UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                                          TO                                         .

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

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

Class		Outstanding as of August 1, 2007
Common Stock ($1.00 par value)		51,341,243

 

 

STERLING FINANCIAL CORPORATION

FORM 10-Q
For the Quarter Ended JUNE 30, 2007

TABLE OF CONTENTS

		Page
PART I — Financial Information			1
Item 1 Financial Statements (Unaudited)			1
Consolidated Balance Sheets			1
Consolidated Statements of Income			2
Consolidated Statements of Cash Flows			3
Consolidated Statements of Comprehensive Income			5
Notes to Consolidated Financial Statements			6
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3 Quantitative and Qualitative Disclosures About Market Risk			31
Item 4 Controls and Procedures			31
PART II — Other Information			32
Item 1 Legal Proceedings			32
Item 1a Risk Factors			32
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			32
Item 3 Defaults Upon Senior Securities			32
Item 4 Submission of Matters to a Vote of Security Holders			33
Item 5 Other Information			33
Item 6 Exhibits			33
Signatures			34
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I — Financial Information

		June 30,				December 31,
		2007				2006
		(Dollars in thousands)
ASSETS:
Cash and cash equivalents:
Interest bearing		$	10,851			$	13,846
Non-interest bearing and vault			180,425				164,719
Total cash and cash equivalents			191,276				178,565
Restricted cash			1,125				1,150
Investment securities and mortgage-backed securities (“MBS”):
Available for sale			1,697,424				1,820,583
Held to maturity			108,430				93,063
Loans receivable, net			8,507,423				7,021,241
Loans held for sale			84,613				91,469
Accrued interest receivable			60,436				55,519
Real estate owned and other collateralized assets, net			4,012				4,052
Office properties and equipment, net			96,361				93,796
Bank-owned life insurance (“BOLI”)			147,354				139,206
Goodwill			456,315				247,244
Other intangible assets, net			34,078				28,570
Mortgage servicing rights, net			10,130				7,335
Prepaid expenses and other assets, net			64,670				52,699
Total assets		$	11,463,647			$	9,834,492
LIABILITIES:
Deposits		$	7,620,362			$	6,746,028
Advances from Federal Home Loan Bank (“FHLB”)			1,594,844				1,308,617
Securities sold subject to repurchase agreements and funds purchased			744,903				616,354
Other borrowings			250,074				240,226
Cashiers checks issued and payable			4,279				18,144
Borrowers’ reserves for taxes and insurance			2,418				2,348
Accrued interest payable			39,615				39,863
Accrued expenses and other liabilities			84,981				79,496
Total liabilities			10,341,476				9,051,076
Commitments and Contingencies
SHAREHOLDERS’ EQUITY:
Preferred stock, $1 par value; 10,000,000 shares authorized; no shares issued and outstanding			0				0
Common stock, $1 par value; 100,000,000 shares authorized; 51,329,826 and 42,042,740 shares issued and outstanding			51,330				42,043
Additional paid-in capital			889,890				590,218
Accumulated other comprehensive loss:
Unrealized losses on investment securities and MBS available-for-sale, net of deferred income taxes of $26,368 and $19,531			(44,974	)			(33,350	)
Retained earnings			225,925				184,505
Total shareholders’ equity			1,122,171				783,416
Total liabilities and shareholders’ equity		$	11,463,647			$	9,834,492

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

STERLING FINANCIAL CORPORATION

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
		(Dollars in thousands, except per share data)
Interest income:
Loans		$	172,825			$	103,356			$	325,588			$	195,467
MBS			19,356				22,473				39,824				45,818
Investments and cash equivalents			1,880				891				3,551				1,614
Total interest income			194,061				126,720				368,963				242,899
Interest expense:
Deposits			70,666				40,909				134,386				75,719
Short-term borrowings			9,730				8,881				19,405				15,246
Long-term borrowings			24,625				15,881				45,516				31,929
Total interest expense			105,021				65,671				199,307				122,894
Net interest income			89,040				61,049				169,656				120,005
Provision for losses on loans			(3,975	)			(4,650	)			(8,200	)			(9,300	)
Net interest income after provision for losses on loans			85,065				56,399				161,456				110,705
Non-interest income:
Fees and service charges			13,694				10,615				25,886				19,694
Mortgage banking operations			9,807				2,725				18,665				4,996
Loan servicing fees			410				482				1,093				751
Real estate owned and other collateralized assets operations			(93	)			78				(138	)			385
BOLI			1,717				1,203				3,264				2,386
Other non-interest expense			(757	)			27				(544	)			(165	)
Total non-interest income			24,778				15,130				48,226				28,047
Non-interest expenses			69,891				46,989				135,560				91,229
Income before income taxes			39,952				24,540				74,122				47,523
Income tax provision			(12,971	)			(7,609	)			(24,220	)			(15,176	)
Net income		$	26,981			$	16,931			$	49,902			$	32,347
Earnings per share — basic		$	0.53			$	0.48			$	1.03			$	0.92
Earnings per share — diluted		$	0.52			$	0.48			$	1.02			$	0.92
Weighted average shares outstanding — basic			51,189,438				35,077,647				48,230,619				35,012,510
Weighted average shares outstanding — diluted			51,699,098				35,404,364				48,776,780				35,326,837

