Edgar Filing: STERLING FINANCIAL CORP /WA/

e10vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the year ended December 31, 2006
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 0-20800

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Washington		91-1572822
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)


111 North Wall Street, Spokane,Washington		99201
(Address of principal executive offices)		(Zip code)

Registrant’s telephone number, including area code:

(509) 458-3711

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


None		None
(Title of Each Class)		(Name of Each Exchange on Which Registered)

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

Common Stock ($1.00 par value)

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of June 30, 2006, the aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked prices on such date as reported by The NASDAQ National Market, was $1.07 billion.

The number of shares outstanding of the registrant’s common stock, par value $1.00 per share, as of January 31, 2007 was 42,200,432.

DOCUMENTS INCORPORATED BY REFERENCE

Specific portions of the registrant’s Proxy Statement for its 2007 annual meeting of shareholders are incorporated by reference into Part III hereof.

STERLING FINANCIAL CORPORATION

DECEMBER 31, 2006 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS


		Page

PART I			1
Item 1.	Business		1
	General		1
	Company Growth		1
	Profitability Drivers		2
	Lending Activities		2
	Investments and Mortgage-Backed Securities		12
	Sources of Funds		14
	Subsidiaries		16
	Competition		18
	Personnel		18
	Environmental Laws		18
	Regulation		18
	Forward-Looking Statements		24
	Where You Can Find More Information		25
Item 1A.	Risk Factors		25
Item 1B.	Unresolved Staff Comments		31
Item 2.	Properties		31
Item 3.	Legal Proceedings		31
Item 4.	Submission of Matters to a Vote of Security Holders		31
PART II			32
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		32
	Stock Market and Dividend Information		32
Item 6.	Selected Financial Data		34
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		35
	Executive Summary and Highlights		35
	Critical Accounting Policies		36
	Results of Operations for the Years Ended December 31, 2006 and 2005		38
	Results of Operations for the Years Ended December 31, 2005 and 2004		42
	Financial Position		44
	Asset and Liability Management		45
	Liquidity and Capital Resources		48
	Off-Balance Sheet Arrangements and Aggregate Contractual Obligations		50
	Capital		51
	Goodwill Litigation		51
	New Accounting Policies		51
	Effects of Inflation and Changing Prices		52
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		52
Item 8.	Financial Statements and Supplementary Data		52
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		52
Item 9A.	Controls and Procedures		52
	Management’s Report on Internal Control Over Financial Reporting		53
	Report of Independent Registered Public Accounting Firm		54
Item 9B.	Other Information		55
PART III			55
Item 10.	Directors, Executive Officers and Corporate Governance		55
Item 11.	Executive Compensation		55
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		55
Item 13.	Certain Relationships and Related Transactions, and Director Independence		55
Item 14.	Principal Accounting Fees and Services		55
PART IV			56
Item 15.	Exhibits, Financial Statement Schedules		56
SIGNATURES			57
EXHIBIT 10.6
EXHIBIT 12.1
EXHIBIT 12.2
EXHIBIT 21.1
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I

Item 1. Business

General

Sterling Financial Corporation (“Sterling”) is a bank holding company, the principal operating subsidiaries of which are Sterling Savings Bank and Golf Savings Bank. The principal operating subsidiaries of Sterling Savings Bank are Action Mortgage Company (“Action Mortgage”), INTERVEST-Mortgage Investment Company (“INTERVEST”) and Harbor Financial Services, Inc. (“Harbor Financial”). Sterling Savings Bank commenced operations in 1983 as a Washington State-chartered federally insured stock savings and loan association headquartered in Spokane, Washington. On July 8, 2005, Sterling Savings Bank converted to a commercial bank. The main focus of Golf Savings Bank, a Washington State-chartered savings bank acquired by Sterling in July 2006, is the origination and sale of residential mortgage loans.

Sterling provides personalized, quality financial services and “Perfect Fit” banking products to its customers consistent with its “Hometown Helpful” philosophy. Sterling believes that its dedication to personalized service has enabled it to grow both its retail deposit base and its lending portfolio in the western United States. With $9.83 billion in total assets at December 31, 2006, Sterling originates loans and attracts Federal Deposit Insurance Corporation (“FDIC”) insured deposits from the general public through 166 financial service centers located in Washington, Oregon, Idaho and Montana. In addition, Sterling originates loans through Golf Savings Bank and Action Mortgage residential loan production offices and through INTERVEST commercial real estate lending offices throughout the western United States. Sterling also markets fixed income and equity products, mutual funds, fixed and variable annuities and other financial products through Harbor Financial service representatives located throughout Sterling’s financial service center network.

Sterling continues to implement its strategy to become the leading community bank in the western United States by increasing its commercial real estate, commercial banking, consumer and construction lending, which generally produce higher yields than residential loans, as well as increasing its retail deposits, particularly transaction accounts. Such loans generally involve a higher degree of risk than financing residential real estate. Management believes that a community bank mix of assets and liabilities will enhance its net interest income (“NII”) (the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings) and will increase other fee income, although there can be no assurance in this regard. Sterling’s revenues are derived primarily from interest earned on loans and mortgage-backed securities (“MBS”), fees and service charges, and mortgage banking operations (“MBO”). The operations of Sterling, and banking institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities, the Board of Governors of the Federal Reserve System (“FRB”), the FDIC and the Washington State Department of Financial Institutions (“Washington Supervisor”).

Company Growth

On November 30, 2006, Sterling completed its acquisition of FirstBank NW Corp., a Washington corporation (“FirstBank”), by issuing cash of $15.6 million and 4,821,913 shares of Sterling common stock valued at $145.3 million in exchange for all outstanding FirstBank shares. The total value of the transaction, including options converted, was $165.4 million. FirstBank was merged with and into Sterling, with Sterling being the surviving corporation in the merger. FirstBank’s financial institution subsidiary, FirstBank Northwest, was merged with and into Sterling’s subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.

On July 5, 2006, Sterling completed its acquisition of Lynnwood Financial Group, Inc. (“Lynnwood”), the parent company of Golf Savings Bank, by issuing $15.8 million in cash and 1,799,961 shares of Sterling common stock valued at $48.8 million in exchange for all outstanding Lynnwood shares. The total value of the transaction, including options converted, was $66.3 million. Lynnwood merged with and into Sterling, with Sterling being the surviving entity in the merger. Lynnwood’s wholly owned subsidiaries, Golf Savings Bank and Golf Escrow Corporation, have become subsidiaries of Sterling.

On July 31, 2006, a wholly owned subsidiary of INTERVEST acquired the mortgage banking operations, including the commercial servicing portfolio, brand name and investor/customer list, of Mason-McDuffie Financial Corporation (“Mason-McDuffie”), located in northern California. INTERVEST’s mortgage banking business in northern California is now being conducted by Mason-McDuffie. The transaction was valued at $2.7 million, including $1.8 million in cash paid at closing, with the remainder to be paid in Sterling common stock, subject to the terms of a three-year earnout. Mason-McDuffie is dedicated to commercial loan originations and loan servicing.

On September 17, 2006, Sterling entered into a definitive agreement to acquire Northern Empire Bancshares, a California corporation (“Northern Empire”). Under the terms of the agreement, Northern Empire will be merged with and into Sterling, with Sterling being the surviving corporation in the merger. The agreement also provides that Sterling may elect to merge Northern Empire’s financial institution subsidiary, Sonoma National Bank, with and into Sterling’s financial institution subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution. Under the terms of the agreement, each share of Northern Empire common stock would be converted into 0.8050 shares of Sterling common stock and $2.71 in cash, subject to certain conditions. The transaction, which was valued at approximately $335 million as of the date that the parties agreed to merge, is expected to close on February 28, 2007.

Sterling intends to continue to pursue an aggressive growth strategy to become the leading community bank in the western United States. This strategy may include acquiring other financial businesses or branches thereof, or other substantial assets or deposit liabilities. However, Sterling may not be successful in identifying further acquisition candidates, integrating acquisitions or preventing such acquisitions from having an adverse effect on Sterling. There is significant competition for acquisitions in Sterling’s market area, and Sterling may not be able to acquire other businesses on attractive terms. Furthermore, the success of Sterling’s growth strategy will depend on increasing and maintaining sufficient levels of regulatory capital, obtaining necessary regulatory approvals, generating appropriate growth and the existence of favorable economic and market conditions. There can be no assurance that Sterling will be successful in implementing its growth strategy.

Profitability Drivers

We expect to increase our profitability in the future by:


	•	continuing to increase the volume of our loans and change the mix of our loan portfolio to higher-yielding commercial banking, construction and consumer loans.

	•	growing our core deposits, particularly non-interest bearing consumer and commercial transaction deposits.

	•	expanding products and services for commercial customers, including depository and treasury management services such as lockbox, on-line net banking, merchant services, analyzed and sweep accounts, remote deposit and international services.

	•	diversifying and growing our fee income through existing and new fee income sources, including deposit fees, transaction fees, fees from mortgage banking and other fees.

	•	maintaining strong asset quality through robust underwriting and credit approval functions.

	•	managing interest rate risk to protect net interest margin in a changing interest rate environment.

Together, we believe these strategies will contribute to increasing high quality earnings and maximizing shareholder value. The effect of these strategies on our financial results is discussed further in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).

Lending Activities

Focus on Community Lending. In recent years, Sterling repositioned its loan portfolio and operations to be more like that of a community bank. Commercial real estate, commercial banking, consumer and construction loans generally produce higher yields than residential permanent mortgage loans. Such loans, however, generally involve a higher degree of risk than financing residential real estate.

Commercial Lending. Sterling has structured its commercial lending in three groups: Commercial Banking, Corporate Banking and Private Banking. Sterling’s Commercial Banking Group provides a full range of credit products to small-and medium-sized businesses and to individuals. Credit products include lines of credit, receivable and inventory financing, equipment loans, and permanent and construction real restate financing. Loans may be made unsecured, partially secured or fully secured based on certain credit criteria. The credit product line for both businesses and individuals includes standardized products, as well as customized accommodations.

Sterling’s Corporate Banking Group provides a full line of financial services to middle market companies in its service area. Credit products include lines of credit, receivable and inventory financing, equipment loans and permanent and construction financing. Loans may be made on an unsecured, partially secured or fully secured basis. The Corporate Banking Group also serves the needs of the owners and key employees of its business customers.

Sterling’s Private Banking Group provides services to higher-net-worth and higher-income borrowers by originating a variety of consumer and commercial banking loans. Such loans generally, but do not always, meet the same underwriting requirements or have the same terms as general consumer loans of the same type.

Sterling has established minimum underwriting standards, which delineate criteria for sources of repayment, financial strength and credit enhancements such as guarantees. Typically, the primary source of repayment is recurring cash flow of the borrower or cash flow from the business or project being financed. Depending on the type of loan, underwriting standards include minimum financial requirements, maximum loan-to-collateral value ratios, minimum cash flow coverage of debt service, debt-to-income ratios and minimum liquidity requirements. Exceptions to the minimum underwriting standards may be made depending upon the type of loan and financial strength of the borrower. Exceptions are reported to the appropriate level of authority up to and including the board of directors. Common forms of collateral pledged to secure commercial banking loans include real estate, accounts receivable, inventory, equipment, agricultural crops or livestock and marketable securities. Most loans have maximum terms of one to ten years and loan-to-value ratios in the range of 65% to 80%, based on an analysis of the collateral pledged.

Commercial, corporate and private banking loans generally involve a higher degree of risk than financing real estate, primarily because collateral is more difficult to appraise, the collateral may be difficult to obtain or liquidate following an uncured default and it is difficult to accurately predict the borrower’s ability to generate future cash flows. These loans, however, typically offer relatively higher yields and variable interest rates. The availability of such loans enables potential depositors to establish full-service banking relationships with Sterling.

Multifamily Residential and Commercial Real Estate Lending. Sterling offers multifamily residential and commercial real estate loans as both construction and permanent loans collateralized by real property. Construction loans on such properties typically have terms of 12 to 24 months and have variable interest rates. Permanent fixed- and adjustable-rate loans on existing properties typically have maturities of three to ten years. Multifamily residential and commercial real estate loans generally involve a higher degree of risk than one- to four-family residential real estate loans, because they typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the real estate project and is subject to certain risks not present in one- to four-family residential mortgage lending. These risks include excessive vacancy rates or inadequate operating cash flows. Construction lending is subject to risks such as construction delays, cost overruns, insufficient values and an inability to obtain permanent financing in a timely manner. Sterling attempts to reduce its exposure to these risks by limiting loan amounts to the amounts readily accepted in the secondary market, by closely monitoring the construction disbursement process, by investigating the borrowers’ finances and, depending on the circumstances, requiring annual financial statements from the borrowers, requiring operating statements on the properties or acquiring personal guarantees from the borrowers.

One- to Four-Family Residential Lending. Sterling originates fixed- and adjustable-rate residential mortgages (“ARMs”), which have interest rates that adjust annually or every three, five or seven years and are indexed to a variety of market indices, as well as interest only residential mortgages.

Sterling continues to originate conventional and government-insured residential loans for sale into the secondary mortgage market. Within the secondary mortgage market for conventional loans, Sterling sells its

residential loans both on a servicing-released and servicing-retained basis primarily to the Federal Home Loan Mortgage Corporation (“FHLMC”) and to the Federal National Mortgage Association (“FNMA”). Sterling endeavors to underwrite residential loans in compliance with these agencies’ underwriting standards. Loans sold into the secondary market are all sold without recourse to Sterling, except that Sterling may be obligated to repurchase any loans that are not underwritten in accordance with these agencies’ or applicable investor underwriting guidelines.

Conventional residential mortgage loans are originated for up to 103% of the appraised value or selling price of the mortgaged property, whichever is less. Borrowers must purchase private mortgage insurance from approved third parties so that Sterling’s risk is limited to approximately 80% of the appraised value on all loans with loan-to-value ratios in excess of 80%. Sterling’s residential lending programs are designed to comply with all applicable regulatory requirements. For a discussion of Sterling’s management of interest rate risk (“IRR”) on conventional loans, see “— Secondary Market Activities.”

Sterling originates residential construction loans on presold and spec homes, as well as townhouses and condominiums. Sterling also provides land, lot, and acquisition and development loans for residential subdivisions. Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied real estate. Sterling’s risk of loss on construction loans depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, Sterling might have to advance funds beyond the amount originally committed to permit completion of the development and to protect its security position. Sterling also might be confronted, at or prior to maturity of the loan, with a project with insufficient value to ensure full repayment. Sterling’s underwriting, monitoring and disbursement practices with respect to construction financing are intended to ensure that sufficient funds are available to complete construction projects. Sterling endeavors to limit its risk through its underwriting procedures by using only approved, qualified appraisers and by dealing only with qualified builders/borrowers.

Consumer Lending. Consumer loans and lines of credit are originated directly through Sterling’s retail branches and Private Banking Group, and indirectly through Sterling’s Dealer Banking Department. Sterling finances purchases of consumer goods including automobiles, boats and recreational vehicles, and lines of credit for personal use. Generally, consumer loans are originated for terms ranging from six months to ten years. Interest rates may be either fixed or adjustable based on a contractual formula tied to established external indices. Sterling also makes loans secured by borrowers’ savings accounts and equity loans collateralized by residential real estate. Equity loans may have maturities of up to 20 years.

The following table sets forth information on loan originations for the periods indicated:


	Years Ended December 31,
	2006				2005				2004
	Amount		%		Amount		%		Amount		%
	(Dollars in thousands)

Mortgage — permanent:
One- to four-family residential	$	830,619		16.7	$	461,414		11.9	$	400,391		13.7
Multifamily residential		4,215		0.1		57,571		1.5		43,395		1.5
Commercial real estate		131,001		2.6		218,396		5.6		241,754		8.3

		965,835		19.4		737,381		19.0		685,540		23.5

Mortgage — construction:
One- to four-family residential		1,425,248		28.7		1,106,632		28.5		719,146		24.6
Multifamily residential		156,932		3.2		175,018		4.5		102,970		3.5
Commercial real estate		752,458		15.1		519,893		13.4		203,401		7.0

		2,334,638		47.0		1,801,543		46.4		1,025,517		35.1

Total mortgage loans		3,300,473		66.4		2,538,924		65.4		1,711,057		58.6

Commercial and consumer:
Commercial banking		1,154,304		23.2		898,768		23.1		818,594		28.1
Consumer — direct		327,027		6.6		353,840		9.1		332,076		11.4
Consumer — indirect		189,505		3.8		90,096		2.4		56,403		1.9

Total commercial and consumer loans		1,670,836		33.6		1,342,704		34.6		1,207,073		41.4

Total loans originated	$	4,971,309		100.0	$	3,881,628		100.0	$	2,918,130		100.0

Loan Portfolio Analysis. The following table sets forth the composition of Sterling’s loan portfolio by type of loan at the dates indicated:


	December 31,
	2006					2005					2004					2003					2002
	Amount			%		Amount			%		Amount			%		Amount			%		Amount			%
	(Dollars in thousands)

Mortgage — permanent:
One- to four-family residential	$	654,661			9.2	$	488,633			9.9	$	794,632			18.4	$	407,999			13.8	$	358,359			14.8
Multifamily residential		263,053			3.7		332,211			6.7		184,754			4.3		167,220			5.7		161,547			6.7
Commercial real estate		795,386			11.2		792,219			16.0		699,879			16.3		463,191			15.7		458,712			18.9

		1,713,100			24.1		1,613,063			32.6		1,679,265			39.0		1,038,410			35.2		978,618			40.4

Mortgage — construction:
One- to four-family residential		1,429,772			20.1		591,362			11.9		356,644			8.3		271,480			9.2		280,514			11.6
Multifamily residential		189,819			2.7		143,272			2.9		102,166			2.4		127,424			4.3		96,297			4.0
Commercial real estate		671,291			9.4		286,868			5.8		194,085			4.5		154,061			5.2		104,108			4.3

		2,290,882			32.2		1,021,502			20.6		652,895			15.2		552,965			18.7		480,919			19.9

Total mortgage loans		4,003,982			56.3		2,634,565			53.2		2,332,160			54.2		1,591,375			53.9		1,459,537			60.3
Commercial and consumer:
Commercial banking		2,069,086			29.1		1,531,079			30.9		1,311,197			30.4		948,304			32.2		655,727			27.0
Consumer — direct		749,626			10.5		618,528			12.5		543,895			12.6		309,931			10.5		246,578			10.2
Consumer — indirect		288,704			4.1		166,143			3.4		120,894			2.8		99,697			3.4		62,896			2.5

Total commercial and consumer loans		3,107,416			43.7		2,315,750			46.8		1,975,986			45.8		1,357,932			46.1		965,201			39.7

Total loans receivable		7,111,398			100.0		4,950,315			100.0		4,308,146			100.0		2,949,307			100.0		2,424,738			100.0

Deferred fees, net		(12,308	)				(8,916	)				(6,907	)				(7,276	)				(6,450	)

Gross loans receivable		7,099,090					4,941,399					4,301,239					2,942,031					2,418,288
Allowance for loan losses		(83,689	)				(55,483	)				(49,362	)				(35,605	)				(27,866	)

Loans receivable, net	$	7,015,401				$	4,885,916				$	4,251,877				$	2,906,426				$	2,390,422

Contractual Principal Payments. The following table sets forth the scheduled contractual principal repayments for Sterling’s loan portfolio at December 31, 2006. Demand loans, loans having no stated repayment schedule

and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, deferred loan origination costs and fees, or allowances for loan losses.


