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

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED June 30, 2002

OR

FOR THE TRANSITION PERIOD FROM                          TO                         .

Commission file number.....0-20800

(Exact name of registrant as specified in its charter)

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

(509) 458-2711
(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 ý No o

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

STERLING FINANCIAL CORPORATION

FORM 10-Q
For the Quarter Ended June 30, 2002

TABLE OF CONTENTS

PART I—Financial Information

Item 1—Financial Statements

STERLING FINANCIAL CORPORATION

Consolidated Balance Sheets

(Unaudited)

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

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STERLING FINANCIAL CORPORATION

Consolidated Statements of Income

(Unaudited)

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

2

STERLING FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Unaudited)

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

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

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STERLING FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income

(Unaudited)

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

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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 for the year ended December 31, 2001. 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.    Interim Financial Statements:

        The financial information set forth in the unaudited interim consolidated financial statements reflects the adjustments, all of which are of a normal and recurring nature, which, in the opinion of management, are necessary for a fair presentation of the periods reported.

3.    Other Borrowings:

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

(1)

Sterling has a variable-rate term note with U.S. Bank, N.A. ("U.S. Bank") with a balance of $25.0 million outstanding at June 30, 2002. This note matures on September 17, 2007. Interest accrues at the 30-day London Interbank Offering Rate ("LIBOR") plus 2.50% (4.35% at June 30,

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2002) and is payable monthly. This note is collateralized by a majority of the Common and Preferred Stock of Sterling Savings Bank.

(2)

Sterling has a $5.0 million revolving line-of-credit with U.S. Bank. This line of credit matures on September 16, 2002. The interest rate is adjustable monthly at the 30-day LIBOR plus 2.50% (4.35% at June 30, 2002) and is payable monthly. This note is collateralized by a majority of the Common and Preferred Stock of Sterling Savings Bank. At June 30, 2002, no amounts were outstanding under this line.

(3)

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

(4)

Sterling has outstanding $24.7 million of 10.25% junior subordinated deferrable interest debentures ("Junior Subordinated Debentures-II") to Sterling Capital Trust II ("Trust-II"), a Delaware business trust, in which Sterling owns all of the common equity. The sole asset of Trust-II is the Junior Subordinated Debentures-II. Trust-II issued $24.0 million of 10.25% Cumulative Capital Securities ("Trust-II Preferred Securities") to investors. Sterling's obligations under Junior Subordinated Debentures-II and related documents, taken together, constitute a full and unconditional guarantee by Sterling of Trust-II's obligations under the Trust-II Preferred Securities. The Trust-II Preferred Securities are treated as debt of Sterling. Although Sterling, as a savings and loan holding company, is not subject to the Federal Reserve capital requirements for bank holding companies, the Trust-II Preferred Securities have been structured to qualify as Tier 1 capital, subject to certain limitations, if Sterling were to become regulated as a bank holding company. The Junior Subordinated Debentures-II and related Trust-II Preferred Securities mature in 2031 and are redeemable at the option of Sterling in the event the deduction of related interest for federal income taxes is prohibited, treatment as Tier 1 capital is no longer permitted or certain other contingencies arise. The Trust-II Preferred Securities must be redeemed upon maturity of the Junior Subordinated Debentures-II in 2031.

(5)

Sterling has outstanding $30.0 million of Floating Rate Notes Due 2006. These notes are unsecured general obligations of Sterling and are subordinated to certain other existing and future indebtedness. Under terms of the notes, Sterling is limited in the amount of certain long-term debt that it may incur, and the notes restrict Sterling, under certain circumstances, as to the amount of cash dividends on its preferred or common stock and capital distributions which can be made. At June 30, 2002, Sterling could have incurred approximately $21.1 million of additional long-term debt. At June 30, Sterling could have paid up to approximately $22.2 million in additional

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dividends. Interest accrues at the 90-day LIBOR plus 2.50% (4.39% until September 15, 2002) and is adjustable and payable quarterly. The notes mature in 2006 and may be redeemed under certain conditions after June 15, 2002.

