*Table
          of Contents*





**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**





**Washington,
      D.C. 20549**





**FORM
      10-Q**





**(Mark
      One)**





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


**FOR
      THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007**





**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
            91-1572822(State
                or other jurisdiction of
            (I.R.S.
                Employerincorporation
                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 x No  ̈





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 x Accelerated Filer  ̈ Non-accelerated filer  ̈





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes  ̈ No x





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 ofNovember
                1,
                2007Common
                Stock ($1.00 par value)
            51,431,361









*Table
        of Contents*


**STERLING
      FINANCIAL CORPORATION**





**FORM
      10-Q**


**For
      the Quarter Ended SEPTEMBER 30, 2007**





**TABLE
      OF CONTENTS**




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




-i-
 *Table
            of Contents*


**PART
        I - Financial Information**
 **Item
        1 - Financial Statements******
 **STERLING
        FINANCIAL CORPORATION**
 **Consolidated
        Balance Sheets**
 **(Unaudited)**


September
                30,
            
            December
                31,2007
            
            2006(Dollars
                in thousands)ASSETS:Cash
                and cash equivalents:Interest
                bearing
            
            $3,492
            
            $13,846Non-interest
                bearing and vault
            
            
            163,764
            
            
            164,719Total
                cash and cash equivalents
            
            
            167,256
            
            
            178,565Restricted
                cash
            
            
            1,100
            
            
            1,150Investment
                securities and mortgage-backed securities ("MBS"):Available
                for sale
            
            
            1,788,911
            
            
            1,820,583Held
                to maturity
            
            
            115,518
            
            
            93,063Loans
                receivable, net
            
            
            8,747,430
            
            
            7,021,241Loans
                held for sale
            
            
            54,460
            
            
            91,469Accrued
                interest receivable
            
            
            65,676
            
            
            55,519Real
                estate owned and other collateralized assets, net
            
            
            3,427
            
            
            4,052Office
                properties and equipment, net
            
            
            94,939
            
            
            93,796Bank-owned
                life insurance ("BOLI")
            
            
            149,136
            
            
            139,206Goodwill
            
            
            453,294
            
            
            247,244Other
                intangible assets, net
            
            
            32,852
            
            
            28,570Mortgage
                servicing rights, net
            
            
            9,970
            
            
            7,335Prepaid
                expenses and other assets, net
            
            
            62,946
            
            
            52,699Total
                assets
            
            $
            11,746,915
            
            $
            9,834,492LIABILITIES:Deposits
            
            $
            7,766,392
            
            $
            6,746,028Advances
                from Federal Home Loan Bank ("FHLB")
            
            
            1,462,132
            
            
            1,308,617Repurchase
                agreements and federal funds
            
            
            941,143
            
            
            616,354Other
                borrowings
            
            
            273,467
            
            
            240,226Cashiers
                checks issued and payable
            
            
            5,976
            
            
            18,144Borrowers'
                reserves for taxes and insurance
            
            
            3,223
            
            
            2,348Accrued
                interest payable
            
            
            39,172
            
            
            39,863Accrued
                expenses and other liabilities
            
            
            96,692
            
            
            79,496Total
                liabilities
            
            
            10,588,197
            
            
            9,051,076Commitments
                and ContingenciesSHAREHOLDERS'
                EQUITY:Preferred
                stock, $1 par value; 10,000,000 shares authorized;no
                shares issued and outstanding
            
            
            0
            
            
            0Common
                stock, $1 par value; 100,000,000 shares authorized;51,422,336
                and 42,042,740 shares issued and outstanding
            
            
            51,422
            
            
            42,043Additional
                paid-in capital
            
            
            891,518
            
            
            590,218Accumulated
                other comprehensive loss:Unrealized
                losses on investment securities and MBS available-for-sale,net
                of deferred income taxes of $18,793 and $19,531
            
            
            (32,067
            )
            
            (33,350
            )Retained
                earnings
            
            
            247,845
            
            
            184,505Total
                shareholders' equity
            
            
            1,158,718
            
            
            783,416Total
                liabilities and shareholders' equity
            
            $
            11,746,915
            
            $
            9,834,492The
                accompanying notes are an integral part of the consolidated financial
                statements.





-1-
 *Table
            of Contents*


**STERLING
        FINANCIAL CORPORATION**
 **Consolidated
        Statements of Income**
 **(Unaudited)**
  Three
                    Months Ended
                
                Nine
                    Months EndedSeptember
                    30,
                
                September
                    30,2007
                
                2006
                
                2007
                
                2006(Dollars
                    in thousands, except per share data)Interest
                    income:Loans
                
                $
                179,132
                
                $
                125,554
                
                $
                504,720
                
                $
                321,021MBS
                
                
                18,882
                
                
                21,626
                
                
                58,706
                
                
                67,444Investments
                    and cash equivalents
                
                
                1,904
                
                
                1,028
                
                
                5,455
                
                
                2,642Total
                    interest income
                
                
                199,918
                
                
                148,208
                
                
                568,881
                
                
                391,107Interest
                    expense:Deposits
                
                
                71,489
                
                
                51,653
                
                
                205,875
                
                
                127,372Short-term
                    borrowings
                
                
                6,690
                
                
                10,055
                
                
                26,095
                
                
                25,301Long-term
                    borrowings
                
                
                28,075
                
                
                16,467
                
                
                73,591
                
                
                48,396Total
                    interest expense
                
                
                106,254
                
                
                78,175
                
                
                305,561
                
                
                201,069Net
                    interest income
                
                
                93,664
                
                
                70,033
                
                
                263,320
                
                
                190,038Provision
                    for losses on loans
                
                
                (3,888
                )
                
                (4,698
                )
                
                (12,088
                )
                
                (13,998
                )Net
                    interest income after provision for losses on loans
                
                
                89,776
                
                
                65,335
                
                
                251,232
                
                
                176,040Non-interest
                    income:Fees
                    and service charges
                
                
                14,966
                
                
                11,526
                
                
                40,852
                
                
                31,220Mortgage
                    banking operations
                
                
                7,314
                
                
                5,572
                
                
                25,979
                
                
                10,568Loan
                    servicing fees
                
                
                366
                
                
                473
                
                
                1,459
                
                
                1,224Real
                    estate owned and other collateralized assets operations
                
                
                223
                
                
                (138
                )
                
                85
                
                
                247BOLI
                
                
                1,553
                
                
                1,225
                
                
                4,817
                
                
                3,611Other
                
                
                (215
                )
                
                (207
                )
                
                (759
                )
                
                (372
                )Total
                    non-interest income
                
                
                24,207
                
                
                18,451
                
                
                72,433
                
                
                46,498Non-interest
                    expenses
                
                
                74,104
                
                
                55,302
                
                
                209,664
                
                
                146,531Income
                    before income taxes
                
                
                39,879
                
                
                28,484
                
                
                114,001
                
                
                76,007Income
                    tax provision
                
                
                (13,349
                )
                
                (9,145
                )
                
                (37,569
                )
                
                (24,321
                )Net
                    income
                
                $
                26,530
                
                $
                19,339
                
                $
                76,432
                
                $
                51,686Earnings
                    per share - basic
                
                $
                0.52
                
                $
                0.52
                
                $
                1.55
                
                $
                1.45Earnings
                    per share - diluted
                
                $
                0.51
                
                $
                0.52
                
                $
                1.54
                
                $
                1.44Weighted
                    average shares outstanding - basic
                
                
                51,279,114
                
                
                36,891,986
                
                
                49,257,951
                
                
                35,645,887Weighted
                    average shares outstanding - diluted
                
                
                51,660,186
                
                
                37,273,560
                
                
                49,768,308
                
                
                35,992,764The
                    accompanying notes are an integral part of the consolidated financial
                    statements.
  -2-
 *Table
              of Contents*
  **STERLING
          FINANCIAL CORPORATION**
 **Consolidated
          Statements of Cash Flows**
 **(Unaudited)**
  Nine
                      Months EndedSeptember
                      30,2007
                  
                  2006(Dollars
                      in thousands)Cash
                      flows from operating activities:Net
                      income
                  
                  $
                  76,432
                  
                  $
                  51,686Adjustments
                      to reconcile net income to net cash provided by operating
                      activities:Provisions
                      for losses on loans and real estate owned
                  
                  
                  12,088
                  
                  
                  14,168Accretion
                      of deferred gain on sale of branches
                  
                  
                  (536
                  )
                  
                  (151
                  )Net
                      gain on sales of loans, investment securities and MBS
                  
                  
                  (16,499
                  )
                  
                  (4,832
                  )Stock
                      based compensation
                  
                  
                  1,013
                  
                  
                  182Excess
                      tax benefit from stock based compensation
                  
                  
                  (1,419
                  )
                  
                  (1,638
                  )Stock
                      issuances relating to 401(k) match
                  
                  
                  1,637
                  
                  
                  1,203Other
                      gains and losses
                  
                  
                  3,024
                  
                  
                  888Increase
                      in cash surrender value of BOLI
                  
                  
                  (4,817
                  )
                  
                  (3,611
                  )Depreciation
                      and amortization
                  
                  
                  18,184
                  
                  
                  14,084Change
                      in:Accrued
                      interest receivable
                  
                  
                  (3,117
                  )
                  
                  (8,770
                  )Prepaid
                      expenses and other assets
                  
                  
                  (10,027
                  )
                  
                  1,217Cashiers
                      checks issued and payable
                  
                  
                  (16,867
                  )
                  