	Balance
	Outstanding at		Principal Payments
	December 31,		Contractually Due in Fiscal Years
	2006		2007		2008-2011		Thereafter
	(In thousands)

Mortgage — permanent:
Fixed rate	$	785,819	$	50,989	$	191,245	$	543,585
Variable rate		927,281		67,120		263,518		596,643
Mortgage — construction		2,290,882		1,562,065		682,318		46,499
Consumer — direct		749,626		271,566		139,410		338,650
Consumer — indirect		288,704		60,201		201,032		27,471
Commercial banking		2,069,086		1,071,813		509,287		487,986

	$	7,111,398	$	3,083,754	$	1,986,810	$	2,040,834

Loan Servicing. Sterling services its own loans, as well as loans owned by others. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, holding escrow funds for the payment of real estate taxes and insurance premiums, contacting delinquent borrowers and supervising foreclosures in the event of unremedied defaults. For loans serviced by others, Sterling generally receives a fee based on the unpaid principal balance of each loan to compensate for the costs of performing the servicing function.

For residential mortgage loans serviced for other investors, Sterling receives a fee, generally ranging from 5 to 25 basis points of the unpaid principal balance. At December 31, 2006 and 2005, Sterling serviced for itself and for other investors, residential mortgage loans totaling $1.17 billion and $972.5 million, respectively. Of such mortgage loans, $621.6 million in 2006 and $606.7 million in 2005 were primarily serviced for FHLMC and FNMA. Sterling’s ability to continue as a seller/servicer for these agencies is dependent upon meeting their qualifications. Sterling currently meets all applicable requirements.

Sterling receives a fee for servicing commercial and multifamily real estate loans for other investors. This fee generally ranges from 5 to 25 basis points of the unpaid principal balance. At December 31, 2006 and 2005, Sterling serviced for itself and other investors, commercial and multifamily real estate loans totaling $2.57 billion and $1.74 billion, respectively.

Secondary Market Activities. Sterling has developed correspondent relationships with a number of mortgage companies and financial institutions to facilitate the origination or purchase and sale of mortgage loans in the secondary market on either a participation or whole loan basis. Substantially all of such purchased loans or participations are secured by real estate. Those agents who present loans to Sterling for purchase are required to provide a processed loan package prior to commitment. Sterling then underwrites the loan in accordance with its established lending standards.

Sterling, from time to time, sells participations in certain commercial real estate loans to investors on a servicing-retained basis. During the years ended December 31, 2006, 2005 and 2004, Sterling sold approximately $54.9 million, $125.5 million and $16.3 million in loans under participation agreements, resulting in net gains of $747,000, $449,000 and $44,000, respectively.

Sterling generally receives a fee of approximately 100 to 200 basis points of the principal balance of mortgage loans for releasing the servicing. In 2006, 99% of Sterling’s sales of Federal Housing Administration (“FHA”) and Department of Veterans Affairs (“VA”) insured loans were sold into the secondary market on a loan-by-loan, servicing-released basis, compared with 94% in 2005.

In 2006, 1% of Sterling’s sales of conventional, FHA and VA insured loans were sold into the secondary market on a servicing-retained basis, compared with 6% in 2005. Sterling records a valuation of approximately 100 to 115 basis points of the principal balance of such loans for retaining the servicing. At December 31, 2006 and 2005,

Sterling had recorded as net assets $7.3 million and $5.4 million in servicing rights, respectively. See Note 4 of “Notes to Consolidated Financial Statements.”

Loan Commitments. Sterling makes written commitments to individual borrowers and mortgage brokers for the purposes of originating and purchasing loans. These loan commitments establish the terms and conditions under which Sterling will fund the loans. Sterling had outstanding commitments to originate or purchase loans, the undisbursed portion of which aggregated $1.36 billion and $925.8 million at December 31, 2006 and 2005, respectively. Sterling also had secured and unsecured commercial and personal lines of credit, the undisbursed portion of which was approximately $944.7 million and $826.2 million at December 31, 2006 and 2005, respectively. See Note 16 of “Notes to Consolidated Financial Statements.”

Derivatives and Hedging. Sterling, in the conduct of ordinary business operations routinely enters into contracts that may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contracts. Sterling is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Management does not believe that these off-balance sheet arrangements have a material current effect on Sterling’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources but there is no assurance that such arrangements will not have a future effect.

As part of its mortgage banking activities, Sterling issues interest rate lock commitments (“rate locks”) to prospective borrowers on residential one-to-four family mortgage loan applications. Pricing for the sale of these loans is fixed with various qualified investors, such as FNMA, under both non-binding (“best-efforts”) and binding (“mandatory”) delivery programs at or near the time the interest rate is locked with the borrowers. For mandatory delivery programs, Sterling hedges IRR by entering into offsetting forward sale agreements on MBS with third parties. Risks inherent in mandatory delivery programs include the risk that if Sterling does not close the loans subject to rate locks, it is nevertheless obligated to deliver MBS to the counterparty under the forward sale agreement. Sterling could incur significant costs in acquiring replacement loans or MBS and such costs could have a material adverse effect on mortgage banking operations in future periods. At December 31, 2006, Sterling did not have any loans locked with investors under mandatory delivery programs, nor hold any offsetting forward sale agreements on MBS. As of December 31, 2006, Sterling had entered into best efforts forward commitments to sell $142.6 million of mortgage loans.

Rate lock commitments to borrowers and best-effort loan delivery commitments from investors are off-balance-sheet commitments that are considered to be derivatives. Sterling accounts for these commitments by recording their estimated fair value on its balance sheet. As of December 31, 2006, Sterling recorded an asset of approximately $482,000 for the estimated fair value of rate locks issued and a liability of approximately $482,000 for the estimated fair value of delivery commitments received. As of December 31, 2005, Sterling had loans subject to rate locks under a mandatory delivery program and held off-setting forward sale agreements for MBS. Correspondingly, as of December 31, 2005, Sterling recorded an asset of $147,000 for the fair value of rate locks and a liability of $25,000 for the fair value of forward sale agreements.

Sterling enters into interest rate swap derivative contracts with customers. The IRR on these contracts is offset by entering into comparable dealer swaps. These contracts are carried at fair value.

Classified Assets, Real Estate Owned and Delinquent Loans. To measure the quality of assets, including loans and real estate owned (“REO”), Sterling has established guidelines for classifying assets and determining provisions for anticipated loan and REO losses. Under these guidelines, an allowance for anticipated loan and REO losses is established when certain conditions exist. This system for classifying and reserving for loans and REO is administered by Sterling’s Special Assets and Asset Recovery Departments, which are responsible for minimizing loan deficiencies and losses therefrom. An oversight committee, comprised of senior management, monitors the activities of the Special Assets and Asset Recovery Departments and reports results to Sterling’s Board of Directors.

Under this system, Sterling classifies loans and other assets it considers of questionable quality. Sterling’s system employs the classification categories of “substandard,” “doubtful” and “loss.” Substandard assets have deficiencies, which give rise to the distinct possibility that Sterling will sustain some loss if the deficiencies are not

corrected. Doubtful assets have the weaknesses of substandard assets, and on the basis of currently existing facts, there is a high probability of loss. An asset classified as loss is considered uncollectible and of such little value that it should not be included as an asset of Sterling. Total classified assets decreased to $48.4 million at December 31, 2006, from $59.6 million at December 31, 2005. As a percentage of total assets, classified assets decreased from the prior year. The percentage of classified assets to total assets was 0.49% and 0.79% at December 31, 2006 and 2005, respectively. See “— Major Classified Loans.”

Assets classified as substandard or doubtful require the establishment of valuation allowances in amounts considered by management to be adequate under accounting principles generally accepted in the United States of America (“GAAP”). Assets classified as loss require either a specific valuation allowance of 100% of the amount classified or a write-off of such amount. At December 31, 2006, Sterling’s assets classified as loss totaled $1.4 million compared to $2.2 million at December 31, 2005. Judgments regarding the adequacy of a valuation allowance are based on ongoing evaluations of the nature, volume and quality of the loan portfolio, REO, specific problem assets and current economic conditions that may affect the recoverability of recorded amounts.

REO is recorded at the lower of estimated fair value, less estimated selling expenses, or carrying value at foreclosure. Fair value is defined as the amount in cash or other consideration that a real estate asset would yield in a current sale between a willing buyer and a willing seller. Development and improvement costs relating to the property are capitalized to the extent they are deemed to be recoverable upon disposal. The carrying value of REO is continuously evaluated and, if necessary, an allowance is established to reduce the carrying value to net realizable value, which considers, among other things, estimated direct holding costs and selling expenses.

The following table sets forth the activity in Sterling’s REO for the periods indicated:


	Years Ended December 31,
	2006			2005			2004
	(Dollars in thousands)

Balance at beginning of period	$	779		$	1,865		$	4,226
Loan foreclosures and other additions		4,581			2,271			4,445
Improvements and other changes		(244	)		331			(132	)
Sales		(894	)		(3,665	)		(6,669	)
Provisions for losses		(170	)		(23	)		(5	)

Balance at end of period	$	4,052		$	779		$	1,865

Major Classified Loans. Within Sterling’s classified loans as of December 31, 2006, three borrowers each held loans that in the aggregate exceeded $4.0 million. These loans, which together constitute 30% of classified assets, included the following:

Sterling holds commercial loans for auto dealership flooring lines and equipment, secured by auto inventory, real estate and personal guarantees. The aggregate carrying value of these loans at December 31, 2006 was $5.1 million. These loans have been classified due to delinquency and because the borrower has been selling inventory out of trust. These loans are currently in default.

Sterling holds commercial loans secured by equipment and real estate. The aggregate carrying value of these loans at December 31, 2006 was $5.0 million. These loans have been classified due to operating losses. These loans remain current.

Sterling holds commercial loans for auto dealership flooring lines. The aggregate carrying value of these loans at December 31, 2006 was $4.4 million. These loans are secured by auto inventory and real estate. These loans remain current under revisions to lending arrangement.

Major Real Estate Owned. At December 31, 2006, the aggregate value of REO properties was $4.1 million, with the majority representing two hotels.

Delinquent Loan Procedures. Delinquent and problem loans are part of any lending business. If a borrower fails to make a required payment when due, Sterling institutes internal collection procedures. For residential mortgage and consumer loans, Sterling’s collection procedures generally require that an initial request for payment

be mailed to the borrower when the loan is 15 days past due. At 25 days past due, the borrower is contacted by telephone and payment is requested orally. At 30 days past due, Sterling records the loan as a delinquency. In the case of delinquent residential mortgage loans, a notice of intent to foreclose is mailed at 45 days past due. If the loan is still delinquent 30 days following the mailing of the notice of intent to foreclose, Sterling generally initiates foreclosure proceedings.

For consumer loans, a demand letter is sent when the account becomes delinquent for two payments. Additional collection work or repossession may follow. In certain instances, Sterling may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs. Collection procedures similar to those used for consumer and residential mortgage loans are followed for commercial, construction and income property loans, with the exception that these accounts are generally handled as a joint effort between the originating loan officer and the Special Assets Department during initial stages of delinquency. On or before 60 days of delinquency, the collection effort is typically shifted from the originating loan officer to the Special Assets Department.

The following table summarizes the principal balances of nonperforming assets at the dates indicated:


	December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)

Nonaccrual loans	$	7,107		$	6,542		$	10,738		$	16,208		$	16,278
Restructured loans		0			1,081			1,305			1,164			594

Total nonperforming loans		7,107			7,623			12,043			17,372			16,872
Real estate owned(1)		4,052			779			1,865			4,226			3,953

Total nonperforming assets	$	11,159		$	8,402		$	13,908		$	21,598		$	20,825

Ratio of total nonperforming assets to total assets		0.11	%		0.11	%		0.20	%		0.50	%		0.59	%
Ratio of total nonperforming loans to gross loans		0.10	%		0.15	%		0.28	%		0.59	%		0.70	%
Ratio of allowance for estimated losses on loans to total nonperforming loans(2)		1437.0	%		975.9	%		538.3	%		216.6	%		174.3	%


(1)		Amount is net of the allowance for REO losses.

(2)		Excludes loans classified as loss. Loans classified as loss that are excluded from allowance for loan losses were $1,379,000, $2,159,000, $3,528,000, $2,897,000 and $2,067,000 at December 31, 2006, 2005, 2004, 2003 and 2002, respectively. There were no loans classified as loss that are excluded from total nonperforming loans in any of the periods.

Sterling regularly reviews the collectibility of accrued interest and generally ceases to accrue interest on a loan when either principal or interest is past due by 90 days or more. Any accrued and uncollected interest is reversed from income at that time. Loans may be placed in nonaccrual status earlier if, in management’s judgment, the loan may be uncollectible. Interest on such a loan is then recognized as income only if collected or if the loan is restored to performing status. Interest income of $249,000, $258,000, and $659,000 was recorded on these loans during the years ended December 31, 2006, 2005 and 2004, respectively. Additional interest income of $321,000, $693,000 and $1,348,000 would have been recorded during the years ended December 31, 2006, 2005 and 2004, respectively, if nonaccrual and restructured loans had been current in accordance with their original contractual terms.

Allowance for Loan and Real Estate Owned Losses. Generally, Sterling establishes specific allowances for the difference between the anticipated fair value (market value less selling costs, foreclosure costs and projected holding costs), adjusted for other possible sources of repayment, and the book balance (loan principal and accrued interest or carrying value of REO) of its loans classified as loss and REO. Each classified loan and REO property is reviewed at least monthly. Allowances are established or periodically adjusted, if necessary, based on the review of information obtained through on-site inspections, market analysis, appraisals and purchase offers.

The allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for probable losses related to specifically identified loans as well as probable losses in the remaining portfolio. The allowance is based upon historical loss experience, delinquency trends, portfolio size, concentrations of risk, prevailing and anticipated economic conditions, industry experience, estimated collateral values, management’s assessment of credit risk inherent in the portfolio, specific problem loans and other relevant factors. The portfolio is grouped into standard industry categories for homogeneous loans based on characteristics such as loan type, borrower and collateral. Multiple years of historical loss experience are used to develop loss emergence periods and expected losses for each loan category.

Additions to the allowance, in the form of provisions, are reflected in current operating results, while charge-offs to the allowance are made when a loss is determined to have occurred. Because the allowance for loan losses is based on estimates, ultimate losses may materially differ from the estimates. See Note 3 of “Notes to Consolidated Financial Statements.”

Management believes that the allowance for loan losses is adequate given the composition and risks of the loan portfolios, although there can be no assurance that the allowance will be adequate to cover all contingencies. The following table sets forth information regarding changes in Sterling’s allowance for estimated losses on loans for the periods indicated:


	Years Ended December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)

Balance at beginning of period	$	55,483		$	49,362		$	35,605		$	27,866		$	20,599
Charge-offs:
Mortgage — permanent		(32	)		(37	)		(59	)		(165	)		(48	)
Mortgage — construction		(12	)		(19	)		(645	)		(106	)		(868	)
Consumer — direct		(619	)		(1,107	)		(1,373	)		(1,146	)		(954	)
Consumer — indirect		(823	)		(449	)		(370	)		(445	)		(407	)
Commercial banking		(2,919	)		(8,039	)		(3,036	)		(2,391	)		(2,776	)

Total charge-offs		(4,405	)		(9,651	)		(5,483	)		(4,253	)		(5,053	)

Recoveries:
Mortgage — permanent		5			6			25			42			19
Mortgage — construction		20			0			2			3			2
Consumer — direct		193			237			214			160			208
Consumer — indirect		310			201			111			149			170
Commercial banking		225			128			16			268			54

Total recoveries		753			572			368			622			453

Net charge-offs		(3,652	)		(9,079	)		(5,115	)		(3,631	)		(4,600	)
Provisions for loan losses		18,703			15,200			12,150			10,500			11,867
Allowance for losses on assets acquired		13,155			0			6,722			870			0

Balance at end of period	$	83,689		$	55,483		$	49,362		$	35,605		$	27,866

Allowances allocated to loans classified as loss	$	1,379		$	2,159		$	3,528		$	2,897		$	2,067
Ratio of net charge-offs to average loans outstanding during the period		0.06	%		0.20	%		0.13	%		0.13	%		0.21	%

Allowances are provided for individual loans when management considers ultimate collection to be questionable. Such allowances are based, among other factors, upon the estimated net realizable value of the collateral of the loan or guarantees, if applicable. The following table sets forth the allowances for estimated losses on loans by category and summarizes the percentage of total loans in each category to total loans:


	December 31,
	2006				2005				2004				2003				2002
			Loans in				Loans in				Loans in				Loans in				Loans in
			Category				Category				Category				Category				Category
			as a				as a				as a				as a				as a
			Percentage				Percentage				Percentage				Percentage				Percentage
	Allowance		of Total		Allowance		of Total		Allowance		of Total		Allowance		of Total		Allowance		of Total
	Amount		Loans		Amount		Loans		Amount		Loans		Amount		Loans		Amount		Loans
	(Dollars in thousands)

Mortgage — permanent	$	13,782		24.1	$	14,576		32.6	$	10,632		39.0	$	4,902		35.2	$	2,881		40.4
Mortgage — construction		17,925		32.2		8,016		20.6		6,264		15.2		6,336		18.7		6,199		19.9
Consumer — direct		8,205		10.5		6,795		12.5		7,247		12.6		3,843		10.5		2,986		10.2
Consumer — indirect		2,880		4.1		1,205		3.4		1,156		2.8		1,676		3.4		1,349		2.5
Commercial banking		40,082		29.1		23,626		30.9		23,710		30.4		17,979		32.2		14,014		27.0
Unallocated		815		N/A		1,265		N/A		353		N/A		869		N/A		437		N/A

	$	83,689		100.0	$	55,483		100.0	$	49,362		100.0	$	35,605		100.0	$	27,866		100.0

Investments and Mortgage-Backed Securities

Investments and MBS that management has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. At December 31, 2006 and 2005, investments and MBS classified as held to maturity were $93.1 million and $51.9 million, respectively. See “MD&A — Critical Accounting Policies — Investments and MBS.”

At December 31, 2006 and 2005, investments and MBS classified as available for sale were $1.82 billion and $2.08 billion, respectively. The carrying value of these investments and MBS at December 31, 2006 and 2005 includes net unrealized losses of $52.8 million and $54.1 million, respectively. Fluctuations in prevailing interest rates continue to cause volatility in this component of accumulated comprehensive income and may continue to do so in future periods. See “MD&A — Critical Accounting Policies — Investments and MBS.”

Sterling invests primarily in MBS issued by FHLMC and FNMA and other agency obligations. Such investments provide Sterling with a relatively liquid source of interest income and collateral, which can be used to secure borrowings. Sterling invests primarily in investment-grade investments and MBS. See “MD&A — Results of Operations — Non-Interest Income and Non-Interest Expense” and Note 1 of “Notes to Consolidated Financial Statements.”

The following table provides the carrying values, contractual maturities and weighted average yields of Sterling’s investment and MBS portfolio at December 31, 2006. Actual maturities may differ from the contractual maturities, because issuers may have the right to call or prepay obligations with or without prepayment penalties.