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

STERLING FINANCIAL CORPORATION

		Six Months Ended
		June 30,
		2007				2006
		(Dollars in thousands)
Cash flows from operating activities:
Net income		$	49,902			$	32,347
Adjustments to reconcile net income to net cash provided by operating activities:
Provisions for losses on loans and real estate owned			8,200				9,320
Accretion of deferred gain on sale of branches			(352	)			(18	)
Net gain on sales of loans, investment securities and MBS			(11,460	)			(1,316	)
Stock based compensation			627				181
Excess tax benefit from stock based compensation			(1,336	)			(791	)
Stock issuances relating to 401(k) match			1,172				896
Other gains and losses			1,504				387
Increase in cash surrender value of BOLI			(3,264	)			(2,386	)
Depreciation and amortization			12,135				9,230
Change in:
Accrued interest receivable			2,123				(4,695	)
Prepaid expenses and other assets			(6,957	)			1,928
Cashiers checks issued and payable			(18,564	)			(721	)
Accrued interest payable			(2,221	)			10,271
Accrued expenses and other liabilities			(4,580	)			(7,955	)
Proceeds from sales of loans originated for sale			676,063				62,018
Loans originated for sale			(667,682	)			(60,702	)
Net cash provided by operating activities			35,310				47,994
Cash flows from investing activities:
Change in restricted cash			25				(159	)
Loans funded and purchased			(2,376,666	)			(2,128,822	)
Loan principal received			2,026,361				1,485,011
Proceeds from sales of other loans			97,114				0
Purchase of investment securities			(47,195	)			(40,300	)
Proceeds from maturities of investment securities			23,379				10,088
Proceeds from sale of investments			5,609				0
Net cash and cash equivalents acquired			92,419				0
Principal payments on mortgage-backed securities			125,963				139,762
Purchase of office properties and equipment			(7,202	)			(7,486	)
Sales of office properties and equipment			2,792				5,702
Improvements and other changes to real estate owned			(9	)			(221	)
Proceeds from sales and liquidation of real estate owned			106				731
Net cash provided by (used in) investing activities			(57,304	)			(535,694	)

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

STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)

		Six Months Ended
		June 30,
		2007				2006
		(Dollars in thousands)
Cash flows from financing activities:
Net change in transaction and savings deposits		$	151,234			$	135,327
Proceeds from issuance of time deposits			1,547,770				1,781,541
Payments for maturing time deposits			(1,939,136	)			(1,450,573	)
Interest credited to deposits			119,812				65,195
Advances from FHLB			1,232,744				1,379,784
Repayment of advances from FHLB			(1,213,095	)			(1,486,072	)
Net change in securities sold subject to repurchase agreements and funds purchased			128,549				(28,635	)
Proceeds from other borrowings			23,000				75,000
Repayments of other borrowings			(13,403	)			0
Proceeds from stock purchases			3,070				3,340
Excess tax benefit from stock based compensation			1,336				791
Cash dividends paid to shareholders			(7,246	)			(4,023	)
Other			70				492
Net cash provided by (used in) financing activities			34,705				472,167
Net change in cash and cash equivalents			12,711				(15,533	)
Cash and cash equivalents, beginning of period			178,565				131,307
Cash and cash equivalents, end of period		$	191,276			$	115,774
Supplemental disclosures:
Cash paid during the period for:
Interest		$	199,555			$	112,623
Income taxes			28,427				15,686
Noncash financing and investing activities:
Loans converted into real estate owned and other collateralized assets			57				4,436
Common stock issued upon business combination			302,754				0
Common stock cash dividends accrued			8,482				2,282
Deferred gain on sale of branches			804				3,670

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

STERLING FINANCIAL CORPORATION

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
		(Dollars in thousands)								(Dollars in thousands)
Net income		$	26,981			$	16,931			$	49,902			$	32,347
Other comprehensive income:
Change in unrealized gains (losses) on investment securities and MBS available-for-sale			(25,686	)			(17,112	)			(18,461	)			(40,820	)
Less deferred income taxes			9,507				6,335				6,837				15,110
Net other comprehensive income (loss)			(16,179	)			(10,777	)			(11,624	)			(25,710	)
Comprehensive income (loss)		$	10,802			$	6,154			$	38,278			$	6,637

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

1. Basis of Presentation:

The foregoing unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements as disclosed in the annual report on Form 10-K for the year ended December 31, 2006. In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.

