THE MERGER

      The following information describes the material terms and provisions of the merger. This description is not complete. We qualify this discussion in its entirety by reference to the merger agreement, which we

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General.

      The merger agreement provides that:

Background of the Merger.

      Pennsylvania was organized as a Pennsylvania business corporation and incorporated under Pennsylvania law in July, 2003 for the purpose of acquiring Pennsylvania State Bank and thereby enabling Pennsylvania State Bank to operate within a bank holding company structure. Pennsylvania became an active bank holding company on January 1, 2004, when it acquired Pennsylvania State Bank as a wholly owned subsidiary.

      Since January, 2001, when Thomas J. Sposito, II, became President and Chief Executive Officer of Pennsylvania State Bank, the bank’s board of directors and senior executive officers have conducted planning sessions annually to review the bank’s business operations and its strategic alternatives. In late 2003, in anticipation of such a session to have been held by the Pennsylvania board of directors in May, 2004, Mr. Sposito requested Janney Montgomery Scott LLC to prepare an analysis of various strategic business combinations that Pennsylvania might consider. For purposes of the analysis, Mr. Sposito identified to Janney potential “target” banking institutions that Pennsylvania might acquire, “merger of equals” candidates, and upstream buyers of Pennsylvania. Sterling was included among the potential upstream buyers.

      On January 12, 2004, Janney delivered a draft of its analysis to Mr. Sposito and Mr. Sposito met for dinner with a representative of Janney, on January 13, 2004, to discuss the draft analysis. The draft analysis included a valuation analysis of Pennsylvania, a summary of current trends in the merger and acquisition of financial institutions, an evaluation of the ability to pay by the identified potential buyers and pro forma combination analyses of possible combinations with the identified parties.

      Prior to this time, no serious merger discussions occurred between Pennsylvania and Sterling. Mr. Sposito and Thomas P. Dautrich, Chief Banking Officer of Sterling, however, are former colleagues,

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      On February 5, 2004, Messrs. Sposito and Dautrich met for dinner and again discussed the possibility of combining Pennsylvania with Sterling. Promptly following that dinner meeting, Mr. Sposito met with William E. Miller, Jr., Chairman of the Board of Directors of Pennsylvania, and reported Sterling’s potential interest in a business combination with Pennsylvania and shared with Mr. Miller the draft analysis prepared by Janney and delivered to Mr. Sposito in January.

      On February 11, 2004, Mr. Miller met with Mr. Dautrich. Mr. Dautrich presented to Mr. Miller an introduction of Sterling and its business model. No definitive merger discussions occurred at that meeting.

      On February 24, 2004, Messrs. Sposito and Miller met with Michael A. Carenzo and Terrence L. Hormel, directors of Sterling. Mr. Carenzo is Chairman of the Board of Directors of First National Bank of North East, a Sterling subsidiary, and Mr. Hormel is Chairman of the Board of Directors of Bank of Hanover and Trust Company, also a Sterling subsidiary. Mr. Sposito also met with J. Bradley Scovill, Sterling’s Chief Financial Officer, on March 4, 2004. Mr. Scovill was President and Chief Executive Officer of Bank of Hanover and Trust Company from 1994 to 2002.

      The purposes of these meetings were to enable Messrs. Sposito and Miller to discuss with Messrs. Carenzo, Hormel, as directors, and Mr. Scovill, as an executive officer, their respective experiences in connection with Sterling’s prior acquisitions of First National Bank of North East and Bank of Hanover and Trust Company and the subsequent operation of those institutions as separately chartered subsidiaries of Sterling, including the continuing role of each institution’s board of directors, operations and organizational support.

      On March 12, 2004, Messrs. Sposito and Miller met with representatives of Rhoads & Sinon LLP, informed them of the discussions that had taken place with representatives of Sterling and engaged Rhoads & Sinon as legal counsel to Pennsylvania in connection with further discussions and negotiations with Sterling.

      Also on March 12, 2004, Mr. Sposito received a letter, dated March 11, 2004, from Mr. Dautrich expressing Sterling’s interest in a possible merger with Pennsylvania; Sterling’s desire to separately maintain the Pennsylvania State Bank charter and continue to conduct business under the Pennsylvania State Bank name and brand; and Sterling’s intent to preserve the Pennsylvania State Bank board of directors and minimize the displacement of Pennsylvania State Bank employees. Mr. Dautrich further identified, as benefits to such a transaction, the long term employment opportunities available to Sterling employees; the array of products and services offered by Sterling; Sterling’s greater depth of resources; and Sterling’s superior record of financial performance.

      Mr. Sposito met with J. Roger Moyer, Jr., President and Chief Executive Officer of Sterling, on March 15, 2004, during which they discussed Mr. Sposito’s continuing role as President and Chief Executive Officer of Pennsylvania State Bank in the event a merger of Pennsylvania with Sterling could be negotiated and completed.

      On March 16, 2004, during an executive session occurring after adjournment of Pennsylvania’s regularly scheduled board of directors meeting, Messrs. Miller and Sposito reported to the Pennsylvania Board of Directors on their discussions with Sterling and reviewed Mr. Dautrich’s March 11, 2004 letter with the Board of Directors. At that time, the Board of Directors directed Messrs. Miller and Sposito to continue discussions with Sterling.

      On March 19, 2004, Sterling and Pennsylvania entered into a confidentiality agreement. Discussions between Messrs. Miller and Sposito and representatives of Sterling, including Messrs. Moyer, Dautrich,

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      By letter dated as of March 24, 2004, Pennsylvania engaged Janney as its financial advisor in connection with its discussions and negotiations with Sterling.

      On March 31, 2004, Messrs. Miller and Sposito updated the Pennsylvania Board of Directors on their discussions with Sterling. Representatives of Janney also met with the Pennsylvania Board of Directors and reviewed an update of the draft analysis delivered to Mr. Sposito in January, with additional modeling of a possible business combination with Sterling.

      On April 12, 2004, Sterling submitted to Pennsylvania, a written, non-binding indication of interest, including the per share price and form of consideration, the treatment of outstanding stock options, ongoing board representation, the ongoing role of senior executives, severance for employees who might not continue their employment following the transaction, and termination events and fees. Throughout April, representatives of Sterling and Pennsylvania continued to meet and discuss the terms for a potential transaction, including the strategic direction for the combined entity, personnel and integration issues, potential cost savings and revenue enhancements, and pricing.

      On April 13, 2004, representatives of Janney met with Pennsylvania’s Board to discuss Sterling’s indication of interest, as well as an updated analysis of a possible business combination.

      On April 19, 2004, counsel to Sterling delivered a draft merger agreement to Sterling, Pennsylvania and their advisors. During April and May, several drafts of the merger agreement and related documents were circulated and negotiated by the parties and their respective advisors. Issues addressed by the parties during this period included:

      Mr. Sposito and Mr. Miller met on May 4, 2004 with representatives of National Penn Bancshares, Inc., which holds approximately 20% of Pennsylvania’s outstanding shares of common stock. At that time, Mr. Sposito reviewed the status of negotiations with Sterling and requested National Penn’s support for the transaction. After several weeks of negotiation, National Penn agreed to support the proposed Pennsylvania-Sterling merger. See “The Merger — Interests of Management and Others in the Merger — Interest of National Penn,” on page      of this document.

      At its regularly scheduled meeting on, May 18, 2004, Pennsylvania’s Board of Directors received an update from Mr. Sposito on the negotiation of the merger agreement. Representatives of Janney reviewed the business terms that were being discussed and presented an analysis of the merger consideration being proposed. Representatives of Rhoads & Sinon reviewed the terms and conditions of the proposed merger agreement and identified open issues in the negotiation that were then unresolved. Extensive discussion ensued and the Board of Directors provided direction with respect to their desired resolution of the open issues.

      Over the next several weeks, the negotiations were completed.

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      On June 10, 2004, the Pennsylvania Board of Directors met to consider and approve the merger agreement. Representatives of Rhoads & Sinon reviewed the terms and conditions of the merger agreement. Representatives of Janney reviewed the business terms of the transaction and delivered their oral opinion that the merger consideration, as of June 10, 2004, was fair to the Pennsylvania shareholders from a financial point of view. Janney subsequently delivered its written fairness opinion dated June 14, 2004. See “The Merger — Opinion of Pennsylvania’s Financial Advisor,” on page      of this document. After extensive discussion and in reliance upon the reports of its advisors, the Pennsylvania Board of Directors unanimously approved the merger agreement, subject to management’s negotiation of final, non-material terms.

      Pennsylvania and Sterling executed the definitive merger agreement on the morning of June 14, 2004, and publicly announced the transaction later that morning.

