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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

/x/
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the year ended December 31, 2000

OR

/ / 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 (State or other jurisdiction of incorporation or organization)	91-1572822 (IRS Employer Identification No.)
111 North Wall Street, Spokane, Washington (Address of principal executive offices)	99201 (Zip code)

Registrant's telephone number, including area code: (509) 458-2711

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

None
(Title of class) None
(Name of each exchange on which registered)

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

Common Stock ($1.00 par value)
9.50% Cumulative Capital Securities
(Title of class)

   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

   As of February 28, 2001, the aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked prices on such date as reported by the Nasdaq National Market, was $104,415,239.

   The number of shares outstanding of the Registrant's Common Stock, par value $1.00 per share, as of February 28, 2001 was 8,922,021.

DOCUMENTS INCORPORATED BY REFERENCE

   Specific portions of the Registrant's Proxy Statement dated March 23, 2001 are incorporated by reference into Part III hereof.

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

STERLING FINANCIAL CORPORATION

DECEMBER 31, 2000 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

			Page
PART I			1
	Item 1.	Business	1
		General	1
		Growth and Acquisition Strategies	2
		Lending Activities	2
		Investments and Mortgage-Backed Securities	12
		Sources of Funds	13
		Subsidiaries	18
		Competition	19
		Personnel	20
		Regulation	20
	Item 2.	Properties	28
	Item 3.	Legal Proceedings	29
	Item 4.	Submission of Matters to a Vote of Security Holders	29
PART II			29
	Item 5.	Market for the Registrant's Stock and Related Shareholder Matters	29
	Item 6.	Selected Financial Data	30
	Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
		General	31
		Net Interest Income	32
		Asset and Liability Management	34
		Financial Position	37
		Results of Operations for the Years Ended December 31, 2000 and 1999	38
		Results of Operations for the Years Ended December 31, 1999 and 1998	41
		Liquidity and Sources of Funds	44
		Capital Resources	45
		New Accounting Standards	47
		Effects of Inflation and Changing Prices	47
	Item 7.A.	Quantitative and Qualitative Disclosures About Market Risk	48
	Item 8.	Financial Statements and Supplementary Data	48
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	48
PART III			48
	Item 10.	Directors and Executive Officers of the Registrant	48
	Item 11.	Executive Compensation	48
	Item 12.	Security Ownership of Certain Beneficial Owners and Management	48
	Item 13.	Certain Relationships and Related Transactions	48
PART IV			48
	Item 14.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	48
SIGNATURES			51

Any trend or forward-looking information discussed in this report is subject to numerous possible risks and uncertainties. These include but are not limited to: the possibility of adverse economic developments which may, among other things, increase default and delinquency risks in Sterling's loan portfolios; shifts in interest rates which may result in lower interest rate margins; shifts in the demand for Sterling's loan and other products; lower than expected revenue or cost savings in connection with acquisitions; changes in accounting policies; changes in the monetary and fiscal policies of the federal government; changes in laws, regulations and the competitive environment. Sterling's future results may differ materially from historical results as well as from any trend or forward-looking information included in this report.

PART I

Item 1.  Business

General

    Sterling Financial Corporation ("Sterling") is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank ("Sterling Savings Bank"), formerly Sterling Savings Association. The significant 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.

    Sterling provides personalized, quality financial services to its customers as exemplified by its "Hometown Helpful" philosophy. Sterling believes that this dedication to personalized service has enabled it to maintain a stable retail deposit base. With $2.66 billion in total assets at December 31, 2000, Sterling attracts Federal Deposit Insurance Corporation ("FDIC") insured deposits from the general public through 77 retail branches located primarily in rural and suburban communities in Washington, Oregon, Idaho and Montana. Sterling originates loans through its branch offices, as well as Action Mortgage residential loan production offices in the metropolitan areas of Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho, and through INTERVEST commercial real estate lending offices located in the metropolitan areas of Spokane and Seattle, Washington; and Portland, Oregon. Sterling also markets tax-deferred annuities, mutual funds and other financial products through Harbor Financial.

    Sterling is also rapidly developing new channels to better service its customers. During 2000, Sterling launched its Internet Banking Web site at www.sterlingsavingsbank.net. Further, Sterling introduced business cash management, international banking and leasing services. With the implementation of in-house check processing, Sterling offers account imaging and better account analysis and now has the capability to offer lockbox services to its customers. Newer technology advancements will also enable Sterling to implement cost efficiency measures in the future, although there is no assurance that such benefits will be realized.

    Sterling continues to enhance its presence as a community bank by increasing its commercial real estate, business banking, consumer and construction lending while increasing its retail deposits, particularly transaction accounts. Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential loans. Such loans, however, generally involve a higher degree of risk than financing residential real estate. Sterling's revenues are derived primarily from interest earned on loans, investments and mortgage-backed securities ("MBS"), from fees and service charges and from mortgage banking operations. The operations of Sterling Savings Bank, and savings institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities, the Office of Thrift Supervision ("OTS"), the FDIC and the State of Washington Department of Financial Institutions ("Washington Supervisor"). See "Regulation."

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Growth and Acquisition Strategies

    Management believes that by changing the mix of assets and liabilities to be more like a community bank, its net interest income (the difference between the interest earned on loans and investments and the interest paid on liabilities) and other fee income will increase, although there can be no assurance in this regard. Sterling intends to continue to pursue an aggressive growth strategy, which may include acquiring other financial institutions or branches thereof or other substantial assets or deposit liabilities. Sterling may not be successful in identifying further acquisition candidates, integrating acquired institutions or preventing deposit erosion or loan quality deterioration at acquired institutions. There is significant competition for acquisitions in Sterling's market area, and Sterling may not be able to acquire other institutions 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 favorable economic and market conditions. There can be no assurance that Sterling will be successful in implementing its growth strategy.

Lending Activities

    Focus on Community Lending.  In recent years, Sterling has focused its efforts on becoming more like a community retail bank. Accordingly, Sterling is increasing its commercial real estate (including multifamily residential real estate), business banking, consumer and construction lending. Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential mortgage loans. Such loans, however, generally involve a higher degree of risk than the financing of residential real estate.

    Business Banking Lending.  Sterling has a Business Banking Group which provides a full range of credit products to small- and medium-sized businesses, including consumer, private banking and agriculture loans. Credit products include lines of credit, receivables and inventory financing, equipment loans and permanent and construction real restate financing. Loans may be made on an unsecured, partially-secured or fully-secured basis. The credit product line for both businesses and individuals includes standardized products as well as customized, individual accommodations.

    Sterling's Private Banking Group provides services to higher-net-worth and higher-income borrowers by originating a variety of consumer and business banking loans. Such loans generally, but do not always, meet the same underwriting requirements as general consumer loans of the same type. Private banking loans typically involve larger balances and may have nonstandard terms.

    Sterling's Agriculture Lending Group offers agriculture loans to a variety of agricultural producers. In connection with such loans, Sterling evaluates the borrowers' financial, production, marketing and management abilities. Such loans may include annual operating loans and term loans to finance the purchase of machinery, equipment, production livestock and real estate. Such loans also may be made to cover interim operating and family living expenses.

    Sterling has established minimum underwriting standards which delineate criteria for sources of repayment, financial strength and credit enhancements such as guarantees. Typically, the primary source of repayment is recurring cash flow of the borrower or cash flow from the business or project being financed. Depending on the type of loan, underwriting standards include minimum financial requirements, maximum loan-to-collateral value ratios, minimum cash flow coverage of debt service, debt-to-income ratios and minimum liquidity requirements. Exceptions to the minimum underwriting standards may be made depending upon the type of loan and financial strength of the borrower. All exceptions are reported to the Sterling Senior Loan Committee and in some cases are reported to Sterling's Board of Directors. Common forms of collateral pledged to secure business banking loans include real estate, accounts receivable, inventory, equipment, agricultural crops or livestock and

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marketable securities. Most loans have maximum terms of one to seven years and loan-to-value ratios in the range of 65% to 80%, based on an analysis of the collateral pledged.

    Business banking loans generally involve a higher degree of risk than the financing of real estate, primarily because collateral is more difficult to appraise, security interests in the collateral are more difficult to perfect, the collateral may be difficult to obtain or liquidate following an uncured default and it is difficult to accurately predict the borrower's ability to generate future cash flows. Business banking loans, however, typically offer relatively higher yields and variable interest rates. The availability of such loans enables potential depositors to establish full-service banking relationships with Sterling. At December 31, 2000, business banking loans were 21.9% of Sterling's total loan portfolio.

    Consumer Lending.  Sterling's Consumer Lending Group provides loans for home improvements, automobiles, personal lines of credit, boats and certain other purposes. Generally, consumer loans are originated for terms ranging from six months to ten years. Interest rates are either fixed or adjustable monthly, quarterly or semiannually, based on a contractual formula at a margin over an established external indices. Sterling also makes loans collateralized by savings accounts and second mortgage loans collateralized by real estate. Fixed-rate secured financing is available with amortization terms of up to 15 years.

    Sterling actively participates in the transportation finance market, primarily through consumer indirect auto loans (sales finance contracts). Sterling also makes direct (branch originated) auto, marine and recreational vehicle loans. Most applicants for these credit products are assigned a credit score, which is designed to indicate the relative probability of repayment. The credit scoring models are validated as to their predictive power on a periodic basis. The Consumer Lending Group includes in its credit criteria other judgmental factors, such as the advance rate and debt-to-income ratio, which are used to augment this credit score. However, all credit decisions made contrary to an established cut-off score are required to be supported and documented by a credit officer with the appropriate approval authority. Consumer loans, especially those originated through dealers, generally have greater inherent risks than other types of loans. At December 31, 2000, consumer direct and indirect loans were 11.8% and 0.9%, respectively, of Sterling's total loan portfolio. Consumer indirect loans at December 31, 2000 declined as a percentage of total loans due to the automobile loan securitization described below.

    On December 22, 2000, Sterling completed its first securitization of automobile receivables. A subsidiary of Sterling Savings Bank issued $87.0 million of 6.61% asset-backed (Class A) notes rated AAA and $4.9 million of 7.39% asset-backed (Class B) notes rated A-. Principal and interest will be distributed monthly to the note holders. The final maturity date on the notes is February 15, 2008. However, payment of the notes could occur earlier than that date. The notes were privately placed to qualified institutional buyers (as defined under Rule 144A under the Securities Act). Sterling recognized a gain of $149,000 on the sale and will receive a .50% servicing fee.

    One- to Four-Family Residential Lending.  Sterling originates fixed-rate and adjustable rate mortgages ("ARMs"), which have interest rates that adjust annually or every three, five and seven years and are indexed to a variety of market indices. Sterling also originates one- to four-family residential construction loans.

    Sterling continues to originate conventional and government-insured residential loans for sale into the secondary mortgage market. Within the secondary mortgage market for conventional loans, Sterling sells its residential loans primarily on a servicing-released basis to others. Sterling also sells loans to the Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association ("FNMA"). Sterling endeavors to underwrite residential loans in compliance with FHLMC and FNMA underwriting standards. Loans sold into the secondary market are all sold without recourse to Sterling, except that Sterling may be obligated to repurchase any loans which are not underwritten in accordance with FHLMC and FNMA or applicable investor underwriting guidelines. At December 31,

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2000, 20.6% of Sterling's total loan portfolio consisted of conventional one- to four-family residential loans.

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

    Sterling makes residential construction loans on custom homes, presold homes and homes that are built for sale. Sterling also provides acquisition and development loans for residential subdivisions. Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied real estate. Sterling's risk of loss on construction loans depends largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. If the estimate of construction costs proves to be inaccurate, Sterling might have to advance funds beyond the amount originally committed to permit completion of the development and to protect its security position. Sterling also might be confronted, at or prior to maturity of the loan, with a project with insufficient value to ensure full repayment. Sterling's underwriting, monitoring and disbursement practices with respect to construction financing are intended to ensure that sufficient funds are available to complete construction projects. Sterling endeavors to limit its risk through its underwriting procedures by using only approved, qualified appraisers and by dealing only with qualified builders/borrowers. The properties that serve as underlying collateral for these construction loans are located primarily in the Puget Sound, Portland, Oregon, Boise, Idaho, and eastern Washington regions.

    At December 31, 2000, 10.8% of Sterling's total loan portfolio consisted of one- to four-family residential construction loans, approximately 86% of which were for properties that were built for sale. Further, approximately 53% of Sterling's one- to four-family residential construction loan portfolio was concentrated in the Portland, Oregon market which is served by one loan production office. A reduction in market values or in the demand for residential housing, particularly in the Portland market, could lead to higher delinquencies and foreclosures and have a negative impact on Sterling.

    Multifamily Residential and Commercial Property Lending.  Sterling offers multifamily residential and commercial real estate loans as both construction and permanent loans collateralized by real property primarily in the Pacific Northwest. Construction loans on such properties typically have terms of 12 to 18 months and provide for variable interest rates. Permanent loans on existing properties typically have maturities of three to ten years. Multifamily residential and commercial property loans generally involve a higher degree of risk than the financing of one- to four-family residential real estate because they typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the real estate project and is subject to certain risks not present in one- to four-family residential mortgage lending. These risks include excessive vacancy rates or inadequate operating cash flows. Construction lending is subject to risks such as construction delays, cost overruns, insufficient values and an inability to obtain permanent financing in a timely manner. Sterling attempts to reduce its exposure to these risks, typically by investigating the borrowers' finances and, depending on the circumstances, requiring annual financial statements from the borrowers, requiring operating statements on the properties or acquiring personal guarantees from the borrowers. At December 31, 2000, 8.2% of Sterling's total loan portfolio consisted of multifamily residential construction and commercial property construction loans. At December 31, 2000, 25.7% of Sterling's total loan portfolio consisted of multifamily residential and commercial property permanent loans.

4

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

	Years Ended December 31,
	2000			1999			1998
	Amount		%	Amount		%	Amount		%
	(Dollars in thousands)
Mortgage—permanent:
One-to four-family residential	$	95,527	9.3	$	172,115	14.4	$	241,725	24.0
Multifamily residential		55,465	5.4		58,319	4.9		83,904	8.3
Commercial property		51,797	5.1		108,216	9.0		34,735	3.5
Mortgage—construction:
One-to four-family residential		310,065	30.3		320,136	26.6		226,025	22.5
Multifamily residential		48,112	4.7		66,520	5.5		47,809	4.8
Commercial property		84,053	8.2		31,651	2.6		42,301	4.2
Non-mortgage:
Consumer—direct		88,364	8.7		97,047	8.1		99,449	9.8
Consumer—indirect		45,991	4.5		51,956	4.3		51,958	5.2
Business banking		242,916	23.8		295,915	24.6		178,209	17.7
Total loans originated	$	1,022,290	100.0	$	1,201,875	100.0	$	1,006,115	100.0

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

	December 31,
	2000				1999				1998				1997				1996
	Amount			%	Amount			%	Amount			%	Amount			%	Amount			%
	(Dollars in thousands)
Mortgage—permanent:
One-to four-family residential	$	409,592		20.6	$	396,565		22.0	$	342,757		23.1	$	313,792		28.1	$	304,216		31.1
Multifamily residential		163,675		8.2		137,835		7.6		124,656		8.4		68,697		6.2		73,455		7.5
Commercial property		347,654		17.5		317,565		17.6		177,912		12.0		120,068		10.8		104,372		10.7
Land and other		956		0.1		0		0.0		0		0.0		434		0.0		385		0.0
		921,877		46.4		851,965		47.2		645,325		43.5		502,991		45.1		482,428		49.3
Mortgage—construction:
One-to four-family residential		215,844		10.8		184,081		10.2		141,288		9.5		131,701		11.8		100,694		10.3
Multifamily residential		80,728		4.1		71,024		3.9		45,794		3.1		59,212		5.3		39,191		4.0
Commercial property		81,347		4.1		32,018		1.8		46,485		3.1		20,979		1.9		32,368		3.3
		377,919		19.0		287,123		15.9		233,567		15.7		211,892		19.0		172,253		17.6
Total mortgage loans		1,299,796		65.4		1,139,088		63.1		878,892		59.2		714,883		64.1		654,681		66.9
Consumer—direct		235,423		11.8		223,286		12.4		224,651		15.1		139,666		12.5		124,529		12.7
Consumer—indirect		17,368		0.9		94,420		5.2		64,764		4.4		19,016		1.7		0		0.0
Business banking		435,284		21.9		348,941		19.3		315,614		21.3		241,808		21.7		199,848		20.4
Total loans receivable		1,987,871		100.0		1,805,735		100.0		1,483,921		100.0		1,115,373		100.0		979,058		100.0
Deferred loan origination (fees) and costs		(5,383	)			(4,338	)			(2,309	)			232				156
Premium (discount) on loans acquired pursuant to purchase transactions		179				1,977				1,545				(380	)			(629	)
Allowance for loan losses		(16,740	)			(15,603	)			(14,623	)			(9,486	)			(8,389	)
Loans receivable, net	$	1,965,927			$	1,787,771			$	1,468,534			$	1,105,739			$	970,196

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    Contractual Principal Payments.  The following table sets forth the scheduled contractual principal repayments for Sterling's loan portfolio at December 31, 2000. Demand loans, loans having no stated repayment schedule and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, unearned discounts and premiums, deferred loan origination costs and fees, or allowances for loan losses.

				Principal Payments Contractually Due in
		Balance Outstanding at December 31, 2000
				2001		2002-2005		Thereafter
		(Dollars in thousands)
Mortgage—permanent:
	Fixed rate	$	528,867	$	14,327	$	52,888	$	461,652
	Variable rate		393,010		11,725		109,197		272,088
Mortgage—construction			377,919		250,263		117,797		9,859
Consumer—direct			235,423		68,059		69,672		97,692
Consumer—indirect			17,368		1,632		7,052		8,684
Business banking			435,284		146,842		149,199		139,243
		$	1,987,871	$	492,848	$	505,805	$	989,218

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

    For residential mortgage loans serviced for other investors, Sterling receives a fee, generally ranging from 0.25% to 0.375% of the unpaid principal balance. At December 31, 2000 and 1999, Sterling serviced for itself and for other investors residential mortgage loans totaling $777.5 million and $751.7 million, respectively. Of such mortgage loans, Sterling serviced $121.4 million and $140.5 million, respectively, at these dates for FHLMC and FNMA. Sterling's ability to continue as a seller/servicer for FHLMC and FNMA is dependent upon meeting the qualifications of these agencies. Sterling currently meets all applicable requirements.

    Sterling receives a fee for servicing commercial real estate loans for other investors. This fee generally ranges from 0.10% to 0.25% of the unpaid principal balance. At December 31, 2000 and 1999, Sterling serviced for itself and other investors commercial real estate loans totaling $475.3 million and $402.9 million, respectively.

    Sterling also receives a fee of .50% of the unpaid principal balance of each loan for servicing automobile loans for other investors. At December 31, 2000, Sterling serviced $89.3 million of such loans.

    From time to time, Sterling sells portfolios of servicing rights primarily to improve earnings and to increase its regulatory capital ratios. During the year ended December 31, 1998, Sterling sold, in bulk, rights to service conventional loans for others of approximately $117.6 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations (hereafter referred to as "Management's Discussion and Analysis")—Results of Operations—Other Income."

    Secondary Market Activities.  Sterling has developed correspondent relationships with a number of mortgage companies and financial institutions to facilitate the origination or purchase and sale of mortgage loans in the secondary market on either a participation or whole loan basis. Substantially all of such purchased loans or participations are secured by real estate. Those agents who present loans to

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Sterling for purchase are required to provide a processed loan package prior to commitment. Sterling then underwrites the loan in accordance with its established lending standards.

    Sterling, from time to time, sells participations in certain commercial real estate loans to investors on a servicing-retained basis. During the years ended December 31, 2000 and 1999, Sterling sold approximately $21.4 million and $43.0 million in loans under participation agreements, resulting in net gains of $127,000 and $209,000, respectively.

    In originating one- to four-family residential mortgage loans for sale in the secondary market, Sterling incurs market risk from the time of the loan commitments until such time as the loans are sold. To help minimize this risk, Sterling typically obtains simultaneous commitments from investors to purchase such loans at specified yields.

    In recent years, the majority of conventional, Federal Housing Administration ("FHA") and Veteran's Administration ("VA") insured loans have been sold into the secondary market on a loan-by-loan servicing-released basis. Sterling generally receives a fee of approximately 1.0% to 2.0% of the principal balance of such loans for releasing the servicing.

    Loan Commitments.  Sterling uses written commitments to individual borrowers and mortgage brokers for the purposes of originating and purchasing loans. These commitments establish the terms and conditions under which Sterling will fund the loans. Sterling had outstanding commitments to originate or purchase loans aggregating $258.2 million at December 31, 2000. Sterling also had secured and unsecured commercial and personal lines of credit totaling approximately $357.9 million, of which the undisbursed portion was approximately $216.0 million at December 31, 2000. See Note 17 of "Notes to Consolidated Financial Statements."

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

    Under this system, Sterling classifies loans and other assets it considers of questionable quality. Sterling's system employs the classification categories of "substandard," "doubtful" and "loss." Substandard assets have deficiencies which give rise to the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets, and on the basis of currently existing facts, there is a high probability of loss. An asset classified as loss is considered uncollectible and of such little value that it should not be included as an asset of Sterling. Total classified assets increased to $26.9 million at December 31, 2000 from $19.9 million at December 31, 1999. As a percentage of total assets, classified assets were 1.0% and 0.8% at December 31, 2000 and 1999, respectively. See "—Major Classified Loans."

    Assets classified as substandard or doubtful require the establishment of general valuation allowances in amounts considered by management to be adequate under generally accepted accounting principles ("GAAP"). Assets classified as loss require either a specific valuation allowance of 100% of the amount classified or a write-off of such amount. At December 31, 2000, Sterling's assets classified as loss totaled $1.1 million. Judgments regarding the adequacy of a general valuation allowance are based on on-going evaluations of the nature, volume and quality of the loan portfolio, REO and other assets, specific problem assets and current economic conditions that may affect the recoverability of recorded amounts.

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

    The following table sets forth the activity in Sterling's REO for the periods indicated.

	Years Ended December 31,
	2000			1999			1998
	(Dollars in thousands)
Balance at beginning of period	$	7,299		$	6,232		$	8,817
Loan foreclosures and other additions		5,966			4,875			2,394
Capitalized expenses		794			208			202
Sales and other reductions		(7,652	)		(3,811	)		(5,110	)
Provisions for losses		0			(205	)		(71	)
Balance at end of period	$	6,407		$	7,299		$	6,232

    Major Classified Loans.  Each of Sterling's classified loans with a net carrying value at December 31, 2000 of more than $1.0 million is described below.

    Sterling holds six construction loans to one borrower for three commercial projects and three single-family homes being built for sale in Keizer, Oregon. The commercial projects are between 50% to 60% complete, and the single-family homes are between 74% to 100% complete. As a result of the borrower's failure to adhere to a repayment agreement for the completion of construction and marketing of the subject properties, foreclosure has been commenced on all projects. Sales are scheduled for February, March and April 2001. The aggregate carrying value of these loans at December 31, 2000 was $2.1 million, net of a specific allowance of $30,000.

    Sterling holds four construction loans and twelve permanent loans collateralized by row houses located in Portland, Oregon. The loans were classified as substandard due to the borrower's nonpayment and failure to sell the properties. Deeds in lieu of foreclosure on these sixteen properties are anticipated to be recorded in February 2001. The aggregate carrying value of these loans at December 31, 2000 was $1.9 million. No specific allowance has been established for these loans.

    Sterling holds a commercial agricultural loan collateralized by a first mortgage on farmland located in the Tri-Cities, Washington area. The loan was classified as substandard due to operating losses, and the borrower has recently filed for a debtor conversion from a Chapter 11 bankruptcy to Chapter 7 liquidation. Sterling is proceeding with an action to allow Sterling to proceed against the collateral. The carrying value of this loan at December 31, 2000 was $1.3 million. No specific allowance has been established for this loan.

    Major Real Estate Owned.  Each of Sterling's REO properties with a net carrying value at December 31, 2000 of more than $1.0 million is described below.

    Sterling acquired through foreclosure in March 2000 a 28-unit apartment complex located in Hayden, Idaho. The property is currently being marketed for sale. The carrying value of this loan at December 31, 2000 was $1.1 million. No specific allowance has been established for this loan.

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

9

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

    For consumer loans, a demand letter is sent when the account becomes delinquent for two payments. Additional collection work or repossession may follow. In certain instances, Sterling may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs. Similar collection procedures to those for consumer and mortgage loans are followed for business loans with the exception that these accounts are generally handled as a joint effort between the originating loan officer and the collection department during initial stages of delinquency. On or before 75 days of delinquency, the collection effort is typically shifted from the originating loan officer to the collection department with legal action to follow.

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

	December 31,
	2000			1999			1998			1997			1996
	(Dollars in thousands)
Nonaccrual loans	$	8,385		$	9,259		$	3,050		$	4,755		$	2,329
Restructured loans		0			66			87			150			215
Total nonperforming loans		8,385			9,325			3,137			4,905			2,544
Real estate owned(1)		6,407			7,299			6,232			8,817			3,974
Total nonperforming assets	$	14,792		$	16,624		$	9,369		$	13,722		$	6,518
Ratio of total nonperforming assets to total assets		0.56	%		0.65	%		0.40	%		0.71	%		0.41	%
Ratio of total nonperforming loans to total loans		0.42	%		0.52	%		0.21	%		0.44	%		0.26	%
Ratio of allowance for estimated losses on loans to total nonperforming loans(2)		190.1	%		164.4	%		462.5	%		193.8	%		325.2	%

(1)

Amount is net of the allowance for REO losses.

(2)

Excludes loans classified as loss. Loans classified as loss that are excluded from allowance for loan losses were $803,000, $275,000, $114,000, $47,000 and $262,000 at December 31, 2000, 1999, 1998, 1997 and 1996, respectively. Loans classified as loss that are excluded from total nonperforming loans were $0, $0, $0, $35,000 and $45,000 at December 31, 2000, 1999, 1998, 1997 and 1996, respectively.