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

2. Other Borrowings:

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

		June 30,				December 31,
		2007				2006
Junior Subordinated Debentures		$	223,620			$	236,772
Other			26,454				3,454
Total		$	250,074			$	240,226

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

Carrying

Maturity

Rate at

Value (in

Subsidiary Issuer

Issue Date

Date

Call Date

June 30, 2007

thousands)

Sterling Capital Trust VIII

Sept 2006

Sept 2036

N/A

Floating

6.99

%

$

51,547

Sterling Capital Trust VII

June 2006

June 2036

N/A

Floating

6.89

56,702

Lynnwood Financial Statutory Trust II

June 2005

June 2035

N/A

Floating

7.16

10,310

Sterling Capital Trust VI

June 2003

Sept 2033

Sept 2008

Floating

8.56

10,310

Sterling Capital Statutory Trust V

May 2003

May 2033

June 2008

Floating

8.61

20,619

Sterling Capital Trust IV

May 2003

May 2033

May 2008

Floating

8.51

10,310

Sterling Capital Trust III

April 2003

April 2033

April 2008

Floating

8.61

14,433

Lynnwood Financial Statutory Trust I

Mar 2003

Mar 2033

Mar 2007

Floating

8.51

9,480

Klamath First Capital Trust I

July 2001

July 2031

June 2006

Floating

9.15

15,166

Sterling Capital Trust II

July 2001

July 2031

June 2006

Fixed

10.25

24,743

7.94

%*

$

223,620

Sterling has entered into a $40.0 million revolving credit agreement (the “Credit Facility”) with Wells Fargo Bank, N.A., with amounts advanced on the Credit Facility included in the “Other” caption of other borrowings. As of June 30, 2007, $23.0 million was drawn on the Credit Facility. Subsequent to June 30, 2007, the outstanding balance on the Credit Facility was paid in full. Amounts loaned pursuant to the Credit Facility bear interest, at Sterling’s election, either floating at two percent below prime or fixed at LIBOR plus 90 basis points. The Credit Facility contains representations and warranties, and negative and affirmative covenants by Sterling, including financial covenants and restrictions on certain actions by Sterling, such as Sterling’s ability to incur debt, make investments and merge into or consolidate with other entities. The Credit Facility may be terminated and loans under the Credit Facility may be accelerated if an event of default occurs, as defined in the Credit Facility. The Credit Facility is expected to be renewed prior to it maturing in August 2007. If the Credit Facility is not renewed, any outstanding balance would be payable in full.

In April 2007, Sterling elected to exercise its early redemption right to call the Klamath First Capital Trust II debenture. The redemption occurred on April 23, 2007.

On July 25, 2007, Sterling’s wholly owned subsidiary, Sterling Capital Trust IX, sold $45.0 million of Trust Preferred Securities. The rate payable on these securities will be the 90-day LIBOR plus 1.40% and is adjustable and payable quarterly. These securities mature in 2037.

3. Income Taxes:

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). This pronouncement requires a certain methodology for measuring and reporting uncertain tax positions, as well as disclosures regarding such tax positions. FIN No. 48 became effective for Sterling as of January 1, 2007. The following were estimated amounts as of the effective date:

		January 1, 2007
		(Dollars in thousands)
Unrecognized Tax Benefit		$	1,553
Potential Effective Tax Rate Impact			1,245
Recognized Penalties and Interest			308

Sterling does not expect unrecognized tax benefits to significantly change within the next twelve months. Sterling’s tax positions for the years 2003 through 2006 remain subject to review by the Internal Revenue Service. Penalties and interest associated with any potential estimate variances would be included in income tax expense on the Consolidated Statement of Income.

4. Earnings Per Share:

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

		Three Months Ended June 30,
		2007												2006
		Net				Weighted				Per Share				Net				Weighted				Per Share
		Income				Avg. Shares				Amount				Income				Avg. Shares				Amount
		(Dollars in thousands, except per share amounts)
Basic computations		$	26,981				51,189,438			$	0.53			$	16,931				35,077,647			$	0.48
Effect of dilutive securities:
Common stock options and restricted shares			0				509,660				(0.01	)			0				326,717				0.00
Diluted computations		$	26,981				51,699,098			$	0.52			$	16,931				35,404,364			$	0.48
Antidilutive options not included in diluted earnings per share							307,945												0

		Six Months Ended June 30,
		2007												2006
		Net				Weighted				Per Share				Net				Weighted				Per Share
		Income				Avg. Shares				Amount				Income				Avg. Shares				Amount
		(Dollars in thousands, except per share amounts)
Basic computations		$	49,902				48,230,619			$	1.03			$	32,347				35,012,510			$	0.92
Effect of dilutive securities:
Common stock options and restricted shares			0				546,161				(0.01	)			0				314,327				0.00
Diluted computations		$	49,902				48,776,780			$	1.02			$	32,347				35,326,837			$	0.92
Antidilutive options not included in diluted earnings per share							254,613												0

