111 North Wall Street

Spokane, Washington 99201

 

[ • ], 2007

 

Dear Fellow Shareholder:

 

It is my pleasure to invite you to attend the Annual Meeting of Shareholders of Sterling Financial Corporation. The Annual Meeting will be held at the Cheney Cowles Center Building, 2316 West First Avenue in Spokane, Washington, on Tuesday, April 24, 2007, at 10:00 a.m., local time.

 

The formal Notice of Annual Meeting of Shareholders and the proxy statement are attached and describe the proposals to be voted on at the Annual Meeting. The Board of Directors believes the proposals are in the best interests of Sterling and its Shareholders and, accordingly, recommends that you vote “FOR” each of the proposals. We will also report on Sterling’s operations and respond to questions of general interest to Shareholders.

 

It is very important that you be represented at the Annual Meeting regardless of the number of shares you own or whether you are able to attend the Annual Meeting in person. We urge you to complete, sign and date your proxy card today and promptly return it in the postage-paid envelope provided, even if you plan to attend the Annual Meeting. This will not prevent you from voting in person, but will ensure that your vote is counted if you are unable to attend.

 

Your continued support is sincerely appreciated.

 

Sincerely,

 

Harold B. Gilkey

Chairman of the Board

and Chief Executive Officer

STERLING FINANCIAL CORPORATION

 

111 North Wall Street

Spokane, Washington 99201

 

NOTICE OF ANNUAL MEETING
OF SHAREHOLDERS

 

The Annual Meeting of Shareholders of Sterling Financial Corporation (“Sterling”) will be held in the Eric A. Johnston Auditorium of the Cheney Cowles Center Building, 2316 West First Avenue, Spokane, Washington, on Tuesday, April 24, 2007, at 10:00 a.m., local time, for the following purposes:

 

1. To elect three Directors of Sterling for terms ending in the year 2010, and one Director of Sterling for a term ending in 2009;

 

2. To approve an amendment to Sterling’s Articles of Incorporation to increase the number of authorized shares of common stock;

 

3. To approve Sterling’s 2007 Long-Term Incentive Plan;

 

4. To ratify the appointment of BDO Seidman, LLP as the independent registered public accounting firm for Sterling for the fiscal year ending December 31, 2007; and

 

5. To transact such other business as may properly come before the Annual Meeting or any adjournment or postponement thereof.

 

These matters are more fully described in the attached proxy statement. Only Shareholders of record at the close of business on March 1, 2007, the record date, will be entitled to vote at the Annual Meeting or any adjournment or postponement thereof.

 

YOUR VOTE IS IMPORTANT REGARDLESS OF THE NUMBER OF SHARES YOU OWN, OR WHETHER OR NOT YOU PLAN TO ATTEND THE ANNUAL MEETING. EVEN IF YOU EXPECT TO ATTEND THE ANNUAL MEETING, WE URGE YOU TO COMPLETE, SIGN AND DATE THE ENCLOSED PROXY CARD AND RETURN IT PROMPTLY IN THE ENCLOSED POSTAGE-PAID ENVELOPE.

 

By Order of the Board of Directors,

 

 

Andrew J. Schultheis

Secretary

 

Spokane, Washington

[ • ], 2007

 

TABLE OF CONTENTS

 

STERLING FINANCIAL CORPORATION
111 North Wall Street
Spokane, Washington 99201

 

The 2007 annual meeting of Shareholders of Sterling Financial Corporation (“Sterling”), including any postponements or adjournments thereof (the “Annual Meeting”), will be held at 10:00 a.m., local time, on Tuesday, April 24, 2007, in the Eric A. Johnston Auditorium of the Cheney Cowles Center Building, 2316 West First Avenue, Spokane, Washington. At the meeting, Sterling’s Shareholders as of March 1, 2007 (the “Record Date”) will be asked to elect each of the nominees for the Board of Directors, approve an amendment to Sterling’s Articles of Incorporation to increase the number of authorized shares of Sterling common stock, approve Sterling’s 2007 Long-Term Incentive Plan, and to ratify the appointment of BDO Seidman, LLP (“BDO”) as the independent registered public accounting firm for Sterling for 2007. This proxy statement is first being sent to holders of Sterling common stock on or about [ • ], 2007, and is accompanied by a proxy that is being solicited by the Sterling Board of Directors for use at the Annual Meeting.

 

Only holders of record of Sterling common stock at the close of business on the record date are entitled to notice of and to vote at the Annual Meeting. Each holder of Sterling common stock is entitled to one vote for each share of Sterling common stock owned as of the record date. As of the record date, there were [ • ] shares of Sterling common stock outstanding.

 

Under Washington law, any Shareholder action at a meeting requires that a quorum exist with respect to that action. A quorum for the actions to be taken at the Annual Meeting will consist of a majority of the outstanding shares of Sterling common stock entitled to vote, present in person or by proxy at the Annual Meeting. Shareholders of record, including brokers holding customers’ shares of record, who are present at the Annual Meeting in person or by proxy and who abstain from voting are considered present and entitled to vote, and will count toward a quorum.

 

If a quorum exists at the Annual Meeting, those nominees for election to the Board of Directors who receive the greatest number of affirmative votes cast for Directors will be elected as Directors. The affirmative vote by holders of a majority of the outstanding common stock of Sterling is required to approve the amendment to Sterling’s Articles of Incorporation increasing the number of authorized shares of common stock. If a quorum exists, the affirmative vote by the holders of a majority of the common stock present in person or represented by proxy and entitled to vote is required to approve other matters to be acted upon at the Annual Meeting. Abstentions and broker non-votes will have no impact on the election of Directors or other proposals. Proxies and ballots will be received and tabulated by American Stock Transfer & Trust Company, Sterling’s transfer agent.

 

The Board of Directors requests that you complete, date and sign the proxy card accompanying this proxy statement and promptly return the card in the enclosed postage-paid envelope. Unless contrary instructions are specified, all properly signed proxies received by Sterling and not revoked before the vote at the Annual Meeting will be voted: 1) FOR the election of the four Directors nominated by the Board of Directors; 2) FOR approval of an amendment to Sterling’s Articles of Incorporation to increase the number of authorized shares of Sterling common stock; 3) FOR approval of Sterling’s 2007 Long-Term Incentive Plan; 4) FOR the ratification of the appointment of BDO as the independent registered public accounting firm for Sterling for 2007; and 5) in accordance with the best

judgment of the proxy agents on any other matters properly brought before the Annual Meeting. If the Annual Meeting is postponed or adjourned, your proxy will still be effective and may be voted at the rescheduled meeting. You will still be able to change or revoke your proxy until it is voted.

 

If you own your shares in “street name,” that is, through a brokerage account or in another nominee form, you must provide instructions to the broker or nominee as to how your shares should be voted. Otherwise, your shares may not be voted and will be recorded as broker non-votes. Your broker or nominee will usually provide you with the appropriate instruction forms at the time you receive this proxy statement. If you own your shares in this manner, you cannot vote in person at the Annual Meeting unless you receive a proxy to do so from the broker or the nominee and you bring the proxy to the Annual Meeting.

 

If you are a participant in Sterling’s 401(k) Employee Savings and Investment Plan and Trust, your completed proxy will serve as voting instructions to the plan trustee. However, your voting instructions must be received at least five days prior to the Annual Meeting to count. In accordance with the terms of the plan, if you fail to instruct the plan trustee how to vote your plan shares, the trustee will vote your plan shares in accordance with the recommendations of the 401(k) Advisory Committee.

 

You may revoke your proxy at any time by taking any of the following actions before your proxy is voted at the Annual Meeting:

 

 

Also, please note that if you have voted through your broker, bank or other nominee and you wish to change your vote, you must follow the instructions received from such entity to change your vote.

 

A large number of banks and brokerage firms provide Shareholders whose shares are registered in the name of such firms the opportunity to vote via the Internet or by telephone. The voting form sent to a beneficial owner will provide instructions if such options are available.

 

The expense of preparing, printing and mailing this proxy statement and the proxies solicited hereby will be borne by Sterling. Proxies will be solicited by Sterling by mail and may also be solicited on behalf of Sterling by directors, officers and other employees of Sterling, without additional remuneration, in person or by telephone or facsimile transmission. Sterling will also request brokerage firms, banks, nominees, custodians and fiduciaries to forward proxy materials to the beneficial owners of shares of Sterling common stock as of the record date and will reimburse such entities for the cost of forwarding the proxy materials in accordance with customary practice.

 

The Board of Directors of Sterling believes the proposals described herein are in the best interests of Sterling and its Shareholders and, accordingly, recommends that the Shareholders vote “FOR” the proposals identified in the Notice.

 

There are no dissenters’ rights applicable to any matters to be considered at the Annual Meeting.