    Sterling regularly reviews the collectibility of accrued interest and generally ceases to accrue interest on a loan when either principal or interest is past due by 90 days or more. Any accrued and uncollected interest is eliminated from income at that time. Loans may be placed in nonaccrual status earlier if, in management's judgment, the loan may be uncollectible. Interest on such a loan is then recognized as income only if collected or if the loan is restored to performing status. Additional interest income of $722,000, $485,000 and $159,000 would have been recorded during the years ended December 31, 2000, 1999 and 1998, respectively, if nonaccrual and restructured loans had been current in accordance with their original contractual terms. Interest income of $890,000, $442,000 and $194,000 was recorded on these loans during the years ended December 31, 2000, 1999 and 1998, respectively. Sterling's quality control staff also reviews various aspects of loans originated and acquired by Sterling in an effort to ensure compliance with appropriate underwriting criteria. These reviews assist Sterling in monitoring the performance of its personnel and independent appraisers. Sterling's mortgage loan

10

quality control function is intended to conform to guidelines and standards established by FNMA, FHLMC, and, as applicable, other private investors.

    Allowance for Loan and Real Estate Owned Losses.  Generally, Sterling establishes specific allowances for the difference between the anticipated fair value (market value less selling costs, foreclosure costs and projected holding costs), adjusted for other possible sources of repayment, and the book balance (loan principal and accrued interest or carrying value of REO) of its loans classified as loss and REO. Each classified loan and REO property is reviewed at least monthly. Allowances are established or periodically increased, if necessary, based on the review of information obtained through on-site inspections, market analysis, appraisals and purchase offers. Management believes that allowances for loan and REO losses are adequate, although there can be no assurance in this regard. See Note 6 of "Notes to Consolidated Financial Statements."

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

														Six Months Ended December 31, 1996			Fiscal Year Ended June 30, 1996
		Years Ended December 31,
		2000			1999			1998			1997
		(Dollars in thousands)
Balance at beginning of period		$	15,603		$	14,623		$	9,486		$	8,389		$	8,366		$	7,796
Charge-offs:
	Mortgage—permanent		(209	)		(483	)		(252	)		(219	)		(767	)		(752	)
	Mortgage—construction		(618	)		(227	)		(28	)		(202	)		(7	)		0
	Consumer—direct		(1,181	)		(1,434	)		(1,048	)		(999	)		(384	)		(412	)
	Consumer—indirect		(1,048	)		(925	)		(738	)		(29	)		0			0
	Business banking		(835	)		(103	)		(325	)		(119	)		(19	)		(5	)
Total charge-offs			(3,891	)		(3,172	)		(2,391	)		(1,568	)		(1,177	)		(1,169	)
Recoveries:
	Mortgage—permanent		27			16			34			58			30			23
	Mortgage—construction		1			0			0			0			0			0
	Consumer—direct		165			76			106			96			41			49
	Consumer—indirect		209			152			42			6			0			0
	Business banking		26			8			21			23			8			24
Total recoveries			428			252			203			183			79			96
Net charge-offs			(3,463	)		(2,920	)		(2,188	)		(1,385	)		(1,098	)		(1,073	)
Provisions for loan losses			4,600			3,900			5,325			2,482			1,121			1,643
Allowance for losses on assets acquired			0			0			2,000			0			0			0
Balance at end of period		$	16,740		$	15,603		$	14,623		$	9,486		$	8,389		$	8,366
Allowances allocated to loans classified as loss		$	803		$	275		$	114		$	47		$	262		$	213
Ratio of net charge-offs to average loans outstanding during the period			0.18	%		0.17	%		0.17	%		0.13	%		0.11	%		0.10	%

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

	December 31,
	2000				1999				1998				1997				1996
	Amount		Loans in Category as a Percentage of Total Gross Loans		Amount		Loans in Category as a Percentage of Total Gross Loans		Amount		Loans in Category as a Percentage of Total Gross Loans		Amount		Loans in Category as a Percentage of Total Gross Loans		Amount		Loans in Category as a Percentage of Total Gross Loans
	(Dollars in thousands)
Mortgage—permanent	$	3,801	46.4	%	$	4,837	47.2	%	$	4,535	43.5	%	$	3,800	45.1	%	$	3,589	49.3	%
Mortgage—construction		3,903	19.0			3,336	15.9			3,199	15.7			3,108	19.0			2,380	17.6
Consumer—direct		2,907	11.8			2,397	12.4			3,113	15.1			400	12.5			399	12.7
Consumer—indirect		760	0.9			938	5.2			650	4.4			153	1.7			0	0.0
Business banking		5,166	21.9			3,595	19.3			2,626	21.3			1,200	21.7			1,196	20.4
Unallocated		203	N/A			500	N/A			500	N/A			825	N/A			825	N/A
	$	16,740	100.0	%	$	15,603	100.0	%	$	14,623	100.0	%	$	9,486	100.0	%	$	8,389	100.0	%

Investments and Mortgage-Backed Securities

    Investments and MBS that management has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. Unrealized gains and losses on such investments and MBS are not reported in the Consolidated Financial Statements, as these investments and MBS are held for investment purposes. See "Management's Discussion and Analysis—Results of Operations—Other Income" and Note 2 of "Notes to Consolidated Financial Statements."

    Sterling classifies specific investments and MBS as available for sale. Investments classified as available for sale are carried at fair value. Unrealized gains and losses are excluded from earnings and are reported net of deferred income tax as a separate component of accumulated comprehensive income (loss) in shareholders' equity until such investments and MBS mature or are actually sold. These investments and MBS may be sold in response to changes in market interest rates and related changes in prepayment risk, needs for liquidity, changes in the availability of and the yield on alternative investments and changes in funding sources and terms.

    At December 31, 2000 and 1999, investments and MBS classified as available for sale were $476.7 million and $494.5 million, respectively. The carrying value of these investments and MBS at December 31, 2000 and 1999 includes unrealized losses of $3.6 million (net of a $1.9 million related income tax benefit) and $13.6 million (net of a $7.3 million related income tax benefit), respectively. The increase in fair value since December 31, 1999 is primarily due to a decrease in long-term interest rates.

    Sterling invests primarily in MBS issued by FHLMC and FNMA and other agency obligations. Such investments provide Sterling with a relatively liquid source of interest income and collateral which can be used to secure borrowings. Sterling invests primarily in investment-grade investments and MBS.

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    The following table provides the carrying values, contractual maturities and weighted average yields of Sterling's investment and MBS portfolio at December 31, 2000.

		Maturity
		Less than One Year			One to Five Years			Five to Ten Years			Over Ten Years			Total
		(Dollars in thousands)
MBS
	Balance	$	0		$	3,997		$	23,682		$	286,755		$	314,434
	Weighted average yield		0.00	%		7.26	%		6.00	%		6.50	%		6.47	%
U.S. government and agency obligations
	Balance	$	0		$	94,358		$	0		$	0		$	94,358
	Weighted average yield		0.00	%		5.91	%		0.00	%		0.00	%		5.91	%
FHLB Seattle stock
	Balance	$	0		$	0		$	0		$	37,082		$	37,082
	Weighted average yield(1)		0.00	%		0.00	%		0.00	%		6.50	%		6.50	%
Municipal bonds(2)
	Balance	$	2,236		$	6,181		$	1,215		$	0		$	9,632
	Weighted average yield		4.53	%		4.80	%		4.37	%		0.00	%		4.68	%
Other(3)
	Balance	$	0		$	5,712		$	0		$	24,964		$	30,676
	Weighted average yield		0.00	%		11.95	%		0.00	%		7.86	%		8.62	%
Total carrying value		$	2,236		$	110,248		$	24,897		$	348,801		$	486,182
Weighted average yield			4.53	%		6.21	%		5.92	%		6.60	%		6.47	%

(1)

The weighted average yield on Federal Home Loan Bank of Seattle ("FHLB Seattle") stock is based upon the dividends received for the year ended December 31, 2000.

(2)

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

(3)

Other investments relate primarily to trust-preferred securities and residual interests in an asset-backed securitization.

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

		December 31,
		2000			1999			1998
		(Dollars in thousands)
MBS		$	314,434		$	343,311		$	405,725
U.S. government and agency obligations			94,358			90,830			112,906
FHLB Seattle stock			37,082			34,767			32,318
Municipal bonds			9,632			10,873			13,047
Other			30,676			25,949			22,409
	Total	$	486,182		$	505,730		$	586,405
Available-for-sale			476,732			494,483		$	566,372
Held-to-maturity			9,450			11,247			20,033
	Total	$	486,182		$	505,730		$	586,405
Weighted average yield			6.47	%		6.61	%		6.16	%

Sources of Funds

    General.  Sterling's primary sources of funds for use in lending and for other general business purposes are deposits, loan repayments, FHLB Seattle advances, secured lines of credit and other borrowings, proceeds from sales of investments and MBS and proceeds from sales of loans. Scheduled loan repayments are a relatively stable source of funds, while other sources of funds are influenced

13

significantly by prevailing interest rates, interest rates available on other borrowings and other economic conditions. Borrowings also may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and to match repricing intervals of assets. See "Lending Activities" and "Investments and Mortgage-Backed Securities."

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

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

    Sterling supplements its retail deposit gathering by soliciting funds from public entities. Public funds were 8.6% and 8.2% of deposits at December 31, 2000 and 1999, respectively. Public funds are generally obtained by competitive bidding among qualifying financial institutions. Sterling had no brokered deposits at December 31, 2000 or 1999.

    The primary retail deposit vehicles being utilized by Sterling's customers are CDs with terms of one year or less, regular savings accounts, money market accounts and negotiable order of withdrawal ("NOW") accounts. The following table presents the average balance outstanding and weighted average interest rate paid for each major category of deposits for the periods indicated.

		Years Ended December 31,
		2000				1999				1998
		Average Balance		Weighted Average Interest Rate		Average Balance		Weighted Average Interest Rate		Average Balance		Weighted Average Interest Rate
		(Dollars in thousands)
Certificates of deposit		$	968,109	5.94	%	$	866,461	5.14	%	$	791,311	5.46	%
Regular savings accounts and money market accounts			392,456	3.79			428,710	3.38			351,759	3.62
Checking accounts:
	NOW accounts		193,026	.87			189,207	1.02			145,335	1.14
Noninterest-bearing demand accounts			114,315	0.00			111,017	0.00			72,828	0.00
		$	1,667,906	4.44	%	$	1,595,395	3.82	%	$	1,361,233	4.23	%

    The following table shows the amounts and maturities of CDs that had balances of $100,000 or more at December 31, 2000.

(Dollars in thousands)
Remaining maturity:
Less than three months	$	183,335
Three to six months		75,011
Six to 12 months		86,582
Over 12 months		39,796
	$	384,724

14

    The following table presents the types of deposit accounts and the rates offered by Sterling Savings Bank and the balance in such accounts as of the specified dates.

		December 31, 2000							December 31, 1999
Minimum Term	Category	Minimum Balances		Amount		Percentage of Total Deposits	Interest Rate Offered		Minimum Balances		Amount		Percentage of Total Deposits	Interest Rate Offered
		(Dollars in thousands, except minimum amounts)
Transaction Accounts:
None	NOW checking	$	100	$	203,130	11.8	1.09	%	$	100	$	186,012	11.5	1.24	%
None	Commercial checking		100		123,440	7.1	0.00			100		104,005	6.4	0.00
None	Regular savings		100		75,415	4.4	1.59			100		84,526	5.2	1.50
None	Money market demand		1,000		307,001	17.8	1.09			2,500		326,133	20.2	1.24
None	Total transaction accounts				708,986	41.1						700,676	43.3
Certificates of Deposit:
3 months	Fixed term, fixed rate		500		7,511	0.4	5.00			500		4,712	0.3	4.59
6 months	Fixed term, fixed rate		500		38,682	2.2	5.60			500		46,945	2.9	4.87
9 months	Fixed term, adjustable rate		5,000		6,146	0.4	5.60			5,000		13,215	0.8	4.46
11 months	Fixed term, fixed rate		500		81,582	4.7	5.60			500		4,797	0.3	4.17
12 months	Fixed term, fixed rate		500		133,107	7.7	5.89			500		274,923	17.0	5.22
12 months	Fixed term, fixed rate		N/A		135	0.0	N/A	(1)		5,000		155	0.0	N/A	(2)
12 months	Fixed term, adjustable rate		N/A		4	0.0	N/A	(1)		500		4	0.0	N/A	(2)
12 months	Fixed term, adjustable rate		N/A		911	0.1	N/A	(1)		5,000		1,530	0.1	N/A	(2)
15 months	Fixed term, adjustable rate		5,000		98,671	5.7	5.65			5,000		98,901	6.1	5.60
18 months	Fixed term, fixed rate		500		159,340	9.2	5.65			500		43,324	2.7	5.22
24 months	Fixed term, fixed rate		500		33,492	1.9	5.65			500		27,731	1.7	4.41
36 months	Fixed term, fixed rate		500		59,315	3.4	5.65			500		58,343	3.6	5.84
36 months	Zero coupon, fixed term		N/A		5	0.0	N/A	(1)		N/A		5	0.0	N/A	(2)
Greater than 36 months	Fixed term, fixed rate		500		72,305	4.2	5.65			500		76,640	4.8	4.65
18 months	Variable rate, IRA		100		12,106	0.7	6.41			100		8,255	0.5	6.26
18 months	Fixed rate, IRA		500		8,215	0.5	5.75			500		2,132	0.1	5.13
36 months	Variable rate, IRA		2,000		5,584	0.3	5.75			2,000		13,503	0.8	5.13
7 days	Fixed term, fixed rate		5,000		1,888	0.1	4.17			5,000		2,259	0.1	3.54
7 days	Mini-jumbos		80,000		21,760	1.3	6.20			80,000		18,677	1.2	5.45
7 days	Jumbos		100,000		274,474	15.9	6.30			100,000		220,641	13.7	5.55
	Total CDs				1,015,233	58.9						916,692	56.7
	Total deposits			$	1,724,219	100.0					$	1,617,368	100.0

(1)

Not currently offered.

(2)

Not offered.

15

    The following table sets forth the composition of Sterling's deposit accounts at the dates indicated.

	December 31,
	2000			1999
	Amount		Percentage of Total Deposits	Amount		Percentage of Total Deposits
	(Dollars in thousands)
NOW checking	$	203,130	11.8	$	186,012	11.5
Commercial checking		123,440	7.1		104,005	6.4
Regular savings		75,415	4.4		84,526	5.2
Money market demand		307,001	17.8		326,133	20.2
Variable-rate certificates:
9-36 months		123,427	7.2		135,408	8.4
Fixed-rate certificates:
1-11 months		425,897	24.7		293,234	18.1
12-35 months		334,289	19.4		426,624	26.4
36-240 months		131,620	7.6		61,426	3.8
Total deposits	$	1,724,219	100.0	$	1,617,368	100.0

    Substantially all of Sterling's depositors are residents of the states of Washington, Idaho, Montana and Oregon. Sterling is a member of The Exchange, an automated teller machine ("ATM") system that allows participating customers to deposit or withdraw funds from NOW accounts, money market demand accounts and savings accounts throughout the United States and Canada. Sterling is also a member of the Plus System ATM network, with numerous locations in the United States and internationally. Sterling has 59 ATMs to better serve customers in those markets. Customers also can access the system through ATMs operated by other financial institutions.

    Borrowings.  Deposit accounts are Sterling's primary source of funds. Sterling does, however, rely upon advances from the FHLB Seattle and reverse repurchase agreements to supplement its funding and to meet deposit withdrawal requirements. See "Management's Discussion and Analysis—Liquidity and Sources of Funds."

    The FHLB Seattle is part of a system, which consists of 12 regional Federal Home Loan Banks (the "FHL Banks") each subject to Federal Housing Finance Board supervision and regulation, that functions as a central reserve bank providing credit to savings institutions. As a member, Sterling is required to own stock of the FHLB Seattle in an amount determined by a formula based upon Sterling's loans outstanding and advances from the FHLB Seattle. At December 31, 2000, Sterling exceeded its FHLB Seattle stock ownership requirement. The stock of the FHLB Seattle always has been redeemable at par value, but there can be no assurance that this always will be the case.

    As a member of the FHLB Seattle, Sterling is authorized to apply for advances on the security of its FHLB Seattle stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States or its agencies), provided certain standards related to creditworthiness are met. Each credit program has its own interest rate and range of maturities. At December 31, 2000, Sterling had advances totaling $530.7 million from the FHLB Seattle which mature from 2001 through 2015 at interest rates ranging from 4.60% to 8.40%. See "Management's Discussion and Analysis—Liquidity and Sources of Funds" and Note 9 of "Notes to Consolidated Financial Statements."

    Sterling also borrows funds under reverse repurchase agreements pursuant to which it sells investments (generally U.S. agency and MBS) under an agreement to buy them back at a specified

16

price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and MBS sold. Sterling uses these borrowings to supplement deposit gathering for funding the origination of loans. Sterling had $110.3 million and $179.5 million in reverse repurchase agreements outstanding at December 31, 2000 and 1999, respectively. Sterling enters into short-term repurchase agreements with selected retail customers. The balance of such short-term repurchase agreements was $6.8 million and $6.2 million at December 31, 2000 and 1999, respectively. The use of reverse repurchase agreements may expose Sterling to certain risks not associated with other borrowings, including IRR and the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines. For additional information regarding reverse repurchase agreements, see "Management's Discussion and Analysis—Asset and Liability Management," "Management's Discussion and Analysis—Liquidity and Sources of Funds" and Note 10 of "Notes to Consolidated Financial Statements."

    On June 4, 1997, Sterling issued $41.2 million of 9.50% junior subordinated deferrable interest debentures (The "Junior Subordinated Debentures") to Sterling Capital Trust I (the "Trust"), a Delaware business trust, of which Sterling owns all of the common equity. The sole asset of the Trust is the Junior Subordinated Debentures. The Trust issued $40.0 million of 9.50% Cumulative Capital Securities (the "Trust Preferred Securities") to investors. The indenture governing the Junior Subordinated Debentures limits the ability of Sterling under certain circumstances to pay dividends or make other capital distributions. The Trust Preferred Securities are treated as debt of Sterling. The Trust Preferred Securities mature on June 30, 2027 and are redeemable at the option of Sterling on June 30, 2002, or earlier in the event the deduction of related interest for federal income taxes is prohibited, treatment as Tier 1 capital is no longer permitted, or certain other contingencies arise.

    In May 1999, Sterling issued $30.0 million of Floating Rate Notes Due 2006. Interest accrues at the 90-day London Interbank Offering Rate ("LIBOR") Index plus 2.50% (9.08% at December 31, 2000) and is adjustable and payable quarterly. The notes mature on June 15, 2006 and may be redeemed under certain conditions after June 15, 2002.

    In June 1999, Sterling redeemed the outstanding balance of its 8.75% Subordinated Notes Due 2000, including accrued interest thereon, in the aggregate amount of $17.4 million. Sterling incurred a charge of approximately $97,000 upon early extinguishment of these notes.

    In addition to the borrowings described above, at December 31, 2000 Sterling had a $50.0 million non-revolving variable-rate line of credit from KeyBank National Association ("KeyBank"), of which $40.0 million was outstanding at December 31, 2000. The line of credit matures on June 1, 2003. Sterling also has a $5.0 million revolving line-of-credit agreement with KeyBank which matures on June 1, 2001. These lines of credit are collateralized by all of the stock of Sterling Savings Bank. See Note 11 of "Notes to the Consolidated Financial Statements."

    Sterling Savings Bank has an unsecured $10.0 million line-of-credit agreement from KeyBank. Advances under the line of credit accrue interest at a defined variable rate (6.50% at December 31, 2000) and the line matures in April 2001. Management expects that the line of credit will be renewed at that time on substantially the same terms, although there can be no assurance in this regard. No amounts were outstanding on this line of credit at December 31, 2000 and 1999.

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

		Years Ended December 31,
		2000			1999			1998
		(Dollars in thousands)
Maximum amount outstanding at any month-end during the period:
	Short-term reverse repurchase agreements	$	79,668		$	52,060		$	336,734
	Short-term advances		183,918			158,900			373,738
Average amount outstanding during the period:
	Short-term reverse repurchase agreements		36,427			43,574			123,659
	Short-term advances		99,733			113,256			203,652
Weighted average interest rate paid during the period:
	Short-term reverse repurchase agreements		6.09	%		5.14	%		5.56	%
	Short-term advances		5.77	%		5.99	%		6.03	%
Weighted average interest rate paid at end of period:
	Short-term reverse repurchase agreements		5.92	%		5.07	%		5.58	%
	Short-term advances		5.85	%		6.03	%		5.91	%

    The following table sets forth certain information concerning Sterling's outstanding borrowings.

		December 31,
		2000				1999				1998
		Amount		%		Amount		%		Amount		%
		(Dollars in thousands)
FHLB Seattle advances:
	Short-term	$	84,184	11.2		$	158,900	20.4		$	95,000	15.6
	Long-term		446,468	59.5			331,603	42.5			224,540	36.7
Securities sold subject to reverse repurchase agreements:
	Short-term		6,776	0.9			33,715	4.3			49,274	8.1
	Long-term		103,550	13.8			145,800	18.7			145,800	23.8
8.75% Subordinated Notes			0	0.0			0	0.0			17,240	2.8
Floating Rate Note			30,000	4.0			30,000	3.9			0	0.0
Advances under lines of credit			40,000	5.3			40,000	5.1			40,000	6.5
Trust Preferred Securities			40,000	5.3			40,000	5.1			40,000	6.5
Total borrowings		$	750,978	100.0		$	780,018	100.0		$	611,854	100.0
Weighted average interest rate				6.65	%			5.82	%			5.71	%

Subsidiaries

    Sterling's principal subsidiary is Sterling Savings Bank. Sterling Savings Bank has three principal subsidiaries which have been previously described: Action Mortgage, Harbor Financial and INTERVEST. Additionally, Sterling and Sterling Savings Bank have the following wholly owned

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subsidiaries that are either inactive or exist solely for the purpose of holding and owning specific assets or properties:

Sterling Financial Corporation

(1)

Tri-Cities Mortgage Corporation was obtained as part of an acquisition in April 1988. Until June 30, 2000, the corporation's principal asset was a 99.5% partnership interest in Renton Plaza Investors (a partnership which owns a five-story office building in Renton, Washington). In June 2000, the entire interest was sold at a net gain of $82,500.



(2)

Sterling Capital Trust I was organized in May 1997 as a Delaware business trust. Sterling owns all the common equity of the Trust. The sole asset of the Trust is the Junior Subordinated Debentures issued by Sterling.

Sterling Savings Bank

(1)

Fidelity Service Corporation was organized in 1983 to acquire and sell real and personal property in eastern Washington and Idaho. At December 31, 2000, the corporation's assets, which consisted principally of land and equipment, were transferred to Sterling Savings Bank.



(2)

Evergreen Environmental Development Corporation was organized to engage in real estate development and was obtained as part of an acquisition in December 1988. This corporation's assets include a 33% interest in the Grapetree Partnership, which owns a parcel of raw land in Spokane, Washington that it intends to develop into single-family residential lots. Sterling Savings Bank's investment in the Grapetree Partnership has been deemed by its primary federal regulators to be an impermissible investment. Accordingly, Sterling Savings Bank's investment has been deducted from core and risk-based capital.



(3)

Tri-West Mortgage, Inc. was obtained as part of an acquisition in 1988 and was originally engaged in mortgage banking.



(4)

Evergreen First Service Corporation was obtained as part of an acquisition in 1988 and owns all of the outstanding capital stock of Harbor Financial, through which Sterling offers tax-deferred annuities, mutual funds and other financial products.



(5)

Sterling Automobile Loan Securitization 2000-1, L.L.C. was established in December 2000 as a special purpose subsidiary to enable Sterling Savings Bank to sell approximately $93 million of motor vehicle retail installment contracts.

Competition

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

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Personnel

    As of December 31, 2000, Sterling, including its subsidiaries, had 822 full-time equivalent employees. Employees are not represented by a collective bargaining unit. Sterling believes its relationship with its employees is excellent.

Regulation

    Introduction.The following is not intended to be a complete discussion but is intended to be a summary of some of the most significant provisions of laws applicable to Sterling and its subsidiaries.

    Sterling is a savings and loan holding company and as such is subject to OTS regulations, examinations and reporting requirements. Sterling Savings Bank is chartered by the State of Washington and its deposits are insured by the FDIC. Sterling Savings Bank is subject to comprehensive regulation, examination and supervision by the OTS, the FDIC and the Washington Supervisor. Furthermore, certain transactions and savings deposits are subject to regulations and controls promulgated by the Federal Reserve Board (the "Fed").

    Savings and Loan Holding Company Regulation.  Sterling is registered as a savings and loan holding company under the Home Owners' Loan Act (the "HOLA"). The HOLA generally permits a savings and loan holding company to engage in activities which are unrelated to the operation of a savings and loan association, provided the holding company controls only one savings and loan association and such savings and loan association meets the Qualified Thrift Lender Test (the "QTL Test"). Sterling presently controls only one savings and loan association, Sterling Savings Bank, which at December 31, 2000 met the QTL Test.

    If Sterling Savings Bank fails to meet the QTL Test in the future, Sterling will become subject to restrictions on the activities in which it may engage. Such activities would generally be limited to any activity that the Fed by regulation has determined is permissible for bank holding companies pursuant to Section 4(c) of the Bank Holding Company Act of 1956, as amended (unless limited or prohibited by the OTS by regulation), and certain other limited services and activities. Sterling currently has no plans to engage in any new activity that would be restricted if Sterling Savings Bank were to fail to meet the QTL Test in the future. Although Sterling Savings Bank expects to remain in compliance with the QTL Test in the future, there can be no assurance in this regard.

    Under the HOLA, no person may acquire control of a savings association or a savings and loan holding company without the prior approval of the OTS. As a savings and loan holding company, Sterling is prohibited from acquiring (i) control of another savings association or a savings and loan holding company without the prior approval of the OTS; (ii) the assets of another savings association or savings and loan holding company by merger, consolidation or purchase, without the prior approval of the OTS; (iii) more than 5% of the voting shares of a savings association or a savings and loan holding company which is not a subsidiary of Sterling or (iv) control of a depository institution, the accounts of which are not insured by the FDIC.