5. Non-Interest Expenses:

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
		(Dollars in thousands)
Employee compensation and benefits		$	39,163			$	25,710			$	77,234			$	50,799
Occupancy and equipment			11,681				7,375				22,148				14,291
Data processing			4,176				3,523				8,373				6,855
Depreciation			3,341				2,432				6,536				4,715
Advertising			3,279				2,334				5,956				4,255
Travel and entertainment			2,133				1,444				3,641				2,586
Amortization of core deposit intangibles			1,226				555				2,267				1,111
Goodwill litigation costs			1,132				135				1,312				220
Legal and accounting			547				704				1,223				1,239
Insurance			513				316				908				599
Merger and acquisition costs			413				0				844				0
Other			2,287				2,461				5,118				4,559
Total		$	69,891			$	46,989			$	135,560			$	91,229

6. Segment Information:

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

•		The Community Banking segment consists of the operations conducted by Sterling’s subsidiary, Sterling Savings Bank.
•		The Residential Mortgage Banking segment originates and sells servicing-retained and servicing-released residential loans through loan production offices of Sterling’s subsidiary, Golf Savings Bank and Sterling Savings Bank’s subsidiary, Action Mortgage Company (“Action Mortgage”).
•		The Commercial Mortgage Banking segment originates, sells and services commercial real estate loans and participation interests in commercial real estate loans through offices in the western region primarily through Sterling Savings Bank’s subsidiary INTERVEST-Mortgage Investment Company (“INTERVEST”).
•		The Retail Brokerage segment markets fixed income and equity products, mutual funds, fixed and variable annuities, insurance and other financial products within the Sterling Savings Bank financial service center network through sales representatives of Sterling Savings Bank’s subsidiary Harbor Financial Services, Inc.
•		The Other and Eliminations segment represents the parent company expenses and intercompany eliminations of revenue and expenses.

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

		As of and for the Three Months Ended June 30, 2007
						Residential				Commercial
		Community				Mortgage				Mortgage				Retail				Other and
		Banking				Banking				Banking				Brokerage				Eliminations				Total
		(Dollars in thousands)
Interest income		$	179,487			$	12,365			$	2,044			$	0			$	165			$	194,061
Interest expense			(96,950	)			(3,377	)			0				0				(4,694	)			(105,021	)
Net interest income (expense)			82,537				8,988				2,044				0				(4,529	)			89,040
Provision for loan losses			(3,900	)			(75	)			0				0				0				(3,975	)
Noninterest income			20,036				7,561				1,967				1,006				(5,792	)			24,778
Noninterest expense			(55,263	)			(10,045	)			(2,417	)			(1,000	)			(1,166	)			(69,891	)
Income before income taxes		$	43,410			$	6,429			$	1,594				6			$	(11,487	)		$	39,952
Total assets		$	11,179,900			$	364,419			$	8,984			$	622			$	(90,278	)		$	11,463,647

		As of and for the Three Months Ended June 30, 2006
						Residential				Commercial
		Community				Mortgage				Mortgage				Retail				Other and
		Banking				Banking				Banking				Brokerage				Eliminations				Total
		(Dollars in thousands)
Interest income		$	120,406			$	3,775			$	2,406			$	0			$	133			$	126,720
Interest expense			(63,074	)			0				0				0				(2,597	)			(65,671	)
Net interest income (expense)			57,332				3,775				2,406				0				(2,464	)			61,049
Provision for loan losses			(4,650	)			0				0				0				0				(4,650	)
Noninterest income			13,478				2,465				1,246				1,015				(3,074	)			15,130
Noninterest expense			(39,407	)			(3,959	)			(2,055	)			(760	)			(808	)			(46,989	)
Income before income taxes		$	26,753			$	2,281			$	1,597			$	255			$	(6,346	)		$	24,540
Total assets		$	8,091,408			$	14,446			$	9,922			$	907			$	(72,345	)		$	8,044,338

		As of and for the Six Months Ended June 30, 2007
						Residential				Commercial
		Community				Mortgage				Mortgage				Retail				Other and
		Banking				Banking				Banking				Brokerage				Eliminations				Total
		(Dollars in thousands)
Interest income		$	341,537			$	23,177			$	4,235			$	0				14			$	368,963
Interest expense			(184,201	)			(6,251	)			0				0				(8,855	)			(199,307	)
Net interest income (expense)			157,336				16,926				4,235				0				(8,841	)			169,656
Provision for loan losses			(8,050	)			(150	)			0				0				0				(8,200	)
Noninterest income			38,119				14,775				4,174				1,823				(10,665	)			48,226
Noninterest expense			(106,192	)			(20,324	)			(5,329	)			(1,839	)			(1,876	)			(135,560	)
Income before income taxes		$	81,213			$	11,227			$	3,080				(16	)		$	(21,382	)		$	74,122
Total assets		$	11,179,900			$	364,419			$	8,984			$	622			$	(90,278	)		$	11,463,647