                  721Accrued
                      interest payable
                  
                  
                  (2,664
                  )
                  
                  16,307Accrued
                      expenses and other liabilities
                  
                  
                  7,094
                  
                  
                  (2,910
                  )Proceeds
                      from sales of loans originated for sale
                  
                  
                  988,255
                  
                  
                  304,302Loans
                      originated for sale
                  
                  
                  (975,871
                  )
                  
                  (299,639
                  )Net
                      cash provided by operating activities
                  
                  
                  75,910
                  
                  
                  83,207Cash
                      flows from investing activities:Change
                      in restricted cash
                  
                  
                  50
                  
                  
                  (501
                  )Loans
                      funded and purchased
                  
                  
                  (3,702,199
                  )
                  
                  (3,169,552
                  )Loan
                      principal received
                  
                  
                  3,122,955
                  
                  
                  2,120,741Proceeds
                      from sales of other loans
                  
                  
                  112,651
                  
                  
                  51,144Purchase
                      of investment securities
                  
                  
                  (79,941
                  )
                  
                  (44,416
                  )Proceeds
                      from maturities of investment securities
                  
                  
                  38,580
                  
                  
                  11,400Proceeds
                      from sale of investments
                  
                  
                  5,609
                  
                  
                  0Net
                      change in cash and cash equivalents from acquisitions
                  
                  
                  92,419
                  
                  
                  (5,983
                  )Purchase
                      of mortgage-backed securities
                  
                  
                  (120,419
                  )
                  
                  0Principal
                      payments on mortgage-backed securities
                  
                  
                  183,899
                  
                  
                  208,160Purchase
                      of office properties and equipment
                  
                  
                  (10,806
                  )
                  
                  (11,742
                  )Sales
                      of office properties and equipment
                  
                  
                  3,810
                  
                  
                  18,882Improvements
                      and other changes to real estate owned
                  
                  
                  30
                  
                  
                  (248
                  )Proceeds
                      from sales and liquidation of real estate owned
                  
                  
                  1,348
                  
                  
                  1,353Net
                      cash used in investing activities
                  
                  
                  (352,014
                  )
                  
                  (820,762
                  )The
                      accompanying notes are an integral part of the consolidated
                      financial
                      statements.
  -3-
 *Table
                of Contents*
  **STERLING
            FINANCIAL CORPORATION**
 **Consolidated
            Statements of Cash Flows**
 **(Unaudited)**
  Nine
                        Months EndedSeptember
                        30,2007
                    
                    2006(Dollars
                        in thousands)Cash
                        flows from financing activities:Net
                        change in transaction and savings deposits
                    
                    $
                    105,673
                    
                    $
                    224,549Proceeds
                        from issuance of time deposits
                    
                    
                    3,010,268
                    
                    
                    2,803,087Payments
                        for maturing time deposits
                    
                    
                    (3,280,346
                    )
                    
                    (2,437,358
                    )Interest
                        credited to deposits
                    
                    
                    190,115
                    
                    
                    110,760Advances
                        from FHLB
                    
                    
                    1,517,744
                    
                    
                    1,985,866Repayment
                        of advances from FHLB
                    
                    
                    (1,630,642
                    )
                    
                    (2,055,766
                    )Net
                        change in securities sold subject to repurchase agreementsand
                        funds purchased
                    
                    
                    324,789
                    
                    
                    11,936Proceeds
                        from other borrowings
                    
                    
                    69,392
                    
                    
                    130,000Repayments
                        of other borrowings
                    
                    
                    (36,403
                    )
                    
                    (25,000
                    )Proceeds
                        from stock purchases
                    
                    
                    3,546
                    
                    
                    4,774Excess
                        tax benefit from stock based compensation
                    
                    
                    1,419
                    
                    
                    1,638Cash
                        dividends paid to shareholders
                    
                    
                    (11,635
                    )
                    
                    (6,670
                    )Other
                    
                    
                    875
                    
                    
                    2,044Net
                        cash provided by financing activities
                    
                    
                    264,795
                    
                    
                    749,860Net
                        change in cash and cash equivalents
                    
                    
                    (11,309
                    )
                    
                    12,305Cash
                        and cash equivalents, beginning of period
                    
                    
                    178,565
                    
                    
                    131,307Cash
                        and cash equivalents, end of period
                    
                    $
                    167,256
                    
                    $
                    143,612Supplemental
                        disclosures:Cash
                        paid during the period for:Interest
                    
                    $
                    306,252
                    
                    $
                    184,122Income
                        taxes
                    
                    
                    35,902
                    
                    
                    28,732Noncash
                        financing and investing activities:Loans
                        converted into real estate owned and other collateralized
                        assets
                    
                    
                    753
                    
                    
                    4,406Common
                        stock issued upon business combination
                    
                    
                    8,927
                    
                    
                    50,565Common
                        stock cash dividends accrued
                    
                    
                    4,611
                    
                    
                    2,594Deferred
                        gain on sale of branches
                    
                    
                    804
                    
                    
                    9,029The
                        accompanying notes are an integral part of the consolidated
                        financial
                        statements.
  -4-
 *Table
                of Contents*
  **STERLING
            FINANCIAL CORPORATION**
 **Consolidated
            Statements of Comprehensive
            Income**
 **(Unaudited)**
  Three
                      Months Ended
                  
                  Nine
                      Months EndedSeptember
                      30,
                  
                  September
                      30,2007
                  
                  2006
                  
                  2007
                  
                  2006(Dollars
                      in thousands)
                  
                  (Dollars
                      in thousands)Net
                      income
                  
                  $
                  26,530
                  
                  $
                  19,339
                  
                  $
                  76,432
                  
                  $
                  51,686Other
                      comprehensive income:Change
                      in unrealized gains (losses) on investmentsecurities
                      and MBS available-for-sale
                  
                  
                  20,482
                  
                  
                  39,170
                  
                  
                  2,021
                  
                  
                  (1,650
                  )Less
                      deferred income taxes
                  
                  
                  (7,575
                  )
                  
                  (14,490
                  )
                  
                  (738
                  )
                  
                  620Net
                      other comprehensive income (loss)
                  
                  
                  12,907
                  
                  
                  24,680
                  
                  
                  1,283
                  
                  
                  (1,030
                  )Comprehensive
                      income
                  
                  $
                  39,437
                  
                  $
                  44,019
                  
                  $
                  77,715
                  
                  $
                  50,656The
                      accompanying notes are an integral part of the consolidated
                      financial
                      statements.


-5-
 *Table
            of Contents*
  **STERLING
        FINANCIAL CORPORATION**
 **Notes
        to 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):




September
                  30,
              
              December
                  31,2007
              
              2006Junior
                  Subordinated Debentures
              
              $
              270,013
              
              $
              236,772Other
              
              
              3,454
              
              
              3,454Total
              
              $
              273,467
              
              $
              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:





-6-
 *Table
            of Contents*






**Subsidiary
                  Issuer**
              
              **Issue**
                **Date**
              
              **Maturity**
                **Date**
              
              **Call
                  Date**
              
              **Rate
                  at**
                **September
                  30, 2007**
              
              **Carrying
                  Value**
                **(in
                  thousands)**Sterling
                  Capital Trust IX
              
              
              July
                  2007
              
              
              Oct
                  2037
              
              
              N/A
              
              
              Floating
              
              
              6.76
              %
              $
              46,392Sterling
                  Capital Trust VIII
              
              
              Sept
                  2006
              
              
              Sept
                  2036
              
              
              N/A
              
              
              Floating
              
              
              7.32
              
              
              51,547Sterling
                  Capital Trust VII
              
              
              June
                  2006
              
              
              June
                  2036
              
              
              N/A
              
              
              Floating
              
              
              7.22
              
              
              56,702Lynnwood
                  Financial Statutory Trust II
              
              
              June
                  2005
              
              
              June
                  2035
              
              
              N/A
              
              
              Floating
              
              
              7.49
              
              
              10,310Sterling
                  Capital Trust VI
              
              
              June
                  2003
              
              
              Sept
                  2033
              
              
              Sept
                  2008
              
              
              Floating
              
              
              8.89
              
              
              10,310Sterling
                  Capital Statutory Trust V
              
              
              May
                  2003
              
              
              May
                  2033
              
              
              June
                  2008
              
              
              Floating
              
              
              8.45
              
              
              20,619Sterling
                  Capital Trust IV
              
              
              May
                  2003
              
              
              May
                  2033
              
              
              May
                  2008
              
              
              Floating
              
              
              8.71
              
              
              10,310Sterling
                  Capital Trust III
              
              
              April
                  2003
              
              
              April
                  2033
              
              
              April
                  2008
              
              
              Floating
              
              
              8.61
              
              
              14,433Lynnwood
                  Financial Statutory Trust I
              
              
              Mar
                  2003
              
              
              Mar
                  2033
              
              
              Mar
                  2007
              
              
              Floating
              
              
              8.35
              
              
              9,478Klamath
                  First Capital Trust I
              
              
              July
                  2001
              
              
              July
                  2031
              
              
              June
                  2006
              
              
              Floating
              
              
              9.06
              
              
              15,169Sterling
                  Capital Trust II
              
              
              July
                  2001
              
              
              July
                  2031
              
              
              June
                  2006
              
              
              Fixed
              
              
              10.25
              
              
              24,7437.88
              %*
              $
              270,013





*
            weighted
                average rate





Sterling
      has a $40.0 million revolving credit agreement (the "Credit Facility") through
      August 2008 with Wells Fargo Bank, N.A., with amounts advanced on the Credit
      Facility included in the "Other" caption of other borrowings. As of September
      30, 2007 and December 31, 2006, no amount was drawn on the Credit Facility.
      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.