    The HOLA authorizes the OTS to issue a directive to a savings and loan holding company and any of its subsidiaries if the OTS determines that there is reasonable cause to believe that the continuation by the holding company of any activity constitutes a serious risk to the financial safety, soundness or stability of the holding company's subsidiary savings association. The OTS may impose restrictions through such directive to limit such risk, including limiting (i) the payment of dividends by the savings association, (ii) transactions between the savings association, the holding company and the subsidiaries or affiliates of either and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its other affiliates may be imposed on the savings association. Such a directive has the same effect as a final cease and desist order. The issuance of the directive can be appealed to the Director of the OTS.

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

    The GLBA, among other things, provides customers with greater financial privacy by requiring financial institutions to safeguard their nonpublic personal information. Financial institutions must advise customers of their policies regarding the sharing of nonpublic personal information with non-affiliated third parties and allow customers to "opt-out" of such sharing (subject to several exceptions related mainly to processing customer-initiated transactions and compliance with current law.) Final regulations were promulgated on June 1, 2000 with a mandatory compliance date of July 1, 2001. Sterling continues to review its policies and procedures and intends to implement the necessary policies and procedures by July 1, 2001.

    The Federal Deposit Insurance Corporation Improvement Act of 1991.  The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") provides for expanded regulation of depository institutions and their affiliates, including parent holding companies. FDICIA further provides the OTS with broad powers to take "prompt corrective action" to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized."

    Under OTS regulations which implement the "prompt corrective action" system mandated by FDICIA, an institution is "well capitalized" if its total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) is 10% or more, its Tier 1 risked-based capital ratio (the ratio of core (Tier 1) capital to risk-weighted assets) is 6% or more, its core (Tier 1) capital ratio (the ratio of core (Tier 1) capital to total assets) is 5% or more and it is not subject to any written agreement, order or directive to meet a specified capital level. At December 31, 2000, Sterling Savings Bank met the standards for a "well capitalized" institution.

    An institution which is "undercapitalized" must submit a capital restoration plan to the OTS. The plan may be approved only if the OTS determines it is likely to succeed in restoring the institution's capital and will not appreciably increase the risks to which the institution is exposed. The institution's performance under the plan must be guaranteed by any company which controls the institution, up to a maximum of 5% of the institution's assets. The OTS also may require an undercapitalized institution to take various actions deemed appropriate to minimize the potential losses to the deposit insurance fund. Institutions that are "significantly undercapitalized" or "critically undercapitalized" are subject to additional sanctions.

    FDICIA directs each bank regulatory agency and the OTS to review its capital standards every two years to determine whether those standards require sufficient capital to facilitate prompt corrective action to prevent or minimize loss to the deposit insurance funds. FDICIA, as amended, also requires the OTS to prescribe minimum operational and managerial standards and standards for asset quality, earnings and stock valuation for savings institutions. Any savings institution which fails to meet the standards may be required to submit a plan for corrective action. If a savings institution fails to submit or implement an acceptable plan, the OTS may require the institution to take any action the OTS determines will best carry out the purpose of prompt corrective action.

    Under FDICIA, only a "well capitalized" depository institution may accept brokered deposits without prior regulatory approval. FDICIA also requires annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well capitalized institutions and state-chartered institutions examined by state regulators. The federal banking agencies are required to set compensation standards for insured depository institutions that prohibit excessive

21

compensation, fees or benefits to officers, directors, employees and principal shareholders. FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts. FDICIA also greatly expanded the range of merger, purchase and assumption, and deposit transfer transactions involving banks and savings associations that are exempt from payment of exit and entry fees as transfers of deposits between the FDIC's Bank Insurance Fund ("BIF") and its Savings Association Insurance Fund ("SAIF"). Many of the provisions of FDICIA have been implemented through the adoption of regulations by the federal banking agencies.

    Regulatory Capital Requirements.  Pursuant to the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the OTS adopted regulations implementing new capital standards applicable to all savings associations, including Sterling Savings Bank. Such capital standards require that savings associations maintain (i) capital of not less than 1.5% of adjusted total assets, (ii) core (Tier 1) capital of not less than 4% of adjusted total assets and (iii) total risk-based capital of not less than 8% of risk-weighted assets. As of December 31, 2000, Sterling Savings Bank met all regulatory capital requirements. For additional information, see "Management's Discussion and Analysis—Liquidity and Sources of Funds" and "Management's Discussion and Analysis—Capital Resources."

    Core (Tier 1) Capital.  Core (Tier 1) capital consists of common shareholders' equity, including retained earnings; non-cumulative perpetual preferred stock; certain non-withdrawable and pledged deposits; and minority interests in equity accounts of fully consolidated subsidiaries. In calculating core (Tier 1) capital, certain items must be deducted. These items are goodwill and other intangible assets, nonqualifying purchased mortgage servicing rights and investments (whether debt or equity) in subsidiaries engaged as of April 1989 in activities which were permissible for national banks. With respect to purchased mortgage servicing rights, the amount that qualifies to be included in core (Tier 1) capital is the lower of (a) 90% of fair market value if determinable, (b) 90% of original cost or (c) the current amortized book value. See "Subsidiaries."

    Risk-Based Capital.  The total risk-based capital requirement is an amount equal to 8% of risk-adjusted assets. A risk weight is assigned to both the on-balance sheet assets and off-balance sheet commitments of a savings association. Risk weights range from zero to 100% depending on the type of asset.

    Both core (Tier 1) capital and supplementary (Tier 2) capital may be used to meet the total risk-based capital requirement, although Tier 2 capital is limited to 100% of Tier 1 capital. For purposes of the total risk-based capital requirement, Tier 2 capital includes permanent capital instruments such as cumulative perpetual preferred stock, perpetual or mandatory convertible subordinated debt, maturing capital instruments such as subordinated debt, intermediate-term preferred stock, commitment notes and certain grandfathered mandatory redeemable preferred stock (although the amount included declines as the instrument approaches maturity), and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. The total risk-based capital requirement was equal to 8% of risk-weighted assets at December 31, 2000.

22

    The following tables set forth Sterling Savings Bank's core (Tier 1) capital, core (Tier 1) risk-based capital and total risk-based capital positions as reported on the quarterly Thrift Financial Report at December 31, 2000 and 1999. See "Management's Discussion and Analysis—Capital Resources."

		December 31,
		2000					1999
		Core (Tier 1) Capital
		Dollars			Ratio(1)		Dollars			Ratio(1)
		(Dollars in thousands)
Total shareholders' equity		$	231,621		8.89	%	$	211,184		8.47	%
Adjustment:
	Unrealized losses (gains) on securities		3,558		0.14			13,553		0.54
Less:
	Intangibles		(49,998	)	(1.92	)		(55,488	)	(2.23	)
	Excess qualifying purchased mortgage loan servicing		(0	)	(0.00	)		(7	)	(0.00	)
	Investment in non-includable subsidiaries		(352	)	(0.01	)		(353	)	(0.01	)
Total core (Tier 1) capital			184,829		7.10			168,889		6.77
Core (Tier 1) capital requirement			104,199		4.00			99,738		4.00
Core (Tier 1) capital excess		$	80,630		3.10	%	$	69,151		2.77	%

	Core (Tier 1) Risk-based Capital
	Dollars		Ratio(1)		Dollars		Ratio(1)
	(Dollars in thousands)
Total core (Tier 1) capital	$	184,829	9.71	%	$	168,889	9.50	%
Core (Tier 1) risk-based capital requirement		76,141	4.00			71,099	4.00
Core (Tier 1) risk-based capital excess	$	108,688	5.71	%	$	97,790	5.50	%

	Total Risk-based Capital
	Dollars			Ratio(1)		Dollars		Ratio(1)
	(Dollars in thousands)
Total core (Tier 1) capital	$	184,829		9.71	%	$	168,889	9.50	%
General valuation allowances		15,937		0.84			15,329	0.86
Low-level recourse deduction		(5,712	)	(0.30	)		0	0.00
Total risk-based capital		195,054		10.25			184,218	10.36
Risk-based capital requirement		152,281		8.00			142,199	8.00
Risk-based capital excess	$	42,773		2.25	%	$	42,019	2.36	%

(1)

Ratio of core (Tier 1) capital to adjusted total assets for the core (Tier 1) capital ratio and ratio of core (Tier 1) and total risk-based capital to risk-weighted assets for core (Tier 1) risk-based and total risk-based capital.

    The OTS has adopted a regulation that adds an IRR component to the risk-based capital requirement for savings institutions like Sterling Savings Bank. The OTS may waive or defer inclusion of the IRR component on a case-by-case basis. Under the rule, institutions meeting or exceeding a base level of interest rate exposure must deduct an IRR component from the total capital available to meet their risk-based capital requirement. That deduction is equal to one-half of the difference between the institution's actual measured exposure and the base level of exposure. The institution's actual measured IRR is expressed as the change that occurs in its net present value ("NPV") as a result of a hypothetical 200 basis point increase or decrease in interest rates (whichever leads to the lower NPV)

23

divided by the estimated economic value of its assets. The base level of IRR, which would require inclusion of a capital component, is defined as a decline in NPV which exceeds 2.0% of an institution's assets expressed in terms of economic value. Using a computer model, the OTS will calculate changes in each institution's NPV based on financial data the institution submits on its Thrift Financial Report. The OTS then will advise each institution of its required IRR deduction. The OTS, using December 31, 2000 financial information, has calculated that no IRR component deduction is required to be added to Sterling Savings Bank's risk-based capital.

    Savings associations that fail to meet the core (Tier 1) or risk-based capital requirements are subject to a number of sanctions or restrictions. Under FIRREA, the OTS must prohibit any asset growth, except that the OTS may permit growth in an amount not in excess of net interest credited to the savings association's deposit liabilities, if (i) the savings association obtains the prior approval of the OTS; (ii) any increase in assets is accompanied by an increase in core (Tier 1) capital in an amount not less than 3.0% of the increase in assets; (iii) any increase in assets is accompanied by an increase in capital not less in percentage amount than required under the risk-based capital standards then applicable; (iv) any increase in assets is invested in low-risk assets and (v) the savings association's ratio of core (Tier 1) capital to total assets is not less than the ratio existing on January 1, 1991.

    The OTS also may require any savings association not in compliance with capital standards (including any individual minimum capital requirement) to comply with a capital directive issued by the OTS. Such a capital directive may order the savings association to (a) achieve its minimum capital requirements by a specified date; (b) adhere to a compliance schedule for achieving its minimum capital requirements; (c) submit and adhere to a capital plan acceptable to the OTS and/or (d) take other actions, including reducing its assets or rate of liability growth and/or restricting its payment of dividends in order to reach the required capital levels. The OTS, by such capital directive, enforcement proceedings or otherwise, may require an association not in compliance with the capital requirements to (i) increase the amount of its regulatory capital to a specified level; (ii) convene a meeting with the OTS supervision staff for the purpose of accomplishing the objectives of the regulations; (iii) reduce or limit the rate of interest that may be paid on savings accounts; (iv) limit the receipt of deposits to those made to existing accounts; (v) cease or limit lending or the making of a particular loan or category of loan; (vi) cease or limit the purchase of loans or the making of specified other investments; (vii) limit operational expenditures to specific levels; (viii) increase liquid assets and maintain such increased liquidity at specified levels or (ix) take such other action or actions as the OTS may deem necessary or appropriate for the safety and soundness of the savings association or the protection of its depositors. The material failure of a savings association to comply with any plan, regulation, written agreement, order or directive issued will be treated as an unsafe or unsound practice which could result in the imposition of certain penalties or sanctions, including but not limited to the assessment of civil monetary penalties, the issuance of a cease and desist order or the appointment of a conservator or receiver.

    Any savings association which does not meet its regulatory capital requirements may not accept, without a written waiver from the OTS, brokered deposits if such deposits, together with any existing brokered deposits outstanding, would exceed 5.0% of the association's total deposits. In addition, the FDIC prohibits, with certain exceptions, an "insolvent institution" from accepting any brokered deposits. An insolvent institution is defined as any insured depository institution which does not meet the minimum capital requirements applicable with respect to such institution. This prohibition includes any renewal of an account in any insolvent institution and any rollover of any amount on deposit. The FDIC may waive this restriction upon application by an insured depository institution and a finding that the acceptance of such deposits does not constitute an unsafe or unsound practice with respect to such institution. Sterling had no brokered deposits at December 31, 2000 or 1999.

    A savings association which is not in compliance with its capital requirements may apply to the OTS for an exemption from the sanctions and penalties imposed upon a savings association for failure

24

to comply with its minimum capital standards. Pursuant to FIRREA, the OTS may approve an application for a capital exemption if such exemption would pose no significant risk to the affected insurance fund, the savings association's management is competent, the savings association is in compliance with all applicable statutes, regulations, orders and supervisory agreements and directives and the savings association's management has not engaged in insider dealing, speculative practices or any other activities that could have jeopardized the association's safety and soundness or contributed to impairing the association's capital. Any application for a capital exemption must be accompanied by an acceptable capital plan. If a savings association receives approval of capital exemption and operates in accordance with an acceptable capital plan, it will be deemed to be in compliance with its capital standards for purposes of OTS capital regulation only. The savings association must request and receive approval of specific, express exemptions from the provisions of other rules, regulations and policy statements as part of the accepted capital plan to be deemed in capital compliance for purposes of such other rules, regulations and policy statements.

    Federal Deposit Insurance Corporation.  Sterling's deposits are insured up to $100,000 per insured depositor (as defined by law and regulations) by the FDIC through the SAIF. The SAIF is administered and managed by the FDIC. The FDIC is authorized to conduct examinations of and to require reporting by SAIF member institutions. The FDIC may prohibit any SAIF member institution from engaging in any activity the FDIC determines by regulation or order poses a serious threat to the SAIF. The FDIC also has the authority to initiate enforcement actions against savings associations.

    Deposits insured by SAIF are currently assessed at the rate of zero for well-capitalized institutions displaying little risk to the SAIF to $0.27 per $100 of domestic deposits for undercapitalized institutions displaying high risk. The SAIF assessment rate may increase or decrease as is necessary to maintain the designated SAIF reserve ratio of 1.25% of insured deposits.

    The Financing Corporation ("FICO"), established by the Competitive Equality Banking Act of 1987, is a mixed-ownership government corporation whose sole purpose was to function as a financing vehicle for the Federal Savings & Loan Insurance Corporation. Outstanding FICO bonds, which are 30-year noncallable bonds, mature in 2017 through 2019. The FICO has assessment authority separate from the FDIC's authority to assess risk-based premiums for deposit insurance, to collect funds from FDIC-insured institutions sufficient to pay interest on FICO bonds. The FDIC acts as collection agent for the FICO. The FICO assessment rate, currently $0.02 per $100 of deposits, is adjusted quarterly.

    The FDIC is empowered to initiate a termination of insurance proceeding in cases where the FDIC determines that an insured depository institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated an applicable law, regulation, order or condition imposed by the FDIC. The FDIC may deem failure to comply with applicable regulatory capital requirements an unsafe and unsound practice. If the FDIC terminates a savings association's deposit insurance, funds then on deposit continue to be insured for at least six months and up to two years after notice of such termination is provided to the account holders. Furthermore, if the FDIC initiates an insurance termination proceeding against a savings association that has no core (Tier 1) capital, the FDIC may issue a temporary order immediately suspending deposit insurance on all deposits received by such savings association.

    Loans to Affiliates.  FIRREA amended the statutory provisions governing transactions between a savings association and its affiliates. Such transactions are subject to the restrictions of Sections 23A and 23B of the Federal Reserve Act (the "FRA") in the same manner and to the same extent as if the savings association were a member bank as defined in the FRA, except that a savings association may not (i) extend credit to any affiliate engaged in activities that are impermissible for a bank holding company or (ii) purchase or invest in any securities of an affiliate other than shares of a subsidiary.

    Section 23A of the FRA limits the aggregate amount of "covered transactions" with any one affiliate to 10% of the capital stock and surplus of the member bank. "Covered transactions" are

25

defined in Section 23A to include extending credit to, purchasing the assets of, issuing a guarantee, acceptance or letter of credit on behalf of, or investing in the stock or securities of, any affiliate. Section 23A also requires a bank to obtain specified levels of collateral for any extension of credit to an affiliate. Section 23B, in general, requires that any transaction with an affiliate be on terms and conditions no less favorable to the member bank than those applicable to transactions with unaffiliated entities. The OTS has recently adopted regulations further defining and clarifying the applicability of Section 23A and 23B to savings associations. The OTS has the authority to impose any additional restrictions on any transaction between a savings association and an affiliate that it determines are necessary to protect the safety and soundness of the association.

    In addition, FIRREA provides that extensions of credit to executive officers, directors and principal shareholders of a savings association are governed by the FRA. The FRA requires prior approval by the board of directors of the bank before a loan can be made to an executive officer, director or 10% shareholder. In addition, such loan or extension of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and may not involve more than the normal risk of repayment or present other unfavorable features. The FRA also prohibits any loan or extension of credit to an executive officer or a controlling shareholder if such loan or extension of credit (when aggregated with the amount of all other loans or extensions of credit then outstanding to such individual) would exceed the limits on loans to a single borrower applicable to national banks. The OTS may impose additional restrictions for safety and soundness reasons.

    Liquidity.  All savings associations, including Sterling Savings Bank, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of average daily balances of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the required liquid asset ratio is 4.0%. In addition to meeting the required liquid asset ratio, savings associations, including Sterling Savings Bank, must maintain sufficient liquidity to ensure safe and sound operations. Sterling Savings Bank's liquidity ratios at December 31, 2000 and 1999 were 7.7% and 9.1%, respectively.

    Loans-to-One-Borrower.  Under FIRREA, the permissible amount of loans-to-one-borrower follows the national bank standard for all loans made by savings associations (except that loans-to-one-borrower not in excess of $500,000 may be made in any event). OTS regulations generally do not permit loans-to-one-borrower to exceed 15% of unimpaired capital and unimpaired surplus. Loans in an amount equal to an additional 10% of unimpaired capital and unimpaired surplus also may be made to a borrower if the loans are fully secured by readily marketable collateral. In addition, institutions which meet applicable capital requirements may make domestic residential housing development loans in an amount up to the lesser of $30.0 million or 30% of the institution's unimpaired capital and unimpaired surplus, subject to certain conditions. At December 31, 2000, Sterling's loans-to-one-borrower limit was $27.7 million, which management believes is adequate to allow for loan originations.

    Qualified Thrift Lender.  Under the QTL Test, as revised by FDICIA, an institution generally is required to invest at least 65% of its portfolio assets (as defined in the OTS regulations) in "qualified thrift investments" on a monthly average basis in nine out of every twelve months. Qualified thrift investments include, in general, loans, securities and other investments that are related to housing. At December 31, 2000, Sterling's qualified thrift investments were 68.0% of portfolio assets. An institution's failure to remain a qualified thrift lender ("QTL") may result in: (1) limitations on new investments and activities; (2) imposition of branching restrictions; (3) loss of borrowing privileges at the FHLB Seattle and (4) limitations on the payment of dividends.

26

    Restriction on Business Banking Loans.  According to the OTS, Sterling is permitted to hold no more than 20% of its assets in certain business banking loans as defined in the Thrift Financial Report. At December 31, 2000, Sterling had $435.7 million of such loans, or approximately 16% of total assets.

    Community Reinvestment.  Under the Community Reinvestment Act ("CRA"), as implemented by the OTS regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a financial institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institutions. The CRA requires public disclosure of an institution's CRA rating and requires the OTS to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system of "outstanding," "satisfactory," "needs to improve" or "substantial noncompliance." Sterling's current CRA rating is "satisfactory."

    Change of Control.  Under applicable statutes and regulations, a person may not acquire control of a savings association without the prior approval of the OTS and the Washington Supervisor. Control is conclusively deemed to be acquired when, among other things, a person, either alone or acting in concert with others, acquires more than 25% of any class of voting stock of a savings association. Under federal statutes and regulations, a rebuttable presumption of control arises if a person acquires, either alone or acting in concert with others, more than ten percent of any class of voting stock of a savings association and is subject to a "control factor," or acquires more than 25% of any class of stock, and is subject to a "control factor." A person is subject to a control factor as a result of specified ownership levels of the savings association's debt or equity or as a result of certain relationships with the savings association.

    As indicated above, if a person's ownership of the savings association stock is below the threshold levels for control, such person may nevertheless be deemed to be "acting in concert" with one or more other persons who own stock in the savings association, in which case all of the stock ownership of each person acting in concert will be aggregated and attributed to each member of the group, thereby putting each one over the control threshold. Under certain circumstances, acquirers will be presumed to be acting in concert. For example: (i) a company will be presumed to be acting in concert with a controlling shareholder or management official; (ii) a company controlling or controlled by another company and companies under common control will be presumed to be acting in concert and (iii) persons will be presumed to be acting in concert where they constitute a group under Section 13 or the proxy rules under Section 14 of the Securities Exchange Act of 1934, as amended.

    Restrictions on Activities of State-Chartered Associations.  FIRREA prohibits a state-chartered savings association from engaging in any type of activity or any activity in an amount that is not permissible for a federal savings association unless (i) the FDIC has determined that such activity poses no threat to the insurance fund and (ii) the savings association continues to be in compliance with applicable capital requirements. If the FDIC determines that the amount of such activity does not pose a significant threat to the insurance fund, an association which is in compliance with applicable capital requirements may engage in activities in an amount greater than that permissible for a federal savings association. FIRREA also prohibits a state-chartered savings association from acquiring or retaining any equity investment (other than shares in certain service corporations) of a type or in an amount not permissible for a federal savings association. A savings association must divest any such equity investment as quickly as can be prudently done. Pursuant to applicable equity investment rules, Sterling

27

has excluded its investment in assets totaling $352,000 from its calculation of risk-based capital as of December 31, 2000. Sterling is actively marketing these properties. See "Subsidiaries."

    Restrictions on Capital Distributions by Savings Associations.  The OTS has adopted a capital distribution regulation which limits the ability of savings institutions to make capital distributions. Certain factors are considered by the OTS in determining whether to permit a savings institution to pay dividends, including, among other things, whether an institution meets applicable capital requirements. Those savings institutions which meet the applicable capital requirements have discretion in making capital distributions, while those with lower capitalization have less discretion in this regard and, in some cases, are required to seek the approval of the OTS.

    Sterling's income is derived primarily from dividends to the extent they are declared and paid by Sterling Savings Bank. Current OTS regulations require Sterling Savings Bank to give the OTS 30 days advance notice of any proposed declaration of dividends to Sterling, as its holding company. The OTS has approved all of Sterling Savings Bank Preferred Stock dividend payments to Sterling, but there can be no assurance as to the approval of future dividends.

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

    Under the provisions of the Depository Institutions Deregulation and Monetary Control Act of 1980, savings and loan associations, like Sterling Savings Bank, also have authority to borrow from the Federal Reserve Bank "discount window," but Federal Reserve regulations require associations to exhaust all FHL Bank sources before borrowing from the Fed.

    Federal Taxation.  Sterling is subject to federal income taxation under the Internal Revenue Code of 1986 as amended, in the same manner as other corporations. Sterling files consolidated federal income tax returns on the accrual basis. See Note 12 of "Notes to Consolidated Financial Statements."

    State Law and Regulation.  Sterling Savings Bank is a Washington State-chartered institution and is subject to regulation by the Washington Supervisor, which conducts regular examinations to ensure that Sterling Savings Bank's operations and policies conform with sound industry practice. The liquidity and other requirements set by the Washington Supervisor are generally no stricter than the liquidity and other requirements set by the OTS. State law regulates the amount of credit that can be extended to any one person or marital community and the amount of money that can be invested in any one property. Without the Washington Supervisor's approval, Sterling Savings Bank currently cannot extend credit to any one person or marital community in an amount greater than 2.5% of Sterling Savings Bank's total assets. State law also regulates the types of loans Sterling Savings Bank can make. Without the Washington Supervisor's approval, Sterling Savings Bank cannot currently invest more than 10% of its total assets in other corporations. Sterling Savings Bank also operates branches within the states of Oregon, Idaho and Montana and therefore is also subject to the supervision of the Oregon Department of Consumer and Business Services, the Idaho Department of Finance and the Montana Department of Finance.

Item 2.  Properties

    Sterling Savings Bank owns 44 branches and leases 14 branches in Washington, owns 5 branches in Oregon, owns 9 branches and leases 2 branches in Idaho and owns 3 branches in Montana. Action

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Mortgage leases 3 residential loan production branches (one in Washington, one in Oregon and one in Idaho). INTERVEST leases one office in Washington and leases one office in Oregon. These branches and offices range in size from 500 to 105,000 square feet and have a total net book value, including leasehold improvements and furniture and fixtures, of $50.2 million at December 31, 2000. Leases on these properties expire between June 30, 2001 and December 31, 2014. Sterling believes it will be able to renew the leases or obtain comparable properties.

Item 3.  Legal Proceedings

    Periodically, various claims and lawsuits are brought against issues incident to Sterling's business. In addition, Sterling succeeded to several claims as a result of past acquisitions by Sterling and its subsidiaries, such as claims to enforce liens, condemnation proceedings involving properties on which Sterling holds security interests and claims involving the making and servicing of loans. No material loss is expected from any of such pending claims or lawsuits, although there can be no assurance in this regard.

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

    No matters were submitted to a vote of security holders during the quarter ended December 31, 2000.

PART II

Item 5.  Market for the Registrant's Stock and Related Shareholder Matters

    Sterling has outstanding one class of Common Stock. As of February 28, 2001, there were 8,922,021 shares of Common Stock outstanding. As of February 28, 2001, the Common Stock was owned by 781 shareholders of record. The Common Stock is quoted on the Nasdaq National Market tier of the Nasdaq stock market under the symbol "STSA." For information concerning the payment of dividends, see "Business—Regulation—Regulatory Capital Requirements," "Management's Discussion and Analysis—Liquidity and Sources of Funds" and Note 25 of "Notes to Consolidated Financial Statements."

    The following table sets forth the high and low bid prices per share for the Common Stock for the periods indicated.

