10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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	(I.R.S. Employer
incorporation or organization)	Identification No.)

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

(509) 458-3711
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 whether the registrant is a large accelerated filer, an accelerated filer, or a 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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

Class	Outstanding as of November 1, 2006
Common Stock ($1.00 par value)	37,086,449

STERLING FINANCIAL CORPORATION

FORM 10-Q
For the Quarter Ended September 30, 2006

TABLE OF CONTENTS

	Page
PART I — Financial Information		1
Item 1 Financial Statements (Unaudited)		1
Consolidated Balance Sheets		1
Consolidated Statements of Income		2
Consolidated Statements of Cash Flows		3
Consolidated Statements of Comprehensive Income		5
Notes to Consolidated Financial Statements		6
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3 Quantitative and Qualitative Disclosures About Market Risk		35
Item 4 Controls and Procedures		35
PART II — Other Information		36
Item 1 Legal Proceedings		36
Item 1a Risk Factors		36
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		36
Item 3 Defaults Upon Senior Securities		36
Item 4 Submission of Matters to a Vote of Security Holders		36
Item 5 Other Information		36
Item 6 Exhibits		36
Signatures		37
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I — Financial Information

Item 1 — Financial Statements

STERLING FINANCIAL CORPORATION

Consolidated Balance Sheets

(Unaudited)

	September 30,			December 31,
	2006			2005
	(Dollars in thousands)
ASSETS:
Cash and cash equivalents:
Interest bearing	$	8,779		$	9,400
Non-interest bearing and vault		134,833			121,907
Restricted cash		1,363			862
Investment securities and mortgage-backed securities (“MBS”):
Available for sale		1,864,923			2,076,615
Held to maturity		83,681			51,924
Loans receivable, net		6,240,512			4,885,916
Loans held for sale		119,406			7,894
Accrued interest receivable		47,843			35,805
Real estate owned and other collateralized assets, net		4,369			779
Office properties and equipment, net		79,150			82,432
Bank-owned life insurance (“BOLI”)		112,383			107,649
Goodwill		144,861			112,707
Other intangible assets		16,634			17,625
Mortgage servicing rights, net		6,813			5,430
Prepaid expenses and other assets, net		47,167			41,983
Total assets	$	8,912,717		$	7,558,928
LIABILITIES:
Deposits	$	5,953,767		$	4,806,301
Advances from Federal Home Loan Bank Seattle (“FHLB Seattle”)		1,373,513			1,443,462
Securities sold subject to repurchase agreements and funds purchased		623,612			611,676
Other borrowings		237,222			110,688
Cashiers checks issued and payable		7,336			5,483
Borrowers’ reserves for taxes and insurance		3,571			1,527
Accrued interest payable		35,116			18,169
Accrued expenses and other liabilities		69,859			54,937
Total liabilities		8,303,996			7,052,243
Commitments and Contingencies
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value; 10,000,000 shares authorized; no shares issued and outstanding		0			0
Common stock, $1 par value; 60,000,000 shares authorized; 37,024,265 and 34,855,549 shares issued and outstanding		37,024			34,856
Additional paid-in capital		441,547			385,353
Accumulated other comprehensive loss:
Unrealized losses on investment securities and MBS available-for-sale, net of deferred income taxes of $20,641 and $20,021		(35,249	)		(34,219	)
Retained earnings		165,399			120,695
Total shareholders’ equity		608,721			506,685
Total liabilities and shareholders’ equity	$	8,912,717		$	7,558,928

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

1

STERLING FINANCIAL CORPORATION

Consolidated Statements of Income

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
				(Dollars in thousands, except per share data)
Interest income:
Loans	$	125,554		$	73,375		$	321,021		$	214,037
MBS		21,626			20,757			67,444			65,697
Investments and cash equivalents		1,028			642			2,642			2,162
Total interest income		148,208			94,774			391,107			281,896
Interest expense:
Deposits		51,653			23,827			127,372			63,255
Short-term borrowings		10,055			10,491			25,301			26,856
Long-term borrowings		16,467			7,368			48,396			32,065
Total interest expense		78,175			41,686			201,069			122,176
Net interest income		70,033			53,088			190,038			159,720
Provision for losses on loans		(4,698	)		(3,400	)		(13,998	)		(10,550	)
Net interest income after provision for losses on loans		65,335			49,688			176,040			149,170
Non-interest income:
Fees and service charges		11,526			9,260			31,220			24,868
Mortgage banking operations		5,572			2,969			10,568			14,447
Loan servicing fees		473			90			1,224			330
Real estate owned and other collateralized assets operations		(138	)		(23	)		247			188
BOLI		1,225			1,164			3,611			3,331
Other non-interest expense		(207	)		(154	)		(372	)		186
Total non-interest income		18,451			13,306			46,498			43,350
Non-interest expenses		55,302			42,599			146,531			123,848
Income before income taxes		28,484			20,395			76,007			68,672
Income tax provision		(9,145	)		(6,505	)		(24,321	)		(22,883	)
Net income	$	19,339		$	13,890		$	51,686		$	45,789
Earnings per share — basic	$	0.52		$	0.40		$	1.45		$	1.32
Earnings per share — diluted	$	0.52		$	0.40		$	1.44		$	1.31
Weighted average shares outstanding — basic		36,891,986			34,660,107			35,645,887			34,581,606
Weighted average shares outstanding — diluted		37,273,560			35,097,474			35,992,764			35,033,011

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

2

STERLING FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended
	September 30,
	2006			2005
	(Dollars in thousands)
Cash flows from operating activities:
Net income	$	51,686		$	45,789
Adjustments to reconcile net income to net cash provided by operating activities:
Provisions for losses on loans and real estate owned		14,168			10,550
Stock dividends on FHLB Seattle stock		0			(303	)
Accretion of deferred gain on sale of branches		(151	)		0
Net gain on sales of loans, investment securities and MBS		(4,832	)		(9,280	)
Stock based compensation		182			0
Excess tax benefit from stock based compensation		(1,638	)		0
Stock issuances relating to 401(k) match		1,203			0
Other gains and losses		888			(16,818	)
Change in cash surrender value of BOLI		(3,611	)		(3,332	)
Depreciation and amortization		14,084			14,805
Change in:
Accrued interest receivable		(8,770	)		(2,446	)
Prepaid expenses and other assets		1,217			13,071
Cashiers checks issued and payable		721			602
Accrued interest payable		16,307			1,117
Accrued expenses and other liabilities		(2,910	)		(263	)
Proceeds from sales of loans originated for sale		304,302			129,711
Loans originated for sale		(299,639	)		(126,830	)
Net cash provided by operating activities		83,207			56,373
Cash flows from investing activities:
Change in restricted cash		(501	)		(5,705	)
Loans funded and purchased		(3,169,552	)		(2,418,560	)
Loan principal received		2,120,741			1,889,705
Proceeds from sales of other loans		51,144			472,682
Purchase of investment securities		(44,416	)		(13,645	)
Proceeds from maturities of investment securities		11,400			1,405
Proceeds from sales of investment securities		0			14,844
Purchase of BOLI		0			(10,000	)
Purchase of mortgage-backed securities		0			(203,276	)
Principal payments on mortgage-backed securities		208,160			292,211
Proceeds from sales of mortgage-backed securities		0			115,837
Purchase of office properties and equipment		(11,742	)		(9,066	)
Sales of office properties and equipment		18,882			249
Improvements and other changes to real estate owned		(248	)		(273	)
Proceeds from sales and liquidation of real estate owned		1,353			2,158
Cash and cash equivalents issued as part of mergers		(5,983	)		0
Net cash provided by (used in) investing activities		(820,762	)		128,566

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

3

STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)

	Nine Months Ended
	September 30,
	2006			2005
	(Dollars in thousands)
Cash flows from financing activities:
Net change in checking, regular savings and money market deposits	$	224,549		$	246,858
Proceeds from issuance of time deposits		2,803,087			1,674,652
Payments for maturing time deposits		(2,437,358	)		(1,453,474	)
Interest credited to deposits		110,760			59,425
Advances from FHLB Seattle		1,985,866			530,229
Repayment of advances from FHLB Seattle		(2,055,766	)		(881,710	)
Net change in securities sold subject to repurchase agreements and funds purchased		11,936			(318,418	)
Proceeds from other borrowings		130,000			0
Repayment of other borrowings		(25,000	)		(19,000	)
Payments for fractional shares and certain merger costs		0			(14	)
Proceeds from stock issuance and exercise of stock options, net of repurchases		4,774			2,781
Excess tax benefit from stock based compensation		1,638			0
Deferred financing costs		0			(75	)
Cash dividend paid to shareholders		(6,670	)		0
Other		2,044			446
Net cash provided by (used in) financing activities		749,860			(158,300	)
Net change in cash and cash equivalents		12,305			26,639
Cash and cash equivalents, beginning of period		131,307			93,187
Cash and cash equivalents, end of period	$	143,612		$	119,826
Supplemental disclosures:
Cash paid during the period for:
Interest	$	184,122		$	121,059
Income taxes		28,732			9,560
Noncash financing and investing activities:
Loans converted into real estate owned and other collateralized assets		4,406			2,266
Common stock cash dividends accrued		2,594			1,738
Deferred gain on sale of branches		9,029			0
Common stock issued upon business combination		50,565			0

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

4

STERLING FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
				(Dollars in thousands)
Net income	$	19,339		$	13,890		$	51,686		$	45,789
Other comprehensive income:
Change in unrealized gains (losses) on investment securities and MBS available-for-sale		39,170			(25,624	)		(1,650	)		(27,260	)
Less deferred income taxes		(14,490	)		9,483			620			10,095
Net other comprehensive income (loss)		24,680			(16,141	)		(1,030	)		(17,165	)
Comprehensive income (loss)	$	44,019		$	(2,251	)	$	50,656		$	28,624

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

5

STERLING FINANCIAL CORPORATION

Notes to Consolidated Statements

1. Basis of Presentation:

The foregoing unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2005. In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of Sterling Financial Corporation’s (“Sterling’s”) consolidated financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of Sterling’s consolidated financial position and results of operations.

2. Other Borrowings:

The components of other borrowings are as follows (in thousands):

	September 30,		December 31,
	2006		2005
Trust Preferred Securities	$	236,768	$	108,707
Other		454		1,981
Total	$	237,222	$	110,688

Sterling raises capital from time to time through the formation of trusts (“Capital Trusts”), which issue capital securities (“Trust Preferred Securities”) to investors. Sterling has also acquired Capital Trusts in connection with business acquisitions. These Capital Trusts are business trusts in which Sterling owns all of the common equity. The proceeds from the sale of the Trust Preferred Securities are used to purchase junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”) issued by Sterling. Sterling’s obligations under the Junior Subordinated Debentures and related documents, taken together, constitute a full and unconditional guarantee by Sterling of the Capital Trusts’ obligations under the Trust Preferred Securities. The Trust Preferred Securities are treated as debt of Sterling. The Junior Subordinated Debentures and related Trust Preferred Securities generally mature 30 years after issuance and are redeemable at the option of Sterling under certain conditions, including, with respect to certain of the Trust Preferred Securities, payment of call premiums. Interest is paid quarterly or semi-annually. Details of the Trust Preferred Securities are as follows:

6

2. Other Borrowings, continued:

					Rate at			Carrying
		Maturity	Initial		September 30,			Value (in
Subsidiary Issuer	Issue Date	Date	Call Date	Rate Index	2006			thousands)
Sterling Capital	Sept 2006	Sept 2036	Sept 2011	3 month LIBOR		7.02	%	$	51,547
Trust VIII				plus 1.63%
Sterling Capital	June 2006	June 2036	June 2011	3 month LIBOR		6.92			56,702
Trust VII				plus 1.53%
Lynnwood Financial	June 2005	June 2033	June 2008	3 month LIBOR		7.19			10,310
Statutory Trust II				plus 1.80%
Sterling Capital	June 2003	Sept 2033	Sept 2008	3 month LIBOR		8.59			10,310
Trust VI				plus 3.20%
Sterling Capital	May 2003	May 2033	June 2008	3 month LIBOR		8.62			20,619
Statutory Trust V				plus 3.25%
Sterling Capital	May 2003	May 2033	May 2008	3 month LIBOR		8.56			10,310
Trust IV				plus 3.15%
Sterling Capital	April 2003	April 2033	April 2008	3 month LIBOR		8.74			14,433
Trust III				plus 3.25%
Lynnwood Financial	Mar 2003	Mar 2033	Mar 2007	3 month LIBOR		8.52			9,486
Statutory Trust I				plus 3.15%
Klamath First Capital	April 2002	April 2032	April 2007	6 month LIBOR		8.99			13,151
Trust II				plus 3.70%
Klamath First Capital	July 2001	July 2031	June 2006	6 month LIBOR		9.30			15,157
Trust I				plus 3.75%
Sterling Capital	July 2001	July 2031	June 2006	Fixed		10.25			24,743
						8.04	%*	$	236,768

* weighted average rate

During 2002, Sterling financed the sale of certain loans to an unrelated party. Since the underlying loans served as collateral on the loan to the purchaser, this sale was accounted for as a financing, and is included in other borrowings under the caption “Other.”

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 September 30, 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

7

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.

3. Earnings Per Share:

The following table presents the basic and diluted earnings per share computations.