(6)

In September 2001, Sterling assumed $3.5 million of 7.50% Convertible Subordinated Debentures due 2008 (the "Debentures") as a result of a business combination. As of May 31, 2002, the holders of all of the Debentures had exercised their right to convert the Debentures into shares of Sterling's Common Stock resulting in the issuance of 228,305 shares of Sterling Common Stock.

4.    Income Per Share:

        The following table presents the basic and diluted income per share computations including the effects of the 10% stock dividend which was paid on May 31, 2002:

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5.    Operating Expenses:

        The following table details Sterling's components of total operating expenses:

6.    Business Segments:

        Sterling has identified its business segments as residential loan production and commercial real estate production.

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

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

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        The following summarizes certain financial information regarding Sterling's segments and provides a reconciliation to the amounts reported in the consolidated financial statements:

        Sterling adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS Nos. 137 and 138, effective January 1, 2001. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under recently adopted Derivatives Implementation Group Statement 133 Implementation Issue C13, "Scope Exceptions: When a Loan Commitment Is Included in the Scope of Statement 133," Sterling must apply Statement 133 to interest rate lock agreements related to the origination or acquisition of mortgage loans that will be held for resale beginning in July 2002. The recognition of loan commitments related to the origination or acquisition of mortgage loans held for resale may accelerate the recognition of some of the gain or loss on the sale of mortgage loans held for

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resale. Sterling estimates that the effect of adopting this guidance will increase its assets and liabilities by approximately $4.0 million.

7.    Goodwill and Intangible Assets:

        In June 2001, the Financial Accounting Standards Board ("FASB") approved for issuance Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Intangible Assets," which revises the accounting for purchased goodwill and intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives will no longer be amortized, but will be tested for impairment at least annually. If goodwill is found to be impaired, it will be written down to its fair market value. Sterling adopted SFAS No. 142 on January 1, 2002. Sterling tested the amortized balance of goodwill and determined that no impairment existed as of June 30, 2002. The net effect of adopting this accounting standard was to increase net income by $717,000 or $0.06 per diluted share for the quarter ended June 30, 2002. For the six months ended June 30, 2002, the increase to net income was $1.4 million or $0.11 per diluted share.

        In May 2002, the FASB issued a Proposed Statement of Financial Accounting Standards, "Acquisition of Certain Financial Institutions, an amendment of FASB Statements No. 72 and No. 144 and FASB Interpretation No. 9" (the ED). While the ED provides guidance that management believes is consistent with Sterling's adoption of SFAS No. 142 and subsequent discontinuation of the amortization of goodwill, the final statement, if changed from the ED, could alter the treatment adopted by Sterling and require a continuation of amortization, which would have the effect of increasing annual expenses by approximately $3.8 million, resulting in a decrease in net income.

        In accordance with SFAS No. 142, the effect of this accounting change is reflected prospectively. Comparative disclosure as if the change had been retroactively applied to the prior year is as follows:

8.    Other Accounting Policies:

        In August 2001, the FASB approved for issuance Statement of Financial Accounting Standards No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 was issued to resolve implementation issues that had been created under Statement of Financial Accounting Standards No. 121. Under SFAS No. 144, one accounting model is required to be

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used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and certain additional disclosures are required. The adoption of SFAS No. 144 did not have a material effect on Sterling's consolidated financial statements.

        In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies and simplifies existing accounting pronouncements, by rescinding SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses. Additionally, SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. Finally, SFAS No. 145 also makes technical corrections to existing pronouncements. Management currently believes that the adoption of SFAS No. 145 will not have a material impact on Sterling's consolidated financial statements.

