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As filed with the Securities and Exchange Commission on September 15, 2003.

Registration No. 333-            



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

FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

STERLING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

WASHINGTON
(State or other jurisdiction of
incorporation or organization)
  6719
(Primary Standard Industrial
Classification Code Number)
  91-1572822
(I.R.S. Employer
Identification No.)

111 North Wall Street
Spokane, Washington 99201
(509) 458-2711
(Address, including zip code, and telephone number, including area code, of registrant's principal executive offices)

Ned M. Barnes, Secretary
Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
(509) 458-2884
(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies of communications to:

Donald J. Lukes, Esq.
Richard A. Repp, Esq.
Witherspoon, Kelley, Davenport & Toole, P.S.
1100 U.S. Bank Building
422 West Riverside Avenue
Spokane, Washington 99201
(509) 624-5265
  John F. Breyer, Jr., Esq.
Breyer & Associates PC
8180 Greensboro Drive
Suite 785
McLean, Virginia 22102
(703) 883-1100

        Approximate date of commencement of proposed sale of the securities to public: As soon as practicable after the effective date of this registration statement and the satisfaction or waiver of all other conditions to the merger described in the joint proxy statement/prospectus.

        If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G check the following box: o

        If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

        If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o

CALCULATION OF REGISTRATION FEE


Title of each class of securities to be registered
  Amount to be registered(1)
  Proposed maximum offering price per unit
  Proposed maximum aggregate offering price(2)
  Amount of registration fee(2)

Common Stock, par value $1.00 per share   5,870,153   N/A   $165,888,992   $13,421

(1)
Represents the maximum number of shares of common stock of Sterling Financial Corporation issuable or reserved for issuance upon consummation of the merger described herein.

(2)
Pursuant to Rule 457(c) and 457(f), the registration fee is based on the high and low prices of Klamath First Bancorp, Inc. common stock as reported by Nasdaq on September 12, 2003 ($21.76) multiplied by 7,623,575 (the maximum number of shares of Klamath common stock to be converted in the merger).


        The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.




GRAPHIC   GRAPHIC

        The boards of directors of Sterling Financial Corporation and Klamath First Bancorp, Inc. have unanimously approved an agreement to combine our companies. In the merger, Klamath will merge into Sterling, with Sterling being the surviving corporation. Each share of Klamath common stock will be converted into 0.77 shares of Sterling common stock. The exchange ratio is fixed and will not be adjusted based on changes in the prices of our common stock prior to the closing, except under certain circumstances that are described in the accompanying joint proxy statement/prospectus.

        The value of the merger consideration received by Klamath's shareholders will fluctuate with the market price of Sterling common stock.

        We urge you to obtain current market price quotations for Sterling and Klamath common stock. Sterling common stock is quoted on the Nasdaq National Market under the symbol "STSA." Klamath common stock is quoted on the Nasdaq National Market under the symbol "KFBI." We expect that the merger will be a tax free transaction for Klamath's shareholders.

        Each of our companies will hold a special meeting of shareholders to vote on the proposed merger. Your vote is very important. Whether or not you plan to attend your special meeting, please take the time to vote by completing and mailing the enclosed proxy card to us. The date of both the Sterling and Klamath special meetings is [December 11, 2003] and notices of both meetings follow this letter.

        The accompanying joint proxy statement/prospectus gives you important information about the proposed merger and related matters. You should read this entire document carefully, including the section entitled "Risk Factors" beginning on page [    ], before you decide how to vote on the merger and the transactions contemplated by the merger agreement.

        The respective boards of directors of Sterling and Klamath have unanimously determined that the terms of the merger agreement and the merger are fair to and in the best interests of their respective shareholders. The financial advisors for Sterling and Klamath have reached the same conclusion. We enthusiastically join the other members of our boards of directors in recommending that you vote FOR approval of the merger.


Harold B. Gilkey
Chairman and Chief Executive Officer
Sterling Financial Corporation

 

Kermit K. Houser
President and Chief Executive Officer
Klamath First Bancorp, Inc.

        Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved the Sterling common stock to be issued in the merger or determined if this joint proxy statement/prospectus is accurate or adequate. Any representation to the contrary is a criminal offense. The securities offered through this document are not deposits, savings accounts or other obligations of a depository institution and are not insured by the Federal Deposit Insurance Corporation or any other governmental agency.

        This joint proxy statement/prospectus is dated [October    , 2003] and is first being mailed to shareholders on or about [November     , 2003].



REFERENCES TO ADDITIONAL INFORMATION

        This joint proxy statement/prospectus incorporates important business and financial information about Sterling and Klamath from other documents that are not included in or delivered with this document. This information is available to you without charge upon written or oral request. You can obtain documents relating to Sterling and Klamath that are incorporated by reference in this document through the SEC's website at http://www.sec.gov or by requesting them in writing or by telephone from the appropriate company:

Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
Attn: Investor Relations
(509) 458-2711
  Klamath First Bancorp, Inc.
540 Main Street
Klamath Falls, Oregon 97601
Attn: Investor Relations
(541) 882-3444

        If you would like to request documents please do so by [December 1, 2003], in order to receive them before the special meeting of shareholders. See "Where You Can Find More Information" on page [    ].



STERLING FINANCIAL CORPORATION
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON DECEMBER 11, 2003

        A special meeting of shareholders of Sterling Financial Corporation will be held on the third floor of the headquarters of Sterling Financial Corporation located at 111 North Wall Street, Spokane, Washington, on [Thursday, December 11, 2003,] at 10:00 a.m., local time, for the following purposes:

        We have fixed October 13, 2003 as the record date for determining those shareholders entitled to vote at the special meeting and any adjournments or postponements of the special meeting. Accordingly, only shareholders of record at the close of business on that date are entitled to notice of, and to vote at, the special meeting and any adjournments or postponements of the special meeting.

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

    By Order of the Board of Directors,

 

 

Ned M. Barnes
Secretary

Spokane, Washington
[October 31, 2003]

 

 

 


KLAMATH FIRST BANCORP, INC.
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD DECEMBER 11, 2003

        NOTICE IS HEREBY GIVEN that a special meeting of shareholders of Klamath First Bancorp, Inc. will be held at the Ross Ragland Theater Cultural Center, 218 N. 7th Street, Klamath Falls, Oregon 97601, on [Thursday, December 11, 2003], at 10:00 a.m., for the following purposes:

        The proposed merger is discussed more fully in the joint proxy statement/prospectus attached to this notice. We urge you to read this document and its appendices carefully before voting.

        Only Klamath shareholders of record at the close of business on October 13, 2003 are entitled to notice of and to vote at the special meeting, or any adjournment thereof. A majority of the shares of Klamath common stock outstanding on the record date must be voted in favor of the merger agreement in order for the merger to be completed. Therefore, your vote is very important.

        All Klamath shareholders are cordially invited to attend the special meeting. However, we encourage you to vote by proxy so that your shares will be represented and voted at the meeting even if you cannot attend. You may vote by written proxy card using the instructions provided on the enclosed proxy card. Of course, this will not prevent you from voting in person at the meeting. Your failure to vote your shares is the same as voting against approval of the merger agreement.

        After careful consideration, the board of directors of Klamath has determined that the merger and the merger agreement are fair and in the best interests of Klamath and its shareholders and unanimously recommends that Klamath shareholders vote FOR approval of the merger agreement.

    By Order of the Board of Directors,

 

 

Craig M Moore
Secretary

Klamath Falls, Oregon
[October 31, 2003]

 

 

 

IMPORTANT: THE PROMPT RETURN OF PROXIES WILL SAVE THE COMPANY THE EXPENSE OF FURTHER REQUESTS FOR PROXIES. THEREFORE, PLEASE COMPLETE, SIGN AND DATE THE ENCLOSED PROXY CARD AND PROMPTLY RETURN IT. A SELF-ADDRESSED ENVELOPE IS ENCLOSED FOR YOUR CONVENIENCE. NO POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES.



TABLE OF CONTENTS

QUESTIONS AND ANSWERS ABOUT THE MERGER   1
SUMMARY OF THIS JOINT PROXY STATEMENT/PROSPECTUS   3
  The Companies   3
  Summary of the Transaction   4
  Selected Financial Data of Sterling   8
  Selected Financial Data of Klamath   11
  Comparative Stock Price and Dividend Information   13
  Selected Combined Consolidated Unaudited Pro Forma Financial Data   14
  Selected Combined Consolidated Unaudited Pro Forma Comparative Per Share Data   16
RISK FACTORS   17
THE STERLING SPECIAL MEETING   19
  Date, time, place and purpose of Sterling's special meeting   19
  Record date; outstanding shares; shares entitled to vote   19
  Quorum; vote required   19
  Voting of proxies   19
  How to revoke your proxy   20
  Abstentions and broker non-votes   20
  Voting electronically via Internet or telephone   20
  Expenses of proxy solicitation   20
  Certificates   20
  Recommendation of Sterling's board of directors   20
THE KLAMATH SPECIAL MEETING   21
  Date, time, place and purpose of Klamath's special meeting   21
  Record date; outstanding shares; shares entitled to vote   21
  Quorum; vote required   21
  Voting of proxies   21
  Participants in the Klamath First Federal ESOP   21
  How to revoke your proxy   22
  Abstentions and broker non-votes   22
  Voting electronically via Internet or telephone   22
  Expenses of proxy solicitation   22
  Certificates   23
  Share ownership of management   23
  Recommendation of Klamath's board of directors   23
THE MERGER   23
  Background of the merger   23
  Sterling's reasons for the merger   26
  Recommendation of Sterling's board of directors   27
  Klamath's reasons for the merger   27
  Recommendation of Klamath's board of directors   30
  Opinion of Sterling's financial advisor   30
  Opinion of Klamath's financial advisor   38
  Structure of the merger   46
  Exchange ratio; possible adjustment of exchange ratio   46
  Treatment of options and employee stock purchase and benefit plans   46
  Interests of Klamath's directors and executive officers in the merger   47
  Restrictions on sales by affiliates   50
  Material United States federal income tax consequences of the merger   51
     

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  Accounting treatment of the merger   52
  Exchange of Klamath stock certificates for Sterling stock certificates   52
  Conditions to completion of the merger   52
  Representations and warranties   53
  Exclusivity   54
  Other agreements   54
  Termination of the merger agreement   57
  Termination fees   58
  Extension; waiver   58
  Amendment of the merger agreement   58
  Klamath management voting agreements   58
COMPARISON OF RIGHTS OF HOLDERS OF KLAMATH COMMON STOCK AND STERLING COMMON STOCK   59
  Board of directors   59
  Right to call special meeting of shareholders   59
  Preemptive rights   59
  Removal of directors   60
  Removal of officers   60
  Filling vacancies on the board of directors   60
  Amendment of articles and bylaws   60
  Right to call special meeting of directors   60
  Shareholder nomination and shareholder proposals   61
  Voting rights   61
  Related person transactions   61
  Anti-takeover provisions   62
SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND DIRECTORS OF STERLING   63
SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND DIRECTORS OF KLAMATH   65
PRO FORMA FINANCIAL INFORMATION   67
LEGAL MATTERS   74
EXPERTS   74
SHAREHOLDER PROPOSALS   74
DOCUMENTS INCORPORATED BY REFERENCE INTO THIS JOINT PROXY STATEMENT/PROSPECTUS   75
WHERE YOU CAN FIND MORE INFORMATION   76
FORWARD-LOOKING INFORMATION   76

ANNEX A—Agreement and Plan of Merger

 

 
ANNEX B—Fairness Opinion of Sandler O'Neill & Partners, L.P.    
ANNEX C—Fairness Opinion of D.A. Davidson & Co.    

ii



QUESTIONS AND ANSWERS ABOUT THE MERGER

Q:
Why are the companies proposing to merge?

A:
We are proposing to merge because we believe that the combined company will be a stronger, more competitive company. We also believe that the complementary distribution networks of our two companies will result in the combined company being a leading regional community bank in the Pacific Northwest. See "The Merger-Sterling's reasons for the merger" and "Klamath's reasons for the merger."

Q:
What will Klamath shareholders receive in the merger?

A:
Under the merger agreement, each outstanding share of Klamath common stock will be converted into 0.77 shares of Sterling common stock and cash in lieu of fractional shares.

Q:
What do I need to do now?

A:
First, please carefully read this joint proxy statement/prospectus. Then, whether or not you expect to attend your shareholders meeting, please mail your completed and signed proxy card in the enclosed return envelope as soon as possible so that your shares will be represented at your shareholders meeting. Your proxy card must be received prior to your shareholders meeting in order for your shares to be voted at your shareholders meeting, unless you attend and vote at your shareholders meeting. If you are able to attend your shareholders meeting, you may revoke your proxy and vote your shares in person even if you have previously completed and returned the proxy card. See "The Sterling Special Meeting" and "The Klamath Special Meeting" as applicable.

Q:
What vote is required to approve the merger?

A:
For the merger agreement to be approved by Sterling shareholders, a majority of the votes cast in person or by proxy at the special meeting must vote FOR approval of the merger agreement.
Q:
Can I dissent and require appraisal of my shares?

A:
Shareholders are not entitled to dissenters' appraisal rights in connection with the merger.

Q:
What do I do if I want to change my vote?

A:
You can change your vote in one of three ways at any time before your proxy is voted at your special meeting. First, you can send Klamath or Sterling, as appropriate, a written notice stating that you would like to revoke your proxy. Second, you can complete and send a new proxy card. Third, you can attend your special meeting and vote in person. If you have voted through a broker, bank or other nominee, you must follow the directions you receive from such entity to change your vote.

Q:
If my shares are held in "street name" by my broker, will my broker vote my shares for me?

A:
Your broker will vote your shares only if you provide instructions on how to vote. You should fill out the voter instruction form sent to you by your broker with this joint proxy statement/prospectus. Klamath shareholders who do not give instructions to their broker will, in effect, be voting against the merger agreement.

Q:
Should I send in my Klamath stock certificates now?

A:
No. After the merger is completed, we will send you written instructions for exchanging your Klamath stock certificates for Sterling stock certificates. Please do not send in your stock certificates with your proxy card. Sterling shareholders will continue to hold their certificates.

Q:
When do you expect the merger to be completed?

A:
We are working toward completing the merger as quickly as possible. We hope to complete the merger in early January 2004, if all required matters have been completed at that time.

Q:
Will I recognize a taxable gain or loss on the transaction?

A:
We expect that if the merger is completed, you will not recognize a gain or loss for United States federal income tax purposes as a result of the merger, except that Klamath shareholders will recognize a gain or loss with respect to cash received in lieu of a fractional share of Sterling common stock. However, we urge you to consult your own tax advisor to determine the tax consequences particular to your situation.

Q:
Whom should I call with questions?

A:
If you have any questions or if you need additional copies of the joint proxy statement/prospectus or other information, you should contact:

Klamath First Bancorp, Inc.
Investor Relations
540 Main Street
Klamath Falls, OR 97601
(541) 882-3444
  Sterling Financial Corporation
Investor Relations
111 North Wall Street
Spokane, WA 99201
(509) 458-2711
Q:
Are there any risks related to the proposed transaction or any risks related to owning Sterling common stock?

A.
Yes. You should carefully review the section entitled "Risk Factors" beginning on page [    ] of this joint proxy statement/prospectus.

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SUMMARY OF THIS JOINT PROXY STATEMENT/PROSPECTUS

        This summary and the preceding "Questions and Answers about the Merger" highlight selected information from this joint proxy statement/prospectus and may not contain all of the information that is important to you. To understand the merger fully and for a more complete description of the legal terms of the merger, you should carefully read this entire joint proxy statement/prospectus and the other documents to which we refer you. See "Where You Can Find More Information" on page [    ]. We have included page references in parentheses to direct you to a more complete description of some of the topics presented in this summary.


The Companies

Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
(509) 458-2711
www.sterlingsavingsbank.com

        Sterling Financial Corporation is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank. The principal operating subsidiaries of Sterling Savings Bank are Action Mortgage Company, INTERVEST-Mortgage Investment Company and Harbor Financial Services, Inc. Sterling Savings Bank commenced operations in 1983 as a Washington State-chartered, federally insured stock savings and loan association headquartered in Spokane, Washington.

        Sterling provides personalized, quality financial services to its customers as exemplified by its "Hometown Helpful" philosophy. Sterling believes that this dedication to personalized service has enabled it to maintain a stable retail deposit base. With $4.09 billion in total assets at June 30, 2003, Sterling attracts Federal Deposit Insurance Corporation insured deposits from the general public through 83 retail branches located in Washington, Oregon, Idaho and Montana. Sterling originates loans through its branch offices as well as Action Mortgage residential loan production offices in the four-state area and through INTERVEST commercial real estate lending offices in Washington and Oregon. Sterling also markets tax-deferred annuities, mutual funds and other financial products through Harbor Financial and property and casualty insurance coverage through Dime Insurance Agency, a subsidiary of Sterling Savings Bank.

        For additional information about Sterling's business, see Sterling's Annual Report on Form 10-K for the year ended December 31, 2002 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003 and June 30, 2003 and other documents Sterling has filed with the SEC, which are incorporated into this joint proxy statement/prospectus by reference. See "Where You Can Find More Information" on page [    ].

Klamath First Bancorp, Inc.
540 Main Street
Klamath Falls, Oregon 97601
(541) 882-3444
www.Klamathfirst.com

        Klamath First Bancorp, Inc. is a unitary savings and loan holding company, the significant subsidiary of which is Klamath First Federal Savings and Loan Association.

        Klamath First Federal is a progressive, community-oriented savings and loan association that focuses on customer service within its primary market area. Klamath First Federal is primarily engaged in attracting deposits from the general public and using those and other available sources of funds to originate permanent residential one-to four-family real estate loans and loans on commercial real estate, multi-family residential properties, and to consumers and small businesses within its market

3



area. While Klamath First Federal has historically emphasized fixed rate mortgage lending, it has been diversifying its loan portfolio by focusing on increasing the number of originations of commercial real estate loans, multi-family residential loans, residential construction loans, commercial and industrial loans, business loans and non-mortgage consumer loans. A significant portion of these newer loan products carry adjustable rates, higher yields, or shorter terms than the traditional fixed rate mortgages. This lending strategy is designed to enhance earnings, reduce interest rate risk, and provide a more complete range of financial services to customers and the local communities served.

        At June 30, 2003, Klamath had total consolidated assets of $1.45 billion, consolidated shareholders' equity of $121.5 million and 59 offices. In September 2003, Klamath announced that it had entered into an agreement to sell seven of its branches with aggregate deposits of approximately $66 million. The sale of such branches is expected to be completed in December 2003.

