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	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

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.

Sterling Financial Corporation

Table of Contents

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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.

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

(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

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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.

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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.

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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

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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

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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

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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

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      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.

      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.

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Item 6 — Selected Financial Data

(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.

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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

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      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.

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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.

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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.

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