		High		Low
Year ended December 31, 2000:
	Fourth quarter	$	13.00	$	9.77
	Third quarter		11.25		9.44
	Second quarter		12.05		8.59
	First quarter		11.36		8.69
Year ended December 31, 1999:
	Fourth quarter	$	12.16	$	10.00
	Third quarter		14.89		11.82
	Second quarter		15.35		12.05
	First quarter		15.91		13.64

29

Item 6.  Selected Financial Data(1)

														Six Months Ended December 31,
		Years Ended December 31,
																				Fiscal Year Ended June 30, 1996
		2000			1999			1998			1997			1996			1995
		(Dollars in thousands, except per share amounts)
Interest income		$	205,477		$	177,374		$	155,763		$	135,885		$	59,916		$	59,874		$	117,799
Interest expense			(125,544	)		(102,004	)		(96,558	)		(88,077	)		(38,626	)		(41,785	)		(80,172	)
Net interest income			79,933			75,370			59,205			47,808			21,290			18,089			37,627
Provision for loan losses			(4,600	)		(3,900	)		(5,325	)		(2,482	)		(1,121	)		(822	)		(1,643	)
Net interest income after provision for loan losses			75,333			71,470			53,880			45,326			20,169			17,267			35,984
Other income			14,321			13,297			12,313			9,474			4,775			5,062			9,533
Merger, acquisition and conversion costs			0			0			(5,464	)		0			0			0			0
Amortization of intangibles			(5,490	)		(5,692	)		(3,971	)		(2,242	)		(1,590	)		(1,669	)		(3,332	)
Goodwill litigation			(1,074	)		(272	)		0			0			0			0			0
Other operating expenses			(61,404	)		(58,514	)		(46,856	)		(36,187	)		(24,217	)		(14,562	)		(29,777	)
Income (loss) before income taxes			21,686			20,289			9,902			16,371			(863	)		6,098			12,408
Income tax provision			(8,033	)		(7,470	)		(3,679	)		(6,152	)		(162	)		(2,252	)		(4,667	)
Net income (loss)			13,653			12,819			6,223			10,219			(1,025	)		3,846			7,741
Preferred stock dividends declared			0			0			0			(940	)		(942	)		(942	)		(1,885	)
Net income (loss) applicable to common shares		$	13,653		$	12,819		$	6,223		$	9,279		$	(1,967	)	$	2,904		$	5,856
Income (loss) per common share:
	Basic(1)	$	1.53		$	1.44		$	0.70		$	1.27		$	(0.30	)	$	0.45		$	0.91
	Diluted(1)	$	1.52		$	1.43		$	0.69		$	1.14		$	(0.30	)	$	0.44		$	0.88
Weighted average common shares outstanding:
	Basic(1)		8,908,833			8,891,329			8,830,291			7,298,059			6,550,926			6,413,884			6,424,395
	Diluted(1)		8,953,446			8,961,722			9,038,774			8,987,743			8,882,060			8,771,683			8,800,499
Ratios:
Return on average assets			0.52	%		0.52	%		0.30	%		0.58	%		(0.13	)%		0.48	%		0.49	%
Return on average common shareholders' equity			11.0			10.7			5.4			11.1			(5.7	)		8.0			8.1
Shareholders' equity to total assets at end of period			5.3			4.6			5.1			5.7			6.0			6.3			6.0
Book value per common share at end of period(1)		$	15.86		$	13.22		$	13.43		$	12.54		$	10.71		$	11.31		$	10.36
Net interest margin			3.25	%		3.35	%		3.05	%		2.84	%		2.83	%		2.35	%		2.51	%
Nonperforming assets to total assets at end of period			0.56			0.65			0.40			0.71			0.41			0.55			0.55
Operating Cash Performance Ratios:(2)
Operating cash earnings		$	17,112		$	16,415		$	13,929		$	11,618		$	4,371		$	4,899		$	9,820
Operating cash earnings per common share—diluted(1)		$	1.91		$	1.83		$	1.54		$	1.29		$	0.49		$	0.56		$	1.12
Operating cash return on average common shareholders' equity			13.8	%		13.7	%		12.1	%		12.7	%		9.9	%		10.8	%		10.9	%
Operating cash return on average assets			0.65			0.67			0.66			0.66			0.55			0.61			0.62
Operating efficiency			66.3			66.3			65.0			63.2			69.3			62.9			63.1

		December 31,
		2000		1999		1998		1997		1996
		(Dollars in thousands, except per share amounts)
Financial Position Data:
Total assets		$	2,662,779	$	2,546,925	$	2,314,587	$	1,938,353	$	1,594,430
Loans receivable			1,965,927		1,787,771		1,468,534		1,105,739		970,196
Mortgage-backed securities			314,434		343,310		405,725		477,513		379,965
Investments			171,748		162,420		180,680		213,426		118,005
Deposits			1,724,219		1,617,368		1,545,425		1,084,445		952,379
FHLB Seattle advances			530,652		490,503		319,540		460,085		259,626
Other borrowings			110,000		110,000		97,240		72,240		32,240
Shareholders' equity			141,338		117,639		119,017		110,617		96,269
Statistical Data:
Number of:
Employees (full-time equivalents)			822		817		746		525		512
Offices:
	Full service		77		77		77		44		44
	Residential loan production		8		8		10		8		10
Real estate loans			6,254		6,472		6,877		8,338		10,233
Deposit accounts			156,717		156,197		156,362		88,969		89,350

(1)

All prior period per common share and weighted average common share amounts have been restated to reflect the 10% common stock dividend distributed on November 27, 2000.

30

Sterling

changed its fiscal year end from June 30 to December 31, effective December 31, 1996. The selected financial data (except the ratios and statistical data) of Sterling for each of the periods has been derived from Sterling's consolidated financial statements. Such consolidated financial statements for the years ended December 31, 2000, 1999, 1998 and 1997, the six months ended December 31, 1996 and the fiscal year ended June 30, 1996 have been audited by PricewaterhouseCoopers LLP. The selected financial data as of and for all other periods presented are derived from unaudited financial statements and reflect the adjustments, all of which are of a normal and recurring nature, which in the opinion of management are considered necessary for a fair presentation of the financial position and results of operations for such periods.

(2)

Amounts and ratios exclude intangible amortization and other non-recurring items, including acquisition-related costs and adjustments and one-time SAIF assessments, net of related income taxes. Intangible amortization, net of income tax effect, was $3,459, $3,596, $2,512, $1,399, $1,011, $1,043 and $2,079 for the years ended December 31, 2000, 1999, 1998 and 1997, the six months ended December 31, 1996 and 1995, and for the fiscal year ended June 30, 1996, respectively. Acquisition-related costs and other adjustments, net of income tax effect, were $5.2 million for the year ended December 31, 1998. One-time SAIF assessments, net of income tax effect, were $4,385 for the six months ended December 31, 1996.

For

the operating efficiency ratios, intangible amortization excluded from operating expenses was $5,490, $5,692, $3,971, $2,242, $1,590, $1,669 and $3,332 for the years ended December 31, 2000, 1999, 1998 and 1997, and six months ended December 31, 1996 and 1995, and for the fiscal year ended June 30, 1996, respectively. Acquisition-related costs excluded from operating expenses were $5,464 for the year ended December 31, 1998. One-time SAIF assessments, excluded from operating expenses were $6,145 for the six months ended December 31, 1996. Acquisition-related adjustments included in other income were $581,000 for the year ended December 31, 1998.

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

General

    Sterling is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank. The significant operating subsidiaries of Sterling Savings Bank are Action Mortgage, INTERVEST and 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.

    Sterling provides personalized, quality financial services to its customers as exemplified by its "Hometown Helpful" philosophy. Sterling believes that this dedication to personalized service has enabled it to maintain a stable retail deposit base. With $2.66 billion in total assets at December 31, 2000, Sterling attracts FDIC-insured deposits from the general public through 77 retail branches located primarily in rural and suburban communities in Washington, Oregon, Idaho and Montana. Sterling originates loans through its branch offices as well as Action Mortgage residential loan production offices in the metropolitan areas of Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho; and through INTERVEST commercial real estate lending offices located in the metropolitan areas of Spokane and Seattle, Washington; and Portland, Oregon. Sterling also markets tax-deferred annuities, mutual funds and other financial products through Harbor Financial.

    Sterling is also rapidly developing new channels to better service its customers. During 2000, Sterling launched its Internet Banking Web site at www.sterlingsavingsbank.net. Further, Sterling introduced business cash management, international banking and leasing services. With the implementation of in-house check processing, Sterling offers account imaging and better account analysis and now has the capability to offer lockbox services to its customers. Newer technology advancements will also enable Sterling to implement cost efficiency measures in the future, although there is no assurance that such benefits will be realized.

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    Sterling continues to enhance its presence as a community bank by increasing its commercial real estate, business banking, consumer and construction lending while increasing its retail deposits, particularly transaction accounts. Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential loans. Such loans, however, generally involve a higher degree of risk than financing residential real estate. Sterling's revenues are derived primarily from interest earned on loans and MBS, from fees and service charges and from mortgage banking operations. The operations of Sterling Savings Bank, and savings institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities, the OTS, the FDIC and the Washington Supervisor. See "Regulation."

    Sterling intends to continue to pursue an aggressive growth strategy, which may include acquiring other financial institutions or branches thereof or other substantial assets or deposit liabilities. Sterling may not be successful in identifying further acquisition candidates, integrating acquired institutions or preventing deposit erosion or loan quality deterioration at acquired institutions. There is significant competition for acquisitions in Sterling's market area, and Sterling may not be able to acquire other institutions 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 favorable economic and market conditions. There can be no assurance that Sterling will be successful in implementing its growth strategy.

Net Interest Income

    The most significant component of earnings for a financial institution typically is net interest income ("NII"), which is the difference between interest income, primarily from loan, MBS and investment portfolios, and interest expense, primarily on deposits and borrowings. Changes in NII result from changes in volume, net interest spread and net interest margin. 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 interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. During the years ended December 31, 2000, 1999 and 1998, the increases in NII were primarily due to increases in loan volumes.

    The following table sets forth, for the periods indicated, information with regard to the average balances of interest-earning assets and interest-bearing liabilities, average noninterest-earning assets and noninterest-bearing liabilities and average shareholders' equity, the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields

32

or costs, NII, net interest spread, net interest margin and the ratio of average interest-earning assets to average interest-bearing liabilities.

	Years Ended December 31,
	2000						1999						1998
	Average Balance(1)		Interest Earned or Paid		Average Yield or Cost(2)		Average Balance(1)		Interest Earned or Paid		Average Yield or Cost(2)		Average Balance(1)		Interest Earned or Paid		Average Yield or Cost(2)
	(Dollars in thousands)
Loans	$	1,953,951	$	173,121	8.86	%	$	1,716,279	$	143,800	8.38	%	$	1,282,668	$	113,813	8.87	%
Mortgage-backed securities		336,085		21,630	6.44			364,266		22,828	6.27			428,220		26,938	6.29
Investment and cash equivalents		168,002		10,726	6.38			171,565		10,746	6.26			233,264		15,012	6.44
Total interest-earning assets	$	2,458,038	$	205,477	8.36	%	$	2,252,110	$	177,374	7.88	%	$	1,944,152	$	155,763	8.01	%
Noninterest-earning assets		174,869						193,922						150,688
Total assets	$	2,632,907					$	2,446,032					$	2,094,840
Interest-bearing liabilities:
Certificates of deposit	$	968,109	$	57,525	5.94	%	$	866,461	$	44,507	5.14	%	$	791,311	$	43,188	5.46	%
Regular savings accounts and money market accounts		392,456		14,875	3.79			428,710		14,493	3.38			351,759		12,745	3.62
Interest-bearing demand accounts		193,026		1,673	0.87			187,207		1,921	1.03			145,335		1,662	1.14
Total interest-bearing deposits		1,553,591		74,073	4.77			1,482,378		60,921	4.10			1,288,405		57,595	4.47
FHLB Seattle advances		520,791		31,792	6.10			404,301		22,141	5.48			345,898		21,348	6.17
All other borrowings		174,396		9,396	5.39			191,419		9,714	5.07			187,395		10,333	5.51
Trust Preferred Securities		40,000		3,860	9.65			40,000		3,860	9.65			40,000		3,800	9.50
8.75% Subordinated Notes		0		0	0.00			8,572		927	10.81			17,240		1,509	8.75
Floating Rate Notes		30,000		2,870	9.57			17,823		1,485	8.33			0		0	0.00
Advances under line of credit		40,019		3,553	8.88			38,591		2,956	7.66			21,667		1,973	9.11
Total interest-bearing liabilities		2,358,797	$	125,544	5.32	%		2,183,084	$	102,004	4.67	%		1,900,605	$	96,558	5.08	%
Noninterest-bearing deposits		114,315						111,071						72,828
Other noninterest-bearing liabilities		35,623						31,881						6,559
Total liabilities		2,508,735						2,326,036						1,979,992
Shareholders' equity		124,172						119,996						114,848
Total liabilities and shareholder's equity	$	2,632,907					$	2,446,032					$	2,094,840
Net interest spread			$	79,933	3.04	%			$	75,370	3.21	%			$	59,205	2.93	%
Net interest margin					3.25	%					3.35	%					3.05	%
Ratio of average interest-earning assets to average interest-bearing liabilities					104.2	%					103.1	%					102.3	%

(1)

Average balances are computed on a monthly basis.

(2)

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

    The following table illustrates the changes in Sterling's NII due to changes in volume (change in volume multiplied by initial rate), changes in interest rate (change in rate multiplied by initial volume)

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and changes in rate/volume (change in rate multiplied by change in average volume) for the periods indicated.

	December 31, 2000 vs. December 31, 1999 Increase (Decrease) Due to:												December 31, 1999 vs. December 31, 1998 Increase (Decrease) Due to:
	Volume			Rate			Rate/ Volume			Total			Volume			Rate			Rate/ Volume			Total
	(Dollars in thousands)
Interest income on:
Loans	$	19,914		$	8,263		$	1,144		$	29,321		$	38,475		$	(6,343	)	$	(2,145	)	$	29,987
Mortgage-backed securities		(223	)		207			(4	)		(20	)		(4,023	)		(102	)		15			(4,110	)
Investments and cash equivalents		(1,766	)		616			(48	)		(1,198	)		(3,971	)		(401	)		106			(4,266	)
Total interest income		17,925			9,086			1,092			28,103			30,481			(6,846	)		(2,024	)		21,611
Interest-bearing deposits:
Certificates of deposit		5,221			6,978			819			13,018			4,102			(2,541	)		(242	)		1,319
Regular savings accounts and money market accounts		(1,226	)		1,756			(148	)		382			2,788			(853	)		(187	)		1,748
Interest-bearing demand accounts		39			(281	)		(6	)		(248	)		502			(186	)		(57	)		259
Total interest-bearing deposits		4,034			8,453			665			13,152			7,392			(3,580	)		(486	)		3,326
FHLB Seattle advances		6,379			2,540			732			9,651			3,604			(2,405	)		(406	)		793
All other borrowings		(864	)		599			(53	)		(318	)		222			(823	)		(18	)		(619	)
Trust Preferred Securities		0			0			0			0			0			60			0			60
8.75% Subordinated Notes		(927	)		0			0			(927	)		(759	)		355			(178	)		(582	)
Floating Rate Notes		1,015			220			150			1,385			0			0			1,485			1,485
Advances under line of credit		109			470			18			597			1,541			(313	)		(245	)		983
Total interest expense		9,746			12,282			1,512			23,540			12,000			(6,706	)		152			5,446
Net interest income	$	8,179		$	(3,196	)	$	(420	)	$	4,563		$	18,481		$	(140	)	$	(2,176	)	$	16,165

Asset and Liability Management

    The results of operations for savings 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 NPV, or estimated fair value, are subject to fluctuations in interest rates. For example, some of Sterling's ARMs are indexed to the one-year or five-year U.S. Treasury index or fixed-rate LIBOR Swaps. 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 results of operations. Currently, Sterling's interest-bearing liabilities, consisting primarily of savings and time deposits, FHLB Seattle advances and other borrowings, mature or reprice more rapidly, or on different terms, than do its interest-earning assets. The fact that liabilities mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates; however, such an asset/liability structure may result in declining NII during periods of rising interest rates. See "Business—Lending Activities."

    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.

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    Sterling maintains an asset and liability management program intended to manage NII through interest rate cycles and to protect 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 more difficult to estimate because such instruments are 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.

    The calculations of present value have certain shortcomings. The discount rates utilized for loans, investments 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.

    The total measurement of Sterling's exposure to IRR as presented in the following table 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 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 and NPV through the origination and retention of variable-rate consumer, business banking, construction and commercial real estate loans, which generally have higher yields than residential permanent loans, and by increasing the level of its core deposits, which are generally a lower-cost funding source than 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 presents Sterling's estimates of changes in NPV for the periods indicated. The results indicate the potential effects of instantaneous, parallel shifts in the market yield curve. These

35

calculations are highly subjective and technical and are relative measurements of IRR which do not necessarily reflect any expected rate movement.

	At December 31, 2000						At December 31, 1999
Change in Interest Rate in Basis Points (Rate Shock)	NPV		Ratio of NPV to the Present Value of Total Assets		% Change in NPV		NPV		Ratio of NPV to the Present Value of Total Assets		% Change in NPV
(Dollars in thousands)
+300	$	50,550	1.94	%	(60.4	)	$	2,712	0.12	%	(97.2	)
+200		80,812	3.11		(36.7	)		36,369	1.51		(62.5	)
+100		104,108	4.00		(18.4	)		63,177	2.57		(34.8	)
Static		127,609	4.90		N/A			96,899	3.86		N/A
-100		130,460	5.01		2.2			112,812	4.43		16.4
-200		112,735	4.33		(11.7	)		103,314	4.03		6.6
-300		73,483	2.82		(42.4	)		73,835	2.89		(23.8	)

    At December 31, 2000, Sterling calculated that its NPV was $127.6 million and that its NPV would decrease by 36.7% and 60.4% if interest rate levels generally were to increase by 2% and 3%, respectively. This compares with an NPV of $96.9 million at December 31, 1999, where its NPV would decrease by 62.5% and 97.2% if interest rate levels generally were to increase by 2% and 3%, respectively. The increase in NPV at December 31, 2000 from December 31, 1999 was primarily due to the decrease in long-term interest rates.

    Sterling also uses gap analysis, a traditional 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. Sterling calculated its one-year cumulative gap position to be a negative 10.0% and a negative 12.3% at December 31, 2000 and 1999, respectively. Sterling calculated its three-year gap position to be a negative 10.0% and a negative 20.8% at December 31, 2000 and 1999, respectively. The decrease in the negative readings at the three-year gap position was primarily due to new and existing loans being funded with longer-term deposits and borrowings. Management attempts to maintain Sterling's gap position between positive 10% and negative 25%. At December 31, 2000, Sterling's gap positions were within limits 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 Resources."

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    The following table sets forth the estimated maturity/repricing and the resulting gap between Sterling's interest-earning assets and interest-bearing liabilities at December 31, 2000. Other than loans which are in the available-for-sale portfolio, all of the financial instruments of Sterling are intended to be held to maturity. The estimated maturity/repricing amounts reflect contractual maturities and amortizations, assumed loan prepayments based upon Sterling's historical experience, estimates from secondary market sources such as FHLMC and estimated passbook deposit decay rates (the rate of withdrawals or transfers to higher-yielding CDs). Management believes these assumptions and estimates are reasonable, but there can be no assurance in this regard. The classification of mortgage loans, investments and MBS is based upon regulatory reporting formats and, therefore, may not be consistent with the financial information reported in accordance with GAAP and contained elsewhere in this Report on Form 10-K.

	Maturity or Repricing
	0 to 3 Months			Over 3 Months to 1 Year			Over 1 Year to 3 Years			Over 3 Years to 5 Years			Over 5 Years			Total
	(Dollars in thousands)
Interest-earning assets:
Mortgage loans, investments and MBS:
ARM and balloon mortgage loans	$	495,373		$	166,768		$	130,643		$	27,240		$	6,551		$	826,575
Fixed-rate mortgage loans		29,240			80,194			167,918			127,549			381,075			785,976
Loans held for sale		1,489			0			0			0			0			1,489
Total mortgage loans, investments and MBS		526,102			246,962			298,561			154,789			387,626			1,614,040
Nonmortgage loans:
Consumer		66,313			52,894			75,366			33,942			24,276			252,791
Commercial		205,535			73,828			81,782			52,448			18,166			431,759
Total loans, investments and MBS		797,950			373,684			455,709			241,179			430,068			2,298,590
Cash, investments and MBS		78,235			19,165			59,662			8,619			11,721			177,402
Total rate-sensitive assets		876,185			392,849			515,371			249,798			441,789			2,475,992
Cash on hand and in banks		0			0			0			0			59,044			59,044
Other noninterest-earning assets		0			0			0			0			127,743			127,743
Total assets	$	876,185		$	392,849		$	515,371		$	249,798		$	628,576		$	2,662,779
Interest-bearing liabilities:
Deposits:
Certificates of deposit	$	342,105		$	506,167		$	136,721		$	16,922		$	13,318		$	1,015,233
Checking accounts		6,829			20,486			54,630			54,630			189,995			326,570
Money market accounts		307,001			0			0			0			0			307,001
Passbook accounts		3,017			9,050			24,133			24,133			15,082			75,415
Total deposits		658,952			535,703			215,484			95,685			218,395			1,724,219
FHLB Seattle advances		34,184			180,000			245,659			65,615			5,194			530,652
Repurchase agreements		6,776			50,000			53,550			0			0			110,326
Other borrowings		70,000			0			0			0			40,000			110,000
Total interest-bearing liabilities	$	769,912		$	765,703		$	514,693		$	161,300			263,589			2,475,197
Other noninterest-bearing liabilities														46,244			46,244
Shareholders' equity														141,338			141,338
Total liabilities and shareholders' equity														451,171			2,662,779
Net gap	$	106,273		$	(372,854	)	$	678		$	88,498		$	177,405		$	0
Cumulative gap	$	106,273		$	(266,581	)	$	(265,903	)	$	(177,405	)	$	0		$	0
Cumulative gap to total assets		3.99	%		(10.01	)%		(9.99	)%		(6.66	)%		0.00	%		0.00	%

Financial Position

    Assets.  At December 31, 2000, Sterling's assets were $2.66 billion, up 4.6% from $2.55 billion at December 31, 1999. The increase was primarily due to growth in net loans receivable.

    Investments and MBS.  Sterling's investment and MBS portfolio at December 31, 2000 was $486.2 million, down $19.5 million from the December 31, 1999 balance of $505.7 million. The decrease was primarily due to principal repayments of MBS.

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    Loans Receivable.  At December 31, 2000, net loans receivable were $1.97 billion, up $178.2 million from $1.79 billion at December 31, 1999. The increase was primarily due to growth in construction and business banking loans. See "Business—Lending—Loan Portfolio Analysis."

    Deposits.  Total deposits increased $106.9 million to $1.72 billion at December 31, 2000 from $1.62 billion at December 31, 1999. The increase in the average cost of total deposits noted in the table below was primarily due to the increase in the rates paid on certificates of deposit. The following table sets forth the composition of Sterling's deposits at the dates indicated.

	December 31,
	2000				1999
	Amount			%	Amount			%
	(Dollars in thousands)
Certificates of deposit	$	1,015,233		58.9	$	916,692		56.7
Savings and money market		382,416		22.2		410,659		25.4
NOW checking		203,130		11.8		186,012		11.5
Noninterest checking		123,440		7.1		104,005		6.4
Total deposits	$	1,724,219		100.0	$	1,617,368		100.0
Weighted average cost of deposits at end of period		4.66	%			4.04	%

    Borrowings.  Sterling's primary sources of borrowing are the FHLB Seattle advances, securities sold under agreements to repurchase and other borrowings. At December 31, 2000, total borrowings were $751.0 million, compared with $780.0 million at December 31, 1999, a decrease of $29.0 million. The decrease reflects the payoff of certain reverse repurchase agreements at year-end. See "Liquidity and Sources of Funds."

Results of Operations for the Years Ended December 31, 2000 and 1999

    Overview.  Sterling recorded net income of $13.7 million, or $1.52 per diluted share, for the year ended December 31, 2000, compared with net income of $12.8 million, or $1.43 per diluted share, for the year ended December 31, 1999. The increase in net income reflected higher net interest income and other income.

    In addition:

•

Sterling securitized and sold $91.9 million of automobile receivables resulting in a gain of $149,000 during the fourth quarter. This transaction marked Sterling's first securitization.



•

Sterling increased fee and service charge income by 16.5% for the year over the prior year.



•

Sterling launched Internet Banking with its Web site located at www.sterlingsavingsbank.net.



•

Sterling introduced business cash management and international banking services.



•

For the third year in a row, loan originations were over $1.0 billion.



•

Asset quality measures remained consistent with historical levels, reflecting portfolio quality performance.



•

With continued strong operating fundamentals, Sterling's Board of Directors declared a 10% stock dividend, payable on November 27, 2000 to shareholders of record on November 6, 2000.



•

Book value increased substantially to $15.86 per share primarily due to retention of earnings and improvement in the market value of investments.

38

    On an operating cash basis, earnings were $17.1 million, or $1.91 per diluted share, for the year ended December 31, 2000, compared with $16.4 million, or $1.83 per diluted share for 1999. On an operating cash flow basis, return on average equity for the year ended December 31, 2000 increased to 13.8%, compared with 13.7% for the same period in 1999. Operating cash flow refers to net income excluding intangible amortization net of related income tax.

    The annualized return on average assets was .52% for the years ended December 31, 2000 and 1999. The annualized return on average equity was 11.0% and 10.7% for the years ended December 31, 2000 and 1999, respectively.

    Net Interest Income.  Net interest income for the years ended December 31, 2000 and 1999 was $79.9 million and $75.4 million, respectively. The 6.1% increase in NII was primarily due to an increase in the average volume of loans and a change in the mix of loans and investments. During the year ended December 31, 2000, average loans increased by $237.7 million, an increase of 13.8% over 1999. The volume factor, attributable primarily to an increase in loans and investments, resulted in an increase in NII of approximately $8.2 million, which was offset by a $3.5 million reduction in the rate factor, attributable primarily to an increase in cost of funds.