        For additional information about Klamath's business, see Klamath's Annual Report on Form 10-K for the year ended September 30, 2002 and Quarterly Reports on Form 10-Q for the quarters ended December 31, 2002, March 31, 2003 and June 30, 2003, and other documents Klamath has filed with the SEC, which are incorporated into this joint proxy statement/ prospectus by reference. See "Where You Can Find More Information" on page [    ].


Summary of the Transaction

The merger (page [    ]).

        In the merger, Klamath will merge with and into Sterling. The merger agreement is attached to this joint proxy statement/prospectus as Annex A and is incorporated herein by reference. We encourage you to carefully read the merger agreement and the discussion of the merger and merger agreement in this joint proxy statement/prospectus.

Our reasons for the merger (pages [    ] and [    ]).

        We are proposing to merge our two companies because we believe that:

        These potential benefits, however, may not be achieved. For a more complete description of the factors considered by the respective boards of directors, see "The Merger-Sterling's reasons for the merger" and "Klamath's reasons for the merger." In addition, there are potential risks related to the merger. See "Risk Factors" on page [    ] and "Forward-Looking Information" on page [    ].

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Our boards of directors recommend that you vote for the merger (pages [    ] and [    ]).

        The Sterling and the Klamath boards of directors believe that the merger is fair to and in the best interests of their respective shareholders. The Sterling board and the Klamath board have each, by unanimous votes of their members, approved the merger agreement and the transactions contemplated thereby and unanimously recommends that you vote FOR the approval of the merger agreement.

Our financial advisors say the merger consideration is fair (pages [    ] and [    ]; Annexes B and C).

        In deciding to approve the merger, Klamath's board of directors considered a written opinion, dated July 14, 2003, from its financial advisor, D.A. Davidson & Co., Inc. ("Davidson"), that the consideration to be received in the merger was fair from a financial point of view to holders of Klamath common stock.

        In deciding to approve the merger, Sterling's board of directors considered a written opinion, dated July 14, 2003, from its financial advisor, Sandler O'Neill & Partners, L.P. ("Sandler O'Neill"), that the exchange ratio was fair to Sterling from a financial point of view.

The exchange ratio (page [    ]).

        Pursuant to the merger agreement, each share of Klamath common stock will be converted into 0.77 shares of Sterling common stock. Instead of issuing fractional shares of stock, Sterling will pay cash for fractional shares based on the average closing price of Sterling common stock over a specified period of time before the closing of the merger.

Possible adjustment of exchange ratio ([page [    ]).

        If the average closing price of Sterling's common stock during a specified period just prior to the closing date is less than $20.53 and the price has also declined since June 13, 2003 by 15% or more relative to a weighted average index of a certain group of financial institution holding companies, Klamath has the right to terminate the merger agreement under certain conditions. Sterling, however, will then have the option to avoid the termination by increasing the number of shares of Sterling common stock to be exchanged for shares of Klamath common stock.

Special shareholders meetings (page [    ]).

        Klamath.    The special meeting of Klamath's shareholders will be held on [Thursday, December 11, 2003], at 10:00 a.m., local time, at the Ross Ragland Theater Cultural Center, 218 N. 7th Street, Klamath Falls, Oregon. At the meeting, you will be asked to approve the merger agreement for the merger of Klamath with and into Sterling. You can vote at the special meeting only if you owned shares of Klamath common stock at the close of business on October 13, 2003, the record date.

        Sterling.    The special meeting of Sterling's shareholders will be held on [Thursday, December 11, 2003], at 10:00 a.m. local time, at the headquarters of Sterling, 111 North Wall Street, Spokane, Washington, on the third floor. At the meeting, you will be asked to approve the merger agreement for the merger of Klamath with and into Sterling. You can vote at the special meeting only if you owned shares of Sterling common stock at the close of business on October 13, 2003, the record date.

Votes required for approval (page [    ]).

        Klamath.    For the merger agreement to be approved by Klamath shareholders, a majority of all the votes entitled to be cast in person or by proxy at the special meeting must vote FOR approval of the merger agreement. Klamath's shareholders are entitled to cast one vote for each share of Klamath common stock they owned as of the record date. For a discussion of a certain limitation on voting rights, see "The Klamath Special Meeting-Record date; outstanding shares; shares entitled to vote."

5


        Sterling.    For the merger to be approved by Sterling shareholders, a majority of the votes cast in person or by proxy by Sterling shareholders at the special meeting must vote FOR approval of the merger agreement. Sterling's shareholders are entitled to cast one vote for each share of Sterling common stock they owned as of the record date. As of the record date, Sterling's directors and executive officers collectively owned [    ] shares of Sterling common stock, or approximately [    ] percent of Sterling's outstanding shares.

Klamath's directors and certain executive officers have agreed to vote in favor of the merger agreement (page [    ]).

        As a condition to the merger, Klamath's directors and certain executive officers, who collectively held approximately [    ] percent of Klamath's outstanding common stock as of October 13, 2003, the record date, have agreed to vote all the shares of Klamath common stock beneficially owned by them in favor of approval of the merger agreement.

Interests of Klamath's directors and executive officers in the merger (page [    ]).

        When considering the recommendation of Klamath's board of directors, you should be aware that some of Klamath's directors and executive officers have interests in the merger that are different from, or in addition to, yours. These include indemnification rights, board appointments, and acceleration of vesting for options and restricted stock, and other benefits and payments under agreements and employee benefit and retention plans. Klamath's board of directors was aware of and considered the interests of Klamath's directors and executive officers in approving the merger and recommending that Klamath's shareholders approve the merger.

The merger will generally be tax-free to shareholders (page [    ]).

        Sterling and Klamath intend the merger to qualify as a tax-free reorganization under the Internal Revenue Code. It is a condition to the completion of the merger that both parties receive an opinion from their tax counsel that the merger will so qualify. We expect that none of Klamath, Sterling or their respective shareholders will recognize a gain or loss for United States federal income tax purposes, except for taxes payable by Klamath shareholders for cash received instead of fractional shares of Sterling common stock. Because tax matters are complicated, however, we urge you to consult your own tax advisor to understand fully how the merger will affect you, including how any state, local or foreign tax laws may apply to you.

Accounting treatment of the merger (page [    ]).

        Sterling expects to account for the merger using the purchase method of accounting in accordance with generally accepted accounting principles.

Certain conditions must be met prior to completion of the merger (page [    ]).

        Klamath's and Sterling's respective obligations to effect the merger are subject to the prior satisfaction or waiver of specific conditions including the approval of the merger by shareholders of Sterling and Klamath.

The merger agreement may be terminated (page [    ]).

        Even if Klamath's shareholders approve the merger, Sterling and Klamath can agree at any time to terminate the merger agreement without completing the merger. In addition, subject to qualifications, the merger agreement may be terminated by either Klamath or Sterling if certain conditions occur.

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Termination fees may become payable (page [    ]).

        Klamath must pay Sterling a termination fee of up to $6.0 million if the merger agreement is terminated under certain conditions. Sterling must pay Klamath a termination fee of $1.5 million if the merger agreement is terminated under certain conditions.

Differences in rights of Klamath and Sterling shareholders (page [    ]).

        The rights of Klamath's shareholders are governed by Oregon law and Klamath's articles of incorporation and bylaws. When the merger is completed, Klamath's shareholders will become shareholders of Sterling. Because Sterling is a Washington corporation, the rights of Klamath's shareholders will be governed following the merger by Washington law and by Sterling's articles of incorporation and bylaws, which differ in some respects from Klamath's.

Treatment of options (page [    ]).

        Pursuant to the terms of Klamath's stock option plan, as a result of the merger, each outstanding option to purchase shares of Klamath common stock will be converted into the right to purchase a number of shares of Sterling common stock, based upon the exchange ratio.

Treatment of employee benefit plans (page [    ]).

        Klamath has agreed to terminate or withdraw from all of Klamath's employee benefit plans, except for the Klamath 401(k) Plan, at or as soon as reasonably practicable after the effective time of the merger. Sterling has agreed to merge the Klamath 401(k) Plan into Sterling's 401(k) Plan. Sterling will also offer Klamath employees who remain at Sterling benefits commensurate with the benefits it provides to comparable Sterling employees.

Comparative common stock price and dividend information (page [    ]).

        Shares of both Sterling common stock and Klamath common stock are listed on the Nasdaq National Market under the symbols "STSA" and "KFBI," respectively. On July 14, 2003, the last full trading day before the public announcement of the proposed merger, Sterling's common stock closed at $26.55 per share and Klamath's common stock closed at $17.45 per share. On [October 31, 2003], a date just prior to the time of the printing of this joint proxy statement/prospectus, Sterling's common stock closed at [$    ] per share and Klamath's common stock closed at [$    ] per share. We urge you to obtain current market quotations.

7



Selected Financial Data of Sterling

        The following tables set forth selected historical consolidated financial and other data of Sterling as of and for the five years ended December 31, 2002 and as of and for the six months ended June 30, 2003 and 2002. The historical consolidated financial data for the six months ended June 30, 2003 and 2002 is derived from unaudited consolidated financial statements. However, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation at such dates and for such periods have been made. Operating results for the six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for any interim period or the entire year ending December 31, 2003. The financial information for the five years ended December 31, 2002 is based on, and qualified in its entirety by, the consolidated financial statements of Sterling, including the notes thereto, which are incorporated by reference in this joint proxy statement/prospectus and should be read in conjunction herewith.

 
  June 30,
  December 31,
 
 
  2003
  2002
  2002
  2001
  2000
  1999
  1998
 
 
  (Dollars in thousands)

 
BALANCE SHEET DATA                                            

Total assets

 

$

4,094,587

 

$

3,088,078

 

$

3,506,064

 

$

3,038,593

 

$

2,652,709

 

$

2,546,925

 

$

2,314,587

 
Loans receivable, net     2,668,990     2,173,176     2,390,263     2,109,479     1,965,927     1,787,771     1,468,534  
Asset-backed securities     980,791     580,042     743,610     617,569     314,434     343,310     405,725  
Investments     95,912     78,080     86,558     76,479     171,748     162,420     180,680  
Deposits     2,393,707     1,979,219     2,014,096     1,853,536     1,724,219     1,617,368     1,545,425  
FHLB Seattle advances     995,119     620,249     874,515     633,054     530,652     490,503     319,540  
Reverse repurchase agreements     276,958     151,258     249,769     118,549     110,326     179,515     195,074  
Other borrowings     139,782     119,000     127,682     127,500     110,000     110,000     97,240  
Shareholders' equity     246,343     186,778     203,656     165,690     141,338     117,639     119,017  

CAPITAL RATIOS(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Core capital ratio

 

 

7.43

%

 

8.22

%

 

7.57

%

 

8.00

%

 

7.10

%

 

6.77

%

 

6.39

%
Tier I risk-based capital ratio     10.10 %   10.55 %   10.03 %   10.83 %   9.71 %   9.50 %   9.40 %
Total risk-based capital ratio     11.05 %   11.44 %   10.96 %   11.69 %   10.25 %   10.36 %   10.30 %

STATISTICAL DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Employees (full time equivalents)     1,058     944     953     890     822     817     746  
Full service offices     83     77     79     77     77     77     77  

8


Selected Operating Data of Sterling(1)(2)

 
  Six Months Ended
June 30,

  Years Ended December 31,
 
 
  2003
  2002
  2002
  2001
  2000
  1999
  1998
 
 
  (Dollars in thousands, except per share amounts)

 
OPERATING RESULTS                                            

Interest income

 

$

104,136

 

$

95,867

 

$

197,313

 

$

201,385

 

$

205,310

 

$

177,109

 

$

155,763

 
Interest expense     (45,525 )   (49,110 )   (96,965 )   (116,516 )   (125,544 )   (102,004 )   (96,558 )
   
 
 
 
 
 
 
 
Net interest income     58,611     46,757     100,348     84,869     79,766     75,105     59,205  
Provision for losses on loans     (4,800 )   (4,313 )   (11,867 )   (8,000 )   (4,600 )   (3,900 )   (5,325 )
   
 
 
 
 
 
 
 
Net interest income after provision for losses on loans     53,811     42,444     88,481     76,869     75,166     71,205     53,880  
Other income     16,798     12,574     29,080     21,021     14,488     13,562     12,313  
Merger, acquisition and conversion costs     (188 )   0     0     (283 )   0     0     (5,464 )
Amortization of goodwill and other intangibles     (105 )   (644 )   (644 )   (5,377 )   (5,490 )   (5,692 )   (3,971 )
Goodwill litigation     (314 )   (520 )   (1,100 )   (890 )   (1,074 )   (272 )   0  
Other operating expenses     (43,408 )   (38,255 )   (79,199 )   (66,743 )   (61,404 )   (58,514 )   (46,856 )
   
 
 
 
 
 
 
 
Income before income taxes     26,594     15,599     36,618     24,597     21,686     20,289     9,902  
Income tax provision     (9,294 )   (4,282 )   (11,031 )   (8,409 )   (8,033 )   (7,470 )   (3,679 )
   
 
 
 
 
 
 
 
Net income   $ 17,300   $ 11,317   $ 25,587   $ 16,188   $ 13,653   $ 12,819   $ 6,223  
   
 
 
 
 
 
 
 

Earnings per share-basic(1)

 

$

1.21

 

$

0.88

 

$

1.96

 

$

1.34

 

$

1.15

 

$

1.08

 

$

0.53

 

Earnings per share-diluted(1)

 

$

1.18

 

$

0.85

 

$

1.91

 

$

1.31

 

$

1.15

 

$

1.08

 

$

0.52

 

Weighted average shares outstanding—basic(1)

 

 

14,244,227

 

 

12,903,754

 

 

13,027,884

 

 

12,105,546

 

 

11,857,657

 

 

11,834,358

 

 

11,753,117

 

Weighted average shares outstanding—diluted(1)

 

 

14,602,015

 

 

13,392,933

 

 

13,432,770

 

 

12,364,029

 

 

11,911,639

 

 

11,919,534

 

 

12,005,381

 

FINANCIAL RATIOS(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Return on average assets     0.92 %   0.75 %   0.80 %   0.58 %   0.52 %   0.52 %   0.30 %
Return on average shareholders' equity     15.0 %   13.2 %   13.9 %   10.5 %   11.0 %   10.7 %   5.4 %
Shareholders' equity to total assets at end of period     6.0 %   6.1 %   5.8 %   5.5 %   5.3 %   4.6 %   5.1 %
Book value per share at end of period   $ 16.67   $ 14.22   $ 15.48   $ 12.99   $ 11.92   $ 9.93   $ 10.09  
Operating efficiency     58.4 %   66.4 %   62.5 %   69.2 %   72.1 %   72.7 %   78.7 %
Net interest margin     3.33 %   3.30 %   3.37 %   3.27 %   3.25 %   3.33 %   3.05 %
Nonperforming assets to total assets at end of period     0.77 %   0.94 %   0.59 %   0.82 %   0.56 %   0.65 %   0.40 %

Reported net income

 

$

17,300

 

$

11,317

 

$

25,587

 

$

16,188

 

$

13,653

 

$

12,819

 

$

6,223

 
Add back: goodwill amortization, net of tax(3)     0     0     0     2,538     2,494     2,621     1,595  
   
 
 
 
 
 
 
 
Total   $ 17,300   $ 11,317   $ 25,587   $ 18,726   $ 16,147   $ 15,440   $ 7,818  
   
 
 
 
 
 
 
 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Reported net income   $ 1.21   $ 0.88   $ 1.96   $ 1.34   $ 1.15   $ 1.08   $ 0.53  
  Goodwill amortization     0.00     0.00     0.00     0.21     0.21     0.22     0.14  
   
 
 
 
 
 
 
 
  Adjusted earnings per share   $ 1.21   $ 0.88   $ 1.96   $ 1.55   $ 1.36   $ 1.30   $ 0.67  
   
 
 
 
 
 
 
 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Reported net income   $ 1.18   $ 0.85   $ 1.91   $ 1.31   $ 1.15   $ 1.08   $ 0.52  
  Goodwill amortization     0.00     0.00     0.00     0.21     0.21     0.22     0.13  
   
 
 
 
 
 
 
 
  Adjusted earnings per share   $ 1.18   $ 0.85   $ 1.91   $ 1.52   $ 1.36   $ 1.30   $ 0.65  
   
 
 
 
 
 
 
 

9


10



Selected Financial Data of Klamath

        The following tables set forth selected historical consolidated financial and other data of Klamath as of and for the five years ended September 30, 2002, and as of and for the nine months ended June 30, 2003 and 2002. The historical consolidated financial data for the nine months ended June 30, 2003 and 2002 is derived from unaudited consolidated financial statements. However, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation at such dates and for such periods have been made. Operating results for the nine months ended June 30, 2003 are not necessarily indicative of the results that may be expected for any interim period or the entire year ended September 30, 2003. The financial information for the five years ended September 30, 2002 and the periods ended June 30, 2003 and 2002, is based on, and qualified in its entirety by, the consolidated financial statements of Klamath, including the notes thereto, which are incorporated by reference in this joint proxy statement/prospectus and should be read in conjunction herewith.

