvisors (employee benefits insurance
consulting and brokerage services), CapRisk (provides financial
protection nationally to employers who self-fund their medical,
dental and prescription plans), and the Lancaster Chamber Health
Plan (a joint partnership with the Lancaster Chamber of Commerce
which includes over 1,200 employer groups in Lancaster
County, Pennsylvania).

82



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##### 



STERLING FINANCIAL CORPORATION AND SUBSIDIARIES


Notes to Consolidated Financial
Statements  (Continued)

Sterling has agreed to issue up to 338,461 shares of its common
stock and pay $8.800 million in cash to acquire the Stoudt
Companies. Up to 30% of the merger consideration is subject to
performance criteria for payment over the next four years.
Assuming that all conditions are satisfied without delay, it is
anticipated that the effective date of the merger will occur
early in the second quarter of 2004.

83



---



##### 






Item 9  Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure

Not applicable.




Item 9A  Controls and Procedures

Disclosure Controls and Procedures are controls and other
procedures that are designed to ensure that information required
to be disclosed in Sterlings reports filed or submitted
under the Securities and Exchange Act of 1934 (the
Exchange Act) is recorded, processed, summarized and
reported within the time periods specified in the Securities and
Exchange Commissions rules and forms. Disclosure Controls
and Procedures include, without limitation, controls and
procedures designed to ensure that information required to be
disclosed in Sterlings reports filed under the Exchange
Act is accumulated and communicated to management, including
Sterlings Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding
required disclosure.

At the end of the period covered by this annual report, Sterling
conducted an evaluation of the effectiveness of the design and
operation of Sterlings disclosure controls and procedures,
as required by Rule 13a-15 under the Exchange Act. This
evaluation was carried out under the supervision and with the
participation of Sterlings management, including its Chief
Executive Officer and Chief Financial Officer. Based upon that
evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that Sterlings controls and procedures
are effective. There have been no changes in Sterlings
internal control over financial reporting that materially
affected, or are reasonably likely to materially affect,
internal control over financial reporting.




Item 10  Directors and Executive Officers of
the Registrant

Incorporated by reference is the information appearing under the
headings Information about Nominees and Continuing
Directors, Executive Officers and Section 16(a)
Beneficial Ownership Reporting Compliance in the 2004
Annual Meeting Proxy Statement.

Sterling has adopted a Code of Ethics, which applies to
Sterlings directors and senior officers, including its
Chief Executive Officer and President, Chief Financial Officer,
and Chief Accounting Officer. This Code of Ethics has been
included as Exhibit 14 to Sterlings 2003 Annual
Report on Form 10-K. We intend to disclose any amendments
to our waivers of a required provision of the Code of Ethics on
our website.




Item 11  Executive Compensation

Incorporated by reference is the information under the headings
Executive Compensation and Sterling Financial
Corporation Directors Compensation in the 2004
Annual Meeting Proxy Statement.






|          |                                                                                                   
|--------- | --------------------------------------------------------------------------------------------------
|Item 12  | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters

Incorporated by reference is the information appearing under the
headings Principal Holders and Beneficial
Ownership of Executive Officers, Directors and Nominees in
the 2004 Annual Meeting Proxy Statement.




Item 13  Certain Relationships and Related
Transactions

Incorporated by reference is the information appearing under the
heading Transactions with Directors and Executive
Officers in the 2004 Annual Meeting Proxy Statement and
under Notes to Consolidated Financial
Statements  Note 18  Related Party
Transactions located elsewhere in this Form 10-K.




Item 14  Principal Accountant Fees and
Services

Incorporated by reference is the information appearing under the
heading Report of the Audit Committee in the 2004
Annual Meeting Proxy Statement.