    During the same periods, the net interest margins were 3.25% and 3.35%, respectively. Net interest spreads were 3.04% and 3.21%, respectively. Net interest margin and net interest spread decreased primarily due to higher costs for all wholesale funding sources, which increased by more than the yield on interest-earning assets, primarily the yield on loans.

    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.

    Sterling recorded provisions for losses on loans of $4.6 million and $3.9 million for the years ended December 31, 2000 and 1999, respectively. The level of loan charge-offs to average loans increased modestly to 0.18% for the year ended December 31, 2000 compared to 0.17% in both 1999 and 1998, respectively. At December 31, 2000, Sterling's loan delinquency rate (60 days or more) as a percentage of total loans was 0.51%, compared with 0.52% at December 31, 1999. Total nonperforming loans were $8.4 million, or 0.42% of total loans at December 31, 2000, compared with $9.3 million, or 0.52% of total loans at December 31, 1999. Management believes that Sterling's asset quality remains at acceptable levels and reflects the greater emphasis on higher-risk commercial real estate, construction, business banking and consumer loans. Management further anticipates it may need to continue to maintain and enhance its overall allowance position proportionate with growth and diversification in the loan portfolio.

    Management believes the provisions for losses on loans for the years ended December 31, 2000 and 1999 are appropriate based upon its evaluation of factors affecting the adequacy of valuation allowances, although there can be no assurance in this regard. Such factors include locations and concentrations of loans, loan loss experience and economic factors affecting the Pacific Northwest economy.

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    Other Income.  The following table summarizes the components of other income for the periods indicated.

		Years Ended December 31,
		2000		1999
		(Dollars in thousands)
Fees and service charges		$	12,489	$	10,720
Mortgage banking operations			787		1,082
Loan servicing fees			895		798
Net gains on sales of securities			1		593
Real estate owned operations and other			149		104
	Total other income	$	14,321	$	13,297

    Fees and service charges primarily consist of service charges on deposit accounts, fees for certain customer services, commissions on sales of credit life insurance, commissions on sales of mutual funds and annuity products and late charges on loans. The increase for the year ended December 31, 2000, compared with the year ended December 31, 1999, were primarily due to the implementation of new service charges on transaction accounts, improved efficiencies in assessing overdraft charges and higher commissions on sales of mutual funds and annuity products. During the years ended December 31, 2000 and 1999, sales of mutual funds and annuity products were $37.3 million and $28.7 million, respectively.

    The following table summarizes loan originations and sales of loans for the periods indicated.

	Years Ended December 31,
	2000		1999
	(Dollars in thousands)
Originations of one- to four-family permanent mortgage loans	$	95.5	$	172.1
Sales of residential loans		43.6		72.7
Sales of commercial real estate loans		21.4		43.0
Principal balances of mortgage loans serviced for others		203.7		205.5

    The decrease in income from mortgage banking operations for the year ended December 31, 2000 compared to the same period in 1999, were primarily due to a lower volume of commercial real estate and residential loan sales.

    Real estate owned operations and other for the year ended December 31, 2000 were $149,000, compared with $104,000 for the year ended December 31, 1999. Real estate owned operations and other for the year ended December 31, 2000 included a $149,000 gain on the sale of certain automobile loans and $0 net gain from real estate owned operations.

    During the year ended December 31, 2000, Sterling sold approximately $2.1 million of investments, resulting in net gains of $1,000. During the year ended December 31, 1999, Sterling sold approximately $29.1 million of investments and MBS, resulting in net gains of $593,000.

    Operating Expenses.  Operating expenses were $68.0 million and $64.5 million for the years ended December 31, 2000 and 1999, respectively. This represents an increase of 5.4%. The higher level of operating expenses was primarily a result of higher compensation costs, increased goodwill litigation expenses and the full implementation of the item processing operations.

    Employee compensation and benefits were $31.8 million and $29.1 million for the years ended December 31, 2000 and 1999, respectively. The increase reflected higher costs for personnel, lower loan

40

origination cost deferrals, increased employee benefit costs, and additional staff for the implementation of fee-based business service operations. At December 31, 2000, full-time-equivalent employees were 822, compared with 817 at December 31, 1999.

    Goodwill litigation expenses were $1.1 million and $272,000 for the years ended December 31, 2000 and 1999, respectively. The increase reflected increased activity related to the discovery phase of Sterling's goodwill litigation. Because of the increased level of effort required to bring the case to conclusion, Sterling will likely see an increase in these costs over the next few years.

    Occupancy and equipment expenses were $10.4 million and $10.1 million for the years ended December 31, 2000 and 1999, respectively. The increase reflected costs associated with the item processing centers and higher maintenance costs.

    During the years ended December 31, 2000 and 1999, data processing expenses were $5.5 million and $5.2 million, respectively. The increase was primarily attributable to costs associated with the item processing centers, internal data processing upgrades and increased computer maintenance.

    Other expenses were $3.0 and $3.4 million for the years ended December 31, 2000 and 1999, respectively. The decrease in other expenses was primarily due to cost savings realized from in-house item processing.

    Insurance expenses were $711,000 and $986,000 for the years ended December 31, 2000 and December 31, 1999, respectively. The decrease was primarily due to lower FDIC assessments on deposits.

    Income Tax Provision.  Sterling recorded federal and state income tax provisions of $8.0 million and $7.5 million for the years ended December 31, 2000 and 1999, respectively. The effective tax rates during these periods approximated the applicable statutory federal and state income tax rates.

Results of Operations for the Years Ended December 31, 1999 and 1998

    Overview.  Sterling reported net income of $12.8 million, or $1.43 per diluted share, for the year ended December 31, 1999. Core earnings, which are defined as total earnings before acquisition and conversion costs, associated with two acquisitions and certain other charges (collectively, "non-core charges"), for the year ended December 31, 1998 were $11.4 million, or $1.26 per diluted share. After the non-core charges, Sterling recorded net income of $6.2 million, or $0.69 per diluted share for the year ended December 31, 1998. The increase in net income for the year ended December 31, 1999 reflected an increase in net interest income and other income.

    On June 15, 1998, Sterling acquired 33 branch offices in Washington, Idaho and Oregon from KeyBank. The purchase included approximately $518 million of deposit balances and approximately $125 million of loan balances. Upon acquisition, the weighted average interest rate on deposits assumed was approximately 3.42%. Sterling recorded an approximate $57 million intangible asset associated with the acquisition. Sterling is amortizing the intangible asset over a period of 15 years using the straight-line method. With the net cash received from the branch acquisition, Sterling repaid approximately $322 million of certain reverse repurchase borrowings and FHLB Seattle advances.

    In 1999, Sterling began processing checks for its customers in-house rather than out-sourcing this function. This change has increased staffing and occupancy expenses, but management believes that this change will improve its float management. This should result in increased net interest income and enhanced service to deposit customers in future periods, although there can be no assurance in this regard.

    Sterling completed its merger with Big Sky Bancorp, Inc. ("Big Sky") on November 13, 1998. This transaction was accounted for as a pooling of interests; and accordingly, all historical amounts have been restated to include the results of Big Sky. The after-tax non-core charges associated with the Big

41

Sky acquisition were approximately $1.5 million. During the second quarter of 1998, Sterling completed the acquisition of 33 Northwest KeyBank branches. After-tax non-core charges associated with the KeyBank branch acquisition were approximately $2.0 million. See "Operating Expenses."

    The returns on average assets were .52% and .30% for the years ended December 31, 1999 and 1998, respectively. The returns on average common shareholders' equity were 10.7% and 5.4% for the years ended December 31, 1999 and 1998, respectively. These increases were primarily due to an increase in net income. The returns on average assets and average common shareholders' equity during 1998 were negatively impacted by the non-core charges.

    Net Interest Income.  Net interest income for the years ended December 31, 1999 and 1998 was $75.4 million and $59.2 million, respectively. During these same periods, the net interest margins were 3.35% and 3.05%, respectively, and the volumes of interest-earning assets were $2.25 billion and $1.94 billion, respectively. The increase in NII was primarily due to an increase in the volume of average interest-earning assets which were primarily loans and an increase in the net interest margin. The increase in the net interest margin was primarily due to an increase in the volume of loans and a decrease in the cost of deposits.

    Provision for Loan Losses.  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. Sterling recorded provisions for loan losses of $3.9 million and $5.3 million for the years ended December 31, 1999 and 1998, respectively. Sterling increased its provision for loan losses in 1998 in anticipation of higher levels of loss from its expanded construction, business banking and consumer lending activities. Additionally, during the quarter ended June 30, 1998, Sterling provided approximately $2.9 million for loan losses, reflecting a more conservative view of the factors used to determine such reserves, including impacts on Pacific Northwest economy resulting from a slowdown of trade with Asia. Management anticipates that its provisions for loan losses will continue to increase in the future as Sterling originates more construction, business banking and consumer loans.

    At December 31, 1999, Sterling's loan delinquency rate as a percentage of total loans was 0.52%, compared with 0.43% at December 31, 1998. Total nonperforming loans were $9.3 million at December 31, 1999, compared with $3.1 million at December 31, 1998. As a percentage of total loans, nonperforming loans were 0.52% at December 31, 1999, compared with 0.21% at December 31, 1998.

    Management believes the loan loss provisions represent appropriate allowances for loan losses based upon its evaluation of factors affecting the adequacy of valuation allowances, although there can be no assurance in this regard. Such factors include concentrations of the types of loans and associated risks within the loan portfolio and economic factors affecting the Pacific Northwest economy.

    Other Income.  The following table summarizes the components of other income for the periods indicated:

	Years Ended December 31,
	1999		1998
	(Dollars in thousands)
Fees and service charges	$	10,720	$	7,858
Mortgage banking operations		1,082		1,848
Loan servicing fees		798		791
Net gain on sales of securities		593		2,038
Real estate owned operations		104		(222	)
	$	13,297	$	12,313

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    Fees and service charges consist primarily of service charges on deposit accounts, fees for certain customer services, commissions on sales of credit life insurance, commissions on sales of mutual funds and annuity products and late charges on loans. The increase for the year ended December 31, 1999, compared with the year ended December 31, 1998, was primarily due to an increase in service charges on deposit accounts, fees for certain customer services and commissions on sales of mutual funds and annuity products. The increase in service charges on deposit accounts and fees for certain customer services was primarily due to a full year's effect of fee income from accounts associated with the KeyBank branch acquisition.

    The following table summarizes loan originations and sales of loans for the periods indicated:

	Years Ended December 31,
	1999		1998
	(Dollars in thousands)
Originations of one- to four-family permanent mortgage loans	$	172.1	$	241.7
Sales of residential loans		72.7		110.2
Principal balances at end of period of mortgage loans serviced for others		205.5		211.0

    During the years ended December 31, 1999 and 1998, Sterling sold in bulk rights to service conventional loans for others with principal balances of $0 and $117.6 million, respectively. Sterling's average loan servicing portfolios for the years ended December 31, 1999 and 1998 were approximately $203.6 million and $283.3 million, respectively.

    During the year ended December 31, 1999, Sterling sold approximately $29.1 million of investments and MBS, resulting in a net gain of $593,000. In the same period in 1998, Sterling sold $394.8 million in investments and MBS, resulting in a net gain of $2.0 million.

    Operating Expenses.  Operating expenses were $64.5 million for the year ended December 31, 1999. Operating expenses before non-core charges were $50.8 million for the year ended December 31, 1998. Including non-core charges, total operating expenses were $56.3 million in 1998. Non-core charges include acquisition and conversion costs, the buyout of certain management contracts and the costs associated with mailing customer notices, issuing new checks and ATM cards, training new employees, related travel expenses, equipping branches with office supplies, implementing a targeted marketing campaign and converting computer systems.

    Employee compensation and benefits were $29.1 million and $22.4 million for the years ended December 31, 1999 and 1998, respectively. The increase was primarily due to additional staff for the new check-processing centers and additional lending staff related to Sterling's efforts to increase its commercial real estate, business banking and consumer lending areas. The increase was also primarily due to a full year's effect of additional staffing for the acquired KeyBank branches.

    Occupancy and equipment expenses were $10.1 million and $7.5 million for the years ended December 31, 1999 and 1998, respectively. Amortization of intangibles was $5.7 million and $4.0 million for the years ended December 31, 1999 and 1998, respectively. These increases were primarily due to a full year's effect of increased expenses and amortization related to the KeyBank acquisition.

    Data processing expenses were $5.2 million and $3.8 million for the years ended December 31, 1999 and 1998, respectively. The increase was primarily due to costs associated with the new check-processing centers and internal computer network upgrades that were added in 1999.

    Advertising expenses were $2.7 million and $2.1 million for the years ended December 31, 1999 and 1998, respectively. The increase was primarily due to an enhanced advertising campaign.

43

    Other expenses were $3.4 million and $3.7 million for the years ended December 31, 1999 and 1998, respectively. The decrease was primarily due to refunds of prior period excise taxes. See Note 19 of "Notes to Consolidated Financial Statements."

    Sterling measures the efficiency of its operations by its operating efficiency ratio (the ratio of total operating expenses to total revenues, which includes NII and total other income but excludes intangible amortization expense). Sterling's operating efficiency ratios were 66.3% and 73.2% for the years ended December 31, 1999 and 1998, respectively. Management is striving to reduce its operating efficiency ratio below 65%, but there can be no assurance that it will be able to achieve this goal. Sterling also measures the efficiency of its operations by its cash operating efficiency ratio (the ratio of total operating expenses to total revenues, which includes NII and total other income but excludes non-core charges and intangible amortization expense). Sterling's cash operating efficiency ratios were 66.3% and 65.0% for the years ended December 31, 1999 and 1998, respectively.

    Income Tax Provision.  For the year ended December 31, 1999, Sterling's federal and state income tax provision of $7.5 million represented 36.8% of income before income taxes. For the year ended December 31, 1998, Sterling's federal and state income tax provision of $3.7 million represented 37.2% of income before income taxes. The effective income tax rates during these periods approximated the applicable statutory federal state income tax rates.

Liquidity and Sources of Funds

    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 the FHLB Seattle and other borrowings. Deposits increased to $1.72 billion at December 31, 2000, from $1.62 billion at December 31, 1999. Advances from the FHLB Seattle increased to $530.7 million at December 31, 2000 from $490.5 million at December 31, 1999. See "Business—Sources of Funds—Borrowings."

    Sterling also borrows funds under reverse repurchase agreements pursuant to which it sells investments (generally U.S. agency and MBS) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and MBS sold. Sterling uses these borrowings to fund loans. Sterling had $110.3 million and $179.5 million in reverse repurchase agreements outstanding at December 31, 2000 and 1999, respectively. Sterling enters into short-term repurchase agreements with selected retail customers. The balances of such short-term repurchase agreements were $6.4 million and $6.2 million at December 31, 2000 and 1999, respectively. The use of reverse repurchase agreements may expose Sterling to certain risks not associated with other borrowings, including IRR and the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines. For additional information regarding reverse repurchase agreements, see "Asset and Liability Management" and Note 10 of "Notes to Consolidated Financial Statements."

    During the year ended December 31, 2000, cash provided by or used in investing activities consisted primarily of principal and interest payments on loans and MBS, maturities of investments and approximately $92.0 million of proceeds from the sale of automobile receivables. The levels of these payments increase or decrease depending on the size of the loan and MBS portfolios and the general trend and level of interest rates, which influences the level of refinancing and mortgage prepayments. During the year ended December 31, 2000, net cash was used in investing activities primarily to fund loans.

    Cash provided or used by operating activities is determined largely by changes in the level of loan sales. The level of loans held for sale depends on the level of loan originations and the time within which investors fund the purchase of loans from Sterling. A majority of conventional loans held for sale are sold within 10 days of the closing while the sale of FHA- and VA-insured loans may take up to

44

60 days. Sterling typically offsets fluctuations in the level of loans held for sale by changing the level of advances from the FHLB Seattle, using reverse repurchase agreements or cash. Management believes that proceeds from loans sold, advances from the FHLB Seattle and reverse repurchase agreements will be sufficient to fund loan commitments in the future.

    Sterling Savings Bank's credit line with the FHLB Seattle provides for borrowings up to 30% of its total assets. At December 31, 2000, this credit line represented a total borrowing capacity of $746.9 million, of which $216.2 million was available. Sterling Savings Bank also borrows on a secured basis from major broker/dealers and financial entities by selling securities subject to repurchase agreements. At December 31, 2000, Sterling Savings Bank had $110.3 million in outstanding borrowings under reverse repurchase agreements and had securities available for additional secured borrowings of $231.2 million. Sterling Savings Bank also had a secured line-of-credit agreement from KeyBank of $10.0 million as of December 31, 2000. At December 31, 2000, Sterling Savings Bank had no funds drawn on this line of credit.

    Sterling, on a parent company-only basis, had cash and other resources of approximately $4.3 million and a revolving line of credit from KeyBank of $5.0 million at December 31, 2000 with no funds drawn on this line of credit. At December 31, 2000, Sterling also had $40.0 million outstanding on a $50.0 million non-revolving variable-rate line of credit from KeyBank. The KeyBank lines of credit are secured by all of the stock of Sterling Savings Bank. See Note 11 of "Notes to the Consolidated Financial Statements."

    At December 31, 2000 and 1999, Sterling had an investment of $95.1 million in the Preferred Stock of Sterling Savings Bank. Sterling received cash dividends on Sterling Savings Bank Preferred Stock of $10.0 million during the year ended December 31, 2000. These resources were sufficient to meet the operating needs of Sterling, including interest expense on the Floating Rate Notes Due 2006 and other borrowings. Sterling Savings Bank's ability to pay dividends is limited by its earnings, financial condition and capital requirements, as well as rules and regulations imposed by the OTS.

    OTS regulations require savings institutions such as Sterling Savings Bank to maintain an average daily balance of liquid assets equal to or greater than a specific percentage (currently 4%) of the average daily balance of net withdrawable accounts and borrowings payable on demand in one year or less during the preceding calendar month. At December 31, 2000 and 1999, Sterling Savings Bank's liquidity ratio was 7.7% and 9.1%, respectively. The lower level of liquidity at December 31, 2000 was primarily due to a decrease in the average balance of cash and cash equivalents. Sterling Savings Bank's strategy generally is to maintain its liquidity ratio at or near the level necessary to support expected and potential loan fundings and deposit withdrawals. Sterling Savings Bank tries to minimize liquidity levels in order to maximize its yield on alternative investments. The regulatory liquidity ratio does not take into account certain other sources of liquidity, such as funds invested through Sterling Savings Bank subsidiaries, potential borrowings against investments and MBS and other potential financing alternatives. The required minimum liquidity ratio may vary from time to time, depending on economic conditions, savings flows and loan funding needs. See "Business—Regulation."

Capital Resources

    Sterling's total shareholders' equity was $141.3 million at December 31, 2000, compared with $117.6 million at December 31, 1999. At December 31, 2000 and 1999, shareholders' equity was 5.3% and 4.6% of total assets, respectively.

    On October 24, 2000, Sterling's Board of Directors declared a 10% common stock dividend that was distributed on November 27, 2000 to shareholders of record on November 6, 2000.

    At December 31, 2000, Sterling had an unrealized loss of $3.6 million, net of related income taxes, on investments and MBS classified as available for sale. At December 31, 1999, Sterling had an

45

unrealized loss of $13.6 million, net of related income taxes. Since the start of the year, long-term interest rates have declined, decreasing the unrealized loss on investments and MBS. Fluctuations in prevailing interest rates continue to cause volatility in this component of accumulated comprehensive income (loss) in shareholders' equity and may continue to do so in future periods. See "Business—Investments and Mortgage-Backed Securities."

    Sterling has issued and outstanding $40.0 million of Trust Preferred Securities. The indenture governing the Trust Preferred Securities limits the ability of Sterling under certain circumstances to pay dividends or make other capital distributions. The Trust Preferred Securities are treated as debt of Sterling. The Trust Preferred Securities mature on June 30, 2027 and are redeemable at the option of Sterling on June 30, 2002, or earlier in the event the deduction of related interest for federal income taxes is prohibited, treatment as Tier 1 capital is no longer permitted or certain other contingencies arise.

    Sterling anticipates total capital expenditures of approximately $2.0 million for the year ended December 31, 2001. Sterling anticipates continuing to fund these expenditures from various sources, including retained earnings and borrowings with various maturities. Sterling is exploring opportunities to sell certain developed properties and enter into lease arrangements. There can be no assurance that Sterling's estimates of capital or the funding thereof are accurate.

    Sterling Savings Bank is required by applicable regulations to maintain certain minimum capital levels with respect to core (Tier 1) capital, core (Tier 1) risk-based capital and total risk-based capital. Sterling Savings Bank anticipates that it will continue to enhance its capital resources and the regulatory capital ratios of Sterling Savings Bank through the retention of earnings, the amortization of intangible assets and the management of the level and mix of assets, although there can be no assurance in this regard. At December 31, 2000, Sterling Savings Bank exceeded all such regulatory capital requirements. See Note 16 of "Notes to Consolidated Financial Statements."

    In connection with Sterling Savings Bank's acquisition of three insolvent savings institutions between 1985 and 1988, the U.S. government agreed that Sterling could use $13.5 million of cash assistance and $38.0 million of "supervisory goodwill" associated with the acquisitions to help meet its regulatory capital and liquidity requirements. In 1989, Congress enacted FIRREA which provided, among other things, that savings institutions such as Sterling Savings Bank were no longer permitted to include supervisory goodwill in their regulatory capital. Consequently, Sterling Savings Bank was required to discontinue use of its supervisory goodwill in calculating its capital ratios, which resulted in Sterling Savings Bank's failing to comply with its minimum regulatory capital requirements from 1989 through 1991.

    In May 1990, Sterling sued the U.S. Government with respect to the loss of the goodwill treatment and other matters in a lawsuit entitled Sterling Savings Association and Sterling Financial Corporation v. The United States, No. 95 829 C (the "Goodwill Litigation"). In the Goodwill Litigation, Sterling seeks damages for, among other things, breach of contract and for deprivation of property without just compensation.

    In 1996 the United States Supreme Court ruled in three cases similar to the Goodwill Litigation that the U.S. Government was liable for having breached its acquisition contracts with certain savings associations. Sterling is encouraged by the Supreme Court's decision, however, the outcome of the Goodwill Litigation cannot be predicted with certainty.

    Sterling's Goodwill Litigation, which had been stayed for almost ten years, has completed the fact discovery phase and is scheduled to proceed with the expert witness discovery phase of this case. Although it is impossible to accurately predict when this effort will be concluded, management anticipates that the expert witness discovery stage will be completed in late 2001 or early 2002 and that, thereafter, Sterling's case will be scheduled for trial in the ensuing two or three years. Because of the

46

increased level of effort required to bring the case to conclusion, Sterling likely will see an increase in legal expenses over the next few years.

New Accounting Standards

    In October 2000, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"). SFAS 140 replaces SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." It revises the standards for accounting for securitization and other transfers of financial assets and collateral and requires certain disclosures. SFAS 140 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. However, SFAS 140 also requires recognition and reclassification of collateral and certain additional disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Sterling has implemented the disclosure requirements of SFAS 140. Since SFAS 140 requirements are prospectively applied to future transactions, Sterling believes that the application of this statement will not have a material effect on the consolidated financial statements.

    In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 133, as amended by SFAS 137, "Deferral of the Effective Date of FASB Statement 133," is effective for all fiscal quarters of fiscal years beginning after June 15, 2000; however, earlier application of all of the provisions of this Statement is encouraged as of the beginning of any fiscal quarter. Sterling does not believe the effect of implementing SFAS 133 will be material to its consolidated financial statements.

Effects of Inflation and Changing Prices

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

47

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

    For a discussion of Sterling's market risk, see "Management's Discussion and Analysis—Asset and Liability Management."

Item 8.  Financial Statements and Supplementary Data

    The required information is contained on pages F-1 through F-46 of this Form 10-K.

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

    During the year ended December 31, 2000, Sterling neither changed nor had any disagreements with its independent accountants on accounting and financial disclosures.

PART III

Item 10.  Directors and Executive Officers of the Registrant

    The required information is contained under the captions "Board of Directors of Sterling Financial Corporation" and "Executive Officers" in Sterling's Proxy Statement dated March 23, 2001, for the annual meeting of Shareholders on April 24, 2001, and is incorporated herein by reference.

Item 11.  Executive Compensation

    The required information is contained under the captions "Personnel Committee Report on Executive Compensation" and "Executive Compensation" in Sterling's Proxy Statement dated March 23, 2001, for the annual meeting of Shareholders on April 24, 2001, and is incorporated herein by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management

    The required information is contained under the caption "Security Ownership of Certain Beneficial Owners and Management" in Sterling's Proxy Statement dated March 23, 2001, for the annual meeting of Shareholders on April 24, 2001, and is incorporated herein by reference.

Item 13.  Certain Relationships and Related Transactions

    The required information is contained under the caption "Interest of Directors, Officers and Others in Certain Transactions" in Sterling's Proxy Statement dated March 23, 2001, for the annual meeting of Shareholders on April 24, 2001, and is incorporated herein by reference.

PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)

Documents which are filed as a part of this report:



1.

Financial Statements: The required financial statements are contained in pages F-1 through F-46 of this Form 10-K.



2.

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

48

3.