In
      April
      2007, Sterling elected to exercise its early redemption right to call the
      Klamath First Capital Trust II debenture in the amount of $13.0 million. 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.


-7-
 *Table
          of Contents*


**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
              
              $
              1,553Potential
                  Effective Tax Rate Impact
              
              
              1,245Recognized
                  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 September 30,2007
              
              2006Net
              
              Weighted
              
              Per
                  Share
              
              Net
              
              Weighted
              
              Per
                  ShareIncome
              
              Avg.
                  Shares
              
              Amount
              
              Income
              
              Avg.
                  Shares
              
              Amount(Dollars
                  in thousands, except per share amounts)Basic
                  computations
              
              $
              26,530
              
              
              51,279,114
              
              $
              0.52
              
              $
              19,339
              
              
              36,891,986
              
              $
              0.52Effect
                  of dilutive securities:Common
                  stock options andrestricted
                  shares
              
              
              0
              
              
              381,072
              
              
              (0.01
              )
              
              0
              
              
              369,570
              
              
              0.00Contingently
                  issuable shares
              
              
              0
              
              
              0
              
              
              0.00
              
              
              0
              
              
              12,004
              
              
              0.00Diluted
                  computations
              
              $
              26,530
              
              
              51,660,186
              
              $
              0.51
              
              $
              19,339
              
              
              37,273,560
              
              $
              0.52Antidilutive
                  options not includedin
                  diluted earnings per share
              
              
              
              
              
              735,749
              
              
              
              
              
              
              
              
              0
  Nine
                  Months Ended September 30,2007
              
              2006Net
              
              Weighted
              
              Per
                  Share
              
              Net
              
              Weighted
              
              Per
                  ShareIncome
              
              Avg.
                  Shares
              
              Amount
              
              Income
              
              Avg.
                  Shares
              
              Amount(Dollars
                  in thousands, except per share amounts)Basic
                  computations
              
              $
              76,432
              
              
              49,257,951
              
              $
              1.55
              
              $
              51,686
              
              
              35,645,887
              
              $
              1.45Effect
                  of dilutive securities:Common
                  stock options andrestricted
                  shares
              
              
              0
              
              
              510,357
              
              
              (0.01
              )
              
              0
              
              
              334,873
              
              
              (0.01
              )Contingently
                  issuable shares
              
              
              0
              
              
              0
              
              
              0.00
              
              
              0
              
              
              12,004
              
              
              0.00Diluted
                  computations
              
              $
              76,432
              
              
              49,768,308
              
              $
              1.54
              
              $
              51,686
              
              
              35,992,764
              
              $
              1.44Antidilutive
                  options not includedin
                  diluted earnings per share
              
              
              
              
              
              281,396
              
              
              
              
              
              
              
              
              0





-8-
 *Table
          of Contents*


**5.** **Non-Interest
      Expenses** **:**





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




Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  30,
              
              September
                  30,2007
              
              2006
              
              2007
              
              2006(Dollars
                  in thousands)Employee
                  compensation and benefits
              
              $
              41,114
              
              $
              31,479
              
              $
              118,348
              
              $
              82,278Occupancy
                  and equipment
              
              
              10,767
              
              
              8,755
              
              
              32,915
              
              
              23,046Data
                  processing
              
              
              4,833
              
              
              3,746
              
              
              13,206
              
              
              10,601Depreciation
              
              
              3,387
              
              
              2,662
              
              
              9,923
              
              
              7,377Advertising
              
              
              3,289
              
              
              2,900
              
              
              9,245
              
              
              7,155Travel
                  and entertainment
              
              
              2,022
              
              
              1,454
              
              
              5,663
              
              
              4,040Goodwill
                  litigation costs
              
              
              1,525
              
              
              25
              
              
              2,837
              
              
              245Insurance
              
              
              1,338
              
              
              364
              
              
              2,246
              
              
              963Amortization
                  of core deposit intangibles
              
              
              1,225
              
              
              586
              
              
              3,492
              
              
              1,697Legal
                  and accounting
              
              
              591
              
              
              622
              
              
              1,814
              
              
              1,861Merger
                  and acquisition costs
              
              
              263
              
              
              191
              
              
              1,883
              
              
              191Other
              
              
              3,750
              
              
              2,518
              
              
              8,092
              
              
              7,077Total
              
              $
              74,104
              
              $
              55,302
              
              $
              209,664
              
              $
              146,531
 **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.


-9-
 *Table
          of Contents*


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




As
                  of and for the Three Months Ended September 30,
                  2007Community
                Banking
              
              Residential
                Mortgage
                  Banking
              
              Commercial
                Mortgage
                  Banking
              
              Retail
                Brokerage
              
              Other
                  and
                Eliminations
              
              Total(Dollars
                  in thousands)Interest
                  income
              
              $
              183,366
              
              $
              14,178
              
              $
              2,309
              
              $
              0
              
              $
              65
              
              $
              199,918Interest
                  expense
              
              
              (97,636
              )
              
              (3,908
              )
              
              0
              
              
              0
              
              
              (4,710
              )
              
              (106,254
              )Net
                  interest income (expense)
              
              
              85,730
              
              
              10,270
              
              
              2,309
              
              
              0
              
              
              (4,645
              )
              
              93,664Provision
                  for loan losses
              
              
              (3,775
              )
              
              (113
              )
              
              0
              
              
              0
              
              
              0
              
              
              (3,888
              )Noninterest
                  income
              
              
              19,982
              
              
              6,190
              
              
              1,751
              
              
              1,458
              
              
              (5,174
              )
              
              24,207Noninterest
                  expense
              
              
              (58,966
              )
              
              (10,572
              )
              
              (2,881
              )
              
              (1,140
              )
              
              (545
              )
              
              (74,104
              )Income
                  before income taxes
              
              $
              42,971
              
              $
              5,775
              
              $
              1,179
              
              
              318
              
              $
              (10,364
              )
              $
              39,879Total
                  assets
              
              $
              11,429,438
              
              $
              407,668
              
              $
              10,370
              
              $
              1,160
              
              $
              (101,721
              )
              $
              11,746,915
  As
                  of and for the Three Months Ended September 30,
                  2006Community
                Banking
              
              Residential
                Mortgage
                  Banking
              
              Commercial
                Mortgage
                  Banking
              
              Retail
                Brokerage
              
              Other
                and Eliminations
              
              Total(Dollars
                  in thousands)Interest
                  income
              
              $
              136,616
              
              $
              10,870
              
              $
              2,407
              
              $
              0
              
              $
              (1,685
              )
              $
              148,208Interest
                  expense
              
              
              (72,246
              )
              
              (3,886
              )
              
              0
              
              
              0
              
              
              (2,043
              )
              
              (78,175
              )Net
                  interest income (expense)
              
              
              64,370
              
              
              6,984
              
              
              2,407
              
              
              0
              
              
              (3,728
              )
              
              70,033Provision
                  for loan losses
              
              
              (4,650
              )
              
              (45
              )
              
              0
              
              
              0
              
              
              (3
              )
              
              (4,698
              )Noninterest
                  income
              
              
              14,398
              
              
              6,173
              
              
              1,129
              
              
              759
              
              
              (4,008
              )
              
              18,451Noninterest
                  expense
              
              
              (40,546
              )
              
              (11,016
              )
              
              (2,272
              )
              
              (726
              )
              
              (742
              )
              
              (55,302
              )Income
                  before income taxes
              
              $
              33,572
              
              $
              2,096
              
              $
              1,264
              
              $
              33
              
              $
              (8,481
              )
              $
              28,484Total
                  assets
              
              $
              8,669,081
              
              $
              354,447
              
              $
              10,660
              
              $
              897
              
              $
              (117,410
              )
              $
              8,917,675





-10-
 *Table
          of Contents*




As
                  of and for the Nine Months Ended September 30,
                  2007Community
                Banking
              
              Residential
                Mortgage
                  Banking
              
              Commercial
                Mortgage
                  Banking
              
              Retail
                Brokerage
              
              Other
                  and
                Eliminations
              
              Total(Dollars
                  in thousands)Interest
                  income
              
              $
              524,903
              
              $
              37,355
              
              $
              6,544
              
              $
              0
              
              $
              79
              
              $
              568,881Interest
                  expense
              
              
              (281,837
              )
              
              (10,159
              )
              
              0
              
              
              0
              
              
              (13,565
              )
              
              (305,561
              )Net
                  interest income (expense)
              
              
              243,066
              
              
              27,196
              
              
              6,544
              
              
              0
              
              
              (13,486
              )
              
              263,320Provision
                  for loan losses
              
              
              (11,825
              )
              
              (263
              )
              
              0
              
              
              0
              
              
              0
              
              
              (12,088
              )Noninterest
                  income
              
              
              58,101
              
              
              20,965
              
              
              5,925
              
              
              3,281
              
              
              (15,839
              )
              
              72,433Noninterest
                  expense
              
              
              (165,158
              )
              
              (30,896
              )
              
              (8,210
              )
              
              (2,979
              )
              
              (2,421
              )
              