 
  June 30,
  September 30,
 
  2003(1)
  2002
  2002
  2001
  2000
  1999
  1998
 
  (Dollars in thousands)

FINANCIAL CONDITION DATA                                          

Assets

 

$

1,449,887

 

$

1,465,883

 

$

1,513,495

 

$

1,468,572

 

$

995,575

 

$

1,041,641

 

$

1,031,302
Cash and cash equivalents     58,989     67,814     45,791     118,389     29,947     24,523     66,985
Loans receivable, net     555,287     626,490     607,465     679,990     729,037     739,793     668,146
Investment securities held to maturity         457         135     267     560     2,889
Investment securities available for sale     141,347     141,267     119,542     154,676     116,628     158,648     203,224
Mortgage-backed & related securities held to maturity         378         1,621     2,160     2,601     3,662
Mortgage-backed & related securities available for sale     591,058     538,726     650,796     421,638     75,331     72,695     43,336
Stock in FHLB of Seattle, at cost     14,152     13,309     13,510     12,698     11,877     10,957     10,173
Advances from FHLB of Seattle     208,000     158,000     205,250     168,000     173,000     197,000     167,000
Deposit liabilities     1,081,010     1,148,589     1,142,006     1,152,824     695,381     720,401     689,541
Shareholders' equity     121,477     115,492     119,938     114,141     108,725     109,585     145,081

       

 
  Nine Months
Ended June 30,

  Years Ended September 30,
 
  2003(1)
  2002
  2002
  2001
  2000
  1999
  1998
 
  (Dollars in thousands, except per share data)

SELECTED OPERATING DATA                                          

Total interest income

 

$

54,345

 

$

66,447

 

$

87,293

 

$

70,133

 

$

72,158

 

$

71,691

 

$

69,733
Total interest expense     22,398     30,824     39,531     40,751     40,756     38,382     37,848
Net interest income     31,947     35,623     47,762     29,382     31,402     33,309     31,885
Provision for loan losses         156     156     387     1,764     932     674
Net interest income after provision for loan losses     31,947     35,467     47,606     28,995     29,638     32,377     31,211
Non-interest income     12,970     8,256     12,614     11,013     4,094     3,629     3,202
Non-interest expense     42,826     36,929     50,171     28,720     23,773     21,186     19,523
Earnings before income taxes     2,091     6,794     10,049     11,288     9,959     14,820     14,890
Provision for income tax     605     2,374     3,260     3,717     3,533     5,665     5,339
Net earnings   $ 1,486   $ 4,420   $ 6,789   $ 7,571   $ 6,426   $ 9,155   $ 9,551
Basic earnings per share   $ 0.23   $ 0.69   $ 1.06   $ 1.14   $ 0.94   $ 1.21   $ 1.05
Weighted average shares—basic     6,508,796     6,418,168     6,411,351     6,627,200     6,822,025     7,564,415     9,115,404

11


Selected Financial Data of Klamath (continued)

 
  Nine Months Ended
June 30,

  Years Ended September 30,
 
 
  2003(1)
  2002
  2002
  2001
  2000
  1999
  1998
 
 
  (Annualized)

  (Annualized)

   
   
   
   
   
 
KEY OPERATING RATIOS                                            

Performance Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Return on average assets (net earnings (loss) divided by average assets)     0.13 %   0.40 %   0.46 %   0.72 %   0.62 %   0.88 %   0.96 %
  Return on average equity (net earnings (loss) divided by average equity)     1.65 %   5.19 %   5.92 %   6.64 %   5.82 %   7.55 %   6.52 %
  Interest rate spread (difference between average yield on interest-earning assets and average cost of interest-bearing liabilities)     2.72 %   3.03 %   3.04 %   2.18 %   2.50 %   2.73 %   2.57 %
  Net interest margin (net interest income as a percentage of average interest-earning assets)     0.03 %   3.47 %   3.48 %   2.93 %   3.14 %   3.37 %   3.36 %
  Average interest-earning assets to average interest-bearing liabilities     117.14 %   114.58 %   115.18 %   118.37 %   115.71 %   116.47 %   119.84 %
  Net interest income after provision for loan losses to total non-interest expenses     74.60 %   96.04 %   94.89 %   100.96 %   124.39 %   152.82 %   159.87 %
  Non-interest expense to average total assets     3.79 %   3.33 %   3.37 %   2.74 %   2.29 %   2.05 %   1.96 %
  Efficiency ratio (non-interest expense divided by net interest income plus non-interest income)     95.34 %   84.16 %   83.10 %   55.48 %   66.97 %   57.36 %   55.64 %
  Dividend payout ratio (dividends declared per share divided by net earnings per share)     169.57 %   56.52 %   49.06 %   45.61 %   54.79 %   38.98 %   34.50 %
  Book value per share   $ 18.31   $ 18.28   $ 18.84   $ 17.40   $ 16.25   $ 15.52   $ 16.30  

Asset Quality Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Allowance for loan losses to total loans at end of period     1.23 %   1.22 %   1.19 %   1.13 %   0.54 %   0.32 %   0.28 %
  Non-performing assets to total assets     0.12 %   0.07 %   0.12 %   0.05 %   0.16 %   0.46 %   0.05 %
  Non-performing loans to total loans, before net items     0.21 %   0.17 %   0.18 %   0.04 %   0.11 %   0.43 %   0.07 %

Capital Ratios(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Equity to assets ratio     8.38 %   7.88 %   7.92 %   7.77 %   10.92 %   10.52 %   14.07 %
  Tangible capital ratio     6.89 %   6.46 %   6.55 %   5.16 %   10.35 %   8.91 %   8.26 %
  Core capital ratio     6.89 %   6.46 %   6.55 %   5.16 %   10.35 %   8.91 %   8.26 %
  Risk-based capital ratio     12.95 %   13.52 %   14.01 %   10.36 %   20.30 %   17.41 %   16.13 %

Other Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Number of loans outstanding     10,660     12,183     11,835     12,624     8,807     9,297     9,155  
  Number of deposit accounts     125,971     130,516     131,001     111,542     85,706     85,112     82,585  
  Number of full service offices     59     57     57     52     35     34     34  

12



Comparative Stock Price and Dividend Information

        Klamath common stock is listed on the Nasdaq National Market under the symbol "KFBI." Sterling common stock is listed on the Nasdaq National Market under the symbol "STSA." The following table sets forth the high and low sale prices of shares of Sterling common stock and Klamath common stock as reported on the Nasdaq National Market, and the Klamath cash dividends declared per share for the dates indicated. Sterling has not declared cash dividends in the past. Sales prices in the table have been adjusted to reflect stock dividends.

 
  Sterling
Common Stock

  Klamath
Common Stock

 
  High
  Low
  High
  Low
  Dividends
2003                              
  Quarter ended June 30   $ 24.75   $ 18.91   $ 17.64   $ 16.32   $ 0.13
  Quarter ended March 31     19.30     17.01     17.75     15.86     0.13

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Quarter ended December 31   $ 18.67   $ 15.23   $ 16.44   $ 13.24   $ 0.13
  Quarter ended September 30     18.45     14.43     16.25     13.35     0.13
  Quarter ended June 30     21.00     16.86     16.75     13.05     0.13
  Quarter ended March 31     18.80     12.19     13.67     13.00     0.13

2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Quarter ended December 31   $ 12.42   $ 11.14   $ 13.71   $ 11.91   $ 0.13
  Quarter ended September 30     13.04     10.86     15.22     12.60     0.13
  Quarter ended June 30     11.47     9.92     15.00     12.95     0.13
  Quarter ended March 31     10.21     8.61     14.13     11.94     0.13

2000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Quarter ended December 31     N/A     N/A   $ 13.23   $ 10.81   $ 0.13

        Pursuant to the merger agreement, Klamath may continue to pay quarterly cash dividends of up to $0.13 per share consistent with past practice, but may not declare other dividends without Sterling's written consent. Sterling has paid stock dividends in the past but has never paid cash dividends on its shares of common stock. The board of directors of Sterling is currently evaluating the payment of cash dividends in the future although it has reached no decision in this regard. The timing and amount of any future dividends will depend upon earnings, cash requirements, capital requirements, the financial condition of Sterling and its subsidiaries, applicable government regulations and other factors deemed relevant by Sterling's board of directors.

        The following table presents closing sales prices for Sterling common stock and Klamath common stock on the Nasdaq National Market on July 14, 2003, which was the last full trading day prior to the public announcement of the signing of the merger agreement and [October    ], 2003, which was the

13



last full trading day for which information was available prior to the date of the printing of this joint proxy statement/prospectus.

 
  Closing Sales Price
 
 
  Sterling
  Klamath
  Klamath
Equivalent(1)

 
Price per share:                    
  July 14, 2003   $ 26.55   $ 17.45   $ 20.44  
  [October            ], 2003     [     ]   [     ]   [     ]

        We advise you to obtain current market quotations for Sterling common stock and Klamath common stock. Past price performance is not necessarily indicative of likely future performance. The market prices of Sterling common stock and Klamath common stock at any time before the merger, and the market price of Sterling common stock at any time after the merger, may fluctuate. The exchange ratio will not be adjusted for any increases or decreases in the market price of Sterling common stock that occur before the merger becomes effective.


Selected Combined Consolidated Unaudited Pro Forma Financial Data
(In thousands, except shares and per share amounts)

        The following table shows information about Sterling's financial condition and operations, including per share data and financial ratios, after giving effect to the merger. This information is called pro forma information in this joint proxy statement/prospectus. The table sets forth the information as if the merger had become effective on June 30, 2003, with respect to financial condition data, and as of January 1, 2002 and carried through the interim period, with respect to operations data. Sterling's fiscal year end is December 31st and Klamath's fiscal year end is September 30th. Therefore, the information presented below for the twelve months includes Sterling's year ended December 31, 2002 and Klamath's year ended September 30, 2002. The six month periods presented below includes Sterling's six months ended June 30, 2003 and Klamath's six months ended March 31, 2003. The pro forma data in the tables assume that the merger is accounted for using the purchase method of accounting. This table should be read in conjunction with and is qualified in its entirety by, the historical financial statements, including the notes thereto, of Sterling and Klamath incorporated by reference herein and the more detailed pro forma financial information, including the notes thereto, appearing elsewhere in this joint proxy statement/prospectus. See "Where You Can Find More Information" on page [    ] and "Pro Forma Financial Information" on page [    ].

        We anticipate that the merger will provide the combined company with financial benefits that include reduced operating expenses. The pro forma information, while helpful in illustrating the financial characteristics of the combined company under one set of assumptions, does not reflect the benefits of expected cost savings or opportunities to earn additional revenue and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical

14



results of the combined company would have been had our companies been combined during these periods.

 
  June 30, 2003
SELECTED STATEMENT OF FINANCIAL CONDITION DATA:      
Total assets   $ 5,607,986
Asset-backed securities     1,571,849
Investments     237,259
Loans receivable, net     3,274,902
Deposits     3,474,717
Borrowed funds(1)     1,674,202
Shareholders' equity     391,787

       

 
  Six Months Ended
June 30, 2003

  Year Ended
December 31, 2002

 
SELECTED STATEMENTS OF INCOME DATA:              
Interest income   $ 141,134   $ 284,606  
Interest expense     59,417     132,879  
   
 
 
Net interest income     81,717     151,727  
Provision for losses on loans     (4,800 )   (12,023 )
   
 
 
Net interest income after provision for losses on loans     76,917     139,704  
Other operating income     24,915     41,694  
Non-interest expense     69,585     131,545  
   
 
 
Income before income tax expense     32,247     49,853  
Income tax expense     (11,119 )   (15,438 )
   
 
 
Net income   $ 21,128   $ 34,415  
   
 
 
WEIGHTED AVERAGE COMMON SHARES:              
Basic     19,203,473     17,964,624  
Diluted     19,678,516     18,434,303  

PER COMMON SHARE DATA:(2)

 

 

 

 

 

 

 
Basic earnings   $ 1.10   $ 1.92  
Diluted earnings     1.07     1.87  
Cash dividends declared     0.09     0.18  
Book value per share at end of period     19.45     N/A  

SELECTED FINANCIAL RATIOS:(2)

 

 

 

 

 

 

 
Return on average assets(3)     0.81 %   0.74 %
Return on average shareholders' equity(4)     12.1     11.5  
Shareholders' equity to total assets     7.0     N/A  
Efficiency ratio(5)     65.3     68.0  

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Selected Combined Consolidated Unaudited Pro Forma Comparative Per Share Data

        The following table sets forth for Sterling common stock and Klamath common stock certain historical, pro forma and pro forma-equivalent per share financial information. The pro forma and pro forma equivalent per share information gives effect to the merger as if the merger had been effective on the dates presented, in the case of the book value data presented, and as if the merger had become effective at the beginning of the periods presented, in the case of the earnings per common share and dividends declared data presented. The pro forma data in the tables assume that the merger is accounted for using the purchase method of accounting. See "Accounting treatment of the merger" on page [    ]. The information in the following table is based on, and should be read together with, the historical financial information that Sterling and Klamath have presented in prior filings with the SEC and the pro forma financial information that appears elsewhere in this document. See "Where You Can Find More Information" on page [    ] and "Pro Forma Financial Information" on page [    ].

        We anticipate that the merger will provide the combined company with financial benefits that include reduced operating expenses. The pro forma information, while helpful in illustrating the financial characteristics of the combined company under one set of assumptions, does not reflect the benefits of expected costs savings or opportunities to earn additional revenue and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had our companies been combined during these periods.

 
  Sterling
Historical

  Klamath
Historical

  Pro Forma
Combined(2)

  Per
Equivalent
Klamath
Share(3)

Earnings for fiscal year 2002(1)                        
  Basic   $ 1.96   $ 1.06   $ 1.92 (4) $ 1.48
  Diluted     1.91     1.05     1.87 (4)   1.44

Earnings for the first six months of fiscal year 2003(1)

 

 

 

 

 

 

 

 

 

 

 

 
  Basic     1.21     0.44     1.10     0.85
  Diluted     1.18     0.43     1.07     0.82

Cash dividends declared:

 

 

 

 

 

 

 

 

 

 

 

 
  For fiscal year 2002(1)     0.00     0.52     0.18 (5)   0.14
  For the first six months of fiscal year 2003(1)     0.00     0.26     0.09 (5)   0.07

Book value:

 

 

 

 

 

 

 

 

 

 

 

 
  As of December 31, 2002     15.48     18.84     N/A     N/A
  As of June 30, 2003     16.67     18.31 (6)   19.45     14.98

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RISK FACTORS

        In addition to the other information contained or incorporated by reference into this joint proxy statement/prospectus, including the matters addressed under the caption "Forward-Looking Information" beginning on page [    ], you should carefully consider the following risk factors in deciding whether to vote for approval of the merger agreement and the transactions contemplated thereby.

Because the market price of Sterling common stock may fluctuate, Klamath shareholders cannot be sure of the value of the merger consideration that they will receive.

        The market value of Sterling common stock is likely to change, both before and after the merger, and no one can accurately predict what the market value will be at any given time. Market prices of Sterling and Klamath common stock may vary for many reasons, including changes in the business, operations or prospects of Sterling or Klamath, market assessments of the likelihood that the merger will be completed and general market and economic conditions. Because the merger will be completed after the special meetings, the prices of Sterling and Klamath common stock on the date of the special meetings may not be indicative of their prices on the date the merger is completed. We urge you to obtain current market quotations for Sterling and Klamath common stock.

The exchange ratio for Sterling common stock to be received in the merger is fixed and limits the amount of shares that Klamath shareholders will receive.

        Regardless of the market prices of Sterling and Klamath common stock at the effective time of the merger, Klamath shareholders will receive no more than 0.77 shares of Sterling common stock for each share of Klamath common stock they own except under certain circumstances described in this proxy statement/prospectus. See "The Merger-Exchange ratio; possible adjustment of exchange ratio."

We may fail to realize the anticipated benefits of the merger and the costs relating to the merger could reduce Sterling's future earnings per share.

        The success of the merger will depend on, among other things, Sterling's ability to realize anticipated cost savings and to combine the businesses of Sterling and Klamath in a manner that does not materially disrupt the existing business of Sterling or result in the loss of key customers or employees. If Sterling is not able to successfully achieve these objectives, the anticipated benefits of the merger may not be fully realized or may take longer to realize than expected. Sterling believes that it has reasonably estimated the likely costs of integrating the operations of Klamath into Sterling, and the incremental costs of operating as a combined company. However, it is possible that unexpected transaction costs or unexpected future operating expenses could have a material adverse effect on the results of operations and financial condition of Sterling after the merger.

Failure to complete the merger could negatively impact prices and future business and operations.

        If the merger is not completed for any reason, the price of Sterling and Klamath common stock may decline to the extent that the current market prices reflect an assumption that the merger will be completed. Costs related to the merger must be paid even if the merger is not completed. In certain circumstances, the parties may be obligated to pay termination fees if the merger agreement is terminated. Further, if the merger agreement is terminated and Klamath's board of directors determines to seek another merger or business combination, it may not be able to find a partner willing to pay an equivalent or more attractive price than what Sterling would have paid in the merger. Finally, while the merger agreement is in effect, subject to limited exceptions, Klamath is prohibited from soliciting, initiating, participating in any negotiations regarding, or entering into specified extraordinary

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transactions, such as a merger, sale of assets or other business combination with any party other than Sterling.

The price of Sterling common stock may be affected by factors different from those affecting the price of Klamath common stock.

        Upon completion of the merger, the holders of Klamath common stock will become holders of Sterling common stock. Sterling's business differs from that of Klamath, and Sterling's results of operations and the price of Sterling common stock may be affected by factors different from those that affected Klamath's results of operations and the price of Klamath common stock before the merger. Sterling's results could also be adversely affected if losses on Klamath's assets are higher than currently anticipated. For a discussion of Sterling's and Klamath's businesses and factors to consider in connection with those businesses in connection with the merger, you should carefully review the financial statements and other documents which are incorporated by reference into this joint proxy statement/prospectus. See "Where You Can Find More Information" on page [    ].

Directors and officers of Klamath have a potential conflict of interest in the merger.

        You should be aware that some directors and officers of Klamath have interests in the merger that are different from, or in addition to, the interests of Klamath shareholders generally. For example, certain executive officers and directors will receive severance payments or payments pursuant to various benefit plans in connection with the merger. These agreements may create potential conflicts of interest. These agreements and certain other additional interests of Klamath's directors and officers may cause some of those persons to view the proposed transaction differently than you view it. See "The Merger—Interests of Klamath's directors and executive officers in the merger."

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THE STERLING SPECIAL MEETING

Date, time, place and purpose of Sterling's special meeting

        The special meeting of Sterling's shareholders will be held at 10:00 a.m. local time on [December 11, 2003], on the third floor of the headquarters of Sterling located at 111 North Wall Street, Spokane, Washington. At the meeting, Sterling's shareholders as of the record date will be asked to approve the merger with Klamath. This joint proxy statement/prospectus is first being sent to holders of Sterling common stock on or about [November    , 2003] and is accompanied by a form of proxy that is being solicited by the Sterling board of directors for use at the special meeting and any adjournment or postponement thereof.

Record date; outstanding shares; shares entitled to vote

        Only holders of record of Sterling common stock at the close of business on the record date, October 13, 2003, are entitled to notice of and to vote at the special meeting. As of the record date, there were [    ] shares of Sterling common stock outstanding and were held of record by approximately [    ] shareholders. Each holder of Sterling common stock is entitled to one vote for each share of Sterling common stock owned as of the record date.

Quorum; vote required

        The required quorum for the transaction of business at the special meeting is a majority of the shares of Sterling common stock outstanding on the record date, represented in person or by proxy. For the merger agreement to be approved by Sterling shareholders, a majority of the votes cast in person or by proxy at the special meeting must vote FOR approval of the merger agreement. As of the record date, directors and executive officers of Sterling and their affiliates had the right to vote [    ] shares of Sterling common stock or [ %] of the total number of shares of Sterling common stock outstanding.