        In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS No. 146"), "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS No. 146 replaces the prior guidance that was provided by EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

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Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations

STERLING FINANCIAL CORPORATION

Comparison of the Three and Six Months Ended June 30, 2002 and 2001

        This report contains forward-looking statements, which are not historical facts and pertain to our future operating results. These forward-looking statements are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and similar expressions are generally intended to identify forward-looking statements. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements because of numerous possible risks and uncertainties. These include but are not limited to: the possibility of adverse economic developments which may, among other things, increase default and delinquency risks in Sterling's loan portfolios; shifts in interest rates which may result in lower interest rate margins; shifts in the demand for Sterling's loan and other products; lower than expected revenue or cost savings in connection with acquisitions; changes in accounting policies; changes in the monetary and fiscal policies of the federal government; changes in laws, regulations and the competitive environment. 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 current annual report on Form 10-K.

General

        Sterling Financial Corporation ("Sterling") is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank. The significant operating subsidiaries of Sterling Savings Bank are Action Mortgage Company ("Action Mortgage"), INTERVEST—Mortgage Investment Company ("INTERVEST") and Harbor Financial Services, Inc. ("Harbor Financial").

        Sterling provides personalized, quality financial services to its customers as exemplified by its "Hometown Helpful" philosophy. Sterling believes that this dedication to personalized service has enabled it to maintain a stable retail deposit base. With $3.09 billion in total assets at June 30, 2002, Sterling attracts Federal Deposit Insurance Corporation ("FDIC") insured deposits from the general public through 77 retail branches located primarily in rural and suburban communities in Washington, Oregon, Idaho and Montana. Sterling originates loans through its branch offices as well as Action Mortgage residential loan production offices in the metropolitan areas of Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho; and through INTERVEST commercial real estate lending offices located in the metropolitan areas of Spokane and Seattle, Washington; and Portland, Oregon. Sterling also markets tax-deferred annuities, mutual funds and other financial products through Harbor Financial.

        On May 31, 2002, Sterling paid a 10% stock dividend to shareholders of record at May 3, 2002. As a result, Sterling issued 1,084,646 shares of common stock.

        Sterling continues to enhance its presence as a community bank by increasing its commercial real estate, business banking, consumer and construction lending while increasing its retail deposits, particularly transaction accounts. Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential loans. Such loans, however, generally involve a higher degree of risk than financing residential real estate. Sterling's revenues are derived primarily

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from interest earned on loans, investments and asset-backed securities ("ABS"), from fees and service charges and from mortgage banking operations. The operations of Sterling Savings Bank, and savings institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities: the Office of Thrift Supervision ("OTS"); the FDIC and the State of Washington Department of Financial Institutions ("Washington Supervisor").

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

Critical Accounting Policies

        Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, we have identified five policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the valuation of our goodwill and other intangibles, the determination of our allowance for loan losses, the valuation of investments, the valuation of and accounting for stock options and the valuation of real estate held for sale. These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of Management's Discussion and Analysis, in the Consolidated Financial Statements included herein, and in the "Summary of Significant Accounting Policies" presented in Sterling's current annual report on Form 10-K. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our Consolidated Financial Statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.

Results of Operations

        Overview.    Sterling recorded net income of $5.7 million, or $0.47 per diluted share, for the three months ended June 30, 2002, compared with net income of $3.8 million, or $0.35 per diluted share, for the three months ended June 30, 2001. Sterling recorded net income of $11.3 million, or $0.93 per diluted share, for the six months ended June 30, 2002. This compares with net income of $7.4 million, or $0.68 per diluted share, for the six months ended June 30, 2001. The increase in net income for both periods reflected an increase in other income, net interest income and a discontinuation of the amortization of goodwill.

        The annualized return on average assets was 0.75% and 0.57% for the three months ended June 30, 2002 and 2001, respectively. For the six months ended June 30, 2002 and 2001, the annualized return on average assets was 0.75% and 0.56%, respectively. The increases in the ratios were primarily due to the increase in other income.

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        The annualized return on average equity was 13.0% and 10.2% for the three months ended June 30, 2002 and 2001, respectively. For the six months ended June 30, 2002 and 2001, the annualized return on average equity was 13.2% and 10.2%, respectively. The increases in the ratios were primarily due to the increase in net income.