	Maturity
	Less Than			One to			Over Five to			Over Ten
	One Year			Five Years			Ten Years			Years			Total
	(Dollars in thousands)

Mortgage-backed securities
Balance	$	0		$	78,196		$	9,115		$	1,600,361		$	1,687,672
Weighted average yield		0.00	%		3.94	%		4.03	%		4.82	%		4.77	%
U.S. government and agency obligations
Balance	$	12,469		$	9,859		$	0		$	0		$	22,328
Weighted average yield		4.82	%		3.94	%		0.00	%		0.00	%		4.43	%
FHLB Seattle stock, at cost
Balance	$	0		$	0		$	0		$	91,897		$	91,897
Weighted average yield(1)		0.00	%		0.00	%		0.00	%		0.39	%		0.39	%
Municipal bonds
Balance	$	1,800		$	1,755		$	9,445		$	79,808		$	92,808
Weighted average yield(2)		3.64	%		3.46	%		4.10	%		4.40	%		4.33	%
Other(3)
Balance	$	80		$	175		$	0		$	18,686		$	18,941
Weighted average yield		3.20	%		4.20	%		0.00	%		0.55	%		0.60	%

Total carrying value	$	14,349		$	89,985		$	18,560		$	1,790,752		$	1,913,646

Weighted average yield		4.66	%		3.93	%		4.07	%		4.53	%		4.49	%


(1)		FHLB Seattle resumed paying dividends during the second half of 2006.

(2)		The weighted average yields on municipal bonds reflect the actual yields on the bonds and are not presented on a tax-equivalent basis.

(3)		Other investments relate primarily to limited partnership interests in low-income housing projects.

The following table sets forth the carrying values and classifications for financial statement reporting purposes of Sterling’s investment and MBS portfolio at the dates indicated:


	December 31,
	2006			2005			2004
	(Dollars in thousands)

Mortgage-backed securities	$	1,687,672		$	1,960,582		$	2,036,920
U.S. government and agency obligations		22,328			21,793			28,070
FHLB Seattle stock		91,897			76,626			74,846
Municipal bonds		92,808			50,907			47,449
Other		18,941			18,631			17,300

Total	$	1,913,646		$	2,128,539		$	2,204,585

Available for sale	$	1,820,583		$	2,076,615		$	2,157,136
Held to maturity		93,063			51,924			47,449

Total	$	1,913,646		$	2,128,539		$	2,204,585

Weighted average yield		4.49	%		4.46	%		4.50	%

Sources of Funds

General. Sterling’s primary sources of funds for use in lending and for other general business purposes are deposits, loan repayments, FHLB Seattle advances, reverse repurchase agreements and other borrowings, proceeds from investments and MBS, and sales of loans. Scheduled loan repayments are a relatively stable source of funds, while other sources of funds are influenced significantly by prevailing interest rates, interest rates available on other borrowings and other economic conditions. Borrowings may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and to match repricing intervals of assets. See “— Lending Activities” and “— Investments and Mortgage-Backed Securities.”

Deposit Activities. Sterling offers a variety of accounts for depositors designed to attract both short-term and long-term deposits from the general public. These accounts include transaction accounts, savings accounts, money market deposit accounts (“MMDA”), and certificates of deposit (“CDs”) accounts. Sterling offers both interest- and non-interest-bearing checking accounts. The interest-bearing checking accounts can be subject to monthly service charges, unless a minimum balance is maintained. MMDA, CDs and savings accounts earn interest at rates established by management and are based on a competitive market analysis. The method of compounding varies from simple interest credited at maturity to daily compounding, depending on the type of account.

With the exception of certain promotional CDs and variable-rate 18-month Individual Retirement Account certificates, all CDs carry a fixed rate of interest for a defined term from the opening date of the account. Substantial penalties are imposed if principal is withdrawn from most CDs prior to maturity.

Sterling supplements its retail deposit gathering by soliciting funds from public entities and acquiring brokered deposits. Public funds were 5.6% and 8.9% of deposits at December 31, 2006 and 2005, respectively. Public funds are generally obtained by competitive bidding among qualifying financial institutions. Sterling had $1.10 billion and $628.3 million of brokered deposits at December 31, 2006 and 2005, respectively.

The following table presents the average balance outstanding and weighted average interest rate paid for each major category of deposits for the periods indicated:


	Years Ended December 31,
	2006					2005					2004
			Weighted					Weighted					Weighted
			Average					Average					Average
	Average		Interest			Average		Interest			Average		Interest
	Balance		Rate			Balance		Rate			Balance		Rate
						(Dollars in thousands)

Time deposits	$	2,962,017		4.58	%	$	2,041,122		3.35	%	$	1,608,599		2.57	%
Savings and MMDA		1,512,198		3.16			1,158,270		1.92			1,092,612		1.04
Transaction accounts:
Interest-bearing		399,690		0.42			419,137		0.32			399,963		0.21
Noninterest-bearing		706,631		0.00			648,385		0.00			546,128		0.00

	$	5,580,536		3.32	%	$	4,266,914		2.16	%	$	3,647,302		1.47	%

The following table shows the amounts and remaining maturities of time deposits that had balances of $100,000 or more at December 31, 2006 and 2005:


	December 31,
	2006		2005
	(Dollars in thousands)

Three months or less	$	931,437	$	525,623
After three months through six months		644,825		332,184
After six months through twelve months		509,732		449,559
After twelve months		212,639		201,183

	$	2,298,633	$	1,508,549

Sterling has 163 automated teller machines (“ATM”). Customers also can access ATMs operated by other financial institutions. Sterling is a member of The Exchange and the Plus System ATM networks that allow participating customers to deposit or withdraw funds from transaction accounts, MMDA and savings accounts at numerous locations in the United States and internationally.

Borrowings. Deposit accounts are Sterling’s primary source of funds. Sterling does, however, rely upon advances from the Federal Home Loan Bank Seattle (“FHLB Seattle”), reverse repurchase agreements and other borrowings to supplement its funding and to meet deposit withdrawal requirements. Other borrowings increased from December 31, 2005 due to Sterling’s wholly owned subsidiaries, Sterling Capital Trusts VII and VIII, issuing $105.0 million of Trust Preferred Securities. Other borrowings also increased as a result of acquiring $19.0 million of Trust Preferred Securities in the acquisition of Golf Savings Bank. See “MD&A — Liquidity and Capital Resources.”

The FHLB Seattle is part of a system that consists of 12 regional Federal Home Loan Banks each subject to Federal Housing Finance Board supervision and regulation, and that function as a central reserve bank providing credit to financial institutions. As a condition of membership in the FHLB Seattle, Sterling Savings Bank is required to own stock of the FHLB Seattle in an amount determined by a formula based upon the larger of Sterling Savings Bank’s total qualifying mortgages and MBS, or total advances from the FHLB Seattle. At December 31, 2006, Sterling Savings Bank held more than the minimum FHLB Seattle stock ownership requirement. The stock of the FHLB Seattle always has been redeemable at par value, but there can be no assurance that this always will be the case.

As a member of the FHLB Seattle, Sterling Savings Bank can apply for advances collateralized by certain loans or securities, provided certain standards related to creditworthiness, including a minimum ratio of total capital assets of at least five percent, are met. Each available credit program has its own interest rate and range of maturities. At December 31, 2006, Sterling had advances totaling $1.31 billion from the FHLB Seattle, which mature from 2007 through 2030 at interest rates ranging from 2.32% to 8.08%. See “MD&A — Liquidity and Capital Resources” and Note 8 of “Notes to Consolidated Financial Statements.”

Sterling also borrows funds under reverse repurchase agreements with major broker/dealers and financial entities pursuant to which it sells investments (generally, U.S. agency obligations and MBS) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and MBS sold. Sterling uses these borrowings to supplement deposit gathering for funding the origination of loans. Sterling had $616.4 million and $611.7 million in wholesale and retail reverse repurchase agreements outstanding at December 31, 2006 and 2005, respectively. The use of reverse repurchase agreements may expose Sterling to certain risks not associated with other borrowings, including IRR and the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines. For additional information regarding reverse repurchase agreements, see “MD&A — Asset and Liability Management,” “MD&A — Liquidity and Capital Resources” and Note 9 of “Notes to Consolidated Financial Statements.”

On August 21, 2006, Sterling entered into a $30 million one-year variable-rate revolving credit agreement (the “Credit Facility”) with Wells Fargo Bank, National Association, replacing a $40 million credit facility Sterling previously had with Bank of Scotland. As of December 31, 2006, no amount was drawn on the credit facility. Amounts loaned pursuant to the Credit Facility will bear interest, at Sterling’s election, at either two percent below prime, or at LIBOR plus 90 basis points. The Credit Facility contains representations and warranties, and negative and affirmative covenants by Sterling, including financial covenants and restrictions on certain actions by Sterling, such as Sterling’s ability to incur debt, make investments and merge into or consolidate with other entities. The Credit Facility may be terminated and loans under the Credit Facility may be accelerated if an event of default occurs, as defined in the Credit Facility. Sterling is obligated to repay the principal balance of any advances issued pursuant to the Credit Facility on August 3, 2007.

The following table sets forth certain information regarding Sterling’s short-term borrowings as of and for the periods indicated:


	Years Ended December 31,
	2006			2005			2004
	(Dollars in thousands)

Maximum amount outstanding at any month-end during the period:
Short-term reverse repurchase agreements	$	235,495		$	821,363		$	779,012
Short-term advances		803,307			670,047			648,648
Average amount outstanding during the period:
Short-term reverse repurchase agreements	$	160,702		$	634,838		$	630,057
Short-term advances		674,929			461,897			517,499
Weighted average interest rate paid during the period:
Short-term reverse repurchase agreements		4.64	%		3.23	%		2.22	%
Short-term advances		4.44	%		3.15	%		2.77	%
Weighted average interest rate paid at end of period:
Short-term reverse repurchase agreements		4.81	%		4.07	%		2.53	%
Short-term advances		5.14	%		3.39	%		3.36	%

The following table sets forth certain information concerning Sterling’s outstanding borrowings for the periods indicated:


	December 31,
	2006					2005					2004
	Amount		%			Amount		%			Amount		%
						(Dollars in thousands)

FHLB Seattle advances:
Short-term	$	803,307		37.1		$	670,047		30.9		$	562,238		22.1
Long-term		505,310		23.3			773,415		35.7			1,073,695		42.1
Securities sold subject to reverse repurchase agreements and funds purchased:
Short-term		86,354		4.0			261,676		12.1			780,012		30.6
Long-term		530,000		24.5			350,000		16.2			0		0.0
Term note payable(1)		0		0.0			0		0.0			19,000		0.7
Trust Preferred Securities		236,772		10.9			108,707		5.0			108,685		4.3
Other		3,454		0.2			1,981		0.1			4,137		0.2

Total borrowings	$	2,165,197		100.0		$	2,165,826		100.0		$	2,547,767		100.0

Weighted average interest rate at end of period				5.17	%				4.03	%				3.36	%


(1)		These notes were redeemed in full in April 2005.

Subsidiaries

Sterling’s principal operating subsidiaries are Sterling Savings Bank and Golf Savings Bank. Sterling Savings Bank has three principal subsidiaries, which have been previously described: Action Mortgage, INTERVEST and

Harbor Financial. Additionally, Sterling and Sterling Savings Bank have the following other wholly owned, direct subsidiaries:

Sterling Financial Corporation.

(1) Golf Escrow Corporation was acquired in July 2006 and offers a full range of escrow closing services.

(2) Sterling Capital Trust II (“SCT-II”) was organized in July 2001 as a Delaware business trust. Sterling owns all the common equity of SCT-II. The sole asset of SCT-II is the Junior Subordinated Debentures-II issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(3) Sterling Capital Trust III (“SCT-III”) was organized in April 2003 as a Delaware business trust. Sterling owns all the common equity of SCT-III. The sole asset of SCT-III is the Junior Subordinated Debentures-III issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(4) Sterling Capital Trust IV (“SCT-IV”) was organized in May 2003 as a Delaware business trust. Sterling owns all the common equity of SCT-IV. The sole asset of SCT-IV is the Junior Subordinated Debentures-IV issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(5) Sterling Capital Statutory Trust V (“SCT-V”) was organized in May 2003 as a Connecticut business trust. Sterling owns all the common equity of SCT-V. The sole asset of SCT-V is the Junior Subordinated Debentures-V issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(6) Sterling Capital Trust VI (“SCT-VI”) was organized in June 2003 as a Delaware business trust. Sterling owns all the common equity of SCT-VI. The sole asset of SCT-VI is the Junior Subordinated Debentures-VI issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(7) Sterling Capital Trust VII (“SCT-VII”) was organized in June 2006 as a Delaware business trust. Sterling owns all the common equity of SCT-VII. The sole asset of SCT-VII is the Junior Subordinated Debentures-VII issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(8) Sterling Capital Trust VIII (“SCT-VIII”) was organized in September 2006 as a Delaware business trust. Sterling owns all the common equity of SCT-VIII. The sole asset of SCT-VIII is the Junior Subordinated Debentures-VIII issued by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(9) Klamath First Capital Trust I (“KCT-I”) was organized in July 2001 as a Delaware business trust. Sterling owns all the common equity of KCT-I. The sole asset of KCT-I is the Junior Subordinated Debentures-I issued by KFBI and assumed by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(10) Klamath First Capital Trust II (“KCT-II”) was organized in April 2002 as a Delaware business trust. Sterling owns all the common equity of KCT-II. The sole asset of KCT-II is the Junior Subordinated Debentures-II issued by KFBI and assumed by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(11) Lynnwood Financial Statutory Trust I (“LCT-I”) was organized in March 2003 as a Connecticut business trust. Sterling owns all the common equity of LCT-I. The sole asset of LCT-I is the Junior Subordinated Debentures-I issued by Lynnwood and assumed by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(12) Lynnwood Financial Statutory Trust II (“LCT-II”) was organized in June 2005 as a Delaware business trust. Sterling owns all the common equity of LCT-II. The sole asset of LCT-II is the Junior Subordinated Debentures-II issued by Lynnwood and assumed by Sterling. See Note 10 of “Notes to Consolidated Financial Statements.”

(13) Tri-Cities Mortgage Corporation was organized to engage in real estate development.

Sterling Savings Bank.

(1) The Dime Service Corporation was acquired as part of a merger in February 2003.

(2) Evergreen Environmental Development Corporation was organized to engage in real estate development.

(3) Evergreen First Service Corporation owns all of the outstanding capital stock of Harbor Financial, through which Sterling offers tax-deferred annuities, mutual funds and other financial products.

(4) Fidelity Service Corporation acts as a trustee in the reconveyance of deeds of trust originated by Sterling Savings Bank and Action.

(5) Mason-McDuffie Financial Corporation (“Mason-McDuffie”) conducts mortgage banking operations.

(6) Peter W. Wong Associates, Inc. was organized to offer alternative financial services.

(7) Source Capital Corporation was acquired in September 2001. The corporation was organized to hold and service loans, and is currently inactive.

(8) Source Capital Leasing Corporation was acquired in September 2001, and was organized to engage in corporate leasing.

Competition

Sterling faces strong competition, both in attracting deposits and in originating, purchasing and selling loans, from savings and loan associations, mutual savings banks, credit unions, commercial banks and other institutions, many of which have greater resources than Sterling. Sterling also faces strong competition in marketing financial products such as annuities, mutual funds and other financial products and in pursuing acquisition opportunities. Some or all of these competitive businesses operate in Sterling’s market areas.

Personnel

As of December 31, 2006, Sterling, including its subsidiaries, had 2,405 full-time equivalent employees. Employees are not represented by a collective bargaining unit. Sterling believes it has good relations with its employees.

Environmental Laws

Environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental clean-up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean-up costs, and liability to the institution for clean-up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, Sterling may require an environmental examination and report with respect to the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. This examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, with the costs of such examinations and reports being the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sterling. Sterling is not aware of any borrower who is currently subject to any environmental investigation or clean-up proceeding that is likely to have a material adverse effect on the financial condition or results of operations of Sterling.

Regulation

The following is not intended to be a complete discussion but is intended to be a summary of some of the more significant provisions of laws applicable to Sterling and its subsidiaries. This regulatory framework is intended to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. To the extent that the information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Further, such statutes, regulations and policies are continually under review by Congress and state legislatures, and federal and state regulatory agencies. A change in statutes, regulations or

regulatory policies applicable to Sterling, including changes in interpretation or implementation thereof, could have a material effect on Sterling’s business.

General

Sterling is a bank holding company and as such is subject to comprehensive examination and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Sterling Savings Bank is a Washington State-chartered commercial bank and Golf Savings Bank is a Washington State-chartered savings bank. The deposits of both banks are insured by the FDIC. Sterling Savings Bank and Golf Savings Bank are subject to comprehensive regulation, examination and supervision by the FDIC and the Washington Department of Financial Institutions, Division of Banks. Furthermore, certain transactions and savings deposits are subject to regulations and controls promulgated by the Federal Reserve Board. Sterling’s nonbank subsidiaries are also subject to regulation by the Federal Reserve Board and other applicable federal and state agencies for the states in which they conduct business.

These laws and regulations could restrict Sterling’s ability to diversify into other areas of financial services, acquire depository institutions, and pay dividends on its capital stock. Sterling may also be required to provide financial support to one or more of its subsidiary banks, maintain capital balances in excess of those desired by management, and pay higher deposit insurance premiums as a result of a general deterioration in the financial condition of depository institutions.

Bank Holding Company Regulation

The Fair and Accurate Credit Transactions Act. In December 2003, the Fair and Accurate Credit Transactions Act of 2003 (the “FACT”) was signed into law. The FACT includes many provisions concerning national credit reporting standards and permits consumers, including Sterling’s customers, to opt out of information sharing among affiliated companies for marketing purposes. The FACT also requires financial institutions to provide consumers certain information regarding the consumer’s credit score. Additionally, financial institutions must notify their customers if they report negative information about them to credit bureaus or if the credit terms offered to a customer are materially less favorable than the most favorable terms offered to a substantial portion of customers because of information in the customer’s credit report. The FACT also contains provisions intended to help detect identity theft.

The Sarbanes-Oxley Act. In July 2002, the Sarbanes-Oxley Act of 2002 (the “SOA”) was enacted in response to public concerns regarding corporate accountability. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The SOA generally applies to all companies that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, as amended (“Exchange Act”).

The SOA includes new disclosure requirements and corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC and the Comptroller General. In particular, the SOA establishes: new requirements for audit committees; additional responsibilities regarding financial statements of reporting companies; new standards for auditors and regulation of audits; increased disclosure and reporting obligations for a reporting company and its directors and executive officers; and new civil and criminal penalties for violation of the securities laws. The SEC has enacted rules to implement various of the provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.

The U.S.A. Patriot Act. In December 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) became effective. The Patriot Act is designed to combat money laundering and terrorist financing while protecting the U.S. financial system. The Patriot Act imposes enhanced policy, record keeping and due diligence requirements on domestic financial

institutions. The Patriot Act also amended the Bank Secrecy Act to facilitate access to customer account information by government officials while immunizing banks from liability for releasing such information.

The Gramm-Leach-Bliley Act. In November 1999, the Gramm-Leach-Bliley Act (the “GLBA”) was enacted. The GLBA is also known as the Financial Services Modernization Act due to its sweeping overhaul of the financial services industry. Enactment of the GLBA allows banks, securities firms and insurance companies to affiliate. Now financial institutions can act as financial “supermarkets” offering customers “one stop shopping” for bank accounts, insurance policies and securities transactions.

The GLBA, among other things, provides customers with greater financial privacy by requiring financial institutions to safeguard their nonpublic personal information. Financial institutions must advise customers of their policies regarding sharing nonpublic personal information with non-affiliated third parties and allow customers to “opt-out” of such sharing (subject to several exceptions related mainly to processing customer-initiated transactions and compliance with current law).