              (209,664
              )Income
                  before income taxes
              
              $
              124,184
              
              $
              17,002
              
              $
              4,259
              
              $
              302
              
              $
              (31,746
              )
              $
              114,001Total
                  assets
              
              $
              11,429,438
              
              $
              407,668
              
              $
              10,370
              
              $
              1,160
              
              
              (101,721
              )
              $
              11,746,915
  As
                  of and for the Nine Months Ended September 30,
                  2006Community
                Banking
              
              Residential
                Mortgage
                  Banking
              
              Commercial
                Mortgage
                  Banking
              
              Retail
                Brokerage
              
              Other
                  and
                Eliminations
              
              Total(Dollars
                  in thousands)Interest
                  income
              
              $
              367,562
              
              $
              18,112
              
              $
              6,670
              
              $
              0
              
              $
              (1,237
              )
              $
              391,107Interest
                  expense
              
              
              (190,402
              )
              
              (3,886
              )
              
              0
              
              
              0
              
              
              (6,781
              )
              
              (201,069
              )Net
                  interest income (expense)
              
              
              177,160
              
              
              14,226
              
              
              6,670
              
              
              0
              
              
              (8,018
              )
              
              190,038Provision
                  for loan losses
              
              
              (13,953
              )
              
              (45
              )
              
              0
              
              
              0
              
              
              0
              
              
              (13,998
              )Noninterest
                  income
              
              
              39,330
              
              
              10,725
              
              
              3,612
              
              
              2,602
              
              
              (9,771
              )
              
              46,498Noninterest
                  expense
              
              
              (117,393
              )
              
              (18,791
              )
              
              (6,195
              )
              
              (2,197
              )
              
              (1,955
              )
              
              (146,531
              )Income
                  before income taxes
              
              $
              85,144
              
              $
              6,115
              
              $
              4,087
              
              $
              405
              
              $
              (19,744
              )
              $
              76,007Total
                  assets
              
              $
              8,669,081
              
              $
              354,447
              
              $
              10,660
              
              $
              897
              
              $
              (117,410
              )
              $
              8,917,675


**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 nine months ended September 30, 2007, stock option activity and related
      information was as follows:




Number
              
              Weighted
                  Average Exercise Price
              
              Weighted
                  Average Remaining Contractual Life (in years)
              
              Aggregate
                  Intrinsic Value (in thousands)Outstanding,
                  December 31, 2006
              
              
              1,485,661
              
              $
              19.72Granted
              
              
              340,000
              
              
              32.37Exercised
              
              
              (314,155
              )
              
              11.48Acquisitions
              
              
              573,212
              
              
              12.67Cancelled
              
              
              (11,623
              )
              
              18.74Outstanding,
                  September 30, 2007
              
              
              2,073,095
              
              $
              21.10
              
              
              4.90
              
              $
              12,048Exercisable,
                  September 30, 2007
              
              
              1,734,095
              
              $
              18.90
              
              
              4.58
              
              $
              13,897


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 September 30, 2007, a total of 2,011,249 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,
      eight or ten years.


-11-
 *Table
          of Contents*


During
      the nine months ended September 30, 2007 and 2006, the fair value of options
      granted were $3.4 million and $171,000, respectively, and the intrinsic value
      of
      options exercised were $6.2 million and $4.9 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.




Nine
                  Months EndedSeptember
                  30,2007
              
              2006Expected
                  volatility
              
              
              26%
                  - 29
              %
              
              31
              %Expected
                  term (in years)
              
              
              4.7
                  - 6.0
              
              
              5.5Expected
                  dividend yield
              
              
              0.90%
                  - 1.47
              %
              
              0.87
              %Risk
                  free interest rate
              
              
              4.65%
                  - 4.80
              %
              
              4.36
              %




Other
      stock based compensation during the nine months ended September 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 nine months ended
      September 30, 2007 and 2006 was $1.0 million and $146,000,
      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 September 30, 2007, Sterling
      had entered into best efforts forward commitments to sell $189.3 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 $1.1 million. As of December 31, 2006, these
      rate locks and delivery commitments were valued at $482,000. As
      of


-12-
 *Table
          of Contents*


September
      30, 2007, Sterling had loans locked with investors under mandatory delivery
      programs valued at $18,000, and held offsetting forward sale agreements on
      MBS
      valued at $20,000, with a net 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 September 30, 2007 and December 31, 2006, were $706,000 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
              
              TotalJanuary
                  2006
              
              $
              0.055
              
              $
              1.9
                  millionApril
                  2006
              
              
              0.060
              
              
              2.1
                  millionJuly
                  2006
              
              
              0.065
              
              
              2.3
                  millionOctober
                  2006
              
              
              0.070
              
              
              2.6
                  millionJanuary
                  2007
              
              
              0.075
              
              
              3.2
                  millionApril
                  2007
              
              
              0.080
              
              
              4.1
                  millionJuly
                  2007
              
              
              0.085
              
              
              4.3
                  millionOctober
                  2007
              
              
              0.090
              
              
              4.6
                  million




**11.** **Business
      Combinations** **:**





On
      April
      11, 2007, Sterling announced the signing of a definitive agreement (the "Merger
      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. On October
      26,
      2007, Sterling announced that it appears unlikely that the pending merger
      between Sterling and North Valley will be completed during the fourth quarter
      of
      2007 as previously intended. Sterling has revised its expectation for regulatory
      approval of the merger based upon recent conversations between Sterling and
      the
      FDIC. Sterling has been asked by the FDIC to strengthen its internal regulatory
      compliance program to ensure that Sterling's infrastructure is keeping pace
      with
      its growth rate. The FDIC has also informed Sterling that, at this time, it
      cannot advise Sterling when or if the pending application to merge Sterling
      Savings Bank with North Valley Bank will be approved. Sterling and North Valley
      are currently in discussions regarding an amendment to the Merger Agreement
      to
      extend the date after which either party may terminate the Merger Agreement
      if
      the merger has not been consummated, which is currently November 30, 2007;
      however, no agreement to amend the Merger Agreement has yet been reached. 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


-13-
 *Table
          of Contents*


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, 2007Cash
                  and cash equivalents
              
              $
              110,775Investments
                  and MBS
              
              
              22,574Loans
                  receivable, net
              
              
              1,228,816Goodwill
              
              
              208,944Core
                  deposit intangible
              
              
              7,775Other
                  assets
              
              
              19,523Total
                  assets acquired
              
              $
              1,598,407Deposits
              
              $
              987,694Other
                  borrowings
              
              
              266,853Other
                  liabilities
              
              
              11,093Total
                  liabilities assumed
              
              
              1,265,640Net
                  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
                September
                  30,
              
              Nine
                  Months Ended
                September
                  30,2007
              
              2006
              
              2007
              
              2006Pro
                  forma interest income
              
              $
              199,918
              
              $
              173,438
              
              $
              585,859
              
              $
              461,380Pro
                  forma interest expense
              
              
              106,254
              
              
              91,363
              
              
              314,562
              
              
              235,510Pro
                  forma net interest income
              
              
              93,664
              
              
              82,075
              
              
              271,297
              
              
              225,870Pro
                  forma net income
              
              
              26,530
              
              
              23,492
              
              
              75,337
              
              
              64,565Pro
                  forma earnings per share - basic
              
              $
              0.52
              
              $
              0.51
              
              $
              1.48
              
              $
              1.45Pro
                  forma earnings per share - diluted
              
              $
              0.51
              
              $
              0.50
              
              $
              1.47
              
              $
              1.43


**12.** **Subsequent
      Event** **:**





In
      October 2007, Sterling announced a quarterly cash dividend of $0.095 per share,
      payable on January 11, 2008 to shareholders of record as of December 31,
      2007.


-14-
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            of Contents*
  **PART
        I - Financial Information (continued** **)**
 **Item
        2 - Management's Discussion and Analysis of Financial Condition
        and Results of Operation**
 
 **STERLING
        FINANCIAL CORPORATION**
 **September
        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 Washington
      State-chartered 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 $11.75  billion
      in total assets at September 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").


-15-
 *Table
            of Contents*
  **Executive
        Summary and Highlights**





During
      2006 and 2007, Sterling completed the acquisitions of 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
      periods 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.





During
      the third quarter of 2007, disruptions in the mortgage market impacted many
      financial institutions, including Sterling.  Although Sterling's total
      assets, total loans receivable and total deposits have increased on an
      annualized basis, on a linked quarter basis these market conditions have
      contributed to Sterling experiencing a decrease in loan originations, a lower
      level of income from mortgage banking operations and a decline in asset quality.
       The lower level of income from mortgage banking operations is primarily
      the result of the declining volume and prices for loan sales into the secondary
      market, while residential construction loans are the primary source of the
      decline in asset quality.





Highlights
      for the third quarter of 2007 as
      compared to the second quarter of 2007 were as follows:




·
            Net
                interest margin was 3.50 percent, a 9 basis point improvement over
                last
                quarter.





·
            Total
                assets were a record $11.75 billion, representing a 10 percent growth
                on
                an annualized basis over last quarter.





·
            Net
                income was $26.5 million, slightly below the $27.0 million last
                quarter.





·
            Non-interest
                income was $24.2 million, compared to $24.8 million last
                quarter.





·
            Total
                loans receivable increased to a record $8.75 billion, representing an
                11 percent growth on an annualized basis over last quarter.





·
            Total
                deposits increased to a record $7.77 billion, representing an 8
                percent growth on an annualized basis over last quarter.