Reasons for the Merger: Pennsylvania’s Board of Directors.

      At its meeting on June 10, 2004, the Pennsylvania Board of Directors determined that the terms of the merger agreement and the merger transaction with Sterling were in the best interests of Pennsylvania. In making this determination, the Board concluded that the transaction with Sterling was superior to the other alternatives available to Pennsylvania and to the prospects of continuing to operate Pennsylvania as an independent, community-focused banking company.

      In the course of reaching its decision to approve the merger agreement, the Pennsylvania Board of Directors consulted with Janney Montgomery Scott LLC, its financial adviser, and Rhoads & Sinon LLP, its legal counsel. The Board considered, among other things, the factors described above and the following:

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      The foregoing discussion of the information and factors considered by the Pennsylvania Board of Directors is not intended to be exhaustive but is believed to include all material factors considered by the Pennsylvania Board of Directors. In reaching its determination to approve and recommend the transaction, the Pennsylvania Board of Directors did not assign any relative or specific weights to the foregoing or other factors. Rather, the Board based its recommendation on the totality of the information presented to it. In addition, individual directors may have given differing weights to different factors.

      After deliberating with respect to the merger transaction with Sterling, considering, among other things, the matters discussed above and the opinion of Janney referred to above, the Pennsylvania Board of Directors unanimously approved and adopted the merger agreement and the merger with Sterling.

      There can be no certainty that the benefits of the merger anticipated by the Pennsylvania Board of Directors will occur. Actual results may vary materially from those anticipated. For more information on the factors that could offset actual results, see “A Warning About Forward–Looking Information,” at page      and “Risk Factors,” at page      .

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Recommendation of the Pennsylvania Board of Directors.

      The Pennsylvania Board of Directors has unanimously approved the merger and the merger agreement, and believes that the proposed merger is in the best interests of Pennsylvania. Accordingly, the Pennsylvania Board of Directors unanimously recommends that Pennsylvania shareholders vote “FOR” approval of the merger agreement and the merger.

Opinion of Pennsylvania’s Financial Advisor.

      By letter dated as of March 24, 2004, Pennsylvania retained Janney Montgomery Scott LLC to act as its financial advisor in connection with a possible business combination with another financial institution. Janney is a nationally recognized investment banking firm whose principal business specialty is financial institutions. In the ordinary course of its investment banking business, Janney is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

      Pursuant to the terms of its agreement, Janney was retained by Pennsylvania to act as its financial advisor in connection with a possible business combination with select other institutions. Pennsylvania selected Janney because of Janney’s knowledge of, experience with, and reputation in the financial services industry. Janney agreed to assist Pennsylvania in analyzing, structuring, negotiating and effecting a possible merger. Janney, as part of its investment banking business, is engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

      Pennsylvania’s board considered and approved the merger agreement at the June 10, 2004 Board meeting. Janney delivered to the Board of Directors its verbal opinion on June 10, 2004, and its written opinion on June 14, 2004, that as of June 10, 2004, the merger consideration was fair to Pennsylvania’s shareholders from a financial point of view.

      The full text of Janney’s opinion is attached as Annex D to this document. Pennsylvania’s shareholders are urged to read the opinion in its entirety for a description of the procedures followed, assumptions made, matters considered, and qualifications and limitations on the review undertaken by Janney in rendering its opinion. The description of the opinion set forth below is qualified in its entirety by reference to the opinion.

      Janney’s opinion speaks only as of the date of the opinion. The opinion was directed to the Pennsylvania Board of Directors and addresses only the fairness, from a financial point of view, of the consideration offered in the merger. It does not address the underlying business decision of Pennsylvania to proceed with the merger or any other aspect of the merger and does not constitute a recommendation to any Pennsylvania shareholder as to how the shareholder should vote at the special meeting on the merger or any related matter.

      In rendering its opinion, Janney has, among other things:

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      In performing its review and in rendering its opinion, Janney has relied upon the accuracy and completeness of all of the financial and other information that was available to it from public sources, that was provided to it by Pennsylvania or Sterling or their respective representatives, or that was otherwise reviewed by Janney, and has assumed its accuracy and completeness for purposes of rendering its opinion. Janney has further relied on the assurances of the management of Pennsylvania and of Sterling that they are not aware of any facts or circumstances that would make any of the information inaccurate or misleading. Janney has not been asked to and has not undertaken any independent verification of any of the information and Janney does not assume any responsibility or liability for the accuracy or completeness thereof. Janney did not make an independent evaluation or appraisal of the specific assets, the collateral securing assets or the liabilities (contingent or otherwise) of Pennsylvania or of Sterling or any of their subsidiaries, or the collectibility of any such assets, nor has Janney been furnished with any such evaluations or appraisals. Janney did not make any independent evaluation of the adequacy of the allowance for loan losses of Pennsylvania or of Sterling or any of their subsidiaries and Janney has not reviewed any individual credit files and has assumed that their respective allowance for loan losses are adequate to cover their losses and will be adequate on a pro forma basis.

      The earnings projections for Pennsylvania and for Sterling used by Janney in certain of its analyses were based upon internal financial projections, in the case of Pennsylvania, and upon discussions with management and published earnings estimates, in the case of Sterling. The financial projections provided by management of Pennsylvania and of Sterling were prepared for internal purposes only and not with a view towards public disclosure. These projections, as well as other estimates used by Janney in its analyses, were based on numerous variables and assumptions that are inherently uncertain, and accordingly, actual results could vary materially from those set forth in the projections.

      In performing its analyses, Janney also made numerous assumptions with respect to industry performance, business, economic and market conditions and various other matters, many of which cannot be predicted and are beyond the control of Pennsylvania and of Sterling. The analyses performed by Janney are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. Estimates on the values of companies do not purport to be appraisals or necessarily reflect the prices at which companies or their securities may actually be sold. Accordingly, these analyses and estimates are inherently subject to substantial uncertainty. Janney prepared its analyses solely for purposes of rendering its opinion and provided such analyses to the Pennsylvania Board on June 10, 2004. In addition, the Janney opinion was among several factors taken into consideration by the Pennsylvania Board of Directors in making its decision to approve the merger agreement and the merger.

      The following is a summary of the material analyses performed by Janney and presented to the Pennsylvania Board on June 10, 2004. The summary is not a complete description of all the analyses underlying Janney’s opinion. The preparation of a fairness opinion is a complex process involving subjective judgments as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances. Therefore, a fairness opinion is not readily susceptible to partial analysis or summary description. Janney believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses considered, without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors and analyses, could create an incomplete view of the evaluation process underlying its opinion. The financial analyses summarized below

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      Summary of Proposal. Janney reviewed the financial terms of the proposed transaction. Based upon the average closing price of Sterling’s common stock for the 20 trading days ending June 9, 2004, which was $24.92 and assuming 75% of the consideration is paid in Sterling stock and 25% of the consideration paid in cash, Janney calculated an implied transaction value of $21.01 per share. Based upon Pennsylvania’s financial information, as of and for the twelve months ended March 31, 2004, Janney calculated the following ratios:

Transaction Ratios

      For purposes of Janney’s analyses, earnings per share were based on fully diluted earnings per share, and the aggregate transaction value was approximately $46 million, based upon 2.1 million shares of Pennsylvania common stock outstanding and including the intrinsic value of options to purchase 227,221 shares with a weighted average exercise price of $9.39.

      Stock Trading History. Janney reviewed the history of the reported trading prices and volume of Sterling’s common stock and the relationship between the movements in the prices of Sterling’s common stock and Pennsylvania’s common stock, respectively, to movements in certain stock indices, including the Standard & Poor’s 500 Index, the NASDAQ Bank Index, and the median performance of a composite peer group of publicly traded regional commercial banking institutions selected by Janney. During the one-year period ended June 9, 2004, Pennsylvania’s common stock outperformed each of the indices to which it was compared while Sterling’s common stock outperformed each of the indices as well.

One-Year Stock Performance of Sterling and Pennsylvania

      Selected Peer Group Analyses. Janney compared the financial performance and market performance of Pennsylvania to those of a group of Pennsylvania community banks and bank holding companies and of

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      Companies included in Sterling’s peer group were:

      For purposes of such analysis, the financial information used by Janney was as of and for the twelve months ended March 31, 2004. Stock price information was as of June 9, 2004. Certain financial data prepared by Janney, and as referenced in the tables presented below, may not correspond to the data presented in Pennsylvania’s and Sterling’s historical financial statements, as a result of the different periods, assumptions and methods used by Janney to compute the financial data presented.