84



---



##### 






Item 15  Exhibits, Financial Statements and
Reports on Form 8-K

|    |  |                                                                                                                                                                                                                                          |  |                                                                                                                                                                                                                                                                                                                                                                                   
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | The following documents are filed as part of this
    report:                                                                                                                                                                           
|    |  | The financial statements listed on the index set
    forth in Item 8 of this Annual Report on Form 10-K are
    filed as part of this Annual Report.                                                                                    
|    |  | Financial statement schedules  all schedules are omitted because they are
either not applicable, the data is not significant or the required information is shown in the
financial statements or the notes thereto or elsewhere herein.
|    |  | Exhibits  the following is a list of
    Exhibits required by Item 601 of Regulation S-K and
    are incorporated by reference herein or annexed to this Annual
    Report.                                                            
|    |  | 3(i)                                                                                                                                                                                                                                     |  | Amended Articles of Incorporation. (Incorporated
    by reference to Exhibit 3(i) to Registrants Current
    Report on Form 8-K, dated April 30, 2002, filed with
    the Commission on May 15, 2002.)                                                                                                                                                                           
|    |  | 3(ii)                                                                                                                                                                                                                                    |  | Amended Bylaws. (Incorporated by reference to
    Exhibit 3(ii) to Registrants Current Report on
    Form 8-K, dated and filed with the Commission on
    April 25, 2000.)                                                                                                                                                                                                       
|    |  | 10.1                                                                                                                                                                                                                                     |  | 1996 Stock Incentive Plan (Incorporated by
    reference to Exhibit 4.3 of Registration Segment
    No. 333-28065 on Form S-8, filed with the Commission
    on May 30, 1997.)                                                                                                                                                                                                    
|    |  | 10.2                                                                                                                                                                                                                                     |  | Dividend Reinvestment and Stock Purchase Plan
    (Incorporated by reference to Registration Statement
    No. 33-55131 on Form S-3, filed with the Commission on
    August 18, 1994, and as amended by Registrants
    Rule 424 (b) prospectus, filed with the Commission on
    December 23, 1998, and by Amendment No. 1, filed with
    the Commission on January 16, 2001.)
|    |  | 10.3                                                                                                                                                                                                                                     |  | Stock Disposition Agreement, dated
    September 6, 2001, by and between Howard E. Groff,
    Sr., and Sterling Financial Corporation. (Incorporated by
    reference to Exhibit 99.1 in Registrants Current
    Report on Form 8-K, dated September 6, 2001, and filed
    with the Commission on September 26, 2001.)                                                          
|    |  | 10.4                                                                                                                                                                                                                                     |  | 1997 Directors Stock Compensation Plan and
    Policy. (Incorporated by reference to Exhibit 4.3 to
    Registrants Registration Statement No. 333-28101 on
    Form S-8, filed with the Commission on May 30, 1997.)                                                                                                                                                            
|    |  | 10.5                                                                                                                                                                                                                                     |  | Supplemental Executive Retirement Agreement,
    dated April 22, 2002, between Sterling Financial
    Corporation and John Stefan. (Incorporated by reference to
    Exhibit 10.1 to Registrants Current Report on
    Form 8-K, dated April 30, 2002, filed with the
    Commission on May 15, 2002.)                                                                           
|    |  | 10.6                                                                                                                                                                                                                                     |  | Consulting Agreement and General Release, dated
    April 22, 2002, between Sterling Financial Corporation and
    John E. Stefan. (Incorporated by reference to
    Exhibit 10.2 to Registrants Current Report on
    Form 8-K, dated April 30, 2002, filed with the
    Commission on May 15, 2002.)                                                                           
|    |  | 10.7                                                                                                                                                                                                                                     |  | Employment Agreement, dated December 18,
    2001, between Sterling Financial Corporation, Bank of Lancaster
    County, N.A. and J. Roger Moyer, Jr. (Incorporated by
    reference to Exhibit 10.6 to Registrants Statement
    No. 333-75650 on Form S-4, filed with the Commission
    on January 16, 2002.)                                                                 
|    |  | 10.8                                                                                                                                                                                                                                     |  | Employment Agreement, dated July 23, 2002,
    between Sterling Financial Corporation, Bank of Lancaster
    County, N.A. and Thomas P. Dautrich. (Incorporated by
    reference to Exhibit 10 to Registrants Quarterly
    Report on 10-Q for the quarter-ended June 30, 2002, filed
    with the Commission on August 14, 2002.)                                               
|    |  | 10.9                                                                                                                                                                                                                                     |  | Employment Agreement, dated as of
    February 28, 2002, between Sterling Financial Corporation,
    Bank of Lancaster County, N.A. and J. Bradley Scovill.
    (Incorporated by reference to Exhibit 10.10 to
    Registrants Annual Report on Form 10-K for the year
    ended December 31, 2001, filed with the Commission
    March 27, 2002.)                               