The Riegle-Neal Interstate Banking and Branching Efficiency Act. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

Washington enacted “opting in” legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain “aging” requirements. Washington restricts an out-of-state bank from opening de novo branches. However, once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank’s assets, the out-of-state bank may open additional branches within the state.

The Bank Holding Company Act. As a bank holding company, Sterling is governed by The Bank Holding Company Act of 1956, as amended (the “BHCA”), and is therefore subject to supervision and examination by the Federal Reserve Board. Sterling files annual reports of operations with the Federal Reserve Board.

In general, the BHCA limits bank holding company business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the Federal Reserve Board’s approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5 percent of the voting shares of such bank; (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of any additional banks. Subject to certain state laws, such as age and contingency restrictions, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state and out-of-state banks. With certain exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve Board determines that the activities of such company are incidental or closely related to the business of banking. If a bank holding company is well-capitalized and meets certain criteria specified by the Federal Reserve Board, it may engage de novo in certain permissible non-banking activities without prior Federal Reserve Board approval.

The Change in Bank Control Act. Pursuant to The Change in Bank Control Act of 1978, as amended, a person (or group of persons acting in concert) acquiring “control” of a bank holding company is required to provide the Federal Reserve Board with 60 days prior written notice of the proposed acquisition. Following receipt of this notice, the Federal Reserve Board has 60 days within which to issue a notice disapproving the proposed acquisition, but the Federal Reserve Board may extend this time period for up to another 30 days. An acquisition may be completed before expiration of the disapproval period if the Federal Reserve Board issues written notice of its intent not to disapprove the transaction. In addition, any “company” must obtain the Federal Reserve Board’s approval before acquiring 25% (5% if the “company” is a bank holding company) or more of the outstanding shares or otherwise obtaining control over Sterling.

The Federal Reserve Act. Sterling and its subsidiaries are deemed affiliates within the meaning of the Federal Reserve Act, and transactions between affiliates are subject to certain restrictions. Accordingly, Sterling and its subsidiaries must comply with Sections 23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B (1) limit the extent to which a financial institution or its subsidiaries may engage in “covered transactions” with an affiliate, as defined, to an amount equal to 10% of such institution’s capital and surplus and an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital and surplus, and (2) require all transactions with an affiliate, whether or not “covered transactions,” to be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.

Transactions with Affiliates. Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on extensions of credit to the holding company or its subsidiaries, on investments in their securities, and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit Sterling’s ability to obtain funds from its banking subsidiaries for its cash needs, including funds for payment of dividends, interest and operational expenses.

Tying Arrangements. Sterling is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, neither Sterling nor its subsidiaries may condition an extension of credit to a customer on either (1) a requirement that the customer obtain additional services provided by Sterling or (2) an agreement by the customer to refrain from obtaining other services from a competitor.

Support of Subsidiary Banks. Under Federal Reserve policy, Sterling is expected to act as a source of financial and managerial strength to its banking subsidiary. This means that Sterling is required to commit, as necessary, resources to support Sterling Savings Bank. Any capital loans a bank holding company makes to its subsidiary banks are subordinate to deposits and to certain other indebtedness of those subsidiary banks.

Federal and State Regulation of Banking Activities

General. The deposits of Sterling Savings Bank and Golf Savings Bank are insured by the FDIC. As a result, they are subject to supervision and regulation by the FDIC as well as the Washington Department of Financial Institutions, Division of Banks. These agencies have the authority to prohibit banks from engaging in what they believe constitute unsafe or unsound banking practices.

Community Reinvestment. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their jurisdiction, the Federal Reserve or the FDIC evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of the institution. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.

Insider Credit Transactions. Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons. Extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (2) must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to insiders. A violation of these restrictions may result in the assessment of substantial civil monetary penalties, the imposition of a cease and desist order, and other regulatory sanctions.

Regulation of Management. Federal law: (1) sets forth circumstances under which officers or directors of a bank may be removed by the institution’s federal supervisory agency; (2) places restraints on lending by a bank to its executive officers, directors, principal shareholders, and their related interests; and (3) prohibits management personnel of a bank from serving as a director or in a management position of another financial institution whose assets exceed a specified amount or which has an office within a specified geographic area.

Safety and Soundness Standards. The Federal Deposit Insurance Corporation Act of 1991 requires the FDIC to imposes upon banks certain non-capital safety and soundness standards. These standards cover, among other

things, internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation and benefits. Additional standards apply to asset quality, earnings and stock valuation. An institution that fails to meet these standards must develop a plan acceptable to its regulators, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions.

Lending Restrictions and Disclosure Requirements. The Federal Reserve Board has adopted amendments to the Home Ownership and Equity Protection Act of 1994 (“HOEPA”), which expand the protections of HOEPA to cover more transactions and prohibit certain practices deemed harmful to borrowers. If a loan qualifies as a HOEPA loan, certain practices and terms on high-cost mortgages are restricted and require special consumer disclosures. The interest rate trigger on first-time liens used to determine whether a loan qualifies as a HOEPA loan has been lowered from 10% to 8% and the cost of single-premium credit insurance products has been added to the points and fees test. As a result, more of Sterling’s loans are expected to be subject to HOEPA restrictions and disclosure requirements.

Deposit Insurance Assessments. On February 15, 2006, President Bush signed the Federal Deposit Insurance Reform Conforming Amendments Act of 2005, which contains comprehensive deposit insurance reform provisions. This bill provides for legislative reforms to modernize the federal deposit insurance system. Among other things, provisions in the modernization legislation: 1) merge the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”) into a new Deposit Insurance Fund (“DIF”); 2) index the $100,000 deposit insurance limit to inflation beginning in 2010 and every succeeding five years while giving the FDIC authority to determine whether raising the standard maximum deposit insurance is warranted; 3) increase the deposit insurance limit for certain retirement accounts to $250,000, with such limit indexed to inflation; 4) allow the FDIC Board to set assessments; and 5) require final regulations to be issued no later than 270 days after enactment.

On March 31, 2006, the FDIC merged the BIF and SAIF to form the DIF. The DIF and FDIC insure deposits of Sterling Savings Bank and Golf Savings Bank up to the prescribed limits for each depositor. The FDIC maintains the DIF by assessing each depository institution an insurance premium. The amount of FDIC assessments paid by a DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized. An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required.

The DIF assessment rate currently ranges from 5 to 43 cents per $100 of domestic deposits. The DIF assessment rate for Sterling Savings Bank and Golf Savings Bank, as well capitalized institutions, currently ranges from 5 to 7 cents per $100 of domestic deposits. The FDIC may increase or decrease the assessment rate schedule up to three basis points from one quarter to the next. An increase in the assessment rate could have a material adverse effect on Sterling’s earnings, depending on the amount of the increase. The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound, or that the institution has engaged in unsafe or unsound practices, or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance for Sterling’s subsidiaries, Sterling Savings Bank or Golf Savings Bank, could have a material adverse effect on Sterling’s earnings.

All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds (commonly referred to as FICO bonds) were issued to capitalize the Federal Savings and Loan Insurance Corporation. FDIC-insured depository institutions paid approximately 1.28 cents per $100 of BIF-assessable deposits in 2006. The FDIC established the FICO assessment rate effective for the first quarter of 2007 at approximately 1.22 cents annually per $100 of assessable deposits.

Dividends Restrictions. Sterling is a legal entity separate and distinct from its subsidiary bank and other subsidiaries. Its principal source of funds to pay dividends on its common and preferred stock and principal and interest on its debt is dividends from its subsidiaries. Various federal and state statutory provisions and regulations

limit the amount of dividends Sterling Savings Bank, Golf Savings Bank and certain other subsidiaries may pay without regulatory approval.

Federal bank regulatory agencies have the authority to prohibit Sterling Savings Bank and Golf Savings Bank from engaging in unsafe or unsound practices in conducting their business. The payment of dividends, depending on each bank’s financial condition, could be deemed an unsafe or unsound practice. The ability of Sterling Savings Bank and Golf Savings Bank to pay dividends in the future is currently, and could be further, influenced by bank regulatory policies and capital guidelines.

Federal Reserve System. Sterling Savings Bank and Golf Savings Bank are subject to various regulations promulgated by the Fed, including, among others, Regulation B (Equal Credit Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds) and Regulation DD (Truth in Savings). Regulation D requires non-interest-bearing reserve maintenance in the form of either vault cash or funds on deposit at the Federal Reserve Bank of San Francisco or another designated depository institution in an amount calculated by formula. The balances maintained to meet the reserve requirements imposed by the Fed may be used to satisfy liquidity requirements. As of December 31, 2006, Sterling Savings Bank and Golf Savings Bank met these requirements.

Federal Taxation. Sterling is subject to federal income taxation under the Internal Revenue Code of 1986, as amended, in the same manner as other corporations. Sterling files consolidated federal income tax returns on the accrual basis. See Note 11 of “Notes to Consolidated Financial Statements.”

State Law and Regulation. Sterling Savings Bank and Golf Savings Bank, as Washington State-chartered institutions, are subject to regulation by the Washington Supervisor of the Washington Department of Financial Institutions, which conducts regular examinations to ensure that Sterling Savings Bank’s and Golf Savings Bank’s operations and policies conform with sound industry practice. The liquidity and other requirements set by the Washington Supervisor are generally no stricter than the liquidity and other requirements set by the Federal Reserve Board. State law regulates the amount of credit that can be extended to any one person or marital community and the amount of money that can be invested in any one property. Without the Washington Supervisor’s approval, Sterling Savings Bank and Golf Savings Bank currently cannot extend credit to any one person or marital community in an amount greater than 2.5% of Sterling Savings Bank’s or Golf Savings Bank’s total assets. State law also regulates the types of loans Sterling Savings Bank and Golf Savings Bank can make. Without the Washington Supervisor’s approval, Sterling Savings Bank and Golf Savings Bank cannot currently invest more than 10% of their total assets in other corporations. Sterling Savings Bank also operates branches within the states of Oregon, Idaho and Montana and therefore its operations in these states are subject to the supervision of the Oregon Department of Consumer and Business Services, the Idaho Department of Finance and the Montana Department of Finance, as applicable. All of Golf Savings Bank’s branches are located in the state of Washington. Sterling and its subsidiaries are also required to comply with applicable laws and regulations for activities in Arizona, California, Utah and Colorado.

Capital Adequacy

Regulatory Capital Guidelines. Federal bank regulatory agencies use capital adequacy guidelines in the examination and regulation of bank holding companies and banks. The guidelines are “risk-based,” meaning that they are designed to make capital requirements more sensitive to differences in risk profiles among banks and bank holding companies.

Tier I and Tier II Capital. Under the guidelines, an institution’s capital is divided into two broad categories, Tier I capital and Tier II capital. Tier I capital generally consists of common stockholders’ equity, surplus, undivided profits, and trust preferred obligations. Tier II capital generally consists of the allowance for loan losses and hybrid capital instruments. The sum of Tier I capital and Tier II capital represents an institution’s total capital. The guidelines require that at least 50% of an institution’s total capital consist of Tier I capital.

Risk-based Capital Ratios. The adequacy of an institution’s capital is gauged primarily with reference to the institution’s risk-weighted assets. The guidelines assign risk weightings to an institution’s assets in an effort to quantify the relative risk of each asset and to determine the minimum capital required to support that risk. An institution’s risk-weighted assets are then compared with its Tier I capital and total capital to arrive at a Tier I risk-

based ratio and a total risk-based ratio, respectively. The guidelines provide that an institution must have a minimum Tier I risk-based ratio of 4% and a minimum total risk-based ratio of 8%.

Leverage Ratio. The guidelines also employ a leverage ratio, which is Tier I capital as a percentage of total assets, less intangibles. The principal objective of the leverage ratio is to constrain the maximum degree to which a bank holding company may leverage its equity capital base. The minimum leverage ratio is 3%; however, for all but the most highly rated bank holding companies and for bank holding companies seeking to expand, regulators expect an additional cushion of at least 1% to 2%.

Prompt Corrective Action. Under the guidelines, an institution is assigned to one of five capital categories depending on its total risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio, together with certain subjective factors. The categories range from “well capitalized” to “critically undercapitalized.” Institutions that are “undercapitalized” or lower are subject to certain mandatory supervisory corrective actions.

Forward-Looking Statements

From time to time, Sterling and its senior managers have made and will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may be contained in this report and in other documents that Sterling files with the Securities and Exchange Commission. Such statements may also be made by Sterling and its senior managers in oral or written presentations to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Also, forward-looking statements can generally be identified by words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “seek,” “expect,” “intend,” “plan” and similar expressions.

Forward-looking statements provide management’s expectations or predictions of future conditions, events or results. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date they are made. Sterling does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. There are a number of factors, many of which are beyond Sterling’s control that could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. These factors, some of which are discussed elsewhere in this report, include:


	•	the inflation, interest rate levels and market and monetary fluctuations;

	•	trade, monetary and fiscal policies and laws, including interest rate policies of the federal government;

	•	applicable laws and regulations and legislative or regulatory changes;

	•	the timely development and acceptance of new products and services of Sterling;

	•	the willingness of customers to substitute competitors’ products and services for Sterling’s products and services;

	•	Sterling’s success in gaining regulatory approvals, when required;

	•	technological and management changes;

	•	growth and acquisition strategies;

	•	Sterling’s critical accounting policies and the implementation of such policies;

	•	lower-than-expected revenue or cost savings or other issues in connection with mergers and acquisitions;

	•	changes in consumer spending and saving habits;

	•	the strength of the United States economy in general and the strength of the local economies in which Sterling conducts its operations; and

	•	Sterling’s success at managing the risks involved in the foregoing.

Where You Can Find More Information

The periodic reports Sterling files with the SEC are available on Sterling’s website at www.sterlingsavingsbank.com after the reports are filed with the SEC. The SEC maintains a website located at www.sec.gov that also contains this information. The information on Sterling’s website and the SEC’s website is not part of this annual report on Form 10-K. Sterling will provide you with copies of these reports, without charge, upon request made to:

Investor Relations

Sterling Financial Corporation

111 North Wall Street

Spokane, Washington 99201

(509) 458-3711


Item 1A.	*Risk Factors*

Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents Sterling files with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.

As a bank holding company, Sterling’s earnings are dependent upon the performance of its bank and non-bank subsidiaries as well as by business, economic and political conditions.

Sterling is a legal entity separate and distinct from its subsidiaries, including Sterling Savings Bank and Golf Savings Bank, although the principal source of Sterling’s cash is dividends from Sterling Savings Bank and Golf Savings Bank. Sterling’s right to participate in the assets of any subsidiary upon that subsidiary’s liquidation, reorganization or otherwise will be subject to the claims of the subsidiary’s creditors, which will take priority except to the extent that Sterling may be a creditor with a recognized claim.

Sterling Savings Bank and Golf Savings Bank are also subject to restrictions under federal law that limit the transfer of funds to Sterling or to other affiliates, whether in the form of loans, extensions of credit, investments, asset purchases or otherwise. Such transfers by Sterling Savings Bank or Golf Savings Bank to Sterling or any other affiliate are limited in amount to 10% of each bank’s capital and surplus. Furthermore, such loans and extensions of credit are required to be collateralized.

Earnings are impacted by business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy and the local economies in which Sterling operates. Business and economic conditions that negatively impact household or corporate incomes could decrease the demand for Sterling products and increase the number of customers who fail to pay their loans.

A downturn in the local economies or real estate markets could negatively impact Sterling’s banking business.

A downturn in the local economies or real estate markets could negatively impact Sterling’s banking business. Because Sterling primarily serves individuals and businesses located in the western United States, a significant portion of its total loan portfolio is originated in the western United States or secured by western United States real estate or other assets. As a result of this geographic concentration, the ability of customers to repay their loans, and consequently Sterling’s results, are impacted by the economic and business conditions in the Pacific Northwest, in particular in the metropolitan areas of Seattle, Washington, Portland, Oregon, Boise, Idaho, Sacramento, California and Phoenix, Arizona. Any adverse economic or business developments or natural disasters in these areas could cause uninsured damage and other loss of value to real estate that secures Sterling loans or could negatively affect the ability of borrowers to make payments of principal and interest on the underlying loans. In the event of such adverse development or natural disaster, Sterling’s results of operations or financial condition could be adversely affected.

Furthermore, current uncertain geopolitical trends and negative economic trends, including uncertainty regarding economic growth and increased unemployment, may negatively impact businesses in Sterling’s markets. While the short-term and long-term effects of these events remain uncertain, they could adversely affect general economic conditions, consumer confidence, market liquidity or result in changes in interest rates, any of which could have a negative impact on banking business.

Sterling has shifted its focus to community banking.

Sterling is increasing its commercial, consumer and construction lending while placing an increased emphasis on attracting greater volumes of retail deposits. Commercial, consumer and construction loans generally produce higher yields than residential mortgage loans. Such loans, however, generally involve a higher degree of risk than the financing of residential real estate, primarily because the collateral may be difficult to obtain or liquidate in the event of default. Construction lending is subject to risks such as construction delays, cost overruns, insufficient collateral and the inability to obtain permanent financing in a timely manner. Commercial and construction loans are more expensive to originate than residential mortgage loans. As a result, Sterling’s operating expenses are likely to increase as Sterling increases its lending in these areas. Additionally, Sterling is likely to experience higher levels of loan losses than it would on residential mortgage loans. There can be no assurance that Sterling’s emphasis on community banking will be successful or that any increase in the yields on commercial, consumer and construction loans will offset higher levels of expense and losses on such loans.

Sterling’s loan originations are highly concentrated in certain types of loans.

Sterling’s loans, with limited exceptions, are secured by real estate, marketable securities or corporate assets. A significant portion of Sterling’s loans are residential construction loans. At December 31, 2006, approximately 32% of Sterling Savings Bank’s total loan portfolio consisted of construction loans, approximately 32% of which were for speculative endeavors. Additionally, at December 31, 2006, 15% of Sterling Savings Bank’s and Golf Savings Bank’s loan portfolio consisted of multifamily residential and commercial property loans. A reduction in the demand for new construction or multifamily residential and commercial property loans or a decline in residential or commercial real estate values could have a negative impact on Sterling Savings Bank or Golf Savings Bank.

Sterling’s ability to continue to originate such loans may be impaired by adverse changes in local and regional economic conditions in the real estate markets, or by acts of nature. Due to the concentration of real estate collateral, these events could have a material adverse impact on the value of the collateral, resulting in losses or delinquencies. Sterling’s residential mortgage and home equity loans are primarily secured by residential property in the Pacific Northwest. As a result, conditions in the real estate markets specifically, and the Pacific Northwest economy generally, can materially impact the ability of its borrowers to repay their loans and affect the value of the collateral securing these loans. Customer demand for loans secured by real estate could be reduced by a weaker economy, an increase in unemployment, a decrease in real estate values or an increase in interest rates. A decline in real estate values could have an adverse effect on Sterling’s financial condition.

Sterling’s earnings are significantly affected by the fiscal and monetary policies of governmental and regulatory agencies.

The Board of Governors of the Federal Reserve System, also known as the Federal Reserve Board, regulates the supply of money and credit in the United States. Its policies determine in large part our cost of funds for lending and investing and the return we earn on those loans and investments, both of which impact net interest margin, and can materially affect the value of financial instruments such as debt securities and mortgage servicing rights. Its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and hard to predict or anticipate.