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      The results of this analysis are summarized in the following table:

      Comparable Transactions Analysis. Janney reviewed certain financial data related to four sets of comparable bank transactions.

      The first group of comparable transactions included 54 acquisitions of bank institutions nationwide, announced from June 9, 2003 to June 9, 2004, with an asset size between $100 million and $300 million (which we refer to as the Nationwide transactions). The second group of transactions included fourteen transactions of bank institutions in Pennsylvania, announced from September 1, 2002 to June 9, 2004 (which we refer to as the Regional transactions). The third group of comparable transactions included thirteen acquisitions of bank institutions nationwide, announced from June 9, 2003 to June 9, 2004, with an asset size between $100 million and $300 million, with the selling institutions having a return on average assets between 0.50% & 1.00% and return on average equity between 8.0%-12.0% (which we refer to as Performance-Based transactions). The fourth group of comparable transactions included twenty-nine acquisitions of bank institutions nationwide, announced from June 9, 2003 to June 9, 2004, with an asset size between $100 million and $300 million, with the selling institutions having a tangible equity/assets ratio between 7.0%-9.0% (which we refer to as Tangible Equity-Based transactions).

      Transaction multiples from the merger were derived from the $21.01 deal price per share and financial data as of and for the twelve months ended March 31, 2004, for Pennsylvania. Janney compared these

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      No company or transaction used in the Comparable Transaction Analysis is identical to Pennsylvania, Sterling or the merger. Accordingly, an analysis of these results is not mathematical. Rather, it involves complex considerations and judgments concerning the differences in financial and operating characteristics of the companies involved.

      Discounted Dividend Analysis. Janney estimated the present value of Pennsylvania’s common stock based on a continued independence scenario by estimating the future stream of after-tax dividend flows of Pennsylvania over the period beginning November 2004 and ending in December 2009. Based on discussions with Pennsylvania’s management an earnings growth rate of 7.5% was used to project these streams of dividend flows. To approximate the terminal value of Pennsylvania’s common stock at December 31, 2009, Janney applied price/earnings multiples ranging from 14.0x to 22.0x and multiples of tangible book value ranging from 150% to 250%. The dividend income streams and terminal values were then discounted to present values using discount rates ranging from 8.0% to 12.0%. The discount rates were chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Pennsylvania common stock. This analysis indicated an implied range of values from $7.99 to $15.19 when applying the price/earnings multiples and $10.47 to $21.13 when applying multiples of tangible book value.

      Janney also estimated the present value of Sterling’s common stock based on a continued independence scenario by estimating the future stream of after-tax dividend flows of Sterling over the period beginning November 2004 and ending in December 2009. Based on published earnings estimates and discussions with management, an earnings growth rate of 10.0% was used to project these streams of dividend flows. To approximate the terminal value of Sterling’s common stock at December 31, 2009, Janney applied price/earnings multiples ranging from 12.0x to 20.0x and multiples of tangible book value ranging from 240% to 300%. The dividend income streams and terminal values were then discounted to present values using discount rates ranging from 8.0% to 12.0%. The discount rates were chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Sterling’s common stock. This analysis indicated an implied range of values from $18.66 to $35.31, when applying the price/earnings multiples, and $21.80 to $32.01, when applying multiples of tangible book value.

      In connection with the discounted dividend analysis performed, Janney considered and discussed with Pennsylvania’s Board how the present value analysis would be affected by changes in the underlying assumptions, including variations with respect to the growth rate of assets, net income and the dividend payout ratio (in other words, the percentage of adjusted earnings per share payable to shareholders). Janney noted that the discounted dividend analysis is a widely used valuation methodology but noted that it relies on numerous assumptions that must be made, and the results thereof are not necessarily indicative of the actual values or expected values of Pennsylvania or Sterling common stock.

      Financial Impact Analysis. Janney performed a pro forma merger analysis that combined projected balance sheet and income statement information of Sterling and of Pennsylvania. Certain assumptions regarding acquisition adjustments and cost savings were used to calculate the financial impact that the

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      Janney has acted as financial advisor to Pennsylvania in connection with the merger and will receive a fee for its services, a portion of which is contingent upon the consummation of the merger. Pennsylvania will pay Janney an advisory fee equal to between .85% and 1.05% of the aggregate consideration received by Pennsylvania shareholders. The specific percentage to be utilized will depend upon the value of the offer per share of Pennsylvania common stock at the time of the merger. Based on the 10 day average closing price of Sterling’s common stock on July 30, 2004, Janney’s fee would be equal to .95% of the aggregate consideration received by Pennsylvania shareholders, or approximately $427,391, of which $158,154 was paid to Janney by Pennsylvania at the time the merger agreement was signed. In addition, Pennsylvania has agreed to reimburse certain of Janney’s reasonable out-of-pocket expenses incurred in connection with its engagement and has also agreed to indemnify Janney for certain liabilities arising out of rendering this opinion. In addition, in the ordinary course of its business as a broker-dealer, Janney may, from time to time, have a long or short position in, and buy or sell, debt or equity securities of Pennsylvania or Sterling for its own account or for the accounts of its customers.

Reasons for the Merger: Sterling’s Board of Directors

      Sterling’s acquisition strategy consists of identifying financial institutions with business philosophies that are similar to those of Sterling, that operate in markets that geographically complement Sterling’s operations, and have strong management teams. In evaluating acquisition opportunities, Sterling considers its three long-range master strategies — a financial strategy, a customer strategy and a people strategy. Sterling, from time to time, reviews its strategic plan to analyze its geographic scope, financial performance and diversification of business lines. Expansion of Sterling’s franchise into Pennsylvania’s State capital region has been among Sterling’s priorities in its strategic plan. Sterling has explored a number of opportunities to expand its branch footprint into the Dauphin and Cumberland County, Pennsylvania area; however, Sterling’s Board of Directors concluded that the acquisition of Pennsylvania was the best alternative to accomplish this business objective. As part of the acquisition analysis process, Sterling engaged Griffin Financial Group LLC to provide financial advice with regard to a transaction with Pennsylvania.

      Sterling’s Board of Directors held a special meeting on May 19, 2004, to consider the proposed transaction. At that meeting, representatives of Griffin Financial presented a detailed analysis of the proposed transaction with Pennsylvania and legal counsel to Sterling reviewed in detail the terms of the merger agreement. Following a comprehensive discussion of the transaction and the information presented by Sterling’s advisors, the board approved the agreement subject to management’s negotiation of final non-material terms. Over the next several weeks, the negotiations were completed and the parties executed the definitive agreement on the morning of June 14, 2004, and publicly announced the transaction later that morning. On June 14, 2004, Griffin Financial advised Sterling’s Board of Directors by written opinion to the Board, that in the opinion of Griffin Financial, and based on facts known to it on that date, and subject to the qualifications and limitations on the review undertaken by Griffin Financial in rendering the opinion, the consideration to be paid in the merger by Sterling was fair, from a financial point of view, to Sterling.

      In connection with its approval of the merger with Pennsylvania, Sterling’s Board of Directors reviewed the terms of the proposed acquisition and definitive agreements and their potential impact on Sterling. In reaching its decision to approve the merger, Sterling’s Board of Directors, with the assistance

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      The discussion and factors considered by Sterling’s Board of Directors is not intended to be exhaustive, but includes all factors considered. In approving the merger and ancillary agreements, Sterling’s Board did not specifically identify any one factor or group of factors as being more significant than any other factor in the decision making process. Rather, Sterling’s Board of Directors based its recommendation on the totality of information presented to it. In addition, individual members of the Sterling Board may have given differing weight or priority to different factors.

      We cannot provide certainty that the above benefits of the merger anticipated by the Sterling Board will occur. Actual results may vary materially from those anticipated. For more information on the factors that could affect actual results, see “A Warning About Forward-Looking Information,” at page      and “Risk Factors,” at page      .

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Terms of the Merger

      Upon completion of the merger, Pennsylvania will be merged with and into Sterling and the separate legal existence of Pennsylvania will cease. All property, rights, powers, duties, obligations, debts and liabilities of Pennsylvania will automatically be deemed transferred to Sterling, as the surviving corporation in the merger. Sterling will continue to be governed by its articles of incorporation and bylaws as in effect immediately prior to the merger.

      For at least three years following the merger, Pennsylvania State Bank will operate as a separate subsidiary of Sterling and will continue to be managed by its current Board of Directors, with the addition of Thomas P. Dautrich, Chief Banking Officer of Sterling.

      Each share of Pennsylvania stock that you hold at the effective time of the merger will automatically be exchanged into the right to receive either $22.00 in cash or Sterling common stock. The number of shares of Sterling common stock that you may receive in exchange for your shares of Pennsylvania common stock depends on the average closing sales price of Sterling common stock as reported on the NASDAQ National Market for the 20 consecutive trading days (the average final price) ending three business days immediately prior to the effective date (the determination date).