	Three Months Ended September 30,
	2006						2005
	Net		Weighted		Per Share		Net		Weighted		Per Share
	Income		Avg. Shares		Amount		Income		Avg. Shares		Amount
	(Dollars in thousands, except per share amounts)
Basic computations	$	19,339		36,891,986	$	0.52	$	13,890		34,660,107	$	0.40
Effect of dilutive securities:
Common stock options		0		369,570		0.00		0		401,355		0.00
Contingently issuable shares		0		12,004		0.00		0		36,012		0.00
Diluted computations	$	19,339		37,273,560	$	0.52	$	13,890		35,097,474	$	0.40
Antidilutive options not included in diluted earnings per share				0						456,000

	Nine Months Ended September 30,
	2006							2005
	Net		Weighted		Per Share			Net		Weighted		Per Share
	Income		Avg. Shares		Amount			Income		Avg. Shares		Amount
	(Dollars in thousands, except per share amounts)
Basic computations	$	51,686		35,645,887	$	1.45		$	45,789		34,581,606	$	1.32
Effect of dilutive securities:
Common stock options		0		334,873		(0.01	)		0		415,393		(0.01	)
Contingently issuable shares		0		12,004		0.00			0		36,012		0.00
Diluted computations	$	51,686		35,992,764	$	1.44		$	45,789		35,033,011	$	1.31
Antidilutive options not included in diluted earnings per share				0							456,000

8

4. Non-Interest Expenses:

The following table details the components of Sterling’s total non-interest expenses:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
	(Dollars in thousands)				(Dollars in thousands)
Employee compensation and benefits	$	31,479	$	23,274	$	82,278	$	67,625
Occupancy and equipment		8,755		6,578		23,046		19,241
Depreciation		2,662		2,227		7,377		6,348
Amortization of core deposit intangibles		586		556		1,697		1,667
Advertising		2,900		2,251		7,155		6,668
Data processing		3,746		3,179		10,601		9,391
Insurance		364		304		963		934
Legal and accounting		622		486		1,861		2,274
Travel and entertainment		1,454		1,081		4,040		3,263
Goodwill litigation costs		25		0		245		189
Merger and acquisition costs		191		0		191		0
Other		2,518		2,663		7,077		6,248
Total	$	55,302	$	42,599	$	146,531	$	123,848

5. Segment Information:

For purposes of measuring and reporting financial results, Sterling is divided into five business segments:

• The Community Banking segment consists of the operations conducted by Sterling’s subsidiaries, Sterling Savings Bank and Golf Savings Bank.

• The Residential Mortgage Banking segment originates and sells servicing-retained and servicing-released residential loans through loan production offices of Golf Savings Bank and Sterling Savings Bank’s subsidiary Action Mortgage Company (“Action Mortgage”).

• The Commercial Mortgage Banking segment originates, sells and services commercial real estate loans and participation interests in commercial real estate loans through offices in the western region primarily through Sterling Savings Bank’s subsidiary INTERVEST-Mortgage Investment Company (“INTERVEST”).

• The Retail Brokerage segment markets fixed income and equity products, mutual funds, fixed and variable annuities, insurance and other financial products within the Sterling Savings Bank financial service center network through sales representatives of Sterling Savings Bank’s subsidiary Harbor Financial Services, Inc.

• The Other and Eliminations segment represents the parent company expenses and intercompany eliminations of revenue and expenses.

9

5. Segment Information, continued:

The following table presents certain financial information regarding Sterling’s segments and provides a reconciliation to Sterling’s consolidated totals for the periods presented:

	As of and for the Three Months Ended September 30, 2006
				Residential			Commercial
	Community			Mortgage			Mortgage			Retail			Other and
	Banking			Banking			Banking			Brokerage			Eliminations			Total
	(Dollars in thousands)
Interest income	$	142,654		$	4,832		$	2,407		$	0		$	(1,685	)	$	148,208
Interest expense		(76,132	)		0			0			0			(2,043	)		(78,175	)
Net interest income (expense)		66,522			4,832			2,407			0			(3,728	)		70,033
Provision for loan losses		(4,698	)		0			0			0			0			(4,698	)
Noninterest income		14,758			5,813			1,129			759			(4,008	)		18,451
Noninterest expense		(45,638	)		(5,924	)		(2,272	)		(726	)		(742	)		(55,302	)
Income before income taxes	$	30,944		$	4,721		$	1,264		$	33		$	(8,478	)	$	28,484
Total assets	$	9,003,443		$	15,127		$	10,660		$	897		$	(117,410	)	$	8,912,717

	As of and for the Three Months Ended September 30, 2005
				Residential			Commercial
	Community			Mortgage			Mortgage			Retail			Other and
	Banking			Banking			Banking			Brokerage			Eliminations			Total
	(Dollars in thousands)
Interest income	$	89,576		$	3,189		$	1,150		$	0		$	859		$	94,774
Interest expense		(39,718	)		0			0			0			(1,968	)		(41,686	)
Net interest income (expense)		49,858			3,189			1,150			0			(1,109	)		53,088
Provision for loan losses		(3,400	)		0			0			0			0			(3,400	)
Noninterest income		11,092			2,865			1,720			964			(3,335	)		13,306
Noninterest expense		(34,344	)		(4,927	)		(1,998	)		(1,041	)		(289	)		(42,599	)
Income before income taxes	$	23,206		$	1,127		$	872		$	(77	)	$	(4,733	)	$	20,395
Total assets	$	6,862,568		$	21,166		$	20,200		$	748		$	(108,634	)	$	6,796,048

10

5. Segment Information, continued:

	As of and for the Nine Months Ended September 30, 2006
				Residential			Commercial
	Community			Mortgage			Mortgage			Retail			Other and
	Banking			Banking			Banking			Brokerage			Eliminations			Total
	(Dollars in thousands)
Interest income	$	373,600		$	12,074		$	6,670		$	0		$	(1,237	)	$	391,107
Interest expense		(194,288	)		0			0			0			(6,781	)		(201,069	)
Net interest income (expense)		179,312			12,074			6,670			0			(8,018	)		190,038
Provision for loan losses		(13,998	)		0			0			0			0			(13,998	)
Noninterest income		39,690			10,365			3,612			2,602			(9,771	)		46,498
Noninterest expense		(122,485	)		(13,699	)		(6,195	)		(2,197	)		(1,955	)		(146,531	)
Income before income taxes	$	82,519		$	8,740		$	4,087		$	405		$	(19,744	)	$	76,007
Total assets	$	9,003,443		$	15,127		$	10,660		$	897		$	(117,410	)	$	8,912,717

	As of and for the Nine Months Ended September 30, 2005
				Residential			Commercial
	Community			Mortgage			Mortgage			Retail			Other and
	Banking			Banking			Banking			Brokerage			Eliminations			Total
	(Dollars in thousands)
Interest income	$	267,494		$	8,297		$	5,247		$	0		$	858		$	281,896
Interest expense		(116,345	)		0			0			0			(5,831	)		(122,176	)
Net interest income (expense)		151,149			8,297			5,247			0			(4,973	)		159,720
Provision for loan losses		(10,550	)		0			0			0			0			(10,550	)
Noninterest income		39,015			7,446			4,409			2,635			(10,155	)		43,350
Noninterest expense		(102,451	)		(13,311	)		(5,124	)		(2,665	)		(297	)		(123,848	)
Income before income taxes	$	77,163		$	2,432		$	4,532		$	(30	)	$	(15,425	)	$	68,672
Total assets	$	6,862,568		$	21,166		$	20,200		$	748		$	(108,634	)	$	6,796,048

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6. Stock Options:

On January 1, 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 123 (R), “Share Based Payment” (“SFAS No. 123 (R)”), became effective for Sterling. As such, stock options issued as compensation are recorded as an expense at their estimated fair value. Prior to SFAS No. 123 (R)’s effective date, Sterling had elected to retain the compensation measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Under APB No. 25, compensation cost was recognized at the measurement date of the amount, if any, that the quoted market price of Sterling’s common stock exceeded the option exercise price. Sterling has only granted its common stock options to employees with exercise prices equal to the market price of Sterling’s common stock on the measurement dates. Thus, prior to the implementation of SFAS No. 123 (R), no compensation cost had been recognized.

During the nine months ended September 30, 2006, stock option activity and related information was as follows:

			Weighted		Weighted Average		Aggregate
			Average		Remaining Contractual		Intrinsic Value
	Number		Exercise Price		Life (in years)		(in thousands)
Outstanding, December 31, 2005		1,703,959	$	19.46
Granted		20,000		25.28
Issued in merger		77,258		8.19
Exercised		322,025		14.71
Outstanding, September 30, 2006		1,479,192	$	19.98		5.36	$	18,421
Exercisable, September 30, 2006		1,476,162	$	20.00		5.37	$	18,349

As of September 30, 2006, a total of 436,249 stock options remained available for grant under Sterling’s 2001 and 2003 Long-Term Incentive Plans. These options have terms of four, six or ten years.

During the nine months ended September 30, 2006 and 2005, the fair value of options granted were $8.55 and $0, respectively, and the intrinsic value of options exercised were $4.9 million and $5.3 million, respectively. Stock compensation expense recognized during the nine months ended September 30, 2006 was $182,000. Had SFAS No. 123 (R) been effective during the nine months ended September 30, 2005, $146,000 of stock based compensation expense would have been recognized. The Black-Scholes option-pricing model was used in estimating the fair value of option grants. The weighted average assumptions used are presented in the table below.

	Nine Months Ended
	September 30, 2006
	2006			2005(1)
Expected volatility		31	%		N/A
Expected term (in years)		5.5			N/A
Expected dividend yield		0.87	%		N/A
Risk free interest rate		4.36	%		N/A

⁽¹⁾ There were no options granted during the nine months ended September 30, 2005.

7. 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. EITF 06-5 is effective January 1, 2007. Sterling is currently assessing the potential impact of these standards.

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In September 2006, FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires an employer to recognize the funded status of defined benefit pension and other postretirement benefit plans as an asset or liability. The standard is effective for Sterling as of December 31, 2006. Sterling is currently assessing the impact of this standard and does not expect SFAS No. 158 to have a material effect on Sterling.

In September 2006, the FASB issued 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.

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8. Derivatives and Hedging:

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 Fannie Mae, 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 Interest Rate Risk (“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 September 30, 2006, Sterling did not have any loans locked with investors under mandatory delivery programs, nor hold any offsetting forward sale agreements on MBS. At September 30, 2006, Sterling had entered into best efforts forward commitments to sell $90.3 million of mortgage loans.

Rate lock commitments to borrowers and best-effort loan delivery commitments with 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. At September 30, 2006, Sterling recorded an asset of approximately $775,000 for the estimated fair value of rate locks issued and a liability of approximately $775,000 for the estimated fair value of delivery commitments received. At 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, at 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 comparable dealer swaps. These contracts are carried at fair value.

9. Cash Dividends:

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

10. Business Combinations:

On June 4, 2006, Sterling entered into a definitive agreement to acquire FirstBank NW Corp., a Washington corporation (“FirstBank”). Under the terms of the agreement, FirstBank would be merged with and into Sterling, with Sterling being the surviving corporation in the merger. The agreement also provides for the merger of FirstBank’s financial institution subsidiary, FirstBank Northwest, 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 FirstBank common stock would be converted into the right to receive 0.789 shares of Sterling common stock and $2.55 in cash. Based upon the closing price for Sterling’s common stock on June 2, 2006, of $31.19 per share, the consideration is equivalent to $27.16 per share of FirstBank common stock. The transaction, which is valued at approximately $169.6 million, is expected to close in the fourth quarter of 2006, pending receipt of regulatory and FirstBank shareholder approvals and satisfaction of other customary closing conditions.

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On July 5, 2006, Sterling completed its acquisition of Lynnwood Financial Group, Inc. (“Lynnwood”), the parent company of Golf Savings Bank, by issuing $15,750,000 in cash, and 1,799,961 shares of Sterling common stock in exchange for all outstanding Lynnwood shares at a ratio of 1.73%. Lynnwood options totaling 34,662 were converted into 77,258 Sterling options, valued at $1.7 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. Golf Savings Bank is a Washington state-chartered federally insured savings bank. Golf Savings Bank’s primary focus is the origination of single-family residential mortgage loans. The transaction was valued at approximately $66.3 million. Golf Savings Bank’s strong mortgage banking operations and construction lending portfolio contributed to Sterling’s growth strategy of becoming the leading community bank in the western United States.

As a result of the merger, Sterling acquired approximately $539 million of assets, including approximately $488 million in loans, approximately $488 million of liabilities, including approximately $446 million in deposits, and approximately $51 million in capital. The following summarizes the unaudited proforma results of operations as if the Lynnwood acquisition had occurred on January 1, 2005. Proforma results for the three months ended September 30, 2006 equal reported results, as the entities were combined for the entire period.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
	(Dollars in thousands, except per share data)
Proforma interest income	$	148,208	$	104,414	$	415,518	$	306,152
Proforma interest expense		78,175		45,470		211,069		130,798
Proforma net interest income		70,033		58,944		204,449		175,354
Proforma net income		19,339		16,286		53,356		52,052
Proforma earnings per share — basic		0.52		0.45		1.45		1.43
Proforma earnings per share — diluted		0.52		0.44		1.43		1.41

On July 31, 2006, a wholly owned subsidiary of INTERVEST acquired the mortgage banking operations, including the geographically diverse 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 approximately $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 loan brokerage originations and loan servicing. During the fiscal year ended September 30, 2005, Mason-McDuffie’s loan brokerage originations were approximately $180 million.