The amount of income taxes that Sterling is required to pay on its earnings is based on federal and state legislation and regulations. Sterling provided for current and deferred taxes in its financial statements, based on its results of operations, business activity, legal structure and interpretation of tax statutes. Sterling may take filing positions or follow tax strategies that may be subject to challenge. Sterling’s net income and earnings per share may

be reduced if a federal, state, or local authority assessed charges for taxes that have not been provided for in its consolidated financial statements. There can be no assurance that Sterling will achieve its effective tax rate or that taxing authorities will not change tax legislation, challenge filing positions, or assess taxes and interest charges.

The OCC, Federal Reserve and FDIC have recently adopted final guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.” The guidance applies to institutions that have a high concentration of real estate and related loans in their portfolio. The guidance provides that such institutions may be required in the future to maintain higher capital ratios than other institutions with lower such concentrations. Based on the guidance as adopted, Sterling may be subject to increased regulatory oversight and guidance. While Sterling believes that it is and will continue to be well capitalized under current policies of the banking authorities, Sterling could become subject to higher capital requirements under the guidance which could result in lower earnings.

Changes in market interest rates could adversely affect Sterling’s earnings.

Sterling’s earnings are impacted by changing market interest rates. Changes in market interest rates impact the level of loans, deposits and investments, the credit profile of existing loans and the rates received on loans and investment securities and the rates paid on deposits and borrowings. One of Sterling’s primary sources of income from operations is net interest income, which is equal to the difference between the interest income received on interest-earning assets (usually, loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (usually, deposits and borrowings). These rates are highly sensitive to many factors beyond our control, including general economic conditions, both domestic and foreign, and the monetary and fiscal policies of various governmental and regulatory authorities. Net interest income can be affected significantly by changes in market interest rates. Changes in relative interest rates may reduce net interest income as the difference between interest income and interest expenses decreases.

Interest rates recently have been rising and could cause the amount of interest Sterling pays on deposits and borrowings to increase more quickly than the amount of interest Sterling receives on its loans, mortgage-related securities and investment securities. This could cause Sterling’s profits to decrease. Rising interest rates would likely reduce the value of Sterling’s mortgage-related securities and investment securities and may decrease demand for loans and make it more difficult for borrowers to repay their loans. Increasing market interest rates may also depress property values, which could affect the value of collateral securing Sterling loans.

An increase in interest rates could also have a negative impact on Sterling’s results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and write-offs, but also necessitate further increases to the allowances for loan losses. In addition, fluctuations in interest rates may result in disintermediation, which is the flow of funds away from depository institutions into direct investments that pay a higher rate of return and may affect the value of Sterling investment securities and other interest-earning assets.

Sterling’s cost of funds may increase as a result of general economic conditions, interest rates or competitive pressures.

Sterling’s cost of funds may increase because of general economic conditions, unfavorable conditions in the capital markets, interest rates and competitive pressures. Sterling has traditionally obtained funds principally through deposits and borrowings. As a general matter, deposits are a cheaper source of funds than borrowings, because interest rates paid for deposits are typically less than interest rates charged for borrowings. If, as a result of general economic conditions, market interest rates, competitive pressures, or other factors, Sterling’s level of deposits decreases relative to its overall banking operation. Sterling may have to rely more heavily on borrowings as a source of funds in the future, which may negatively impact net interest margin.

Competition may adversely affect Sterling’s ability to attract and retain customers at current levels.

The banking and financial services businesses in Sterling’s market areas are highly competitive. Competition in the banking, mortgage and finance industries may limit Sterling’s ability to attract and retain customers. Sterling faces competition from other banking institutions, savings banks, credit unions and other financial institutions.

Sterling also competes with non-bank financial service companies within the states that it serves and out of state financial intermediaries that have opened loan production offices or that solicit deposits in its market areas. There also has been a general consolidation of financial institutions in recent years, which results in new competitors and larger competitors in Sterling’s market areas.

In particular, Sterling’s competitors include major financial companies whose greater resources may provide them a marketplace advantage. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits and the range and quality of services provided. Because Sterling has fewer financial and other resources than larger institutions with which it competes, Sterling may be limited in its ability to attract customers. In addition, some of the current commercial banking customers may seek alternative banking sources as they develop needs for credit facilities larger than Sterling can accommodate. If Sterling is unable to attract and retain customers, it may be unable to continue its loan and deposit growth, and its results of operations and financial condition may otherwise be negatively impacted.

Sterling may not be able to successfully implement its internal growth strategy.

Sterling has pursued and intends to continue to pursue an internal growth strategy, the success of which will depend primarily on generating an increasing level of loans and deposits at acceptable risk levels and terms without proportionate increases in non-interest expenses. There can be no assurance that Sterling will be successful in implementing its internal growth strategy. Furthermore, the success of Sterling’s growth strategy will depend on maintaining sufficient regulatory capital levels and on continued favorable economic conditions in Sterling’s market area.

There are risks associated with potential acquisitions.

Sterling may make opportunistic acquisitions of other banks or financial institutions from time to time that further its business strategy. For example, Sterling completed the acquisitions of Golf Savings Bank on July 5, 2006 and of FirstBank on November 30, 2006, and is expected to close the acquisition of Northern Empire on February 28, 2007. Risks associated with the integration of multiple acquisitions within a relatively short time period that may affect Sterling include, without limitation: the businesses might not be combined successfully, or such combination may take longer, be more difficult, time-consuming or costly to accomplish than expected; the expected growth opportunities and cost savings from the acquisitions may not be fully realized or may take longer to realize than expected; operating costs, customer losses and business disruption following the acquisitions, including adverse effects on relationships with employees, may be greater than expected; adverse governmental or regulatory policies may be enacted; the interest rate environment may further compress margins and adversely affect net interest income; results may be adversely affected by continued diversification of assets and adverse changes to credit quality; competition from other financial services companies in Sterling’s markets could adversely affect operations; and an economic slowdown could adversely affect credit quality and loan originations.

Sterling may make opportunistic acquisitions of other banks or financial institutions from time to time that further its business strategy. These acquisitions could involve numerous risks including lower than expected performance or higher than expected costs, difficulties in the integration of operations, services, products and personnel, the diversion of management’s attention from other business concerns, changes in relationships with customers and the potential loss of key employees. Any acquisitions will be subject to regulatory approval, and there can be no assurance that Sterling will be able to obtain such approvals. Sterling may not be successful in identifying further acquisition candidates, integrating acquired institutions or preventing deposit erosion or loan quality deterioration at acquired institutions. Competition for acquisitions is highly competitive, and Sterling may not be able to acquire other institutions on attractive terms. There can be no assurance that Sterling will be successful in completing future acquisitions, or if such transactions are completed, that Sterling will be successful in integrating acquired businesses into its operations. Sterling’s ability to grow may be limited if it is unable to successfully make future acquisitions.

Sterling may not be able to replace key members of management or attract and retain qualified relationship managers in the future.

Sterling depends on the services of existing management to carry out its business and investment strategies. As Sterling expands, it will need to continue to attract and retain additional management and other qualified staff. In particular, because Sterling plans to continue to expand its locations, products and services, Sterling will need to continue to attract and retain qualified banking personnel and investment advisors. Competition for such personnel is significant in Sterling’s geographic market areas. The loss of the services of any management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our results of operations, financial conditions and prospects.

Defaults may negatively impact Sterling’s business.

Increased delinquencies or loan defaults by Sterling’s customers may negatively impact business. A borrower’s default on its obligations under one or more loans may result in lost principal and interest income and increased operating expenses as a result of the allocation of management time and resources to the collection and workout of the loan.

If collection efforts are unsuccessful or acceptable workout arrangements cannot be reached, Sterling may have to charge-off all or a part of the loan. In such situations, Sterling may acquire any real estate or other assets, if any, that secure the loan through foreclosure or other similar available remedies. The amount owed under the defaulted loan may exceed the value of the assets acquired.

The allowance for loan losses may be inadequate.

Sterling loan customers may not repay their loans according to the terms of the loans, and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. Sterling therefore may experience significant loan losses, which could have a material adverse effect on its operating results.

Sterling makes various assumptions and judgments about the collectibility of its loan portfolio, including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of Sterling’s loans. Sterling relies on its loan quality reviews, experience and evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If Sterling’s assumptions prove to be incorrect, its allowance for loan losses may not be sufficient to cover losses inherent in the loan portfolio, resulting in additions to Sterling’s allowance. Increases in this allowance result in an expense for the period. If, as a result of general economic conditions or a decrease in asset quality, management determines that additional increases in the allowance for loan losses are necessary, Sterling may incur additional expenses.

Sterling’s loans are primarily secured by real estate, including a concentration of properties located in the Pacific Northwest. If an earthquake, volcano eruption or other natural disaster were to occur in one of the major market areas, loan losses could occur that are not incorporated in the existing allowance for loan losses.

Sterling is expanding its lending activities in riskier areas.

Sterling has identified commercial real estate, business and consumer loans as areas for increased lending emphasis. While increased lending diversification is expected to increase interest income, commercial real estate, business and consumer loans carry greater risk of payment default than residential real estate loans. As the volume of these loans increases, credit risk increases. In the event of substantial borrower defaults, Sterling’s provision for loan losses would increase and therefore, earnings would be reduced.

Sterling operations could be interrupted if its third-party service providers experience difficulty, terminate their services or fail to comply with banking regulations.

Sterling depends, and will continue to depend, to a significant extent, on a number of relationships with third-party service providers. Specifically, Sterling receives core systems processing, essential web hosting and other Internet systems and deposit and other processing services from third-party service providers. If these third-party service providers experience difficulties or terminate their services and Sterling is unable to replace them with other

service providers, its operations could be interrupted. If an interruption were to continue for a significant period of time, business, financial condition and results of operations could be materially adversely affected.

Sterling’s internal control systems could fail to detect certain events.

Sterling is subject to certain operations risks, including but not limited to data processing system failures and errors and customer or employee fraud. Sterling maintains a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks, but should such an event occur that is not prevented or detected by Sterling’s internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on its business, financial condition or results of operations.

The network and computer systems on which Sterling depends could fail or experience a security breach.

Sterling’s computer systems could be vulnerable to unforeseen problems. Because Sterling conducts part of its business over the Internet and outsources several critical functions to third parties, operations will depend on the ability, as well as that of third-party service providers, to protect computer systems and network infrastructure against damage from fire, power loss, telecommunications failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in operations could have a material adverse effect on business, financial condition and results of operations.

In addition, a significant barrier to online financial transactions is the secure transmission of confidential information over public networks. Sterling’s Internet banking system relies on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms its third-party service providers use to protect customer transaction data. If any such compromise of security were to occur, it could have a material adverse effect on Sterling’s business, financial condition and results of operations.

Sterling could be held responsible for environmental liabilities of properties acquired through foreclosure.

If Sterling is forced to foreclose on a defaulted mortgage loan to recover its investment, it may be subject to environmental liabilities related to the underlying real property. Hazardous substances or wastes, contaminants, pollutants or sources thereof may be discovered on properties during its ownership or after a sale to a third party. The amount of environmental liability could exceed the value of real property. There can be no assurance that Sterling would not be fully liable for the entire cost of any removal and clean-up on an acquired property, that the cost of removal and clean-up would not exceed the value of the property, or that costs could be recovered from any third party. In addition, Sterling may find it difficult or impossible to sell the property prior to or following any environmental remediation.

Sterling’s banking business is highly regulated.

State-chartered banks operate in a highly regulated environment and are subject to supervision and examination by federal and state regulatory agencies. As a Washington State-chartered commercial bank, Sterling’s subsidiary Sterling Savings Bank is subject to regulation and supervision by the FDIC and the Washington Department of Financial Institutions, or DFI. Federal and state laws and regulations govern numerous matters, including changes in the ownership or control of banks, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts, and terms of extensions of credit and investments, maintenance of permissible non-banking activities, maintenance of deposit insurance, protection of financial privacy the level of reserves against deposits, and restrictions on dividend payments.

The FDIC, the Federal Reserve Board and the DFI possess cease and desist powers to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulations. These and other restrictions limit the manner in which Sterling may conduct business and obtain capital or financing.

Sterling’s stock price can be volatile.

Sterling’s stock price can fluctuate widely in response to a variety of factors, including actual or anticipated variations in quarterly operating results; changes in shareholder dividend policy; recommendations by securities analysts; and news reports relating to trends, concerns and other issues in the financial services industry. Other factors include new technology used or services offered by Sterling’s competitors; operating and stock price performance of other companies that investors deem comparable to us; and changes in government regulations.

General market fluctuations, industry factors and general economic and political conditions and events, such as future terrorist attacks and activities, economic slowdowns or recessions, interest rate changes or credit loss trends, also could cause Sterling’s stock price to decrease regardless of its operating results.

Shares eligible for future sale could have a dilutive effect.

Shares of Sterling common stock eligible for future sale, including those that may be issued in the acquisition of Northern Empire, in future acquisitions and any other offering of Sterling common stock for cash, could have a dilutive effect on the market for Sterling common stock and could adversely affect its market price. On July 25, 2006, Sterling filed a “shelf” registration statement on Form S-3 that provides for the issuance by Sterling of up to $100 million in Sterling common stock and preferred stock. This will enable Sterling to offer additional shares of common and/or preferred stock for such consideration, on such terms and at such times as is determined by Sterling’s board of directors.

There are 60,000,000 shares of Sterling common stock authorized, of which 42,042,740 shares were outstanding as of December 31, 2006. As a result of the merger of Sterling and Northern Empire, a maximum of 9,434,960 shares of Sterling common stock may be issued to Northern Empire shareholders.

Future legislation could change our competitive position.

Various legislation, including proposals to change substantially the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies, is from time to time introduced in the Congress. This legislation may change banking statutes and Sterling’s operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Sterling cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on Sterling’s financial condition or results of operations.


Item 1B.	*Unresolved Staff Comments*

Not applicable.


Item 2.	*Properties*

Sterling owns the building in which its headquarters are located in Spokane, Washington. As of December 31, 2006, Sterling also owned 107 of its 166 full-service banking offices, while leasing the remainder of the properties. These facilities are located throughout Sterling’s banking network, primarily in the Pacific Northwest. Additionally, Sterling operates 49 non-depository loan production offices throughout the western United States, the majority of which are leased. See Note 5 to the Consolidated Financial Statements.


Item 3.	*Legal Proceedings*

Periodically, various claims are brought in connection with Sterling’s business. No material loss is expected from any of such pending claims or lawsuits, although there can be no assurance in this regard.


Item 4.	*Submission of Matters to a Vote of Security Holders*

Not applicable.

PART II


Item 5.	*Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities*

Stock Market and Dividend Information

Sterling has outstanding one class of common stock. As of January 31, 2007, there were 42,200,432 shares of Sterling’s common stock outstanding. As of January 31, 2007, Sterling’s common stock was held by 2,092 shareholders of record, and the closing price as of that date for its common stock was $33.17. Sterling’s common stock is listed on The NASDAQ National Market under the symbol “STSA.”

The following table sets forth the high and low bid prices per share for Sterling’s common stock for the periods indicated. Prior period amounts have been restated to reflect the 3 for 2 stock split that was effected on August 31, 2005:


	High		Low

Year ended December 31, 2006:
Fourth quarter	$	34.97	$	31.75
Third quarter		33.78		29.50
Second quarter		32.35		28.31
First quarter		29.91		24.50
Year ended December 31, 2005:
Fourth quarter	$	26.78	$	21.86
Third quarter		27.39		21.66
Second quarter		25.12		21.69
First quarter		26.75		23.36

The board of directors of Sterling from time to time evaluates the payment of cash dividends. The timing and amount of any future dividends will depend upon earnings, cash and capital requirements, the financial condition of Sterling and its subsidiaries, applicable government regulations and other factors deemed relevant by Sterling’s board of directors. Sterling has paid the following historical cash dividends:


Date Paid	Per Share Amount		Total

October 2005	$	0.050	$	1.7 million
January 2006		0.055		1.9 million
April 2006		0.060		2.1 million
July 2006		0.065		2.3 million
October 2006		0.070		2.6 million
January 2007		0.075		3.2 million

Performance Graph

The following graph compares our cumulative total stockholder return since December 31, 2001 with the Russell 2000 Index and the SNL NASDAQ Bank Index. The graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100.00 on December 31, 2001.

Total Return Performance

Item 6. Selected Financial Data

The following selected financial data is derived from Sterling’s audited financial statements. Comparability among particular amounts may be affected by past acquisitions:


	Years Ended December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands, except per share amounts)

Interest income	$	550,855		$	387,811		$	319,761		$	214,727		$	197,313
Interest expense		(286,943	)		(171,276	)		(122,945	)		(89,807	)		(96,965	)

Net interest income		263,912			216,535			196,816			124,920			100,348
Provision for losses on loans		(18,703	)		(15,200	)		(12,150	)		(10,500	)		(11,867	)

Net interest income after provision for loss on loans		245,209			201,335			184,666			114,420			88,481
Non-interest income		69,340			59,569			47,799			33,735			29,080
Merger and acquisition costs		(454	)		0			(4,835	)		(792	)		0
Amortization of core deposit intangibles		(2,405	)		(2,222	)		(2,222	)		(262	)		(644	)
Goodwill litigation		(275	)		(179	)		(141	)		(600	)		(1,100	)
Non-interest expenses		(203,239	)		(167,880	)		(141,172	)		(92,910	)		(79,199	)

Income before income taxes		108,176			90,623			84,095			53,591			36,618
Income tax provision		(34,230	)		(29,404	)		(27,790	)		(18,678	)		(11,031	)

Net income	$	73,946		$	61,219		$	56,305		$	34,913		$	25,587

Earnings per share:
Basic(1)	$	2.03		$	1.77		$	1.66		$	1.45		$	1.19
Diluted(1)		2.01			1.75			1.62			1.42			1.16
Dividends declared per share	$	0.270		$	0.105		$	0.000		$	0.000		$	0.000
Weighted average shares outstanding:
Basic(1)		36,423,095			34,633,952			33,931,509			23,980,113			21,496,008
Diluted(1)		36,841,866			35,035,029			34,708,794			24,590,172			22,115,723
Financial Ratios:
Book value per share(1)	$	18.63		$	14.54		$	13.65		$	10.21		$	9.38
Return on average assets		0.88	%		0.87	%		0.88	%		0.88	%		0.80	%
Return on average shareholders’ equity		13.0	%		12.4	%		13.2	%		14.4	%		13.9	%
Shareholders’ equity to total assets		8.0	%		6.7	%		6.8	%		5.9	%		5.8	%
Operating efficiency		61.9	%		61.7	%		60.7	%		59.6	%		62.5	%
Net interest margin		3.30	%		3.28	%		3.32	%		3.35	%		3.37	%
Nonperforming assets to total assets		0.11	%		0.11	%		0.20	%		0.50	%		0.59	%
Statistical Data:
Number of:
Employees (full-time equivalents)		2,405			1,789			1,624			1,121			953
Full service branches		166			140			135			86			79


	December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)

Balance Sheet Data:
Total assets	$	9,828,652		$	7,558,928		$	6,942,224		$	4,279,321		$	3,507,021
Loans receivable, net		7,015,401			4,885,916			4,251,877			2,906,426			2,390,422
Mortgage-backed securities		1,687,672			1,960,582			2,036,920			983,736			743,610
Investments		225,974			167,957			167,665			89,448			86,558
Deposits		6,746,028			4,806,301			3,863,296			2,455,076			2,014,096
FHLB Seattle advances		1,308,617			1,443,462			1,635,933			1,026,031			874,515
Reverse repurchase agreements and funds purchased		616,354			611,676			780,012			363,137			249,769
Other borrowings		240,226			110,688			131,822			137,998			127,682
Shareholders’ equity		783,416			506,685			469,844			250,348			203,656
Capital Ratios(2):
Tier 1 leverage (to average assets) Sterling		8.7	%		7.4	%		N/A			N/A			N/A
Sterling Savings Bank		8.6	%		7.2	%		6.6	%		7.4	%		7.6	%
Golf Savings Bank		6.9	%		N/A			N/A			N/A			N/A
Tier I (to risk-weighted assets) Sterling		10.0	%		9.5	%		N/A			N/A			N/A
Sterling Savings Bank		9.7	%		9.2	%		9.7	%		9.9	%		10.0	%
Golf Savings Bank		10.9	%		N/A			N/A			N/A			N/A
Total (to risk-weighted assets)
Sterling		11.1	%		10.5	%		N/A			N/A			N/A
Sterling Savings Bank		10.8	%		10.2	%		10.7	%		10.9	%		11.0	%
Golf Savings Bank		11.6	%		N/A			N/A			N/A			N/A


(1)		All prior period per share and weighted average share amounts have been restated to reflect the 3 for 2 stock split that was effected August 31, 2005.