Exhibits:

Exhibit No.	Exhibit
3.1	Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.1 to Sterling's Form S-4 dated November 7, 1994 and incorporated by reference herein.
3.2	Articles of Amendment of Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.2 to Sterling's Form S-4 dated November 7, 1994 and incorporated by reference herein.
3.3	Amended and Restated Bylaws of Sterling. Filed as Exhibit 3.3 to Sterling's Annual Report on Form 10-K dated February 22, 2000 and incorporated by reference herein.
4.1	Reference is made to Exhibits 3.1 and 3.2.
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	Sterling Financial Corporation 1998 Long-term Incentive Plan, filed as Exhibit A to Sterling's Proxy Statement in connection with the Annual Meeting of Shareholders held on April 28, 1998 and incorporated by reference herein.
10.2	First Federal Savings and Loan Association of Montana 1992 Stock Option and Incentive Plan, incorporated by reference from the Registration Statement on Form 10 filed by the Association with the Office of Thrift Supervision on May 15, 1992.
10.3	Sterling Savings Bank 1992 Incentive Stock Option Plan. Filed as Exhibit 10.2 to Sterling's Form S-4 dated August 28, 1992 and incorporated by reference herein.
10.4	Sterling Financial Corporation Amended and Restated Deferred Compensation Plan, effective July 1, 1999. Filed as Exhibit 10.5 to Sterling's Annual Report on Form 10-K dated February 22, 2000 and incorporated by reference herein.
10.5	Sterling Savings Bank Employment Savings and Incentive Plan and Trust dated September 21, 1990. Filed as Exhibit 10.4 to Sterling's Form S-4 dated August 28, 1992 and incorporated by reference herein.
10.6	Employment Agreement, dated July 1, 1999, between Sterling Financial Corporation and Harold B. Gilkey. Filed as Exhibit 10.7 to Sterling's Annual Report on Form 10-K dated February 22, 2000 and incorporated by reference herein.
10.7	Employment Agreement, dated July 1, 1999, between Sterling Financial Corporation and William W. Zuppe. Filed as Exhibit 10.8 to Sterling's Annual Report on Form 10-K dated February 22, 2000 and incorporated by reference herein.
10.8	Form of Employment Agreement for Executive Officers. Filed as Exhibit 10.9 to Sterling's Annual Report on Form 10-K dated February 22, 2000 and incorporated by reference herein.
10.9	Form of Employment Agreement for Executive Officers. Filed herewith.
12.1	Statement regarding Computation of Return on Average Common Shareholders' Equity. Filed herewith.

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12.2	Statement regarding Computation of Return on Average Assets. Filed herewith.
12.3	Statement regarding Computation of Operating Cash Performance Ratios. Filed herewith.
21.1	List of Subsidiaries of Sterling. Filed herewith.
23.1	Consent of PricewaterhouseCoopers LLP. Filed herewith.

(b)

Reports on Form 8-K. Three reports on Form 8-K were filed during the period covered by this report. The reports were filed on October 25, July 28 and May 2, 2000, respectively.

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SIGNATURES

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

	STERLING FINANCIAL CORPORATION
February 27, 2001	By:	/s/ HAROLD B. GILKEYHarold B. Gilkey Chairman of the Board, Chief Executive Officer

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

February 27, 2001	By:	/s/ HAROLD B. GILKEYHarold B. Gilkey Chairman of the Board, Chief Executive Officer, Principal Executive Officer
February 27, 2001	By:	/s/ WILLIAM W. ZUPPEWilliam W. Zuppe President, Chief Operating Officer, Director
February 27, 2001	By:	/s/ DANIEL G. BYRNEDaniel G. Byrne Senior Vice President, Assistant Secretary and Principal Financial Officer
February 27, 2001	By:	/s/ WILLIAM R. BASOMWilliam R. Basom Vice President, Treasurer and Principal Accounting Officer
February 27, 2001	By:	/s/ NED M. BARNESNed M. Barnes, Secretary, Director
February 27, 2001	By:	/s/ RODNEY W. BARNETTRodney W. Barnett, Director
February 27, 2001	By:	/s/ THOMAS H. BOONEThomas H. Boone, Director
February 27, 2001	By:	/s/ JAMES P. FUGATEJames P. Fugate, Director
February 27, 2001	By:	/s/ ROBERT D. LARRABEERobert D. Larrabee, Director
February 27, 2001	By:	/s/ ROBERT E. MEYERSRobert E. Meyers, Director
February 27, 2001	By:	/s/ DAVID O. WALLACEDavid O. Wallace, Director

51

Sterling Financial Corporation
Report on Audit of Consolidated Financial Statements
For the Years Ended December 31, 2000, 1999 and 1998

Report of Independent Accountants

The Board of Directors and Shareholders
Sterling Financial Corporation
Spokane, Washington

    In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income (loss), changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Sterling Financial Corporation and its subsidiaries ("Sterling") as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Sterling's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP

February 8, 2001
Spokane, Washington

F-1

Sterling Financial Corporation

Consolidated Balance Sheets

December 31, 2000 and 1999

(Dollars in thousands)

				2000			1999
Assets:
	Cash and cash equivalents:
		Interest bearing		$	3,466		$	23,365
		Non-interest bearing and vault			57,129			72,221
		Restricted			1,915			1,018
	Investments and mortgage-backed securities:
		Available for sale			476,732			494,483
		Held to maturity			9,450			11,247
	Loans receivable, net				1,965,927			1,787,771
	Loans held for sale				1,489			985
	Accrued interest receivable				18,455			16,720
	Real estate owned, net				6,407			7,299
	Office properties and equipment, net				50,220			52,649
	Other intangibles, net				49,998			55,488
	Mortgage servicing rights, net				349			222
	Prepaid expenses and other assets, net				21,242			23,457
			Total assets	$	2,662,779		$	2,546,925
Liabilities:
	Deposits			$	1,724,219		$	1,617,368
	Advances from Federal Home Loan Bank of Seattle				530,652			490,503
	Securities sold subject to repurchase agreements				110,326			179,515
	Other borrowings				110,000			110,000
	Cashiers checks issued and payable				17,529			11,967
	Borrowers' reserves for taxes and insurance				1,649			1,369
	Accrued interest payable				9,616			7,539
	Accrued expenses and other liabilities				17,450			11,025
			Total liabilities		2,521,441			2,429,286
Commitments and contingencies (Notes 9, 10, 11 and 17)
Shareholders' equity:
	Preferred stock, $1 par value; 10,000,000 shares authorized; no shares issued and outstanding				0			0
	Common stock, $1 par value; 20,000,000 shares authorized; 8,911,150 and 8,089,844 shares issued and outstanding				8,911			8,090
	Additional paid-in capital				78,035			70,339
	Accumulated other comprehensive income (loss):
	Unrealized losses on investments and mortgage-backed securities available for sale, net of deferred income taxes of $1,915 and $7,298				(3,558	)		(13,553	)
	Retained earnings				57,950			52,763
			Total shareholders' equity		141,338			117,639
Total liabilities and shareholders' equity				$	2,662,779		$	2,546,925

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

F-2

Sterling Financial Corporation

Consolidated Statements of Income

For the Years Ended December 31, 2000, 1999 and 1998

(Dollars in thousands, except per share amounts)

			2000			1999			1998
Interest income:
	Loans		$	173,121		$	143,800		$	113,813
	Mortgage-backed securities			21,630			22,828			26,938
	Investments and cash equivalents			10,726			10,746			15,012
		Total interest income		205,477			177,374			155,763
Interest expense:
	Deposits			74,073			60,921			57,595
	Short-term borrowings			8,885			11,013			26,005
	Long-term borrowings			42,586			30,070			12,958
		Total interest expense		125,544			102,004			96,558
		Net interest income		79,933			75,370			59,205
Provision for losses on loans				(4,600	)		(3,900	)		(5,325	)
	Net interest income after provision for losses on loans			75,333			71,470			53,880
Other income (expense):
	Fees and service charges			12,489			10,720			7,858
	Mortgage banking operations			787			1,082			1,848
	Loan servicing fees			895			798			791
	Net gains on sales of securities			1			593			2,038
	Real estate owned operations and other			149			104			(222	)
		Total other income		14,321			13,297			12,313
Operating expenses (Note 19)				67,968			64,478			56,291
	Income before income taxes			21,686			20,289			9,902
Income tax benefit (provision):
	Current			(8,175	)		(6,915	)		(7,392	)
	Deferred			142			(555	)		3,713
		Total income tax provision		(8,033	)		(7,470	)		(3,679	)
Net income			$	13,653		$	12,819		$	6,223
Income per common share—basic			$	1.53		$	1.44		$	.70
Income per common share—diluted			$	1.52		$	1.43		$	.69
Weighted average common shares outstanding—basic				8,908,833			8,891,329			8,830,291
Weighted average common shares outstanding—diluted.				8,953,446			8,961,722			9,038,774

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

F-3

Sterling Financial Corporation

Consolidated Statements of Comprehensive Income (Loss)

For the Years Ended December 31, 2000, 1999 and 1998

(Dollars in thousands)

		2000		1999			1998
Net income		$	13,653	$	12,819		$	6,223
Other comprehensive income (loss):
	Change in unrealized gains or losses on investments and mortgage-backed securities available for sale		15,378		(22,063	)		2,269
	Less deferred income tax provision (benefit)		5,383		(7,722	)		775
	Net other comprehensive income (loss)		9,995		(14,341	)		1,494
Comprehensive income (loss)		$	23,648	$	(1,522	)	$	7,717

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

F-4

Sterling Financial Corporation

Consolidated Statements of Changes in Shareholders' Equity

For the Years Ended December 31, 2000, 1999 and 1998

(Dollars in thousands)

		Common Stock
							Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Unearned Stock Compensation			Retained Earnings			Total Shareholders' Equity
		Shares		Amount
Balance, December 31, 1997		8,017,821		$	8,018		$	69,889		$	(706	)	$	(305	)	$	33,721		$	110,617
	Shares issued upon exercise of stock options	39,301			39			428												467
	Shares acquired and retired upon exercise of stock options	(969	)		(1	)		(84	)											(85	)
	Cash paid for fractional shares	(81	)					(4	)											(4	)
	Change in unrealized loss on investments and mortgage-backed securities available for sale, net of income taxes										1,494									1,494
	Vesting of unearned stock compensation													305						305
	Net income																6,223			6,223
Balance, December 31, 1998		8,056,072			8,056			70,229			788			0			39,944			119,017
	Shares issued upon exercise of stock options	38,592			39			185												224
	Shares acquired and retired upon exercise of stock options	(4,820	)		(5	)		(75	)											(80	)
	Change in unrealized gain on investments and mortgage-backed securities available for sale, net of income taxes										(14,341	)								(14,341	)
	Net income																12,819			12,819
Balance, December 31, 1999		8,089,844			8,090			70,339			(13,553	)		0			52,763			117,639
	Shares issued upon exercise of stock options	29,000			29			241												270
	Shares acquired and retired upon exercise of stock options	(17,503	)		(18	)		(197	)											(215	)
	Change in unrealized loss, net of income taxes										9,995									9,995
	10% common stock dividend	810,134			810			7,656									(8,466	)
	Cash paid for fractional shares	(325	)					(4	)											(4	)
	Net income																13,653			13,653
Balance, December 31, 2000		8,911,150		$	8,911		$	78,035		$	(3,558	)	$	0		$	57,950		$	141,338

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

F-5

Sterling Financial Corporation

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2000, 1999 and 1998

(Dollars in thousands)

					2000			1999			1998
Cash flows from operating activities:
	Net income				$	13,653		$	12,819		$	6,223
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provisions for losses on loans and real estate owned				4,600			4,105			5,396
		Stock dividends on Federal Home Loan Bank of Seattle stock				(2,315	)		(2,449	)		(2,370	)
		Net gain on sales of loans, investments and mortgage-backed securities and mortgage servicing rights				(704	)		(1,561	)		(3,578	)
		Net gain on sales of real estate owned				(190	)		(456	)		(133	)
		Depreciation and amortization				10,674			11,228			8,820
		Deferred income tax (provision) benefit				142			(555	)		3,713
		Compensation expense associated with stock grants				0			0			305
		Change in:
			Accrued interest receivable			(1,735	)		(1,782	)		246
			Prepaid expenses and other assets			(3,707	)		(2,102	)		(2,467	)
			Cashiers checks issued and payable			5,562			(5,545	)		6,252
			Accrued interest payable			2,077			1,900			(976	)
			Accrued expenses and other liabilities			6,425			(2,289	)		(2,627	)
		Proceeds from sales of loans				65,554			72,994			111,591
		Real estate loans originated for sale				(65,001	)		(72,661	)		(110,162	)
				Net cash provided by operating activities		35,035			13,646			20,233
Cash flows from investing activities:
	Change in restricted cash					(897	)		7,757			(5,787	)
	Loans disbursed					(1,094,132	)		(1,304,940	)		(1,211,678	)
	Loan principal received					819,150			993,493			952,479
	Purchase of investments					(29,126	)		(36,680	)		(350,111	)
	Proceeds from maturities of investments					21,667			52,766			374,648
	Proceeds from sales of available-for-sale investments					2,138			542			10,825
	Purchase of mortgage-backed securities					0			(62,274	)		(401,897	)
	Principal payments on mortgage-backed securities					42,338			77,463			90,965
	Proceeds from sales of mortgage-backed securities					0			29,104			385,979
	Purchase of office properties and equipment					(2,160	)		(5,119	)		(4,896	)
	Improvements and other changes to real estate owned					(1,028	)		(360	)		126
	Proceeds from sales and liquidation of real estate owned					7,678			3,385			4,525
	Proceeds from sales of mortgage servicing rights					0			0			1,123
	Net cash received from branch acquisitions					0			0			327,183
	Proceeds from securitization					86,304			0			0
				Net cash provided by (used in) investing activities		(148,068	)		(244,863	)		173,484

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

F-6

Sterling Financial Corporation

Consolidated Statements of Cash Flows, Continued

For the Years Ended December 31, 2000, 1999 and 1998

(Dollars in thousands)

				2000			1999			1998
Cash flows from financing activities:
	Net change in checking, passbook and money market deposits			$	(7,808	)	$	(46,681	)	$	52,054
	Proceeds from issuance of certificates of deposit				609,906			824,261			725,755
	Payments for maturing certificates of deposit				(567,382	)		(765,485	)		(892,557	)
	Interest credited to deposits				72,135			59,848			58,228
	Advances from Federal Home Loan Bank of Seattle				454,184			330,877			238,192
	Repayment of Federal Home Loan Bank of Seattle advances				(414,135	)		(160,123	)		(379,084	)
	Net change in securities sold subject to repurchase agreements				(69,189	)		(15,559	)		14,997
	Proceeds from other borrowings				7,000			35,000			40,000
	Repayment of other borrowings				(7,000	)		(22,240	)		(15,000	)
	Payments for fractional shares				(4	)		0			(4	)
	Proceeds from exercise of stock options, net of repurchases				55			144			382
	Deferred financing costs				0			(1,113	)		0
	Other				280			(457	)		58
			Net cash provided by (used in) financing activities		78,042			238,472			(156,979	)
Net change in cash and cash equivalents					(34,991	)		7,255			36,738
Cash and cash equivalents, beginning of year					95,586			88,331			51,593
Cash and cash equivalents, end of year				$	60,595		$	95,586		$	88,331
Supplemental disclosures:
	Cash paid during the period for:
		Interest		$	123,467		$	100,104		$	96,798
		Income taxes			6,282			7,468			5,873
	Noncash financing and investing activities:
		Loans converted into real estate owned		$	5,568		$	3,841		$	2,004
		Common stock dividend			8,466			0			0
		Retention of residual interests from securitization			5,712			0			0

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

F-7

Sterling Financial Corporation

Notes to Consolidated Financial Statements

For the Years Ended December 31, 2000, 1999 and 1998

1.  Business and Significant Accounting Policies:

Business

    Sterling Financial Corporation ("Sterling") is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank. Sterling Savings Bank is a Washington State-chartered savings association headquartered in Spokane, Washington, that conducts business from 77 offices located throughout Washington, Oregon, Idaho and Montana. Sterling Savings Bank provides full-service banking, including attracting deposits insured by the Federal Deposit Insurance Corporation ("FDIC") and originating consumer, business banking, residential and commercial real estate and residential construction loans. Action Mortgage Company ("Action Mortgage"), a wholly owned subsidiary of Sterling Savings Bank, operates residential loan production offices in the metropolitan areas of Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho. INTERVEST-Mortgage Investment Company ("INTERVEST"), also a wholly owned subsidiary of Sterling Savings Bank, provides commercial real estate lending through its offices in the metropolitan areas of Portland, Oregon; Spokane, Washington; and the Puget Sound region. Sterling Savings Bank also owns Harbor Financial Services, Inc. ("Harbor Financial"), which markets tax-deferred annuities, mutual funds and other financial products through regional representatives.

Principles of Consolidation

    The accompanying consolidated financial statements include the accounts of Sterling and its directly and indirectly wholly owned subsidiaries. Results of operations of all business combinations required to use the purchase accounting method are consolidated for all periods after the date of acquisition. All significant intercompany accounts and transactions have been eliminated in consolidation.

    On June 15, 1998, Sterling assumed approximately $518.0 million in deposit liabilities and acquired certain branch assets from 33 branch offices of KeyBank National Association ("KeyBank"). The following shows the allocation of the purchase price for the KeyBank transaction (in thousands):

Liabilities assumed:
	Certificates of deposit		$	233,864
	NOW accounts			79,887
	Non-interest bearing demand accounts			76,419
	Savings and money market accounts			127,330
				517,500
	Accrued interest payable			736
		Total liabilities assumed		518,236
Less assets acquired:
	Loans receivable, net			121,569
	Office properties and equipment			10,996
	Accrued interest on loans			1,126
	Intangible asset			57,362
		Total assets acquired		191,053
Net cash received from branch acquisitions			$	327,183

F-8

    The intangible asset includes both the identifiable value of existing depositor relationships and the remaining unidentified intangible asset. As it was not practical to separately value the existing depositor relationships, Sterling is amortizing the entire intangible asset over 15 years using the straight-line method.

    On November 13, 1998, Sterling completed a business combination with Big Sky Bancorp, Inc. ("Big Sky"), whereby Big Sky was merged with Sterling. In connection with the merger, Sterling issued 448,030 shares of its common stock for all of the outstanding common shares of Big Sky based on an exchange ratio of 1.384 Sterling shares for each Big Sky share. The merger has been accounted for as a pooling of interests. Accordingly, Sterling's consolidated financial statements have been restated to present the combination of Sterling and Big Sky as if the merger had occurred at the beginning of the earliest period presented.

    The following table presents a reconciliation of interest income and net income previously reported by Sterling and Big Sky individually, prior to the merger, to the combined amounts included in the consolidated statements of income (in thousands).

		Nine Months Ended September 30, 1998
Interest income:
	Sterling	$	110,537
	Big Sky		3,554
		$	114,091
Net income:
	Sterling	$	4,466
	Big Sky		333
		$	4,799

Cash and Cash Equivalents

    Cash equivalents are any highly liquid debt instrument with a remaining maturity of three months or less at the date of purchase. Cash and cash equivalents are on deposit with other banks and financial institutions in amounts that periodically exceed the federal insurance limit. Sterling evaluates the credit quality of these banks and financial institutions to mitigate its credit risk.

    At December 31, 2000 and 1999, Sterling had approximately $3.0 million and $20.3 million, respectively, of uninsured non-interest bearing deposits. Restricted cash consisted primarily of non-interest bearing deposits maintained as a reserve at the Federal Reserve Bank.

    Sterling has purchased approximately $3.4 million and $22.0 million of securities under an agreement to resell substantially identical securities with another institution at December 31, 2000 and 1999, respectively. The amounts advanced under this agreement represent short-term loans and are reflected as interest-bearing cash equivalents in the consolidated balance sheet. The securities underlying the agreements are comprised of shares of a mutual fund, which trades primarily in U.S. government securities.

F-9

Investments and Mortgage-Backed Securities

    Sterling classifies debt and equity investments and mortgage-backed securities ("MBS") as follows:

•

Available for Sale.  Except for Federal Home Loan Bank of Seattle ("FHLB Seattle") stock, debt and equity investments and MBS that will be held for indefinite periods of time are classified as available for sale and are carried at market value. Market value is determined using published quotes or other indicators of value as of the close of business on December 31, 2000 and 1999. Unrealized gains and losses are reported, net of deferred income taxes, as a component of accumulated other comprehensive income or loss in shareholders' equity until realized. FHLB Seattle stock may only be redeemed by FHLB Seattle or sold to another member institution at par. Therefore, this investment is restricted and is carried at cost.

•

Held to Maturity.  Investments in debt securities that management of Sterling has the intent and ability to hold until maturity are classified as held to maturity and are carried at their remaining unpaid principal balance, net of unamortized premiums or unaccreted discounts. Premiums are amortized and discounts are accreted using the level interest yield method over the estimated remaining term of the underlying security.

    Realized gains and losses on sales of investments and MBS are recognized in the statement of income in the period sold using the specific identification method.

Loans Receivable

    Loans receivable that management of Sterling has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance less any origination and commitment fees, net of direct loan origination costs and an associated allowance for losses on loans.

    Interest income is recognized over the term of the loans receivable on a level yield basis. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to make payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received.

    When Sterling sells receivables in securitizations of automobile loans, it retains interest-only strips, one or more subordinated tranches, servicing rights, and in some cases a cash reserve account, all of which are retained interests in the securitized receivables. Gain or loss on sale of the receivables depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of transfer. To obtain fair values, quoted market prices are used if available. However, quotes are generally not available for retained interests; therefore, Sterling generally estimates fair value based on the present value of future expected cash flows estimated using management's best estimates of the key assumptions, which are credit losses, prepayment speeds, forward yield curves, and discount rates commensurate with the risks involved.

Allowance for Losses on Loans

    Management of Sterling provides an allowance for losses on loans based upon estimates of the cash flows to be received from the loans or the fair value of the underlying collateral, net of selling costs. These estimates are affected by factors including changes in the economic environment in the Pacific Northwest region and the resultant effect on collateral values. As a result of changing economic

F-10

conditions, it is reasonably possible that the amount of the allowance for losses on loans could change in the near term. A provision for losses on loans is charged to income based on management's evaluation of the probable losses that have occurred or may occur in the loan portfolio.

Loans Held for Sale

    Loans held for sale are reported at the lower of amortized cost or market value as determined on an aggregate basis. Any loan that management determines will not be held to maturity is classified as held for sale. Market value is determined for loan pools of common interest rates using published quotes as of the close of business. Unrealized losses on loans held for sale are included in the consolidated statements of income in the period that the unrealized loss is identified.

Loan Origination and Commitment Fees

    Loan origination fees, net of direct origination costs, are deferred and recognized as interest income using the level interest yield method over the contractual term of each loan adjusted for actual loan prepayment experience. If the related loan is sold, the remaining net amount deferred, which is part of the basis of the loan, is considered in determining the gain or loss on sale.

    Loan commitment fees are deferred until the expiration of the commitment period unless management believes there is a remote likelihood that the underlying commitment will be exercised, in which case the fees are amortized to fee income using the straight-line method over the commitment period. If a loan commitment is exercised, the deferred commitment fee is accounted for in the same manner as a loan origination fee. Deferred commitment fees associated with expired commitments are recognized as fee income.

Office Properties and Equipment

    Office properties and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the lesser of the estimated useful lives or the related lease terms of the assets. Expenditures for new properties and equipment and major renewals or betterments are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. Upon sale or retirement, the cost and related accumulated depreciation are removed from the respective property or equipment accounts, and the resulting gains or losses are reflected in operations.

Real Estate Owned

    Property acquired in satisfaction of defaulted mortgage loans is carried at the lower of cost or fair value less estimated costs to sell. Development and improvement costs relating to the property are capitalized to the extent they are deemed to be recoverable.

    An allowance for losses on real estate owned is established to include amounts for estimated losses as a result of an impairment in value of the real property. Sterling reviews its real estate owned for impairment in value whenever events or circumstances indicate that the carrying value of the property may not be recoverable. In performing the review, if expected future undiscounted cash flow from the use of the property or the fair value, less selling costs, from the disposition of the property is less than its carrying value, an impairment loss is recognized. As a result of changes in the real estate markets in which these properties are located, it is reasonably possible that the carrying values could be reduced in the near term.

Intangible Assets

    Sterling records identifiable and unidentifiable intangibles in connection with the acquisition of certain assets or subsidiaries. Where separately identifiable, the value of depositor relationships that existed at the date of an acquisition are amortized over the estimated life of the depositor relationships acquired (generally 8 to 10 years). Unidentified intangible assets are amortized on a straight-line basis over periods ranging from 8 to 20 years. Accumulated amortization of intangible assets was approximately $40.7 million and $35.2 million at December 31, 2000 and 1999, respectively.

F-11

    Sterling performs a review for impairment of intangible assets whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.

Mortgage Banking Operations

    Sterling, through Action Mortgage and INTERVEST, originates and sells loans and participating interests in loans to provide additional funds for general corporate purposes. Loans and participating interests therein are held for sale and are carried at the lower of cost or market value. Sterling recognizes a gain or loss on these loan sale transactions which includes a component reflecting the differential between the contractual interest rate of the loan and the interest rate which will be received by the investor. The present value of the estimated future profit for servicing the loans, together with the normal servicing fee rate, is taken into account in determining the amount of gain or loss on the sale of loans.

    Sterling adopted Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"), which applies to transactions involving sales or securitizations of financial assets, such as mortgage loans, and the liquidation of financial liabilities on January 1, 1997. In October 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 140"). SFAS No. 140 replaces SFAS No. 125. SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. However, SFAS No. 140 also requires recognition and reclassification of collateral and certain additional disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. Sterling has implemented the disclosure requirements of SFAS No. 140. Since SFAS No. 140 requirements are prospectively applied to future transactions, Sterling believes that the application of this statement will not have a material effect on the consolidated financial statements.

    At December 31, 2000 and 1999, mortgage servicing rights were approximately $349,000, and $222,000, respectively, which are net of accumulated amortization of approximately $431,000 and $380,000, respectively. The cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified based primarily on prepayment and interest rate risks. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value.

Income Taxes

    Sterling accounts for income taxes using the liability method, which requires that deferred tax assets and liabilities be determined based on the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities and tax attributes using enacted tax rates in effect in the years in which the temporary differences are expected to reverse.

    Sterling files a consolidated federal income tax return with its subsidiaries.

Income Per Share

    Income per share—basic is computed by dividing net income by the weighted average number of common shares outstanding during the period. Income per share—diluted is computed by dividing net income by the weighted average number of common shares outstanding increased by the additional

F-12

common shares that would have been outstanding if the potentially dilutive common shares had been issued.

Comprehensive Income

    Sterling has adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements.

    Reclassification adjustments, representing the net (gains) losses on available-for-sale securities that were realized during the period, net of related deferred income taxes, were as follows (in thousands):

	Amount
Year ended December 31, 2000	$	0
Year ended December 31, 1999		(440	)
Year ended December 31, 1998		25

    These (gains) losses had previously been included in other comprehensive income as unrealized (gains) losses on investments and MBS available for sale.