        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, ABS and investment portfolios, and interest expense, primarily on deposits and borrowings. During the three months ended June 30, 2002 and 2001, NII was $23.4 million and $20.3 million, respectively, representing an increase of 15.3%. During the six months ended June 30, 2002 and 2001, NII was $46.8 million and $40.5 million, respectively, an increase of 15.3%.

        Changes in NII result from changes in volume, net interest spread and net interest margin. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin refers to NII divided by total interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. The increase in NII during the three and six months ended June 30, 2002, compared to the same periods in 2001, was primarily due to an approximate 15% increase in the volume of average interest-earning assets and to a significant decrease in the cost of funds.

        During the three months ended June 30, 2002 and 2001, the volume of average interest-earning assets was $2.86 billion and $2.49 billion, respectively. For the three months ended June 30, 2002, average loans increased by $163.3 million, while average investments and ABS increased by $201.9 million over the same period in 2001. Net interest spread during these periods was 3.28% and 3.22%, respectively. The net interest margin for the three months ended June 30, 2002 and 2001 was 3.28% and 3.27%, respectively. Net interest spread increased due to a sharper decrease in the cost of funds relative to the yields on average interest-earning assets. Sterling has been asset-sensitive in preparation for the Federal Reserve raising interest rates, which resulted in a slight margin compression during the current quarter.

        During the six months ended June 30, 2002 and 2001, the volume of average interest-earnings assets was $2.85 billion and $2.49 billion, respectively. Net interest spread during these periods was 3.30% and 3.25%, respectively. The net interest margin for the six months ended June 30, 2002 and 2001 was 3.30% and 3.28%, respectively. The increase in the net interest spread for the six months ended June 30, 2002, compared with the same period in 2001, was primarily due to a sharper decrease in the cost of funds relative to the yields on average interest-earning assets.

        Provision for Losses on Loans and Leases.    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, trends in classified assets, trends in delinquency and nonaccrual loans, trends in portfolio volume, diversification as to type of loan, size of individual credit exposure, current and anticipated economic conditions, 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 and leases of $2.2 million and $1.5 million for the three months ended June 30, 2002 and 2001, respectively. Sterling recorded provisions for losses on loans of $4.3 million and $2.9 million for the six months ended June 30, 2002 and 2001. The current provision reflects the analysis and assessment of the relevant factors mentioned in the preceding paragraph. Management anticipates that its provisions for losses on loans and leases will continue to increase, reflecting Sterling's strategic direction of originating more commercial real estate,

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construction, business banking and consumer loans which have a somewhat higher loss profile than the traditional thrift institution mix of loans.

        The following table summarizes loan and lease loss allowance activity for the periods indicated.

        At June 30, 2002, Sterling's total classified assets were $67.6 million, compared with $29.3 million at June 30, 2001. Total nonperforming loans and leases were $28.9 million at June 30, 2002, compared with $13.5 million at June 30, 2001. The increase in nonperforming loans and leases and classified assets was primarily attributable to the nonperforming loans, leases and classified assets acquired in the business combination with Source Capital Corporation. At June 30, 2002, Sterling's loan and lease delinquency rate (60 days or more) as a percentage of total loans and leases was 1.09%, compared with 0.54% at June 30, 2001. Excluding delinquent Source Capital loans, the delinquency ratio at June 30, 2002 would have been 0.74%.

        The delinquency ratio, even without the Source Capital assets, has increased over the prior year's comparable quarter. This increase reflects both the continuing change in Sterling's loan mix to a greater emphasis on commercial and consumer loans and the low level of economic activity in the region. Management believes that Sterling's emphasis on originating higher-risk commercial real estate, construction, business banking and consumer loans is appropriate and will endeavor to maintain asset quality at acceptable levels.

        Other Income.    Other income was $6.7 million and $4.6 million for the three months ended June 30, 2002 and 2001, respectively. The increase for the three months ended June 30, 2002, compared with the three months ended June 30, 2001 was primarily due to increases in fee structures for service charges and an increase in the cash surrender value of BOLI. For the six months ended June 30, 2002, other income was $12.6 million compared with $8.8 million for the six months ended June 30, 2001. Also included in other income for the three months ended June 30, 2002 was a $311,000 gain on the sale of securities.

