Income Taxes:

During the year ended December 31, 2012, Sterling recorded a $292.0 million income tax benefit, which was the result of reversing the deferred tax asset valuation allowance. Sterling did not recognize any federal or state income tax expense during 2011. As of December 31, 2012, the net deferred tax asset was $292.1 million, including $274.0 million of net operating loss and tax credit carry-forwards. A valuation allowance of $1.8 million remains, relating to certain state tax credits that will likely expire unused. As of December 31, 2011, Sterling had a fully reserved net deferred tax asset of $327.4 million, including $285.0 million of net operating loss and tax credit carry-forwards.

A deferred tax asset valuation allowance was established during 2009 due to the three year cumulative loss and uncertainty at that time regarding Sterling's ability to generate future taxable income. Reversal of the deferred tax asset valuation allowance occurred during the quarter ended June 30, 2012, which marked the sixth consecutive quarter of profitability for Sterling. Prior to reversing the allowance, management analyzed both positive and negative evidence that could affect the realization of the deferred tax asset. Based on the earnings performance trend and projections of income through 2013, improvement in asset quality, higher net interest margin and improvements in other key financial ratios, expectations of continued profitability, the length of the carry-forward period for its net operating losses and tax credits, an analysis of the reversal of existing temporary differences, and an evaluation of its loss carry-back ability and tax planning strategies, Sterling determined that it was more likely than not that the net deferred tax asset would be realized. This assessment was updated as of December 31, 2012, resulting in the same conclusion. As a result, the deferred tax asset valuation allowance was $1.8 million at December 31, 2012, compared to $327.4 million at December 31, 2011.

The components of income tax expense (benefit) included in the consolidated statements of operations were as follows:



	Years Ended December 31,
	2012			2011			2010
	(in thousands)
Current income taxes:
Federal	$	(163	)	$	(248	)	$	(102	)
State	0			(27		)	(11		)
Total current income taxes	(163		)	(275		)	(113		)

Deferred income taxes:
Federal	(269,968		)	248			102
State	(21,912		)	27			11
Total deferred income taxes	(291,880		)	275			113
Total income tax (benefit) expense	$	(292,043	)	$	0		$	0

The tax effects of the principal temporary differences giving rise to deferred tax assets and liabilities were as follows:



	December 31,
	2012			2011
	(in thousands)
Deferred tax assets:
NOL carryforwards - federal	$	242,318		$	250,946
NOL carryforwards - state	21,443			22,110
Tax credits - federal	7,671			7,587
Tax credits - state	2,594			4,167
Allowance for losses on loans	61,385			75,393
Deferred compensation	10,760			12,485
Bonus accrual	4,670			2,138
Intangibles	2,284			6
Purchase accounting premiums and discounts	2,087			3,877
Nonaccrual loans	1,931			2,167
Deferred rent	1,119			1,063
Other	3,394			3,044
Total deferred tax assets	361,656			384,983
Deferred tax liabilities:
Unrealized gains on available-for-sale securities	22,627			22,670
FHLB Seattle dividends	16,325			16,486
Mortgage servicing rights	11,869			8,169
Fair value - loans held for sale	8,966			3,093
Deferred loan fees	5,867			5,162
Prepaid expenses	2,151			1,945
ASC 740 (FIN 48) - temporary differences	5			9
Total deferred tax liabilities	67,810			57,534
Valuation allowance	(1,764		)	(327,449		)
Net deferred tax asset	$	292,082		$	0

As of December 31, 2012, the net operating loss carry-forwards represented the tax effect of $692.3 million of federal operating loss carry-forwards, $442.4 million of state operating loss carry-forwards, federal tax credits of $7.7 million, and state tax credits of $2.6 million. These operating loss carry-forwards and tax credits expire between 2014 and 2031.

With regard to the deferred tax asset, the benefits of Sterling’s accumulated tax losses would be reduced in the event of an “ownership change,” as determined under Section 382 of the Internal Revenue Code. During 2010, in order to preserve the benefits of these tax losses, Sterling’s shareholders approved a protective amendment to Sterling's Restated Articles of Incorporation and Sterling’s board adopted a tax preservation rights plan, both of which restrict certain stock transfers that would result in an investor acquiring more than 4.95% of Sterling’s total outstanding common stock.

The following table summarizes the calculation of Sterling's effective tax rates for the periods presented:



	Years Ended December 31,
	2012		2011		2010
Income tax provision at the federal statutory rate	35.0	%	35.0	%	35.0	%
Tax effect of:
Deferred tax valuation allowance	(347.8	)%	(25.0	)%	(40.1	)%
State taxes, net of federal benefit	3.8	%	0.0	%	3.1	%
Tax-exempt interest	(2.5	)%	(6.3	)%	1.0	%
Bank owned life insurance	(3.2	)%	(5.8	)%	1.1	%
Tax credits	0.0	%	(1.6	)%	0.9	%
Other, net	3.2	%	3.7	%	(1.0	)%
Effective tax rate	(311.5	)%	0.0	%	0.0	%

The following is a reconciliation of the beginning and ending amount of unrecognized tax positions for the periods presented:



	2012			2011			2010
	(in thousands)
Balance at January 1	$	525		$	1,586		$	6,330
Additions - current year tax positions	70			75			65
Additions - prior year tax positions	0			0			0
Reductions - prior year tax positions	(183		)	(1,136		)	(4,809		)
Balance at December 31	412			525			1,586
Accrued interest and penalties, net of tax effect at December 31	100			103			140
Total liability for unrecognized tax positions at December 31	$	512		$	628		$	1,726

Sterling's tax positions for the years 2008 through 2012 remain subject to review by federal and state taxing authorities. Realization of $386,000 of unrecognized tax benefits would result in a favorable impact to the effective tax rate.