      If the average final price of Sterling common stock on the determination date is:

      You will not know the exchange ratio until the determination date. On the determination date, the exchange ratio will be fixed. However, if you receive Sterling common stock as consideration, the value of the stock consideration will fluctuate with the market price of Sterling common stock between the determination date and the date you actually receive certificates representing the stock and may be higher or lower than the value of the stock consideration on the determination date.

      The market value of the stock consideration you receive in the merger will be equal to the product of (i) the number of shares of Pennsylvania common stock that you own, multiplied by (ii) the applicable per share exchange ratio determined based on the average final price of Sterling common stock on the determination date, multiplied by (iii) the market value of a share of Sterling common stock on the effective date of the merger.

      In addition, Sterling will not issue fractional shares of Sterling common stock to Pennsylvania shareholders. If you are otherwise entitled to receive a fractional share of Sterling common stock under the exchange procedure described above, you will instead have the right to receive cash, without interest, in an amount equal to the product of the fraction of a share that would otherwise be due to you and the average final price of Sterling common stock on the determination date.

      Regardless of the average final price of Sterling common stock on the determination date, you may elect to receive all cash, all Sterling common stock or a combination of cash and Sterling common stock for your shares of Pennsylvania common stock.

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      Under the terms of the merger agreement, between 70% and 75% of the outstanding shares of Pennsylvania common stock will be exchanged for Sterling common stock and between 25% and 30% of the outstanding shares of Pennsylvania common stock will be exchanged for cash. In the event that the holders of more than 30% of the outstanding shares of Pennsylvania common stock elect to receive cash, the number of shares that you elected to exchange for cash (if any) will be reduced through an allocation formula and the rest of your shares will be exchanged for stock consideration. Similarly, in the event that the holders of more than 75% of the outstanding shares of Pennsylvania common stock elect to receive Sterling common stock consideration, the number of your shares that you elected to exchange for Sterling common stock (if any) may be reduced through an allocation formula and the rest of your shares will be exchanged for cash.

      Accordingly, after Pennsylvania shareholder elections have been tabulated, the elected amounts of stock or cash may be adjusted to achieve a mix of consideration to Pennsylvania security holders that consists of between 70% and 75% in Sterling common stock and between 30% and 25% in cash. National Penn has elected to receive 90% Sterling common stock and 10% cash for the 428,238 shares of Pennsylvania common stock it owns. Therefore, the amount of cash or Sterling common stock that Pennsylvania shareholders (other than National Penn) receive in the merger may vary substantially from the consideration they elect to receive. See “The Merger — Interests of Management and Others in the Merger,” beginning at page      .

      If you do not make a valid election, you will be deemed to have made no election. No election shares will be converted into stock consideration, cash consideration or a mix of stock and cash consideration, depending on the elections of other Pennsylvania shareholders.

      You may receive significantly more or less cash or more or fewer shares of Sterling common stock than you elect. For more information about the allocation rules and the potential effects of the allocation procedures described above see the sections entitled “The Merger Election and Exchange Procedures” and “The Merger Allocation of Sterling Common Stock and Cash,” on pages      and                     , respectively.

      The market price of a share of Sterling common stock will fluctuate between the date of this document and the completion of the merger. The following table contains examples of the exchange ratio and the cash and stock consideration that you would receive, based on various hypothetical average final prices of Sterling common stock on the determination date and the market values of Sterling common stock on the effective date of the merger, assuming that you own 100 shares of Pennsylvania common stock at the effective time of the merger and you elect to receive 50% cash and 50% shares of Sterling common stock as consideration and no adjustment in that election occurs. The examples provided assume

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      Subject to the allocation process described in the next section, each Pennsylvania shareholder may elect to receive with respect to his or her shares of Pennsylvania common stock, all Sterling common stock, all cash or a combination of Sterling common stock and cash.

      Stock Election Shares. Pennsylvania shareholders who validly elect to receive Sterling common stock for some or all of their shares will receive the per share stock consideration for that portion of the shareholder’s shares of Pennsylvania common stock equal to the shareholder’s stock election, subject to the allocation process described below. In our discussion below, we refer to shares held by shareholders who have made stock elections as “stock election shares.”

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      Cash Election Shares. Pennsylvania shareholders who validly elect to receive cash for some or all of their shares will receive $22.00 in cash per share for that portion of the shareholder’s shares of Pennsylvania common stock equal to the shareholder’s cash election, subject to the allocation process described below. In our discussion below, we refer to shares held by Pennsylvania shareholders who have made cash elections as “cash election shares.”

      No-Election Shares. Shares held by Pennsylvania shareholders (i) who indicate that they have no preference as to whether they receive Sterling common stock or cash, (ii) who do not make a valid election, or (iii) who fail to properly perfect dissenters’ rights will be deemed to be “no election shares.” No election shares will be treated as stock election shares unless, to the extent that the number of stock election shares would not exceed 75% of the outstanding shares of Pennsylvania common stock. In the event the number of stock election shares would exceed 75% of the outstanding shares of Pennsylvania common stock, then no election shares will be treated as cash election shares. See “Allocation of Sterling Common Stock and Cash” below.

      A fixed amount of Sterling common stock and cash will be paid to Pennsylvania shareholders, as described above. Accordingly, there is no assurance that a Pennsylvania shareholder will receive the form of consideration that the shareholder elects with respect to any or all of his or her shares of Pennsylvania common stock. If the elections of Pennsylvania shareholders, would exceed the specified limits, then the procedures for allocating Sterling common stock and cash to be received by Pennsylvania shareholders will be followed by Sterling’s exchange agent. See “Allocation of Sterling Common Stock and Cash” below.

      Election Form. At least 20 business days before the anticipated date of completion of the merger, Sterling’s exchange agent will mail an election form to you along with instructions on electing to receive Sterling common stock or cash or a combination of stock and cash for your Pennsylvania stock. The deadline for making your election will be 5:00 p.m. on the day that is two business days prior to closing of the merger. You must carefully follow the instructions from Sterling’s exchange agent. Your election will be properly made only if by the deadline date, you have submitted to Sterling’s exchange agent at its designated office, a properly completed and signed election form that is accompanied by your Pennsylvania stock certificate. The Pennsylvania stock certificate must be in a form that is acceptable for transfer (as explained in the election form). If your election is not properly made, your shares of Pennsylvania stock will be treated as “no election shares.” Neither Sterling nor its exchange agent will be under any obligation to notify any person of any defects in an election form.

      Please note that if you have not exchanged your Pennsylvania State Bank stock certificates for Pennsylvania stock certificates, your Pennsylvania State Bank stock certificates nevertheless will be treated as Pennsylvania stock certificates in connection with the exchange and election procedures.

      Within ten business days after the effective date of the merger, Sterling’s exchange agent will mail certificates representing shares of Sterling common stock and/or checks representing the merger consideration for shares of Pennsylvania common stock, together with cash in lieu of fractional share interests, to former shareholders of Pennsylvania who have timely submitted an effective election form along with their Pennsylvania stock certificates.

      If you do not timely submit an election form along with your certificates for Pennsylvania common stock, Sterling’s exchange agent will mail to you within ten business days after completion of the merger, a letter of transmittal with instructions for submitting your Pennsylvania stock certificate in exchange for Sterling common stock or the cash consideration of $22.00 per share. At that time, you will need to carefully review the instructions, complete the materials enclosed with the instructions and return the materials along with your Pennsylvania stock certificate(s). Whether you will receive Sterling common stock or cash will depend on the election of other Pennsylvania shareholders. (See “Allocation of Sterling Common Stock and Cash,” below.) Within ten business days after receipt of the properly completed letter of transmittal and your Pennsylvania stock certificate(s), Sterling’s exchange agent will mail a certificate representing shares of Sterling common stock or a check (or a combination of stock certificate and check) for the merger consideration. No interest will be paid on any cash payment.

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      Certificates representing shares of Sterling common stock will be dated the effective date of the merger and will entitle the holders to dividends, distributions and all other rights and privileges of a Sterling shareholder from the effective date. Until the certificates representing Pennsylvania common stock are surrendered for exchange after completion of the merger, holders of such certificates will not receive the cash or stock consideration or dividends or distributions on the Sterling common stock into which such shares have been converted. When the certificates are surrendered to the exchange agent, any unpaid dividends or other distributions will be paid without interest. Sterling has the right to withhold dividends or any other distributions on its shares until the Pennsylvania stock certificates are surrendered for exchange.