·
            Total
                nonperforming assets increased to 0.49 percent of total assets, up
                from
                0.27 percent of total assets last quarter.





**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 (the "Merger
      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


-16-
 *Table
          of Contents*


closing
      conditions. On October 26, 2007, Sterling announced that it appears unlikely
      that the pending merger between Sterling and North Valley will be completed
      during the fourth quarter of 2007 as previously intended. Sterling has revised
      its expectation for regulatory approval of the merger based upon recent
      conversations between Sterling and the FDIC. Sterling has been asked by the
      FDIC
      to strengthen its internal regulatory compliance program to ensure that
      Sterling's infrastructure is keeping pace with its growth rate. The FDIC has
      also informed Sterling that, at this time, it cannot advise Sterling when or
      if
      the pending application to merge Sterling Savings Bank with North Valley Bank
      will be approved. Sterling and North Valley are currently in discussions
      regarding an amendment to the Merger Agreement to extend the date after which
      either party may terminate the Merger Agreement if the merger has not been
      consummated, which is currently November 30, 2007; however, no agreement to
      amend the Merger Agreement has yet been reached. 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


-17-
 *Table
          of Contents*


on
      a loan
      has become doubtful, which generally occurs after the loan is 90 days past
      due,
      Sterling discontinues the accrual of interest and any previously accrued
      interest recognized in income deemed uncollectible is reversed. Interest
      received on nonperforming loans is included in income only if principal recovery
      is reasonably assured. A nonperforming loan is restored to accrual status when
      it is brought current, has performed in accordance with contractual terms for
      a
      reasonable period of time, and the collectibility of the total contractual
      principal and interest is no longer in doubt.





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





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





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





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


-18-
 *Table
          of Contents*




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 September 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 recovery, 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.




-19-
 *Table
          of Contents*





**Results
      of Operations**




***Overview*** **.** Sterling
      recorded net income of $26.5 million, or $0.51 per diluted share, for the three
      months ended September 30, 2007, compared with net income of $19.3 million,
      or
      $0.52 per diluted share, for the three months ended
      September 30, 2006, and $27.0 million, or $0.52 per diluted share, for
      the three months ended June 30, 2007. Net income for the nine months ended
      September 30, 2007 was $76.4 million,
      or $ 1.54 per
      diluted share compared with net income of $51.7 million, or $ 1.44 per
      diluted share for the nine months ended September 30, 2006. The year
      over year increase in net income mainly reflected an increase in net interest
      income generated by margin expansion and growth in interest earnings assets,
      while the linked quarter decrease primarily reflected disruption in the mortgage
      market.





The
      annualized return on average assets ("ROA") was 0.91% and 0.89 %
      for the
      three months ended September 30, 2007 and 2006, respectively, and
      0.93 %
      and 0.85 %
      for the
      nine months ended September 30, 2007 and 2006,
      respectively .
      The
      annualized return on average equity ("ROE") was 9.3% and 13.4 %
      for the
      three months ended September 30, 2007 and 2006, respectively, and
      9.7 %
      and 12.9 %
      for the
      nine months ended September 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 September 30, 2007 and
      2006, NII was $93.7 million and $70.0 million, respectively, an increase of
      33.7%. During the nine months ended September 30, 2007 and 2006, NII was $263.3 million
      and $190.0 million, respectively, an increase of 38.6 %. 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 September 30,
              
              Nine
                  Months Ended September 30,2007
                  vs. 2006
              
              2007
                  vs. 2006Increase
                  (Decrease) Due to:
              
              Increase
                  (Decrease) Due to:Rate/
              
              
              
              
              
              
              
              Rate/Volume
              
              Rate
              
              Volume
              
              Total
              
              Volume
              
              Rate
              
              Volume
              
              TotalRate/volume
                  analysis:
              
              (Dollars
                  in thousands)Interest
                  income:Loans
              
              $
              53,037
              
              $
              443
              
              $
              141
              
              $
              53,621
              
              $
              160,583
              
              $
              15,431
              
              $
              7,793
              
              $
              183,807MBS
              
              
              (2,855
              )
              
              126
              
              
              (16
              )
              
              (2,745
              )
              
              (8,888
              )
              
              173
              
              
              (23
              )
              
              (8,738
              )Investments
                  and cash equivalents
              
              
              (303
              )
              
              1,803
              
              
              (369
              )
              
              1,131
              
              
              452
              
              
              2,760
              
              
              332
              
              
              3,544Total
                  interest income
              
              
              49,879
              
              
              2,372
              
              
              (244
              )
              
              52,007
              
              
              152,147
              
              
              18,364
              
              
              8,102
              
              
              178,613Interest
                  expense:Deposits
              
              
              15,363
              
              
              3,461
              
              
              1,012
              
              
              19,836
              
              
              48,997
              
              
              21,337
              
              
              8,169
              
              
              78,503Borrowings
              
              
              6,652
              
              
              1,272
              
              
              319
              
              
              8,243
              
              
              13,216
              
              
              10,830
              
              
              1,943
              
              
              25,989Total
                  interest expense
              
              
              22,015
              
              
              4,733
              
              
              1,331
              
              
              28,079
              
              
              62,213
              
              
              32,167
              
              
              10,112
              
              
              104,492Net
                  changes in NII
              
              $
              27,864
              
              $
              (2,361
              )
              $
              (1,575
              )
              $
              23,928
              
              $
              89,934
              
              $
              (13,803
              )
              $
              (2,010
              )
              $
              74,121


-20-
 *Table
          of Contents*


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




Three
                  Months Ended
              
              Tax
                  Equivalent Net Interest MarginSeptember
                  30, 2007
              
              
              3.50
              %June
                  30, 2007
              
              
              3.41
              %March
                  31, 2007
              
              
              3.41
              %December
                  31, 2006
              
              
              3.37
              %September
                  30, 2006
              
              
              3.34
              %




Average
      interest-earning assets for the three and nine months ended September 30, 2007
      were $10.70 billion and $10.30 billion, respectively, reflecting growth of
      $2.31 billion and $2.57 billion, respectively, over the comparative 2006
      amounts. The growth in the loan portfolio is driving the increase in interest
      earning assets, resulting in an increase in net interest margin as loans are
      becoming a larger percentage of earning assets. Another positive influence
      on
      the net interest margin was the drop in the cost of wholesale funding in
      anticipation of a Federal Reserve rate cut in September 2007.





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





Sterling
      recorded provisions for losses on loans of $3.9 million and $4.7  million
      for the three months ended September 30, 2007 and 2006, respectively. The
      current provision reflects the analysis and assessment of the relevant factors
      mentioned in the preceding paragraph, growth in the allowance as a percentage
      of
      loans, as well as the decrease for the three month comparative period in loan
      originations. Management anticipates that its provision for losses on loans
      may
      increase, reflecting, among other factors, market conditions surrounding
      residential construction lending.





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




Nine
                  Months Ended
                September
                  30,2007
              
              2006(Dollars
                  in thousands)Allowance
                  - loans, January 1
              
              $
              77,849
              
              $
              52,034Acquired
              
              
              15,294
              
              
              4,552Provision
              
              
              11,838
              
              
              13,998Charge
                  offs, net of recoveries
              
              
              (2,733
              )
              
              (2,570
              )Transfers
              
              
              (206
              )
              
              (1,509
              )Allowance
                  - loans, September 30
              
              
              102,042
              
              
              66,505Allowance
                  - unfunded commitments, January 1
              
              
              5,840
              
              
              3,449Acquired
              
              
              0
              
              
              0Provision
              
              
              258
              
              
              0Transfers
              
              
              206
              
              
              1,509Allowance
                  - unfunded commitments, September 30
              
              
              6,304
              
              
              4,958Total
                  credit allowance
              
              $
              108,346
              
              $
              71,463




-21-
 *Table
          of Contents*


During
      2007, Sterling acquired an allowance for losses on loans in the amount of $15.0
      million as a result of the Northern Empire acquisition. These acquired loans
      were determined to not have exhibited a deterioration in credit quality since
      origination, and thus were not included within the scope of the American
      Institute of Certified Public Accountants' Statement of Position 03-3,
      "Accounting for Certain Loans or Debt Securities Acquired in a
      Transfer."





At
      September 30, 2007, Sterling's total classified assets were 1.84% of total
      assets, compared with 0.52% of total assets at September 30, 2006.
      Nonperforming assets were 0.49% of total assets at September 30, 2007, compared
      with 0.21 %
      of
      total assets at September 30, 2006. At September 30, 2007, the loan delinquency
      ratio was 0.53% of total loans compared to 0.25 %
      of
      total loans at September 30, 2006. Deterioration in credit quality during the
      periods presented was due to recent market conditions and weakness in
      residential construction, particularly in the Boise, Idaho and Bend, Oregon
      markets.