 

The Board of Directors currently consists of nine Directors who are divided into three classes. The members of each class serve three-year terms, and one class is elected annually. The Board of Directors has nominated current Directors James P. Fugate, James B. Keegan, Jr., and Robert D. Larrabee for election at this year’s Annual Meeting as Directors to serve terms of three years ending at the annual meeting of Shareholders of Sterling in the year 2010, or when their respective successors have been duly elected and qualified. In addition, the Board of Directors has nominated current Director Michael F. Reuling to serve a term ending at the annual meeting of Shareholders in the year 2009, or when his respective successor has been duly elected and qualified.

 

Mr. Reuling was selected to serve as a member of Sterling’s Board of Directors pursuant to Sterling’s merger agreement with FirstBank NW Corp. (“FirstBank”) whereby Sterling agreed to appoint one of FirstBank’s Directors to serve on Sterling’s Board of Directors. Mr. Keegan was selected to serve as a member of Sterling’s Board of Directors pursuant to Sterling’s merger agreement with Northern Empire Bancshares (“Northern Empire”) whereby Sterling agreed to appoint one of Northern Empire’s Directors to serve on Sterling’s Board of Directors.

 

Each nominee for election as a Director at the Annual Meeting has consented to serve if elected. Sterling has no reason to believe that any of the nominees will be unable to serve. Should any nominee become unable to serve as a Director for any reason, the Board of Directors shall designate a substitute nominee. Unless instructions to the contrary are specified on the proxy card, proxies will be voted in favor of the persons who have been nominated by the Board of Directors.

 

The Board of Directors recommends that Shareholders
vote “FOR” the election of each of the nominees.

 

 

HAROLD B. GILKEY

 

Mr. Gilkey, 67, has served as Chairman of the Board and Chief Executive Officer (“CEO”) of Sterling since its inception in 1992, and served as Chairman of the Board and CEO of Sterling’s wholly owned subsidiary, Sterling Savings Bank (“Sterling Savings”) from its inception in 1981 until October 2003, and continues to serve as a Director of Sterling Savings. Mr. Gilkey co-founded Sterling Savings in 1981. Additionally, he is Chairman of the Board and CEO of Golf Savings Bank and a Director of INTERVEST-Mortgage Investment Company (“INTERVEST”), Action Mortgage Company (“Action Mortgage”) and Harbor Financial Services, Inc. (“Harbor Financial”), each of which are wholly owned subsidiaries of Sterling Savings. Mr. Gilkey brought to Sterling Savings over 20 years of commercial and mortgage banking experience. He served as President of Bancshares Mortgage Company of Spokane, Washington, and Senior Vice President of Old National Bank of Spokane, Washington. Prior to that, Mr. Gilkey was employed by Bank of America for 12 years. Mr. Gilkey serves on the Federal Home Loan Bank of Seattle Board of Directors. Mr. Gilkey is a past Director of the Washington Savings League and Chairman of the Savings Association Insurance Fund Industry Advisory Committee, an advisory committee of the Federal Deposit Insurance Corporation. Mr. Gilkey received a Bachelor’s degree in Business Administration from the University of Montana in 1962 and a Master of Business Administration degree from the University of Southern California in 1970. His term will expire in 2008.

 

WILLIAM W. ZUPPE

 

Mr. Zuppe, 65, has served as Director, President and Chief Operating Officer of Sterling since its inception and served as Director, President and Chief Operating Officer of Sterling Savings from 1981 until October 2003, when he was promoted to lead Sterling Savings as Chairman of the Board and CEO. He is also Vice President and Chairman of the Board of INTERVEST, Action Mortgage and Harbor Financial and a Director of Golf Savings Bank. Mr. Zuppe co-founded Sterling Savings in 1981. Mr. Zuppe brought to Sterling Savings 18 years of mortgage lending experience as Vice President of Bancshares Mortgage Company and Manager of Loan Administration of Sherwood & Roberts, Inc. of Walla Walla, Washington, a mortgage banking company. Mr. Zuppe is past Chairman of the Board for America’s Community Bankers, a national trade association. He is past Chairman of the

Washington Savings League Board of Directors and past member of the Federal Reserve Board — Thrift Institutions Advisory Council. His term will expire in 2010.

 

DONALD N. BAUHOFER

 

Mr. Bauhofer, 55, has served as a Director of Sterling since his appointment in January 2004. He is Founder and President of The Pennbrook Company, a real estate development firm in Bend, Oregon, established in 1985. In addition, he is Founder and CEO of Pennbrook Homes, Inc., and Praxis Medical Group; co-owner of Arrowood Development, LLC; and co-owner and CEO of Pacific Education Corporation. Mr. Bauhofer served on the Board of Directors of Klamath First Bancorp, Inc. (“Klamath”), from November 2002 until December 2003. Mr. Bauhofer was then appointed to Sterling’s Board of Directors after Klamath was merged into Sterling in January 2004. Mr. Bauhofer received a Bachelor’s degree and a Master of Business Administration degree from Stanford University and a Juris Doctorate from the University of California at Davis. His term will expire in 2008.

 

WILLIAM L. EISENHART

 

Mr. Eisenhart, 54, has served as a Director of Sterling since his appointment in January 2004. He serves as an independent financial advisor to privately held and publicly traded companies on investment banking matters. Previously, Mr. Eisenhart was a Managing Director at Dain Bosworth, Inc., in Seattle, Washington, a Partner in Corporate Finance for Cable Howse & Ragen in Seattle, Washington, and Vice President of Corporate Finance at Goldman, Sachs & Company in New York City. Currently, he serves as a member of the Finance Committee of the YMCA of Greater Seattle, as a member of the Board of Directors of Jumbo Foods, Inc., a privately held business serving convenience stores in western states, and is Co-Chair of Harvard College Schools and the Scholarship Committee of Western Washington. He has been a board member of Emerald Hills Coffee, Inc., a privately held coffee distributor, since 2002. Mr. Eisenhart received a Bachelor’s degree from Harvard College and a Master of Business Administration degree from the University of Chicago. His term will expire in 2009.

 

JAMES P. FUGATE

 

Dr. Fugate, 74, has served as a Director of Sterling since its inception and as a Director of Sterling Savings from 1989 until 2006. He is the retired Superintendent of Auburn School District No. 408. Dr. Fugate is a former director of Central Evergreen Savings & Loan Association. He is on the Board of Governors of the Auburn Regional Medical Center and serves as the Chairman of the Board. Dr. Fugate received a Bachelor and Master degree from Central Washington State University. He received his Ph.D. from the University of Idaho in 1970. If reelected, his term will expire in 2010.

 

JAMES B. KEEGAN, JR.

 

Mr. Keegan, 57, has served as a Director of Sterling since March 1, 2007. Mr. Keegan served as a director and vice-chairman of the board of Northern Empire Bancshares and as a director and chairman of the board of Sonoma National Bank from 1982 and 1984, respectively, until Sterling’s acquisition of Northern Empire Bancshares and Sonoma National Bank on February 28, 2007. He has been a partner in Keegan & Coppin Company, Inc., a Santa Rosa real estate brokerage and development firm, since 1976. If elected, his term will expire in 2010.

 

ROBERT D. LARRABEE

 

Mr. Larrabee, 71, has served as a Director of Sterling since its inception and as a Director of Sterling Savings from 1983 until 2006. Mr. Larrabee is the owner of Merchant Funeral Home in Clarkston, Washington. He is also a former director of Laurentian Capital Corporation, a former director of Lewis and Clark Savings & Loan Association and a past President of the Board of Regents of the University of Washington. Mr. Larrabee received a degree in Mortuary Science from The California College of Mortuary Science in 1958. If reelected, his term will expire in 2010.

 

DONALD J. LUKES

 

Mr. Lukes, 58, has served as a Director of Sterling since January 2006. He retired in 2005 as a principal with the law firm of Witherspoon, Kelley, Davenport & Toole, P.S. Mr. Lukes joined Witherspoon Kelley in 1987 after having served as General Counsel and Senior Vice President of Citicorp’s mortgage banking business. He has served as a director and President of the Board of the Friends of Seven (Public Television); a Commissioner of the

Chase Youth Commission; a director of Goodwill Industries of the Inland Northwest; President of the Hamblen School Parent-Teacher Group and General Counsel to the Friends of the Centennial Trail. Mr. Lukes received his Bachelor of Arts degree from the University of Montana and his Juris Doctorate from St. John’s University School of Law in June 1978. His term will expire in 2009.

 

MICHAEL F. REULING

 

Mr. Reuling, 60, has served as a Director of Sterling since his appointment in December 2006. He has been a self-employed real estate development consultant in Boise, Idaho since retiring as Vice Chairman of Albertson’s, Inc. in 2001. Mr. Reuling received a Bachelor’s degree from Carleton College in Northfield, Minnesota in 1968 and a Juris Doctorate from the University of Michigan in Ann Arbor, Michigan in 1971. If elected, his term will expire in 2009.