Voting of proxies

        The Sterling board of directors requests that you return the proxy card accompanying this joint proxy statement/prospectus for use at the special meeting. Please complete, date and sign the proxy card and promptly return it in the enclosed postage-paid envelope. All properly signed proxies received by Sterling and not revoked before the vote at the special meeting will be voted at the special meeting according to the instructions indicated on the proxies or, if no instructions are given, to approve the merger agreement.

        If you are a participant in Sterling's 401(k) Employment Savings and Incentive Plan and Trust, your completed proxy will serve as voting instructions to the plan trustee. The deadline for returning your voting instructions is December [    ], 2003. 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.

        We do not expect that any matter other than approval of the merger agreement will be brought before the special meeting. If other matters are properly presented and are within the purpose of the special meeting, however, the persons named as proxies will vote in accordance with their judgment with respect to those matters.

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How to revoke your proxy

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

        Please note, however, 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.

Abstentions and broker non-votes

        Brokers who hold shares of Sterling common stock in street name for a customer who is the beneficial owner of those shares may not give a proxy to vote the customer's shares without specific instructions from the customer. These non-voted shares are referred to as broker non-votes. If your broker holds your Sterling stock in street name, your broker will vote your shares only if you provide instructions on how to vote by filling out the voter instruction form sent to you by your broker with this joint proxy statement/prospectus. Abstentions and broker non-votes will be included in determining the presence of a quorum, but will have no effect on the proposal to approve the merger agreement.

Voting electronically via Internet or telephone

        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.

Expenses of proxy solicitation

        The enclosed proxy for the Sterling special meeting is solicited by and on behalf of Sterling's board of directors. Sterling will pay the expenses of soliciting proxies to be voted at the meeting. Following the original mailing of the proxies and other soliciting materials, Sterling and its agents also may solicit proxies by mail, telephone, facsimile or in person. Sterling intends to reimburse persons who hold Sterling stock of record but not beneficially, such as brokers, custodians, nominees and fiduciaries, for their reasonable expenses in forwarding copies of proxies and other soliciting materials to, and requesting authority for the exercise of proxies from, the persons for whom they hold the shares. Sterling has retained Mellon Shareholder Services LLC to serve as proxy solicitor and information agent and will pay that firm $5,000 plus reasonable costs and expenses for its services.

Certificates

        You should not send in any certificates representing Sterling common stock. Following the effective time of the merger, you will continue to hold your Sterling stock certificates.

Recommendation of Sterling's board of directors

        Sterling's board of directors unanimously recommends that you vote FOR approval of the merger agreement.

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THE KLAMATH SPECIAL MEETING

Date, time, place and purpose of Klamath's special meeting

        The special meeting of Klamath's shareholders will be held at 10:00 a.m., local time, on [December 11, 2003], at the Ross Ragland Theater Cultural Center, 218 N. 7th Street, Klamath Falls, Oregon 97601. At the meeting, Klamath's shareholders as of the record date will be asked to approve the merger agreement that provides for the merger of Klamath with and into Sterling. This joint proxy statement/prospectus is first being sent to holders of Klamath common stock on or about [November     , 2003] and is accompanied by a form of proxy that is being solicited by the Klamath board of directors for use at the special meeting and any adjournment or postponement thereof.

Record date; outstanding shares; shares entitled to vote

        Only holders of record of Klamath common stock at the close of business on the record date, October 13, 2003, are entitled to notice of and to vote at the special meeting. As of the record date, there were [    ] shares of Klamath common stock outstanding and held of record by approximately [    ] shareholders. Each holder of Klamath common stock is entitled to one vote for each share of Klamath common stock owned as of the record date, subject to limited exceptions. If you do not vote, either in person or by proxy, it will have the same effect as voting against approval of the merger agreement.

        Although Klamath is not aware, as of the date hereof, of any person owning more than 10% of its common stock, Klamath's articles of incorporation materially limit the voting power of 10% shareholders under certain conditions. See "Comparison of Rights of Holders of Klamath Common Stock and Sterling Common Stock."

Quorum; vote required

        The required quorum for the transaction of business at the special meeting is a majority of the shares of Klamath common stock outstanding on the record date, represented in person or by proxy. For the merger agreement to be approved by Klamath shareholders, a majority of all the votes entitled to be cast in person or by proxy at the special meeting must vote FOR approval of the merger agreement.

Voting of proxies

        The Klamath board of directors requests that you return the proxy card accompanying this joint proxy statement/prospectus for use at the meeting. Please complete, date and sign the proxy card and promptly return it in the enclosed postage-paid envelope. All properly signed proxies received by Klamath and not revoked before the vote at the meeting will be voted at the meeting according to the instructions indicated on the proxies or, if no instructions are given, to approve the merger agreement.

        We do not expect that any matter other than approval of the merger agreement will be brought before the special meeting. If other matters are properly presented and are within the purpose of the special meeting, however, the persons named as proxies will vote in accordance with their judgment with respect to those matters.

Participants in the Klamath First Federal ESOP

        If a shareholder is a participant in the Klamath First Federal Employee Stock Ownership Plan ("ESOP"), the proxy card represents a voting instruction to the trustee of the ESOP as to the number of shares in the participant's plan account. Each participant may direct the trustee as to the manner in which shares of common stock allocated to the participant's plan account are to be voted. Unallocated shares of common stock held by the ESOP, and allocated shares for which no voting instructions are

21



received from participants, will be voted by the trustee, to the extent not inconsistent with its fiduciary obligations, in the same proportion as shares for which the trustee has received voting instructions.

How to revoke your proxy

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

        Please note, however, that if you have voted through a 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.

Abstentions and broker non-votes

        Only shares affirmatively voted for approval of the merger agreement, including shares represented by properly executed proxies that do not contain voting instructions, will be counted as votes FOR the merger agreement. Abstentions and broker non-votes will be included in determining the presence of a quorum, but will have the same effect as voting against the merger agreement.

        Brokers who hold shares of Klamath common stock in street name for a customer who is the beneficial owner of those shares may not give a proxy to vote the customer's shares without specific instructions from the customer. These non-voted shares are referred to as broker non-votes. If your broker holds your Klamath stock in street name, your broker will vote your shares only if you provide instructions on how to vote by filling out the voter instruction form sent to you by your broker with this joint proxy statement/prospectus.

Voting electronically via Internet or telephone

        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.

Expenses of proxy solicitation

        The enclosed proxy for the Klamath special meeting is solicited by and on behalf of Klamath's board of directors. Klamath will pay the expenses of soliciting proxies to be voted at the special meeting. Following the original mailing of the proxies and other soliciting materials, Klamath and its agents also may solicit proxies by mail, telephone, facsimile or in person. Klamath intends to reimburse persons who hold Klamath stock of record but not beneficially, such as brokers, custodians, nominees and fiduciaries, for their reasonable expenses in forwarding copies of proxies and other soliciting materials to, and requesting authority for the exercise of proxies from, the persons for whom they hold the shares. Klamath has retained Mellon Shareholder Services LLC to serve as proxy solicitor and information agent and will pay that firm $5,000 plus reasonable costs and expenses for its services.

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Certificates

        You should not send in any certificates representing Klamath common stock. Following the effective time of the merger, you will receive instructions for the surrender and exchange of your Klamath stock certificates.

Share ownership of management

        As of the record date, Klamath's directors and executive officers collectively owned [    ] shares of Klamath common stock, or approximately [    ] percent of Klamath's outstanding shares. All of Klamath's directors and certain executive officers have executed voting agreements with Sterling, under which they have agreed to vote their shares for approval of the merger agreement.

Recommendation of Klamath's board of directors

        Klamath's board of directors unanimously recommends that you vote FOR approval of the merger agreement.


THE MERGER

        This section of the joint proxy statement/prospectus describes the proposed merger. While we believe that this description covers the material terms of the merger agreement, this summary may not contain all of the information that is important to you. You should carefully read this entire joint proxy statement/prospectus and the other documents to which we refer for a more complete understanding of the merger. In particular, you should read the entire merger agreement attached to this document as Annex A because it is the legal document that governs the merger.

Background of the merger

        Klamath First Federal was organized in 1934 and grew gradually over the next 60 years while offering traditional thrift products, primarily mortgage loans and savings or time deposits. In 1995, Klamath was organized and went public as a unitary thrift holding company in connection with Klamath First Federal's conversion from mutual to stock form. Management then began actively looking for expansion opportunities to utilize the excess capital created from the sale of stock. In July 1997, Klamath First Federal purchased 25 branches from Wells Fargo Bank increasing assets to approximately $980 million, and establishing a presence through most of rural Oregon. Also, to improve returns on equity, stock repurchase programs were periodically conducted and in January 1999 Klamath completed a Modified Dutch Auction Tender in which it repurchased 1,984,000 shares or 20% of its outstanding shares of common stock. A sales and service culture and related training were introduced in early 2001, with the intent of changing its operations to those more similar to a commercial bank by expanding product offerings, and diversifying the loan portfolio. This was supported with the purchase of 13 full-service branches from Washington Mutual Bank in September 2001, which included a portfolio of commercial loans and a team of seasoned commercial lenders. The delivery of retail services began to expand at about the same time with the opening of nine consumer branches in Wal-Mart stores.

        In the fall of 2002, management's focus was to continue asset growth and profitability both internally and through acquisition, which was considered necessary for Klamath's long-term success. A comprehensive, independent compensation study was authorized and conducted to ensure that high quality executives and other employees could be attracted and/or retained. The study generally included market pricing of about one-third of all Klamath First Federal positions, with the remainder set aside based on a matrix of position characteristics. In addition, the executive portion of the study included both cash and equity based compensation, and was conducted through use of proxy information and multiple survey data analyses. There was little stock available for additional restricted stock or stock

23



option awards, and the board of directors felt that other compensation incentives were necessary to entice long-term retention of key management. Therefore, funding of retention benefits through the purchase of bank-owned life insurance ("BOLI") began to be evaluated, with insurance purchased in December 2002, which included director fee continuation agreements, executive salary continuation agreements, and shared life insurance benefits. Employment contracts were also reviewed, with changes recommended. During the design of the benefits, the board of directors considered the amount of the cost that would be funded by income from the BOLI and the cost of accelerated vesting of these benefits in the event of a change in control. The preparation and completion of formal documents relating to these benefits took several months and were approved by the board of directors at the end of April 2003.

        Davidson was engaged on November 28, 2002 by the board of directors to assist Klamath in the identification and analysis of potential acquisition targets. In connection therewith, Davidson agreed to assist in negotiating terms, coordinating due diligence efforts, and issuing a fairness opinion. The agreement was non-exclusive until Davidson presented a potential transaction to Klamath's board, then would be exclusive as to the particular transaction. The term of the engagement was through May 30, 2003, but subject to extension. Through March 2003, several acquisition targets were identified and analyzed, with offers made to two potential targets, but no transaction was consummated. One target had no interest in a transaction and the other was found to have higher risk characteristics than expected.

        After the two targeted acquisitions did not materialize, a strategic planning retreat with the board of directors and executive management of Klamath was held on April 28, 2003, with a Davidson representative present. The retreat included reviews of the economic landscape affecting Klamath, including financial and market performance relative to peers. Discussions were held regarding Klamath's strengths, weaknesses, opportunities and threats, plus the process and timelines for completing the business plan for the next fiscal year.

        The Klamath board and management recognized that financial results were lagging the peer group, primarily as a result of the impact of the low interest rates which would continue to pressure earnings if rates remained depressed. The reduction in the balance of residential mortgage loan assets because of refinancing activity, coupled with sales in the secondary market of new and refinanced residential mortgage loans to reduce interest rate risk was not offset by new consumer loan and commercial loan originations. Klamath First Federal had also entered into long-term borrowings with the Federal Home Loan Bank when interest rates were higher than current market rates, which resulted in a further reduction in earnings. These borrowings could not be prepaid without incurring significant penalties. Further, the investment portfolio had largely been structured with regular cash flows from mortgage-backed securities, which would provide greater returns through reinvestment in a rising rate environment but reduced returns in periods of low and declining interest rates as currently existed.

        Opportunities identified for further investigation and implementation included opening commercial loan production offices in major metropolitan areas, expanding more aggressively into key markets, reevaluating the retail branch structure from a market presence and efficiency perspective, emphasizing more non-deposit retail investment sales, implementing more aggressive expense controls, and reevaluating and adjusting service fees. Management was directed by the Klamath board of directors to overhaul and redraft the business plan in light of the current business, economic and interest rate environment, and with a view to improving financial results. A follow-up retreat to present the next fiscal year's business plan was scheduled for mid-September 2003.

        On May 7, 2003, Kermit K. Houser, President and Chief Executive Officer, and Marshall J. Alexander, Executive Vice President and Chief Financial Officer, attended the D.A. Davidson Financial Services Investor Conference in Seattle, Washington. While there, Messrs. Houser and Alexander were informally approached by Harold Gilkey, Sterling Corporation's Chairman & Chief Executive Officer,

24



to find out Klamath's philosophy regarding mergers. A similar informal discussion was initiated by another financial institution's representative who was also attending the meeting. A few days later, Mr. Houser received a call from Mr. Gilkey requesting a dinner meeting during the week of May 12, 2003, when both individuals would be attending the Federal Home Loan Bank annual meeting in Seattle, Washington. Mr. Houser notified Rodney N. Murray, Chairman of the board of directors of Klamath Bancorp of the request. During the dinner meeting on May 14, 2003, Mr. Gilkey suggested that Sterling and Klamath merge. Additional informal discussions about that possibility were held the following day among the Sterling and Klamath representatives who attended the Federal Home Loan Bank meeting. Early the following week, Chairman Murray was informed of Sterling's interest. Klamath executed a confidentiality agreement with Sterling on May 27, 2003.

        At its regular board of directors meeting on May 28, 2003, the Klamath board of directors was informed of Sterling's interest in a merger, considered whether to extend the Davidson engagement beyond its May 30, 2003 expiration date, and decided to meet with Mr. Gilkey. Mr. Al Glowasky of Davidson facilitated a discussion which included, but was not limited to, the factors that affect the value of the Klamath franchise such as trailing earnings, dividend yield, level of non-performing loans, core competencies, stability and cost of deposits, market capitalization and performance of regional thrifts and banks; comparisons to Klamath's and Sterling's results; Klamath's business plan projections and the impact of Klamath's various budget forecast scenarios; the combined geographic market area with a Sterling merger, and possible board and management structures relating to Sterling's proposed merger. Mr. Glowasky and the board of directors also reviewed other alternatives to enhance shareholder value. The board of directors approved the extension of the Davidson engagement, and agreed to meet with Mr. Gilkey. Special Counsel, John F. Breyer, Jr., of Breyer & Associates PC was engaged to assist in advising the board of directors in connection with Sterling's expression of interest.

        Mr. Gilkey met with the Klamath board of directors in Klamath Falls, Oregon, on June 3, 2003. Mr. Gilkey discussed Sterling's history and philosophy, strengths and weaknesses, and reasons why a business combination was of interest. Sterling's general expectations to obtain cost savings and earnings contribution, as well as timing for a possible transaction to be successful were presented. Sterling's past merger experiences and resolution of social issues with acquired management and boards of directors were described. The members of the board of directors of Klamath were invited to visit Sterling's headquarters to meet members of Sterling's board of directors and senior management team, and to tour its headquarters. Most Klamath directors traveled to Spokane, Washington and visited Sterling a few days later. Subsequent to that visit, Klamath and Sterling representatives, with their advisors present, held off-site discussions on June 10, 2003 to address potential earnings improvements and cost savings in the event of a merger. Klamath received proposed merger terms on June 13, 2003.

        Klamath held a meeting of its board of directors on June 17, 2003, with its special counsel Breyer & Associates PC, investment advisor Davidson, and executive management to review the proposed merger terms. The board of directors was advised of its fiduciary duties, alternatives to consider such as remaining independent compared to methods of soliciting indications of interest such as a market auction, limited auction or negotiating on an exclusive basis, stock compared to cash transactions, disclosure requirements and related regulatory matters, and terms to consider when evaluating a merger transaction. The investment advisor provided a presentation that covered Klamath's operations and stock performance as compared to the market, management forecasts along with probability of success and execution risks, the Sterling proposed merger terms from a financial perspective, a comparison of the proposed merger terms to management forecasts, and a likely merger timeline. Other possible merger partners were discussed. Mr. Glowasky stated that he had contacted eight other financial institutions who would be likely acquirers, of which three had no interest in purchasing a thrift institution, such as Klamath First Federal, and one had no interest in Klamath. The others were either not currently targeting Oregon or were otherwise unwilling or unable to pay a price or exchange rate similar to the Sterling offer. Analyst coverage of Sterling was also reviewed. Initial

25



pricing was proposed as a stock exchange with Klamath shareholders receiving shares of Sterling common stock for each share of Klamath common stock, which the investment advisor's initial analysis indicated should be fair from a financial perspective. The investment advisor also recommended that due diligence in connection with the proposed transaction be pursued as a result of the various information presented, especially the company's forecast that two to three years would be required to implement the internal business plan and regain the momentum and profitability of a year ago. In addition, the execution risk in the current economy and financial marketplace was deemed high. The board of directors engaged in extensive discussions regarding the proposal and other information presented. The board of directors then authorized management, Davidson and its special counsel to begin negotiating a definitive merger agreement and to conduct due diligence on Sterling.

        Sterling performed most of its due diligence review of Klamath from June 19 through July 1, 2003. Klamath performed most of its due diligence review of Sterling from June 25 through July 1, 2003. The Klamath board held a special meeting on July 3, 2003, when the initial draft of the merger agreement was delivered and due diligence results were shared. Due diligence reports were given which covered lending, operations, legal, compliance, internal control, human resources, accounting, tax, and investments. The Klamath board concluded that there were no issues presented by the due diligence reports that should stop the merger discussions from proceeding. Special Counsel John F. Breyer, Jr. of Breyer & Associates PC also reviewed the initial draft of the merger agreement in detail, discussed various negotiating points, and advised further regarding fiduciary duties. The merger agreement continued to be negotiated through July 14, 2003.

        On July 9, 2003 the board of directors and its investment advisor met to discuss the status of the negotiations with Sterling and the open issues that were being negotiated including the termination provisions contained in the proposed merger agreement. Sterling representatives had expressed that they would only negotiate on an exclusive basis and were not willing to enter into the transaction without the protection of the current termination provision and fee. After considering factors such as the results that could be attained under the current Klamath First Federal business plan, Davidson's work in identifying and analyzing other potential suitors and its opinion that if Klamath did not proceed with the Sterling proposal that it was unlikely that there would be a comparable or better proposal available, the board of directors concluded it was in the best interest of the Klamath shareholders to continue merger negotiations with Sterling.