      Until surrendered, each Pennsylvania stock certificate, following the effective date of the merger, is evidence solely of the right to receive the merger consideration. In no event will either Sterling or Pennsylvania be liable to any former Pennsylvania shareholder for any amount paid in good faith to a public official or agency pursuant to any applicable abandoned property, escheat or similar law.

      Sterling will not issue any fractions of a share of common stock. Rather, Sterling will pay cash for any fractional share interest any Pennsylvania shareholder would otherwise be entitled to receive in the merger. For each fractional share that would otherwise be issued, Sterling will pay by check an amount equal to the fractional share interest to which the holder would otherwise be entitled multiplied by the average final price of Sterling common stock on the determination date. Shares of Pennsylvania common stock issued and held by Pennsylvania as treasury shares as of the effective date of the merger, if any, will be canceled.

      Notwithstanding the election of Pennsylvania shareholders to receive cash, Sterling common stock or a combination of stock and cash in the merger (i) the number of shares of Pennsylvania common stock that will be exchanged for Sterling common stock will be not less than 70% and not more than 75% of the total number of shares of Pennsylvania common stock issued and outstanding on the effective date of the merger and (ii) the number of shares of Pennsylvania common stock that will be exchanged for $22.00 in cash per share will be not more than 30% but not less than 25% of the total number of shares of Pennsylvania common stock issued and outstanding on the effective date of the merger.

      National Penn owns 428,238 shares, approximately 20%, of Pennsylvania common stock. National Penn has elected to receive Sterling common stock for 90% of its shares and $22.00 in cash per share for 10% of its shares. See “The Merger — Interests of Management and Others in the Merger,” beginning at page      .

      Over-election of the Stock Consideration. If the aggregate number of stock election shares is more than 75% of the total number of shares of Pennsylvania common stock issued and outstanding on the effective date of the merger, then:

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      Under-election of the Stock Consideration. If the aggregate number of stock election shares is less than 70% of the total number of shares of Pennsylvania common stock issued and outstanding on the effective date of the merger, then:

      Because the United States federal income tax consequences of receiving Sterling common stock, cash, or both Sterling common stock and cash will differ, Pennsylvania shareholders are urged to read carefully the information included under the caption “Certain Federal Income Tax Consequences” and to consult their tax advisors for a full understanding of the merger’s tax consequences to them. In addition, because Sterling common stock can fluctuate in value during the election period, the economic value per share received by Pennsylvania shareholders who receive stock may, as of the date of receipt by them, be more or less than the $22.00 cash per share received by Pennsylvania shareholders who receive cash.

      As of the record date for the special meeting, various directors, officers and employees of Pennsylvania held options to purchase a total of                      shares of Pennsylvania common stock, all granted under Pennsylvania’s stock option plans. Upon the effective date of the merger, each Pennsylvania stock option still outstanding will cease to be a right to purchase shares of Pennsylvania common stock and will be converted automatically into an option to purchase shares of Sterling common stock. Sterling will assume each such option, in accordance with the terms of the Pennsylvania stock option plans, except that from and after the merger’s effective date:

Sterling Common Stock

      Each share of Sterling common stock outstanding immediately prior to completion of the merger will remain outstanding and unchanged by the merger.

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Effective Date.

      The merger will take effect when all conditions, including obtaining shareholder and regulatory approval, have been fulfilled or waived, or as soon as practicable thereafter as Sterling and Pennsylvania may mutually select. Regulatory approval cannot be waived. We presently expect to close the merger on or about November 10, 2004. See “The Merger — Conditions to the Merger” and “The Merger — Regulatory Approvals,” beginning at pages      and                     , respectively.

Representations and Warranties.

      The merger agreement contains customary representations and warranties relating to, among other things:

Conduct of Business Pending the Merger.

      In the merger agreement, we each agreed to use our reasonable good faith efforts to preserve our business organizations intact, to maintain good relationships with employees, and to preserve the goodwill of customers and others with whom we do business.

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      In addition, Pennsylvania agreed to conduct its business and to engage in transactions only in the ordinary course of business, consistent with past practice, except as otherwise required by the merger agreement or consented to by Sterling. Pennsylvania also agreed in the merger agreement that Pennsylvania will not, without the written consent of Sterling:

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      Pennsylvania also agreed in the merger agreement, among other things:

      We jointly agreed, among other things:

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Conditions to the Merger

      Our obligations to complete the merger are subject to various conditions, including the following:

      In addition to the foregoing, our obligations to close the merger are each conditioned on:

      Except for the requirements of Pennsylvania shareholder approval, regulatory approvals and the absence of any order, decree, or injunction preventing the transactions contemplated by the merger agreement, we each may waive each of the conditions described above in the manner and to the extent described in “The Merger — Amendment; Waiver,” at page      .

Amendment; Waiver

      Subject to applicable law, at any time prior to completion of the merger, we may:

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Termination.

      The merger agreement may be terminated at any time prior to the effective date of the merger by our mutual consent.

      The merger agreement may also be terminated by either party if:

      In addition, the merger agreement contains a provision under which Pennsylvania may terminate the merger agreement if the average final price of Sterling common stock is less than $21.21 and the decline in the price of Sterling common stock is at least 20% more than the decline during the period beginning April 12, 2004 in a peer group index. See Exhibit 7.01(c) to the merger agreement, which is attached to this proxy statement/ prospectus as Annex A.

      The bank holding companies comprising the peer group index are Columbia Bancorp; Community Banks, Inc.; Pennsylvania Commerce Bancorp, Inc.; Citizens & Northern; First Mariner Bancorp; First United Corporation; Harleysville National Corporation; Interchange Financial Services Corporation; Lakeland Bancorp, Incorporated; PennRock Financial Services Corp.; Royal Bancshares of Pennsylvania, Inc.; Sandy Spring Bancorp, Inc.; Sun Bancorp, Inc.; S & T Bancorp, Inc.; Univest Corporation of Pennsylvania; and Yardville National Bancorp. If any peer group company declares or effects a stock split or similar capital transaction during the measurement period, the prices of that company’s common stock will be appropriately adjusted in determining the average per share closing sale price of the peer group common stocks.

      Sterling may terminate the merger agreement if Pennsylvania enters into a term sheet, letter of intent or agreement to merge with someone else. However, Pennsylvania may terminate the merger agreement if it enters into a term sheet, letter of intent or agreement to merge after receiving written advice of counsel that failure to do so would breach the fiduciary duty of Pennsylvania Board of Directors.

      Sterling may also terminate the merger agreement if Pennsylvania withdraws, changes or modifies its recommendation to its shareholders to approve the merger agreement and the merger.

      Pennsylvania’s Board of Directors has made no decision as to whether it would exercise its right to terminate the merger agreement if the termination provision relating to the price of Sterling common stock is triggered. In considering whether to exercise its right to terminate the merger agreement, Pennsylvania’s Board of Directors would, consistent with its fiduciary duties, take into account all relevant facts and circumstances that exist at the time and would consult with its financial advisors and legal counsel.

      The fairness opinion received by Pennsylvania from Janney is dated as of June 10, 2004, and is based on conditions in effect on that date. Accordingly, the fairness opinion does not address the possibilities

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      Approval of the merger agreement by Pennsylvania’s shareholders will confer on Pennsylvania’s Board of Directors the power to complete the merger even if the price-related termination provision is triggered, without any further action by or re-solicitation of the votes of Pennsylvania shareholders.

      Pennsylvania shareholders should be aware that the market price of Sterling common stock will fluctuate and could possibly decline. Accordingly, the value of the Sterling common stock actually received by holders of Pennsylvania common stock may be more or less than the value of Sterling common stock used in applying the market price test or on the effective date of the merger.

Termination Fee.

      Pennsylvania has agreed to pay a fee of $2,000,000 to Sterling if Pennsylvania fails to complete the merger and Sterling is not in material breach of the merger agreement after the occurrence of any one of the following events:

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No Solicitation of Other Transactions.

      Pennsylvania has agreed that it will not, and will not allow others under its control to, directly or indirectly:

unless it believes, after receipt of written advice from its legal counsel, that failure to do so would violate the Pennsylvania directors’ fiduciary duties.

      Pennsylvania has also agreed to notify Sterling promptly, if any acquisition proposal or inquiry described above is received by Pennsylvania from any third party.

      For a discussion of circumstances under which certain actions relating to a possible change in control involving Pennsylvania could result in Pennsylvania being required to pay the termination fee of $2,000,000. See “The Merger — Termination Fee,” beginning on page      .

NASDAQ Listing.

      Pennsylvania’s obligation to complete the merger is subject to the condition that Sterling’s common stock continues to be authorized for quotation on the NASDAQ National Market.