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        The increase in income from mortgage banking operations for the six months ended June 30, 2002 compared to the same period in 2001, was primarily due to increased refinancing activity and loan sales. The following table summarizes loan originations and sales of loans for the periods indicated.

        Operating Expenses.    Operating expenses were $19.8 million and $17.6 million for the three months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002 and 2001, operating expenses were $39.4 million and $35.2 million, respectively. The higher level of operating expenses was primarily a result of expanded staffing in Sterling's branch delivery network, an increase in employee benefits, data processing and increased occupancy costs.

        Employee compensation and benefits were $10.4 million and $8.2 million for the three months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002 and 2001, employee compensation and benefits were $21.0 million and $16.5 million, respectively. The employee costs reflected increased mortgage banking staff and additional staff for Sterling's cash management operations and Portland Corporate Banking Center. At June 30, 2002, full-time-equivalent employees were 944, compared with 837 at June 30, 2001.

        Data processing expense was $1.5 million and $1.3 million for the three months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002 and 2001, data processing expense was $3.0 million and $2.7 million, respectively. The increase in both periods was primarily due to an increase in costs associated with a higher volume of transaction accounts.

        Goodwill litigation expenses were $225,000 and $255,000 for the three months ended June 30, 2002 and 2001, respectively. During the six months ended June 30, 2002 and 2001, goodwill litigation expenses were $520,000 and $515,000, respectively. The increase primarily reflected the completion of the fact discovery phase and commencement of the expert discovery phase of Sterling's goodwill litigation. Because of the increased level of effort required to bring the case to conclusion, Sterling likely will continue to incur legal expenses at recent levels over the next one to two years.

        Amortization of goodwill was $0 and $963,000 for the three months ended at June 30, 2002 and 2001, respectively, reflecting the cessation of goodwill amortization. For the six months ended June 30, 2002 and 2001, respectively, amortization of goodwill was $0 and $1.9 million. With Sterling's adoption of SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized, but will be tested annually for impairment. See Note 7 of "Notes to Consolidated Financial Statements."

        Income Tax Provision.    Sterling recorded federal and state income tax provisions of $2.4 million and $2.0 million for the three months ended June 30, 2002 and 2001, respectively. Tax provisions were $4.3 million and $4.0 million for the six months ended June 30, 2002 and 2001, respectively. The income tax provision for the three months ended June 30, 2002, is reflective of earnings and an effective tax rate of 29%, compared to an effective tax rate of 35% for the three months ended June 30, 2001. The decrease in the effective tax rate for the three months ended June 30, 2002 is due to the tax effect of (1) the change in the cash surrender value of BOLI which is excluded from taxable

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earnings, (2) the tax treatment relating to certain discounts of the Source Capital acquisition and (3) tax-exempt municipal bond interest.

Financial Position

        Assets.    At June 30, 2002, Sterling's assets were $3.09 billion, up $50.0 million from $3.04 billion at December 31, 2001.

        Investments and ABS.    Sterling's investment and ABS portfolio at June 30, 2002 was $658.1 million, a decrease of $35.9 million from the December 31, 2001 balance of $694.0 million. The decrease was primarily due to principal payments on ABS and sales of investments and ABS.

        Loans and Leases Receivable.    At June 30, 2002, gross loans and leases receivable were $2.20 billion, up $63.9 million from $2.13 billion at December 31, 2001. The increase was primarily due to increases in loan originations, primarily in business banking, commercial real estate and consumer lending. During the three months ended June 30, 2002, total loan originations were $450.9 million compared with $384.5 million for the prior year's comparable quarter. Approximately 84% of these were construction, business banking and consumer loans. During the six months ended June 30, 2002 and 2001, total loan originations were $806.6 million and $620.3 million, respectively, approximately 80% of which were construction, business banking and consumer loans.

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