 

 

The Board of Directors has approved and is submitting to the Shareholders for approval, an amendment to Article V of Sterling’s Restated Articles of Incorporation. The amendment would increase the number of shares of common stock Sterling is authorized to issue to 100,000,000 shares. Sterling’s Articles of Incorporation currently authorize the issuance of up to 60,000,000 shares of common stock and 10,000,000 shares of preferred stock. As of March 1, 2007, [ • ] shares of common stock were outstanding. No shares of preferred stock have been outstanding since 1997.

 

The following is the text of the first sentence of Article V of the Articles of Incorporation, as proposed to be amended:

 

The total number of shares of stock which the Corporation shall have the authority to issue is one hundred and ten million (110,000,000), of which one hundred million shall be Common Stock having a par value of One Dollar ($1.00) per share and ten million (10,000,000) shall be Preferred Stock having a par value of One Dollar ($1.00) per share.

 

The proposed amendment to Sterling’s Articles of Incorporation has been unanimously approved by the Board of Directors for consideration by Shareholders. The Board believes that the increase in the capitalization of Sterling will assure that an adequate number of authorized but unissued shares are available for Sterling to issue shares of common stock to obtain equity capital, effect acquisitions, grant awards under Sterling’s stock option plans, and to use for stock dividends or in stock splits.

 

Once Shareholders approve a level of authorized shares for any class of Sterling’s capital stock, no subsequent approval by Shareholders is required for issuance of shares of that class in an amount up to the number of shares authorized, except to the extent required under the rules of the Nasdaq Global Select Market. Pursuant to Sterling’s Articles of Incorporation, the Board has the authority to determine the relative rights of Sterling’s common stock and preferred stock, including voting, conversion, liquidation and dividend rights and sinking fund provisions. Sterling’s Articles of Incorporation provide that no holder of Sterling’s capital stock will have any preemptive rights to acquire any of Sterling’s securities.

 

If common stock were issued, the per share voting power, Shareholder’s equity, or amounts available for distribution as dividends and on any liquidation of Sterling may be diluted as a result of any such additional issuances. Certain effects of this proposal could operate to deter a potential takeover of Sterling. For example, the additional shares proposed to be authorized could be issued to dilute the stock ownership of a person seeking to obtain control of Sterling, thereby preserving current management, making more difficult or discouraging a merger, tender offer or proxy contest directed at Sterling, delaying the assumption of control by a holder of a large block of Sterling’s shares, increasing the degree of control of current management, or operating to the advantage of incumbent management in a hostile takeover attempt and to the disadvantage of Shareholders who might want to participate in the takeover transaction. Approval of the Amendment of Sterling’s Articles of Incorporation requires the affirmative vote of a majority of shares of common stock that are issued and outstanding as of March 1, 2007.

 

The Board of Directors unanimously recommends that Shareholders vote “FOR” the
Proposal to Amend the Articles of Incorporation.

 

The Board of Directors adopted the Sterling Financial Corporation 2007 Long-Term Incentive Plan (the “2007 Incentive Plan”), as of February 26, 2007, subject to the approval of the Shareholders at the Annual Meeting. The Board of Directors believes that it is in the best interests of Sterling to adopt the 2007 Incentive Plan and recommends that the Shareholders vote in favor of the 2007 Incentive Plan. Approximately 436,249 options to purchase shares of common stock were available for grant under Sterling’s existing equity compensation plans as of December 31, 2006.

 

The following summary of the 2007 Incentive Plan is qualified in its entirety by reference to the complete text of the 2007 Incentive Plan, which is included with this proxy statement as Exhibit A. Capitalized terms used in this summary that are not separately defined below have the meanings set forth in the 2007 Incentive Plan.

 

The purpose of the 2007 Incentive Plan is to: a) foster and promote the long-term financial success of Sterling and materially increase Shareholder value; b) enable Sterling to attract, motivate and retain highly-qualified key employees and directors; and c) encourage key employees and directors to link their interests with the long-term financial success of Sterling and the growth of Shareholder value. Under the 2007 Incentive Plan, the following types of Awards may be granted: (i) Incentive Stock Options; (ii) Non-Qualified Stock Options; (iii) Stock Appreciation Rights (“SARs”); (iv) Restricted Stock; (v) Restricted Stock Units; (vi) Performance Shares; and (vii) supplemental payments dedicated to payment of any federal income taxes that may be payable in conjunction with Awards under the 2007 Incentive Plan. Non-employee directors, consultants and advisors of Sterling are eligible to participate in the 2007 Incentive Plan but may not receive Incentive Stock Options. Generally, Awards will be granted under the 2007 Incentive Plan to executive and other officers, approximately [ • ] individuals, although all Employees are eligible to participate. Sterling has reserved 2 million shares of common stock for grants of Awards under the 2007 Incentive Plan. The 2007 Incentive Plan will generally be administered by the Personnel Committee of the Board of Directors, which consists of at least two Outside Directors; however, the 2007 Incentive Plan allows administration of the Plan to be delegated to such other committees as are deemed appropriate by the Board and by any applicable laws depending on the group of employees or service providers who are subject to the committee’s granting authority (any of these committees are referred to as the “Administrator” in the Plan as well as in this summary).

 

No Incentive Stock Option, Non-Qualified Stock Option or SAR may be granted with an exercise price per share less than the Fair Market Value of the common stock at the date of grant. In the Administrator’s discretion, the exercise price of an Option may be paid in cash, by check, by delivery of already owned shares of common stock, via a broker-assisted cashless exercise program, by a combination of the foregoing methods or any other method permitted by law and acceptable to the Administrator. However, if the Participant acquired the stock to be surrendered upon exercise directly or indirectly from Sterling, he or she must have owned the stock to be surrendered for at least six months prior to tendering such stock for the exercise of an Option.

 

An eligible Participant may receive more than one Incentive Stock Option, but the maximum aggregate Fair Market Value of the common stock (determined when the Incentive Stock Option is granted) with respect to which Incentive Stock Options are first exercisable by such Participant in any calendar year cannot exceed $100,000. In addition, no Incentive Stock Option may be granted to a Participant owning directly or indirectly stock possessing more than 10% of the total combined voting power of all classes of stock of Sterling (a “Ten-Percent Shareholder”), unless the exercise price is not less than 110% of the Fair Market Value of the shares subject to such Incentive Stock Option on the date of grant.

 

Except as otherwise provided by the Administrator, Awards under the 2007 Incentive Plan are not transferable other than as designated by the Participant by will or by the laws of descent and distribution. The expiration date of an Incentive Stock Option is determined by the Administrator at the time of the grant, but in no event may an Incentive Stock Option be exercisable after the expiration of ten years from the date of grant of the Incentive Stock Option (five years in the case of an Incentive Stock Option granted to a Ten-Percent Shareholder).

 

SARs may be granted under the 2007 Incentive Plan upon such terms and conditions as the Administrator may determine, subject to the provisions of the Plan. The exercise price of the SAR shall not be less than the Fair Market Value of the common stock on the date of the grant. Upon the exercise of a SAR, Sterling will pay to the Participant in cash, common stock, or a combination thereof (the method of payment to be at the discretion of the Administrator), an amount equal to the excess of the Fair Market Value of the common stock on the exercise date over the exercise price, multiplied by the number of SARs being exercised.

 

Shares of Restricted Stock may be granted under the 2007 Incentive Plan upon such terms and conditions as the Administrator may determine, subject to the provisions of the Plan. In making an Award of Restricted Stock, the Administrator will determine the periods during which the Restricted Stock is subject to forfeiture and such other terms and conditions as the Administrator may deem admissible and appropriate. The Administrator also has discretion to accelerate the time at which the restrictions to which Restricted Stock is subject will lapse or be removed. During the Period of Restriction, as set forth in the Award Agreement, the Participant may not sell, transfer, pledge or assign the Restricted Stock, but will be entitled to vote the Restricted Stock, unless the Administrator determines otherwise. During the Period of Restriction, the Participant also has the right to receive dividends with respect to the Restricted Stock unless provided otherwise in the Award Agreement.

 

The Administrator may grant Awards in the form of Restricted Stock Units or Performance Shares, which are both generally subject to performance vesting criteria as established by the Administrator. The Administrator may set vesting criteria based upon the achievement of company-wide, business unit, or individual goals (including, but not limited to, continued employment), other performance milestones or any other basis determined by the Administrator in its discretion.

 

The basis for payment of Restricted Stock Units or Performance Shares for a given Performance Period shall be the achievement of those financial and nonfinancial vesting criteria determined by the Administrator in the Award Agreement. Upon meeting the applicable vesting criteria, the payout of Restricted Stock Units or Performance Shares shall be dependent on the extent to which the vesting criteria are met as determined by the Administrator and provided in the Award Agreement. Payments shall be made, in the discretion of the Administrator, solely in cash or common stock, or a combination of cash and common stock, as soon as practicable following the date(s) set forth in the Award Agreement.