(2)		Sterling Financial Corporation did not have regulatory capital ratio requirements prior to its conversion to a bank holding company. Golf Savings Bank’s capital ratios have not been disclosed for periods prior to Sterling’s acquisition of Golf Savings Bank in July 2006.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto presented elsewhere in this report. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of the risks and uncertainties inherent in such statements, see “Business — Forward-Looking Statements.”

Executive Summary and Highlights

During 2006, Sterling achieved significant loan, deposit and earnings growth. The organic growth our banking teams achieved was complemented by several acquisitions. Increases in construction, commercial and residential lending were funded with growth in deposits. Net interest income increased primarily from growth in average loan balances. Growth in non-interest income was driven through fees and service charges, and mortgage banking operations. The Golf Savings Bank acquisition increased our presence in the mortgage banking business.

2006 Highlights


	•	Net income increased by 21 percent to a record $73.9 million.

	•	Total assets increased 30 percent year-over-year to a record $9.83 billion. Sterling’s organic growth represented 10 percent of total asset growth.

	•	Loan originations of nearly $5.0 billion reflect an increase of 28 percent over 2005.

	•	Total loans receivable increased to a record $7.02 billion, a 44 percent increase over 2005. Sterling’s organic growth represented 21 percent of total loan growth.

	•	Total deposits increased to a record $6.75 billion, a 40 percent increase over 2005. Sterling’s organic growth represented 18 percent of total deposit growth.

	•	Net interest income increased to $263.9 million, a 22 percent increase over 2005.

	•	The number of transaction accounts increased to over 185,000, a 21 percent increase over 2005.

	•	Asset quality remains solid and slightly stronger than regional peer averages.

Critical Accounting Policies

The accounting and reporting policies of Sterling conform to GAAP and to general practices within the banking industry. The preparation of the financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Sterling’s management has identified the accounting policies described below as those that, due to the judgments, estimates and assumptions inherent in those policies are critical to an understanding of Sterling’s Consolidated Financial Statements and MD&A.

Income Recognition. Sterling recognizes interest income by methods that conform to general accounting practices within the banking industry. In the event management believes collection of all or a portion of contractual interest on a loan has become doubtful, which generally occurs after the loan is 90 days past due, Sterling discontinues the accrual of interest, and any previously accrued interest recognized in income deemed uncollectible is reversed. Interest received on nonperforming loans is included in income only if principal recovery is reasonably assured. A nonperforming loan is restored to accrual status when it is brought current, has performed in accordance with contractual terms for a reasonable period of time, and the collectibility of the total contractual principal and interest is no longer in doubt.

Allowance For Loan Losses. In general, determining the amount of the allowance for loan losses requires significant judgment and the use of estimates by management. Sterling maintains an allowance for loan losses to absorb probable losses in the loan portfolio based on a quarterly analysis of the portfolio and expected future losses. This analysis is designed to determine an appropriate level and allocation of the allowance for losses among loan types by considering factors affecting loan losses, including specific losses, levels and trends in impaired and nonperforming loans, historical loan loss experience, current national and local economic conditions, volume, growth and composition of the portfolio, regulatory guidance and other relevant factors. Management monitors the loan portfolio to evaluate the adequacy of the allowance. The allowance can increase or decrease each quarter based upon the results of management’s analysis.

The amount of the allowance for the various loan types represents management’s estimate of expected losses from existing loans based upon specific allocations for individual lending relationships and historical loss experience for each category of homogeneous loans. The allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation requires management to make estimates of the amounts and timing of future cash flows on impaired loans, which consist primarily of non-accrual and restructured loans.

Individual loan reviews are based upon specific quantitative and qualitative criteria, including the size of the loan, loan quality ratings, value of collateral, repayment ability of borrowers, and historical experience factors. The historical experience factors used and allowances for homogeneous loans (such as residential mortgage loans,

consumer loans, etc.) are collectively evaluated based upon historical loss experience, trends in losses and delinquencies, growth of loans in particular markets, and known changes in economic conditions in each particular lending market.

While management uses available information to provide for loan losses, the ultimate collectibility of a substantial portion of the loan portfolio and the need for future additions to the allowance will be based on changes in economic conditions and other relevant factors. A slowdown in economic activity could adversely affect cash flows for both commercial and individual borrowers, as a result of which Sterling could experience increases in nonperforming assets, delinquencies and losses on loans. There can be no assurance that the allowance for loan losses will be adequate to cover all losses, but management believes the allowance for loan losses was adequate at December 31, 2006.

Investments and MBS. Assets in the investment and MBS portfolios are initially recorded at cost, which includes any premiums and discounts. Sterling amortizes premiums and discounts as an adjustment to interest income using the level interest yield method over the estimated life of the security. The cost of investment securities sold, and any resulting gain or loss, is based on the specific identification method.

The loans underlying Sterling’s MBS are subject to the prepayment of principal of the underlying loans. The rate at which prepayments are expected to occur in future periods impacts the amount of premium to be amortized in the current period. If prepayments in a future period are higher or lower than expected, then Sterling will need to amortize a larger or smaller amount of premium to interest income in that future period.

Management determines the appropriate classification of investment securities at the time of purchase. Held-to-maturity securities are those securities that Sterling has the positive intent and ability to hold to maturity and are recorded at amortized cost. Available-for-sale securities are those securities that would be available to be sold in the future in response to Sterling’s liquidity needs, changes in market interest rates, and asset-liability management strategies, among other factors. Available-for-sale securities are reported at fair value, with unrealized holding gains and losses reported in shareholders’ equity as a separate component of other comprehensive income, net of applicable deferred income taxes.

Management evaluates investment securities for other than temporary declines in fair value on a quarterly basis. If the fair value of investment securities falls below their amortized cost and the decline is deemed to be other than temporary, the securities will be written down to current market value, resulting in a loss recorded in the income statement. There were no investment securities which management identified to be other-than-temporarily impaired for the year ended December 31, 2006, because the decline in fair value was attributable to changes in interest rates and not credit quality, and because Sterling has the ability and intent to hold these investments until a recovery in market price occurs, or until maturity. Realized losses could occur in future periods due to a change in management’s intent to hold the investments to maturity, a change in management’s assessment of credit risk, or a change in regulatory or accounting requirements. See Note 1 of “Notes to Consolidated Financial Statements.”

Goodwill and Other Intangible Assets. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Sterling’s goodwill relates to value inherent in the banking business and the value is dependent upon Sterling’s ability to provide quality, cost-effective services in a competitive market place. As such, goodwill value is supported ultimately by revenue that is driven by the volume of business transacted. A decline in earnings as a result of a lack of growth or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods.

Sterling’s management performed an annual test of its goodwill and other intangible assets as of June 30, 2006, and concluded that the recorded values were not impaired. There are many assumptions and estimates underlying the determination of impairment. Another estimate using different but still reasonable assumptions could produce a significantly different result. Additionally, future events could cause management to conclude that Sterling’s goodwill or other intangible assets are impaired, which would result in Sterling recording an impairment loss. Any resulting impairment loss could have a material adverse impact on Sterling’s financial condition and results of operations. Other intangible assets consisting of core deposit intangibles with definite lives are amortized over the estimated life of the acquired depositor relationships.

Loan Purchases. In accordance with the American Institute of Certified Public Accountants’ Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” loans are recorded at fair value if, when they are acquired, they show evidence of deteriorating in terms of credit quality, and a loss is deemed likely to occur. Fair value is defined as the present value of future cash flows, including interest income, to be recognized over the life of the loan. SOP 03-3 prohibits the carryover of an allowance for loan loss on certain acquired loans within its scope that are considered in the future cash flow assessment. Sterling considers this guidance when entering into applicable transactions.

Real Estate Owned. Property and other assets acquired through foreclosure of defaulted mortgage or other collateralized loans are carried at the lower of cost or fair value, less estimated costs to sell the property and other assets. The fair value of REO is generally determined from appraisals obtained by independent appraisers. Development and improvement costs relating to such property are capitalized to the extent they are deemed to be recoverable.

An allowance for losses on real estate and other assets owned is designed to include amounts for estimated losses as a result of impairment in value of the real property after repossession. Sterling reviews its real estate owned for impairment in value whenever events or circumstances indicate that the carrying value of the property or other assets may not be recoverable. In performing the review, if expected future undiscounted cash flow from the use of the property or other assets or the fair value, less selling costs, from the disposition of the property or other assets is less than its carrying value, an impairment loss is recognized.

Income Taxes. Sterling estimates income taxes payable based on the amount it expects to owe various tax authorities. Taxes are discussed in more detail in Note 12 of Notes to Consolidated Financial Statements. Accrued income taxes represent the net estimated amount due to, or to be received from, taxing authorities. In estimating accrued income taxes, Sterling assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account the applicable statutory, judicial and regulatory guidance in the context of Sterling’s tax position. Sterling also considers recent audits and examinations, as well as its historical experience in making such estimates. Although Sterling uses available information to record income taxes, underlying estimates and assumptions can change over time as a result of unanticipated events or circumstances.

Sterling’s deferred tax assets and liabilities are also discussed in more detail in Note 12 of Notes to Consolidated Financial Statements. Sterling uses an estimate of future earnings to support its position that the benefit of its net deferred taxes will be realized. If future pre-tax income should prove nonexistent or less than the amount of temporary differences giving rise to the net deferred tax assets within the tax years to which they may be applied, the assets will not be realized and Sterling’s net income will be reduced.

Results of Operations for the Years Ended December 31, 2006 and 2005

Net Interest Income. The most significant component of earnings for a financial institution typically is NII, which is the difference between interest income, primarily from loan, MBS and investment securities portfolios, and interest expense, primarily on deposits and borrowings. During the years ended December 31, 2006 and 2005, NII was $263.9 million and $216.5 million, respectively, an increase of 21.9%. The increase in NII during 2006 compared to 2005 was mainly because the average loan balance increased by $1.41 billion.

During the years ended December 31, 2006 and 2005, net interest margin was 3.30% and 3.28%, respectively, and net interest spread was 3.17% and 3.23%, respectively. Net interest spread refers to the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin refers to NII divided by total average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. Average interest earning assets were greater relative to average interest bearing liabilities in 2006 versus 2005, resulting in an increase in net interest margin. The decrease in net interest spread was primarily due to the cost of funds increasing more rapidly than the yield on earning assets.

The following table sets forth, for the periods indicated, information with regard to Sterling’s NII, net interest spread and net interest margin:


	Years Ended December 31,
	2006							2005							2004
			Interest		Average					Interest		Average					Interest		Average
			Earned		Yield					Earned		Yield					Earned		Yield
	Average		or		or			Average		or		or			Average		or		or
	Balance(1)		Paid(2)		Cost(3)			Balance(1)		Paid(2)		Cost(3)			Balance(1)		Paid(2)		Cost(3)
	(Dollars in thousands)

Interest-earning assets:
Loans	$	5,891,595	$	458,558		7.78	%	$	4,482,012	$	296,306		6.61	%	$	3,852,247	$	229,448		5.96	%
Mortgage-backed securities		1,862,144		88,398		4.75	%		1,948,435		88,682		4.55	%		1,885,239		85,009		4.51	%
Investments and cash equivalents		233,611		3,899		1.67	%		168,853		2,823		1.67	%		190,934		5,304		2.78	%

Total interest-earning assets		7,987,350		550,855		6.90	%		6,599,300		387,811		5.88	%		5,928,420		319,761		5.39	%

Noninterest-earning assets		411,213							447,755							447,997

Total average assets	$	8,398,563						$	7,047,055						$	6,376,417

Interest-bearing liabilities:
Transaction:
Interest-bearing	$	399,690		1,692		0.42	%	$	419,137		1,340		0.32	%	$	399,963		837		0.21	%
Non-interest-bearing		706,631		0		0.00	%		648,385		0		0.00	%		546,128		0		0.00	%
Savings and MMDA		1,512,198		47,844		3.16	%		1,158,270		22,272		1.92	%		1,092,612		11,347		1.04	%
Time deposits		2,962,017		135,737		4.58	%		2,041,122		68,378		3.35	%		1,608,599		41,299		2.57	%

Total deposits		5,580,536		185,273		3.32	%		4,266,914		91,990		2.16	%		3,647,302		53,483		1.47	%
Borrowings		2,125,620		101,670		4.78	%		2,192,934		79,286		3.62	%		2,200,229		69,462		3.16	%

Total interest-bearing liabilities		7,706,156		286,943		3.72	%		6,459,848		171,276		2.65	%		5,847,531		122,945		2.10	%

Noninterest-bearing liabilities		122,435							93,992							101,134

Total average liabilities		7,828,591							6,553,840							5,948,665
Total average shareholders’ equity		569,972							493,215							427,752

Total average liabilities and equity	$	8,398,563						$	7,047,055						$	6,376,417

Net interest spread			$	263,912		3.17	%			$	216,535		3.23	%			$	196,816		3.29	%

Net interest margin						3.30	%						3.28	%						3.32	%

Ratio of average interest-earning assets to average interest-bearing liabilities						103.65	%						102.16	%						101.38	%


(1)		Average balances are computed on a monthly basis.

(2)		Interest earned includes $2.9 million, $1.9 million and $2.2 million of tax exempt interest for 2006, 2005 and 2004, respectively.

(3)		The yield information for the available-for-sale portfolio does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.

Changes in Sterling’s NII are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. The following table presents the composition of the change in NII for the periods presented. For each category of interest-earning assets and interest-bearing liabilities, the following table provides information on changes attributable to:


	•	Volume — changes in volume multiplied by comparative period rate;

	•	Rate — changes in rate multiplied by comparative period volume; and

	•	Rate/volume — changes in rate multiplied by changes in volume.


	December 31, 2006												December 31, 2005
	Increase (Decrease) Due to:												Increase (Decrease) Due to:
							Rate/												Rate/
	Volume			Rate			Volume			Total			Volume			Rate			Volume			Total
	(Dollars in thousands)

Interest income on:
Loans	$	93,832		$	52,392		$	16,028		$	162,252		$	37,508		$	25,226		$	4,124		$	66,858
Mortgage-backed securities		(3,927	)		3,812			(169	)		(284	)		2,850			797			26			3,673
Investment and cash equivalents		1,083			(5	)		(2	)		1,076			(613	)		(2,112	)		244			(2,481	)

Total interest income		90,988			56,199			15,857			163,044			39,745			23,911			4,394			68,050

Interest-bearing deposits:
Time deposits		30,850			25,158			11,351			67,359			11,105			12,589			3,385			27,079
Savings and MMDA		6,806			14,374			4,392			25,572			682			9,662			581			10,925
Interest-bearing transaction accounts		49			293			10			352			40			442			21			503

Total deposits		37,705			39,825			15,753			93,283			11,827			22,693			3,987			38,507
Other borrowings		(2,434	)		25,604			(786	)		22,384			(933	)		9,310			1,447			9,824

Total interest expense		35,271			65,429			14,967			115,667			10,894			32,003			5,434			48,331

Net interest income	$	55,717		$	(9,230	)	$	890		$	47,377		$	28,851		$	(8,092	)	$	(1,040	)	$	19,719

Provision for Losses on Loans. Management’s policy is to establish valuation allowances for estimated losses by charging corresponding provisions against income. The evaluation of the adequacy of specific and general valuation allowances is an ongoing process. This process includes information derived from many factors, including historical loss trends, trends in classified assets, trends in delinquent and nonaccrual loans, trends in portfolio volume, diversification as to type of loan, size of individual credit exposure, current and anticipated economic conditions, loan policies, collection policies and effectiveness, quality of credit personnel, effectiveness of policies, procedures and practices, and recent loss experience of peer banking institutions.

Sterling recorded provisions for losses on loans of $18.7 million and $15.2 million for the years ended December 31, 2006 and 2005, respectively. The current provision reflects the analysis and assessment of the relevant factors mentioned in the preceding paragraph. Management anticipates that its provisions for losses on loans will continue to increase, reflecting Sterling’s strategic direction of originating more commercial, construction and consumer loans, which have a somewhat higher loss profile than Sterling’s historical mix of loans.

The following table summarizes loan loss allowance activity for the periods indicated:


	Years Ended December 31,
	2006			2005
	(Dollars in thousands)

Balance at January 1	$	55,483		$	49,362
Allowance for loan losses acquired		13,155			0
Provision for losses on loans		18,703			15,200
Amounts written off net of recoveries and other		(3,652	)		(9,079	)

Balance at December 31	$	83,689		$	55,483

At December 31, 2006, Sterling’s total classified assets were 0.49% of total assets, compared with 0.79% of total assets at December 31, 2005. Nonperforming assets were 0.11% of total assets at December 31, 2006 and December 31, 2005. At December 31, 2006, Sterling’s loan delinquency rate (60 days or more) as a percentage of total loans was 0.10%, compared with 0.18% at December 31, 2005. Improvements in the quality of the loan portfolio and a general improvement in the economy contributed to the decreases in classified and nonperforming assets. Fewer delinquent loans, as well as the increase in total assets, led to the decrease in the delinquency ratio. Asset quality has been stable over the periods presented.

Non-Interest Income. Non-interest income was as follows for the years presented:


	Years Ended December 31,
	2006			2005
	(Dollars in thousands)

Fees and service charges	$	42,995		$	34,702
Mortgage banking operations		20,216			17,899
Bank-owned life insurance		5,020			5,914
Loan servicing fees		1,812			434
REO operations		176			477
Net gains (losses) on sales of securities		0			(57	)
Gain (charge) related to early repayment of debt		(204	)		645
Other non-interest expense		(675	)		(445	)

Total non-interest income	$	69,340		$	59,569

The increase in non-interest income for the years ended December 31, 2006 and December 31, 2005, was primarily due to an increase in fees and service charges, and income from mortgage banking operations. Fees and service charges for the year ended December 31, 2006 increased primarily due to the success of Sterling’s Balance Shield program, an increase in debit card transactions, treasury management services, and merchant services. The increased income from mortgage banking operations was primarily a result of the acquisition of Golf Savings Bank, which specializes in the origination and sale of residential mortgage loans into the secondary market. Gains on the sale of loans held for sale are recorded as income from mortgage banking operations.

During the year ended December 31, 2006, Sterling did not sell any investment securities or MBS, compared with sales resulting in a net loss of $57,000 for the year ended December 31, 2005. The activity for both periods was a result of management’s response to market conditions and portfolio management needs.