		As of and for the Six Months Ended June 30, 2006
						Residential				Commercial
		Community				Mortgage				Mortgage				Retail				Other and
		Banking				Banking				Banking				Brokerage				Eliminations				Total
		(Dollars in thousands)
Interest income		$	230,946			$	7,242			$	4,263			$	0			$	448			$	242,899
Interest expense			(118,156	)			0				0				0				(4,738	)			(122,894	)
Net interest income (expense)			112,790				7,242				4,263				0				(4,290	)			120,005
Provision for loan losses			(9,300	)			0				0				0				0				(9,300	)
Noninterest income			24,932				4,552				2,483				1,843				(5,763	)			28,047
Noninterest expense			(76,847	)			(7,775	)			(3,923	)			(1,471	)			(1,213	)			(91,229	)
Income before income taxes		$	51,575			$	4,019			$	2,823			$	372			$	(11,266	)		$	47,523
Total assets		$	8,091,408			$	14,446			$	9,922			$	907			$	(72,345	)		$	8,044,338

7. Stock Based Compensation:

On January 1, 2006, Statement of Financial Accounting Standard No. 123 (R), “Share Based Payment,” became effective for Sterling. As a result, stock options issued as compensation are recorded as an expense at their estimated fair value.

During the six months ended June 30, 2007, stock option activity and related information was as follows:

						Weighted				Weighted Average				Aggregate
						Average				Remaining Contractual				Intrinsic Value
		Number				Exercise Price				Life (in years)				(in thousands)
Outstanding, December 31, 2006			1,485,661			$	19.72
Granted			310,000				33.14
Exercised			(251,694	)			12.43
Acquisitions			573,212				12.67
Cancelled			(8,623	)			18.35
Outstanding, June 30, 2007			2,108,556			$	20.65				5.01			$	17,480
Exercisable, June 30, 2007			1,799,556			$	18.51				4.73			$	18,769

On April 24, 2007, Sterling adopted the 2007 Long-Term Incentive Plan, which allows for the issuance of up to an aggregate of 2.0 million options to purchase shares of Sterling’s common stock. As of June 30, 2007, a total of 2,041,249 shares remained available for grant under Sterling’s 2001, 2003 and 2007 Long-Term Incentive Plans. The options granted under these plans have terms of four, six or ten years.

During the six months ended June 30, 2007 and 2006, the fair value of options granted were $3.2 million and $171,000, respectively, and the intrinsic value of options exercised were $5.0 million and $2.5 million, respectively. The Black-Scholes option-pricing model was used in estimating the fair value of option grants. The weighted average assumptions used are presented in the table below.

		Six Months Ended
		June 30,
		2007				2006
Expected volatility			28% - 29	%			31	%
Expected term (in years)			4.7 - 6.0				5.5
Expected dividend yield			0.90% - 1.10	%			0.87	%
Risk free interest rate			4.65% - 4.81	%			4.36	%

Other stock based compensation during the six months ended June 30, 2007 included the issuance to management of 85,000 shares of restricted stock, with a grant date fair value of $2.8 million. These shares vest evenly over a four year period. Stock compensation expense recognized during the six months ended June 30, 2007 and 2006 was $627,000 and $181,000, respectively.

8. New Accounting Pronouncements:

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 provides a fair value measurement election for many financial instruments, on an instrument by instrument basis. SFAS No. 159 will be effective for Sterling as of January 1, 2008. Sterling is currently assessing the impact of this standard and does not expect SFAS No. 159 to have a material effect on Sterling.

In September 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” Under the provisions of EITF Issue No. 06-4, Sterling will recognize the amount, if any, that is owed current or former employees under split dollar BOLI. EITF 06-4 is effective January 1, 2008. Sterling is currently assessing the potential impact of this standard.

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

9. Derivatives and Hedging:

As part of its mortgage banking activities, Sterling issues interest rate lock commitments (“rate locks”) to prospective borrowers on residential one-to-four family mortgage loan applications. Pricing for the sale of these loans is fixed with various qualified investors, such as Fannie Mae, under both non-binding (“best-efforts”) and binding (“mandatory”) delivery programs at or near the time the interest rate is locked with the borrowers. For mandatory delivery programs, Sterling hedges Interest Rate Risk (“IRR”) by entering into offsetting forward sale agreements on MBS with third parties. Risks inherent in mandatory delivery programs include the risk that if Sterling does not close the loans subject to rate locks, it is nevertheless obligated to deliver MBS to the counterparty under the forward sale agreement. Sterling could incur significant costs in acquiring replacement loans or MBS and such costs could have a material adverse effect on mortgage banking operations in future periods.