 

The Administrator may provide for Supplemental Payments by Sterling to Participants in amounts specified by the Administrator, which amounts shall not exceed the amounts necessary to pay the federal income tax payable with respect to Awards and Supplemental Payments, based on the assumption that the Participant is taxed at the maximum effective federal income tax rate on such amount. The Administrator shall have the discretion to grant Supplemental Payments that are payable in cash, common stock, or a combination of both, as determined by the Administrator at the time of payment.

 

The 2007 Incentive Plan provides that following a change in control, any then outstanding Awards that are not assumed or substituted by the successor corporation shall become vested and exercisable in full, all restrictions and conditions of all Restricted Stock then outstanding shall be deemed satisfied and the restriction period shall be deemed to have expired, all performance goals or vesting criteria shall be deemed achieved at 100% of target levels and all other terms and conditions on an outstanding Award shall be deemed met.

 

Under the 2007 Incentive Plan, the Administrator has authority, in its discretion but subject to the provisions of the Plan and the authority delegated by the Board, to: (i) determine the Fair Market Value of the stock subject to Awards under the Plan; (ii) select the Service Providers to whom Awards may be granted thereunder; (iii) determine the number of Shares to be covered by each Award; (iv) approve forms of agreement for use under the Plan; (v) determine the terms and conditions, not inconsistent with the terms of the Plan, of any Award granted hereunder (including, but are not limited to, the exercise price, the time or times when Awards may be exercised or will become vested, any vesting acceleration or waiver of forfeiture restrictions, and any restriction or limitation regarding any Award or the Shares relating thereto, based in each case on such factors as the Administrator will determine); (vi) institute an Exchange Program; (vii) construe and interpret the terms of the Plan and Awards granted pursuant to the Plan; (viii) prescribe, amend and rescind rules and regulations relating to the Plan; (ix) modify or amend each Award (subject to the provisions of the Plan), including the discretionary authority to extend the post-termination exercisability period of Awards longer than is otherwise provided for in the Plan (subject to compliance with Code

Section 409A); provided, however, notwithstanding any contrary provision in this Plan, neither the Administrator nor the Board may directly or indirectly reduce the exercise price of any Award without the approval of Sterling’s stockholders; (x) allow Participants to satisfy withholding tax obligations in such manner as provided in the Plan; (xi) authorize any person to execute on behalf of Sterling any instrument required to effect the grant of an Award previously granted by the Administrator; (xii) allow a Participant to defer the receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Participant under an Award; and (xiii) make all other determinations deemed necessary or advisable for administering the Plan. The decisions, determinations and interpretations made by the Administrator in good faith shall not be subject to review by any person and shall be final and binding on all Participants and any other holders of Awards. No person or member of a committee acting as the Administrator will be liable for any action or determination made in good faith by the Administrator with respect to the 2007 Incentive Plan or any Incentive Award and, to the fullest extent permitted by Sterling’s Restated Articles of Incorporation and Bylaws, Sterling will indemnify each member of the Administrator.

 

Sterling believes that under present law, the following are the U.S. federal income tax consequences generally arising with respect to Options. The grant of an Option will not be a taxable event to the Participant and Sterling will not be entitled to a deduction with respect to such grant.

 

Upon the exercise of a Non-Qualified Stock Option, a Participant will recognize ordinary income at the time of exercise equal to the excess of the then Fair Market Value of the shares of common stock received over the exercise price. The taxable income recognized upon exercise of a Non-Qualified Stock Option will be treated as compensation income subject to withholding and Sterling will be entitled to deduct as a compensation expense an amount equal to the ordinary income a Participant recognizes with respect to such exercise. The treatment to a participant of a disposition of shares acquired through the exercise of an option generally depends on how long the shares were held and on whether the shares were acquired by exercising an incentive stock option or by exercising an option other than an incentive stock option. Generally, there will be no tax consequence to Sterling in connection with a disposition of shares acquired under an option, except that Sterling may be entitled to a deduction in cases in which shares acquired under an incentive stock option are disposed of before the applicable incentive stock option holding periods having been satisfied.

 

A Participant receiving Restricted Stock generally will recognize ordinary income in the amount of the Fair Market Value of the corresponding common stock at the time the common stock is no longer subject to forfeiture, less any consideration paid for the common stock. Sterling will be entitled to a deduction at the same time and in the same amount. The holding period to determine whether the Participant has long-term or short-term capital gain or loss on a subsequent sale generally begins when the restriction period expires, and the Participant’s tax basis for such common stock will generally equal the Fair Market Value of such common stock on such date.

 

However, a Participant may elect, under Section 83(b) of the Code, within 30 days of the grant of the Restricted Stock, to recognize taxable ordinary income on the date of grant equal to the excess of the Fair Market Value of the Restricted Stock (determined without regard to the restrictions) over the price (if any) paid for the Restricted Stock. By reason of such an election, the Participant’s holding period will commence on the date of grant and the Participant’s tax basis will be equal to the Fair Market Value of the common stock on that date (determined without regard to restrictions). Likewise, Sterling generally will be entitled to a deduction at that time in the amount that is taxable as ordinary income to the Participant. If the shares of common stock are forfeited after making such an election, the forfeiture shall be treated as a sale or exchange upon which there is a capital loss equal to the excess of purchase price of the forfeited shares of common stock over any amount realized on such forfeiture.

 

No Incentive Awards have been granted or allocated under the 2007 Incentive Plan. Approval of the 2007 Incentive Plan requires the affirmative vote of the holders of a majority of shares of common stock present and voting at the Annual Meeting.

 

The Board of Directors unanimously recommends that Shareholders vote “FOR” the
Proposal to approve Sterling’s 2007 Incentive Plan.

 

The Audit Committee of the Board of Directors has appointed BDO Seidman, LLP to serve as the independent registered public accounting firm for Sterling and its subsidiaries for the year ending December 31, 2007, and any interim periods. Shareholders are being asked to ratify such appointment. BDO has advised Sterling that it will have in attendance at the Annual Meeting one or more representatives who will be available to respond to appropriate questions presented at the Annual Meeting. Such representatives will have an opportunity to make a statement at the Annual Meeting if they desire to do so. If the appointment of BDO is not ratified by the required number of votes, the Board will review its future selection of independent registered public accounting firms.

 

The Board of Directors unanimously recommends that Shareholders vote “FOR”
the ratification of the appointment of BDO as the
independent registered public accounting firm for Sterling for 2007.

 

 

Audit Fees:  The aggregate fees and expenses billed by BDO for professional services rendered for the audit of Sterling’s annual financial statements, the reviews of the financial statements included in Sterling’s periodic reports filed with the Securities and Exchange Commission (the “SEC”) on Forms 10-Q, SEC registration statement services, and the audits of the financial statements of Sterling’s subsidiaries were $628,500 and $715,823 for the years ended December 31, 2005 and 2006, respectively. Fees for 2005 and 2006 include the integrated audit of Sterling’s consolidated financial statements and management’s assessment of internal controls over financial reporting as required by the Public Company Accounting Oversight Board and the SEC.

 

Audit-Related Fees:  The aggregate fees and expenses billed by BDO for audit related services rendered during 2005 and 2006 were $18,000 and $18,000, respectively. Types of services in this category were primarily audits of the employee benefit plans and consultation on accounting standards.

 

Tax Fees:  The aggregate fees billed by BDO for tax services rendered during 2005 and 2006 were $55,490 and $45,785, respectively. Types of tax services provided by BDO primarily consisted of advice related to preparing Sterling’s corporate tax returns and tax consulting projects.

 

All Other Fees:  There were no other services provided by BDO during 2005 and 2006.

 

It is the responsibility of Sterling’s Audit Committee to pre-approve all audit and non-audit services provided by BDO. The Audit Committee has adopted a policy authorizing certain permissible audit and non-audit services to be performed by BDO with subsequent reporting and oversight required by the Audit Committee. Permissible services, not pre-approved pursuant to this policy, require specific review and approval prior to the engagement by the Audit Committee, or a designated member. Specific pre-approval of such permissible services with estimated fees of $2,500 or less may be waived via the de minimis exception rule. Procedures are in place to ensure the Audit Committee chairman is notified in the event the de minimis rule is used. All services rendered by and fees paid to BDO are reported to and monitored quarterly by the Audit Committee. The Audit Committee considers whether the provision of related audit services are compatible with maintaining the independent registered public accounting firm’s independence. To assist the Audit Committee in its oversight responsibilities, the pre-approval policy identifies the three basic principles of independence with respect to services provided by the independent registered public accounting firm, as well as the non-audit services the independent registered public accounting firm is prohibited from providing. One hundred percent of all services provided by BDO in each of the last two fiscal years were pre-approved by the Audit Committee.