The following table summarizes certain information about Sterling’s residential and commercial mortgage banking activities for the years indicated:


	As of and for the Years Ended December 31,
	2006		2005
	(Dollars in millions)

Originations of residential mortgage loans	$	830.6	$	461.4
Originations of commercial real estate loans		131.0		218.4
Sales of residential loans		655.6		583.2
Sales of commercial real estate loans		54.9		125.5
Principal balances of residential loans serviced for others		621.6		606.7
Principal balances of commercial real estate loans serviced for others		1,622.8		814.2

Non-Interest Expenses. Non-interest expenses were as follows for the years presented:


	Years Ended
	December 31,
	2006		2005
	(Dollars in thousands)

Employee compensation and benefits	$	117,186	$	93,367
Occupancy and equipment		32,769		26,411
Data processing		14,180		12,678
Depreciation		10,280		8,627
Advertising		9,985		9,125
Travel and entertainment		5,955		4,522
Legal and accounting		2,478		3,134
Amortization of core deposit intangibles		2,405		2,222
Insurance		1,360		1,213
Merger and acquisition costs		454		0
Goodwill litigation costs		275		179
Other		9,046		8,803

Total	$	206,373	$	170,281

The increases in non-interest expenses were primarily due to continued company growth. Full-time equivalent employees increased year-over-year by 616 to 2,405 at December 31, 2006. The acquisitions of Golf Savings Bank, FirstBank and Mason-McDuffie added approximately 480 full-time equivalent employees.

Income Tax Provision. Sterling recorded federal and state income tax provisions of $34.2 million and $29.4 million for the years ended December 31, 2006 and 2005, respectively. The effective tax rates for these periods were 31.6% and 32.4%, with the decrease primarily reflecting Sterling’s utilization of available tax credits.

Results of Operations for the Years Ended December 31, 2005 and 2004

Net Interest Income. NII for the years ended December 31, 2005 and 2004 was $216.5 million and $196.8 million, respectively. The 10.0% increase in NII was primarily due to growth in loan and MBS volumes. During the year ended December 31, 2005, average loans increased by $629.8 million, an increase of 16.3% over 2004.

During the same periods, the net interest margins were 3.28% and 3.32%, respectively, and net interest spreads were 3.23% and 3.29%, respectively. The decreases in net interest margin and net interest spread were primarily due to the cost of funds increasing more rapidly than the yield in earning assets.

Provision for Losses on Loans. Sterling recorded provisions for losses on loans of $15.2 million and $12.2 million for the years ended December 31, 2005 and 2004, respectively. The following table summarizes loan loss allowance activity for the periods indicated:


	Years Ended December 31,
	2005			2004
	(Dollars in thousands)

Balance at January 1	$	49,362		$	35,605
Allowance for loan losses acquired		0			6,722
Provision for losses on loans		15,200			12,150
Amounts written off net of recoveries and other		(9,079	)		(5,115	)

	$	55,483		$	49,362

At December 31, 2005, Sterling’s total classified assets were 0.79% of total assets, compared with 0.98% of total assets at December 31, 2004. Total nonperforming assets were 0.11% of total assets at December 31, 2005, compared with 0.20% of total assets at December 31, 2004. At December 31, 2005, Sterling’s loan delinquency rate (60 days or more) as a percentage of total loans was 0.18%, compared with 0.32% at December 31, 2004. Improvements in the quality of the loan portfolio and the sale of certain nonperforming assets contributed to the decreases in classified and nonperforming assets. Fewer delinquent loans, as well as the increase in total assets, led to the decrease in the delinquency ratio. Asset quality has been stable over the periods presented.

Non-Interest Income. The following table summarizes the components of non-interest income for the periods indicated:


	Years Ended December 31,
	2005			2004
	(Dollars in thousands)

Fees and service charges	$	34,702		$	32,692
Mortgage banking operations		17,899			6,155
Bank-owned life insurance		5,914			4,340
Charge related to early repayment of debt		645			(238	)
Real estate owned operations		477			(162	)
Loan servicing fees		434			561
Net gains on sales of securities		(57	)		4,571
Other non-interest expense		(445	)		(120	)

Total non-interest income	$	59,569		$	47,799

The increase in non-interest income was primarily due to an increase in income from mortgage banking operations. The increase resulted from Sterling selling $708.8 million in residential and commercial real estate loans during the year ended December 31, 2005 compared to $202.4 million of such sales during the year ended December 31, 2004. The increase in sales during 2005 reflected Sterling’s repositioning of the loan portfolio to be more like that of a community bank by capitalizing on strong institutional demand for real estate loans. Loan sales during 2005 resulted in gains of $10.2 million compared to gains during 2004 of $2.7 million, with the difference being primarily due to increases in volume.

During the year ended December 31, 2005, Sterling sold investments and MBS, resulting in net loss of $57,000 compared to net gains of $4.6 million for the year ended December 31, 2004. The increase in net gains on sales of investments and MBS mainly reflects Sterling’s strategy to manage interest rate risk on its MBS portfolio.

The following table summarizes certain information regarding Sterling’s residential and commercial mortgage banking activities for the periods indicated:


	Years Ended December 31,
	2005		2004
	(Dollars in millions)

Originations of residential mortgage loans	$	461.4	$	400.4
Originations of commercial real estate loans		218.4		241.8
Sales of residential loans		583.2		186.1
Sales of commercial real estate loans		125.5		16.3
Principal balances of residential loans serviced for others		606.7		373.6
Principal balances of commercial real estate loans serviced for others		814.2		593.3

Non-Interest Expense. Non-interest expenses were as follows for the years presented.


	Years Ended
	December 31,
	2005		2004
	(Dollars in thousands)

Employee compensation and benefits	$	93,367	$	77,617
Occupancy and equipment		26,411		23,051
Data processing		12,678		10,596
Advertising		9,125		6,976
Depreciation		8,627		7,321
Travel and entertainment		4,522		4,071
Legal and accounting		3,134		3,075
Amortization of core deposit intangibles		2,222		2,222
Insurance		1,213		1,155
Goodwill litigation costs		179		141
Merger and acquisition costs		0		4,835
Other		8,803		7,310

Total	$	170,281	$	148,370

The increases in non-interest expenses were primarily due to continued company growth. Full-time equivalent employees increased year-over-year by 165 to 1,789 at December 31, 2005.

Income Tax Provision. Sterling recorded federal and state income tax provisions of $29.4 million and $27.8 million for the years ended December 31, 2005 and 2004, respectively. The effective tax rates for these periods were 32.4% and 33.0%. The decrease in the effective tax rates primarily reflects changes in permanent tax differences and an increase in non taxable BOLI income from December 2005 insurance proceeds of $1.4 million.

Financial Position

Assets. At December 31, 2006, Sterling’s assets were $9.83 billion, up 30.0% from $7.56 billion at December 31, 2005. This growth was driven mainly by increases in the loan portfolio through both originations and acquisitions.

Investments and MBS. Sterling’s investment and MBS portfolio at December 31, 2006 was $1.91 billion, a decrease of $214.9 million from the December 31, 2005 balance of $2.13 billion. The decrease was due to principal repayments and maturities exceeding Sterling’s purchases and acquisitions of securities. As of December 31, 2006, the investment and MBS portfolio had an unrealized loss of $52.8 million versus an unrealized loss of $54.1 million at December 31, 2005, with the fluctuation primarily due to interest rate movements.

Loans Receivable. At December 31, 2006, net loans receivable were $7.02 billion, up $2.13 billion from $4.89 billion at December 31, 2005. The increase was due to record loan originations and acquisitions, net of repayments.

Bank-Owned Life Insurance (“BOLI”). BOLI increased to $139.2 million at December 31, 2006, from $107.6 million at December 31, 2005. The increase was primarily due to the acquisition of FirstBank. Sterling uses the earnings from BOLI to fund employee benefit costs. Through BOLI, Sterling becomes the beneficiary of life insurance policies on certain officers who consent to the issuance of the policies.

Goodwill and Other Intangible Assets. Goodwill and other intangible assets increased to $275.8 million at December 31, 2006, from $130.3 million at December 31, 2005. See Note 6 of “Notes to Consolidated Financial Statements.”

Deposits. The following table sets forth the composition of Sterling’s deposits at the dates indicated:


	December 31, 2006					December 31, 2005
	Amount		%			Amount		%
	(Dollars in thousands)

Interest-bearing transaction	$	483,551		7.2		$	432,936		9.0
Noninterest-bearing transaction		834,140		12.4			673,934		14.0
Savings and MMDA		1,830,313		27.1			1,312,033		27.3
Time deposits		3,598,024		53.3			2,387,398		49.7

Total deposits	$	6,746,028		100.0		$	4,806,301		100.0

Annualized cost of deposits				3.32	%				2.16	%

Deposit growth was primarily in savings and time deposits, reflecting consumer demand, the use of brokered CD’s as a cost competitive source of funds, and the deposit mix of acquired entities.

Borrowings. Deposit accounts are Sterling’s primary source of funds. Sterling does, however, rely upon advances from the FHLB Seattle, reverse repurchase agreements and other borrowings to fund asset growth and meet deposit withdrawal requirements. At both December 31, 2006 and 2005, the total of such borrowings was $2.17 billion. During 2006, FHLB advances decreased by approximately the same amount that other borrowings increased. Other borrowings increased from December 31, 2005 due to Sterling’s wholly owned subsidiaries, Sterling Capital Trusts VII and VIII, issuing $105.0 million of Trust Preferred Securities. Other borrowings also increased as a result of acquiring $19.0 million of Trust Preferred Securities in the acquisition of Golf Savings Bank. See “— Liquidity and Capital Resources.”

Asset and Liability Management

The results of operations for financial institutions may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates, declines in real estate market values and the monetary and fiscal policies of the federal government. The mismatch between maturities, interest rate sensitivities and prepayment characteristics of assets and liabilities, and the changes in each of these attributes under different interest rate scenarios results in interest-rate risk.

Sterling, like most financial institutions, has material interest-rate risk exposure to changes in both short-term and long-term interest rates as well as variable interest rate indices. Sterling’s results of operations are largely dependent upon its net interest income and its ability to manage its interest rate risk.

Sterling’s Asset/Liability Committee (“ALCO”) manages Sterling’s interest-rate risk based on interest rate expectations and other factors within policies and practices approved by the Board. The principal objective of Sterling’s asset and liability management activities is to provide maximum levels of net interest income while maintaining acceptable levels of interest-rate risk and liquidity risk while facilitating Sterling’s funding needs. ALCO manages this process at both the subsidiary and consolidated levels. ALCO measures interest rate risk exposure through three primary measurements: management of the relationship between its interest bearing assets

and its interest bearing liabilities, interest rate shock simulations of net interest income, and net portfolio value (“NPV”) simulation.

The difference between a financial institution’s interest rate sensitive assets (e.g., assets that will mature or reprice within a specific time period) and interest rate sensitive liabilities (i.e. liabilities that will mature or reprice within the specific time period) is commonly referred to as its “interest rate sensitivity gap” (“GAP”). An institution having more interest rate sensitive assets than interest rate sensitive liabilities within a given time period is said to be “asset sensitive,” which generally means that if interest rates increase (other things being equal), a company’s net interest income will increase and if interest rates decrease (other things being equal), its net interest income will decrease. Likewise, an institution having more interest rate sensitive liabilities than interest rate assets within a given time period is said to be “liability sensitive,” which generally means that if interest rates increase, a company’s net interest income will decrease and if interest rates decrease, its net interest income will increase.

The following table sets forth the estimated maturity/repricing and the resulting gap between Sterling’s interest-earning assets and interest-bearing liabilities at December 31, 2006. The estimated maturity/repricing amounts reflect contractual maturities and amortizations, assumed loan prepayments based upon Sterling’s historical experience, estimates from secondary market sources such as FHLMC or FNMA and estimated regular non-maturity deposit decay rates (the rate of withdrawals or transfers to higher-yielding products). Management believes these assumptions and estimates are reasonable, but there can be no assurance in this regard or that action undertaken to mitigate interest rate risk will have the desired effect. The classification of mortgage loans, investments and MBS is based upon regulatory reporting formats and, therefore, may not be consistent with the financial information contained elsewhere in this report on Form 10-K. While the GAP measurement has some limitations, including no assumptions regarding future asset or liability production and a static interest rate assumption (large changes may occur related to those items), the GAP represents the net asset or liability sensitivity at a point in time. A GAP measure could be significantly affected by external factors such as loan prepayments that

occur faster or slower than assumed, early withdrawals of deposits, changes in the correlation of various interest-bearing instruments, competition or a rise or decline in interest rates.


	Maturity or Repricing
				Over			Over			Over
	0 to 3			3 Months			1 Year			3 Years			Over
	Months			to 1 Year			to 3 Years			to 5 Years			5 Years			Total
	(Dollars in thousands)

Interest-earning assets:
Mortgage loans and MBS:
ARM, balloon mortgage loans and MBS	$	2,422,028		$	261,905		$	410,130		$	214,084		$	51,846		$	3,359,993
Fixed-rate mortgage loans and MBS		124,675			338,599			636,033			550,496			585,861			2,235,664
Loans held for sale		91,469			0			0			0			0			91,469

Total mortgage loans and MBS		2,638,172			600,504			1,046,163			764,580			637,707			5,687,126
Commercial and consumer loans:
Consumer		282,406			161,054			314,791			159,138			120,941			1,038,330
Commercial		1,127,062			262,104			417,082			196,081			66,757			2,069,086

Total loans and MBS		4,047,640			1,023,662			1,778,036			1,119,799			825,405			8,794,542
Cash and investments		162,698			1,214			11,070			676			83,751			259,409

		4,210,338			1,024,876			1,789,106			1,120,475			909,156			9,053,951
Cash on hand and in banks		0			0			0			0			146,280			146,280
Other noninterest-earning assets		0			0			0			0			628,421			628,421

Total assets	$	4,210,338		$	1,024,876		$	1,789,106		$	1,120,475		$	1,683,857		$	9,828,652

Interest-bearing liabilities:
Deposits:
Time deposits	$	1,341,352		$	1,802,669		$	259,722		$	121,183		$	73,098		$	3,598,024
Checking accounts		45,912			95,462			83,631			73,544			1,019,142			1,317,691
MMDA		397,181			796,656			50,592			39,301			357,463			1,641,193
Passbook accounts		20,198			40,396			0			0			128,526			189,120

Total deposits		1,804,643			2,735,183			393,945			234,028			1,578,229			6,746,028
FHLB Seattle advances		1,021,006			36,063			108,019			81,792			61,737			1,308,617
Repurchase agreements and funds purchased		86,354			0			80,000			50,000			400,000			616,354
Other borrowings		0			0			0			0			236,772			236,772

Total interest-bearing liabilities		2,912,003			2,771,246			581,964			365,820			2,276,738			8,907,771

Other noninterest-bearing liabilities		0			0			0			0			137,465			137,465
Shareholders’ equity		0			0			0			0			783,416			783,416

Total liabilities and shareholders’ equity	$	2,912,003		$	2,771,246		$	581,964		$	365,820		$	3,197,619		$	9,828,652

Net gap	$	1,298,335		$	(1,746,370	)	$	1,207,142		$	754,655		$	(1,513,762	)	$	0

Cumulative gap	$	1,298,335		$	(448,035	)	$	759,107		$	1,513,762		$	0		$	0

Cumulative gap to total assets		13.21	%		(4.56	)%		7.72	%		15.40	%		0.00	%		0.00	%

ALCO uses interest rate shock simulations of net interest income to measure the effect of changes in interest rates on the net interest income for Sterling over a 12 month period. This simulation consists of measuring the change in net interest income over the next 12 months from a base case scenario when rates are shocked, in a parallel fashion, up and down 100, 200, and 300 basis points. The base case uses the assumption of the existing balance sheet and existing interest rates to simulate the base line of net interest income over the next 12 months for the simulation. The simulation requires numerous assumptions, including relative levels of market interest rates, instantaneous and parallel shifts in the yield curve, loan prepayments and reactions of depositors to changes in interest rates, and should not be relied upon as being indicative of actual or future results. Further, the analysis does not contemplate

actions Sterling may undertake in response to changes in interest rates and market conditions. The results of this simulation as of December 31, 2006 and 2005 are included in the following table:


	December 31,
	2006			2005
	% Change			% Change
Change in Interest Rate in Basis Points (Rate Shock)	in NII			in NII

+200		(1.5	)		(4.6	)
+100		(0.8	)		(2.4	)
Static		0.0			0.0
−100		(0.4	)		(0.5	)
−200		(1.6	)		(5.2	)

ALCO uses NPV simulation analysis to measure risk in the balance sheet that might not be taken into account in the net interest income simulation analysis. Whereas net interest income simulation highlights exposure over a relatively short time period of 12 months, NPV simulation analysis incorporates all cash flows over the estimated remaining life of all balance sheet positions. The NPV simulation analysis of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows minus the discounted value of liability cash flows. The discount rates that are used represent an assumption for the current market rates of each group of assets and liabilities. The difference between the present value of the asset and liability represents the NPV. As with net interest income, this is used as the base line to measure the change in NPV when interest rates are shocked, in a parallel fashion, up and down 100, 200, and 300 basis points. As with the net interest income simulation model, NPV simulation analysis is based on key assumptions about the timing and variability of balance sheet cash flows. However, because the simulation represents much longer time periods, inaccuracy of assumptions may increase the variability of outcomes within the simulation. It also does not take into account actions management may undertake in response to anticipated changes in interest rates. The results of this simulation at December 31, 2006 and 2005 are included in the following table:


	At December 31,
	2006			2005
	% Change			% Change
Change in Interest Rate in Basis Points (Rate Shock)	in NPV			in NPV

+200		(5.0	)		(7.1	)
+100		(1.5	)		(3.5	)
Static		0.0			0.0
−100		(4.6	)		(5.9	)
−200		(17.9	)		(25.5	)

Sterling occasionally enters into customer-related financial derivative transactions primarily consisting of interest rate swaps. Risk exposure from customer positions is managed through transactions with other dealers. As of December 31, 2006, Sterling has not entered into asset/liability related derivative transactions as part of managing its interest rate risk. However, Sterling continues to consider derivatives, including interest rate swaps, caps and floors, as a viable alternative in the asset and liability management process.

Liquidity and Capital Resources

As a financial institution, Sterling’s primary sources of funds are investing and financing activities, including collecting loan principal and interest payments. Financing activities consist primarily of customer deposits, advances from FHLB Seattle and other borrowings. Deposits increased 40% to $6.75 billion at December 31, 2006 from $4.81 billion at December 31, 2005, mainly due to increases of $1.21 billion in time deposits. This increase in time deposits primarily reflected Sterling’s use of funds as a cost competitive source to generate loan growth, in addition to time deposits added as a result of Sterling’s acquisitions.

Sterling Savings Bank and Golf Savings Bank actively manage their liquidity in an effort to maintain an adequate margin over the level necessary to support expected and potential loan fundings and deposit withdrawals.

This is balanced with the need to maximize yield on alternative investments. The liquidity ratio may vary from time to time, depending on economic conditions, deposit fluctuations and loan funding needs.

During the year ended December 31, 2006, net cash used in investing activities was $757.1 million, which consisted mainly of funding of loans, partially offset by cash inflows from loan principal repayments and runoff in the MBS portfolio. During the year, net cash provided by financing activities was $693.2 million, which consisted primarily of net inflows from deposit accounts.