Hedging Activities

    Sterling is authorized by its Board of Directors, subject to certain limitations, to use financial futures and other contractual instruments for the purpose of hedging interest rate risk relative to the investment and MBS portfolio and in anticipation of sales of mortgage loans into the secondary market.

    Sterling invests in MBS for its investment portfolio. Such purchases have been limited to tranches that perform in concert with the underlying mortgages or assets; i.e., improving in value with falling interest rates and declining in value with rising interest rates. Sterling has not invested in "derivative products" that have been structured to perform in a way that magnifies the normal impact of changes in interest rates or in a way dissimilar to the movement in value of the underlying securities.

    Sterling uses forward sales contracts to hedge against interest rate risk arising from mortgage loans held for sale. Gains and losses on interest rate forward sales are deferred and included in the carrying value of the related hedged assets. The unrealized gains and losses are amortized over the estimated lives of the related assets as a yield adjustment. Upon settlement of the assets being hedged, deferral accounting is discontinued and the resultant gain or loss is realized in operations. At December 31, 2000, Sterling was not a party to any derivative financial instruments that required separate accounting treatment as a derivative instrument.

    In June 1998, Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), was issued. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in its balance sheet and measure those instruments at fair value. In June 1999, Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities—Deferral of Effective Date of SFAS 133" ("SFAS No. 137"), was issued. SFAS No. 137 amends SFAS No. 133 to become effective for all quarters of fiscal years beginning after June 15, 2000; however, earlier application is encouraged as of the beginning of any fiscal quarter. Sterling has determined that the effect of the implementation of SFAS No. 133 on its consolidated financial statements will not be material.

F-13

Estimates

    The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications

    Certain amounts in the 1999 and 1998 financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on retained earnings or net income as previously reported.

2.  Investments and Mortgage-Backed Securities:

    The carrying and fair values of investments and MBS are summarized as follows (in thousands):

		Held to Maturity
		Amortized Cost/ Carrying Value		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2000
	U.S. Government and agency obligations	$	95	$	0	$	(1	)	$	94
	Municipal bonds		9,124		74		(5	)		9,193
	Mortgage-backed securities		231		5		0			236
		$	9,450	$	79	$	(6	)	$	9,523
December 31, 1999
	U.S. Government and agency obligations	$	95	$	0	$	(4	)	$	91
	Municipal bonds		10,873		37		(59	)		10,851
	Mortgage-backed securities		279		9		0			288
		$	11,247	$	46	$	(63	)	$	11,230

		Available for Sale
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Carrying/ Fair Value
December 31, 2000
	U.S. Government and agency obligations	$	94,350	$	135	$	(222	)	$	94,263
	FHLB Seattle stock (restricted)		37,082		0		0			37,082
	Municipal bonds		498		10		0			508
	Mortgage-backed securities		317,488		266		(3,551	)		314,203
	Retained residual interests from securitization		5,712		0		0			5,712
	Other		27,076		7		(2,119	)		24,964
		$	482,206	$	418	$	(5,892	)	$	476,732
December 31, 1999
	U.S. Government and agency obligations	$	93,344	$	0	$	(2,609	)	$	90,735
	FHLB Seattle stock (restricted)		34,767		0		0			34,767
	Mortgage-backed securities		359,987		48		(17,003	)		343,032
	Other		27,236		7		(1,294	)		25,949
		$	515,334	$	55	$	(20,906	)	$	494,483

F-14

    At December 31, 2000 and 1999, accrued interest on investments and MBS was $4.1 million and $4.3 million, respectively.

    During the years ended December 31, 2000, 1999 and 1998, Sterling sold available-for-sale investments and MBS which resulted in the following (in thousands):

	Proceeds from Sales		Gross Realized Gains		Gross Realized Losses
Year ended December 31, 2000	$	2,138	$	1	$	0
Year ended December 31, 1999		29,646		593		0
Year ended December 31, 1998		396,804		2,669		631

    At December 31, 2000, the amortized cost and fair value of available-for-sale and held-to-maturity debt securities, by contractual maturity (in thousands), are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

		Amortized Cost		Fair Value
Available for sale MBS:
	After one year through five years	$	3,975	$	3,997
	After five years through ten years		24,041		23,682
	After ten years		289,472		286,524
		$	317,488	$	314,203
Held to maturity MBS:
	After ten years	$	231	$	236
Available for sale U.S. government and agency obligations:
	After one year through five years	$	94,350	$	94,263
Held to maturity U.S. government and agency obligations:
	After one year through five years	$	95	$	94
Available for sale municipal bonds:
	After one year through five years	$	498	$	508
Held to maturity municipal bonds:
	Under one year	$	2,236	$	2,242
	After one year through five years		5,673		5,726
	After five years through ten years		1,215		1,225
		$	9,124	$	9,193
Residual interests from securitization:
	After one year through five years	$	5,712	$	5,712
Other:
	After ten years	$	27,076	$	24,964

    At December 31, 2000 and 1999, U.S. government and agency obligations and MBS with an aggregate fair value of $30.3 million and $26.1 million, respectively, were pledged as collateral for the treasury tax and loan account in accordance with Federal Reserve Board regulations or for wholesale public funds deposits in accordance with Washington, Oregon and Montana state laws and regulations. Additionally, Sterling periodically utilizes MBS as collateral for reverse repurchase agreements and other borrowing transactions (see Notes 10 and 11).

F-15

    On December 22, 2000, Sterling securitized and sold approximately $93.3 million in automobile loans. In the securitization, Sterling retained servicing responsibilities and certain subordinated interests. Sterling's retained residual interests are subordinate to investors' interests. Their value is subject to credit, prepayment and interest rate risks on the transferred financial interests (see Note 26).

3.  Loans Receivable:

    The components of loans receivable are as follows (in thousands):

			December 31,
			2000			1999
Real estate loans:
	Variable rate:
		1-4 unit residential	$	42,014		$	33,852
		5 or more unit residential		94,180			82,825
		Commercial		256,222			196,710
		Land and other		592			674
	Fixed rate:
		Conventional 1-4 unit residential		360,001			319,079
		5- and 7-year balloon or reset 1-4 unit residential		4,273			24,136
		1-4 unit residential, insured by FHA/VA		3,815			19,320
		5 or more unit residential		69,495			67,024
		Commercial		90,921			108,119
		Land and other		364			226
Construction:
		1-4 unit residential		215,844			184,081
		5 or more unit residential		80,728			71,024
		Commercial		81,347			32,018
				1,299,796			1,139,088
Other loans:
	Commercial loans			413,154			245,428
	Commercial and personal lines of credit			60,798			139,427
	Consumer loans			214,123			281,792
				688,075			666,647
Total loans receivable				1,987,871			1,805,735
Deferred loan fees, net of direct origination costs				(5,383	)		(4,338	)
Premium on loans acquired pursuant to purchase transactions				179			1,977
Allowance for losses				(16,740	)		(15,603	)
Loans receivable, net			$	1,965,927		$	1,787,771
Weighted average interest rate				8.86	%		8.32	%

    Accrued interest on loans receivable was approximately $13.7 million and $12.1 million at December 31, 2000 and 1999, respectively.

    Sterling originates residential, commercial real estate, consumer and commercial loans throughout the Pacific Northwest region. Loans originated outside this area are primarily for immediate sale into the secondary market. At December 31, 2000 and 1999, approximately 69%, 23%, 6% and 2% and 71%, 19%, 7% and 3% of real estate loans were collateralized by property located in Washington,

F-16

Oregon, Idaho and Montana, respectively. The value of real estate properties in these geographic regions will be affected by changes in the economic environment of that region. It is reasonably possible that these values could change in the near term, which would affect Sterling's estimate of its allowance for losses on loans associated with these loans receivable.

    Sterling originates both variable- and fixed-rate loans. The variable-rate loans have interest rate adjustment limitations and are generally indexed to various indices. Variable-rate real estate loans are typically indexed to the prime rate, one-year or five-year U.S. Treasury index, or fixed-rate LIBOR swaps. Future market factors may affect the correlation of the interest rates Sterling pays on the short-term deposits that have been primarily utilized to fund these loans.

    At December 31, 2000, the contractual principal payments due on outstanding loans receivable (in thousands) are shown below. Actual payments may differ from expected payments because borrowers have the right to prepay loans, with or without prepayment penalties.

Year Ending December 31,	Amount
2001	$	492,848
2002		172,817
2003		110,799
2004		110,984
2005		111,205
Thereafter		989,218
	$	1,987,871

4.  Loan Servicing:

    Loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balances of these loans as of the dates indicated are summarized as follows (in thousands):

		December 31,
		2000		1999		1998
Loan portfolios serviced for:
	FHLMC	$	106,688	$	122,558	$	167,541
	FNMA		14,722		17,892		25,682
	Residential		82,339		65,050		17,767
	Commercial real estate		129,375		104,283		35,711
	Consumer		89,344		23		70
		$	422,468	$	309,806	$	246,771

    Custodial escrow balances maintained in connection with loans serviced for others were approximately $852,000 and $960,000 at December 31, 2000 and 1999, respectively.

F-17

    The following is an analysis of the changes in mortgage servicing rights (in thousands):

		Purchased Servicing			Originated Servicing			Total
Balance, December 31, 1997		$	1,170		$	0		$	1,170
	Sale of servicing portfolio		(1,023	)		0			(1,023	)
	Amortization		(129	)		0			(129	)
Balance, December 31, 1998			18			0			18
	Additions		0			227			227
	Amortization		(11	)		(12	)		(23	)
Balance, December 31, 1999			7			215			222
	Additions		0			179			179
	Amortization		(7	)		(45	)		(52	)
Balance, December 31, 2000		$	0		$	349		$	349

    Sterling has sold participations in certain commercial real estate loans to investors on a servicing-retained basis. During the years ended December 31, 2000 and 1999, Sterling sold approximately $21.4 million and $43.0 million in loans under participation agreements, resulting in net gains of $127,000 and $209,000, respectively.

    During the year ended December 31, 1998, Sterling sold, in bulk, the rights to service conventional loans for others with an outstanding balance of approximately $117.6 million and recognized a gain of approximately $100,000 on the sale.

    On December 22, 2000, Sterling securitized and sold approximately $93.3 million in automobile loans. In the securitization, Sterling retained servicing responsibilities and certain subordinated interests (see Note 26).

5.  Real Estate Owned:

    The components of real estate owned are as follows (in thousands):

	December 31,
	2000			1999
Commercial	$	1,525		$	3,471
Residential		3,713			1,737
Construction		802			779
Other		773			2,373
		6,813			8,360
Allowance for losses		(406	)		(1,061	)
Real estate owned, net	$	6,407		$	7,299

F-18

6.  Allowances for Losses on Loans and Real Estate Owned:

    The following is an analysis of the changes in the allowances for losses on loans and real estate owned (in thousands):

		Loans			Real Estate Owned			Total
Balance, December 31, 1997		$	9,486		$	884		$	10,370
	Provision		5,325			71			5,396
	Amounts written off		(2,391	)		(4	)		(2,395	)
	Recoveries		203			0			203
	Loss allowances acquired		2,000			0			2,000
Balance, December 31, 1998			14,623			951			15,574
	Provision		3,900			205			4,105
	Amounts written off		(3,172	)		(95	)		(3,267	)
	Recoveries		252			0			252
Balance, December 31, 1999			15,603			1,061			16,664
	Provision		4,600			0			4,600
	Amounts written off		(3,891	)		(655	)		(4,546	)
	Recoveries		428			0			428
Balance, December 31, 2000		$	16,740		$	406		$	17,146

    The following is a summary of loans that are not performing in accordance with their original contractual terms (in thousands):

	December 31,
	2000		1999
Nonaccrual loans(1)	$	8,385	$	9,259
Restructured loans(2)		0		66
Total nonperforming loans	$	8,385	$	9,325

(1)

The total allowance for losses on loans related to these loans was $450,000 and $201,000 at December 31, 2000 and 1999, respectively. For loans on nonaccrual status at period end, additional gross interest income of $722,000, $485,000 and $159,000 would have been recorded during the years ended December 31, 2000, 1999 and 1998, respectively, if nonaccrual and restructured loans had been current in accordance with their original contractual terms. Interest income of $890,000, $442,000 and $194,000 was recorded during the years ended December 31, 2000, 1999 and 1998, respectively, in connection with such loans.

The average recorded investment in impaired loans during the years ended December 31, 2000, 1999 and 1998, was $9.6 million, $7.3 million and $4.5 million, respectively.

(2)

Restructured loans occur when Sterling has agreed to compromise the contractual loan terms to provide a reduction in the rate of interest and, in most instances, an extension of payments of principal or interest, or both, because of a deterioration in the financial position of the borrower. Restructured loans performing in accordance with their new terms are not included in nonaccrual loans unless there is uncertainty as to the ultimate collection of principal or interest.

F-19

7.  Office Properties and Equipment:

    The components of office properties and equipment are as follows (in thousands):

	December 31,
							Estimated Useful Life
	2000			1999
Buildings and improvements	$	38,415		$	40,143		20-40 years
Furniture, fixtures, equipment and computer software		26,618			24,005		3-10 years
Leasehold improvements		3,180			3,539		5-20 years
Automobiles		65			62		3-5 years
		68,278			67,749
Less accumulated depreciation and amortization		(26,225	)		(23,245	)
		42,053			44,504
Land		8,167			8,145
Total office properties and equipment	$	50,220		$	52,649

8.  Deposits:

    The components of deposits and applicable yields are as follows (in thousands):

		December 31,
		2000		1999
Commercial checking accounts (non-interest bearing)		$	123,440	$	104,005
Checking accounts, 1.09% to 1.25%			203,130		186,012
Passbook accounts, 1.53% to 1.59%			75,415		84,526
Money market demand accounts, 1.09% to 4.83%			307,001		326,133
			708,986		700,676
Certificate of deposit accounts:
	Up to 3.99%		7,872		6,463
	4.00 to 4.99%		18,979		219,694
	5.00 to 5.99%		201,093		486,830
	6.00 to 6.99%		725,156		185,330
	7.00 to 7.99%		57,666		13,177
	8.00 to 8.99%		3,193		3,815
	9.00 to 9.99%		959		909
	10.00% and over		315		474
			1,015,233		916,692
Total deposits		$	1,724,219	$	1,617,368

    The weighted average interest rate paid on certificate of deposit accounts was 4.66% and 4.04% at December 31, 2000 and 1999, respectively.

F-20

    At December 31, 2000, the scheduled maturities of certificate of deposit accounts are as follows (in thousands):

Year Ending December 31,	Weighted Average Interest Rate		Amount
2001	6.25	%	$	843,909
2002	6.31			112,898
2003	6.16			28,177
2004	5.96			7,308
2005	6.55			9,623
Thereafter	6.64			13,318
			$	1,015,233

    At December 31, 2000, the remaining maturities of certificate of deposit accounts with a minimum balance of $100,000 were as follows (in thousands):

Less than three months	$	183,335
Three to six months		75,011
Six to twelve months		86,582
Over twelve months		39,796
	$	384,724

    The components of interest expense associated with deposits are as follows (in thousands):

	Years Ended December 31,
	2000		1999		1998
Checking accounts	$	1,673	$	1,921	$	1,662
Passbook accounts		1,433		1,499		1,552
Money market demand accounts		13,442		12,994		11,193
Certificate of deposit accounts		57,525		44,507		43,188
	$	74,073	$	60,921	$	57,595

9.  Advances from Federal Home Loan Bank of Seattle:

    Advances from FHLB Seattle are collateralized by certain investments and MBS and qualifying loans with a carrying value of approximately $1.1 billion at December 31, 2000. Sterling Savings Bank's credit line with FHLB Seattle is limited to 30% of its total assets. At December 31, 2000, Sterling Savings Bank had the ability to borrow an additional $216.2 million from FHLB Seattle.

    The advances from FHLB Seattle at December 31, 2000 are repayable as follows (in thousands):

Year Ending December 31,	Weighted Average Interest Rate		Amount
2001	5.85	%	$	84,184
2002	6.15			65,659
2003	5.97			90,000
2004	6.49			40,000
2005	6.66			110,615
Thereafter	6.22			140,194
			$	530,652

F-21

10. Securities Sold Subject to Repurchase Agreements:

    Sterling enters into sales of securities under agreements to repurchase the same or similar securities ("reverse repurchase agreements"). Fixed-coupon reverse repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheet. The dollar amount of securities underlying the agreements remains in the applicable asset accounts. These agreements had a weighted average interest rate of 6.15% at December 31, 2000. Substantially all of Sterling's reverse repurchase agreements are transacted with Morgan Stanley (MS), Merrill Lynch (ML) and Salomon (SAL). The MBS underlying these agreements were held by MS, ML and SAL. The risk of default under such agreements is limited by the financial strength of these broker-dealers and the level of borrowings relative to the market value of pledged securities. At December 31, 2000, under the reverse repurchase agreements, Sterling has pledged as collateral investments and MBS with aggregate amortized costs and market values of $138.2 million and $137.4 million, respectively.

    The average balances of securities sold subject to reverse repurchase agreements were $170.8 million, $189.4 million and $123.7 million during the years ended December 31, 2000, 1999, and 1998, respectively. The maximum amount outstanding at any month end during these same periods was $183.9 million, $196.6 million and $366.7 million, respectively.

    At December 31, 2000, securities sold subject to repurchase agreements are repayable as follows (in thousands):

Year Ending December 31,	Weighted Average Interest Rate		Amount
2001	5.28	%	$	6,776
2003	7.07			8,550
2004	6.70			20,000
2005	5.97			75,000
			$	110,326

11. Other Borrowings:

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

		December 31,
		2000		1999
Advances on non-revolving line of credit(1)		$	40,000	$	40,000
Advances on revolving line of credit(2)			0		0
Sterling obligated mandatorily redeemable preferred capital securities of subsidiary trust holding solely junior subordinated deferrable interest debentures of Sterling(3)			40,000		40,000
Floating Rate Notes Due 2006(4)			30,000		30,000
	Total other borrowings	$	110,000	$	110,000

(1)

Sterling has a $50.0 million non-revolving, variable-rate, line-of-credit agreement with KeyBank National Association ("KeyBank"), of which $40.0 million was outstanding at December 31, 2000. The line of credit matures on June 1, 2003. Through May 31, 2001, interest accrues at the 30-day London Interbank Offering Rate ("LIBOR") plus 2.00% (8.75% at December 31, 2000) and is payable monthly. On June 1, 2001, the interest rate adjusts to LIBOR plus 2.50%. On June 1, 2002, the interest rate adjusts to LIBOR plus 2.75%. This line of credit, as well as the line of

F-22

credit referred to in footnote (2) below, is collateralized by all of the stock of Sterling Savings Bank.

(2)

Sterling has a $5.0 million revolving line-of-credit agreement with KeyBank. The revolving line of credit matures on June 1, 2001. The interest rate is adjustable monthly at KeyBank's prime interest rate (9.50% at December 31, 2000). At December 31, 2000, no amounts were outstanding under this line-of-credit agreement.

(3)

On June 4, 1997, Sterling issued $41.2 million of 9.50% junior subordinated deferrable interest debentures (the "Junior Subordinated Debentures") to Sterling Capital Trust I (the "Trust"), a Delaware business trust, in which Sterling owns all of the common equity. The sole asset of the Trust is the Junior Subordinated Debentures. The Trust issued $40.0 million of 9.50% Cumulative Capital Securities (the "Trust Preferred Securities") to investors. Sterling's obligations under the Junior Subordinated Debentures and related documents, taken together, constitute a full and unconditional guarantee by Sterling of the Trust's obligations under the Trust Preferred Securities. The Trust Preferred Securities are treated as debt of Sterling. Although Sterling, as a savings and loan holding company, is not subject to the Federal Reserve capital requirements for bank holding companies, the Trust Preferred Securities have been structured to qualify as Tier I capital, subject to certain limitations, if Sterling were to become regulated as a bank holding company. The Junior Subordinated Debentures and related Trust Preferred Securities mature on June 30, 2027 and are redeemable at the option of Sterling in the event the deduction of related interest for federal income taxes is prohibited, treatment as Tier I capital is no longer permitted or certain other contingencies arise. The Trust Preferred Securities must be redeemed upon maturity of the Junior Subordinated Debentures in 2027.

(4)

Sterling has outstanding $30.0 million of Floating Rate Notes Due 2006. These notes are unsecured general obligations of Sterling and are subordinated to certain other existing and future indebtedness. Under the terms of the notes, Sterling is limited in the amount of certain long-term debt that it may incur; and the notes restrict Sterling, under certain circumstances, as to the amount of cash dividends on its preferred or common stock and capital distributions which can be made. At December 31, 2000, Sterling could incur approximately $21.7 million of additional long-term debt, and Sterling would have been limited to the payment of up to approximately $8.9 million in additional dividends. Interest accrues at the 90-day LIBOR plus 2.50% (9.08% until March 14, 2001) and is adjustable and payable quarterly. The notes mature on June 15, 2006 and may be redeemed under certain conditions after June 15, 2002.

    Sterling Savings Bank has an unsecured $10.0 million line-of-credit agreement with KeyBank. Advances under this line-of-credit accrue interest at a defined variable rate (6.50% at December 31, 2000) and the line matures in April 2001. At December 31, 2000 and 1999, no amounts were outstanding under this line-of-credit agreement.

F-23

12. Income Taxes:

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

	December 31,
	2000				1999
	Assets		Liabilities		Assets		Liabilities
Allowance for losses on loans	$	6,185	$	0	$	5,764	$	0
Unrealized losses on available for sale securities		1,915		0		7,298		0
Net operating loss carryforward		5		0		5		0
Purchase accounting discount or premium		1,680		539		1,447		579
FHLB Seattle dividends		0		7,227		0		6,393
Deferred loan fees		0		2,263		0		2,643
Office properties and equipment		0		649		0		441
Equity in losses of partnerships		0		15		0		204
Other		1,211		0		1,290		0
Total deferred income taxes	$	10,996	$	10,693	$	15,804	$	10,260

    A valuation allowance against deferred tax assets has not been established as it is more likely than not that these assets will be realized.

    A reconciliation of the income tax provision and the amount of income taxes computed by applying the statutory federal corporate income tax rate to income before income taxes follows (dollars in thousands):

		Years Ended December 31,
		2000					1999					1998
		Amount			%		Amount			%		Amount			%
Income tax provision at federal statutory rate		$	7,590		35.0		$	7,101		35.0		$	3,466		35.0
Tax effect of:
	State taxes, net of federal benefit		282		1.3			203		1.0			(20	)	(.2	)
Amortization of goodwill			47		.2			117		.6			217		2.2
Tax-exempt interest			(186	)	(.9	)		(216	)	(1.1	)		(160	)	(1.6	)
Other, net			300		1.4			265		1.4			176		1.8
		$	8,033		37.0		$	7,470		36.9		$	3,679		37.2

F-24

13. Stock Options and Warrants:

    Sterling has granted options to purchase shares of its common stock at exercise prices equal to the fair market value of the stock at the date of grant. The options vest over 1 to 4 years and are exercisable from 4 to 10 years from the date of grant. Sterling is authorized to grant 1,100,000 options under various stock option incentive plans. At December 31, 2000, there were 38,745 options available for grant.

    Sterling has chosen not to record compensation expense using fair value measurement provisions in the statement of income. Had compensation cost for Sterling's plans been determined based on the fair value at the grant dates for awards under the plans, Sterling's reported net income and income per common share would have been changed to the pro forma amounts indicated below (dollars in thousands, except per share amounts):

	Years Ended December 31,
	2000				1999				1998
	As Reported		Pro Forma		As Reported		Pro Forma		As Reported		Pro Forma
Net income	$	13,653	$	12,293	$	12,819	$	11,786	$	6,223	$	5,119
Income per commonshare—basic	$	1.53	$	1.38	$	1.44	$	1.33	$	.70	$	.58
Income per common share—diluted	$	1.52	$	1.37	$	1.43	$	1.32	$	.69	$	.57

    The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the periods above: dividend yield of 0% in each period, expected stock price volatility of 85%-97% each period, risk-free interest rates of 4.46% to 6.97% and expected lives of 0 to 10 years, respectively.

    Stock option transactions are summarized as follows:

		Number of Shares		Weighted Average Exercise Price		Exercise Price Per Share		Expiration Date
Balance, December 31, 1997		530,301		$	12.03	$	3.24-$19.18	1998-2007
	Options granted	110,744			14.82	$	14.74-$19.18	1999-2008
	Options exercised	(39,301	)		10.70	$	6.50-$12.71	1998-2007
	Options canceled	(7,250	)		7.89	$	12.60-$19.18	2002-2007
Balance, December 31, 1998		594,494			12.05	$	3.24-$19.18	1999-2008
	Options granted	217,500			11.48	$	10.52-$14.74	2004-2009
	Options exercised	(38,592	)		5.21	$	3.24-$12.76	1999-2007
	Options canceled	(43,500	)		14.58	$	14.74-$19.18	2002-2004
Balance, December 31, 1999		729,902			12.10	$	3.24-$19.18	2000-2009
	Options granted	164,000			10.05	$	9.05-$10.66	2005-2010
	Options exercised	(29,000	)		8.37	$	3.28-$10.73	2000-2001
	Options canceled	(17,750	)		12.91	$	10.04-$19.18	2000-2005
Balance, December 31, 2000		847,152		$	11.82
Exercisable, December 31, 2000		622,952		$	12.15

    The weighted average fair value of options granted during the years ended December 31, 2000, 1999 and 1998 was $10.05, $11.48 and $14.82, respectively.

F-25

    The following table summarizes information about Sterling's plans at December 31, 2000:

	Options Outstanding
					Options Exercisable
		Weighted Average Remaining Contractual Life
Range of Exercise Price	Number Outstanding		Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$3.24	4,869	1.5 years	$	3.24	4,869	$	3.24
$5.41-$6.64	34,250	1.6 years		6.51	34,250		6.51
$8.37-$9.75	462,455	6.0 years		6.71	266,455		10.26
$10.04-$12.73	173,578	3.3 years		12.73	173,578		12.73
$14.74-$17.65	106,000	5.7 years		14.78	85,300		14.79
$19.01-$19.18	66,000	4.9 years		19.18	58,500		19.18
	847,152				622,952

    All share and dollar amounts have been restated to reflect the conversion of each Big Sky stock option into a Sterling stock option at the exchange ratio. All share and dollar amounts have been restated to reflect the 10% common stock dividend on November 27, 2000.