 

During fiscal year 2006, Directors Barnett, Bauhofer, Eisenhart and Fugate served on the Audit Committee, with Director Eisenhart serving as Chairman. As more fully described in the Audit Committee Charter, the Audit Committee is responsible for overseeing Sterling’s accounting and financial reporting processes, including the quarterly review and the annual audit of Sterling’s consolidated financial statements by BDO, Sterling’s independent registered public accounting firm. BDO currently serves as Sterling’s independent registered public accounting firm and has conducted the audit of Sterling’s financial statements for 2006. The Sarbanes-Oxley Act of 2002 requires the Audit Committee to be directly responsible for the appointment, compensation and oversight of the audit work of the independent registered public accounting firm. The Audit Committee has appointed BDO to serve as the independent registered public accounting firm to conduct an audit of Sterling’s financial statements for the fiscal year ending December 31, 2007, and all interim periods. BDO has advised Sterling that it will have in attendance at the Annual Meeting one or more representatives who will have an opportunity to make a statement if they desire to do so and who will be available to respond to appropriate questions presented to the Secretary of Sterling in advance of the Annual Meeting. As part of fulfilling its responsibilities, the Audit Committee has reviewed and discussed Sterling’s audited financial statements with management. The Audit Committee has also discussed with the independent registered public accounting firm the matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees). Finally, the Audit Committee has received the written disclosures and the letter from the independent registered public accounting firm required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and has discussed with the independent registered public accounting firm that firm’s independence.

 

Based on its review and discussions, the Audit Committee recommended to the Board of Directors that the audited financial statements for 2006 be included in Sterling’s 2006 Annual Report on Form 10-K filed with the SEC.

 

Submitted by the Audit Committee of the Board of Directors of Sterling Financial Corporation.

 

William L. Eisenhart, Chairman

Rodney W. Barnett

Donald N. Bauhofer

James P. Fugate

 

Our Board of Directors is responsible for the supervision of the overall affairs of Sterling. During fiscal 2006, individuals serving on the Board included Harold B. Gilkey, William W. Zuppe, Rodney W. Barnett, Donald N. Bauhofer, Thomas H. Boone, William L. Eisenhart, James P. Fugate, Robert D. Larrabee, Donald J. Lukes, and Michael F. Reuling. Mr. Boone retired from the Board effective February 27, 2006 and Mr. Barnett is expected to retire from the Board following the Annual Meeting of Shareholders. Messrs. Lukes and Reuling were appointed to the Board effective January 3, 2006, and December 20, 2006, respectively. On March 1, 2007, James B. Keegan, Jr. was appointed to the Board.

 

To assist in carrying out its duties, the Board has delegated authority to the Audit Committee, the Personnel Committee, and the Nominating Committee. For more information relating to the duties and composition of these committees, please see the sections below entitled “Committees of the Board of Directors.”

 

Following our 2007 Annual Meeting of Shareholders, the Board will consist of ten Directors. In the interim period between Annual Meetings of Shareholders, the Board has the authority under Sterling’s Bylaws to fill vacancies and may increase or decrease the size of the Board by amending the Bylaws. The Directors are classified into three classes with staggered terms of three years.

 

The Board of Directors of Sterling held 8 meetings during 2006. Each Director attended at least 75% of such meetings and those of the Board committees on which the Director served during the year. It is Sterling’s policy that members of the Board of Directors should attend all annual meetings of Shareholders except for absences due to causes beyond the reasonable control of the Directors. At the 2006 annual meeting of Shareholders of Sterling Financial Corporation, all of the Directors were in attendance.

 

The Board of Directors of Sterling has established Audit, Personnel and Nominating Committees.

 

Audit Committee.  The Audit Committee has been established in accordance with the rules of the SEC for the purpose of overseeing Sterling’s accounting and financial reporting processes, the audits of the financial statements, as well as compliance with legal and regulatory requirements. The Audit Committee reviews the independent registered public accounting firm’s qualifications, independence and performance, and oversees and monitors the performance of Sterling’s internal audit function. The Audit Committee is responsible for the retention, supervision and termination of the independent registered public accounting firm and for resolving any disagreements between management and the independent registered public accounting firm. The independent registered public accounting firm reports directly to the Audit Committee. The Audit Committee is also responsible for reviewing the adequacy of the authority, responsibilities and functions of Sterling’s internal audit department. The Audit Committee is not responsible for conducting reviews of auditing or accounting procedures. Management has primary responsibility for Sterling’s financial reporting process and for preparing Sterling’s financial statements. Sterling’s independent registered public accounting firm is responsible for performing an independent audit of the consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Audit Committee serves a board-level oversight role in which it provides advice, counsel and direction to management and the independent registered public accounting firm on the basis of the information it receives, discussions with the independent registered public accounting firm, and the experience of the Audit Committee’s members in business, financial and accounting matters.

 

The Audit Committee held six meetings during 2006 and currently consists of Messrs. Eisenhart (Chairman), Barnett, Bauhofer and Fugate, each of whom has been determined by the Board to be “independent” and financially literate as required by the rules of the NASD and the SEC. Members of the Audit Committee have reviewed and discussed with management and the independent registered public accounting firm the periodic reports of Sterling prior to filing such reports with the SEC. No member of the Audit Committee has participated in the preparation of

the financial statements of Sterling or its subsidiaries at any time during the past three years. The Board has determined that Mr. Barnett is an “audit committee financial expert” as defined by the SEC. The Audit Committee operates under a written charter reviewed and approved annually by Sterling’s Board of Directors. Sterling’s Audit Committee Charter is publicly available on Sterling’s website at www.sterlingfinancialcorporation-spokane.com.

 

Personnel Committee.  The Personnel Committee reviews and makes recommendations to the Board of Directors with respect to personnel policies that include, but are not limited to, officer and employee salaries and benefits. The Personnel Committee does not currently operate under a written charter, but is in the process of preparing and evaluating such a charter for future adoption by the Board of Directors. The Personnel Committee held three meetings during 2006 and currently consists of Messrs. Larrabee (Chairman), Fugate and Bauhofer, each of whom has been determined by the Board to be “independent” as that term is defined by the rules of the NASD and the SEC.

 

Nominating Committee.  The Nominating Committee recommends to the Board of Directors a slate of nominees for election by the Shareholders at each annual meeting of Sterling. At the request of the Board, the Nominating Committee recommends, for approval by the Board, nominees to fill vacancies or new positions on the Board as they may occur or be created from time to time, all in accordance with Sterling’s Bylaws. The Nominating Committee identifies potential nominees from various sources, including recommendations from Directors and officers of Sterling. The Nominating Committee will consider nominees recommended by Shareholders upon submission in writing to the Chairman of the Board of Directors the names of such nominees, together with their qualifications for service as Directors of Sterling. Individuals recommended by Shareholders are evaluated in the same manner as other potential nominees. The Nominating Committee reviews and discusses recommendations received for Director candidates and evaluates the qualifications of such candidates before selecting a slate of nominees to be recommended to the Board. Qualifications that the Nominating Committee will consider in evaluating Director candidates include contacts within Sterling’s market area, skills, experience, time availability and such other criteria as the Nominating Committee shall determine to be relevant. The Nominating Committee held two meetings in 2006, and currently consists of Messrs. Fugate (Chairman), Larrabee and Bauhofer, each of whom has been determined by the Board to be “independent” as that term is defined by the rules of the NASD and the SEC. The Nominating Committee operates under a written charter approved by Sterling’s Board of Directors. Sterling’s Nominating Committee Charter is publicly available on Sterling’s website at www.sterlingfinancialcorporation-spokane.com.

 

Directors of Sterling who are not employees of Sterling are paid an annual fee of $20,000 plus a fee, which is currently $3,000, for every meeting attended. Directors serving on committees of the Board also receive a fee of $500 for every committee meeting attended unless they serve as the chair of such committee, in which case they receive a fee of $1,000 for every committee meeting attended. Directors receive reimbursement for travel and other expenses incurred in connection with Board business.

 

Nonemployee Directors of Sterling also receive annual grants of non-qualified stock options. Such options have an exercise price equal to the fair market value of the Sterling common stock on the date of grant and generally expire ten years from the date of grant. In the event that a nonemployee Director is removed from office for cause, all options granted to such nonemployee Director pursuant to the automatic grants of non-qualified stock options described above will expire immediately upon such removal.

The following table sets forth information with regard to compensation earned by non-employee Directors in 2006. Compensation earned by employee Directors is included in the “Executive Compensation” section of this proxy.

 

 

 

 

 

The following table shows the aggregate number of stock awards and option awards outstanding for each nonemployee Director as of December 31, 2006. There were no stock awards and one stock option was granted to non-employee directors during 2006.

 

 

 

 

Sterling has proactively taken steps to establish a corporate governance framework that affirms our high standards of business conduct, emphasizes the importance of integrity and honesty in the conduct of our business, and ensures the integrity of the controls and procedures implemented by our Directors, officers and employees, including our internal control over financial reporting. Actions we have taken to establish this corporate governance framework include: maintaining a Board composed of a majority of independent Directors; adoption of charters for our Directors’ committees; adoption of a Code of Ethics for all of our Directors, officers and employees; and provision of a procedure for shareholders and employees to communicate with the Board. We believe that the

ethical foundations outlined in our corporate governance framework are critical to our ongoing success and the maximization of shareholder value.