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 is valued at approximately $335 million, is expected to close in the second quarter of 2007, pending Sterling and Northern Empire shareholder and regulatory approval, and satisfaction of other customary closing conditions.

11. Subsequent Event:

In October 2006, Sterling announced a quarterly cash dividend of $0.075 per share, payable on January 12, 2007 to shareholders of record as of December 29, 2006.

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PART I — Financial Information (continued)

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operation

STERLING FINANCIAL CORPORATION

Comparison of the Three and Nine Months Ended September 30, 2006

This report contains forward-looking statements. For a discussion about such statements, including the risks and uncertainties inherent therein, see “Forward-Looking Statements.” Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in Sterling’s 2005 annual report on Form 10-K.

General

Sterling Financial Corporation (“Sterling”) is a bank holding company, the significant 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 of single-family 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 $8.91 billion in total assets at September 30, 2006, Sterling originates loans and attracts Federal Deposit Insurance Corporation (“FDIC”) insured deposits from the general public through 145 financial service centers located throughout the west. In addition, Sterling originates loans through Golf Savings Bank and Action Mortgage residential loan production offices and through INTERVEST commercial real estate lending offices in the west. 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 west 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”) 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”).

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Executive Summary and Highlights

During the three months ended September 30, 2006, Sterling’s net income totaled $19.3 million, or $0.52 per diluted share, compared to $13.9 million, or $0.40 per diluted share for the respective 2005 period. NII and fees and service charges income for the three months ended September 30, 2006 grew by 32% and 24%, respectively, over the comparative 2005 amounts. Mortgage banking operations income also increased by $2.6 million over the 2005 comparative quarter. This growth in net interest income, fees and service charges income and mortgage banking operations income was derived from the July 5, 2006 acquisition of Golf Savings Bank, in addition to continued internal growth. The average yield in the loan portfolio increased due to the loans acquired from Golf Savings Bank, upward repricing in the portfolio, and new production. Fees and service charges income increased due to the success of Sterling’s Balance Shield program, an increase in debit card transactions, treasury management services, and merchant services. Mortgage banking operations income for the three months ended September 30, 2006 increased over the same period in 2005 primarily due to Golf Savings Bank’s production during the quarter. Mortgage banking operations income for the nine months ended September 30, 2006 was lower than the nine months ended September 30, 2005 due to the lower level of loan sales compared to the volume of loan sales in the first and second quarters of 2005, which reflected a higher level of portfolio repositioning. The addition of 330 full time equivalent employees since September 30, 2005 included approximately 250 Golf Savings Bank employees, driving the increase in employee compensation and benefits.

At September 30, 2006, total assets reached a record $8.91 billion, mainly reflecting the continued growth of Sterling’s loan portfolio. Loan originations for the nine months ended September 30, 2006 and 2005 were $3.52 billion and $2.69 billion, respectively, reflecting growth of 31%. The majority of the growth occurred in construction, business and corporate banking lines.

Highlights for the third quarter of 2006 were as follows:

• Total assets increased 18 percent from December 31, 2005 to a record $8.91 billion. Sterling’s organic growth represented 11 percent of total asset growth.

• Loan originations of $1.40 billion reflect an increase of 47 percent over the third quarter of 2005. Sterling’s organic growth represented 14 percent of total loan origination growth.

• Total loans receivable increased to a record $6.24 billion, a 28 percent increase since year end. Sterling’s organic growth represented 19 percent of total loan growth.

• Total deposits increased to a record $5.95 billion, or 24 percent, since year end. Sterling’s organic growth represented 15 percent of total deposits growth.

• Fees and Service Charges income increased to $11.5 million, a 24 percent increase over the third quarter of 2005. Sterling’s organic growth represented 17 percent of total fees and service charges growth.

• Asset quality remained stable, in line with peer averages.

• The Sterling Board of Directors approved a cash dividend of $0.07 per common share, paid on October 13, 2006 to shareholders of record as of September 29, 2006.

• Sterling and Northern Empire Bancshares (“Northern Empire”) announced on September 18, 2006 that they have entered into a definitive agreement for the merger of Northern Empire with and into Sterling, pending shareholder and regulatory approvals as well as other customary closing conditions.

• Sterling Capital Statutory Trust VIII, a subsidiary of Sterling, completed the issuance of $50.0 million of floating rate trust preferred securities on September 20, 2006, bearing an initial rate of 7.02%.

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Company Growth

Sterling intends to continue to pursue an aggressive growth strategy to become the leading community bank in the west. This strategy may include acquiring other financial businesses or branches thereof, or other substantial assets or deposit liabilities. 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.

On June 4, 2006, Sterling entered into a definitive agreement to acquire FirstBank NW Corp., a Washington corporation (“FirstBank”). Under the terms of the agreement, FirstBank would be merged with and into Sterling, with Sterling being the surviving corporation in the merger. The agreement also provides for the merger of FirstBank’s financial institution subsidiary, FirstBank Northwest, with and into Sterling’s financial institution subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution. The transaction, which is valued at approximately $169.6 million, is expected to close in the fourth quarter of 2006, pending receipt of regulatory and FirstBank shareholder approvals and satisfaction of other customary closing conditions.

On July 5, 2006, Sterling completed its acquisition of Lynnwood Financial Group, Inc. (“Lynnwood”), the parent company of Golf Savings Bank, by issuing $15,750,000 in cash and 1,799,961 shares of Sterling common stock in exchange for all outstanding Lynnwood shares. 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. Golf Savings Bank is a Washington state-chartered federally insured savings bank. Golf Savings Bank’s primary focus is the origination of single-family residential mortgage loans. Golf Savings Bank’s primary market area is the greater Puget Sound area of Washington State. The transaction was valued at approximately $66.3 million.

On July 31, 2006, a wholly owned subsidiary of INTERVEST acquired the mortgage banking operations, including the geographically diverse 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 approximately $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 loan brokerage originations and loan servicing. During the fiscal year ended September 30, 2005 Mason-McDuffie’s loan brokerage originations were approximately $180 million.

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 is valued at approximately $335 million, is expected to close in the second quarter of 2007, pending Sterling and Northern Empire shareholder and regulatory approval, and satisfaction of other customary closing conditions.

Critical Accounting Policies

The accounting and reporting policies of Sterling conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry. The preparation of the financial statements in conformity 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

18

judgments, estimates and assumptions inherent in those policies are critical to an understanding of Sterling’s Consolidated Financial Statements and Management’s Discussion and Analysis.

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 utilized and allowances for homogeneous loans (such as residential mortgage loans, personal 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 influenced by changes in economic conditions and other relevant factors. A slowdown in economic activity could adversely affect cash flows for both commercial and individual borrowers, which may result in 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 September 30, 2006.

Investment Securities and MBS. Assets in the investment securities 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. 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 the 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

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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 others. 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 and the establishment of a new basis. During the three months ended September 30, 2006, there were no investment securities that management identified to be other-than-temporarily impaired, 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.

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 generated 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 the 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 is 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 (generally eight to ten years).

Real Estate Owned and Other Collateralized Assets. 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. 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 includes amounts for estimated losses as a result of impairment in value of the property after repossession. Sterling reviews its real estate owned and other collateralized assets 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 taxing authorities. 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 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

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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

Overview. Sterling recorded net income of $19.3 million, or $0.52 per diluted share, for the three months ended September 30, 2006, compared with net income of $13.9 million, or $0.40 per diluted share, for the three months ended September 30, 2005. Net income for the nine months ended September 30, 2006 was $51.7 million, or $1.44 per diluted share, compared with net income of $45.8 million, or $1.31 per diluted share, for the nine months ended September 30, 2005. The increase in net income mainly reflected an increase in net interest income.

The annualized return on average assets (“ROA”) was 0.89% and 0.81% for the three months ended September 30, 2006 and 2005, respectively. The annualized return on average equity (“ROE”) was 13.4% and 10.8% for the three months ended September 30, 2006 and 2005, respectively. The increase in ROA and ROE compared to 2005 was due to growth of net income outpacing increases in assets and equity.

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 three months ended September 30, 2006 and 2005, NII was $70.0 million and $53.1 million, respectively, an increase of 32%. During the nine months ended September 30, 2006 and 2005, NII was $190.0 million and $159.7 million, respectively, an increase of 19%. The increase in NII was mainly due to increases in average loan volumes.

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. 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.

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.

	Three Months Ended September 30,											Nine Months Ended September 30,
	2006 vs. 2005											2006 vs. 2005
	Increase (Decrease) Due to:											Increase (Decrease) Due to:
							Rate/											Rate/
	Volume			Rate			Volume			Total		Volume			Rate			Volume			Total
	(Dollars in thousands)											(Dollars in thousands)
Rate/volume analysis:
Interest income:
Loans	$	32,546		$	13,051		$	6,582		$	52,179	$	56,496		$	39,944		$	10,544		$	106,984
MBS		(372	)		1,263			(22	)		869		(1,403	)		3,219			(69	)		1,747
Investments and cash equivalents		648			(130	)		(132	)		386		884			(287	)		(117	)		480
Total interest income		32,822			14,184			6,428			53,434		55,977			42,876			10,358			109,211
Interest expense:
Deposits		12,147			10,539			5,140			27,826		17,942			35,972			10,203			64,117
Borrowings		2,132			5,834			697			8,663		(3,034	)		18,777			(967	)		14,776
Total interest expense		14,279			16,373			5,837			36,489		14,908			54,749			9,236			78,893
Net changes in NII	$	18,543		$	(2,189	)	$	591		$	16,945	$	41,069		$	(11,873	)	$	1,122		$	30,318

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Net interest margin for each of the last five quarters was as follows:

Three Months Ended	Net Interest Margin
September 30, 2006		3.31	%
June 30, 2006		3.24	%
March 31, 2006		3.30	%
December 31, 2005		3.32	%
September 30, 2005		3.33	%

Average interest-earning assets for the three and nine months ended September 30, 2006 were $8.40 billion and $7.73 billion, respectively, reflecting growth of $2.06 billion and $1.20 billion, respectively, over the comparative 2005 amounts. Internal and acquisition related growth in the loan portfolio contributed to the increase in interest-earning assets. Net interest margin for the three months ended September 30, 2006 and 2005 was 3.31% and 3.33%, respectively, with the compression from 2005 to 2006 reflecting that the cost of funding loan growth through wholesale sources outweighed the increases in interest income from high yielding acquired loans, repricing of existing loans and internal growth.

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 and trends in classified assets, delinquency and nonaccrual loans, and portfolio volume, diversification as to type of loan, size of individual credit exposure, current and anticipated economic conditions, as well as 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 $4.7 million and $3.4 million for the three months ended September 30, 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 real estate, construction, business banking and consumer loans that 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:

	Nine Months Ended September 30,
	2006			2005
	(Dollars in thousands)
Balance at January 1	$	55,483		$	49,362
Acquired allowance		4,552			0
Provision for losses on loans		13,998			10,550
Amounts written off net of recoveries and other		(2,570	)		(6,241	)
Balance at September 30	$	71,463		$	53,671

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At September 30, 2006, Sterling’s total classified assets were 0.52% of total assets, compared with 0.93% of total assets at September 30, 2005. Nonperforming assets were 0.21% of total assets at September 30, 2006, compared with 0.17% of total assets at September 30, 2005. Sterling does not anticipate significant losses in these classified assets, although there can be no assurances in this regard. At September 30, 2006, the loan delinquency ratio was 0.25% of total loans compared to 0.28% of total loans at September 30, 2005. Asset quality has been stable over the periods presented.

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	(Dollars in thousands)						(Dollars in thousands)
Fees and service charges	$	11,526		$	9,260		$	31,220		$	24,868
Mortgage banking operations		5,572			2,969			10,568			14,447
Loan servicing fees		473			90			1,224			330
Real estate owned operations		(138	)		(23	)		247			188
BOLI		1,225			1,164			3,611			3,331
Other non-interest expense		(207	)		(154	)		(372	)		186
Total	$	18,451		$	13,306		$	46,498		$	43,350

The increase in non-interest income for the three months ended September 30, 2006, over the three months ended September 30, 2005, was primarily due to an increase in income from mortgage banking operations and fees and service charges. The increased income from mortgage banking operations was primarily a result of the acquisition of Golf Savings Bank. Golf Savings Bank is engaged in mortgage banking. Loans that are originated are sold into the secondary market. Gains on the sale of loans held for sale are recorded as income from mortgage banking operations. Income from mortgage banking operations for the nine months ended September 30, 2006 was lower than the nine months ended September 30, 2005, because the level of loan sales in the prior year primarily reflected loan portfolio repositioning.

Fees and service charges for the three and nine months ended September 30, 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.

During the nine months ended September 30, 2006, Sterling did not sell any investment securities or MBS, compared with $130.7 million for the nine months ended September 30, 2005. The activity for both periods was a result of management’s response to market conditions and portfolio management needs.