Expenses.

      Sterling and Pennsylvania will each pay all costs and expenses incurred in connection with the transactions contemplated by the merger agreement, including fees and expenses of financial consultants, accountants and legal counsel.

Regulatory Approvals.

      Completion of the merger is subject to the prior receipt of all consents or approvals of, and the provision of all notices to federal and state authorities required to complete the merger of Sterling and Pennsylvania.

      Sterling and Pennsylvania have agreed to use their reasonable best efforts to obtain all regulatory approvals required to complete the merger. These approvals include approval from the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), and the Pennsylvania Department of Banking. The merger cannot proceed in the absence of these required regulatory approvals.

      A merger of two bank holding companies requires the prior approval of the Federal Reserve Board under the Bank Holding Company Act. Under this law, the Federal Reserve Board generally may not approve any proposed transaction:

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      The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and their subsidiary banks and the convenience and needs of the communities to be served. Under the Community Reinvestment Act of 1977, the Federal Reserve Board also must take into account the record of performance of Sterling and Pennsylvania in meeting the credit needs of their communities, including low and moderate-income neighborhoods. In addition, the Federal Reserve Board must take into account the effectiveness of the bank holding companies in combating money laundering activities. Applicable regulations require publication of notice of an application for approval of the merger and an opportunity for the public to comment on the application in writing and to request a hearing. Any transaction approved by the Federal Reserve Board generally may not be completed until 30 days after such approval, during which time the U.S. Department of Justice may challenge such transaction on antitrust grounds and seek divestiture of certain assets and liabilities. With the approval of the Federal Reserve Board and the U.S. Department of Justice, the waiting period may be reduced to 15 days.

      State Approvals and Notices. The merger also is subject to the prior approval of the Pennsylvania Department of Banking under Section 115 of the Pennsylvania Banking Code. In determining whether to approve the merger, the Pennsylvania Department of Banking will consider, among other things, whether the purposes and probable effects of the merger would be consistent with the purposes of the Pennsylvania Banking Code, as set forth in Section 103, and whether the merger would be prejudicial to the interests of the depositors, creditors, beneficiaries of fiduciary accounts or stockholders of the institutions involved.

      Applications. Sterling has filed applications with the Federal Reserve Board and the Pennsylvania Department of Banking, requesting approval of the merger of Pennsylvania with and into Sterling. The applications describe the terms of the merger, the parties involved, and the activities to be conducted by the combined companies as a result of the transaction, and contain certain related financial and managerial information. Copies of the applications will be provided to the U.S. Department of Justice and other governmental agencies.

      We are not aware of any material governmental approvals or actions that are required to complete the merger, except as described above. If any other approval or action is required, we will use our best efforts to obtain such approval or action.

Management and Operations After the Merger.

      Sterling’s approach to acquisitions has been to allow the acquired entity to maintain its autonomy and independence while providing the appropriate corporate oversight and direction. As a result of the merger, Pennsylvania will be merged into Sterling and Pennsylvania State Bank will become a subsidiary of Sterling. Sterling has agreed that Pennsylvania State Bank will continue to operate as a separate subsidiary under its state charter and its current name for three years. Following the merger, Pennsylvania State Bank’s Board of Directors will consist of the current members of the Board with the addition of Thomas P. Dautrich, Chief Banking Officer of Sterling. Further, following the merger, Thomas J. Sposito, II, Pennsylvania’s current President and Chief Executive Officer, will continue as the President and Chief Executive Officer of Pennsylvania State Bank. Robert M. Garst, currently an Executive Vice President and the Chief Lending Officer of Pennsylvania State Bank, will continue to serve in these positions following completion of the merger. Both Messrs. Sposito and Garst entered into employment agreements with Sterling as part of the merger. See “The Merger — Interests of Management and Others in the Merger — Executive Employee Agreements and Benefits,” beginning on page      and the employment agreements, attached to this proxy statement/ prospectus as Annex E and Annex F. Upon completion of the merger, Sterling has agreed that a current director of Pennsylvania, selected by Pennsylvania, who meets certain specified criteria (or one or more successors, similarly selected) will serve as a Sterling director. In the merger agreement, Sterling approved William E. Miller, Jr., currently Chairman of Pennsylvania’s Board of Directors for the Sterling Board position.

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      Following the merger, Sterling is not obligated to continue the employment of any Pennsylvania employee (other than those with employment agreements with Sterling). As a result of the merger, some Pennsylvania positions, primarily in-house back office, support, processing and other operational activities and services, will be eliminated. However, Sterling will endeavor to continue the employment of all non-management employees in positions that will contribute to the successful performance of the combined organization. If a position is duplicative, Sterling will attempt to reassign the individual to a needed position that uses the skills and abilities of the individual. If that is impracticable or Sterling does not have available a comparable position, then Sterling will grant to each exempt employee 8 weeks of severance pay plus 2 weeks of severance pay for each year of service, up to a maximum of 52 weeks of severance pay and to each non-exempt employee 4 weeks of severance pay plus 2 weeks of severance pay for each year of service, up to a maximum of 26 weeks of severance pay. Each Pennsylvania employee who is involuntarily terminated within one year following the effective date of the merger, other than for “cause,” or who voluntarily terminates his or her employment after being offered a position that is not a position of substantially similar job descriptions or responsibilities at substantially the same salary level that is both within 25 miles of the employee’s then current work location with Pennsylvania and within 50 miles of the employee’s then current residence, will remain eligible to receive severance payments and continued medical insurance benefits. Sterling will also provide outplacement and job counseling services to all Pennsylvania employees whose employment is terminated in connection with the merger. No Pennsylvania employee who will receive any payments or benefits pursuant to a “change in control” agreement, employment agreement or similar plan or right will be eligible to receive severance benefits.

      The merger agreement provides that as of the effective date of the merger, each Pennsylvania employee who becomes an employee of Sterling or any Sterling subsidiary, is entitled to employee benefits reasonably equivalent in the aggregate to the employee benefits provided by Sterling or its subsidiaries to their similarly situated employees. Any medical, dental and life insurance plans, programs or policies that become applicable to former Pennsylvania employees shall not contain any exclusion or limitation with respect to any pre-existing condition of any such employees or their dependents. Each Pennsylvania employee who becomes an employee of Sterling or any Sterling subsidiary at the effective date is entitled to full credit for each year of service with Pennsylvania for purposes of determining eligibility for participation and vesting, but not benefit accrual, in the Sterling or Sterling subsidiary’s employee benefit plans, programs and policies.

Employee Stock Purchase Plan.

      Pennsylvania maintains an employee stock purchase plan. Pursuant to the merger agreement, between the date of the merger agreement and the effective date of the merger, or December 31, 2004, whichever is first to occur, Pennsylvania may make distributions of a maximum of 2,000 shares of Pennsylvania common stock pursuant to the employee stock purchase plan. In the event that the effective date of the merger has not occurred on or before December 31, 2004 and the merger agreement has not been terminated, Pennsylvania will suspend its employee stock purchase plan immediately following the automatic purchase of shares pursuant to the plan on December 31, 2004; or, if the effective date of the merger occurs on or before December 31, 2004, Pennsylvania will amend its employee stock purchase plan to cause the “purchase date” to be deemed to occur on the business day immediately prior to the effective date of the merger and to terminate the plan effective as of the effective date of the merger.

Interests of Management and Others in the Merger.

      As of                     , 2004, the record date for the special meeting of Pennsylvania shareholders, the directors, executive officers and other significant shareholders of Pennsylvania may be deemed to be the

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      National Penn owns 428,238 shares of Pennsylvania. These shares were acquired pursuant to the terms of the Stock Purchase Agreement, dated April 29, 1989, by and between Pennsylvania State Bank and National Penn, and the Investment Agreement, dated September 4, 2003, between Pennsylvania and National Penn.

      In connection with the execution and performance of the merger agreement, National Penn entered into a Support Agreement, Irrevocable Election Form and Agreement and Termination of Contract, which documents are attached to this document as Annex C. The following discussion describes the material terms of the documents executed by National Penn. It is not complete and is qualified by reference to the documents.

      In the Support Agreement, National Penn agrees, among other things, that it will not:

      In addition, National Penn agrees that it will not exercise any of its warrants, options or securities convertible into Pennsylvania common stock. National Penn has agreed to:

      When National Penn executed the Support Agreement, it executed an Irrevocable Election Form included in Annex C. National Penn has elected to receive stock for 90% (385,414 shares) of its Pennsylvania common stock and $22.00 cash per share for 10% (42,824 shares) of its Pennsylvania common stock. This election reduces the stock that may be received by other Pennsylvania shareholders because the shares to be received by National Penn are to be included in the allocation process. See “The Merger — Terms of the Merger,” beginning on page      .