 

The Board of Directors has determined that each of the following Directors is an “independent director” as such term is defined by the rules of the National Association of Securities Dealers (“NASD”) and the Securities Exchange Commission (“SEC”):

 

Rodney W. Barnett

Donald N. Bauhofer

William L. Eisenhart

James P. Fugate

James B. Keegan, Jr.

Robert D. Larrabee

Michael F. Reuling

 

The Board of Directors has also determined that each member of the three committees of the Board meets the independence requirements applicable to those committees prescribed by the rules of the NASD and the SEC. These rules generally provide that an “independent director” is a person other than an officer or employee of Sterling or its subsidiaries or any other individual having a relationship that, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a Director. The Nasdaq Rules also provide specific criteria that, if met, disqualify a Director from being independent.

 

The Board of Directors has adopted a Code of Ethics that applies to all Sterling employees and Directors, including Sterling’s senior financial officers. The Code of Ethics is publicly available on Sterling’s website at www.sterlingfinancialcorporation-spokane.com.

 

Shareholders may send communications to the Board of Directors of Sterling by addressing such correspondence to:

 

Harold B. Gilkey

Chairman of the Board

Sterling Financial Corporation

111 North Wall Street

Spokane, WA 99201

 

As Chairman of the Board, Mr. Gilkey monitors Shareholder communications, forwards correspondence to the appropriate committee(s) or Director(s), and facilitates an appropriate response.

 

In addition to Messrs. Gilkey and Zuppe, the executive officers of Sterling and its subsidiaries are Heidi B. Stanley, Daniel G. Byrne, Robert G. Butterfield, Thomas W. Colosimo, John M. Harlow, James L. Kirschbaum and Jeffery D. Schlenker (the “Executive Officers”). Each Executive Officer has held his or her present position for the past five years except as otherwise stated.

 

HEIDI B. STANLEY

 

Ms. Stanley, 50, has served as Vice Chair of the Board and Chief Operating Officer of Sterling Savings Bank since October 2003. In addition to serving as a Director of Sterling Savings Bank, she also currently serves as a Director of INTERVEST, Action Mortgage and Harbor Financial. She joined Sterling in 1985. Prior to joining

Sterling, Ms. Stanley was employed by IBM in San Francisco, California, and Tucson, Arizona. In 2006, she was named one of the “25 Most Powerful Women in Banking” by U.S. Banker Magazine. She is currently on the Board of Directors of Avista Corporation. Ms. Stanley is Chair of the Spokane Regional Chamber of Commerce. She is a past Chairman of the Board of the Association of Washington Business (AWB); past Chair of the Spokane area YMCA and Vice Chair of TVW (Washington Public Affairs Network). She is Vice-Chairman of America’s Community Bankers (ACB) Membership Committee and member of the Government Affairs Steering Committee. She serves on the Board of Governors of the WSU Foundation and the Eastern Washington Advisory Board of the Washington Policy Center. Ms. Stanley received a Bachelor’s degree in Business Administration from Washington State University in 1979.

 

DANIEL G. BYRNE

 

Mr. Byrne, 52, serves as Executive Vice President-Finance, Chief Financial Officer and Assistant Secretary of Sterling and Assistant Secretary of Golf Savings Bank. He has served in these capacities with Sterling and Sterling Savings, which he joined in 1983. Mr. Byrne is also the Assistant Secretary and Treasurer of INTERVEST and Action Mortgage, and the Secretary and Treasurer of Harbor Financial. Before joining Sterling, Mr. Byrne was employed by the accounting firm of Coopers & Lybrand in Spokane, Washington. He is a past Lieutenant Governor of Kiwanis International. Mr. Byrne is a past member of the Board of Trustees, its Executive Committee and its Finance Committee for Gonzaga Preparatory School. He is a member of the Board of Directors of Spokane Community Mental Health and past Chairman of the Parish Council of St. Thomas More Church. He is also a board member and Audit Committee Chairman for Ambassadors Group, Inc., a publicly traded corporation. He serves as a member of the American Institute of Certified Public Accountants, the Washington Society of Certified Public Accountants, the Financial Manager’s Society and the American Community Bankers Association and its Accounting Committee. Mr. Byrne is a certified public accountant, and received a Bachelor’s degree in Accounting from Gonzaga University in 1977.

 

ROBERT G. BUTTERFIELD

 

Robert G. Butterfield, 38, serves as Vice President, Controller and Principal Accounting Officer of Sterling. Mr. Butterfield has also served as Vice President and Controller of Sterling’s wholly owned subsidiary, Sterling Savings Bank, since October 2004 and an Assistant Secretary of Golf Savings Bank since January 2007. Mr. Butterfield previously served as Assistant Controller/Assistant Vice President and as an Accounting Manager of Sterling Savings Bank. He joined Sterling Savings Bank in 2001. Mr. Butterfield is a certified public accountant and holds a Bachelor’s degree from Eastern Washington University.

 

THOMAS W. COLOSIMO

 

Mr. Colosimo, 55, serves as Senior Vice President, Chief Financial Officer of Sterling Savings Bank. He joined Sterling Savings in 2004. Prior to his work at Sterling from February 1998 through December 2003, Mr. Colosimo was employed by Regence BlueShield of Idaho and Regence BlueCross BlueShield of Utah as Vice President, Financial Services and Chief Financial Officer. He is an instructor for, and has served on the Board of Directors of Junior Achievement, of the Inland Northwest. He has also served on United Way allocation committees. Mr. Colosimo is a certified public accountant, and received a Bachelor’s degree in Economics from the University of California, Davis in 1973 and a Master of Business Administration, Taxation degree from California State University, Hayward in 1978.

 

JOHN M. HARLOW

 

Mr. Harlow, 64, serves as Vice President of Sterling Savings and President and a Director of INTERVEST. He joined Sterling Savings in 1987. Mr. Harlow was formerly the President of the Mortgage Banking Division of Moore Financial Services of Portland, Oregon; Senior Vice President of Income Property Lending for Bancshares Mortgage Company of Spokane, Washington; and Vice President/Regional Manager for I.D.S. Mortgage Company in northern California. He is a Certified Mortgage Banker and is a past President of the Oregon Mortgage Bankers Association. Mr. Harlow received a Bachelor’s degree from the University of Illinois in 1965.

 

JAMES L. KIRSCHBAUM

 

Mr. Kirschbaum, 66, serves as Vice President of Sterling Savings and President and Chief Operating Officer of Action Mortgage. He joined Sterling Savings in October 2001. Mr. Kirschbaum was formerly Executive Vice President of Source Capital Corporation in Spokane, Washington. He is a member of the Mortgage Bankers Association of America, a past President of the Seattle Mortgage Lenders Association, and a past President for the second time of the Washington State Mortgage Lenders Association. He is also a board member of the Pacific Real Estate Institute and a past President of the United Way of Spokane County. Mr. Kirschbaum is a graduate of the Stanford University Executive Program and the recipient of an Honorary Master’s degree from Eastern Washington University’s College of Business.

 

JEFFERY D. SCHLENKER

 

Mr. Schlenker, 39, has served as President of Harbor Financial since November 2006 and previously served as Vice President beginning in 2004. He was previously employed by Klamath First Financial Services, where he served as President for two years. Prior to his employment by Klamath, Mr. Schlenker was a financial advisor for approximately seven years. He received a Bachelor’s degree in Business Administration from the University of Phoenix and has his Series 6, 63 and 7 licenses in the securities industry.

 

The following table sets forth information as of January 31, 2007 regarding the shares of Sterling common stock beneficially owned by (i) each person known by Sterling to own beneficially more than 5% of Sterling’s common stock; (ii) each Director of Sterling; (iii) the CEO of Sterling, the CFO of Sterling, and the four other most highly compensated Executive Officers who were serving as Executive Officers at the end of 2006 (together, the “Named Executive Officers”); and (iv) all Directors and Named Executive Officers of Sterling as a group. Except as noted below, each holder has sole voting and investment power with respect to shares of Sterling common stock listed as owned by that person.

 

 

 

 

 

 

The following table provides information about Sterling’s common stock that may be issued upon the exercise of options, warrants and rights under Sterling’s equity compensation plans as of December 31, 2006.

 

 

Sterling seeks to attract and retain a highly qualified management team and promote a strong pay-for-performance culture by aligning compensation with superior short and long-term performance that builds shareholder value.

 

Sterling’s Board of Directors believes that compensation should:

 

 

Sterling uses a compensation framework with multiple payment components to balance various short-term and long-term objectives. This framework is designed to balance the executives’ need for current cash, security, and funds to cover taxes on long-term incentives through vehicles such as salary and annual incentives, with the need to align executives’ long-term interests with those of shareholders through vehicles such as equity grants. The framework is also intended to avoid awarding a particular form of compensation if the tax treatment of such compensation will reduce the incentive to the executive.