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




Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  30,
              
              September
                  30,2007
              
              2006
              
              2007
              
              2006(Dollars
                  in thousands)Fees
                  and service charges
              
              $
              14,966
              
              $
              11,526
              
              $
              40,852
              
              $
              31,220Mortgage
                  banking operations
              
              
              7,314
              
              
              5,572
              
              
              25,979
              
              
              10,568Loan
                  servicing fees
              
              
              366
              
              
              473
              
              
              1,459
              
              
              1,224Real
                  estate owned operations
              
              
              223
              
              
              (138
              )
              
              85
              
              
              247BOLI
              
              
              1,553
              
              
              1,225
              
              
              4,817
              
              
              3,611Other
                  non-interest expense
              
              
              (215
              )
              
              (207
              )
              
              (759
              )
              
              (372
              )Total
              
              $
              24,207
              
              $
              18,451
              
              $
              72,433
              
              $
              46,498


The
      increase in non-interest income for the three and nine months ended September
      30, 2007, over the three and nine months ended September 30, 2006, was
      primarily due to an increase in income from mortgage banking operations and
      fees
      and service charges. The increase in income from mortgage banking operations
      was
      primarily a result of increased loan originations and sales of loans into the
      secondary market by Golf Savings Bank, as well as increased brokered loan fee
      income and sale of SBA commercial real estate loans acquired in the acquisition
      of Sonoma National Bank. On a linked quarter basis, income from mortgage banking
      operations was down 25 percent from $7.3 million for the third quarter of 2007
      compared to $9.8 million for the second quarter of 2007, reflecting the
      disruption in the residential mortgage market that has slowed originations
      and
      adversely affected the pricing and timing on loan sales.





The
      total
      number of transaction accounts for the third quarter of 2007 grew 22 percent
      over the quarter ended September 30, 2006, which helped drive the
      growth in fees and service charge income. Fees and service charges for the
      three
      and nine months ended September 30, 2007 increased as
      a
      result of increases
      in consumer transaction based fees, including Sterling's Balance Shield program,
      plus increases in treasury management and loan related fees, merchant services,
      and business and consumer CheckCard fees.


-22-
 *Table
          of Contents*


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




As
                of and for the
            
            As
                of and for theThree
                Months Ended
            
            Nine
                Months EndedSeptember
                30,
            
            September
                30,2007
            
            2006
            
            2007
            
            2006(Dollars
                in thousands)Originations
                of residential mortgage loans
            
            $
            369,216
            
            $
            328,436
            
            $
            1,168,755
            
            $
            477,657Originations
                of commercial real estate loans
            
            
            80,371
            
            
            38,488
            
            
            97,431
            
            
            110,456Sales
                of residential mortgage loans
            
            
            308,189
            
            
            266,014
            
            
            1,040,820
            
            
            350,614Sales
                of commercial real estate loans
            
            
            14,501
            
            
            0
            
            
            44,004
            
            
            0Principal
                balances of residential loans serviced for others
            
            
            613,134
            
            
            606,807
            
            
            613,134
            
            
            606,807Principal
                balances of commercial real estate loans serviced for
                others
            
            
            1,679,335
            
            
            843,112
            
            
            1,679,335
            
            
            843,112




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




Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  30,
              
              September
                  30,2007
              
              2006
              
              2007
              
              2006(Dollars
                  in thousands)Employee
                  compensation and benefits
              
              $
              41,114
              
              $
              31,479
              
              $
              118,348
              
              $
              82,278Occupancy
                  and equipment
              
              
              10,767
              
              
              8,755
              
              
              32,915
              
              
              23,046Data
                  processing
              
              
              4,833
              
              
              3,746
              
              
              13,206
              
              
              10,601Depreciation
              
              
              3,387
              
              
              2,662
              
              
              9,923
              
              
              7,377Advertising
              
              
              3,289
              
              
              2,900
              
              
              9,245
              
              
              7,155Travel
                  and entertainment
              
              
              2,022
              
              
              1,454
              
              
              5,663
              
              
              4,040Goodwill
                  litigation costs
              
              
              1,525
              
              
              25
              
              
              2,837
              
              
              245Insurance
              
              
              1,338
              
              
              364
              
              
              2,246
              
              
              963Amortization
                  of core deposit intangibles
              
              
              1,225
              
              
              586
              
              
              3,492
              
              
              1,697Legal
                  and accounting
              
              
              591
              
              
              622
              
              
              1,814
              
              
              1,861Merger
                  and acquisition costs
              
              
              263
              
              
              191
              
              
              1,883
              
              
              191Other
              
              
              3,750
              
              
              2,518
              
              
              8,092
              
              
              7,077Total
              
              $
              74,104
              
              $
              55,302
              
              $
              209,664
              
              $
              146,531


The
      increases in non-interest expenses were primarily due to continued company
      growth, litigation costs from the three-week trial relating to the goodwill
      lawsuit, and the increase in the FDIC premium. Full-time equivalent employees
      increased year-over-year by 466 to 2,566
      at
      September 30, 2007. The acquisition of FirstBank Northwest and Sonoma National
      Bank added approximately 420 full-time equivalent employees.





***Income
      Tax Provision*** .
      Sterling recorded federal and state income tax provisions of $13.3 million
      and
      $9.1 million for the three months ended September 30, 2007 and 2006,
      respectively, and $37.6 million and $24.3 million for the nine months ended
      September 30, 2007 and 2006, respectively. The effective tax rate for the three
      months comparative period was 33.5% and 32.1%, respectively, and 33.0% and
      32.0%, respectively, for the nine month comparative period. The increase in
      the
      effective tax rate primarily reflects a higher percentage of income being taxed
      at the statutory rates and the increase in state tax expense due to Sterling's
      expansion into California.





**Financial
      Position**





***Assets*** .
      At
      September 30, 2007, Sterling's assets were $11.75 billion, up $1.91 billion
      from
      $ 9.83 billion
      at December 31, 2006. This growth was mainly a result of increases in
      the loan portfolio through originations and the Northern Empire
      acquisition.


-23-
 *Table
          of Contents*





***Investment
      Securities and MBS*** .
      Sterling's investment and MBS portfolio at September 30, 2007 was
      $1.90  billion,
      a decrease of $9.2 million from the December 31, 2006 balance of $ 1.91 billion.
      The decrease was mainly due to principal repayments and maturities. On September
      30, 2007, the investment and MBS portfolio had an unrealized loss of $50.8
      million versus an unrealized loss of $52.8  million
      at December 31, 2006, with the fluctuation due to interest rate movements.
      During 2007, the FHLB San Francisco repurchased $5.1 million of FHLB stock
      acquired from Sonoma National Bank. During 2006 and 2007, Sterling did not
      sell
      any MBS.





***Loans
      Receivable*** .
      At
      September 30, 2007, net loans receivable were $8.75 billion, up $1.73 b illion
      from $ 7.02 billion
      at December 31, 2006. The increase was due to loan originations during the
      period and the Northern Empire acquisition, net of loan repayments.





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




September
                30, 2007
            
            December
                31, 2006Amount
            
            %
            
            Amount
            
            %(Dollars
                in thousands)Residential
                real estate
            
            $
            673,058
            
            
            7.6
            
            $
            654,661
            
            
            9.2Multifamily
                real estate
            
            
            377,204
            
            
            4.3
            
            
            263,053
            
            
            3.7Commercial
                real estate
            
            
            1,217,458
            
            
            13.7
            
            
            795,386
            
            
            11.2Construction
            
            
            2,877,253
            
            
            32.4
            
            
            2,290,882
            
            
            32.2Consumer
                - direct
            
            
            777,764
            
            
            8.8
            
            
            749,626
            
            
            10.5Consumer
                - indirect
            
            
            358,854
            
            
            4.0
            
            
            288,704
            
            
            4.1Commercial
                banking
            
            
            2,586,233
            
            
            29.2
            
            
            2,069,086
            
            
            29.1Gross
                loans receivable
            
            
            8,867,824
            
            
            100.0
            
            
            7,111,398
            
            
            100.0Net
                deferred origination fees
            
            
            (18,352
            )
            
            
            
            
            (12,308
            )Allowance
                for losses on loans
            
            
            (102,042
            )
            
            
            
            
            (77,849
            )Loans
                receivable, net
            
            $
            8,747,430
            
            
            
            
            $
            7,021,241


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




Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  30,
              
              September
                  30,2007
              
              2006
              
              2007
              
              2006(Dollars
                  in thousands)Residential
                  real estate
              
              $
              369,216
              
              $
              328,436
              
              $
              1,168,755
              
              $
              477,657Multifamily
                  real estate
              
              
              13,240
              
              
              2,750
              
              
              17,890
              
              
              4,215Commercial
                  real estate
              
              
              67,131
              
              
              35,738
              
              
              79,541
              
              
              106,241Construction
              
              
              579,287
              
              
              588,466
              
              
              1,849,659
              
              
              1,614,581Consumer
                  - direct
              
              
              90,440
              
              
              79,063
              
              
              267,329
              
              
              261,571Consumer
                  - indirect
              
              
              63,001
              
              
              56,660
              
              
              184,926
              
              
              127,347Commercial
                  banking
              
              
              198,317
              
              
              312,240
              
              
              796,596
              
              
              924,350Total
                  loans originated
              
              $
              1,380,632
              
              $
              1,403,353
              
              $
              4,364,696
              
              $
              3,515,962


-24-
 *Table
          of Contents*


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




September
                  30, 2007
              
              December
                  31, 2006Amount
              
              %
              
              Amount
              
              %(Dollars
                  in thousands)Interest-bearing
                  checking
              
              $
              465,835
              
              
              6.0
              
              $
              483,551
              
              
              7.2Noninterest-bearing
                  checking
              
              
              913,932
              
              
              11.8
              
              
              834,140
              
              
              12.4Savings
                  and MMDA
              
              
              2,136,253
              
              
              27.5
              
              
              1,830,313
              
              
              27.1Time
                  deposits
              
              
              4,250,372
              
              
              54.7
              
              
              3,598,024
              
              
              53.3Total
                  deposits
              
              $
              7,766,392
              
              
              100.0
              
              $
              6,746,028
              
              
              100.0




Total
      deposits increased to $7.77 billion as of September 30, 2007 from $6.75 billion
      at December 31, 2006. Deposit growth was primarily in time and money market
      demand accounts ("MMDA"), due to the addition of deposits as a result of the
      Northern Empire acquisition.