        On July 14, 2003, the Klamath board held a special meeting to review the definitive merger agreement and a presentation including the fairness opinion delivered by Davidson. Special Counsel reviewed in detail the merger agreement. It was noted that pricing had changed slightly from the original proposal to an exchange rate of 0.77 shares of Sterling common stock for each Klamath share, primarily attributable to the costs associated with terminating vendor contracts, though the change in the exchange rate is only a partial absorption of the cost. Other aspects of the merger were also discussed. Mr. Glowasky made a presentation regarding the financial terms of the transaction and its fairness from a financial point of view. He again presented the various factors the Klamath board of directors considered in determining to proceed with the merger, which are discussed in further detail below. After discussion, the Klamath directors, all of whom were present, unanimously approved and authorized the execution of the merger agreement.

        Klamath and Sterling executed the merger agreement and related documents on July 14, 2003. On July 15, 2003, before trading commenced on the Nasdaq National Market, the companies issued a joint press release announcing the execution of the merger agreement.

Sterling's reasons for the merger

        At its July 14, 2003 meeting, the Sterling board unanimously determined that the merger is fair to and in the best interests of Sterling and its shareholders. In reaching its decision to approve the merger

26



and to unanimously recommend that Sterling shareholders approve the merger agreement, the board considered numerous factors taken as a whole, none of which were accorded any particular or relative weight, and consulted with senior bank management as well as its legal, accounting and financial advisors. The factors considered included:

Recommendation of Sterling's board of directors

        After carefully evaluating relevant factors, including the above, Sterling's board of directors has determined that the merger is fair to and in the best interests of Sterling and its shareholders. Sterling's board of directors unanimously recommends that you vote FOR approval of the merger agreement.

Klamath's reasons for the merger

        At the Klamath board of directors' meetings held June 17, 2003 to consider the merger proposal from Sterling, and on July 14, 2003, when the Klamath board of directors authorized execution of the merger agreement and recommended Klamath shareholder approval of the merger, the various reasons for the merger were discussed. The Klamath board of directors consulted with financial and legal advisors in considering several factors. The Klamath board of directors believes that the merger enhances shareholder value, because the companies' strengths are complementary, Sterling has a history of strong financial performance, and the business combination allows Klamath to achieve financial goals sooner than if it were to remain independent. The material factors considered by the Klamath board of directors in connection with its approval and recommendation of the merger, including the interests of the directors and certain officers in the merger, are detailed below:

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28


        In the course of its deliberations regarding the merger, the Klamath board of directors also considered the following information which the Klamath board of directors determined did not outweigh the benefits to Klamath and its shareholders expected to be generated by the merger:


        The foregoing discussion of the information considered by the Klamath board of directors is not intended to be exhaustive but includes all of the material factors considered by the Klamath board. In reaching its determination to approve and recommend the merger, the Klamath board did not assign any relative or specific weights to the factors considered in reaching that determination and individual

29


directors may have given differing weights to different factors. Given the above, Klamath's board of directors determined that the merger agreement is in the best interests of Klamath and its shareholders and unanimously approved the merger.

Recommendation of Klamath's board of directors

        After carefully evaluating the above factors, both positive and negative, Klamath's board of directors has determined that the merger is fair to and in the best interests of Klamath and its shareholders. Klamath's board of directors unanimously recommends that you vote FOR approval of the merger agreement.

Opinion of Sterling's financial advisor

        By letter dated June 3, 2003, Sterling retained Sandler O'Neill to act as its financial advisor in connection with a possible merger transaction with Klamath based on Sandler O'Neill's experience in mergers and acquisitions and in securities valuation generally. Sandler O'Neill is a nationally recognized investment banking firm whose principal business specialty is financial institutions. In the ordinary course of its investment banking business, Sandler O'Neill is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions.

        Sandler O'Neill acted as financial advisor to Sterling in connection with the proposed merger and participated in certain of the negotiations leading to the execution of the merger agreement. At the July 14, 2003 meeting at which Sterling's board considered and approved the merger agreement, Sandler O'Neill delivered to the board its oral opinion, subsequently confirmed in writing, that, as of such date, the merger consideration Sterling proposed to pay Klamath shareholders was fair to Sterling from a financial point of view. The full text of Sandler O'Neill's opinion is attached as Annex B to this joint proxy statement/prospectus. The opinion outlines the procedures followed, assumptions made, matters considered and qualifications and limitations on the review undertaken by Sandler O'Neill in rendering its opinion. The description of the opinion set forth below is qualified in its entirety by reference to the opinion. We urge you to read the entire opinion carefully in connection with your consideration of the proposed merger.

        Sandler O'Neill's opinion speaks only as of the date of the opinion. The opinion was directed to the Sterling board and is directed only to the fairness of the merger consideration to Sterling from a financial point of view. It does not address the underlying business decision of Sterling to engage in the merger or any other aspect of the merger and is not a recommendation to any Sterling shareholder as to how such shareholder should vote at the special meeting with respect to the merger.

        In connection with rendering its opinion, Sandler O'Neill reviewed and considered, among other things:

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        Sandler O'Neill also discussed with certain members of Sterling's senior management the business, financial condition, results of operations and prospects of Sterling. Sandler O'Neill also held similar discussions with certain members of senior management of Klamath regarding the business, financial condition, results of operations and prospects of Klamath.

        In performing its reviews and analyses and in rendering its opinion, Sandler O'Neill assumed and relied upon the accuracy and completeness of all the financial information, analyses and other information that was publicly available or otherwise furnished to, reviewed by or discussed with it and further relied on the assurances of management of Sterling and Klamath that they were not aware of any facts or circumstances that would make such information inaccurate or misleading. Sandler O'Neill was not asked to and did not independently verify the accuracy or completeness of any of such information and they did not assume any responsibility or liability for the accuracy or completeness of any of such information. Sandler O'Neill did not make an independent evaluation or appraisal of the assets, the collateral securing assets or the liabilities, contingent or otherwise, of Sterling or Klamath or any of their respective subsidiaries, or the collectibility of any such assets, nor was it furnished with any such evaluations or appraisals. Sandler O'Neill is not an expert in the evaluation of allowances for loan losses and it did not make an independent evaluation of the adequacy of the allowance for loan losses of Sterling or Klamath, nor did it review any individual credit files relating to Sterling or Klamath. With Sterling's consent, Sandler O'Neill assumed that the respective allowances for loan losses for both Sterling and Klamath were adequate to cover such losses and will be adequate on a pro forma basis for the combined entity. In addition, Sandler O'Neill did not conduct any physical inspection of the properties or facilities of Sterling or Klamath.

        Sandler O'Neill's opinion was necessarily based upon market, economic and other conditions as they existed on, and could be evaluated as of, the date of its opinion. Sandler O'Neill assumed, in all respects material to its analysis, that all of the representations and warranties contained in the merger agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under such agreements and that the conditions precedent in the merger agreement are not waived. Sandler O'Neill also assumed, with Sterling's consent, that there has been no material change in Sterling's or Klamath's assets, financial condition, results of operations, business or prospects since the date of the last financial statements made available to them, that Sterling and Klamath will remain as going concerns for all periods

31



relevant to its analyses, and that the merger will qualify as a tax-free reorganization for federal income tax purposes.

        In rendering its opinion, Sandler O'Neill performed a variety of financial analyses. The following is a summary of the material analyses performed by Sandler O'Neill, but is not a complete description of all the analyses underlying Sandler O'Neill's opinion. The summary includes information presented in tabular format. In order to fully understand the financial analyses, these tables must be read together with the accompanying text. The tables alone do not constitute a complete description of the financial analyses. The preparation of a fairness opinion is a complex process involving subjective judgments as to the most appropriate and relevant methods of financial analysis and the application of those methods to the particular circumstances. The process, therefore, is not necessarily susceptible to a partial analysis or summary description. Sandler O'Neill believes that its analyses must be considered as a whole and that selecting portions of the factors and analyses considered without considering all factors and analyses, or attempting to ascribe relative weights to some or all such factors and analyses, could create an incomplete view of the evaluation process underlying its opinion. Also, no company included in Sandler O'Neill's comparative analyses described below is identical to Sterling or Klamath and no transaction is identical to the proposed merger. Accordingly, an analysis of comparable companies or transactions involves complex considerations and judgments concerning differences in financial and operating characteristics of the companies and other factors that could affect the public trading values or merger transaction values, as the case may be, of Sterling or Klamath and the companies to which they are being compared.

        The earnings projections used and relied upon by Sandler O'Neill in its analyses were, in the case of Sterling, furnished by Sterling and reviewed by management of Sterling and, in the case of Klamath, furnished by Klamath and reviewed by management of each of Sterling and Klamath, respectively. With respect to such financial projections and all projections of transaction costs, purchase accounting adjustments and expected cost savings relating to the merger, Sterling's and Klamath's managements confirmed to Sandler O'Neill that they reflected the best currently available estimates and judgments of such managements of the future financial performance of Sterling and Klamath, respectively, and Sandler O'Neill assumed for purposes of its analyses that such performances would be achieved. Sandler O'Neill expressed no opinion as to such financial projections or the assumptions on which they were based. The financial projections for Sterling and Klamath were prepared for internal purposes only and not with a view towards public disclosure. These projections, as well as the other estimates used by Sandler O'Neill in its analyses, were based on numerous variables and assumptions that are inherently uncertain and, accordingly, actual results could vary materially from those set forth in such projections.

        In performing its analyses, Sandler O'Neill also made numerous assumptions with respect to industry performance, business and economic conditions and various other matters, many of which cannot be predicted and are beyond the control of Sterling, Klamath and Sandler O'Neill. The analyses performed by Sandler O'Neill are not necessarily indicative of actual values or future results, which may be significantly more or less favorable than suggested by such analyses. Sandler O'Neill prepared its analyses solely for purposes of rendering its opinion and provided such analyses to the Sterling board at the July 14th meeting. Estimates on the values of companies do not purport to be appraisals or necessarily reflect the prices at which companies or their securities may actually be sold. Such estimates are inherently subject to uncertainty and actual values may be materially different. Accordingly, Sandler O'Neill's analyses do not necessarily reflect the value of the common stock of Sterling or Klamath or the prices at which Sterling's or Klamath's common stock may be sold at any time.

        Summary of Proposal.    Sandler O'Neill reviewed the financial terms of the proposed transaction. Based upon the closing price of Sterling's common stock on July 11, 2003 of $26.15 and an exchange ratio of 0.77 shares of Sterling for each share of Klamath, Sandler O'Neill calculated an implied

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transaction value of $20.14 per share. Based upon Klamath's March 31, 2003 financial information, Sandler O'Neill calculated the following ratios:


Transaction Ratios

Transaction value/LTM earnings per share   18.5 x
Transaction value/LTM core earnings per share(1)   21.7 x
Transaction value/Book value per share   110.0 %
Transaction value/Tangible book value per share   162.6 %
Tangible book premium/Core deposits(2)   6.0 %

        For purposes of Sandler O'Neill's analyses, earnings per share were based on fully diluted earnings per share. The aggregate transaction value was approximately $144.5 million, based upon 6.96 million shares of Klamath common stock outstanding and including the intrinsic value of options to purchase 642,940 shares of Klamath common stock with a weighted average exercise price of $13.27 per share. Sandler O'Neill noted that the transaction value represented a 15.7% premium over the July 11, 2003 closing price of Klamath's common stock of $17.40.

        Stock Trading History.    Sandler O'Neill reviewed the history of the reported trading prices and volume of the common stock of Sterling and Klamath and the relationship between the movements in the prices of those stocks to movements in certain stock indices, including the Standard & Poor's 500 Index, the Standard & Poor's Bank Index, the Nasdaq Bank Index and the median performance of a composite peer group of publicly traded regional savings institutions for each of Sterling and Klamath selected by Sandler O'Neill. During the one year period ended July 11, 2003, the common stock of Sterling outperformed each of the indices to which it was compared while the common stock of Klamath underperformed its peer group while outperforming each of the other indices to which it was compared.


Sterling's and Klamath's One-Year Stock Performance

 
  Beginning Index Value
July 11, 2002

  Ending Index Value
July 11, 2003

 
Sterling   100.00 % 144.91 %
Sterling Peer Group   100.00   118.33  
Nasdaq Bank Index   100.00   107.63  
S&P Bank Index   100.00   107.41  
S&P 500 Index   100.00   106.48  
 
  Beginning Index Value
July 11, 2002

  Ending Index Value
July 11, 2003

 
Klamath   100.00 % 115.76 %
Klamath Peer Group   100.00   128.16  
Nasdaq Bank Index   100.00   107.63  
S&P Bank Index   100.00   107.41  
S&P 500 Index   100.00   106.48  

        Comparable Company Analysis.    Sandler O'Neill used publicly available information to compare selected financial and market trading information for Klamath and two groups of selected financial

33



institutions. The first group, or Regional Group, consisted of Klamath and the following publicly traded savings institutions:

    Washington Federal Inc.
PFF Bancorp Inc.
Quaker City Bancorp Inc.
Provident Financial Holdings
Horizon Financial Corp.
EverTrust Financial Group, Inc.
  FirstFed Financial Corp.
Hawthorne Financial Corp.
United PanAm Financial Corp.
Commercial Capital Bancorp
First Mutual Bancshares Inc.

        Sandler O'Neill also compared Klamath to a group of publicly traded savings institutions that had a return on average equity (based upon earnings for the twelve months ended March 31, 2003) greater than 16% and a price-to-tangible book value greater than 190%. This High Performing Group was comprised of the following institutions:

    Anchor BanCorp Wisconsin
First Federal Capital Corp
Hawthorne Financial Corp.
Quaker City Bancorp Inc.
Commercial Capital Bancorp
Coastal Financial Corp.
  Dime Community Bancshares Inc.
TrustCo Bank Corp NY
First Financial Holdings Inc.
United PanAm Financial Corp
NASB Financial Inc.
First Mutual Bancshares Inc.

        The analysis compared publicly available financial information for Klamath for each of the years ended September 30, 1998 through 2002 and as of and for the twelve months ended March 31, 2003 and the median data for each of the Regional Group and High Performing Group as of and for each of the years ended December 31, 1998 through 2002 and as of and for the twelve months ended March 31, 2003. The table below sets forth the comparative data as of and for the twelve months ended March 31, 2003, with pricing data as of July 11, 2003.

 
  Klamath
  Regional Group
  High Performing Group
 
Total assets (in millions)   $ 1,478   $ 1,195   $ 1,891  
Tangible equity/ tangible assets     5.59 %   8.57 %   6.82 %
Intangible assets/total equity     32.34 %   0.47 %   4.19 %
Net loans/total assets     38.80 %   80.75 %   74.63 %
Gross loans/total deposits     52.80 %   120.07 %   115.27 %
Total borrowings/total assets     14.19 %   23.73 %   23.16 %
Non-performing assets/total assets     0.15 %   0.14 %   0.27 %
Loan loss reserves/gross loans     1.25 %   1.18 %   0.98 %
Net interest margin     3.32 %   3.84 %   3.76 %
Non-interest income/average assets     0.87 %   0.61 %   0.81 %
Non-interest expense/average assets     3.34 %   2.17 %   2.25 %
Efficiency ratio     85.26 %   49.49 %   48.89 %
Return on average assets     0.47 %   1.34 %   1.47 %
Return on average equity     6.07 %   16.16 %   17.19 %
Price/tangible book value per share     145.7 %   178.25 %   235.27 %
Price/LTM earnings per share     15.69 x   12.76 x   12.93 x
Dividend payout ratio     47.7 %   9.0 %   22.2 %
Dividend yield     3.0 %   0.49 %   1.42 %

        Analysis of Selected Merger Transactions.    Sandler O'Neill reviewed merger transactions announced from January 1, 2003 to July 14, 2003 involving publicly traded savings institutions as acquired institutions with transaction values greater than $15 million. Sandler O'Neill reviewed 13 transactions

34



announced nationwide and three transactions in the Western region. Sandler O'Neill reviewed the multiples of transaction price at announcement to last twelve months' earnings per share, transaction price to book value per share, transaction price to tangible book value per share, tangible book premium to core deposits and premium to market price and computed median multiples and premiums for both groups of transactions. These multiples were applied to Klamath's financial information as of and for the twelve months ended March 31, 2003. As illustrated in the following table, Sandler O'Neill derived an imputed range of values per share of Klamath's common stock of $9.96 to $34.85 based upon the median multiples for nationwide transactions and $10.10 to $27.96 based upon the median multiples for transactions in the Western region. The implied transaction value of the merger as calculated by Sandler O'Neill was $20.14 per share.


Nationwide & Western Region Transaction Multiples

 
  Nationwide
  Western Region
 
  Median
Multiple

  Implied
Value

  Median
Multiple

  Implied
Value

Transaction value/LTM earnings per share(1)   16.46 x $ 15.23   16.35 x $ 15.13
Transaction value/Book value   162.07 % $ 28.11   155.39 % $ 26.95
Transaction value/Tangible book value   164.50 % $ 19.31   155.39 % $ 18.24
Tangible book premium/Core deposits(2)   15.64 % $ 34.85   10.98 % $ 27.96
Premium to market(3)   21.52 % $ 21.14   20.78 % $ 21.02

        Discounted Dividend Stream and Terminal Value Analysis.    Sandler O'Neill performed an analysis that estimated the future stream of after-tax dividend flows of Klamath through December 31, 2007 under various circumstances, assuming Klamath's projected dividend stream and that Klamath performed in accordance with the earnings projections provided by Klamath and reviewed with managements of Sterling and Klamath. To approximate the terminal value of Klamath common stock at December 31, 2007, Sandler O'Neill applied price/earnings multiples ranging from 8x to 22x and multiples of tangible book value ranging from 87.5% to 175%. The dividend income streams and terminal values were then discounted to present values using different discount rates ranging from 8% to 14% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Klamath common stock. As illustrated in the following tables, this analysis indicated an imputed range of values per share of Klamath common stock of $10.46 to $32.90 when applying the price/earnings multiples and $10.69 to $24.57 when applying multiples of tangible book value. The implied transaction value of the merger as calculated by Sandler O'Neill was $20.14 per share.