Rate lock commitments to borrowers and best-effort loan delivery commitments from investors are off-balance-sheet commitments that are considered to be derivatives. Sterling accounts for these commitments by recording their estimated fair value on its balance sheet. As of June 30, 2007, Sterling had entered into best efforts forward commitments to sell $142.7 million of mortgage loans, with the estimated fair value of rate locks issued and delivery commitments received on the unfunded portion valued as an offsetting asset and liability of approximately $1.3 million. As of December 31, 2006, these rate locks and delivery commitments were valued at $482,000. As of

June 30, 2007, Sterling had loans locked with investors under mandatory delivery programs valued at $54,000, and held offsetting forward sale agreements on MBS valued at $39,000, with a net gain position reflected in mortgage banking income. As of December 31, 2006, Sterling did not have any loans subject to rate locks under mandatory delivery programs.

Sterling enters into interest rate swap derivative contracts with customers. The IRR on these contracts is offset by entering comparable broker dealer swaps. These contracts are carried as an offsetting asset and liability at fair value, and as of June 30, 2007 and December 31, 2006, were $104,000 and $404,000, respectively.

10. Cash Dividends:

The board of directors of Sterling from time to time evaluates the payment of cash dividends. The timing and amount of any future dividends will depend upon earnings, cash and capital requirements, the financial condition of Sterling and its subsidiaries, applicable government regulations and other factors deemed relevant by Sterling’s board of directors. During 2006 and 2007, Sterling paid the following cash dividends:

Date Paid		Per Share Amount				Total
January 2006		$	0.055			$1.9 million
April 2006			0.060			2.1 million
July 2006			0.065			2.3 million
October 2006			0.070			2.6 million
January 2007			0.075			3.2 million
April 2007			0.080			4.1 million
July 2007			0.085			4.3 million

11. Business Combination:

On April 11, 2007, Sterling announced the signing of a definitive agreement to acquire North Valley Bancorp (“North Valley”), headquartered in Redding, California. This pending acquisition required approval by the North Valley shareholders, which was received at a special meeting of the North Valley shareholders on July 31, 2007, and remains subject to regulatory approval and satisfaction of other customary closing conditions. The integration of North Valley into Sterling is expected to increase Sterling’s total assets by approximately $900 million, and would complement the recent growth of its business in northern California, increasing its presence there by 25 depository branches. The transaction was valued at $196.2 million as of the date the parties agreed to merge.

On February 28, 2007, Sterling completed its acquisition of Northern Empire Bancshares (“Northern Empire”), a California corporation by issuing $30.0 million in cash, and 8,914,815 shares of Sterling common stock valued at $290.4 million in exchange for all outstanding Northern Empire shares. Northern Empire options totaling 646,018 were converted into options to purchase an aggregate of 573,212 shares of Sterling’s common stock, valued at $12.3 million. The total value of the transaction was $332.8 million. Northern Empire merged with and into Sterling, with Sterling being the surviving corporation in the merger. Northern Empire’s financial institution subsidiary, Sonoma National Bank, merged with and into Sterling’s subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution. The Sonoma National Bank acquisition provided Sterling Savings Bank entry into the northern California market, enhanced the products and services available to the customers of both companies and strengthened Sterling’s leadership position in the West.

The following summarizes the fair values of the assets acquired and liabilities assumed as of the date of acquisition (in thousands):

		February 28, 2007
Cash and cash equivalents		$	110,775
Investments and MBS			22,574
Loans receivable, net			1,228,816
Goodwill			208,944
Core deposit intangible			7,775
Other assets			19,523
Total assets acquired		$	1,598,407
Deposits		$	987,694
Other borrowings			266,853
Other liabilities			11,093
Total liabilities assumed			1,265,640
Net assets acquired		$	332,767

The following summarizes the unaudited pro forma results of operations as if Sterling acquired Northern Empire on January 1, 2006 (in thousands, except per share amounts):

		Three Months Ended June								Six Months Ended June 30,
		2007				2006				2007				2006
Pro forma interest income		$	194,061			$	150,075			$	385,941			$	287,941
Pro forma interest expense			105,021				76,926				208,305				144,148
Pro forma net interest income			89,040				73,149				177,636				143,793
Pro forma net income			26,981				21,475				48,809				41,071
Pro forma earnings per share — basic		$	0.53			$	0.49			$	0.85			$	0.93
Pro forma earnings per share — diluted		$	0.52			$	0.48			$	0.84			$	0.92

12. Subsequent Events:

In July 2007, Sterling announced a quarterly cash dividend of $0.09 per share, payable on October 10, 2007 to shareholders of record as of September 28, 2007.

PART I – Financial Information (continued)

STERLING FINANCIAL CORPORATION
June 30, 2007

This report contains forward-looking statements. For a discussion about such statements, including the risks and uncertainties inherent therein, see “Forward-Looking Statements.” Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in Sterling’s 2006 annual report on Form 10-K.