 

Base salary and perquisites provide some degree of security to each executive at the base threshold level of compensation and encourage the executives’ day to day productivity. Annual cash incentives are designed to motivate executives to focus on Sterling’s annual goals, while long-term incentives are designed to motivate the executives to focus on long-term strategic goals that will produce both outstanding financial performance for Sterling and long-term rewards for the executives. Components such as employment agreements and stock options are designed to meet Sterling’s goal of attracting and retaining a stable team of effective leaders while providing non-competition and other protections for Sterling.

 

Sterling’s compensation framework is also designed to ensure direct supervision and accountability with regard to performance evaluations at each level of the organization. For this reason, the Personnel Committee is directly responsible for determining the total compensation level and individual components of the CEO’s compensation package, based upon various factors, including a review of Sterling’s performance, and the CEO’s individual performance. The CEO, in turn is directly responsible for conducting a similar review of the President of Sterling and then recommending an appropriate compensation package to be approved by the Personnel Committee. The President, in like manner, reviews the performance of the chief operating officer of Sterling Savings and recommends an appropriate compensation package to be approved by the CEO. This system continues in sequence throughout Sterling’s chain-of-command, so that the compensation of each employee is always based upon an evaluation of the employee’s performance by the employee’s direct supervisor, subject to approval by the next higher level of management, and an overall review by Sterling’s human resources department.

 

The appropriate level of compensation for each officer or employee of Sterling is expected to vary based upon Sterling’s overall performance, Sterling’s financial performance and an individual’s attainment of their personal objectives and contribution to the attainment of Sterling’s objectives. Specific items of Sterling’s performance taken into account when making compensation decisions include:

 

 

Although the current value of historical awards may also be taken into account, the primary objective is to reward Sterling’s management team for their current performance and provide incentive for future performance. Because there is no specific weighting applied to the factors considered, the Personnel Committee and each supervising manager are expected to use their own judgment and expertise in determining appropriate compensation packages that meet Sterling’s overall objectives. Each supervisor, following consultation with and subject to the concurrence of his or her immediate supervisor, has discretion to set a total compensation amount that he or she determines to be appropriate without regard to any fixed minimum, maximum or target incentive level.

 

Sterling does not specifically require that its Executive Officers own Sterling common stock, but does award stock and stock options pursuant to Sterling’s long term incentive plans in part to ensure that the Executive Officers’ financial incentives are aligned with those of Sterling’s shareholders. In order to avoid creating conflicts between an officer’s interests and the interests of shareholders, Sterling’s Insider Trading Policy prohibits all Sterling personnel from engaging in hedging transactions. Officers who are parties to an employment agreement with Sterling are also generally prohibited from pledging their shares of Sterling common stock as collateral for loans or other financing transactions, or otherwise hedging the economic risk of owning their shares.

 

Historically, the Board has determined the number of shares of Sterling common stock and options to purchase shares of Sterling common stock available to be awarded, and then awarded them annually at its regularly scheduled meeting in December. At its December 2006 meeting the Board decided to change its procedure and begin granting all awards of such stock and stock options during the open window in January following the release of earnings for the fourth quarter and fiscal year to increase the likelihood that the awards will be priced at a time when the market has full access to information about Sterling’s performance.

 

The role of Sterling’s management is to provide reviews and recommendations for the Personnel Committee’s consideration, and to manage Sterling’s executive compensation programs, policies and governance. Direct responsibilities include, but are not limited to:

 

 

The Personnel Committee, which is composed of three nonemployee Directors, is responsible for performing compensation committee functions, as provided under the rules of the SEC, including administration of the compensation of the CEO and the other Executive Officers. The actions taken by the Personnel Committee are subject to review and appropriate approval of Sterling’s Board of Directors.

 

The primary purpose of the Personnel Committee is to conduct reviews of Sterling’s general executive compensation policies and strategies and oversee and evaluate Sterling’s overall compensation structure to ensure that Sterling’s compensation objectives are fulfilled.

 

Direct responsibilities of the Personnel Committee include, but are not limited to:

 

 

The Personnel Committee meets regularly in executive session and assesses a number of factors, without giving specific weight to any one factor, in designing and evaluating Sterling’s compensation framework. Additionally, the Personnel Committee is advised from time to time by outside compensation consultants on its compensation policies. In 2004 and 2006, the Personnel Committee retained the firm of Clark Consulting as its compensation consultant to assist in the continual development and evaluation of compensation policies and the Personnel Committee’s determinations of compensation awards. The role of Clark Consulting is to provide independent, third-party advice and expertise in executive compensation issues.

 

During 2006, the Personnel Committee reviewed an informal market survey conducted by Sterling employees to evaluate whether Sterling’s compensation program is competitive with other institutions in the banking industry. Although Sterling generally does not limit its market comparisons to a specific peer group, it did consider companies in the banking and financial services industries with assets ranging from $5 billion to $25 billion as part of its compensation analysis. These companies included: Bank of Hawaii Corp., Cathay General Bancorp, FirstMerit Corp., Fremont General Corp., Pacific Capital Bancorp, UCBH Holdings, Inc., Umpqua Holdings Corp., Whitney Holding Corp., and Wilmington Trust Corp. As a result of this survey, the Personnel Committee determined that Sterling’s compensation levels for the Named Executive Officers are at about 75% of the industry average, but are still competitive for Sterling’s market.

 

The Personnel Committee deems Sterling’s consistent performance, continued growth and strong return to shareholders as evidence that Sterling’s compensation framework is achieving the desired objectives.

 

During 2006, the compensation of Mr. Gilkey, Chairman of the Board and CEO, was based on the general principles of the executive compensation program and on Mr. Gilkey’s Employment Agreement. In determining the salary and other forms of compensation for Mr. Gilkey, the Personnel Committee took into consideration Mr. Gilkey’s substantial experience and standing in the industry in general and with Sterling in particular. The Personnel Committee also considered the increased responsibilities for Mr. Gilkey as a result of Sterling’s diversification and growth in recent years. The Personnel Committee believes that Mr. Gilkey’s compensation as CEO appropriately reflects Sterling’s performance during 2006 and his contributions to that performance.

 

At present, the executive compensation program is comprised of base salary, annual cash incentive compensation, long-term compensation in the form of deferred compensation and stock options, and benefits typically offered to executives of similar corporations.

 

Base Salary.  Sterling pays its executives cash salaries intended to be competitive and take into account the individual’s qualifications, experience, performance, responsibilities, and past and potential contribution to the company. When determining base salary levels of the CEO and evaluating the base salary levels of other executive officers, the Personnel Committee assesses a number of factors, without giving specific weight to any one factor. The Personnel Committee also takes into account Sterling’s financial and operating performance as compared with industry averages, and considers the diverse skills required of its executive management to expand its operations while maintaining good performance. In addition, the Personnel Committee annually reviews a survey of average salaries paid to executive management in the banking industry, without limiting its review to any particular group of peers.

 

Annual Cash Incentive Compensation.  Sterling maintains an Annual Cash Incentive Compensation Program. The annual component of this program is intended to encourage and reward the achievement of growth in Sterling’s: (1) reported earnings, (2) total assets; (3) return on average assets; and (4) return on average equity. These criteria are deemed by the Personnel Committee to be critical in increasing shareholder value on both a short-term and long-term basis. The program also is designed to assist in attracting and retaining qualified employees and to further link the financial interests and objectives of employees with those of shareholders. Pursuant to the terms of his employment agreement, the amount of cash incentive paid to the CEO is generally determined on a discretionary basis by the Personnel Committee if Sterling has achieved its corporate goals and may range from 10% to 100% of the CEO’s base salary. Pursuant to the terms of his employment agreement, the President may also receive a cash incentive that ranges from 10% to 100% of his base salary as determined on a discretionary basis by the CEO with the approval of the Board. For other executive officers, bonuses are determined at the discretion of the executive’s supervisor based on an evaluation of individual contributions to Sterling’s financial performance.

 

Long-Term Incentive Plans.  The Personnel Committee believes that long-term incentive plans, such as the 2003 Long-Term Incentive Plan, provide a competitive incentive that links the achievement of financial goals and individual performance, resulting in greater shareholder value. The purpose of these plans is to encourage the ownership of Sterling common stock, attract and retain qualified employees, develop and maintain strong management and employee loyalty, and give suitable recognition to an individual’s material contributions to Sterling’s success.

 

When determining the quantity and amount of awards to be granted, the Personnel Committee assesses the same factors considered in setting base salary, but with a greater emphasis on long-term growth measurements, such as return on average assets and return on average equity, and the expansion of Sterling’s entire delivery system. Components of Sterling’s delivery system that are considered include growth in the number of total branches, increases in the number of personnel and achievement of specific components of Sterling’s strategic plan.