***Borrowings*** .
      Deposit
      accounts are Sterling's primary source of funds. Sterling does, however, rely
      upon advances from the Federal Home Loan Bank ("FHLB"), reverse repurchase
      agreements ("REPOs") and other borrowings to fund asset growth and meet deposit
      withdrawal requirements. During the nine months ended September
      30, 2007 ,
      these
      funding sources increased a total of $511.5 million, with the aggregate net
      total of FHLB advances, REPOs and Fed funds purchased increasing $478.3 million,
      offset by $45.0 million from the issuance of Trust Preferred Securities by
      Sterling Capital Trust IX. As a result of the Northern Empire acquisition,
      Sterling assumed $266.9  million
      of advances from FHLB of San Francisco with $135.2 million outstanding as of
      September 30, 2007.





**Asset
      and Liability Management**





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





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





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





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


-25-
 *Table
          of Contents*




ALCO
      uses
      interest rate shock simulations of net interest income to measure the effect
      of
      changes in interest rates on the net interest income for Sterling over a 12
      month period. This simulation consists of measuring the change in net interest
      income over the next 12 months from a base case scenario when rates are shocked,
      in a parallel fashion, up and down 100 and 200 basis points. The base case
      uses
      the assumption of the existing balance sheet and existing interest rates to
      simulate the base line of net interest income over the next 12 months for the
      simulation. The simulation requires numerous assumptions, including relative
      levels of market interest rates, instantaneous and parallel shifts in the yield
      curve, loan prepayments and reactions of depositors to changes in interest
      rates, and should not be relied upon as being indicative of actual or future
      results. Further, the analysis does not contemplate actions Sterling may
      undertake in response to changes in interest rates and market conditions. The
      results of this simulation as of September 30, 2007 and December 31, 2006 are
      included in the following table:




Change
                  in Interest Rate in
              
              September
                  30, 2007
              
              December
                  31, 2006Basis
                  Points (Rate Shock)
              
              %
                  Change in NII
              
              %
                  Change in NII+200
              
              
              (8.6
              )
              
              (1.5
              )+100
              
              
              (4.1
              )
              
              (0.8
              )Static
              
              
              0.0
              
              
              0.0-100
              
              
              1.9
              
              
              (0.4
              )-200
              
              
              0.4
              
              
              (1.6
              )




ALCO
      uses
      EVE simulation analysis to measure risk in the balance sheet that might not
      be
      taken into account in the net interest income simulation analysis. Whereas
      net
      interest income simulation highlights exposure over a relatively short time
      period of 12 months, EVE simulation analysis incorporates all cash flows over
      the estimated remaining life of all balance sheet positions. The EVE simulation
      analysis of the balance sheet, at a point in time, is defined as the discounted
      present value of asset cash flows minus the discounted value of liability cash
      flows. The discount rates that are used represent an assumption for the current
      market rates of each group of assets and liabilities. The difference between
      the
      present value of the asset and liability represents the EVE. As with net
      interest income, this is used as the base line to measure the change in EVE
      when
      interest rates are shocked, in a parallel fashion, up and down 100 and 200
      basis
      points. As with the net interest income simulation model, EVE simulation
      analysis is based on key assumptions about the timing and variability of balance
      sheet cash flows. However, because the simulation represents much longer time
      periods, inaccuracy of assumptions may increase the variability of outcomes
      within the simulation. It also does not take into account actions management
      may
      undertake in response to anticipated changes in interest rates. The results
      of
      this simulation at September 30, 2007 and December 31, 2006 are
      included in the following table:




Change
                  in Interest Rate in
              
              September
                  30, 2007
              
              December
                  31, 2006Basis
                  Points (Rate Shock)
              
              %
                  Change in NII
              
              %
                  Change in NII+200
              
              
              (8.5
              )
              
              (5.0
              )+100
              
              
              (3.3
              )
              
              (1.5
              )Static
              
              
              0.0
              
              
              0.0-100
              
              
              (0.9
              )
              
              (4.6
              )-200
              
              
              (9.1
              )
              
              (17.9
              )




Sterling
      occasionally enters into customer-related financial derivative transactions
      primarily consisting of interest rate swaps. Risk exposure from customer
      positions is managed through transactions with other broker dealers. As of
      September 30, 2007, Sterling has not entered into asset/liability related
      derivative transactions as part of managing its interest rate risk. However,
      Sterling continues to consider derivatives, including interest rate
      swaps,


-26-
 *Table
          of Contents*


caps
      and
      floors, as a viable alternative in the asset and liability management process.
      See "- Results of Operations - *Net
      Interest Income* "
      and "-
      Capital."





**Liquidity
      and Capital Resources**





As
      a
      financial institution, Sterling's primary sources of funds are investing and
      financing activities, including the collection of loan principal and interest
      payments. Financing activities consist primarily of customer deposits, advances
      from FHLB and other borrowings. Deposits increased 15.1  percent
      to $7.77 billion at September 30, 2007 from $ 6.75 billion
      at December 31, 2006, mainly due to increases of $652.3 m illion
      and $305.9 million, respectively, in time deposits and savings and MMDA
      accounts. These increases mainly reflected deposits acquired in the Northern
      Empire acquisition.





Sterling
      Savings Bank and Golf Savings Bank actively manage their liquidity in an effort
      to maintain an adequate margin over the level necessary to support expected
      and
      potential loan fundings and deposit withdrawals. This is balanced with the
      need
      to maximize yield on alternative investments. The liquidity ratio may vary
      from
      time to time, depending on economic conditions, deposit fluctuations and loan
      funding needs.





During
      the nine months ended September 30, 2007, net cash used in investing activities
      was $352.0 million, which was primarily due to loan funding exceeding loan
      repayments. During this period, net cash provided by financing activities was
      $264.8 m illion,
      which consisted primarily of net inflows from wholesale funding
      sources.





Sterling
      Savings Bank and Golf Savings Bank have credit lines with FHLB Seattle that
      provide for borrowings up to a percentage of its total assets, subject to
      collateralization requirements. At September 30, 2007, these credit lines
      represented a total borrowing capacity of $2.64 billion, of which $1.32 billion was
      available. The FHLB Seattle has been undergoing organizational and operational
      changes for more than two years pursuant to a written agreement with its
      regulator, the Federal Housing Finance Board ("Finance Board"). During this
      time, FHLB Seattle continued to provide Sterling with ready sources of
      liquidity. Based on FHLB Seattle's recent earnings and capital position, the
      Finance Board permitted the FHLB Seattle to resume dividend payments in December
      2006, and on January 12, 2007, terminated the written agreement. Also, the
      Standard & Poor’s rating outlook for FHLB Seattle improved to "stable."





Sterling
      Savings Bank also borrows funds under reverse repurchase agreements pursuant
      to
      which it sells investments (generally U.S. agency securities and MBS) under
      an
      agreement to buy them back at a specified price at a later date. These
      agreements to repurchase are deemed to be borrowings collateralized by the
      investments and MBS sold. Sterling Savings Bank uses these borrowings to
      supplement deposit gathering for funding the origination of loans. At September
      30, 2007, Sterling Savings Bank had $849.1 million in outstanding borrowings
      under reverse repurchase agreements and had securities available for additional
      secured borrowings of approximately $446.6 million. The use of reverse
      repurchase agreements may expose Sterling to certain risks not associated with
      other borrowings, including IRR and the possibility that additional collateral
      may have to be provided if the market value of the pledged collateral
      declines.





Sterling,
      on a parent company-only basis, had cash of approximately $30.4 million and
      $ 21.1 million
      at September 30, 2007 and December 31, 2006, respectively. At September 30,
      2007 and December 31, 2006, Sterling had an investment of $175.1 million for
      both periods in the preferred stock of Sterling Savings Bank. At
      September 30, 2007 and December 31, 2006, Sterling had an
      investment in the common stock of Sterling Savings Bank of $865.8 million and
      $ 512.6 million,
      respectively. Sterling's investment in the common stock of Sterling Savings
      Bank
      increased as a result of the acquisition and merger of Sonoma National Bank
      into
      Sterling Savings Bank. Sterling received cash dividends from Sterling Savings
      Bank of $26.5 million and $17.1 million during the nine months ended September
      30, 2007 and 2006, respectively. These resources contributed to Sterling's
      ability to meet its operating needs, including interest expense on its long-term
      debt. Sterling Savings Bank's ability to pay dividends is limited by its
      earnings, financial condition, capital requirements, and capital distribution
      regulations. See Note 2 of "Notes to Consolidated Financial
      Statements."





Sterling
      has the ability to secure additional capital through the capital markets. The
      availability and cost of such capital is partially dependent on Sterling's
      credit ratings, which as of September 30, 2007 were as follows:


-27-
 *Table
          of Contents*




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




**Off-Balance
      Sheet Arrangements and Aggregate Contractual Obligations**





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





At
      September 30, 2007, the reserve for unfunded commitments was $6.3 million.
      The
      adequacy of the reserve for unfunded commitments is evaluated on a quarterly
      basis.