Earnings Per Share Multiples

Discount Rate

  8x
  12x
  14x
  16x
  18x
  22x
8.0 % $ 13.13   $ 18.78   $ 21.60   $ 24.43   $ 27.25   $ 32.90
10.0 %   12.15     17.35     19.95     22.55     25.15     30.35
12.0 %   11.26     16.06     18.46     20.85     23.25     28.05
14.0 %   10.46     14.89     17.10     19.31     21.53     25.96

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Tangible Book Value Per Share Multiples

Discount Rate

  87.5%
  112.5%
  125%
  137.5%
  150%
  175%
8.0 % $ 13.42   $ 16.61   $ 18.20   $ 19.79   $ 21.39   $ 24.57
10.0 %   12.42     15.36     16.82     18.29     19.75     22.69
12.0 %   11.52     14.22     15.57     16.92     18.28     20.98
14.0 %   10.69     13.19     14.44     15.69     16.93     19.43

        Sandler O'Neill performed a similar analysis that estimated the future stream of after-tax dividend flows of Sterling through December 31, 2007 under various circumstances, assuming Sterling's projected dividend stream and that Sterling performed in accordance with earnings projections for 2003 and 2004 provided by and reviewed with Sterling's management. For periods after 2004, Sandler O'Neill assumed an annual growth rate of earning per share of 11% to 12%. To approximate the terminal value of Sterling common stock at December 31, 2007, Sandler O'Neill applied price/earnings multiples ranging from 8x to 22x and multiples of tangible book value ranging from 100% to 275%. The dividend income streams and terminal values were then discounted to present values using different discount rates ranging from 8% to 14% chosen to reflect different assumptions regarding required rates of return of holders or prospective buyers of Sterling common stock. As illustrated in the following table, this analysis indicated an imputed range of values per share of Sterling common stock of $14.65 to $52.80 when applying the price/earnings multiples and $14.19 to $51.14 when applying multiples of tangible book value.


Earnings Per Share Multiples

Discount Rate

  8x
  12x
  14x
  16x
  18x
  22x
8.0 % $ 19.20   $ 28.80   $ 33.60   $ 38.40   $ 43.20   $ 52.80
10.0 %   17.52     26.28     30.65     35.03     39.41     48.17
12.0 %   16.01     24.01     28.01     32.02     36.02     44.02
14.0 %   14.65     21.98     25.64     29.30     32.97     40.29


Tangible Book Value Per Share Multiples

Discount Rate

  100%
  150%
  175%
  200%
  225%
  275%
8.0 % $ 18.60   $ 27.89   $ 32.54   $ 37.19   $ 41.84   $ 51.14
10.0 %   16.97     25.45     29.69     33.93     38.17     46.66
12.0 %   15.50     23.26     27.13     31.01     34.88     42.64
14.0 %   14.19     21.29     24.83     28.38     31.93     39.02

        In connection with its analyses, Sandler O'Neill considered and discussed with the Sterling board of directors how the present value analyses would be affected by changes in the underlying assumptions, including variations with respect to the growth rate of assets, net income and dividend payout ratio. Sandler O'Neill noted that the discounted dividend stream and terminal value analysis is a widely used valuation methodology, but the results of such methodology are highly dependent upon the numerous assumptions that must be made, and the results thereof are not necessarily indicative of actual values or future results.

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        Pro Forma Merger Analysis.    Sandler O'Neill analyzed certain potential pro forma effects of the merger, assuming the following: (1) the merger closes in the first quarter of 2004, (2) 6,958,902 Klamath shares of common stock are exchanged for 5,358,355 shares of Sterling common stock, (3) earnings per share projections for Sterling and Klamath are consistent with management projections, and (4) purchase accounting adjustments, charges and transaction costs associated with the merger and cost savings are consistent with determinations of the senior managements of Sterling and Klamath. The analysis indicated that for the year ending December 31, 2004, the merger would be accretive to the combined company's projected earnings per share and dilutive to tangible book value per share. The actual results achieved by the combined company may vary from projected results and the variations may be material.


Pro Forma Merger Analysis

 
  Stand-alone
  Pro Forma
Projected 2004 EPS   $ 2.50   $ 2.60
Projected Tangible Book Value
(at December 31, 2004)
  $ 17.42   $ 16.36

        Contribution Analysis.    Sandler O'Neill reviewed the relative contributions to be made by Sterling and Klamath to the combined institution, based on financial information at and for the twelve months ended March 31, 2003. The percentage of pro forma shares owned was determined using the exchange ratio of 0.77. This analysis indicated that the implied contributions to the combined entity were as follows:

 
  Sterling
  Klamath
 
Total assets   72.1 % 27.9 %
Total cash and securities   56.5   43.5  
Total net loans   81.7   18.3  
Total goodwill   55.6   44.4  
Total deposits   67.5   32.5  
Total borrowings   85.0   15.0  
Tangible equity   70.6   29.4  
Total equity   67.0   33.0  
LTM Net income   79.6   20.4  
Percentage of pro forma shares owned   73.4   26.6  

        Sterling has agreed to pay Sandler O'Neill a transaction fee in connection with the merger equal to 0.50% of the aggregate purchase price, or approximately [$793,000] based upon the closing price of Sterling common stock on [September 12], 2003, $184,000 of which was paid upon execution of the merger agreement and the balance of which is contingent and payable upon closing of the merger. Sterling has also paid Sandler O'Neill $100,000 for rendering its opinion. Sterling has also agreed to reimburse certain of Sandler O'Neill's reasonable out-of-pocket expenses incurred in connection with its engagement up to a maximum of $40,000 and to indemnify Sandler O'Neill and its affiliates and their respective partners, directors, officers, employees, agents, and controlling persons against certain expenses and liabilities, including liabilities under securities laws. In the past, Sandler O'Neill has also provided certain other investment banking services to Sterling and received compensation for such services and may provide, and receive compensation for, such services in the future, including the period in which the merger is pending. Sandler O'Neill has also provided certain investment banking services to Klamath in the past two years and has received compensation for such services.

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        In the ordinary course of its business as a broker-dealer, Sandler O'Neill may purchase securities from and sell securities to Sterling and Klamath and their respective affiliates and may actively trade the debt and/or equity securities of Sterling and Klamath and their respective affiliates for its own account and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities.

Opinion of Klamath's financial advisor

        On May 28, 2003, Klamath's board of directors extended an existing financial advisory engagement with Davidson, retaining Davidson as its financial advisor. The extended engagement also contemplated the issuance of a fairness opinion regarding the merger with Sterling if the Klamath board of directors decided to proceed with the merger. Davidson, as part of its investment banking business, is engaged in the valuation of banking and other businesses and their securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and valuations for estate, corporate and other purposes. Klamath's board of directors retained Davidson based upon its reputation and experience as a financial advisor in mergers and acquisitions of financial institutions and its knowledge of financial institutions.

        On July 14, 2003, Davidson presented its fairness opinion to the Klamath board of directors at the meeting during which the directors considered and approved the merger agreement. Davidson has also delivered to the board a written opinion dated [October    , 2003], which is substantially identical to its July 14th opinion. The Davidson fairness opinion states that, as of the date of the opinion, the merger consideration to be paid by Sterling pursuant to the merger agreement is fair from a financial point of view to the holders of Klamath common stock.

        Davidson's opinion is directed to the Klamath board of directors and addresses only the merger consideration specified in the merger agreement. It does not address the underlying business decision to proceed with the merger and does not constitute a recommendation to any shareholder as to how the shareholder should vote at the special meeting of shareholders with respect to the merger. Davidson has consented to the inclusion herein of the summary of its opinion to the Klamath board and to reference to the entire opinion attached hereto as Annex C.

        Summary of Financial Terms of Proposed Merger.    Davidson reviewed the financial terms of the proposed transaction. Based on the closing price of Sterling's stock on July 11, 2003 of $26.15 per share, Davidson calculated an implied transaction value per share of Klamath common stock of $20.14. The implied aggregate transaction value was approximately $144.5 million at that date, which includes $140.1 million for all common stock, as well as $4.4 million for all outstanding Klamath options to purchase Klamath common stock. Based upon the implied transaction value and Klamath's March 31, 2003 financial information, Davidson calculated the following ratios:

  Implied value/Book Value   1.1 x    


 

Implied value/Tangible Book Value

 

1.6

x

 

 


 

Implied value/Last twelve months EPS

 

18.5

x

 

 


 

Implied value/Assets

 

9.8

%

 

 

        Davidson noted that the implied transaction value represented a 15.7% premium over the July 11, 2003 closing price of Klamath of $17.40.

        Review Procedures.    In connection with providing its opinion, Davidson:

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        In connection with its review, Davidson relied upon and assumed the accuracy and completeness of all of the information listed above that it was provided or obtained through publicly available sources. Davidson does not assume any responsibility for independent verification of the information. Davidson assumed that the assumptions and estimates of both managements used to build their forecasts were reasonably prepared, reflecting the best currently available estimates and judgments of the future financial performance of the combined company. Davidson did not independently verify the validity of the assumptions used by management of Klamath or Sterling.

        Davidson did not make any independent evaluation or appraisal of the assets and liabilities of Klamath or Sterling, nor was it furnished with any appraisals. Davidson did not examine individual loan files of Klamath or Sterling. Davidson is not an expert in the evaluation of loan portfolios for the purpose of assessing the adequacy of the allowance for loan losses and assumed that these allowances are, in the aggregate, adequate to cover future losses.

        Davidson provided its opinion without regard to the necessity for, or level of, any restrictions, obligations, undertakings or other actions, which may be imposed or required in the course of obtaining regulatory approval for the merger. Davidson's opinion is necessarily based upon economic, market and other conditions, and on the information made available to it as of July 14, 2003, and updated as of [October    , 2003]. No limitations were imposed on Davidson regarding the scope of its investigation or otherwise by Klamath or Sterling.

        Valuation Methods.    In connection with providing its opinion, Davidson performed a variety of financial analyses, including those summarized below. The information provided below is not a complete description of the analyses Davidson used in reaching its opinion. Preparation of a fairness opinion involves various determinations and judgments as to the most appropriate and relevant methods of financial analysis and the application of these methods to the particular circumstances.

        Davidson provided the Klamath board with the results of the various analyses that are described below and advised the Klamath board that it believes that all of its analyses must be considered as a whole and that selecting portions of its analyses and factors considered by the analyses, without considering all analyses and factors, or attempting to ascribe relative weights to some or all such analyses and factors, or including other discrete analyses or factors could create an incomplete view of the evaluation process underlying its opinion. The preparation of a fairness opinion is a complex process involving subjective judgments and is not necessarily susceptible to partial analyses or summary descriptions. With respect to the comparable public company analysis and thrift acquisition transaction analysis, no company or transaction utilized as a comparison is identical to Klamath, or the merger, and such analyses necessarily involve complex considerations concerning the differences in financial

39



characteristics of the companies and other factors that could affect the acquisition or public trading values of the companies concerned.

        In performing its analyses, Davidson made numerous assumptions with respect to industry performance, general business and economic conditions and other matters, many of which are beyond the control of Klamath, Sterling, the combined company and Davidson.

        The summary presented by Davidson to Klamath's board of directors on July 14, 2003 included the following:

        The following table summarizes the valuation methodologies and ranges of values that Davidson believed to be material in supporting its fairness conclusion:

Methodology

  Range of Values
Comparable Public Company Market Capitalization   $40 to $635 million
  Klamath on July 11, 2003   $120 million
  Sterling on July 11, 2003   $386 million

Stock Trading Data History

 

 
  Stock Value Range since Oct. 5, 1995   $9.75 to $24.25 per share
  52 Week Trading Range   $13.24 to $17.75 per share

Relative Contribution Analysis

 

$53 to $200 million

Thrift Acquisition Transactions

 

$96 to $234 million
  All Thrifts in U.S. (Group 1)   $120 to $222 million
  Thrifts in the Western U.S. (Group 2)   $96 to $207 million
  U.S. Thrifts: ROAA < 0.75% (Group 3)   $101 to $200 million
  U.S. Thrifts: $500 M < Assets < $5 B (Group 4)   $117 to $234 million
  U.S. Thrifts: ROAA < 0.75% and
$500 Mil < Assets < $5 B (Group 5)
  $115 to $167 million

Discounted Dividend Analysis

 

$97 to $164 million
  12% Discount Rate   $112 to $164 million
  14% Discount Rate   $104 to $152 million
  16% Discount Rate   $97 to $141 million

        Comparable Public Company Analysis.    Using publicly available information, Davidson compared financial information of Klamath and Sterling based on various measures of earnings performance, operating efficiency, capital adequacy and asset quality generally applied to thrifts. For the purpose of such analysis, the financial information used by Davidson was as of and for the three months ended March 31, 2003. The thrifts examined included representative thrifts with assets over $250 million and

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below $5 billion, which were located in the four Western U.S. states where there are publicly traded thrifts (Washington, Oregon, Idaho and California). They included the following:

Commercial Capital Bancorp, Inc.
EverTrust Financial Group, Inc.
FirstBank NW Corp.
FirstFed Financial Corp.
First Mutual Bancshares, Inc.
First PacTrust Bancorp Inc.
Harrington West Financial Group, Inc.
Hawthorne Financial Corporation
  Heritage Financial Corporation
Horizon Financial Corp.
PFF Bancorp Inc.
Provident Financial Holdings, Inc.
Quaker City Bancorp, Inc.
Riverview Bancorp, Inc.
Timberland Bancorp, Inc.

        To provide some historical context for the performance of both Klamath and Sterling, and the comparable thrifts, and establish the underlying trends in the data for Klamath, Sterling, and the comparable thrifts, Davidson compared data for these companies for the three months ending March 31, 2003 (the most recent reported quarter) to data for the three months ending March 31, 2002 and March 31, 2001. The results of this analysis are presented in the following table.

 
  Klamath
  Sterling
  Comparable
Public Thrifts

 
  2001
  2002
  2003
  2001
  2002
  2003
  2001
  2002
  2003
 
  (numbers are %)

Return on Average Assets   1.18   0.46   0.25   0.54   0.74   0.85   0.97   1.16   1.21
Return on Average Equity   10.4   6.0   3.2   10.0   13.2   14.5   8.8   11.1   13.7
Net Interest Margin   3.04   3.55   3.04   3.25   3.28   3.31   3.49   3.90   3.81
Efficiency Ratio   56.4   82.9   90.5   65.8   64.8   58.6   58.6   55.0   55.9
Loan Loss Reserve/Loans   0.77   1.21   1.23   0.86   1.00   1.19   1.07   1.12   1.20
NPA's/Assets   0.14   0.04   0.15   0.63   0.73   0.74   0.39   0.36   0.16

        This historic perspective reveals the performance trends of Klamath, Sterling and the comparable thrift group. Klamath's trends reveal deteriorating performance, while both Sterling's and the comparable group's median performance reflect generally improving metrics over the same two-year period. As of the most recent reported quarter, Klamath's performance was substantially weaker than the comparable group's median performance; although it maintained a slightly larger loan loss reserve, its credit quality was the same as the comparable group's median.

        In addition, Davidson examined various measures of market performance, including, but not limited to, price to: book value, tangible book value, earnings and assets and took the median multiples of the thrift universe and applied those to Klamath's results. The data reflects share prices as of July 11, 2003.

 
  Klamath
  Sterling
  Comparable Company
Medians

 
Price to book value   0.95 x 1.60 x 1.64 x
Price to tangible book value   1.41 x 2.00 x 1.68 x
Price to TTM Earnings   16.0 x 12.9 x 13.8 x
Price to 2003 Earnings(1)   23.2 x 11.7 x 12.5 x
Price to 2004 Earnings(1)   15.8 x 10.5 x 11.1 x
Price to assets   8.1 % 10.1 % 16.4 %

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        Klamath trades at a discount to the comparable company median on price to book value and price to tangible book value, but trades at a significant premium on all three price to earnings ratios. Sterling trades at approximately the median of the comparable companies on price to book value, at a premium on price to tangible book value and at a discount on all three price to earnings ratios. Both Klamath and Sterling trade at a sizable discount on price to assets when compared to the comparable company median.

        Currently, Klamath pays a quarterly cash dividend and no stock dividend, while Sterling pays an annual stock dividend and no cash dividend.

        Historical Trends.    Since 2000, interest rates have fallen dramatically. While the decline in consumer residential mortgage rate has had a positive impact on financial performance at most thrifts, this same trend has been particularly detrimental at Klamath because of its strong reliance on its investment securities portfolio and its fixed rate borrowings from the Federal Home Loan Bank. This effect is likely to continue in the short term.

        In addition to being negatively affected by falling interest rates, Klamath has experienced a severe run-off in revenue producing loans, reflected in its declining loan-to-deposit ratio as illustrated in the table below. Without evidence that this trend is reversing, Klamath is not likely to generate greater net interest income in the short term. The composition of Klamath's loan portfolio and the loan deposit ratios are presented in the following table.


Klamath's Loan Portfolio Composition and Loan/Deposit Ratio

 
  June 30, 2001
  June 30, 2002
  March 31, 2003
 
 
  (Dollars in millions)

 
Real Estate                    
  1-4 Family   $ 421.8   $ 367.9   $ 255.5  
  Construction   $ 22.4   $ 15.5   $ 13.5  
  Commercial and other   $ 67.7   $ 123.6   $ 154.4  
Non Real Estate                    
  Home Equity   $ 10.5   $ 60.4   $ 86.7  
  Other Consumer   $ 8.7   $ 19.9   $ 18.5  
  Commercial Business   $ 6.3   $ 55.7   $ 61.4  
   
 
 
 
Total Gross Loans   $ 537.3   $ 643.0   $ 590.0  

Loan/Deposit Ratio

 

 

73.6

%

 

55.2

%

 

52.8

%

        Stock Trading Data History.    Davidson reviewed daily stock price data for Klamath common stock and Sterling common stock compared to the comparable thrift group listed above and the S&P 500 over a one-year period from July 1, 2002 to July 1, 2003. This analysis showed that over this period, Klamath's common stock increased in value 13%, the value of Sterling's stock increased 40% and the value of the comparable thrift index increased 25%, while the S&P 500 index increased 3%.

        Additionally, Davidson reviewed daily stock price data for Klamath common stock and Sterling common stock compared to the comparable thrift group and the S&P 500 over a three-year period from July 1, 2000 to July 1, 2003. This analysis showed that over this period, Klamath's common stock increased in value 55%, the value of Sterling's common stock increased 242% and the value of the comparable thrift index increased 143%, while the S&P 500 index decreased 33%.

        The trading valuation for Klamath common stock at July 11, 2003 appeared to be significantly higher on a price to book value and price to trailing twelve months and to forward 2003 and 2004 forecast earnings than the valuations for other comparable thrifts when taking into consideration return on average assets and return on average equity.

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        Analysis of Relative Contribution of Parties.    In preparing its opinion, Davidson also reviewed the relative financial contributions of Klamath and Sterling to certain pro forma balance sheet and income statement items of the combined entity. The chart below shows these percentage contributions.