General

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

Sterling provides personalized, quality financial services and “Perfect Fit” banking products to its customers consistent with its “Hometown Helpful” philosophy. Sterling believes that its dedication to personalized service has enabled it to grow both its retail deposit base and its lending portfolio in the western United States. With $11.46 billion in total assets at June 30, 2007, Sterling originates loans and attracts Federal Deposit Insurance Corporation (“FDIC”) insured deposits from the general public through 171 financial service centers throughout Washington, Oregon, California, Idaho and Montana. In addition, Sterling originates loans through Golf Savings Bank and Action Mortgage residential loan production offices and through INTERVEST commercial real estate lending offices in the western United States. Sterling also markets fixed income and equity products, mutual funds, fixed and variable annuities and other financial products through Harbor Financial service representatives located throughout Sterling’s financial service center network.

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

Executive Summary and Highlights

During the last twelve months, Sterling completed four transactions, including acquisitions, Lynnwood Financial Group, Inc. and its subsidiary, Golf Savings Bank on July 5, 2006; FirstBank NW Corp. and its subsidiary, FirstBank Northwest on November 30, 2006; and Northern Empire Bancshares and its subsidiary, Sonoma National Bank on February 28, 2007. On July 31, 2006, Sterling also acquired certain assets of Mason-McDuffie Financial Corporation. As a result, comparability among particular amounts may be affected. The increase in net income over 2006 was mainly due to the increase in net interest income from growth in loan balances causing a change in the mix of interest earning assets.

Highlights for the second quarter of 2007 were as follows:

	•		Net Income was $27.0 million, an increase of 59 percent over the second quarter of 2006.
	•		Non-interest income was $24.8 million, a 64 percent increase over the second quarter of 2006.
	•		Total loan originations of $1.71 billion increased 64 percent over the second quarter of 2006.
	•		Total loans receivable increased to a record $8.51 billion, an increase of 21 percent since year end.
	•		Total deposits increased to a record $7.62 billion, an increase of 13 percent since year end.
	•		Business checking accounts increased 35 percent over the comparable prior year period and 17 percent annualized over the previous quarter.
	•		Sterling’s Board of Directors approved a cash dividend of $0.09 per common share, payable on October 10, 2007, to shareholders of record as of September 28, 2007.

Company Growth

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

On April 11, 2007, Sterling announced the signing of a definitive agreement to acquire North Valley Bancorp (“North Valley”), headquartered in Redding, California. This pending acquisition required approval by the North Valley shareholders, which was received at a special meeting of the North Valley shareholders on July 31, 2007, and remains subject to regulatory approval and satisfaction of other customary closing conditions. The integration of North Valley into Sterling is expected to increase Sterling’s total assets by approximately $900 million, and would complement the recent growth of its business in California, increasing its presence there by 25 depository branches.

On February 28, 2007, Sterling completed its acquisition of Northern Empire Bancshares, a California corporation (“Northern Empire”) by issuing $30.0 million in cash, and 8,914,815 shares of Sterling common stock valued at $290.4 million in exchange for all outstanding Northern Empire shares. Northern Empire options totaling 646,018 were converted into 573,212 Sterling options, valued at $12.3 million. The total value of the transaction was $332.8 million. Northern Empire merged into Sterling, with Sterling being the surviving corporation in the merger. Northern Empire’s financial institution subsidiary, Sonoma National Bank, merged with and into Sterling’s subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.

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

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

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

Critical Accounting Policies

The accounting and reporting policies of Sterling conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Sterling’s management has identified the accounting policies described below as those that, due to the judgments, estimates and assumptions inherent in those policies are critical to an understanding of Sterling’s Consolidated Financial Statements and Management’s Discussion and Analysis.

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

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

The amount of the allowance for the various loan types represents management’s estimate of expected losses from existing loans based upon specific allocations for individual lending relationships and historical loss experience for each category of homogeneous loans. The allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain

collateral dependent loans. This evaluation requires management to make estimates of the amounts and timing of future cash flows on impaired loans, which consist primarily of non-accrual and restructured loans.

Individual loan reviews are based upon specific quantitative and qualitative criteria, including the size of the loan, loan quality ratings, value of collateral, repayment ability of borrowers, and historical experience factors. The historical experience factors utilized and allowances for homogeneous loans (such as residential mortgage loans, personal loans, etc.) are collectively evaluated based upon historical loss experience, trends in losses and delinquencies, growth of loans in particular markets, and known changes in economic conditions in each particular lending market.

While management uses available information to provide for loan losses, the ultimate collectibility of a substantial portion of the loan portfolio and the need for future additions to the allowance will be influenced by changes in economic conditions and other relevant factors. A slowdown in economic activity could adversely affect cash flows for both commercial and individual borrowers, which may result in increases in nonperforming assets, delinquencies and losses on loans. There can be no assurance that the allowance for loan losses will be adequate to cover all losses, but management believes the allowance for loan losses was adequate at June 30, 2007.