Sterling Savings Bank’s credit line with FHLB Seattle provides for borrowings up to a percentage of its total assets, subject to collateralization requirements. FHLB Seattle advances are collateralized with securities, and commercial and residential loans. At December 31, 2006, this credit line represented a total borrowing capacity of $2.04 billion, of which $734.9 million was available. The FHLB Seattle has been undergoing organizational and operational changes for more than two years pursuant to a written agreement with its regulator, the Federal Housing Finance Board (“Finance Board”). During this time, FHLB Seattle continued to provide Sterling with ready sources of liquidity. Based on FHLB Seattle’s recent earnings and capital position, the Finance Board permitted the FHLB Seattle to resume dividend payments in December 2006, and on January 12, 2007, terminated the written agreement. Also, the Standard & Poor’s rating outlook for FHLB Seattle improved to “stable.”

Sterling Savings Bank also borrows funds under reverse repurchase agreements pursuant to which it sells investments (generally U.S. agency securities and MBS) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and MBS sold. Sterling Savings Bank uses these borrowings to supplement deposit gathering for funding the origination of loans. At December 31, 2006, Sterling Savings Bank had $616.4 million in outstanding borrowings under reverse repurchase agreements and had securities available for additional secured borrowings of approximately $193.0 million. The use of reverse repurchase agreements may expose Sterling to certain risks not associated with other borrowings, including IRR and the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines. For additional information regarding reverse repurchase agreements, see “— Asset and Liability Management” and Note 10 of “Notes to Consolidated Financial Statements.”

Sterling, on a parent company-only basis, had cash of approximately $21.1 million and $15.7 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, Sterling had an investment of $175.1 million and $110.1 million, respectively, in the preferred stock of Sterling Savings Bank, and $512.6 million and $294.6 million, respectively, in the common stock of Sterling Savings Bank. The increase in the preferred stock investment reflects proceeds from Trust Preferred Securities issued by Sterling Capital Trusts VII and VIII. The increase in the investment in the common stock of Sterling Savings Bank reflects Sterling’s acquisition and merger of FirstBank Northwest into Sterling Savings Bank, as well as an investment of $52.2 million that was funded with borrowings, and a dividend from Golf Savings Bank of $32.2 million as a result of asset and liability transfers following the closing of the acquisition by Sterling. Also during 2006, Sterling invested $1.5 million in the common stock of Golf Savings Bank. Sterling received cash dividends from Sterling Savings Bank of $24.3 million and $11.6 million during the twelve months ended December 31, 2006, and December 31, 2005, respectively. These resources contributed to Sterling’s ability to meet its operating needs, including interest expense on its long-term debt. Sterling Savings Bank’s ability to pay dividends is limited by its earnings, financial condition, capital requirements, and capital distribution regulations.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

The following table represents Sterling’s on-and-off-balance sheet aggregate contractual obligations to make future payments as of December 31, 2006:


	Payments Due by Period
			Less Than				Over		More Than
	Total		1 Year		1 to 3 Years		3 to 5 Years		5 Years
	(Dollars in thousands)

Long-term debt(1)	$	2,165,197	$	890,114	$	311,615	$	699,224	$	264,244
Capital lease obligations		0		0		0		0		0
Operating leases		86,352		11,703		20,249		14,982		39,418
Purchase obligations(2)		41,161		18,157		15,336		7,668		0
Other long-term liabilities(3)		34,854		478		1,528		1,940		30,908

Total	$	2,327,564	$	920,452	$	348,728	$	723,814	$	334,570


(1)		Excludes interest payments. See Notes 8 — 10 of “Notes to Consolidated Financial Statements.”

(2)		Excludes recurring accounts payable amounts due in the first quarter of 2007.

(3)		Includes amounts associated with retirement and benefit plans and other compensation arrangements. The amounts represent the total future potential payouts assuming all current participants become fully vested in their respective plans or arrangements. See Note 17 of “Notes to Consolidated Financial Statements.”

Sterling, in the conduct of ordinary business operations routinely enters into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contracts. Sterling is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Management does not believe that these off-balance sheet arrangements have a material current effect on Sterling’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources but there is no assurance that such arrangements will not have a future effect.

Sterling enters into interest rate swap derivative contracts with customers. The IRR on these contracts is offset by entering into comparable dealer swaps. These contracts are carried at fair value.

Capital

Sterling’s total shareholders’ equity was $783.4 million at December 31, 2006, compared with $506.7 million at December 31, 2005. The increase in total shareholders’ equity was primarily due to the retention of earnings, and issuance of Sterling’s common stock in connection with the acquisition of Golf Savings Bank and FirstBank. Shareholders’ equity was 8.0% of total assets at December 31, 2006, compared with 6.7% at December 31, 2005.

At December 31, 2006 and 2005, Sterling had an unrealized loss of $52.8 million and $54.1 million, respectively, on investment securities and MBS classified as available for sale. The change since December 31, 2005 reflects the increase in the market value of the MBS portfolio. Fluctuations in prevailing interest rates continue to cause volatility in this component of accumulated comprehensive income or loss in shareholders’ equity and may continue to do so in future periods.

Sterling has outstanding various series of Capital Securities (“Trust Preferred Securities”) issued to investors. The Trust Preferred Securities are treated as debt of Sterling and qualify as Tier 1 capital, subject to certain limitations. For a complete description, see Note 10 of “Notes to Consolidated Financial Statements.”

Sterling, Sterling Savings Bank and Golf Savings Bank are required by applicable regulations to maintain certain minimum capital levels. Sterling’s management intends to enhance the capital resources and regulatory capital ratios of Sterling and its banking subsidiaries through the retention of an adequate amount of earnings and the management of the level and mix of assets, although there can be no assurance in this regard. At December 31, 2006, each of the companies exceeded all such regulatory capital requirements and were “well capitalized” pursuant to such regulations.

Goodwill Litigation

In May 1990, Sterling initiated a lawsuit against the U.S. Government with respect to the loss of the goodwill treatment and other matters relating to Sterling’s past acquisitions of troubled thrift institutions (the “Goodwill Litigation”). In the Goodwill Litigation, Sterling is seeking damages for, among other things, breach of contract and deprivation of property without just compensation. In September 2002, the U.S. Court of Federal Claims granted Sterling Savings Bank’s motion for summary judgment as to liability on its contract claim, holding that the U.S. Government owed contractual obligations to Sterling with respect to the company’s acquisition of three failing regional thrifts during the 1980s and had breached its contracts with Sterling. On March 31, 2005, a hearing was held in the U.S. Court of Federal Claims on the U.S. Government’s motion to reconsider part of the September 2002 liability judgment, relating to Sterling’s acquisition of the largest of the three thrifts it acquired, Central Evergreen Savings & Loan. Sterling opposed the motion.

On August 30, 2006, the Court of Federal Claims granted the U.S. Government’s motion to reconsider, and held that the U.S. Government was not liable for breach of the contract for Sterling’s acquisition of Central Evergreen Savings and Loan. The Court set a trial date of June 25, 2007 to determine what amount, if any, the U.S. Government must pay in damages for its breach of the contracts for the acquisition of the two smaller thrifts, Lewis Federal Savings & Loan and Tri-Cities Savings & Loan. The ultimate outcome of the Goodwill Litigation cannot be predicted with certainty. The U.S. Government will likely appeal any award of damages in favor of Sterling, and Sterling may appeal the adverse ruling as to Central Evergreen Savings & Loan. Because of the effort required to bring the case to conclusion, Sterling will likely continue to incur legal expenses as the case progresses.

New Accounting Policies

In September 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” Under the provisions of EITF Issue No. 06-4, Sterling will recognize the amount, if any, that is owed current or former employees under split dollar BOLI. Also in September, the EITF Issued No. 06-5, “Accounting for Purchases of Life Insurance — Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” EITF Issue No. 06-5 requires recognition of various other amounts under insurance contracts. EITF 06-4 is effective January 1, 2008 and EITF 06-5 is effective January 1, 2007. Sterling is currently assessing the potential impact of these standards.

In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 will be effective for Sterling as of January 1, 2008. Sterling is currently assessing the impact of this standard and does not expect SFAS No. 157 to have a material effect on Sterling.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). This pronouncement requires a certain methodology for measuring and reporting uncertain tax positions, as well as disclosures. Adoption may result in a cumulative adjustment to income tax liabilities and retained earnings, if applicable. FIN No. 48 will be effective for Sterling as of January 1, 2007, and is not expected to have a material effect on Sterling.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of SFAS No. 140” (“SFAS No. 156”). This pronouncement requires the recognition of a servicing asset or liability under specified circumstances, and if practicable, all separately recognized servicing assets and liabilities to be initially measured at fair value. Additionally, the pronouncement allows an entity to choose one of two methods when subsequently measuring its servicing assets and liabilities: the amortization method or the fair value method. The amortization method provided under SFAS No. 140, employs lower of cost or market (“locom”) valuation. The new fair value method allows mark ups, in addition to the mark downs under locom. SFAS No. 156 permits a one-time reclassification of available-for-sale securities to the trading classification. Sterling currently plans to continue to employ the amortization method. Therefore, SFAS No. 156 is not expected to have a material effect on Sterling.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,” an amendment of SFAS No. 133 and SFAS No. 140. This statement addresses the accounting for certain hybrid financial instruments (a financial instrument with an embedded derivative) and also clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133. SFAS No. 155 allows combined valuation and accounting. This statement will be effective for Sterling as of January 1, 2007. Sterling is considering implementing the combined valuation approach when applicable, and does not expect the standard to have a material impact on the consolidated financial results.

Effects of Inflation and Changing Prices

A financial institution has an asset and liability structure that is interest-rate sensitive. As a holder of monetary assets and liabilities, an institution’s performance may be significantly influenced by changes in interest rates. Although changes in the prices of goods and services do not necessarily move in the same direction as interest rates, increases in inflation generally have resulted in increased interest rates, which may have an adverse effect on Sterling’s business.


Item 7A.	*Quantitative and Qualitative Disclosures About Market Risk*

For a discussion of Sterling’s market risk, see “MD&A — Asset and Liability Management.”


Item 8.	*Financial Statements and Supplementary Data*

The required information is contained on pages F-1 through F-45 of this Form 10-K.


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

There were no disagreements with Sterling’s independent accountants on accounting and financial disclosures.


Item 9A.	*Controls and Procedures*

Sterling’s management, with the participation of Sterling’s principal executive officer and principal financial officer, has evaluated the effectiveness of Sterling’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, Sterling’s principal executive officer and principal financial officer have concluded that, as of the end of such period, Sterling’s disclosure controls and procedures are effective in recording, processing,

summarizing and reporting, on a timely basis, information required to be disclosed by Sterling in the reports that it files or submits under the Exchange Act.

There were no changes in internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Sterling’s management, including the principal executive officer and principal financial officer, is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of Sterling’s management, Sterling conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework described in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Based on management’s evaluation under the COSO Framework, Sterling’s management has concluded that Sterling’s internal control over financial reporting was effective as of December 31, 2006.

For purposes of evaluating internal controls over financial reporting, management determined that the internal controls over financial reporting of Lynnwood and FirstBank, which Sterling acquired in July and November of 2006, respectively, would be excluded from the internal control assessment as of December 31, 2006, as permitted by the rules and regulations of the Securities and Exchange Commission. Lynnwood’s and FirstBank’s total assets were 3% and 10% of total consolidated assets, respectively. Since being acquired, Lynnwood’s and FirstBank’s net interest income represented 2% and less than 1% of Sterling’s consolidated net interest income, respectively.

Management’s assessment of the effectiveness of its internal control over financial reporting as of December 31, 2006 has been attested to by BDO Seidman, LLP, the independent registered public accounting firm that audited the financial statements included in Sterling’s annual report on form 10-K, as stated in their report which is included herein.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Sterling Financial Corporation

Spokane, Washington

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Sterling Financial Corporation (“Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria).

Sterling Financial Corporation management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

As described in Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Lynnwood Financial Group, Inc (“Lynnwood”) and FirstBank NW Corp (“FirstBank”), which the Company acquired in July and November of 2006, respectively. Lynnwood’s and FirstBank’s total assets were 3% and 10%, respectively, of total consolidated assets as of December 31, 2006. For the year ended December 31, 2006, Lynnwood’s and FirstBank’s net interest income was 2% and less than 1%, respectively, of consolidated net interest income. Our audit of the effectiveness of the Company’s internal control over financial reporting also did not include an evaluation of the internal control over financial reporting of FirstBank and Lynnwood.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Sterling Financial Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also in our opinion, Sterling Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sterling Financial Corporation as of December 31, 2006 and

2005, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006, of Sterling Financial Corporation and our report dated February 28, 2007, expressed an unqualified opinion on those consolidated financial statements.

BDO Seidman, LLP

Spokane, Washington

February 28, 2007


Item 9B.	*Other Information*

None.

PART III


Item 10.	*Directors, Executive Officers and Corporate Governance*

In response to this Item, the information set forth in Sterling’s Proxy Statement for its 2007 annual meeting of shareholders, under the headings “Board of Directors of Sterling Financial Corporation,” “Executive Officers,” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

Information concerning Sterling’s Audit Committee financial expert is set forth under the caption “Information Concerning the Board of Directors and Its Committees — Committees of the Board of Directors” in Sterling’s Proxy Statement and is incorporated herein by reference.

Sterling has adopted a Code of Ethics that applies to all Sterling employees and directors, including Sterling’s senior financial officers. The Code of Ethics is publicly available on Sterling’s website at www.sterlingsavingsbank.com.


Item 11.	*Executive Compensation*

In response to this Item, the information set forth in the Proxy Statement under the headings “Executive Compensation,” “Personnel Committee Report,” and “Personnel Committee Interlocks and Insider Participation” is incorporated herein by reference.


Item 12.	*Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters*

In response to this Item, the information set forth in the Proxy Statement under the headings “Security Ownership of Management and Certain Beneficial Owners” and “Equity Compensation Plan Information” is incorporated herein by reference.


Item 13.	*Certain Relationships and Related Transactions, and Director Independence*

In response to this Item, the information set forth in the Proxy Statement under the headings “Interest of Directors, Officers and Others in Certain Transactions” and “Corporate Governance — Affirmative Determinations Regarding Director Independence” is incorporated herein by reference.


Item 14.	*Principal Accounting Fees and Services*

In response to this Item, the information set forth in the Proxy Statement under the headings “Ratification of Appointment of Independent Registered Public Accounting Firm,” “Audit Committee Report,” “Independent Public Accounting Firm’s Fees,” and “Pre-Approval of Audit and Non-Audit Services” is incorporated herein by reference.

PART IV


Item 15.	*Exhibits, Financial Statement Schedules*

(a) Documents which are filed as a part of this report:

1. Financial Statements: The required financial statements are contained in pages F-1 through F-45 of this Form 10-K.

2. Financial Statement Schedules: Financial statement schedules have been omitted as they are not applicable or the information is included in the Consolidated Financial Statements.

3. Exhibits: The exhibits filed as part of this report and the exhibits incorporated herein by reference are listed in the Exhibit Index at page E-1.

(b) See (a)(3) above for all exhibits filed herewith.

(c) All schedules are omitted as the required information is not applicable or the information is presented in the Consolidated Financial Statements or related notes.

SIGNATURES

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

STERLING FINANCIAL CORPORATION


	By	/s/ Harold B. Gilkey

Harold B. Gilkey

Chairman of the Board, Chief Executive Officer

February 28, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


	By	/s/ Harold B. Gilkey

Harold B. Gilkey

Chairman of the Board, Chief Executive Officer,

Principal Executive Officer

February 28, 2007


	By	/s/ William W. Zuppe

William W. Zuppe

President, Chief Operating Officer, Director

February 28, 2007


	By	/s/ Daniel G. Byrne

Daniel G. Byrne

Executive Vice President, Assistant Secretary and

Principal Financial Officer

February 28, 2007


	By	/s/ Robert G. Butterfield

Robert G. Butterfield

Vice President, Controller and Principal Accounting Officer

February 28, 2007


	By	/s/ Rodney W. Barnett

Rodney W. Barnett, Director

February 28, 2007


	By	/s/ Donald N. Bauhofer

Donald N. Bauhofer, Director

February 28, 2007


	By	/s/ William L. Eisenhart

William L. Eisenhart, Director

February 28, 2007


	By	/s/ James P. Fugate

James P. Fugate, Director


	By

Robert D. Larrabee, Director

February 28, 2007


	By	/s/ Donald J. Lukes

Donald J. Lukes, Director

February 28, 2007


	By	/s/ Michael F. Reuling

Michael F. Reuling, Director


Exhibit No.			Exhibit Index

	2	.1	Agreement and Plan of Merger by and between Sterling and Northern Empire Bancshares dated as of September 17, 2006. Filed as Exhibit 2.1 to Sterling’s current report on Form 8-K filed September 18, 2006 and incorporated by reference herein.
	2	.2	Agreement and Plan of Merger by and between Sterling and FirstBank NW Corp. dated as of June 4, 2006. Filed as Appendix A to Sterling’s Registration Statement on Form S-4 dated August 31, 2006 and incorporated by reference herein.
	3	.1	Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.1 to Sterling’s report on Form 10-Q filed May 15, 2003, and incorporated by reference herein.
	3	.2	Articles of Amendment of Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.1 to Sterling’s current report on Form 8-K filed September 2, 2005 and incorporated by reference herein.
	3	.3	Amended and Restated Bylaws of Sterling. Filed as Exhibit 3.3 to Sterling’s Registration Statement on Form S-4 dated December 9, 2002, and incorporated by reference herein.
	4	.1	Reference is made to Exhibits 3.1, 3.2 and 3.3.
	4	.2	Sterling has outstanding certain long-term debt. None of such debt exceeds ten percent of Sterling’s total assets; therefore, copies of the constituent instruments defining the rights of the holders of such debt are not included as exhibits. Copies of instruments with respect to such long-term debt will be furnished to the Securities and Exchange Commission upon request.
	10	.1	Credit Agreement by and between Sterling and Wells Fargo Bank, National Association, entered into on August 21, 2006 and dated as of August 4, 2006, and First Amendment thereto dated as of August 29, 2006. Filed as Exhibit 10.1 to Sterling’s Quarterly Report on Form 10-Q dated November 9, 2006 and incorporated by reference herein.
	10	.2	Sterling Financial Corporation 2003 Long-Term Incentive Plan. Filed as Exhibit A to Sterling’s Proxy Statement in connection with the Annual Meeting of Shareholders held on April 22, 2003, and incorporated by reference herein.
	10	.3	Sterling Financial Corporation 2001 Long-Term Incentive Plan. Filed as Exhibit A to Sterling’s Proxy Statement in connection with the Annual Meeting of Shareholders held on April 24, 2001, and incorporated by reference herein.
	10	.4	Sterling Financial Corporation Amended and Restated Deferred Compensation Plan, effective July 1, 1999. Filed as Exhibit 10.5 to Sterling’s Annual Report on Form 10-K dated February 22, 2000, and incorporated by reference herein.
	10	.5	Sterling Financial Corporation 1998 Long-Term Incentive Plan. Filed as Exhibit A to Sterling’s Proxy Statement in connection with the Annual Meeting of Shareholders held on April 28, 1998, and incorporated by reference herein.
	10	.6	Sterling Savings Bank Deferred Compensation Plan, effective date April 1, 2006. Filed herewith.
	10	.7	Sterling Financial Corporation and Sterling Savings Bank Supplemental Executive Retirement Plan. Filed as Exhibit 10.9 to Sterling’s Annual Report on Form 10-K dated March 21, 2004, and incorporated by reference herein.
	12	.1	Statement regarding Computation of Return on Average Shareholders’ Equity. Filed herewith.
	12	.2	Statement regarding Computation of Return on Average Assets. Filed herewith.
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