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

	As of and for the				As of and for the
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
			(Dollars in thousands)
Originations of residential mortgage loans	$	328,436	$	115,870	$	477,657	$	378,842
Originations of commercial real estate loans		38,488		51,065		110,456		134,087
Sales of residential mortgage loans		266,014		71,825		350,614		523,283
Sales of commercial real estate loans		0		0		0		120,001
Principal balances of residential loans serviced for others		606,807		634,867		606,807		634,867
Principal balances of commercial real estate loans serviced for others		843,112		775,199		843,112		775,199

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
	(Dollars in thousands)				(Dollars in thousands)
Employee compensation and benefits	$	31,479	$	23,274	$	82,278	$	67,625
Occupancy and equipment		8,755		6,578		23,046		19,241
Depreciation		2,662		2,227		7,377		6,348
Amortization of core deposit intangibles		586		556		1,697		1,667
Advertising		2,900		2,251		7,155		6,668
Data processing		3,746		3,179		10,601		9,391
Insurance		364		304		963		934
Legal and accounting		622		486		1,861		2,274
Travel and entertainment		1,454		1,081		4,040		3,263
Goodwill litigation costs		25		0		245		189
Merger and acquisition costs		191		0		191		0
Other		2,518		2,663		7,077		6,248
Total	$	55,302	$	42,599	$	146,531	$	123,848

The increases in non-interest expenses were primarily due to continued company growth. Full-time equivalent employees increased year-over-year by 330 to 2,100 at September 30, 2006. The acquisition of Golf Savings Bank added approximately 250 full-time equivalent employees.

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Income Tax Provision. Sterling recorded federal and state income tax provisions of $9.1 million and $6.5 million for the three months ended September 30, 2006 and 2005, respectively, and $24.3 million and $22.9 million for the nine months ended September 30, 2006 and 2005, respectively. The effective tax rate for the three month comparative period was 32.1% and 31.9%, respectively. The increase in the effective tax rate for the three month period was primarily due to the increase in pre-tax income, which resulted in a higher percentage of income being taxed at the statutory rate. The effective tax rate for the nine month comparative period was 32.0% and 33.3%, respectively, with the decrease during the nine month period mainly due to tax credits received as a result of Sterling’s participation in low income housing partnerships.

Financial Position

Assets. At September 30, 2006, Sterling’s assets were $8.91 billion, up $1.35 billion from $7.56 billion at December 31, 2005. This growth was mainly a result of increases in the loan portfolio through originations and acquisitions.

Investment Securities and MBS. Sterling’s investment and MBS portfolio at September 30, 2006 was $1.95 billion, a decrease of $179.9 million from the December 31, 2005 balance of $2.13 billion. The decrease was mainly due to principal repayments and maturities. On September 30, 2006, the investment and MBS portfolio had an unrealized loss of $55.8 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 September 30, 2006, net loans receivable were $6.24 billion, up $1.4 billion from $4.89 billion at December 31, 2005. The increase was primarily due to loan originations during the period and acquisitions, net of loan repayments.

The following table sets forth the composition of Sterling’s loan portfolio as of the dates indicated. Loan balances exclude deferred loan origination costs and fees, and allowances for loan losses:

	September 30, 2006					December 31, 2005
	Amount			%		Amount			%
				(Dollars in thousands)
Residential real estate	$	488,130			7.7	$	488,633			9.9
Multifamily real estate		284,989			4.5		332,211			6.7
Commercial real estate		832,839			13.2		792,219			16.0
Construction		1,985,414			31.4		1,021,502			20.6
Consumer — direct		696,775			11.0		618,528			12.5
Consumer — indirect		229,740			3.6		166,143			3.4
Commercial — business banking		1,236,489			19.5		1,079,939			21.8
Commercial — corporate banking		571,180			9.1		451,140			9.1
Gross loans receivable		6,325,556			100.0		4,950,315			100.0
Net deferred origination fees		(13,581	)				(8,916	)
Allowance for losses on loans		(71,463	)				(55,483	)
Loans receivable, net	$	6,240,512				$	4,885,916

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The following table sets forth Sterling’s loan originations for the periods indicated:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
			(Dollars in thousands)
Residential real estate	$	328,436	$	115,870	$	477,657	$	378,842
Multifamily real estate		2,750		0		4,215		13,267
Commercial real estate		35,738		51,065		106,241		120,820
Construction		588,466		443,521		1,614,581		1,212,960
Consumer — direct		79,063		86,216		261,571		270,760
Consumer — indirect		56,660		30,825		127,347		67,613
Commercial — business banking		205,208		155,831		566,184		380,107
Commercial — corporate banking		107,032		72,176		358,166		241,864
Total loans originated	$	1,403,353	$	955,504	$	3,515,962	$	2,686,233

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

	September 30, 2006				December 31, 2005
	Amount		%		Amount		%
			(Dollars in thousands)
Interest-bearing checking	$	407,383		6.8	$	432,936		9.0
Noninterest-bearing checking		724,454		12.2		673,934		14.0
Savings		1,612,207		27.1		1,312,033		27.3
Time deposits		3,209,723		53.9		2,387,398		49.7
Total deposits	$	5,953,767		100.0	$	4,806,301		100.0

Total deposits increased to $5.95 billion at September 30, 2006 from $4.81 billion at December 31, 2005. Deposit growth was primarily in time and savings accounts, mainly reflecting the higher interest rate environment, consumer’s increased demand for products and services, and Sterling’s use of brokered CD’s as a cost competitive source of funds.

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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 (“REPOs”) and other borrowings to fund asset growth and meet deposit withdrawal requirements. During the nine months ended September 30, 2006, these funding sources increased a total $68.5 million, with the aggregate total of FHLB advances, REPOs and Fed funds purchased decreasing a net $58.0 million, offset by $105.0 million from the issuance of Trust Preferred Securities by Sterling Capital Trusts VII and VIII, and $19.0 million of Trust Preferred Securities acquired 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. Like all financial institutions, Sterling’s NII and the net present value of assets, liabilities and off-balance sheet contracts (“NPV”), or estimated fair value, are subject to fluctuations in interest rates. For example, some of Sterling’s adjustable rate mortgages are indexed to various U.S. Treasury indices or periodic fixed-rate LIBOR and swaps curves. When interest-earning assets such as loans are funded by interest-bearing liabilities such as deposits, FHLB Seattle advances and other borrowings, a changing interest rate environment may have a dramatic effect on Sterling’s earnings. The fact that liabilities mature or reprice more frequently on average than assets may be beneficial in times of decreasing interest rates; however, such an asset/liability structure may result in declining NII during periods of rising interest rates.

Additionally, the extent to which borrowers prepay loans is affected by prevailing interest rates. When interest rates increase, borrowers are less likely to prepay loans; whereas, when interest rates decrease, borrowers are more likely to prepay loans. Prepayments may affect the levels of loans retained in an institution’s portfolio, as well as its NII.

Sterling’s asset and liability management program’s primary focus is the management of NII through interest rate cycles and secondarily, the protection of its NPV by controlling its exposure to changing interest rates. Sterling uses a simulation model designed to measure the sensitivity of NII and NPV to changes in interest rates. This simulation model is designed to enable Sterling to generate a forecast of NII and NPV given various interest rate forecasts and alternative strategies. The model is also designed to measure the anticipated impact that prepayment risk, basis risk, customer maturity preferences, volumes of new business and changes in the relationship between long-term and short-term interest rates have on the performance of Sterling. The model calculates the present value of assets, liabilities, off-balance sheet financial instruments and equity at current interest rates and at hypothetical higher and lower interest rates at various intervals. The present value of each major category of financial instruments is calculated using estimated cash flows based on weighted-average contractual rates and terms, then discounted at the estimated current market interest rate for similar financial instruments. The present value of longer term fixed-rate financial instruments is difficult to estimate because such instruments are more susceptible to changes in market interest rates. Present value estimates of adjustable-rate financial instruments are more reliable since they represent the difference between the contractual and discounted rates until the next interest rate repricing date, combined with adjustments for the impact of rate caps and floors.

The calculations of present value have certain shortcomings. The discount rates utilized for loans, investment securities and MBS are based on estimated nationwide market interest rate levels for similar loans and securities, with prepayment assumptions based on historical experience and market forecasts. The unique characteristics of Sterling’s loans and MBS may not necessarily parallel those in the model. The discount rates utilized for deposits and borrowings are based upon available alternative types and sources of funds, which are not necessarily indicative of the market value of deposits and FHLB Seattle advances, since such deposits and advances are unique to and have certain price and customer relationship advantages for depository institutions. The present values are determined based on the discounted cash flows over the remaining estimated lives of the financial instruments, on the assumption that the resulting cash flows are reinvested in financial instruments with virtually identical terms.

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The total measurement of Sterling’s exposure to interest rate risk (“IRR”) as presented in the tables below may not be representative of the actual values, which might result from a higher or lower interest rate environment. A higher or lower interest rate environment most likely will result in different investment, lending and borrowing strategies by Sterling designed to further mitigate the effect on the value of, and the net earnings generated from, Sterling’s net assets from any change in interest rates.

Sterling is continuing to pursue strategies to manage the level of its IRR while increasing its NII: a) through the origination and retention of variable-rate consumer, commercial banking, construction and commercial real estate loans, which generally have higher yields than residential permanent loans; b) by retaining fewer long-term fixed rate mortgages and not replacing certain long-term fixed rate mortgage investments that have been repaid; and c) by increasing the level of its core deposits, which are generally a lower-cost funding source than wholesale borrowings. There can be no assurance that Sterling will be successful implementing any of these strategies or that, if these strategies are implemented, they will have the intended effect of reducing IRR or increasing NII.

The following table indicates the sensitivity of Sterling’s annual projected NII from the balance sheet dates indicated and for meaningful changes in interest rates:

Change in		September 30,			December 31,
Interest Rate in		2006			2005
Basis Points		% Change in			% Change in
(Rate Shock)		NII			NII
	+300		(3.3	)		(7.3	)
	+200		(2.4	)		(4.6	)
	+100		(1.3	)		(2.4	)
Static			0.0			0.0
	-100		(0.8	)		(0.5	)
	-200		(4.1	)		(5.2	)
	-300		(9.0	)		(7.0	)

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The following table presents Sterling’s estimates of changes in NPV for the periods indicated and for meaningful changes in interest rates. The results indicate the potential effects of instantaneous, parallel shifts in the market yield curve. These calculations are highly subjective and technical and are relative measurements of IRR, which do not necessarily reflect any expected rate movement.

	At September 30, 2006								At December 31, 2005
Change in			Ratio of NPV								Ratio of NPV
Interest Rate			to the Present			%					to the Present			%
in Basis Points			Value of			Change					Value of			Change
(Rate Shock)	NPV		Total Assets			in NPV			NPV		Total Assets			in NPV
			(Dollars in thousands)
+300	$	697,840		7.82	%		(12.5	)	$	697,159		9.16	%		(13.5	)
+200		742,670		8.25			(6.9	)		748,211		9.74			(7.1	)
+100		775,534		8.56			(2.8	)		777,474		10.04			(3.5	)
Static		797,484		8.75			0.0			805,739		10.32			0.0
-100		758,637		8.32			(4.9	)		758,300		9.71			(5.9	)
-200		620,597		6.87			(22.2	)		600,547		7.79			(25.5	)
-300		432,611		4.85			(45.8	)		407,394		5.37			(49.4	)

Sterling does not manage its IRR by means of gap analysis. Instead, Sterling uses simulation modeling, which provides a more complete analysis than gap analysis, because gap analysis is simply an analytical tool designed to measure the difference between the amount of interest-earning assets and the amount of interest-bearing liabilities expected to mature or reprice in a given period. Gap analysis indicates theoretical repricing mismatches, but it does not consider basis differences that simulation modeling attempts to measure, such as differences due to yield curve shape, prepayment variability and other optionality. Gap analysis also does not consider assets or liabilities that have embedded options, a feature that allows early redemption. Cumulative gap positions are provided herein to indicate the general direction of the interest rate sensitivity of Sterling’s assets and liabilities at the balance sheet dates indicated. A positive position indicates that assets maturing or repricing in a given period exceed maturing or repricing liabilities. A negative position indicates the opposite. An indication of a pricing match or mismatch does not necessarily indicate that income will change by any amount as the assets and liabilities may reprice to different indices, market rates for new products may vary and management may change discretionary pricing.

Sterling calculated its one-year cumulative gap position to be a negative 10.0% and a negative 10.4% at September 30, 2006 and December 31, 2005, respectively. Sterling calculated its three-year gap position to be a negative 1.8% and a negative 0.6% at September 30, 2006 and December 31, 2005, respectively. While the one-year cumulative gap shows liability sensitivity at September 30, 2006, it does not correlate directly to an increased exposure to rising interest rates. During 2006, Sterling’s originations of fully floating construction loans were largely match funded with short-term liabilities. Additionally, loan prepayment speeds for long-term loans can vary substantially in a rising rate environment. These effects are not considered when calculating traditional gap analysis. As a result of the aforementioned and ongoing balance sheet strategies, management believes that it has improved Sterling’s IRR profile and will be able to better manage IRR.

Management attempts to maintain Sterling’s gap position between positive 10% and negative 25%. At September 30, 2006 and December 31, 2005, Sterling’s gap positions were within guidelines established by its Board of Directors. Management is pursuing strategies to increase its NII without significantly increasing its cumulative gap positions in future periods. There can be no assurance that Sterling will be successful implementing these strategies or that, if these strategies are implemented, they will have the intended effect of increasing its NII. See “– Results of Operations – Net Interest Income” and “– Capital.”