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 September 30, 2007, Sterling
      had entered into best efforts forward commitments to sell $189.3 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 $1.1 million .
      As of
      December 31, 2006, these rate locks and delivery commitments were valued at
      $482,000. As of September 30, 2007, Sterling had loans locked with investors
      under mandatory delivery programs valued at $18,000, and held offsetting forward
      sale agreements on MBS valued at $20,000, with a net 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 dealer swaps. These contracts
      are carried as an offsetting asset and liability at fair value, and as of
      September 30, 2007 and December 31, 2006, were $706,000 and $404,000,
      respectively.





**Capital**





Sterling's
      total shareholders' equity was $1.16 billion at September 30, 2007, compared
      to
      $ 783.4 million
      at December 31, 2006. The increase in total shareholders' equity was
      primarily from the issuance of Sterling's common stock in connection with the
      purchase of Northern Empire, as well as the retention of earnings. Shareholders'
      equity was 9.9% of total assets at September 30, 2007 compared with 8.0% at
      December 31, 2006.


-28-
 *Table
          of Contents*


At
      September 30, 2007 and December 31, 2006, Sterling had an unrealized loss of
      $50.8 million and $52.8 million, respectively, on investment securities and
      MBS classified as available for sale. Fluctuations in prevailing interest rates
      continue to cause volatility in this component of accumulated comprehensive
      income or loss in shareholders' equity and may continue to do so in future
      periods.





Sterling
      has outstanding various series of capital securities ("Trust Preferred
      Securities") issued to investors. The Trust Preferred Securities are treated
      as
      debt of Sterling, and can qualify as Tier 1 capital, subject to certain
      limitations. For a complete description, see Note 2 of "Notes to
      Consolidated Financial Statements."





Sterling,
      Sterling Savings Bank and Golf Savings Bank are required by applicable
      regulations to maintain certain minimum capital levels. Sterling's management
      intends to enhance the capital resources and regulatory capital ratios of
      Sterling and its banking subsidiaries through the retention of an adequate
      amount of earnings and the management of the level and mix of assets, although
      there can be no assurance in this regard. At September 30, 2007, each of the
      companies exceeded all such regulatory capital requirements and were "well
      capitalized" pursuant to such regulations. The following table sets forth their
      respective capital positions at September 30, 2007:




Minimum
                  Capital
              
              Well-CapitalizedRequirements
              
              Requirements
              
              ActualAmount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio(Dollars
                  in thousands)Tier
                  1 leverage (to average assets)Sterling
              
              $
              428,515
              
              
              4.0
              %
              $
              535,644
              
              
              5.0
              %
              $
              978,749
              
              
              9.1
              %Sterling
                  Savings Bank
              
              
              428,610
              
              
              4.0
              %
              
              535,763
              
              
              5.0
              %
              
              925,460
              
              
              8.6
              %Golf
                  Savings Bank
              
              
              13,507
              
              
              4.0
              %
              
              16,884
              
              
              5.0
              %
              
              23,763
              
              
              7.0
              %Tier
                  1 (to risk-weighted assets)Sterling
              
              
              384,986
              
              
              4.0
              %
              
              577,479
              
              
              6.0
              %
              
              978,749
              
              
              10.2
              %Sterling
                  Savings Bank
              
              
              376,463
              
              
              4.0
              %
              
              564,695
              
              
              6.0
              %
              
              925,460
              
              
              9.8
              %Golf
                  Savings Bank
              
              
              9,232
              
              
              4.0
              %
              
              13,848
              
              
              6.0
              %
              
              23,763
              
              
              10.3
              %Total
                  (to risk-weighted assets)Sterling
              
              
              769,972
              
              
              8.0
              %
              
              962,464
              
              
              10.0
              %
              
              1,090,095
              
              
              11.3
              %Sterling
                  Savings Bank
              
              
              752,926
              
              
              8.0
              %
              
              941,158
              
              
              10.0
              %
              
              1,032,374
              
              
              11.0
              %Golf
                  Savings Bank
              
              
              18,464
              
              
              8.0
              %
              
              23,080
              
              
              10.0
              %
              
              25,195
              
              
              10.9
              %


**Goodwill
      Litigation**





Sterling's
      lawsuit against the U.S. Government for breaches of promises to Sterling, made
      in connection with past acquisitions of troubled thrift institutions, to include
      certain items as capital for purposes of regulatory capital ratios, and to
      forbear from enforcement of certain capital requirements against Sterling (the
      "Goodwill Litigation") was tried to a judge of the U.S. Court of Federal Claims
      from June 25 to July 13, 2007. Summary judgment on liability had previously
      been
      entered and the purpose of the trial was to determine what amount, if any,
      the U.S. Government must pay in damages for its breach of the contracts for
      the
      acquisition of two thrifts, Lewis Federal Savings & Loan and Tri-Cities
      Savings & Loan.  The ultimate outcome of the Goodwill Litigation cannot
      be predicted with certainty, and the U.S. Government will likely appeal any
      award of damages in favor of Sterling. Because of the effort required to bring
      the case to conclusion, Sterling will likely continue to incur legal expenses
      as
      the case progresses.





**New
      Accounting 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.


-29-
 *Table
          of Contents*




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.





**Regulation
      and Compliance**





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





**Forward-Looking
      Statements**





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





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





·
            inflation,
                interest rate levels and market and monetary
                fluctuations;





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





·
            applicable
                laws and regulations and legislative or regulatory
                changes;





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





·
            the
                willingness of customers to substitute competitors' products and
                services
                for Sterling's products and
                services;





·
            Sterling's
                success in gaining regulatory approvals, when
                required;





·
            technological
                and management changes;





·
            growth
                and acquisition strategies;


-30-
 *Table
          of Contents*


·
            Sterling's
                critical accounting policies and the implementation of such
                policies;





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





·
            changes
                in consumer spending and saving
                habits;





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





·
            Sterling's
                success at managing the risks involved in the
                foregoing.





**Item
              3**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**





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





**Item
              4**
            **Controls
                and Procedures**





**Disclosure
      Controls and Procedures**





Sterling's
      management, with the participation of Sterling's principal executive officer
      and
      principal financial officer, has evaluated the effectiveness of Sterling's
      disclosure controls and procedures (as such term is defined in Rules 13a-15(e)
      and 15d-15(e) under the Exchange Act) as of the end of the period covered by
      this report. Based on such evaluation, Sterling's principal executive officer
      and principal financial officer have concluded that, as of the end of such
      period, Sterling's disclosure controls and procedures are effective in
      recording, processing, summarizing and reporting, on a timely basis, information
      required to be disclosed by Sterling in the reports that it files or submits
      under the Exchange Act.





**Changes
      in Internal Control Over Financial Reporting**





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




-31-
 *Table
          of Contents*




**STERLING
        FINANCIAL CORPORATION**
 **PART
        II - Other Information**


**Item
              1**
            **Legal
                Proceedings******





There
      are
      no material pending legal proceedings to which Sterling is a party, or to which
      any of its property is subject, other than ordinary routine litigation
      incidental to the business of banking. No material loss is expected from any
      of
      such pending claims or lawsuits.





**Item
              1a**
            **Risk
                Factors**





You
      should carefully consider the risks and uncertainties we describe both in this
      Report and in our Annual Report on Form 10-K for the fiscal year ended
      December 31, 2006, before deciding to invest in, or retain, shares of our
      common stock. These are not the only risks and uncertainties that we face.
      Additional risks and uncertainties that we do not currently know about or that
      we currently believe are immaterial, or that we have not predicted, may also
      harm our business operations or adversely affect us. If any of these risks
      or
      uncertainties actually occurs, our business, financial condition, operating
      results or liquidity could be materially harmed.





**Item
              2**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





Not
      applicable.





**Item
              3**
            **Defaults
                Upon Senior Securities**





Not
      applicable.





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





Not
      applicable.





**Item
              5**
            **Other
                Information**





Not
      applicable.





**Item
              6**
            **Exhibits**





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




-32-
 *Table
          of Contents*




**STERLING
      FINANCIAL CORPORATION**






**Signatures**






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








**STERLING
      FINANCIAL CORPORATION**


(Registrant)


November
      8 ,
      2007






By: /s/
      Robert G. Butterfield


**Robert
      G. Butterfield**


Senior
      Vice President, Controller, and Principal
      Accounting Officer








-33-
 *Table
          of Contents*




**Exhibit
              No.**
            **Exhibit
              Index**  3.1
            Articles
                of Restatement of Restated Articles of Incorporation of Sterling.
                Filed as
                Exhibit 3.1 to Sterling's registration statement on Form S-4/A, filed
                on
                June 22, 2007, and incorporated by reference
                herein.





3.2
            Amended
                and Restated Bylaws of Sterling. Filed as Exhibit 3.1 to Sterling's
                current report on Forma 8-K filed on March 2, 2007, 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's
                2007 Long-Term Incentive Plan. Filed as Exhibit 99.1 to Sterling's
                registration statement on Form S-8 filed on July 30, 2007, and
                incorporated by reference herein.





31.1
            Certification
                of Principal Executive Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002. Filed
                herewith.





31.2
            Certification
                of Principal Financial Officer pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002. Filed
                herewith.





32.1
            Certification
                of Principal Executive Officer pursuant to 18 U.S.C. Section 1350,
                as
                adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                Furnished herewith.





32.2
            Certification
                of Principal Financial Officer pursuant to 18 U.S.C. Section 1350,
                as
                adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                Furnished herewith.




E-1