      In addition to the Support Agreement and the Irrevocable Election Form, National Penn executed an Agreement on Termination of Contract, also included in Annex C, pursuant to which it agreed to terminate the Stock Purchase Agreement and the Investment Agreement on the effective date of the merger. This discussion describes the material terms of the documents executed by National Penn. The description is not complete. We qualify this discussion in its entirety by reference to the attached documents.

      Sterling has agreed for six years after the merger’s effective date to indemnify the directors and officers of Pennsylvania and its subsidiaries against all costs, expenses (including reasonable attorneys’ fees), judgments, fines, losses, claims, damages or liabilities arising out of actions or omissions occurring prior to the merger’s effective date, including the transactions contemplated by the merger agreement prior

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      Sterling has also agreed that for six years after the merger’s effective date, Sterling will, at its expense, maintain directors’ and officers’ liability insurance for the former directors and officers of Pennsylvania and its subsidiaries with respect to matters occurring at or prior to the merger’s effective date.

      The insurance coverage is to be at least equal to the coverage currently maintained by Pennsylvania and is to contain terms and conditions that are no less favorable to the beneficiaries. Sterling is not obligated to make annual premium payments that exceed (for the portion related to Pennsylvania’s directors and officers) 150% of the initial annual premiums for Pennsylvania’s policy maintained prior to the merger. If the annual premium payments exceed this amount, Sterling will use its reasonable best efforts to obtain the most advantageous policy available up to this maximum amount.

      Effective on the date of Sterling’s first Board of Directors meeting following the effective date of the merger, Pennsylvania State Bank’s Chief Executive Officer, Chief Business Services Officer and Chief Personal Services Officer and other persons occupying similar positions however titled, shall be eligible to participate in Sterling’s stock option plan at levels comparable to other similarly situated executives at Sterling. Further, Pennsylvania’s Board of Directors may recommend to Sterling, and Sterling agrees to grant in accordance with such recommendation, incentive stock option awards of up to 500 options each to a maximum of 15 other Pennsylvania State Bank employees, at such times as Sterling’s Board of Directors grants option awards to Sterling employees.

      Thomas J. Sposito, II, President and Chief Executive Officer of Pennsylvania and Pennsylvania State Bank, currently is employed in those capacities pursuant to an employment agreement originally dated August 7, 2002 and amended March 16, 2004. In addition, Mr. Sposito and Pennsylvania are parties to a change in control agreement also dated March 16, 2004 providing certain benefits to Mr. Sposito upon a termination of his employment subsequent to a change in control of Pennsylvania. Further, Mr. Sposito and Pennsylvania State Bank entered into a supplemental executive retirement plan agreement dated July 1, 2002 providing Mr. Sposito with certain supplemental retirement benefits.

      As a condition to entering into the merger agreement, Sterling required that Mr. Sposito enter into a new employment agreement with Sterling, Pennsylvania and Pennsylvania State Bank dated June 14, 2004, pursuant to which Mr. Sposito will be employed, after the effective date of the merger, as President and Chief Executive Officer of Pennsylvania State Bank and, subject to continued qualification, elected to the Board of Directors of Pennsylvania State Bank throughout the term of his employment. The new employment agreement is to become effective only upon the completion and effective date of the merger, whereupon it would terminate and replace Mr. Sposito’s current employment agreement and change in control agreement. The new employment agreement will not affect Mr. Sposito’s supplemental executive retirement plan agreement.

      The term of Mr. Sposito’s employment under the new employment agreement will begin on the effective date of the merger and continue until the earlier of: (i) January 16, 2008; (ii) Mr. Sposito’s death; (iii) Mr. Sposito’s inability to perform his duties for a period of at least 180 consecutive days or for at least 180 days in any period of 12 consecutive months as a result of physical or mental disability; (iv) Mr. Sposito’s discharge by Pennsylvania State Bank “for cause” (as defined in the agreement); (v) Mr. Sposito’s resignation from his position other than for “good reason” (as defined in the agreement); (vi) the termination of Mr. Sposito’s employment by Pennsylvania State Bank “without cause”; or (vii) Mr. Sposito’s resignation for “good reason.”

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      Under the terms of the new employment agreement, if Mr. Sposito’s employment is terminated for any reason other than “without cause” or for “good reason,” Mr. Sposito would be entitled to receive his salary and certain other benefits accrued to the date of termination.

      If Mr. Sposito’s employment is terminated at any time during the two year period beginning on the effective date of the merger “without cause” or for “good reason,” Mr. Sposito would be entitled to receive his salary accrued to the date of termination, plus severance pay in an amount equal to two times Mr. Sposito’s average annual compensation includible in gross income for federal income tax purposes for the three years immediately preceding the year in which the effective date of the merger occurs, plus continued participation by Mr. Sposito for one year in all non-cash employee benefit plans, programs or arrangements in which he was entitled to participate immediately prior to the date of termination. The severance payments would be paid to Mr. Sposito, at his election, in either (i) 24 equal monthly installments, or (ii) a lump sum equal to the present value of the amounts payable.

      The new employment agreement defines “good reason” for such purposes to include, during the two year period beginning on the effective date of the merger, resignation by Mr. Sposito for any reason. The new employment agreement also contains a non-compete provision which restricts Mr. Sposito from engaging in certain activities of a competitive nature to Sterling and its affiliates during the term of his employment and for two years after termination if Mr. Sposito terminates his employment for “good reason” during the two year period beginning on the effective date of the merger.

      The new employment agreement further provides that if any of the payments or benefits that Mr. Sposito may become entitled to in connection with the merger or the termination of Mr. Sposito’s employment within the two year period beginning on the effective date of the merger would be subject to a federal excise tax because they would constitute an “excess parachute payment,” Mr. Sposito will be reimbursed for the amount of the excise tax and will receive an additional gross-up payment so that, after payment of the excise tax and all income and excise taxes imposed on the reimbursement and gross-up payments, Mr. Sposito would retain approximately the same net-after-tax amounts that he would have retained had there been no excise tax.

      If Mr. Sposito’s employment is terminated at any time after the expiration of the two year period beginning on the effective date of the merger “without cause” or for “good reason,” Mr. Sposito would be entitled to receive his salary and other benefits accrued to the date of termination plus, for the period beginning on the date of termination and ending January 16, 2008, salary at the rate then provided by the new employment agreement.

      Mr. Sposito’s new employment agreement also contains change in control benefits for Mr. Sposito in the event that Sterling would experience a change in control (as defined in the agreement) that would occur more than two years after the effective date of the merger and, in connection with the change in control, Mr. Sposito would terminate his employment for “good reason,” as defined by the agreement for purposes of the change in control benefits. In such an event, Mr. Sposito would be entitled to receive severance payments in an amount equal to 2.5 times the average of his annual compensation includible in gross income for federal income tax purposes for the most recent five taxable years, or such shorter period as Mr. Sposito would have been employed by Sterling and ending before the date on which the Sterling change in control occurred. The payments would be paid, at Mr. Sposito’s election, in either (i) 30 equal monthly installments, or (ii) a lump sum equal to the present value of the amounts payable. In lieu of continued pension, welfare and other benefits, Mr. Sposito also would be entitled to be paid a one-time lump sum cash payment equaling 25% of the basic severance payment. In addition, all Sterling stock options held by Mr. Sposito and not previously exercisable would become exercisable upon the occurrence of a change in control of Sterling. Any payments or benefits that Mr. Sposito may become entitled to in connection with a change in control of Sterling that would be subject to a federal excise tax because they would constitute an “excess parachute payment,” will not be grossed-up. Mr. Sposito, however, would have the right in such circumstances to designate which payments or benefits to reduce or eliminate in order to avoid having the payments to him constitute excess parachute payments.

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      Mr. Sposito’s annual base salary under the new employment agreement will be $167,200 and he will be eligible to be considered for salary increases in accordance with Sterling’s compensation policies. Mr. Sposito will also be entitled to receive annual performance bonuses in accordance with Sterling’s bonus program(s) in effect with respect to other executives of similar rank employed by Sterling or its affiliates. Mr. Sposito will be entitled to participate in all Sterling employee benefit plans that are applicable to other executives of similar rank employed by Sterling or its affiliates including, plans providing retirement benefits, stock options, medical insurance, life insurance, disability insurance and accidental death or dismemberment insurance. Mr. Sposito shall also be entitled to other benefits and perquisites customary for an executive in Mr. Sposito’s position, including, paid time off, use of an automobile, reimbursement for country club fees, dues, and assessments, reimbursement for business expenses, and payment of expenses for annual attendance at a trade association or continuing education meeting.