85



---



##### 



| |  |       |  |                                                                                                                                                                                                                                                                                                                             
| |  | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 10.10 |  | Change in Control Agreement, dated as of
    July 27, 2000, between Sterling Financial Corporation, Bank
    of Hanover, and Chad M. Clabaugh (Incorporated by reference
    to Exhibit 10.10 to Registrants Annual Report on
    Form 10-K, dated December 31, 2002, and filed with the
    Commission on March 27, 2003).
| |  | 10.11 |  | Employment Agreement, dated as of
    December 1, 2000, between Sterling Financial Corporation,
    Bank of Lancaster County, N.A., and Gregory S. Lefever.                                                                                                                                                                 
| |  | 14    |  | Code of Ethics                                                                                                                                                                                                                                                                                                              
| |  | 21    |  | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                              
| |  | 23    |  | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                                
| |  | 31    |  | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                                                                                                                                                                                                     
| |  | 31.1  |  |  Certification of CEO Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                        
| |  | 31.2  |  |  Certification of CFO Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                        
| |  | 32    |  | Section 1350 Certifications                                                                                                                                                                                                                                                                                                 
| |  | 32.1  |  |  Certification of CEO Pursuant to 18
    U.S.C. Section 1350, as Adopted Pursuant to 906 of the
    Sarbanes Oxley Act of 2002                                                                                                                                                                                             
| |  | 32.2  |  |  Certification of CFO Pursuant to 18
    U.S.C. Section 1350, as Adopted Pursuant to 906 of the
    Sarbanes Oxley Act of 2002                                                                                                                                                                                             

Copies of the Exhibits referenced above will be provided to
Shareholders without charge by writing to Shareholder Relations,
Sterling Financial Corporation, 101 North Pointe Boulevard,
Lancaster, PA 17601-4133.

(b) Reports on Form 8-K

During the quarter ended December 31, 2003, the registrant
filed the following reports on Form 8-K.

|                  |  |      |       |             |  |                                                                                                                                                
|----------------- |  | ---- | ----- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|Date of Report    |  | Item |       | Description
|                  |  |      |       |            
|October 1, 2003   |  |      | 5     |             |  | Registrant filed a press release announcing
    agreement to purchase Church Capital Management, Bainbridge
    Securities, Inc.               
|October 15, 2003  |  |      | 5     |             |  | Registrant filed a press release announcing the
    completion of its acquisition of Church Capital Management,
    Bainbridge Securities, Inc.
|October 28, 2003  |  |      | 9, 12 |             |  | Registrant filed a press release announcing
    results of operations for the quarter and nine months ended
    September 30, 2003             
|November 4, 2003  |  |      | 9     |             |  | Slide presentation from Mid-Atlantic 2003 Super
    Community Bank Conference in Philadelphia, Pennsylvania                                    
|November 18, 2003 |  |      | 5     |             |  | Registrant filed a press release announcing the
    fourth quarter dividend declaration                                                        
|December 22, 2003 |  |      | 5     |             |  | Announcement of Michael A. Carenzo and David E.
    Hosler as financial experts on Sterlings audit
    committee                            

86



---



##### 



Signatures

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



| |                               
| | ------------------------------
| | STERLING FINANCIAL CORPORATION



| |     |                        
| | --- | -----------------------
| | By: | /s/ J. ROGER MOYER, JR.

| |                                      
| | -------------------------------------
| |                                      
| | J. Roger Moyer, Jr.                  
| | President and Chief Executive Officer

|                                                       |  |                                                                            |  |               
|------------------------------------------------------ |  | -------------------------------------------------------------------------- |  | --------------
|Signature                                              |  | Title                                                                      |  | Date          
|                                                       |  |                                                                            |  |               
|/s/ JOHN E. STEFAN(John E. Stefan)                     |  | Chairman of the Board                                                      |  | March 12, 2004
|                                                      
|/s/ J. ROGER MOYER, JR.(J. Roger Moyer, Jr.)           |  | President and Chief Executive Officer, Director                            |  | March 12, 2004
|                                                      
|/s/ J. BRADLEY SCOVILL(J. Bradley Scovill)             |  | Senior Executive Vice President, Chief Financial
    Officer and Treasurer |  | March 12, 2004
|                                                      
|/s/ DOUGLAS P. BARTON(Douglas P. Barton)               |  | Vice President, Chief Accounting Officer and
    Secretary                 |  | March 12, 2004
|                                                      
|/s/ RICHARD H. ALBRIGHT, JR.(Richard H. Albright, Jr.) |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ MICHAEL A. CARENZO(Michael A. Carenzo)             |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ BERTRAM F. ELSNER(Bertram F. Elsner)               |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ HOWARD E. GROFF, JR.(Howard E. Groff, Jr.)         |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ JOAN R. HENDERSON(Joan R. Henderson)               |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ TERRENCE L. HORMEL(Terrence L. Hormel)             |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ DAVID E. HOSLER(David E. Hosler)                   |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ W. GARTH SPRECHER(W. Garth Sprecher)               |  | Director                                                                   |  | March 12, 2004
|                                                      
|/s/ GLENN R. WALZ(Glenn R. Walz)                       |  | Director                                                                   |  | March 12, 2004

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