29

Liquidity and Capital Resources

As a financial institution, Sterling’s primary sources of funds are investing and financing activities, including the collection of loan principal and interest payments. Financing activities consist primarily of customer deposits, advances from FHLB Seattle and other borrowings. Deposits increased 24% to $5.95 billion at September 30, 2006 from $4.81 billion at December 31, 2005, mainly due to increases of $822.3 million and $300.2 million, respectively, in time deposits and savings accounts. These increases reflected Sterling’s use of these funds as a cost competitive source to generate loan growth.

Sterling Savings Bank actively manages its 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 nine months ended September 30, 2006, net cash used in investing activities was $820.8 million, which consisted mainly of loan funding, which was partially offset by cash inflows from loan principle paydowns and runoff in the MBS portfolio. During this period, net cash provided by financing activities was $749.9 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. At September 30, 2006, this credit line represented a total borrowing capacity of $1.37 billion, of which $587.7 million was available. In March 2006, the FHLB Seattle’s Board of Directors voted to reduce the amount of stock that member banks must hold, allowing member banks to increase their borrowing capacity. The change became effective April 10, 2006. In May 2005, the FHLB Seattle began operating under a three year business and capital management plan. The plan includes dividend payment and stock repurchase restrictions. Sterling received no dividends during the nine months ended September 30, 2006. In March 2006, the Federal Housing Finance Board (the “Board”) proposed amended regulations for the FHLB banks that would limit the amount of excess stock that FHLB banks could have outstanding and that would prescribe for them a minimum amount of retained earnings. The Board stated that it believed its proposed regulatory changes would reduce the risk that losses could deplete an FHLB’s retained earnings and cause the impairment of the par value of an FHLB’s stock.

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 September 30, 2006, Sterling Savings Bank had $623.6 million in outstanding borrowings under reverse repurchase agreements and had securities available for additional secured borrowings of approximately $215.4 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.

Sterling, on a parent company-only basis, had cash of approximately $31.1 million and $15.7 million at September 30, 2006 and December 31, 2005, respectively. At September 30, 2006 and December 31, 2005, Sterling had an investment of $175.1 million and $110.1 million, respectively, in the preferred stock of Sterling Savings Bank. At September 30, 2006 and December 31, 2005, Sterling had an investment in the common stock of Sterling Savings Bank of $346.7 million and $294.6 million, respectively. The increase in Sterling’s investment in preferred stock of Sterling Savings Bank for the period ended September 30, 2006 reflects an aggregate investment of $65.0 million from the proceeds of the Trust Preferred Securities issued by Sterling Capital Trusts VII and VIII. Sterling also invested $52.1 million in the common stock of Sterling Savings Bank during the nine months ended September 30, 2006. Common stock investments were 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. Sterling received cash dividends from Sterling Savings Bank of $17.1 million and $8.7 million during the nine months ended September 30, 2006, and September 30, 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

30

to pay dividends is limited by its earnings, financial condition, capital requirements, and capital distribution regulations. See Note 2 of “Notes to Consolidated Financial Statements.”

Sterling has the ability to secure additional capital through the capital markets. The availability and cost of such capital is partially dependent on Sterling’s credit ratings, which as of September 30, 2006 were as follows:

				Sterling
	Sterling	Sterling		Savings Bank
Rating	Long-Term	Short-Term		Long-Term
Institution	Debt	Debt		Deposits	Outlook
Fitch	BBB-		F3	BBB	Stable

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

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.

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 Fannie Mae, 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 September 30, 2006, Sterling did not have any loans locked with investors under mandatory delivery programs, nor hold any offsetting forward sale agreements on MBS. At September 30, 2006, Sterling had entered into best efforts forward commitments to sell $90.3 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. At September 30, 2006, Sterling recorded an asset of approximately $775,000 for the estimated fair value of rate locks issued and a liability of approximately $775,000 for the estimated fair value of delivery commitments received. At 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, at 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 comparable dealer swaps. These contracts are carried at fair value.

31

Capital

Sterling’s total shareholders’ equity was $608.7 million at September 30, 2006, compared to $506.7 million at December 31, 2005. The increase in total shareholders’ equity was primarily from the retention of earnings and the issuance of Sterling’s common stock in connection with the purchase of Golf Savings Bank. Shareholders’ equity was 6.8% of total assets at September 30, 2006 compared with 6.7% at December 31, 2005.

At September 30, 2006, Sterling had an unrealized loss of $55.8 million on investment securities and MBS classified as available for sale. 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 can qualify as Tier 1 capital, subject to certain limitations. For a complete description, see Note 2 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. It is management’s intention 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 September 30, 2006, each of the companies exceeded all such regulatory capital requirements and were “well capitalized” pursuant to such regulations. The following table sets forth their respective capital positions at September 30, 2006:

	Minimum Capital					Well-Capitalized
	Requirements					Requirements					Actual
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Tier 1 leverage (to aveage assets)
Sterling	$	346,576		4.0	%	$	433,231		5.0	%	$	703,248		8.1	%
Sterling Savings Bank		332,394		4.0	%		415,492		5.0	%		669,065		8.1	%
Golf Savings Bank		13,762		4.0	%		17,203		5.0	%		20,143		5.9	%
Tier 1 (to risk-weighted assets)
Sterling		284,570		4.0	%		426,854		6.0	%		703,248		9.9	%
Sterling Savings Bank		277,061		4.0	%		415,591		6.0	%		669,065		9.7	%
Golf Savings Bank		7,540		4.0	%		11,310		6.0	%		20,143		10.7	%
Total (to risk-weighted assets)
Sterling		569,139		8.0	%		711,424		10.0	%		774,711		10.9	%
Sterling Savings Bank		554,121		8.0	%		692,652		10.0	%		739,391		10.7	%
Golf Savings Bank		15,080		8.0	%		18,851		10.0	%		21,280		11.3	%

32

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 Financial Accounting Standards Board (“FASB”) issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires an employer to recognize the funded status of defined benefit pension and other postretirement benefit plans as an asset or liability. The standard is effective for Sterling as of December 31, 2006. Sterling is currently assessing the impact of this standard and does not expect SFAS No. 158 to have a material effect on Sterling.

In September 2006, the FASB issued 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

33

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.

Regulation and Compliance

Sterling is subject to many laws and regulations applicable to banking activities. As a bank holding company, Sterling is subject to comprehensive examination and regulation by the FRB. Sterling Savings Bank, as a Washington State-chartered bank, and Golf Savings Bank, as a Washington State-chartered savings bank, are subject to comprehensive regulation and examination by the Washington Supervisor and the FDIC. Sterling Savings Bank and Golf Savings Bank are further subject to FRB regulations related to deposit reserves and certain other matters.

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:

• 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;

34

• 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.

Item 3 Quantitative and Qualitative Disclosures About Market Risk

For a discussion of Sterling’s market risks, see “Management’s Discussion and Analysis — Asset and Liability Management.”

Item 4 Controls and Procedures

Disclosure 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.

Changes in Internal Control Over Financial Reporting

There were no changes in Sterling’s internal control over financial reporting that occurred during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Sterling’s internal control over financial reporting.

35

STERLING FINANCIAL CORPORATION

PART II – Other Information

Item 1 Legal Proceedings

Periodically various claims and lawsuits are brought against Sterling and its subsidiaries, such as claims to enforce liens, condemnation proceedings involving properties on which Sterling holds security interests, claims involving the making and servicing of real property loans and other issues incidental to Sterling’s business. No material loss is expected from any of such pending claims or lawsuits.

Item 1a Risk Factors

You should carefully consider the risks and uncertainties we describe both in this Report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, before deciding to invest in, or retain, shares of our common stock. These are not the only risks and uncertainties that we face. Additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, may also harm our business operations or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, operating results or liquidity could be materially harmed.

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3 Defaults Upon Senior Securities

Not applicable.

Item 4 Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5 Other Information

Not applicable.

Item 6 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.

36

STERLING FINANCIAL CORPORATION

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	STERLING FINANCIAL CORPORATION
		(Registrant)
November 8, 2006	By:	/s/ Daniel G. Byrne
Date		Daniel G. Byrne
		Executive Vice President, Assistant Secretary, Chief Financial Officer and Principal Accounting Officer

37

Exhibit Index

Exhibit No.
2.1	Agreement and Plan of Merger by and between Sterling and Northern Empire Bancshares dated September 17, 2006, filed as Exhibit 2.1 to Sterling’s report on Form 8-K dated September 17, 2006 and incorporated by reference herein.
3.1	Restated Articles of Incorporation of Sterling. Filed as Exhibit 4.1 to Sterling’s registration statement on Form S-3 dated December 20, 2005 and incorporated by reference herein.
3.2	Articles of Amendment of Restated Articles of Incorporation of Sterling. Filed as Exhibit 4.2 to Sterling’s registration statement on Form S-3 dated December 20, 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 filed 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 herewith.
31.1	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act. Filed herewith.
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act. Filed herewith.
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350. Furnished herewith.
32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350. Furnished herewith.

E-1

EX-10.1

                                                                    Exhibit 10.1

                                CREDIT AGREEMENT

     THIS CREDIT AGREEMENT (this "Agreement") is entered into as of August 4,
2006, by and between STERLING FINANCIAL CORPORATION, a Washington corporation
("Borrower"), and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank").

                                    RECITALS

     Borrower has requested that Bank extend or continue credit to Borrower as
described below, and Bank has agreed to provide such credit to Borrower on the
terms and conditions contained herein.

     NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, Bank and Borrower hereby agree as follows:

                                   ARTICLE I
                                  CREDIT TERMS

     SECTION 1.1. LINE OF CREDIT.

     (a) Line of Credit - 364 Days. Subject to the terms and conditions of this
Agreement, Bank hereby agrees to make advances to Borrower from time to time up
to and including August 3, 2007, not to exceed at any time the aggregate
principal amount of Forty Million Dollars ($40,000,000.00) ("Line of Credit"),
the proceeds of which shall be used for Borrower's working capital purposes and
general corporate purposes. Borrower's obligation to repay advances under the
Line of Credit shall be evidenced by a promissory note dated as of August 4,
2006 ("Line of Credit Note"), all terms of which are incorporated herein by this
reference.

     (b) Borrowing and Repayment. Borrower may from time to time during the term
of the Line of Credit borrow, partially or wholly repay its outstanding
borrowings, and reborrow, subject to all of the limitations, terms and
conditions contained herein or in the Line of Credit Note; provided however,
that the total outstanding borrowings under the Line of Credit shall not at any
time exceed the maximum principal amount available thereunder, as set forth
above.

     SECTION 1.2. INTEREST/FEES

     (a) Interest. The outstanding principal balance of the Line of Credit shall
bear interest at the rate of interest set forth in the Line of Credit Note.

     (b) Computation and Payment. Interest shall be computed on the basis of a
360-day year, actual days elapsed. Interest shall be payable at the times and
place set forth in each promissory note or other instrument or document required
hereby.

     (c) Commitment Fee. Borrower shall pay to Bank a non-refundable commitment
fee for the Line of Credit equal to Twenty Thousand Dollars ($20,000.00), which
fee shall be due and payable in full on the date of this Agreement.

     (d) Unused Commitment Fee. Borrower shall pay to Bank a fee equal to
one-fifth percent (0.20%) per annum (computed on the basis of a 360-day year,
actual days elapsed) on


                                       -1-



the average daily unused amount of the Line of Credit, which fee shall be
calculated on a calendar quarter basis by Bank and shall be due and payable by
Borrower in arrears on the last day of each March, June, September and December.

                                   ARTICLE II
                         REPRESENTATIONS AND WARRANTIES

     Borrower makes the following representations and warranties to Bank, which
representations and warranties shall survive the execution of this Agreement and
shall continue in full force and effect until the full and final payment, and
satisfaction and discharge, of all obligations of Borrower to Bank subject to
this Agreement.

     SECTION 2.1 LEGAL STATUS. Borrower is a corporation, duly organized and
existing and in good standing under the laws of Washington and is qualified or
licensed to do business (and is in good standing as a foreign corporation, if
applicable) in all jurisdictions in which such qualification or licensing is
required or in which the failure to so qualify or to be so licensed could have a
material adverse effect on Borrower.

     SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement and each promissory
note, contract, instrument and other document required hereby or at any time
hereafter delivered to Bank in connection herewith (collectively, the "Loan
Documents") have been duly authorized, and upon their execution and delivery in
accordance with the provisions hereof will constitute legal, valid and binding
agreements and obligations of Borrower or the party which executes the same,
enforceable in accordance with their respective terms.

     SECTION 2.3. NO VIOLATION. The execution, delivery and performance by
Borrower of each of the Loan Documents do not violate any provision of any law
or regulation, or contravene and provision of the Articles of Incorporation or
By-Laws of Borrower, or result in any breach of or default under any contract,
obligations, indenture or other instrument to which Borrower is a party or by
which Borrower may be bound.

     SECTION 2.4. LITIGATION. There are no pending, or to the best of Borrower's
knowledge, threatened actions, claims, investigations, suites or proceedings by
or before any governmental authority, arbitrator, court or administrative agency
which could have a material adverse effect on the financial condition or
operation of Borrower other than those disclosed by Borrower to Bank in writing
prior to the date hereof.

     SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The annual financial
statement of Borrower dated December 31, 2005, and all interim financial
statements delivered to Bank since said date, true copies of which have been
delivered by Borrower to Bank prior to the date hereof, (a) are complete and
correct and present fairly the financial condition of Borrower, (b) disclose all
liabilities of Borrower that are required to be reflected or reserved against
under generally accepted accounting principles, whether liquidated or
unliquidated, fixed or contingent, and (c) have been prepared in accordance with
generally accepted accounting principles consistently applied. Since the dates
of such financial statements there has been no material adverse change in the
financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a
security interest in or otherwise encumbered any of its assets or properties
except in favor of Bank or as otherwise permitted by Bank in writing.


                                       -2-



     SECTION 2.6 INCOME TAX RETURNS. Borrower has no knowledge of any pending
assessments or adjustments of its income tax payable with respect to any year.

     SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture, contract
or instrument to which Borrower is a party or by which Borrower may be bound
that requires the subordination in right of payment of any of Borrower's
obligations subject to this Agreement to any other obligation of Borrower.

     SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter
possess, all permits, consents, approvals, franchises and licenses required and
rights to all trademarks, trade names, patents, and fictitious names, if any,
necessary to enable it to conduct the business in which it is now engaged in
compliance with applicable law.

     SECTION 2.9. ERISA. Borrower is in compliance in all material respects with
all applicable provisions of the Employee Retirement Income Security Act of
1974, as amended or recodified from time to time ("ERISA"); Borrower has not
violated any provision of any defined employee pension benefit plan (as defined
in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no
Reportable Event as defined in ERISA as occurred and is continuing with respect
to any Plan initiated by Borrower; Borrower has met its minimum funding
requirements under ERISA with respect to each Plan; and each Plan will be able
to fulfill its benefit obligations as they come due in accordance with the Plan
documents and under generally accepted accounting principles.

     SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any
obligation for borrowed money, any purchase money obligation or any other
material lease, commitment, contract, instrument or obligation.

     SECTION 2.11. BANK SUBSIDIARIES. As of the date of this Agreement Borrower
owns 100% of the issued and outstanding common voting stock in Sterling Savings
Bank. Each bank, if any, named in this Section, and each bank at any time
hereafter established or acquired by Borrower, is referred to as a "Bank
Subsidiary."

                                   ARTICLE III
                                   CONDITIONS

     SECTION 3.1 CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of
Bank to extend any credit contemplated by this Agreement is subject to the
fulfillment to Bank's satisfaction of all of the following conditions:

     (a) Approval of Bank Counsel. All legal matters incidental to the extension
of credit by Bank shall be reasonably satisfactory to Bank's counsel.

     (b) Documentation. Bank shall have received, in form and substance
satisfactory to Bank, each of the following, duly executed:

     (i)  This Agreement and each promissory note or other instrument or
          document required hereby.

     (ii) Certificate of Incumbency.

     (iii) Corporate Borrowing Resolution.

     (iv) Such other documents as Bank may require under any other Section of
          this Agreement.


                                       -3-



     (c) Financial Condition. There shall have been no material adverse change,
as determined by Bank, in the financial condition or business of Borrower, nor
any material decline, as determined by Bank, in the market value of any
collateral required hereunder or a substantial or material portion of the assets
of Borrower.

     SECTION 3.2 CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank
to make each extension of credit requested by Borrower hereunder shall be
subject to the fulfillment to Bank's satisfaction of each of the following
conditions:

     (a) Compliance. The representations and warranties contained herein and in
each of the other Loan Documents shall be true on and as of the date of the
signing of this Agreement and on the date of each extension of credit by Bank
pursuant hereto, with the same effect as though such representations and
warranties had been made on and as of each such date, and on each such date, no
Event of Default as defined herein, and no condition, event or act which with
the giving of notice or the passage of time or both would constitute such an
Event of Default, shall have occurred and be continuing or shall exist.

     (b) Documentation. Bank shall have received all additional documents which
may be required in connection with such extension of credit.

                                   ARTICLE IV
                              AFFIRMATIVE COVENANTS

     Borrower covenants that so long as Bank remains committed to extend credit
to Borrower pursuant thereto, or any liabilities (whether direct or contingent,
liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents
remain outstanding, and until payment in full of all obligations of Borrower
subject hereto, Borrower shall, unless Bank otherwise consents in writing:

     SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal, interest,
fees or other liabilities due under any of the Loan Documents at the times and
place and in the manner specified therein.

     SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records in
accordance with generally accepted accounting principals consistently applied,
and permit any representative of Bank, at any reasonable time, to inspect, audit
and examine such books and records, to make copies of the same, and to inspect
the properties of Borrower; provided, however, Bank understands that Borrower is
a publicly owned company whose shares are traded on a national exchange and
that, as a consequence, Bank agrees that it, its employees attorneys, and
agents, shall keep all non-public financial information of Borrower strictly
confidential and that neither it, or any of its employees, attorneys or agents,
shall trade, sell or otherwise exchange any shares of Borrower's stock while
they are in possession of any of Borrower's nonpublic financial information.

     SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the following, in
form and detail satisfactory to Bank:

     (a) not later than 90 days after and as of the end of each fiscal year, an
unqualified audit of the financial statement of Borrower prepared by the
independent accounting firm of BDO Seidman, or such other independent certified
public accountant reasonably acceptable to


                                       -4-



Bank, to include balance sheet, income statement, statement of Borrower's cash
flow, which Bank confirms is acceptable to it, management report, auditor's
report, all supporting schedules, footnotes and a copy of 10K report filed with
the Securities Exchange Commission;

     (b) not later than 45 days after and as of the end of each fiscal quarter,
company prepared financial statement of Borrower, to include a balance sheet,
income statement, statement of cash flow, and a copy of 10Q report filed with
the Securities Exchange Commission;

     (c) contemporaneously with each annual and quarterly financial statement of
Borrower required hereby, a compliance certificate of the president or chief
financial officer of Borrower that said financial statements are accurate, that
there exists no Event of Default nor any condition, act or event which with the
giving of notice or the passage of time or both would constitute an Event of
Default, and demonstrating compliance with the financial covenants contained in
this Agreement;

     (d) as soon as available, and in any event no later than 15 days after
filing with the Federal Reserve Bank, each quarterly, semi-annual, and annual
financial statement of the Borrower (including but not limited to any FRY-9SP,
FRY-9LP, FRY-6 and FRY-9C, as applicable) required to be filed by Borrower with
the Federal Reserve Bank in the applicable Federal Reserve District;

     (e) as soon as available (but without duplication of any other requirements
set forth in this Section 4.3.) a copy of all reports which are required by law
to be furnished to any regulatory authority having jurisdiction over Borrower or
any Bank Subsidiary (including without limitation Call Reports, but excluding
any report which applicable law or regulation prohibits Borrower or a Bank
Subsidiary from furnishing to Bank);

     (f) from time to time such other information as Bank may reasonably
request.

     SECTION 4.4. COMPLIANCE. Preserve and maintain all license, permits,
governmental approvals, rights, privileges and franchises necessary for the
conduct of its business; and comply with the provisions of all documents
pursuant to which Borrower is organized and/or which govern Borrower's continued
existence and with the requirements of all laws, rules, regulations and orders
of any governmental authority applicable to Borrower and/or its business.

     SECTION 4.5. INSURANCE. Maintain and keep in force, for each business in
which Borrower is engaged, insurance as described in Schedule 4.5 attached
hereto, with all such insurance carried with companies and in amounts
satisfactory to Bank, and deliver to Bank from time to time at Bank's request
schedules setting forth all insurance then in effect.

     SECTION 4.6. FACILITIES. Keep all properties useful or necessary to
Borrower's business in good repair and condition, and from time to time make
necessary repairs, renewals and replacements there to so that such properties
shall be fully and efficiently preserved and maintained.

     SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any
and all indebtedness, obligations, assessments and taxes, both real or personal,
including without limitation federal and state income taxes and state and local
property taxes and assessments, except such (a) as Borrower may in good faith
contest or as to which a bona fide


                                       -5-



dispute may arise, and (b) for which Borrower has made provision, to Bank's
satisfaction, for eventual payment thereof in the event Borrower is obligated to
make such payment.

     SECTION 4.8. LITIGATION. Promptly give notice in writing to Bank of any
litigation pending or threatened against Borrower with a claim in excess of
$10,000,000.00.

     SECTION 4.9. BORROWER'S FINANCIAL CONDITION. Maintain Borrower's
consolidated financial condition as follows using generally accepted account
principles consistently applied and used consistently with prior practices
(except to the extent modified by the definitions herein), with compliance
determined commencing with Borrower's financial statements for period ending
September 30, 2006:

     (a) ROA not less than 0.65% on a rolling four quarter basis, determined as
of each fiscal quarter end, with "ROA" defined as the percentage arrived at by
dividing net income by Total Assets, as reported in the most recent Call Report.

     (b) Allowance for loan and lease losses not less than 100% of the total
amount of Non-Performing Assets, determined as of each fiscal quarter end, with
"Non-Performing Assets" defined as the sum of: (i) all loans classified as past
due 90 days or more and still accruing interest; (ii) all loans classified as
'non-accrual' and no longer accruing interest; (iii) all loans classified as
'restructured loans and leases'; and (iv) all other 'non-performing assets',
including those classified as 'other real estate owned' and 'repossessed
property', as reported in the then most recent Call Report.

     (c) Non-Performing Assets not greater than 10% of Primary Equity Capital,
determined as of each fiscal quarter end, with "Non-Performing Assets" as
defined above, and with "Primary Equity Capital" defined as the aggregate of
allowance for loan and lease losses, as reported in the then most recent Call
Report, plus Equity Capital (defined as the aggregate of perpetual preferred
stock (and related surplus), common stock, surplus (excluding all surplus
related to perpetual preferred stock), undivided profits and capital reserves,
plus the net unrealized holding gains (or less the net realized holding losses)
on available-for-sale securities, less goodwill and other disallowed intangible
assets).

     SECTION 4.10. BORROWER'S AND BANK SUBSIDIARY FINANCIAL CONDITION. Cause
Borrower and each Bank Subsidiary to maintain its categorization as Well
Capitalized as defined by regulatory agencies having jurisdiction, which,
pursuant to Section 38 of the Federal Deposit Insurance Act (created by Section
131 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of
1991) (entitled "Prompt Corrective Action") (herein, "Section 38"), which
considers an institution "Well Capitalized" if, among other things, its Total
Risk-Based Capital Ratio equals or exceeds 10%, its Tier 1 Risk-Based Capital
equals or exceeds 6% and its Leverage equals or exceeds 5%. As used herein,
"Total Risk-Based Capital Ratio," "Tier 1 Risk-Based Capital" and "Leverage"
shall be defined and calculated in conformity with Section 38.

     SECTION 4.11. NOTICE TO BANK. Promptly (but in no event more than five (5)
business days after Borrower knows or in the exercise of reasonable care and
diligence should have known of the occurrence of each such event or matter) give
written notice to Bank in reasonable detail of: (a) the occurrence of any Event
of Default, or any condition, event or act which with the giving or the passage
of time or both would constitute an Event of Default; (b) any change in the name
or legal structure of borrower; (c) the occurrence and nature of any Reportable
Event or Prohibited Transaction, each as defined in ERISA, or any funding


                                       -6-


deficiency with respect to any Plan; (d) any termination or cancellation of any
insurance policy which Borrower is required to maintain, or any uninsured or
partially uninsured loss through liability or property damage, or through fire,
theft or any other cause affecting Borrower's property in excess of an aggregate
of $10,000,000.00; (e) any change in Executive Management of Borrower or any
Bank Subsidiary; with "Executive Management" defined as the Chief Financial
Office or Chief Executive Officer; or (f) any negotiations to sell any capital
stock of Borrower and/or any Bank Subsidiary, together with copies of any
proposed buy/sell agreements; provided however, that this clause shall not be
deemed approval by Bank of any such negotiation and shall not apply to
information which under applicable law or regulation is prohibited from
disclosure to Bank.

                                    ARTICLE V
                               NEGATIVE COVENANTS

     Borrower further covenants that so long as Bank remains committed to extend
credit to Borrower pursuant thereto, or any liabilities (whether direct or
contingent, liquidated or unliquidated) of Borrower to Bank under any of the
Loan Documents remain outstanding, and until payment in full of all obligations
of Borrower subject hereto, Borrower will not without Bank's prior written
consent, which consent shall not be unreasonably withheld, conditioned or
delayed:

     SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any credit extended
hereunder except for the purposes stated in Article 1 hereof.

     SECTION 5.2. CAPITAL EXPENDITURES. Make any additional investment in fixed
assets in any fiscal year in excess of an aggregate of $50,000,000.00.

     SECTION 5.3. LEASE EXPENDITURES. Incur operating lease expense in any
fiscal year in excess of an aggregate of $10,000,000.00.

     SECTION 5.4. OTHER INDEBTEDNESS. Create, incur, assume or permit to exist
any indebtedness or liabilities resulting from borrowings loans or advances,
whether secured or unsecured, matured or unmatured, liquidated or unliquidated,
joint or several, except (a) the liabilities of Borrower to Bank, (b) trade debt
and other similar obligations incurred in the ordinary course of business in
favor of Borrower's suppliers, vendors and other Third Parties; and (c) any
other liabilities of Borrower existing as of, and disclosed to Bank prior to,
the date hereof; provided that Borrower's existing $20,000,000.00 secured line
of credit shall be repaid in full and terminated no later than 30 days from the
date of this Agreement.