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

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

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

Management evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. If the fair value of investment securities falls below their amortized cost and the decline is deemed to be other-than-temporary, the securities will be written down to current market value, resulting in a loss recorded in the income statement and the establishment of a new basis. During the six months ended June 30, 2007, there were no investment securities that management identified to be other-than-temporarily impaired, because the decline in fair value was attributable to changes in interest rates and not credit quality, and because Sterling has the ability and intent to hold these investments until a recovery in market price occurs, or until maturity. Realized losses could occur in future periods due to a change in management’s intent to hold the investments to maturity, a change in management’s assessment of credit risk, or a change in regulatory or accounting requirements.

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

Sterling’s management performed an annual test of its goodwill and other intangible assets as of June 30, 2007, and concluded that the recorded values were not impaired. There are many assumptions and estimates underlying the

determination of impairment. Another estimate using different but still reasonable assumptions could produce a significantly different result. Additionally, future events could cause management to conclude that Sterling’s goodwill is impaired, which would result in Sterling recording an impairment loss. Any resulting impairment loss could have a material adverse impact on Sterling’s financial condition and results of operations. Other intangible assets consisting of core-deposit intangibles with definite lives are amortized over the estimated life of the acquired depositor relationships (generally eight to ten years).

Real Estate Owned and Other Collateralized Assets. Property and other assets acquired through foreclosure of defaulted mortgage or other collateralized loans are carried at the lower of cost or fair value, less estimated costs to sell. Development and improvement costs relating to such property are capitalized to the extent they are deemed to be recoverable.

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

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

Sterling uses an estimate of future earnings to support its position that the benefit of its net deferred tax assets will be realized. If future taxable income should prove nonexistent or less than the amount of temporary differences giving rise to the net deferred tax assets within the tax years to which they may be applied, the assets will not be realized and Sterling’s net income will be reduced.

Results of Operations

Overview. Sterling recorded net income of $27.0 million, or $0.52 per diluted share, for the three months ended June 30, 2007, compared with net income of $16.9 million, or $0.48 per diluted share, for the three months ended June 30, 2006. Net income for the six months ended June 30, 2007 was $49.9 million, or $1.02 per diluted share compared with net income of $32.3 million, or $0.92 per diluted share for the six months ended June 30, 2006. The increase in net income mainly reflected an increase in net interest income generated by margin expansion and growth in interest earnings assets.

The annualized return on average assets (“ROA”) was 0.94% and 0.85% for the three months ended June 30, 2007 and 2006, respectively, and 0.93% and 0.83% for the six months ended June 30, 2007 and 2006, respectively. The annualized return on average equity (“ROE”) was 9.6% and 13.1% for the three months ended June 30, 2007 and 2006, respectively, and 9.9% and 12.6% for the six months ended June 30, 2007 and 2006, respectively. The increase in ROA compared to 2006 was due to growth of net income outpacing the increase in assets, while dilution from recent acquisitions drove the decrease in ROE.

Net Interest Income. The most significant component of earnings for a financial institution typically is NII, which is the difference between interest income, primarily from loan, MBS and investment securities portfolios, and interest expense, primarily on deposits and borrowings. During the three months ended June 30, 2007 and 2006, NII was $89.0 million and $61.0 million, respectively, an increase of 45.9%. During the six months ended June 30, 2007 and 2006, NII was $169.7 million and $120.0 million, respectively, an increase of 41.4%. The increase in NII was mainly influenced by the increase in loans as a percentage of interest earning assets.

Changes in Sterling’s NII are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin refers to NII divided by total average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

The following table presents the composition of the change in NII, on a tax equivalent basis, for the periods presented. Municipal loan and bond interest income are presented gross of their applicable tax savings. For each category of interest-earning assets and interest-bearing liabilities, the following table provides information on changes attributable to:

•		Volume – changes in volume multiplied by comparative period rate;
•		Rate – changes in rate multiplied by comparative period volume; and
•		Rate/volume – changes in rate multiplied by changes in volume.

		Three Months Ended June 30,																Six Months Ended June 30,
		2007 vs. 2006																2007 vs. 2006
		Increase (Decrease) Due to:																Increase (Decrease) Due to:
										Rate/																Rate/
		Volume				Rate				Volume				Total				Volume				Rate				Volume				Total
		(Dollars in thousands)
Rate/volume analysis:
Interest income:
Loans		$	59,993			$	5,925			$	3,587			$	69,505			$	106,403			$	15,117			$	8,666			$	130,186
MBS			(3,098	)			(22	)			3				(3,117	)			(6,034	)			46				(6	)			(5,994	)
Investments and cash equivalents			492				522				203				1,217				958				1,025				429				2,412
Total interest income			57,387				6,425				3,793				67,605				101,327				16,188				9,089				126,604
Interest expense:
Deposits			19,887				6,656				3,214				29,757				36,061				15,374				7,232				58,667
Borrowings			5,349				3,490				754				9,593				8,416				7,917				1,413				17,746
Total interest expense			25,236				10,146				3,968				39,350				44,477				23,291				8,645				76,413
Net changes in NII		$	32,151			$	(3,721	)		$	(175	)		$	28,255			$	56,850			$	(7,103	)		$	444			$	50,191