 

The Personnel Committee currently seeks to limit the number of equity awards to executive management to no more than 30% to 40% of the total number of awards granted under Sterling’s long-term incentive plans in any given year, with the remainder to be awarded to non-executive employees. The availability of equity awards is subject to

the approval of Sterling’s long-term incentive plans by Sterling’s shareholders. The Personnel Committee balances the value of equity awards as an incentive to align employees interests with shareholders, with the dilutive effect that issuing equity awards has on existing shareholders, and seeks to ensure that the number of equity awards authorized in any given long-term incentive plan approved by Sterling’s shareholders will be sufficient to provide incentive awards for three to four years. Accordingly, a new long-term incentive plan is presented to the Shareholders for approval at this Annual Meeting, as summarized elsewhere in this proxy and is attached hereto as Exhibit A.

 

Supplemental Executive Retirement Plan.  In January 2002, Sterling adopted a Supplemental Executive Retirement Plan (the “SERP”). The SERP is a non-qualified, unfunded plan that is designed to provide retirement benefits for certain key employees of Sterling. Depending on their classification under the Plan, participants will receive from 40% to 60% of their annual salary amount as of January 1, 2002, for 10 to 15 years, beginning at normal retirement age. Retirement benefits vest at the rate of 10% per year of service. Except for participants who have completed 25 years of service, benefits are reduced for early retirement. The present value of the retirement benefits becomes 100% vested if, within three years of a change in control of Sterling, either the Plan or the participant’s employment are terminated.

 

Deferred Compensation Plans.  Since 1984, Sterling has maintained a nonqualified Deferred Compensation Plan (the “Old DCP”) intended to link compensation to the long-term performance of Sterling and to provide employees with a strong incentive for increasing shareholder value. No further contributions have been made to this plan since 2001. As of December 31, 2006, there were seven participants in the Old DCP. All amounts in a participant’s account become 100% vested upon death, disability, normal retirement age of 60, upon a change of control, or upon termination of the Plan. Prior to such an event, amounts in a participant’s account vest at the rate of 10% per year of service from and after the year of contribution, provided that such vesting is accelerated so that each participant shall reach 100% vesting by age 60. Payment may be in a lump sum or in installments as determined by the Board, and installments may be accelerated by the Board. Payment must be commenced within one year of the termination of the participant’s employment with Sterling.

 

Due to the enactment of Internal Revenue Code Section 409A (“Section 409A”), the Old DCP was divided into two plans: one for balances that accrued and vested prior to January 1, 2005, which are not subject to Section 409A; and one for balances vesting from and after January 1, 2005, which must comply with the rules and restrictions of Section 409A. Four participants in the Old DCP had balances that were not fully earned and vested prior to January 1, 2005 and these are the only participants in the segregated plan, called the 2005 Deferred Compensation Plan (the “2005 DCP”). Following the publication of the final regulations under Section 409A, the 2005 DCP will be amended as necessary to comply with the requirements of Section 409A. Until the final regulations are published, this 2005 DCP has been and will be operated in good faith compliance with Section 409A and the guidance promulgated thereunder.

 

In 2006, Sterling Savings adopted a new nonqualified Deferred Compensation Plan (the “Sterling Savings DCP”). The Sterling Savings DCP is designed to retain and attract key employees and Directors while serving as a vehicle to assist with saving for retirement. Plan participation is limited to Directors and a select group of management or highly compensated employees as determined by the Plan Committee. As of December 31, 2006, there were 34 participants in the Sterling Savings DCP. Under the plan, participants may contribute up to 75% of their base salary and up to 100% of commissions, bonus and Director fees. The deferred amounts are credited to the participants’ accounts, which do not hold assets but are maintained for record-keeping-purposes. The earnings under the Plan are credited based on the return of measurement funds selected by the participants. The measurement funds are designed to mirror the performance of mutual funds selected by the Plan Committee. All participant contributions vest immediately. Each year, based on a written agreement (such as an employment agreement) or at its sole discretion, Sterling may contribute amounts to all, some or none of the participants. The vesting of the Sterling contributions is determined based on the written agreement between the participant and Sterling or based on a vesting schedule determined by the Plan Committee. Within 60 days after the later of the first business day of the plan year following the plan year in which the participant retires, or the last day of the six month period immediately following the date on which the participant retires, the participant’s account will be distributed either in a lump sum or installments up to 15 years as elected by the participant. Within 60 days after the Plan Committee is notified of the participants’ death or the participant becomes disabled, the participants account will be distributed in a lump sum. Within 60 days after the last day of the six month period immediately following the date on which

employment terminates, the participant’s account will be distributed in a lump sum payment. Participants may elect to receive a scheduled distribution with certain exclusions.

 

Perquisites.  Certain key employees of Sterling receive benefits that are designed to reward their contributions to Sterling and to encourage their productivity and continued service to Sterling. Certain of the perquisites provided to the Named Executive Officers, such as athletic club memberships, are deemed to provide business value to Sterling because they provide a place for executives to continue to interact with customers and develop business during non-business hours. Perquisites provided to certain of the Named Executive Officers during 2006 included an auto allowance, payment of club dues and financial planning and tax preparation assistance.

 

Klamath Plans.  In connection with the acquisition of Klamath First Bancorp, Inc. (“Klamath”) in 2004, Sterling assumed Supplemental Executive Retirement Plans (the “Klamath SERP Agreements”) in place with certain former Klamath executives. Under the Klamath SERP Agreements, these executives are entitled to receive a normal retirement benefit at their normal retirement age that provides a continuation of salary for life, with annual increases of two percent. The amount of the normal retirement benefit is based on each executive’s projected annual salary at the time of his normal retirement age. The former Klamath executives are fully vested in these agreements.

 

Sterling also assumed director fee continuation agreements with the former Klamath directors, which entitle each director to retirement benefits upon termination of service, except for cause. Klamath directors who were terminated subsequent to the transaction are initially entitled to normal retirement benefits of $3,007 per month for directors who were at least age 65 on the effective date of the transaction and $2,834 per month for directors who were under age 65, with annual increases of two percent. A director retiring before age 65 may elect to receive the retirement benefit prior to age 65, in which case the benefit will be reduced accordingly, based on the number of years that payments commence before normal retirement age. If the director dies before 60 monthly payments have been made, such payments will continue until a total of 60 monthly payments have been made, or until the death of the director’s surviving spouse, whichever occurs earlier.

 

FirstBank Plans.  In connection with the acquisition of FirstBank NW Corp. (“FirstBank”) in 2006, Sterling assumed an Executive Nonqualified Retirement Plan (the “FirstBank NQRP”) in place for certain former FirstBank executives. Under the FirstBank NQRP, these executives are entitled to receive a normal retirement benefit at their normal retirement age that provides monthly payments for life, with annual increases of 2.5% for inflation, as provided in their plan agreements under the FirstBank NQRP. The former FirstBank executives are entitled to receive the portion of their normal retirement benefit that was vested as of November 30, 2006 under the FirstBank NQRP.

 

Sterling also assumed the FirstBank Northwest Deferred Compensation Plan (the “FirstBank DCP”) in which the former FirstBank and FirstBank Northwest directors participated. Participants were allowed to defer a portion of their cash compensation into the plan and at all times remained 100% vested in these amounts. Participant balances will be distributed in accordance with the participant elections, which were made in accordance with the Code Section 409A transition guidance.

 

Sterling also assumed five fully paid-up split dollar insurance agreements for the benefit of certain FirstBank and FirstBank Northwest directors under which the insured’s beneficiary will receive 40% of the excess death proceeds upon each insured’s death. The excess death proceeds are the amounts to be received under the designated life insurance policy that are in excess of the account value of the policy at the time of death.

 

The following table sets forth information concerning compensation received from the Named Executive Officers and one officer who retired during 2006 for services in all capacities to Sterling and its subsidiaries during the fiscal year ended December 31, 2006.

 

 

 

 

 

The components of the “All Other Compensation” column in the Summary Compensation Table, including perquisites that in the aggregate exceeded $10,000 for an individual, are detailed in the following table.

 

 

 

 

Under the direction of the Audit Committee, Sterling has reviewed its policy regarding the granting of stock options and affirmed that Sterling has adequate procedures in place to ensure that no option grants have been or may be “back-dated” or “spring-loaded.” In connection with the review of its stock option granting polices, in 2006 the Board determined that stock options will only be granted during the open trading period following the release of earning results. The purpose of this change is to ensure that the market value at the time that options are granted reflects full information disclosure. As a result of the adoption of this policy in 2006, Sterling did not make any grants of plan-based awards during 2006 and any stock option grants based upon the Named Executive Officers’ performance in 2006 will not be awarded until 2007 and will therefore be reported in the 2008 proxy statement.

 

 

 

 

 

The following table sets forth information on the exercise of stock options during 2006 by each of the Named Executive Officers and the value of unexercised in-the-money options at December 31, 2006.