     SECTION 5.5 MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Merge into or
consolidate with any other entity; make any substantial change in the nature of
Borrower's business as conducted as of the date hereof; acquire all or
substantially all of the assets of any other entity; nor sell, lease, transfer
or otherwise dispose of all or a substantial or material portion of Borrower's
assets or consolidations except (a) acquisitions in the same line of business as
Borrower and its subsidiaries currently engage, so long as the cost of any such
acquisition does not exceed 10% of Borrower's total consolidated assets
(determined prior to such acquisition), and (b) acquisitions in a different line
of business than Borrower and its subsidiaries currently engage in, so long as
the cost of any such acquisition does not exceed 5% of Borrower's total
consolidated assets (determined prior to such acquisition).


                                       -7-



     SECTION 5.6. DIVIDENDS, DISTRIBUTIONS. Declare or pay any dividend or
distribution either in cash, stock or any other property on Borrower's stock now
or hereafter outstanding, nor redeem, retire, repurchase or otherwise acquire
any shares of any class of Borrower's stock now or thereafter outstanding;
provided however, that so long as no Event of Default has occurred and is
continuing, Borrower may pay cash dividends or distributions to its shareholders
in any fiscal year not to exceed 10% of Borrower's net income for the prior
fiscal year.

     SECTION 5.7. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to exist a
security interest in, or lien upon, all or any portion of Borrower's assets now
owned or hereafter acquired, except (i) any of the foregoing in favor of Bank or
which is existing as of, and disclosed to Bank in writing prior to, the date
hereof; and (ii) Permitted Liens. As used herein "Permitted Liens" shall mean
(a) Liens securing purchase money indebtedness and capital lease obligations
(and refinancings thereof; (b) Liens for ad valorem, income or property taxes or
assessments and similar charges that either are not delinquent or are being
properly contested; (c) statutory Liens of carriers, warehousemen, mechanics
suppliers, materialmen, repairmen and other Liens imposed by law incurred in the
ordinary course of business for sums not yet delinquent or being properly
contested; (d) Liens incurred or pledges or deposits made in the ordinary course
of business in connection with workers' compensation, unemployment insurance and
other social security legislation, leases, appeal bonds and other obligations of
like nature incurred by Borrower or any of its Subsidiaries in the ordinary
course of business, and deposits made in the ordinary course of business
securing liability to insurance carriers under insurance or self-insurance
arrangements; (e) Liens, deposits or pledges to secure the performance of bids,
tenders, contracts, leases, or other similar obligations arising in the ordinary
course of business; (f) judgment and attachment Liens not giving rise to an
Event of Default and notices of lis pendens and associated rights related to
litigation being properly contested; (g) Liens, deposits or pledges in the
ordinary course of business to secure public or statutory obligations, surety,
stay, appeal, indemnity, performance or other similar bonds or obligations and
liens, deposits or pledges in the ordinary course of business in lieu of such
bonds or obligations, or to secure such bonds or obligations, or to secure
letters of credit in lieu of or supporting the payment of such bonds or
obligations; (h) Liens in favor of collecting or payor banks having a right of
setoff, revocation, refund or chargeback with respect to money or instruments of
Borrower or any Subsidiary on deposit with or in possession of such bank; (i)
any interest or title of a lessor, licensor or sublicensor in the property
subject to any lease, license or sublicense; (j) Liens arising from
precautionary UCC financing statements regarding operating leases or
consignments; and (k) any extension, renewal or replacement (or successive
extensions, renewals or replacements), in whole or in part, of any lien referred
to in the foregoing clauses, provided that such extension, renewal or
replacement Lien shall be limited to all or a part of the property which secured
the Lien so extended, renewed or replaced.

                                   ARTICLE VI
                                EVENTS OF DEFAULT

     SECTION 6.1. The occurrence of any of the following shall constitute an
"Event of Default" under this Agreement:

     (a) Borrower shall fail to pay within five (5) business days of when due
any principal, interest, fees or other amounts payable under any of the Loan
Documents.


                                       -8-



     (b) Any financial statement or certificate furnished to Bank in connection
with, or any representation or warranty made by Borrower under this Agreement or
any other Loan Document fails to fairly present the financial condition of
Borrower.

     (c) Any default in the performance of or compliance with the covenants
contained in Sections 4.9, 4.10, 5.4, 5.5, 5.6 or 5.7 hereof, or any substantial
default in the performance of or compliance with any other material obligation,
agreement or other provision contained herein or in any other Loan Document
(other than those referred to in subsections (a) and (b) above), and with
respect to any such default which by its nature can be cured, such default is
not cured within thirty (30) days from its occurrence, or such longer period of
time as may be reasonably necessary so long as cure of such default is being
diligently pursued by Borrower during such extended cure period.

     (d) Any default under any other agreement between Borrower or any Bank
Subsidiary and Bank, or any defined event of default, under the terms of any
contract or instrument (other than any of the Loan Documents) pursuant to which
Borrower, any Bank Subsidiary, has incurred any debt or other liability to any
person or entity in excess of $100,000.00, but only if such other person or
entity has declared an event of default thereunder and such action is not being
contested in good faith by Borrower or Bank Subsidiary, as applicable.

     (e) The filing of a notice of judgment lien against Borrower or any Bank
Subsidiary in any amount in excess of $100,000.00, and enforcement of any such
judgment has not been superseded or otherwise stayed; or the recording of any
abstract of judgment against Borrower or any Bank Subsidiary in an amount in
excess of $100,000.00 in any county which Borrower or such Bank Subsidiary has
an interest in real property, and enforcement of any such judgment has not been
superseded or otherwise stayed; or the service of a notice of levy and/or of a
writ of attachment or execution; or other like process, against the assets of
Borrower or any Bank Subsidiary, in an amount in excess of $100,000.00, and
enforcement of any such levy or writ has not been superseded or otherwise
stayed.

     (f) Borrower or any Bank Subsidiary shall become insolvent, or shall suffer
or consent to or apply for the appointment of a receiver, trustee, custodian or
liquidator of itself or any of its property, or shall generally fail to pay its
debts as they become due, or shall make a general assignment for the benefit of
creditors; Borrower or any Bank Subsidiary shall file a voluntary petition in
bankruptcy, or seeking reorganization, in order to effect a plan or other
arrangement with creditors or any other relief under the Bankruptcy Reform Act,
Title 11 of the United State Code, as amended ore recodified from time to time
("Bankruptcy Code"), or under any state or federal law granting relief to
debtors, whether now or hereafter in effect; or any involuntary petition or
proceeding pursuant to the Bankruptcy Code or any other applicable state or
federal law relating to bankruptcy, reorganization or other relief for debtors
is filed or commenced against Borrower or any Bank Subsidiary or Third Party
Obligor, or Borrower or nay Bank Subsidiary or Third Party Obligor shall file an
answer admitting the jurisdiction of the court and the material allegations of
any involuntary petition; or Borrower or any Bank Subsidiary or Third Party
Obligor shall be adjudicated a bankruptcy, or an order for relief shall be
entered against Borrower or any Bank Subsidiary by any court of competent
jurisdiction under the Bankruptcy Code or any other applicable state or federal
law relating to bankruptcy, reorganization or other relief for debtors.

     (g) The dissolution or liquidation of Borrower or any Bank Subsidiary; or
Borrower or any Bank Subsidiary shall take action to seeking to effect such
dissolution or liquidation.


                                       -9-



     (h) The issuance or proposed issuance against Borrower, or any affiliate of
Borrower (including without limitation, any Bank Subsidiary) of any or formal
administrative action, temporary or permanent, by any federal or state
regulatory agency having jurisdiction or control over Borrower or such
affiliate, such action taking the form of, but not limited to: (i) any or formal
directive citing conditions or activities deemed to be unsafe or unsound or
breaches of fiduciary duty or law or regulation which directive would impair the
prospect of payment or performance by Borrower of its obligations under the Loan
Documents; (ii) a memorandum of understanding; (iii) a cease and desist order;
(iv) the termination of insurance coverage of customer deposits by the Federal
Deposit Insurance Corporation; (v) the suspension or removal of key executives,
or the prohibition of participation in the business affairs of Borrower or such
affiliate; (vi) any capital maintenance agreement; or (vii) any other regulatory
action, agreement or understanding with respect to Borrower or such affiliate.

     SECTION 6.2. REMEDIES. Upon the occurrence and continuation of any Event of
Default: (a) all indebtedness of Borrower under each of the Loan Documents, any
term thereof to the contrary notwithstanding, shall at Bank's option and without
notice become immediately due and payable without presentment, demand, protest
or notice of dishonor, all of which are hereby expressly waived by Borrower; (b)
the obligation, if any, of Bank to extend any further credit under any of the
Loan Documents shall immediately cease and terminate; and (c) Bank shall have
all rights, powers and remedies available under each of the Loan Documents, or
accorded by law, including without limitation the right to resort to any or all
security for any credit subject hereto and to exercise any or all of the rights
of a beneficiary or secured party pursuant to applicable law. All rights, powers
and remedies of Bank may be exercised at any time by Bank and from time to time
after the occurrence of an Event of Default, are cumulative and not exclusive,
and shall be in addition to any other rights, powers or remedies provided by law
or equity.

                                   ARTICLE VII
                                  MISCELLANEOUS

     SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank in
exercising any right, power or remedy under any of the Loan Documents shall
affect or operate as a waiver of such right, power or remedy; nor shall any
single or partial exercise of any such right, power or remedy preclude, waive or
otherwise affect an other or further exercise thereof or the exercise of any
other right, power or remedy. Any waiver, permit, consent or approval of any
kind by Bank of any breach of or default under any of the Loan Documents must be
in writing and shall be effective only to the extent set forth in such writing.

     SECTION 7.2. NOTICES. All notices, request and demands which any party is
required or may desire to give to any other party under any provision of this
Agreement must be in writing delivered to each party at the following address:

     BORROWER: STERLING FINANCIAL CORPORATION
               111 North Wall Street
               Spokane, WA 99201
               Attn: Chief Financial Officer


                                      -10-



     BANK:     WELLS FARGO BANK, NATIONAL ASSOCIATION
               Correspondent Banking Northwest
               999 3rd Avenue, 14th Floor
               Seattle, WA 98104

Or to such other address as any party may designate by written notice to all
other parties. Each such notice, request and demand shall be deemed given or
made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by
mail, upon the earlier of the date of receipt or three (3) days after deposit in
the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy,
upon receipt.

     SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to
Bank immediately upon demand the full amount of all payments, advances, charges,
costs and expenses, including reasonable attorneys' fees (to include outside
counsel fees and all reasonably and responsibly allocated costs of Bank's
in-house counsel), expended or incurred by Bank in connection with (a) the
negotiation and preparation of this Agreement and the other Loan Documents, and
the preparation of any amendments and waivers hereto and thereto, (b) the
enforcement of Bank's rights and/or the collection of any amounts which become
due to Bank under any of the Loan Documents, and (c) the prosecution of defense
of any action in any way related to any of the Loan Documents, including without
limitation, any action for declatory relief, whether incurred at the trial or
appellate level, in an arbitration proceeding or otherwise, and including any of
the foregoing incurred in connection with any bankruptcy proceeding (including
without limitation, any adversary proceeding, contested matter or motion brought
by Bank or any other person) relating to Borrower or any other person or entity.

     SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon
and inure to the benefit of the heirs, executors, administrators, legal
representative, successors and assigns of the parties; provided however, that
Borrower may not assign or transfer its interests or rights hereunder without
Bank's prior written consent. Bank reserves the right to sell, assign, transfer,
negotiate or grant participations in all or any part of, or any interest in,
Bank's rights and benefits under each of the Loan Documents, subject to
Borrower's consent, which consent shall not be unreasonably conditioned,
withheld or delayed; provided, however, no such assignment, transfer, sale or
participation shall (i) be made to any person or entity other than a Well
Capitalized financial institution, as defined in Section 38; and (ii) release
Bank of its obligations to the Note and remaining Loan Documents. In connection
therewith, Bank may disclose all documents and information which Bank now has or
may hereafter acquire relating to any credit subject hereto, Borrower, any Bank
Subsidiary or any collateral required hereunder.

     SECTION 7.5. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other Loan
Documents constitute the entire agreement between Borrower and Bank with respect
to each credit subject hereto and supersede all prior negotiations,
communications, discussions and correspondence concerning the subject matter
hereof. This Agreement may be amended or modified only in writing signed by each
party hereto.

     SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and
entered into for the sole protection and benefit of the parties hereto and their
respective permitted successors and assigns, and no other person or entity shall
be a third party beneficiary of, or have any direct or indirect cause of action
or claim in connection with, this Agreement or any other of the Loan Documents
to which it is not a party.


                                      -11-


     SECTION 7.7. TIME. Time is of the essence of each and every provision of
this Agreement and each other of the Loan Documents.

     SECTION 7.8 SEVERABILITY OF PROVISIONS. If any provision of this Agreement
shall be prohibited by or invalid under applicable law, such provision shall be
ineffective only to the extent of such prohibition or invalidity without
invalidating the remainder of such provision or any remaining provisions of this
Agreement.

     SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which when executed and delivered shall be deemed to be an
original, and all of which when taken together shall constitute one and the same
Agreement.

     SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of Washington.

     SECTION 7.11. ARBITRATION.