Relative Contributions as of and for the three months ended March 31, 2003

 
  Klamath
  Sterling
  Exchange
Ratio

  Implied Per
Share Value(1)

Est. CY 2003 Net Income   12 % 88 % 0.29 x $ 7.63
Est. CY 2004 Net Income   15 % 85 % 0.38 x $ 9.89
Net Loans   18 % 82 % 0.48 x $ 12.57
TTM Net Income   20 % 80 % 0.55 x $ 14.30
Market Capitalization   24 % 76 % 0.67 x $ 17.40
Total Assets   28 % 72 % 0.82 x $ 21.47
Tangible Equity   29 % 71 % 0.88 x $ 22.90
Deposits   33 % 67 % 1.02 x $ 26.77
Equity   33 % 67 % 1.05 x $ 27.40

        The per share consideration, using the Sterling closing price on July 11, 2003 of $26.15, is $20.14, or $144.5 million in aggregate, which compares favorably with the implied per share value range in the table above of $7.63 to $27.40, or $53 million to $200 million in the aggregate.

        Considering the 5,358,355 common shares of Sterling to be exchanged for all of the outstanding common shares of Klamath, Klamath shareholders will own approximately 26.6% of the combined company based upon the relative amounts of common stock owned by Klamath and Sterling common shareholders following closing of the transaction.

        Analysis of Thrift Acquisition Transactions.    After completing its analysis of the fairness of the total merger consideration based on the relative contributions of the parties, Davidson reviewed other thrift merger and acquisition transactions to further confirm its opinion. Davidson examined the following comparison groups:

Group 1   Group of 124 thrift transactions in the United States that were announced from January 1, 2001 through July 11, 2003. This includes all transactions, regardless of size or other characteristics, announced in the United States during that time period. These acquired thrifts ranged in size from $8.5 million to $54.1 billion in assets at announcement.

Group 2

 

Group of 11 thrift acquisitions in the Western United States (Washington, Oregon, California, Idaho, Nevada, Hawaii, Montana, Wyoming, Colorado and New Mexico) announced between January 1, 2001 and July 11, 2003. These acquired thrifts ranged in size from $21.5 million to $54.1 billion in assets at announcement.

Group 3

 

Group of 75 thrift acquisitions of institutions with less than 0.75% return on average assets. These transactions were announced in the United States from January 1, 2001 through July 11, 2003. These acquired thrifts ranged in size from $8.5 million to $2.2 billion in assets at announcement.

Group 4

 

Group of 29 thrift acquisitions where the target's assets were greater than $500 million, but less than $5 billion in assets. These transactions were announced in the United States from January 1, 2001 through July 11, 2003. These acquired thrifts ranged in size from $507.1 million to $2.9 billion in assets at announcement.
     

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Group 5

 

Group of 10 thrift acquisitions where the target's assets were greater than $500 million but less than $5 billion and return on average assets was less than 0.75%. These transactions were announced in the U.S. from January 1, 2001 through July 11, 2003. These acquired thrifts ranged in size from $507.1 million to $2.2 billion in assets at announcement.

        Below is a table that displays the median value of the targets in each group of transactions.

 
  Group 1
  Group 2
  Group 3
  Group 4
  Group 5
 
Assets ($ Mil)   $ 147.1   $ 213.3   $ 93.9   $ 948.3   $ 937.3  
ROAA     0.67 %   1.00 %   0.38 %   1.00 %   0.58 %
ROAE     6.5 %   12.7 %   3.5 %   11.9 %   8.1 %
Efficiency Ratio     73.2 %   57.6 %   82.3 %   59.0 %   72.8 %
NPA's/Assets     0.37 %   0.68 %   0.45 %   0.31 %   0.68 %

        Davidson reviewed the multiples of transaction value for common stock shareholders at announcement to last twelve months' earnings, tangible book value, assets and premium to market value. These multiples were applied to Klamath's financial information for the last twelve months ending March 31, 2003.

        Davidson derived an imputed range of values for Klamath of $96 million to $234 million based on the median multiples. A summary is shown below:

Group 1 Imputed Value Range   $120 million to $222 million
Group 2 Imputed Value Range   $96 million to $207 million
Group 3 Imputed Value Range   $101 million to $200 million
Group 4 Imputed Value Range   $117 million to $234 million
Group 5 Imputed Value Range   $115 million to $167 million

       

 
  Group 1
  Group 2
  Group 3
  Group 4
  Group 5
 
  Median
  Implied
Value

  Median
  Implied
Value

  Median
  Implied
Value

  Median
  Implied
Value

  Median
  Implied
Value

 
  (Dollars in millions)

TTM EPS   19.5 x $ 140.4   13.3 x $ 95.8   27.4 x $ 197.3   16.3 x $ 117.4   15.9 x $ 114.5
Tangible Bk Value   1.49 x $ 120.0   1.53 x $ 123.2   1.25 x $ 100.6   2.12 x $ 170.7   1.46 x $ 117.5
Assets   15.0 % $ 221.7   14.0 % $ 206.9   13.5 % $ 199.5   15.8 % $ 233.5   11.3 % $ 167.0
Market Premium   31.5 % $ 157.0   30.6 % $ 155.9   40.2 % $ 167.4   23.0 % $ 146.7   31.0 % $ 156.4

        Based on just the imputed valuations of these transaction groups, Davidson reported that the valuation for Klamath would be in a range of $96 million to $234 million. Assuming the July 11, 2003 price of the Sterling common stock, Davidson calculated the value of the consideration in the merger to be $144.5 million. Davidson stated that the most significant determinants of the valuation for Klamath are the Trailing Twelve Months Earning Per Share (TTM EPS) and tangible book value multiples.

        The median values of the five comparison groups are shown below.

 
  TTM EPS
  Tangible
Book Value

  Assets
  Market
Premium

 
  (Dollars in millions)

Median   $ 117.4   $ 120.0   $ 206.9   $ 156.4

        When compared to the median valuation metrics values, the merger valuation of $144.5 million is above the median when valued on a TTM EPS and tangible book value basis. Predictably, the merger valuation is significantly lower than the valuation predicted by the group medians for assets because of Klamath's reduced earnings when compared to its significant total assets and the relatively large percentage of its assets that consists of investment securities rather than higher yielding loans.

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        Discounted Dividend Analysis.    Using a discounted dividend stream analysis, Davidson examined the value of Klamath by adding the present value of estimated earnings that could be paid out as dividends, using management's assumptions and guidance, for calendar years 2003 through 2007 and an estimated terminal value for Klamath's stock assuming a sale at the end of 2007. The terminal value was then estimated by applying a range of multiples of 12 to 18 times estimated 2007 earnings. Davidson discounted the dividend stream and terminal value using discount rates of between 12% and 16%. These rates were chosen to reflect different assumptions regarding required rates of return to holders or prospective buyers of Klamath common stock. The analysis provided three valuation ranges, based on the various discount rates. The 12% discount rate produced a range of $112 million to $164 million, the 14% discount rate produced a range of $104 million to $152 million, and the 16% discount rate produced a range of $97 million to $141 million. The midpoints of these three ranges were $138 million, $128 million and $119 million, respectively. These values compare to the acquisition consideration of approximately $144.5 million, using closing price of Sterling common stock on July 11, 2003 of $26.15.

        Pro Forma Acquisition Analysis.    Davidson reviewed projections prepared by the managements of Klamath and Sterling for year-end 2003, 2004 and 2005.

        The earnings projections for Klamath and Sterling used by Davidson in its analysis were based upon internal projections by Klamath and Sterling for the years ending December 31, 2003, December 31, 2004 and December 31, 2005. The earnings projections furnished to Davidson were prepared for internal purposes only and not intended for public disclosure. The projections assume that there will be no substantial shift in future economic, financial market, competitive and regulatory conditions, all of which are difficult or impossible to predict and largely beyond the control of both parties to this merger. With respect to all financial projections prepared by Klamath's and Sterling's management used by Davidson in its analysis, Davidson assumed that they reflected the best currently available estimates and judgments of the respective managements of the respective future financial performances of Klamath and Sterling and that such performances will be achieved. Davidson expressed no opinion as to such financial projections or the assumptions on which they were based.

        Actual results achieved by the combined company following the merger may vary from this and other forecasts, and the variations may be material. Like all forward-looking statements, this analysis produces results that are inherently uncertain.

        Accretion/Dilution Analysis.    This review examined whether and by how much the proposed transaction is expected to be accretive to Sterling's earnings in calendar year 2004, the first year of the combined company's operations. The critical part of this analysis is the set of assumptions which drive the earnings per share estimate.

        Davidson concurs with the assertion of management of both companies that the proposed merger will be accretive to Sterling shareholders in 2004.

        Relationship of Davidson to Klamath and Sterling.    Klamath agreed to pay Davidson for its financial advisory services and for rendering its fairness opinion, a fee of 0.75% of the aggregate consideration paid by Sterling or approximately [$1,190,000] based upon the closing price of Sterling common stock on [September 12], 2003, of which $175,500 has already been paid. Klamath has also agreed to reimburse Davidson for its reasonable out-of-pocket expenses incurred in connection with its engagement. Klamath also agreed to indemnify Davidson, its affiliates, directors, officers, agents, managers, members, attorneys, stockholders, employees and controlling persons against certain expenses and liabilities in connection with its engagement.

        Davidson has in the past provided investment banking services to Klamath unrelated to the merger, for which it has received compensation. Davidson has also received compensation for

45



investment banking services provided to Sterling unrelated to the merger, including acting as one of the placement agents in connection with a trust preferred securities offering for Sterling.

        Davidson makes a market in the common stock of Klamath, and publishes a research recommendation on and makes a market in the common stock of Sterling. In the ordinary course of Davidson's business, Davidson and its affiliates may actively trade securities of Klamath and Sterling for their own and for the accounts of customers, and may, therefore, at any time hold a long or short position in such securities.

Structure of the merger

        Subject to the terms and conditions of the merger agreement and in accordance with Washington and Oregon law, at the completion of the merger, Klamath will merge with and into Sterling. Sterling will be the surviving corporation and will continue its corporate existence under the laws of Washington and under the name "Sterling Financial Corporation." When the merger is completed, the separate corporate existence of Klamath will terminate. Sterling's articles of incorporation and bylaws will be the articles and bylaws of the combined company. The board of directors of Sterling will continue as the board of directors of the combined company.

        The merger agreement provides that Sterling may change the structure of the merger. However, no such change may reduce the amount or change the form of consideration to be delivered to Klamath shareholders, adversely affect the anticipated tax consequences to Klamath shareholders in the merger, or delay or jeopardize receipt of any required regulatory approvals to complete the merger.

Exchange ratio; possible adjustment of exchange ratio

        At the effective time of the merger, each outstanding share of Klamath common stock will be converted into 0.77 shares of Sterling common stock. The closing price for Sterling common stock on [October 31, 2003] was [$            ]. The market value for Sterling common stock will fluctuate prior to the closing of the merger. The merger exchange ratio is fixed. Therefore, regardless of the market price of Sterling common stock at the time of closing, you will receive no more than 0.77 of a share of Sterling common stock for each share of Klamath common stock that you own. Thus, you may receive more or less than the equivalent of $[    ] per share of Klamath common stock in the merger. You will receive cash for any fractional share you would otherwise receive in the merger. The exchange ratio was determined through arm's-length negotiations between Sterling and Klamath.

        The amount of cash that Sterling will pay you in lieu of a fractional share will equal the average closing price of Sterling common stock on the Nasdaq National Market over the ten trading days ending on and including the fifth trading day before the closing date, multiplied by the fraction of a share of Sterling common stock to which you would otherwise be entitled. Klamath shareholders will not receive interest on cash payments in lieu of fractional shares.

        At the effective time of the merger, shares of Klamath common stock will no longer be outstanding, will automatically be canceled and will cease to exist. Holders of certificates representing shares of Klamath common stock will cease to have any rights as shareholders of Klamath except the right to receive certificates representing shares of Sterling common stock and the right to receive cash for any fractional share of Sterling common stock.

Treatment of options and employee stock purchase and benefit plans

        At the effective time of the merger, each stock option granted by Klamath under the Klamath Stock Option Plan shall be automatically converted into an option to purchase shares of Sterling common stock, based upon the exchange ratio, subject to the terms of the merger agreement and the Klamath Stock Option Plan.

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        Sterling has agreed to allow any unallocated shares of Klamath common stock in the Klamath ESOP (following retirement of all borrowings of the Klamath ESOP) to be allocated to participants and to cause any overfunding to be allocated to participants as earnings. For the period prior to the effective time of the merger, Klamath may make contributions to the Klamath ESOP, payments on the Klamath ESOP loan and one additional allocation, in October 2003, to the accounts of participants in the Klamath ESOP consistent with past practices on the regularly scheduled payment dates.

        Sterling has agreed to merge the Klamath 401(k) Plan into Sterling's 401(k) Plan. Sterling will also offer Klamath employees who remain at Sterling benefits commensurate with the benefits it gives to comparable Sterling employees. To the extent that credited periods of service determine eligibility, vesting and benefit accruals under any Sterling employee benefit plan, Sterling will credit former Klamath employees for any service credit recognized by Klamath or its subsidiaries with respect to eligibility and vesting under the Sterling plans, but not with respect to benefit accruals.

        Except as provided above, Klamath has agreed to terminate or withdraw from all of Klamath's employee benefit plans at or as soon as reasonably practicable after the effective time of the merger. Sterling and Klamath have agreed to cooperate in taking the appropriate actions.

Interests of Klamath's directors and executive officers in the merger

        When considering the recommendation of Klamath's board of directors, you should be aware that some of Klamath's directors and executive officers have interests in the merger and have arrangements that are different from, or are in addition to, their interests as shareholders of Klamath generally. These include, among other things, indemnification rights, potential acceleration of option vesting and other benefits and payments under certain agreements and employee benefit and retention plans.

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48


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Klamath's board of directors was aware of and considered the interests of Klamath's directors and executive officers in approving the merger and recommending that Klamath's shareholders approve the merger agreement.

Restrictions on sales by affiliates

        All shares of Sterling common stock received by Klamath shareholders in connection with the merger will be freely transferable unless the shareholder is considered to be an affiliate of either Klamath or Sterling under the Securities Act of 1933.

        Shares of Sterling common stock held by affiliates may be sold only under a registration statement or an exemption from registration under the Securities Act of 1933. Each of Klamath's executive officers and directors, each of whom may be deemed to be an "affiliate" of Klamath, as that term is defined under Rule 145 of the Securities Act of 1933, has signed a letter agreement with Sterling, agreeing that he or she will sell, offer to sell or otherwise dispose of any Sterling common stock issued in connection with the merger only under an effective registration statement or in compliance with Rule 145 or other exemption from registration under the Securities Act of 1933.

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Material United States federal income tax consequences of the merger

        The following discussion summarizes the material United States federal income tax consequences to Klamath and Klamath's shareholders in connection with the merger. This summary does not purport to be a complete analysis or listing of all of the potential tax effects of the merger. It does not deal with all federal income tax considerations that may be relevant to some Klamath shareholders in light of their particular circumstances, such as dealers in securities, shareholders who do not hold their Klamath common stock as capital assets and those subject to the alternative minimum tax provisions of the Internal Revenue Code. Furthermore, it does not address the tax consequences particular to Klamath shareholders who acquired their shares in connection with stock options or stock purchase plans or in other compensatory transactions, and does not address the effects of the merger on holders of Klamath stock options. Moreover, it does not address the tax consequences of the merger under foreign, state or local tax laws.

        YOU SHOULD CONSULT YOUR OWN TAX ADVISOR AS TO THE CONSEQUENCES OF THE MERGER, INCLUDING THE UNITED STATES FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES APPLICABLE TO YOU.

        It is a condition to the merger that Klamath receive an opinion from Silver, Freedman & Taff, L.L.P. that the merger will constitute reorganization under Section 368 of the Internal Revenue Code. Sterling will receive a similar opinion from its counsel, Witherspoon, Kelley, Davenport & Toole, P.S. The tax opinions will be based on and subject to certain assumptions and limitations as well as factual representations received from Klamath and Sterling, as discussed below. An opinion of counsel represents only counsel's best legal judgment, has no binding effect or official status of any kind and contrary positions may be taken by the Internal Revenue Service or a court considering the issues. Neither Klamath nor Sterling has requested or will request a ruling from the IRS with regard to any of the United States federal income tax consequences of the merger. The tax opinions and this discussion are based on currently existing provisions of the Internal Revenue Code, existing and proposed Treasury regulations and current administrative rulings and court decisions. Future legislative, judicial or administrative changes or interpretations may adversely affect the accuracy of the tax opinions or of the statements and conclusions in this discussion. Any such changes or interpretations could be applied retroactively and could affect the tax consequences of the merger.

        Assuming the merger qualifies as a tax-free reorganization, the material United States federal income tax consequences of the merger are as follows:


        The aggregate tax basis of the Sterling common stock you receive in the merger (including any fractional share deemed received) will be the same as the aggregate tax basis of the Klamath common stock you surrendered in exchange for the Sterling common stock. The holding period of each share of Sterling common stock you receive in the merger will include the period during which you held your Klamath common stock.

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        Cash payments in lieu of a fractional share should be treated as if a fractional share of Sterling common stock had been issued in connection with the merger and then redeemed by Sterling. If you receive cash, you should generally recognize a gain or loss at the time of that payment equal to any difference between the amount of cash received and your basis in the fractional share (which will be a pro rata portion of your basis in the Sterling common stock received in the merger).

        A successful challenge by the IRS to the tax-free reorganization status of the merger would result in Klamath's shareholders recognizing a taxable gain or loss for each share of Klamath common stock surrendered, equal to the difference between the shareholder's basis in that share and the fair market value, as of the effective date of the merger, of the Sterling common stock received in exchange for the Klamath share, plus any cash received. This gain or loss would be treated as capital gain or loss for each shareholder. In that event, a shareholder's aggregate basis in Sterling common stock received would equal the fair market value of such stock at the effective date of the merger and the holding period for the stock would begin on the day after the effective date of the merger.

Accounting treatment of the merger

        Sterling expects to account for the merger using the purchase method of accounting in accordance with generally accepted accounting principles. Sterling will be considered the acquiror and will recognize intangible assets and goodwill. See "Pro Forma Financial Information" on page [    ].

Exchange of Klamath stock certificates for Sterling stock certificates

        You should not send Klamath common stock certificates to Klamath or Sterling at this time. After the closing of the merger, the exchange agent will send a letter of transmittal to all Klamath shareholders of record. This letter will instruct you as to how to exchange your Klamath common stock certificates for Sterling common stock certificates. As soon as practicable after receipt of your properly completed letter of transmittal, the exchange agent will deliver to you a certificate representing the appropriate number of shares of Sterling common stock, together with a check representing the cash payment for any fractional share.