      Robert M. Garst, Executive Vice President and Chief Lending Officer of Pennsylvania State Bank, currently is employed in that capacity pursuant to an employment agreement dated May 25, 2004. In addition, Mr. Garst and Pennsylvania are parties to a change in control agreement dated March 16, 2004 providing for certain benefits to Mr. Garst upon a termination of his employment subsequent to a change in control of Pennsylvania. Mr. Garst and Pennsylvania State Bank also have entered into a supplemental executive retirement plan agreement dated July 1, 2002 providing Mr. Garst with certain supplemental retirement benefits.

      As a condition to entering into the merger agreement, Sterling required that Mr. Garst enter into a new employment agreement with Sterling, Pennsylvania and Pennsylvania State Bank dated June 14, 2004, pursuant to which Mr. Garst will be employed, after the effective date of the merger, as Executive Vice President and Chief Lending Officer of Pennsylvania State Bank. The new employment agreement is to become effective only upon the completion and effective date of the merger, whereupon it would terminate and replace Mr. Garst’s current employment agreement and change in control agreement. The new employment agreement will not affect Mr. Garst’s supplemental executive retirement plan agreement.

      The term of Mr. Garst’s employment under the new employment agreement would begin on the effective date of the merger and continue until the earlier of: (i) May 31, 2007; (ii) Mr. Garst’s death; (iii) Mr. Garst’s inability to perform his duties for a period of at least 180 consecutive days or for at least 180 days in any period of 12 consecutive months as a result of physical or mental disability; (iv) Mr. Garst’s discharge by Pennsylvania State Bank “for cause” (as defined in the agreement); (v) Mr. Garst’s resignation from his position other than for “good reason” (as defined in the agreement); (vi) the termination of Mr. Garst’s employment by Pennsylvania State Bank “without cause”; or (vii) Mr. Garst’s resignation for “good reason.”

      Under the terms of the new agreement, if Mr. Garst’s employment is terminated for any reason other than “without cause” or for “good reason,” Mr. Garst would be entitled to receive his salary and certain other benefits accrued to the date of termination.

      If Mr. Garst’s employment is terminated at any time during the one year period beginning on the effective date of the merger “without cause” or for “good reason,” Mr. Garst would be entitled to receive his salary accrued to the date of termination, plus severance pay in an amount equal to Mr. Garst’s average annual compensation includible in gross income for federal income tax purposes for the three years immediately preceding the year in which the effective date of the merger occurs, plus continued participation by Mr. Garst for one year in all non-cash employee benefit plans, programs or arrangements in which he was entitled to participate immediately prior to the date of termination. The severance payments would be paid to Mr. Garst, at his election, in either (i) 12 equal monthly installments, or (ii) a lump sum equal to the present value of the amounts payable.

      The new employment agreement defines “good reason” for such purposes to include, during the one year period beginning on the effective date of the merger, resignation by Mr. Garst for any reason. The

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      The new employment agreement further provides that if any of the payments or benefits that Mr. Garst may become entitled to in connection with the merger or the termination of Mr. Garst’s employment within the one year period beginning on the effective date of the merger would be subject to a federal excise tax because they would constitute an “excess parachute payment,” Mr. Garst will be reimbursed for the amount of the excise tax and will receive an additional gross-up payment so that, after payment of the excise tax and all income and excise taxes imposed on the reimbursement and gross-up payments, Mr. Garst would retain approximately the same net-after-tax amounts that he would have retained had there been no excise tax.

      If Mr. Garst’s employment is terminated at any time after the expiration of the one year period beginning on the effective date of the merger “without cause” or for “good reason,” Mr. Garst would be entitled to receive his salary and other benefits accrued to the date of termination plus, for the period beginning on the date of termination and ending May 31, 2007, salary at the rate then provided by the new employment agreement.

      Mr. Garst’s new employment agreement also contains change in control benefits for Mr. Garst in the event that Sterling would experience a change in control (as defined in the agreement) that would occur more than one year after the effective date of the merger and, in connection with the change in control, Mr. Garst would terminate his employment for “good reason,” as defined by the agreement for purposes of the change in control benefits. In such an event, Mr. Garst would be entitled to receive severance payments in an amount equal to two times the average of his annual compensation includible in gross income for federal income tax purposes for the most recent five taxable years, or such shorter period as Mr. Garst would have been employed by Sterling and ending before the date on which the Sterling change in control occurred. The payments would be paid, at Mr. Garst’s election, in either (i) 24 equal monthly installments, or (ii) a lump sum equal to the present value of the amounts payable. In lieu of continued pension, welfare and other benefits, Mr. Garst would be entitled to be paid a one-time lump sum cash payment equaling 25% of the basic severance payment. In addition, all Sterling stock options held by Mr. Garst and not previously exercisable would become exercisable upon the occurrence of a change in control of Sterling. Any payments or benefits that Mr. Garst may become entitled to in connection with a change in control of Sterling that would be subject to a federal excise tax because they would constitute an “excess parachute payment,” will not be grossed-up. Mr. Garst, however, would have the right in such circumstances to designate which payments or benefits to reduce or eliminate in order to avoid having the payments to him constitute excess parachute payments.

      Mr. Garst’s annual base salary under the new employment agreement will be $119,000 and he will be eligible to be considered for salary increases in accordance with Sterling’s compensation policies. Mr. Garst will also be entitled to receive annual performance bonuses in accordance with Sterling’s bonus program(s) in effect with respect to other executives of similar rank employed by Sterling or its affiliates. Mr. Garst will be entitled to participate in all Sterling employee benefit plans that are applicable to other executives of similar rank employed by Sterling or its affiliates including, plans providing retirement benefits, stock options, medical insurance, life insurance, disability insurance and accidental death or dismemberment insurance. Mr. Garst shall also be entitled to other benefits and perquisites customary for an executive in Mr. Garst’s position, including, paid time off, use of an automobile, reimbursement for country club fees, dues, and assessments, reimbursement for business expenses, and payment of expenses for annual attendance at a trade association or continuing education meeting.

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Board Positions and Compensation.

      Upon completion of the merger, William E. Miller, Jr., currently the Chairman of the Pennsylvania Board of Directors, shall be appointed as a Sterling director and shall be entitled to compensation in such capacity on the same basis as other Sterling directors.

      In addition, following the merger, Sterling has agreed that the current directors of Pennsylvania shall continue as directors of Pennsylvania State Bank for a period of not less than three years and shall be entitled to receive compensation for such service that is either the same compensation for service as received by directors of Sterling’s other banking institution subsidiaries or compensation generally equal to the directors’ current levels of compensation by Pennsylvania, increased annually by four percent.

Existing Employment and Change-in-Control Agreements.

      In addition to the agreements with Messrs. Sposito and Garst referenced above, Pennsylvania is party to current employment and change in control agreements with Paul H. Weidman, Jr., a director and Executive Vice President and Chief Operating Officer of Pennsylvania and David W. Cathell, Executive Vice President and Chief Financial Officer of Pennsylvania. Under these agreements, Mr. Weidman and Mr. Cathell would each be entitled to a lump sum severance payment in the event their employment is terminated following a change-in-control. The severance payment would equal the executive’s average annual compensation for the three years immediately preceding the change in control times two for Mr. Weidman and times one for Mr. Cathell. Additionally, Mr. Weidman is entitled to continued health and other benefits for two years following termination and Mr. Cathell is entitled to continued health and other benefits for one year following termination.

Supplemental Executive Retirement Plan Agreements.

      Each of Messrs. Sposito, Garst, Weidman and Cathell is a party to supplemental executive retirement plan (SERP) agreements with Pennsylvania State Bank. Under these agreements, which are funded by certain life insurance policies on the life of each executive, Pennsylvania State Bank is obligated to provide each executive or his beneficiaries annual benefits for a period of 15 years after the officer’s death, disability or retirement. The proposed merger will constitute a change in control under these agreements, causing the immediate and complete vesting of all benefits payable thereunder.

Accounting Treatment.

      Sterling will account for the merger under the purchase method of accounting. Sterling will record, at fair value, the acquired tangible and identifiable intangible assets and assumed liabilities of Pennsylvania. To the extent that the total purchase price exceeds the fair value of the assets acquired and liabilities assumed, Sterling will record the excess as “goodwill.” Under generally accepted accounting principles, goodwill is not amortized, but is assessed annually for impairment with any resulting impairment losses included in net income. Sterling will include in its results of operations the results of Pennsylvania’s operations only after completion of the merger.