    Big Sky had adopted a Management Recognition and Development Plan whereby stock was granted to the board of directors and management. In accordance with the vesting provisions of Big Sky's plan, all participants became fully vested upon consummation of the merger. Accordingly, the compensation expense associated with Big Sky's plan was recorded in Sterling's operations during the year ended December 31, 1998.

14. Shareholders' Equity:

    Sterling's Board of Directors declared a 10% common stock dividend on October 24, 2000. The stock dividend was distributed on November 27, 2000 to shareholders of record as of November 6, 2000. Fractional shares were distributed in cash based upon the closing price as of the record date. All weighted average shares outstanding and per share amounts have been retroactively restated to reflect this common stock dividend.

    Sterling's Board of Directors has the authority to issue preferred stock of Sterling in one or more series and to fix the rights, privileges, preferences and restrictions granted to or imposed upon any unissued shares of preferred stock, without further vote or action by the common shareholders.

15. Earnings Per Share:

    The following table (dollars in thousands, except per share amounts) presents a reconciliation of the numerators and denominators used in the basic and diluted income per share computations, which includes the number of antidilutive securities (if any) that were not included in the dilutive income per share computation. These antidilutive securities occur when options outstanding held an option price

F-26

greater than the average market price for the period. Prior periods have been restated to reflect the 10% common stock dividend declared in October 2000.

		For the Year Ended December 31, 2000
		Net Income (Numerator)		Weighted Average Shares (Denominator)	Per Share Amount
Income per common share—basic		$	13,653	8,908,833	$	1.53
Effect of dilutive securities:
	Common stock options			44,613
Income per common share—diluted		$	13,653	8,953,446	$	1.52
Antidilutive options not included in diluted income per share				347,578

		For the Year Ended December 31, 1999
		Net Income (Numerator)		Weighted Average Shares (Denominator)	Per Share Amount
Income per common share—basic		$	12,819	8,891,329	$	1.44
Effect of dilutive securities:
	Common stock options			70,393
Income per common share—diluted		$	12,819	8,961,722	$	1.43
Antidilutive options not included in diluted income per share				389,486

		For the Year Ended December 31, 1998
		Net Income (Numerator)		Weighted Average Shares (Denominator)	Per Share Amount
Income per common share—basic		$	6,223	8,830,291	$	.70
Effect of dilutive securities:
	Common stock options			208,483
Income per common share—diluted		$	6,223	9,038,774	$	.69
Antidilutive options not included in diluted income per share				78,650

16. Regulatory Matters:

    In connection with the insurance of its deposits by the Federal Deposit Insurance Corporation ("FDIC") and general regulatory oversight by the Office of Thrift Supervision ("OTS"), Sterling Savings Bank is required to maintain minimum levels of regulatory capital, including core (Tier I) risk-based and total risk-based capital. At December 31, 2000, Sterling Savings Bank was in compliance with all regulatory capital requirements. The OTS is empowered to take "prompt, corrective action" to resolve problems of insured depository institutions. The extent of these powers depends on whether an institution is classified as "well capitalized," "adequately capitalized," "undercapitalized," "significantly under capitalized," or "critically undercapitalized." At December 31, 2000 and 1999, Sterling Savings Bank was considered "well capitalized."

    The following table sets forth the amounts and ratios regarding actual and minimum core (Tier I) risk-based and total risk-based capital requirements, together with the amounts and ratios

F-27

required in order to meet the definition of a "well-capitalized" institution, without giving effect to forbearance or capital provisions contained in certain acquisition agreements (dollars in thousands).

		Minimum Capital Requirements				Well-Capitalized Requirements				Actual
		Amount		Ratio		Amount		Ratio		Amount		Ratio
As of December 31, 2000:
	Total Risk-Based Capital (to Risk-Weighted Assets)	$	152,281	8.00	%	$	190,352	10.00	%	$	195,054	10.25	%
	Core (Tier I) Capital (to Risk-Weighted Assets)		76,141	4.00			114,211	6.00			184,829	9.71
	Core (Tier I) Capital (to Adjusted Assets)		104,199	4.00			130,249	5.00			184,829	7.10
As of December 31, 1999:
	Total Risk-Based Capital (to Risk-Weighted Assets)	$	142,199	8.00	%	$	177,748	10.00	%	$	184,218	10.36	%
	Core (Tier I) Capital (to Risk-Weighted Assets)		71,099	4.00			106,649	6.00			168,889	9.50
	Core (Tier I) Capital (to Adjusted Assets)		99,738	4.00			124,673	5.00			168,889	6.77

17. Commitments and Contingent Liabilities:

    At December 31, 2000, Sterling had loan commitments to borrowers and brokers totaling $258.2 million, including $17.8 million for fixed-rate loans and $240.4 million for variable-rate loans. At December 31, 2000, commitments to secondary market institutions to sell fixed-rate loans totaled $6.4 million. Commitments, which are disbursed subject to certain limitations, extend over various periods of time, with the majority of funds being disbursed within a twelve-month period. Substantially all of the commitments are for loans that have credit risk similar to Sterling's existing portfolio.

    At December 31, 2000, Sterling had made available to borrowers various secured and unsecured commercial and personal lines of credit totaling approximately $357.9 million, of which the undisbursed portion is approximately $216.0 million. These lines of credit provide for periodic adjustment to market rates of interest and have credit risk similar to Sterling's existing portfolio.

    Sterling historically has not realized credit losses due to these off-balance sheet credits. Based on this fact and Sterling's analysis of the undisbursed portion of these lines of credit, no specific valuation allowances were recorded for these off-balance sheet credits at December 31, 2000 and 1999.

    Rent expense for office properties under operating leases was approximately $1.9 million, $1.2 million and $1.3 million for the years ended December 31, 2000, 1999 and 1998, respectively.

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    Future minimum rental commitments as of December 31, 2000, under noncancelable operating leases with initial or remaining terms of more than one year, are as follows (in thousands):

Year Ending December 31,	Amount
2001	$	1,777
2002		1,520
2003		1,205
2004		918
2005		690
Thereafter		4,722
	$	10,832

18. Employee Savings Plan:

    Sterling maintains an employee savings plan under Section 401(k) of the Internal Revenue Code. Substantially all employees are eligible to participate in the plan subject to certain requirements. Under the plan, employees may elect to contribute up to 10% of their salary, and Sterling will make a matching contribution equal to 35% of the employee's contribution. All matching contributions are made exclusively in the form of Sterling Common Stock. Each employee may make a supplemental contribution of an additional 10% of their salary. All contributions vest immediately. Employees have the option of investing their contributions among selected mutual funds and Sterling Common Stock. During the years ended December 31, 2000, 1999 and 1998, Sterling contributed approximately $528,000, $427,500 and $373,000, respectively, to the employee savings plan.

19. Operating Expenses:

    The components of total operating expenses are as follows (in thousands):

	Years Ended December 31,
	2000		1999		1998
Employee compensation and benefits	$	31,771	$	29,112	$	22,430
Occupancy and equipment		10,359		10,087		7,499
Amortization of intangibles		5,490		5,692		3,971
Data processing		5,488		5,159		3,777
Depreciation		4,588		4,241		3,352
Advertising		2,566		2,656		2,076
Travel and entertainment		1,530		1,572		1,318
Legal and accounting		1,405		1,289		1,597
Insurance		711		986		1,116
Goodwill litigation		1,074		272		0
Acquisition and conversion costs		0		0		5,464
Other		2,986		3,412		3,691
	$	67,968	$	64,478	$	56,291

20. Business Segments:

    Sterling operates residential loan production offices primarily in the Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho metropolitan areas through its subsidiary Action Mortgage. Residential mortgage banking operations include revenues from servicing-released and servicing-retained sales of originated residential loans, bulk sales of loan servicing rights and other fees.

F-29

    The following table summarizes information related to Sterling's residential mortgage banking operations (in thousands):

		As of and for the Years Ended December 31,
		2000			1999			1998
Revenues:
	Gains on sales of originated residential loans	$	426		$	759		$	1,440
	Other fees and income		6,753			5,255			4,629
Total revenues			7,179			6,014			6,069
Identifiable expenses			(3,935	)		(3,369	)		(2,414	)
Income before income taxes		$	3,244		$	2,645		$	3,655
Identifiable assets		$	14,415		$	11,315		$	8,833
Depreciation and amortization expense		$	124		$	123		$	141
Capital expenditures for office properties and equipment		$	229		$	111		$	232

    Sterling also operates commercial real estate loan production offices primarily in the Spokane and Seattle, Washington; and Portland, Oregon metropolitan areas through its subsidiary INTERVEST. Commercial real estate lending operations include revenues from sales of commercial real estate loans and participation interests in commercial real estate loans, loan fees and servicing fees.

    The following table summarizes information related to Sterling's commercial real estate lending operations (in thousands):

		As of and for the Years Ended December 31,
		2000			1999			1998
Revenues:
	Gains on sales of originated commercial real estate loans	$	127		$	209		$	0
	Other fees and income		4,261			3,612			3,573
Total revenues			4,388			3,821			3,573
Identifiable expenses			(1,529	)		(1,204	)		(970	)
Income before income taxes		$	2,859		$	2,617		$	2,603
Identifiable assets		$	19,968		$	16,281		$	13,270
Depreciation and amortization expense		$	17		$	14		$	14
Capital expenditures for office properties and equipment		$	46		$	21		$	12

    Sterling has determined that its reportable business segments are those that are based on its method of disaggregated internal reporting.

F-30

    The following is a reconciliation of certain mortgage banking operations to the amounts reported in the consolidated financial statements (in thousands):

				Mortgage Banking Operations
		Banking Operations		Residential		Commercial Real Estate		Total
As of and for the year ended December 31, 2000:
	Interest income	$	196,288	$	5,768	$	3,421	$	205,477
	Other income		13,534		660		127		14,321
	Income before income taxes		15,583		3,244		2,859		21,686
	Total assets		2,628,396		14,415		19,968		2,662,779
As of and for the year ended December 31, 1999:
	Interest income	$	169,112	$	5,032	$	3,230	$	177,374
	Other income		12,215		873		209		13,297
	Income before income taxes		15,027		2,645		2,617		20,289
	Total assets		2,519,329		11,315		16,281		2,546,925
As of and for the year ended December 31, 1998:
	Interest income	$	148,445	$	4,306	$	3,012	$	155,763
	Other income		10,465		1,848		0		12,313
	Income before income taxes		3,644		3,655		2,603		9,902
	Total assets		2,292,484		8,833		13,270		2,314,587

21. Interest Rate Risk

    The results of operations for savings 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 net interest income and its NPV (the net present value of financial assets, liabilities and off-balance sheet contracts) are subject to fluctuations in interest rates. Currently, Sterling's interest-bearing liabilities, consisting primarily of savings deposits, FHLB Seattle advances and other borrowings, mature or reprice more rapidly, or on different terms, than do its interest-earning assets, consisting primarily of loans receivable and investments and MBS. The fact that liabilities mature or reprice more frequently on average than assets may be beneficial in times of declining interest rates; however, such an asset/liability structure may result in declining net interest income 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 net interest income. Sterling maintains an asset and liability management program intended to manage net interest income through interest rate cycles and to protect its NPV by controlling its exposure to changing interest rates.

    Sterling uses a simulation model designed to measure the sensitivity of net interest income and NPV to changes in interest rates. This simulation model is designed to enable Sterling to generate a forecast of net interest income and NPV given various interest rate forecasts and alternative strategies. The model also is 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-

F-31

and short-term interest rates have on the performance of Sterling. Another monitoring tool used by Sterling to assess interest rate risk is "gap analysis." The matching of repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive" and by monitoring Sterling's interest sensitivity "gap." Management is aware of the sources of interest rate risk and endeavors to actively monitor and manage its interest rate risk although there can be no assurance regarding the management of interest rate risk in future periods.

22. Quarterly Financial Data (Unaudited):

    The following tables present Sterling's condensed operations on a quarterly basis for the years ended December 31, 2000 and 1999 (dollars in thousands, except per share amounts):

	Year Ended December 31, 2000
	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
Interest income	$	47,885		$	50,699		$	52,888		$	54,005
Interest expense		(28,494	)		(30,598	)		(32,525	)		(33,927	)
Provision for losses on loans		(1,100	)		(1,100	)		(1,100	)		(1,300	)
Net interest income after provision for losses on loans		18,291			19,001			19,263			18,778
Net gain on sales of securities		0			1			0			0
Other income		3,363			3,672			3,559			3,726
Other operating expenses		(16,394	)		(17,315	)		(17,307	)		(16,952	)
Income before income taxes		5,260			5,359			5,515			5,552
Income tax (provision) benefit		(1,946	)		(1,983	)		(2,050	)		(2,054	)
Net income	$	3,314		$	3,376		$	3,465		$	3,498
Income per common share—basic	$	.37		$	.38		$	.39		$	.39
Income per common share—diluted	$	.37		$	.38		$	.39		$	.39
Weighted average common shares outstanding—basic		8,903,777			8,909,680			8,910,517			8,911,310
Weighted average common shares outstanding—diluted		8,924,859			8,928,360			8,934,640			8,960,004

F-32

	Year Ended December 31, 1999
	First Quarter			Second Quarter			Third Quarter			Fourth Quarter
Interest income	$	41,506		$	43,483		$	45,244		$	47,141
Interest expense		(23,763	)		(24,698	)		(25,931	)		(27,612	)
Provision for losses on loans		(900	)		(1,000	)		(1,000	)		(1,000	)
Net interest income after provision for losses on loans		16,843			17,785			18,313			18,529
Net gain on sales of securities		593			0			0			0
Other income		2,926			3,063			3,323			3,392
Other operating expenses		(15,862	)		(15,714	)		(16,352	)		(16,550	)
Income before income taxes		4,500			5,134			5,284			5,371
Income tax (provision) benefit		(1,662	)		(1,900	)		(1,955	)		(1,953	)
Net income	$	2,838		$	3,234		$	3,329		$	3,418
Income per common share—basic	$	.32		$	.36		$	.37		$	.38
Income per common share—diluted	$	.32		$	.36		$	.37		$	.38
Weighted average common shares outstanding—basic		8,870,132			8,897,129			8,898,828			8,898,828
Weighted average common shares outstanding—diluted		9,033,160			8,965,509			8,974,468			8,931,446

23. Fair Values of Financial Instruments:

    Fair value estimates are determined as of a specific date in time utilizing quoted market prices, where available, or various assumptions and estimates. As the assumptions underlying these estimates change, the fair value of the financial instruments will change. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. Additionally, Sterling has not disclosed highly subjective values of core deposit intangibles or other non-financial instruments. Accordingly, the aggregate fair value amounts presented do not represent and should not be construed to represent the full underlying value of Sterling.

    The methods and assumptions used to estimate the fair values of each class of financial instruments are as follows:

Cash and Cash Equivalents

    The carrying value of cash and cash equivalents approximates fair value due to the relatively short-term nature of these instruments.

Investments and Mortgage-Backed Securities

    The fair value of investments and MBS is based on quoted market prices. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

Loans Held for Sale

    The fair values are based on the estimated value at which the loans could be sold in the secondary market considering the fair value of options and commitments to sell or issue mortgage loans.

F-33

Loans Receivable

    The fair values of performing residential mortgage loans and home equity loans are estimated using current market comparable information for securitizable mortgages, adjusting for credit and other relevant characteristics. The fair value of performing commercial real estate construction, permanent financing, consumer and commercial loans is estimated by discounting the cash flows using interest rates that consider the current credit and interest rate risk inherent in the loans and current economic and lending conditions.

    The fair value of nonperforming loans is estimated by discounting management's current estimate of future cash flows using a rate estimated to be commensurate with the risks involved.

Deposits

    The fair values for deposits subject to immediate withdrawal such as interest and non-interest bearing checking, passbook savings, and money market deposit accounts, are equal to the amounts payable on demand at the reporting date. The carrying amounts for variable-rate certificates of deposit and other time deposits approximate their fair value at the reporting date. Fair values for fixed-rate certificates of deposit are estimated by discounting future cash flows using interest rates currently offered on time deposits with similar remaining maturities.

Borrowings

    The carrying amounts of short-term borrowings under repurchase agreements, federal funds purchased, short-term FHLB Seattle advances and other short-term borrowings approximate their fair values due to the relatively short period of time between the origination of the instruments and their expected payment. The fair value of advances under lines of credit approximates their carrying value because such advances bear variable rates of interest. The fair value of long-term FHLB Seattle advances and other long-term borrowings is estimated using discounted cash flow analyses based on Sterling's current incremental borrowing rates for similar types of borrowing arrangements with similar remaining terms.

			December 31,
			2000				1999
			Carrying Amount		Fair Value		Carrying Amount		Fair Value
			(in thousands)				(in thousands)
Financial assets:
	Cash and cash equivalents		$	62,510	$	62,510	$	96,604	$	96,604
	Investments and MBS:
		Available for sale		476,732		476,732		494,483		494,483
		Held to maturity		9,450		9,523		11,247		11,230
	Loans held for sale			1,489		1,489		985		985
	Loans receivable, net			1,965,927		1,972,495		1,787,771		1,766,193
	Accrued interest receivable			18,455		18,455		16,720		16,720
Financial liabilities:
	Non-maturity deposits			708,986		708,986		700,676		700,676
	Deposits with stated maturities			1,015,233		1,025,081		916,692		916,598
	Borrowings			750,978		753,749		780,018		771,483
	Accrued interest payable			9,616		9,616		7,539		7,539

    The fair value estimates above do not include the value of residential mortgage loan servicing rights on Sterling's residential mortgage loan servicing portfolio which totaled approximately

F-34

$203.7 million and $205.5 million at December 31, 2000 and 1999, respectively. The gross fair value of these rights is estimated to be approximately $2.6 million at December 31, 2000 and 1999. The carrying amount of the residential mortgage loan servicing rights was approximately $349,000 and $222,000 at December 31, 2000 and 1999, respectively.

24. Related-Party Transactions:

    One of Sterling's directors is a principal in the law firm that provides legal services to Sterling. During the years ended December 31, 2000, 1999 and 1998, Sterling incurred legal fees of approximately $1.8 million, $976,000 and $766,000, respectively, related to services provided by this firm.

25. Parent Company-Only Financial Information:

    Sterling Financial Corporation became the holding company for Sterling Savings Bank on November 1, 1992. The following Sterling Financial Corporation parent company-only financial information should be read in conjunction with the other notes to consolidated financial statements. The accounting policies for the parent company-only financial statements are the same as those used in the presentation of the consolidated financial statements other than the parent company-only financial statements account for the parent company's investments in its subsidiaries under the equity method.

Condensed Balance Sheets

				December 31,
				2000		1999
				(in thousands)
Assets:
	Cash and cash equivalents			$	4,340	$	3,172
	Investments in subsidiaries:
		Sterling Savings Bank			231,621		211,184
		Tri-Cities Mortgage Company			168		1,847
		Sterling Capital Trust I			1,237		1,237
	Income taxes receivable from subsidiaries				13,902		6,175
	Federal income taxes receivable				0		1,888
	Other assets				3,487		3,660
			Total assets	$	254,755	$	229,163
Liabilities and Shareholders' Equity:
	Accrued expenses payable			$	315	$	272
	Advances under lines of credit				40,000		40,000
	Floating Rate Notes Due 2006				30,000		30,000
	Junior Subordinated Debentures of Sterling				41,237		41,237
	Other liabilities				0		15
	Income taxes payable				1,865		0
	Shareholders' equity				141,338		117,639
			Total liabilities and shareholders' equity	$	254,755	$	229,163

F-35

				Years Ended December 31,
				2000			1999			1998
				(in thousands)
Condensed Statements of Income
	Interest income			$	254		$	150		$	219
	Interest expense				(10,283	)		(9,228	)		(7,281	)
		Net interest expense			(10,029	)		(9,078	)		(7,062	)
	Equity in net earnings of subsidiary				20,577			19,133			11,583
	Miscellaneous income, net				0			0			57
	Provision for losses on real estate owned				0			(200	)		0
	Operating expenses				(869	)		(729	)		(1,319	)
	Income before income taxes				9,679			9,126			3,259
	Deferred income tax benefit				3,974			3,693			2,964
	Net income			$	13,653		$	12,819		$	6,223
Condensed Statements of Cash Flows
	Cash flows from operating activities:
		Net income		$	13,653		$	12,819		$	6,223
		Adjustments to reconcile net income to net cash used in operating activities			(24,150	)		(22,078	)		(14,413	)
			Net cash used in operating activities		(10,497	)		(9,259	)		(8,190	)
	Cash flows from investing activities:
		Investments in subsidiaries, net			1,611			(10,566	)		(45,278	)
		Dividends from subsidiary			10,003			9,580			8,088
			Net cash provided by (used in) investing activities		11,614			(986	)		(37,190	)
	Cash flows from financing activities:
		Repayment of note payable and other borrowings			7,000			(22,240	)		(15,000	)
		Proceeds from line of credit and other borrowings			(7,000	)		35,000			40,000
		Proceeds from exercise of stock options, net of repurchases			55			144			382
		Payments for fractional shares			(4	)		0			(4	)
		Deferred financing costs			0			(1,113	)		0
		Other, net			0			0			58
			Net cash provided by financing activities		51			11,791			25,436
	Net change in cash and cash equivalents				1,168			1,546			(19,944	)
	Cash and cash equivalents, beginning of year				3,172			1,626			21,570
	Cash and cash equivalents, end of year			$	4,340		$	3,172		$	1,626

    Federal law prohibits Sterling Financial Corporation from borrowing from its subsidiary savings association unless the loans are collateralized by specified assets and are generally limited to 10% of the subsidiary savings association's capital and surplus.

    During the year ended December 31, 1999, Sterling purchased $10.0 million of Sterling Savings Bank common stock.

    Current income taxes are allocated to Sterling and its subsidiaries as if they were separate taxpayers.

    The payment of dividends to Sterling Financial Corporation by its savings association subsidiary is subject to various federal and state regulatory limitations. Under current regulations, at

F-36

December 31, 2000, the savings association subsidiary could have declared approximately $4.7 million of aggregate dividends in addition to amounts previously paid.

26. Securitization and Automobile Loans:

    On December 22, 2000, Sterling securitized and sold approximately $93.3 million in automobile loans. In the securitization, Sterling retained servicing responsibilities and certain subordinated interests. Sterling receives annual servicing fees approximating 0.5 percent of the outstanding principal balance and rights to future cash flows arising after the investors in the securitization trust have received the return for which they are contracted. The investors and the securitization trust have no recourse to Sterling's other assets for failure of debtors to pay when due. Sterling's retained residual interests are subordinate to investor's interests. Their value is subject to credit, prepayment, and interest rate risks on the transferred financial interests. In 2000, Sterling recognized a pretax gain of approximately $149,000 on the securitization and sale of the automobile loans.

    Key economic assumptions used in measuring both the retained, unrated residual interest and the interest-only strip at the date of securitization and December 31, 2000 were as follows: prepayment speed of 21.19% per annum, weighted average life of 1.96 years, expected annualized credit losses of 1.2% and interest discount rate of 11.95% per annum. Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. Actual and projected credit losses are 0.00%, 0.52% and 0.92% for the years ending December 31, 2000, 2001 and 2002, respectively. Actual credit losses that are substantially larger than projected may adversely impact the calculated value of the retained residual values.

    The following table presents quantitative information about delinquencies, net credit losses and components of securitized financial assets and other assets managed (in thousands):

			December 31, 2000
					Principal Amount of Loans 61 Days or More Past Due(1)		For the Year Ended December 31, 2000
			Total Principal Amount of Loans
							Average Balances		Net Credit Losses(2)
Type of Loans
	Total automobile loans managed or securitized		$	89,334	$	50	$	2,300	$	0
	Less:
		Loans securitized		87,335		0		0		0
	Loans held for portfolio(3)			1,399		0		0		0

(1)

Loans 61 days or more past due are based on end of period total loans.

(2)

Net credit losses represent charge-offs and are based on total loans outstanding.

(3)

Represents the principal amount of the retained, unrated residual interest. The interest-only strip which was also retained by Sterling was valued at approximately $4.3 million.

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    At December 31, 2000, the effects of immediate adverse changes on the key economic assumptions used in estimating the current fair value of residual interests are as follows (dollars in thousands):

Carrying amount/fair value of retained interests		$	5,712
Weighted-average life (in years)			1.96
Prepayment speed assumption (annual rate)			21.19	%
	Impact on fair value of 10% adverse change	$	(47	)
	Impact on fair value of 20% adverse change	$	(95	)
Expected credit losses (annual rate)			1.20	%
	Impact on fair value of 10% adverse change	$	(96	)
	Impact on fair value of 20% adverse change	$	(191	)
Residual cash flows discount rate (annual)			11.95	%
	Impact on fair value of 10% adverse change	$	(107	)
	Impact on fair value of 20% adverse change	$	(210	)

    These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

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STERLING FINANCIAL CORPORATION DECEMBER 31, 2000 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS
PART I
PART II
PART III
PART IV
SIGNATURES
Sterling Financial Corporation Report on Audit of Consolidated Financial Statements For the Years Ended December 31, 2000, 1999 and 1998
Report of Independent Accountants
Sterling Financial Corporation Consolidated Balance Sheets December 31, 2000 and 1999 (Dollars in thousands)
Sterling Financial Corporation Consolidated Statements of Income For the Years Ended December 31, 2000, 1999 and 1998 (Dollars in thousands, except per share amounts)
Sterling Financial Corporation Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31, 2000, 1999 and 1998 (Dollars in thousands)
Sterling Financial Corporation Consolidated Statements of Changes in Shareholders' Equity For the Years Ended December 31, 2000, 1999 and 1998 (Dollars in thousands)
Sterling Financial Corporation Consolidated Statements of Cash Flows For the Years Ended December 31, 2000, 1999 and 1998 (Dollars in thousands)
Sterling Financial Corporation Consolidated Statements of Cash Flows, Continued For the Years Ended December 31, 2000, 1999 and 1998 (Dollars in thousands)
Sterling Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2000, 1999 and 1998