     (a) Arbitration. The parties hereto agree, upon demand by any party, to
submit to binding arbitration all claims, disputes and controversies between or
among them (and their respective employees, officers, directors, attorneys, and
other agents), whether in tort, contract or otherwise in any way arising out of
or relating to (i) any credit subject hereto, or any of the Loan Documents, and
their negotiation, execution, collateralization, administration, repayment,
modification, extension, substitution, formation, inducement, enforcement,
default or termination; or (ii) requests for additional credit.

     (b) Governing Rules. Any arbitration proceeding will (i) proceed in a
location in Washington selected by the American Arbitration Association ("AAA");
(ii) be governed by the Federal Arbitration Act (Title 9 of the United States
Code), notwithstanding any conflicting choice of law provision in any of the
documents between the parties; and (iii) be conducted by the AAA, or such other
administrator as the parties shall mutually agree upon, in accordance with the
AAA's commercial dispute resolution procedures, unless the claim or counterclaim
is at least $1,000,000.00 exclusive of claimed interest, arbitration fees and
costs in which case the arbitration shall be conducted in accordance with the
AAA's optional procedures for large, complex commercial disputes (the commercial
dispute resolution procedures or the optional procedures for large, complex
commercial disputes to be referred to herein, as applicable, the "Rules"). If
there is any inconsistency between the terms hereof and the Rules, the terms and
procedures set forth herein shall control. Any party who fails or refuses to
submit to arbitration following a demand by any other party shall bear all costs
and expenses incurred by such other party in compelling arbitration of any
dispute. Nothing contained herein shall be deemed to be a waiver by any party
that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or
any similar applicable state law.

     (c) Arbitrator Qualifications and Powers. Any arbitration proceeding in
which the amount in controversy is $5,000,000.00 or less will be decided by a
single mutually acceptable arbitrator and who shall not render an award of
greater than $5,000,000.00. Any dispute in which the amount in controversy
exceeds $5,000,000.00 shall be decided by majority vote of a panel of three
arbitrators selected in accordance with the Rules; provided however, that all
three arbitrators must actively participate in all hearings and deliberations.
The arbitrator will be a neutral attorney licensed in the State of Washington or
a neutral retired judge of the stet or federal judiciary of Washington, in
either case with a minimum of ten years experience in the substantive law
applicable to the subject matter of the dispute to be arbitrated. The arbitrator


                                      -12-



will determine whether or not an issue is arbitratable ad will give effect to
the states of limitation in determining any claim. In any arbitration proceeding
the arbitrator will decide (by documents only or with a hearing at the
arbitrator's discretion) any pre-hearing motions which are similar to motions to
dismiss for failure to state a claim or motions for summary adjudication. The
arbitrator shall resolve all disputes in accordance with the substantive law of
Washington and may grant any remedy or relief as is necessary to make effective
any award. The arbitrator shall also have the power to award reasonable fees, to
impose sanctions and to take such other action as the arbitrator seems necessary
to the same extent a judge could pursuant to the Federal Rules of Civil
Procedures, the Washington Rules of Civil Procedure or other applicable law.
Judgment upon the award rendered by the arbitrator may be entered in any court
having jurisdiction. The institution and maintenance of any action for judicial
relief or pursuit of a provisional or ancillary remedy shall not constitute a
waiver of the right of any party, including the plaintiff, to submit the
controversy or claim to arbitration if any other party contests such action for
judicial relief.

     (d) Class Proceedings and Consolidations. No party hereto shall be entitled
to join or consolidate disputes by or against others in any arbitration, except
parties who have executed any Loan Document, or to include in any arbitration
any dispute as a representative or member of a class, or to act in any
arbitration in the interest of the general public or in a private attorney
general capacity.

     (e) Payment of Arbitration Costs and Fees. The arbitrator shall award all
costs and expenses of the arbitration proceeding to the prevailing party.

     (f) Miscellaneous. To the maximum extend practicable, the AAA, the
arbitrators and the parties shall take all action required to conclude any
arbitration proceeding within 180 days of the filing of the dispute with the
AAA. No arbitrator or other party to an arbitration proceeding may disclose the
existence, content or results thereof, except for disclosures of information by
a party required in the ordinary course of its business or by applicable law or
regulation. If more than one agreement for arbitration by or between the parties
potentially applies to a dispute, the arbitration provision most directly
related to the Loan Documents or the subject matter of the dispute shall
control. This arbitration provision shall survive termination, amendment or
expiration of any of the Loan Documents or any relationship between the parties.

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT OR TO FORBEAR
ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW.

     IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the day and year first written above.

STERLING FINANCIAL CORPORATION          WELLS FARGO BANK,
                                        NATIONAL ASSOCIATION


By: /s/ Daniel G. Byrne                 By: /s/ David S. Hernandez
    ---------------------------------       ------------------------------------
Title: EVP - Finance                        David S. Hernandez
                                            SVP & Division Manager


                                      -13-


                       FIRST AMENDMENT TO CREDIT AGREEMENT

     THIS AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered into as of
August 29, 2006, by and between STERLING FINANCIAL CORPORATION, a Washington
corporation ("Borrower"), and WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank").

                                    RECITALS

     WHEREAS, Borrower is currently indebted to Bank pursuant to the terms and
conditions of that certain Credit Agreement between Borrower and Bank dated as
of August 4, 2006, as amended from time to time ("Credit Agreement").

     WHEREAS, Bank and Borrower have agreed to certain changes in the terms and
conditions set forth in the Credit Agreement and have agreed to amend the Credit
Agreement to reflect said changes.

     NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, the parties hereto agree that the Credit
Agreement shall be amended as follows:

     1. Section 1.1 (a) is hereby amended by deleting "Forty Million Dollars
($40,000,000.00)" as the maximum principal amount available under the Line of
Credit, and by substituting for said amount "Thirty Million Dollars
($30,000,000.00)," with such change to be effective upon the execution and
delivery to Bank of a promissory note dated as of August 29, 2006 (which
promissory note shall replace and be deemed the Line of Credit Note defined in
and made pursuant to the Credit Agreement) and all other contracts, instruments
and documents required by Bank to evidence such change.

     2. In consideration of the changes set forth herein, promptly upon receipt
by Bank of an executed copy of this Amendment and the Line of Credit Note
reducing the maximum principal amount of the Line of Credit to $30,000,000.00,
Bank shall refund to Borrower $5,000.00 of the $20,000.00 that the Borrower has
paid to Bank as a commitment fee.

     3. Except as specifically provided herein, all terms and conditions of the
Credit Agreement remain in full force and effect, without waiver or
modification. All terms defined in the Credit Agreement shall have the same
meaning when used in this Amendment. This Amendment and the Credit Agreement
shall be read together, as one document.

     4. Borrower hereby remakes all representations and warranties contained in
the Credit Agreement and reaffirms all covenants set forth therein. Borrower
further certifies that as of the date of this Amendment there exists no Event of
Default as defined in the Credit Agreement, nor any condition, act or event
which with the giving of notice or the passage of time or both would constitute
any such Event of Default.

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT OR TO FORBEAR
ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW.


                                       -1-



     IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed as of the day and year first written above.

STERLING FINANCIAL CORPORATION          WELLS FARGO BANK,
                                        NATIONAL ASSOCIATION


By: /s/ Daniel G. Byrne                 By: /s/ Brandon Kowsky
    ---------------------------------       ------------------------------------
Title: Executive Vice President,            Brandon Kowsky
       Assistant Secretary,                 Vice President
       and Chief Financial Officer


                                       -2-

EX-31.1

                                  EXHIBIT 31.1

                  Certification of Principal Executive Officer

      I, Harold B. Gilkey, certify that:

      1.    I have reviewed this quarterly report on Form 10-Q of Sterling
            Financial Corporation;

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

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

      4.    The registrant's other certifying officer and I are responsible for
            establishing and maintaining disclosure controls and procedures (as
            defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
            control over financial reporting (as defined in Exchange Act Rules
            13a-15(f) and 15d-15(f)) for the registrant and have:

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

            b)    Designed such internal control over financial reporting, or
                  caused such internal control over financial reporting to be
                  designed under our supervision, 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;

            c)    Evaluated the effectiveness of the registrant's disclosure
                  controls and procedures and presented in this report our
                  conclusions about the effectiveness of the disclosure controls
                  and procedures, as of the end of the period covered by this
                  report based on such evaluation; and

            d)    Disclosed in this report any change in the registrant's
                  internal control over financial reporting that occurred during
                  the registrant's most recent fiscal quarter (the registrant's
                  fourth fiscal quarter in the case of an annual report) that
                  has materially affected, or is reasonably likely to materially
                  affect, the registrant's internal control over financial
                  reporting; and

      5.    The registrant's other certifying officer and I have disclosed,
            based on our most recent evaluation of internal control over
            financial reporting, to the registrant's auditors and the audit
            committee of the registrant's board of directors (or persons
            performing the equivalent functions):

            a)    All significant deficiencies and material weaknesses in the
                  design or operation of internal control over financial
                  reporting which are reasonable likely to adversely affect the
                  registrant's ability to record, process, summarize and report
                  financial information; and

            b)    Any fraud, whether or not material, that involves management
                  or other employees who have a significant role in the
                  registrant's internal control over financial reporting.

Dated: November 8, 2006       By:        /s/ Harold B. Gilkey
                                  ----------------------------------------------
                                  HAROLD B. GILKEY
                                  Chairman and Chief Executive Officer

                                      E-2

EX-31.2

                                  EXHIBIT 31.2

                  Certification of Principal Financial Officer

      I, Daniel G. Byrne, certify that:

      1.    I have reviewed this quarterly report on Form 10-Q of Sterling
            Financial Corporation;

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

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

      4.    The registrant's other certifying officer and I are responsible for
            establishing and maintaining disclosure controls and procedures (as
            defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
            control over financial reporting (as defined in Exchange Act Rules
            13a-15(f) and 15d-15(f)) for the registrant and have:

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

            b)    Designed such internal control over financial reporting, or
                  caused such internal control over financial reporting to be
                  designed under our supervision, 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;

            c)    Evaluated the effectiveness of the registrant's disclosure
                  controls and procedures and presented in this report our
                  conclusions about the effectiveness of the disclosure controls
                  and procedures, as of the end of the period covered by this
                  report based on such evaluation; and

            d)    Disclosed in this report any change in the registrant's
                  internal control over financial reporting that occurred during
                  the registrant's most recent fiscal quarter (the registrant's
                  fourth fiscal quarter in the case of an annual report) that
                  has materially affected, or is reasonably likely to materially
                  affect, the registrant's internal control over financial
                  reporting; and

      5.    The registrant's other certifying officer and I have disclosed,
            based on our most recent evaluation of internal control over
            financial reporting, to the registrant's auditors and the audit
            committee of the registrant's board of directors (or persons
            performing the equivalent functions):

            a)    All significant deficiencies and material weaknesses in the
                  design or operation of internal control over financial
                  reporting which are reasonable likely to adversely affect the
                  registrant's ability to record, process, summarize and report
                  financial information; and

            b)    Any fraud, whether or not material, that involves management
                  or other employees who have a significant role in the
                  registrant's internal control over financial reporting.

Dated: November 8, 2006     By:       /s/ Daniel G. Byrne
                                -----------------------------------------------
                                DANIEL G. BYRNE
                                Executive Vice President, Assistant Secretary,
                                and Chief Financial Officer

                                      E-3

EX-32.1

                                  EXHIBIT 32.1

                  Certification of Principal Executive Officer

                       Pursuant to 18 U.S.C. Section 1350

In connection with the accompanying Report on Form 10-Q of Sterling Financial
Corporation ("Sterling") for the period ended September 30, 2006 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Harold B. Gilkey, Chief Executive Officer of Sterling, hereby certify, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:

      1)    The Report fully complies with the requirements of Section 13(a) or
            15(d) of the Securities Exchange Act of 1934, as amended; and

      2)    The information contained in the Report fairly presents, in all
            material respects, the financial condition and results of operations
            of the Company.

Dated: November 8, 2006    By:    /s/ Harold B. Gilkey
                               -------------------------------------------------
                               HAROLD B. GILKEY
                               Chairman and Chief Executive Officer

This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by Sterling for purposes of Section
18 of the Securities Exchange Act of 1934, as amended.

A signed original of this written statement required by Section 906 has been
provided to Sterling and will be retained by Sterling and furnished to the
Securities and Exchange Commission upon request.

                                      E-4

EX-32.2

                                  EXHIBIT 32.2

                  Certification of Principal Financial Officer

                       Pursuant to 18 U.S.C. Section 1350

In connection with the accompanying Report on Form 10-Q of Sterling Financial
Corporation ("Sterling") for the period ended September 30, 2006 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Daniel G. Byrne, Principal Financial Officer of Sterling, hereby certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:

      1)    The Report fully complies with the requirements of Section 13(a) or
            15(d) of the Securities Exchange Act of 1934, as amended; and

      2)    The information contained in the Report fairly presents, in all
            material respects, the financial condition and results of operations
            of the Company.

Dated:  November 8, 2006     By:    /s/ Daniel G. Byrne
                                 --------------------------------------------
                                 DANIEL G. BYRNE
                                 Executive Vice President, Assistant Secretary,
                                 and Chief Financial Officer

This certification accompanies each Report pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the
Sarbanes-Oxley Act of 2002, be deemed filed by Sterling for purposes of Section
18 of the Securities Exchange Act of 1934, as amended.

A signed original of this written statement required by Section 906 has been
provided to Sterling and will be retained by Sterling and furnished to the
Securities and Exchange Commission upon request.

                                      E-5