Conditions to completion of the merger

        The obligations of each of Sterling and Klamath to effect the merger are subject to the satisfaction before the closing date of specific conditions, any or all of which may be waived, including:

52


        The obligations of Sterling to effect the merger are further subject to the satisfaction before the closing date of specific conditions, any or all of which may be waived, including:

        We cannot provide assurance as to when or if all of the conditions to the merger can or will be satisfied or waived by the appropriate party. As of the date of this document, we have no reason to believe that any of these conditions will not be satisfied.

Representations and warranties

        The merger agreement contains customary representations and warranties of each of Klamath and Sterling relating to, among other things:

        Klamath has made additional representations and warranties relating to, among other things:

53


Exclusivity

        In the merger agreement, Klamath agreed that it would not authorize or permit its representatives to (i) initiate, solicit, encourage or knowingly facilitate any inquiries or proposals with respect to, any acquisition proposal (as defined in the merger agreement) or (ii) engage in any negotiations concerning, or provide any nonpublic information to, or have any discussions with, any person relating to, any acquisition proposal. In the event, however, that Klamath receives an unsolicited bona fide acquisition proposal and Klamath's board of directors concludes in good faith that such acquisition proposal constitutes or is reasonably likely to result in a superior proposal (as defined in the merger agreement), Klamath may take any action described in clause (ii) above to the extent that the Klamath board of directors concludes in good faith (based on the advice of its outside counsel) that failure to take such actions would more likely than not result in a violation of its fiduciary duties under applicable law. Prior to providing any nonpublic information, Klamath must have entered into a confidentiality agreement with the third party. Klamath agreed to discontinue any activities, discussions or negotiations conducted before the date of the merger agreement with any persons other than Sterling with respect to any acquisition proposal. Klamath agreed to promptly advise Sterling following receipt of any acquisition proposal of the substance thereof (including the identity of the person making such acquisition proposal), and to keep Sterling apprised of any related developments, discussions and negotiations (including the terms and conditions of the acquisition proposal) on a current basis.

Other agreements

        Sterling and Klamath have each agreed that until the earlier of the termination of the merger agreement or the effective time of the merger, except as expressly contemplated by the merger agreement or with the prior written consent of the other party, they will take specified actions and refrain from taking other actions, as described below.

        Sterling and Klamath have conditionally agreed, among other things, to:

54


        Klamath has agreed that it will carry on its business in the ordinary course consistent with past and prudent practices, and use its reasonable best efforts to preserve intact its business organization, keep its present employees and preserve its goodwill with customers and others having business with Klamath. Klamath has also agreed that, except as contemplated or permitted by the merger agreement or with the prior written consent of Sterling, neither it nor any of its subsidiaries will:

55


        Sterling has conditionally agreed, among other things, to:

56


Termination of the merger agreement

        The merger agreement may be terminated by the mutual written consent of the parties at any time before the effective time of the merger. In addition, subject to certain conditions, the merger agreement may be terminated by either Klamath or Sterling if:

        In addition, the merger agreement may be terminated subject to certain conditions:

57


Termination fees

        Klamath and Sterling have agreed to pay termination fees in certain events. Klamath must pay Sterling a termination fee of $6.0 million in the event of a termination of the merger agreement for the reasons described in subparagraphs (e),(f) or (g) of the preceding section entitled "Termination of the merger agreement." If Sterling terminates the merger agreement for the reasons described in subparagraph (c) of the preceding section, Klamath must pay Sterling a termination fee of $1.5 million, provided that the fee will increase to $6.0 million if, within 18 months after termination, Klamath or any of its subsidiaries consummates or enters into a definitive agreement with respect to an acquisition proposal (as defined in the merger agreement). If Klamath terminates the merger agreement for the reason described in subparagraph (i) of the preceding section, Sterling must pay Klamath a termination fee of $1.5 million.

        The termination fees may increase the likelihood of the completion of the merger in accordance with the terms of the merger agreement. The termination fees may also discourage persons from making an offer to acquire all of or a significant interest in Klamath by increasing the cost of an acquisition. If a party fails to timely pay the termination fee, the other party must pay the costs and expenses incurred by the other party to collect such payment, together with interest.

Extension; waiver

        At any time before the effective time of the merger, either party to the merger agreement may, to the extent legally allowed:

Amendment of the merger agreement

        The merger agreement may be amended by Sterling and Klamath at any time before or after approval by Klamath's shareholders, except that, after shareholder approval, Klamath and Sterling may not make any amendment which reduces the amount or changes the form of consideration to be delivered to Klamath shareholders without the further approval of Klamath's shareholders.

Klamath management voting agreements

        As a condition to the merger agreement, Sterling required Klamath's directors and certain executive officers to enter into voting agreements. These voting agreements require Klamath's directors and certain executive officers to vote all of the shares of Klamath common stock they beneficially own in favor of approval of the merger agreement. As of October 13, 2003, the record date, Klamath's directors and such executive officers collectively owned [    ] shares of Klamath common stock, which represented approximately [    ] percent of Klamath's outstanding common stock. None of Klamath's directors or executive officers were paid additional consideration to enter into the voting agreements.

58



COMPARISON OF RIGHTS OF HOLDERS OF KLAMATH COMMON STOCK AND
STERLING COMMON STOCK

        After completion of the merger, the Klamath shareholders will become shareholders of Sterling. Klamath is an Oregon corporation. Sterling is a Washington corporation. Before the merger, the rights of Klamath shareholders are governed by Klamath's articles of incorporation, its bylaws and the Oregon Business Corporation Act. After the merger, as Sterling shareholders, the rights of Klamath will be governed by Sterling's articles of incorporation, its bylaws and the Washington Business Corporation Act.

        The following discussion summarizes the material differences between the rights of holders of Sterling common stock and holders of Klamath common stock under the articles of incorporation and bylaws of Sterling and the articles of incorporation and bylaws of Klamath. This summary is qualified in its entirety by reference to Sterling's articles of incorporation and bylaws, Klamath's articles of incorporation and bylaws and the relevant provisions of Washington and Oregon corporation law. This discussion is not intended to be a complete statement of the differences between Washington law and Oregon law. Differences between the Washington Business Corporation Act and the Oregon Business Corporation Act should be considered when evaluating the comparative rights of Sterling and Klamath shareholders. Copies of the charter documents are attached as exhibits to Klamath's and Sterling's filings with the SEC. See "Documents Incorporated By Reference Into This Joint Proxy Statement/Prospectus" and "Where You Can Find More Information" on page [    ].

Board of directors

    Klamath.   Klamath's articles of incorporation provide that the number of directors on the Klamath board of directors shall be not less than five nor more than twenty-five and no action can be taken to decrease or increase the number of directors without approval of at least two-thirds of the directors then in office. Klamath currently has eight directors.

 

 

Sterling.

 

Sterling's bylaws provide that the number of directors may be increased or decreased by an amendment to the bylaws. Amendments to the bylaws may be adopted by Sterling's shareholders or by a majority of the board of directors without shareholder approval, subject to the Washington Business Corporation Act.

Right to call special meeting of shareholders

    Klamath.   A special meeting of the shareholders may be called by the board of directors or by a committee of the board of directors designated by the board or as otherwise provided by the Oregon Business Corporation Act.

 

 

Sterling.

 

A special meeting of shareholders may be called by Sterling's board of directors or by the holders of 10% of Sterling's voting shares entitled to vote on the proposals to be considered at the special meeting.

Preemptive rights

    Klamath.   Klamath's articles of incorporation provide that holders of Klamath securities generally do not have preemptive rights. Any unissued securities may, however, be issued by Klamath's board of directors with such terms as they deem advisable, including preemptive rights.
         

59



 

 

Sterling.

 

Sterling's articles of incorporation provide that Sterling shareholders shall not have preemptive rights.

Removal of directors

    Klamath.   Klamath's articles of incorporation generally provide that a director may be removed only for cause and only when the removal is approved by 80% of the outstanding shares of Klamath capital stock authorized to vote at a shareholder meeting called for that purpose. There are no restrictions on removal of directors elected by holders of preferred stock.

 

 

Sterling.

 

Sterling's articles of incorporation do not vary from the Washington Business Corporation Act which provides that a director may be removed with or without cause by a simple majority of the shares authorized to vote.

Removal of officers

    Klamath   Klamath's bylaws provide that any officer may be removed by a vote of two-thirds of the board of directors.

 

 

Sterling.

 

Sterling's bylaws provide that any officer or agent may be removed by a vote of a majority of the board of directors.

Filling vacancies on the board of directors

    Klamath.   Klamath's bylaws provide that any vacancy on Klamath's board may be filled by the affirmative vote of two-thirds of the remaining directors. A director elected to fill a vacancy shall serve for the unexpired term of his predecessor in office.

 

 

Sterling.

 

Sterling's bylaws provide that any vacancy on Sterling's board may be filled by the affirmative vote of a majority of the remaining directors. A director elected to fill a vacancy shall serve for the unexpired term of his predecessor in office.

Amendment of articles and bylaws

    Klamath.   Klamath's articles of incorporation provide that certain specified articles may not be repealed, altered, amended or rescinded without approval by 80% of the outstanding shares authorized to vote. Klamath's bylaws may be adopted, repealed, altered, amended or rescinded by either two-thirds of the full board of directors or by 80% of the outstanding shares entitled to vote.

 

 

Sterling.

 

Sterling's articles of incorporation do not vary from the Washington Business Corporation Act which limits the amendments that the board of directors may make without shareholder approval. Sterling's bylaws, however, permit amendments, alterations and additions to the bylaws by a majority vote of the board of directors.

Right to call special meeting of directors

    Klamath.   A special meeting of the board of directors may be called by the chairman of the board, the president or by one-third of the directors. The meeting may be held anywhere in the State of Oregon.
         

60



 

 

Sterling.

 

A special meeting of the board of directors may be called by the chairman of the board, or any two directors. The meeting may be held anywhere within or without the State of Washington.

Shareholder nomination and shareholder proposals

    Klamath.   Klamath's articles of incorporation provide that nominations for the election of directors and proposals for any new business at a meeting of shareholders may be made by either the board of directors or by any shareholder that gives notice of the nomination or proposal not less than thirty days nor more than sixty days prior to the meeting.

 

 

Sterling.

 

Sterling's articles of incorporation do not vary from the Washington Business Corporation Act which provides that a majority of the board of directors or shareholders may fill any vacancies on the board and permits holders of 10% of Sterling's voting shares to make written demand that special meeting be held for a certain purpose or purposes.

Voting rights

    Klamath.   Klamath's articles of incorporation provide that holders of the common stock exclusively possess all voting power and each share of common stock generally entitles the holder to one vote for each share. However, if any person acquires the beneficial ownership of more than 10% of any class of Klamath stock without the prior approval of two-thirds of the Klamath's board of directors, then the person will only be entitled to cast one-hundredth of a vote for each vote in excess of 10% of the voting power of the outstanding shares of Klamath voting stock.

 

 

Sterling.

 

Sterling's articles of incorporation provide that each outstanding share, regardless of class, shall be entitled to one vote on each matter submitted to a vote at a meeting of shareholders, except as may be otherwise provided by statute or in the articles of incorporation.

Related person transactions

    Klamath.   Klamath's articles of incorporation require that certain transactions such as mergers with, sales of substantial assets to or issuance of stock to an interested person (a person or entity owning fifteen percent or more of Klamath's outstanding common stock) are prohibited for three years from the time a party becomes an interested person unless: (1) prior to the date the party became an interested person, the board of directors approved the transaction which resulted in the person becoming an interested person; (2) upon consummation of the transaction which resulted in the person becoming an interested person, the interested person beneficially owned at least 85% of the Klamath voting stock; or (3) the transaction has been approved by Klamath's board of directors and two-thirds of the voting stock not owned by the interested person.

 

 

Sterling.

 

Sterling's articles of incorporation do not vary from the Washington Business Corporation Act which provides no special provisions for shareholder votes on transactions with related parties.

61


Anti-takeover provisions

    Klamath.   Klamath's articles of incorporation provide for limited voting rights under certain circumstances and prohibit certain transactions with related persons. See "Voting rights" and "Related person transactions." These provisions as well as other provisions in Klamath's articles of incorporation and bylaws may have an anti-takeover effect which may tend to perpetuate management.

 

 

Sterling.

 

With the exception of the provisions noted in this section above, the provisions in Sterling's articles of incorporation which may have an anti-takeover effect or which may tend to perpetuate management are generally similar to Klamath's.

62



SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND
DIRECTORS OF STERLING

        The following table sets forth, as of [August 31,] 2003, information concerning the beneficial ownership of Sterling common stock by each director and executive officer and by the directors and executive officers as a group.

Beneficial Owner

  Amount and Nature
of Beneficial Ownership

  Percent of
Class

 
Beneficial owners of more than 5%          
 
Westport Asset Management, Inc.(1)
253 Riverside Avenue
Westport, CT 06880

 

1,037,766

 

8.68

 
 
Private Capital Management(2)
8889 Pelican Bay Blvd., Ste. 500
Naples, FL 34108

 

941,044

 

7.87

 
 
Dimensional Fund Advisors, Inc.(3)
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401

 

826,188

 

6.91

 

Directors and Executive Officers

 

 

 

 

 
 
Ned M. Barnes

 

42,819

(4)

*

 
  Rodney W. Barnett   34,941 (5) *  
  David P. Bobbitt   46,212 (6) *  
  Thomas H. Boone   45,987 (7) *  
  James P. Fugate   19,578 (8) *  
  Harold B. Gilkey   315,396 (9) *  
  John M. Harlow   64,023 (10) *  
  Robert D. Larrabee   26,146 (8) *  
  Robert E. Meyers   42,473 (8) *  
  Heidi B. Stanley   76,013 (11) *  
  David O. Wallace   19,601 (8) *  
  William W. Zuppe   197,143 (12) *  
 
All executive officers and directors as a group (17 persons)

 

1,086,060

(13)

7.34

%

63


64



SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND
DIRECTORS OF KLAMATH

        The following table sets forth, as of [June 30,] 2003, information as to the shares of Klamath common stock beneficially owned by each person who, to the knowledge of Klamath, is the owner of more than five percent of the outstanding shares of Klamath common stock, by each executive officer and director of Klamath, and by the executive officers and directors of Klamath as a group.

Beneficial Owner

  Amount and Nature of
Beneficial Ownership(1)

  Percent of Common
Stock Outstanding

 
Beneficial owners of more than 5%          
 
Tontine Financial Partners, L.P.(2)
Tontine Management, L.L.C.
Tontine Overseas Associates, L.L.C.
Mr. Jeffrey L. Gendell
55 Railroad Ave., 3rd Floor
Greenwich, CT 06830

 

582,200

 

8.34

%
 
Dimensional Fund Advisors, Inc.(3)
1299 Ocean Avenue, 11th Floor
Santa Monica, California 90401

 

542,900

 

7.78

%
 
Bryn Mawr Capital Management, Inc.(4)
One Town Place, Suite 200
Bryn Mawr, PA 19010-3495

 

468,361

 

6.71

%

Directors and Executive Officers(5)

 

 

 

 

 
 
Rodney N. Murray

 

94,129

(6)

1.35

%
  Kermit K. Houser   116,455 (7) 1.67 %
  Bernard Z. Agrons   68,495 (8) **  
  Timothy A. Bailey   70,298 (9) 1.01 %
  Donald N. Bauhofer   6,116 (10) **  
  James D. Bocchi   78,616 (11) 1.13 %
  William C. Dalton   41,570 (12) **  
  Dianne E. Spires   29,409 (13) **  
  Marshall J. Alexander   177,963 (14) 2.55 %
  Ben A. Gay   19,176 (15) **  
  Frank X. Hernandez   46,487 (16) **  
  Craig M Moore   14,711 (17) **  
  Walter F. Dodrill   13,127 (18) **  
  James E. Essany   10,123 (19) **  
 
All executive officers and directors as a group (14 persons)

 

786,675

(20)

11.27

%

65


66



PRO FORMA FINANCIAL INFORMATION

STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

Unaudited Pro Forma Combined Condensed Consolidated Statement of
Financial Condition and Statements of Income

        The following unaudited pro forma combined condensed consolidated statement of financial condition combines the historical consolidated statement of financial condition of Sterling and subsidiaries and the historical consolidated statement of financial condition of Klamath and subsidiaries giving effect to the consummation of the merger on June 30, 2003, using the purchase method of accounting and giving effect to the related pro forma adjustments described in the accompanying notes to the unaudited pro forma combined condensed consolidated financial statements.

        The following unaudited pro forma combined condensed consolidated statements of income for the six months ended June 30, 2003 and the year ended December 31, 2002 combine the historical consolidated statements of income of Sterling and subsidiaries and Klamath and subsidiaries giving effect to the merger as if the merger had become effective at the beginning of the period presented, using the purchase method of accounting and giving effect to the related pro forma adjustments described in the accompanying notes to the unaudited pro forma combined condensed consolidated financial statements. The unaudited pro forma combined condensed consolidated financial statements included herein are presented for informational purposes only. This information includes various estimates and may not necessarily be indicative of the financial position or results of operations that would have occurred if the merger had been consummated on the date or at the beginning of the period indicated or which may be obtained in the future.

        The unaudited pro forma combined condensed consolidated statement of financial condition and accompanying notes should be read in conjunction with and are qualified in their entirety by reference to the historical financial statements and related notes thereto of Sterling and subsidiaries and of Klamath and subsidiaries incorporated by reference herein.

        We anticipate that the merger will provide the combined company with financial benefits that include reduced operating expenses. The pro forma information, while helpful in illustrating the financial characteristics of the combined company under one set of assumptions, does not reflect the benefits of expected cost savings or opportunities to earn additional revenue and, accordingly, does not attempt to predict or suggest future results. It also does not necessarily reflect what the historical results of the combined company would have been had our companies been combined during these periods.

67



STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

Unaudited Pro Forma Combined Condensed Consolidated Statement of
Financial Condition

 
  June 30, 2003
 
 
  Sterling
Historical

  Klamath
Historical

  Pro Forma
Adjustments

  Pro Forma
Combined

 
 
  (Dollars in thousands)

 
ASSETS                          

Cash and due from banks

 

$

93,605

 

$

58,989

 

$

2,201

(B)

$

154,795

 
Asset-backed securities     980,791     591,058           1,571,849  
Investments     95,912     141,347           237,259  
Loans receivable, net     2,719,615     555,287           3,274,902  
Goodwill     45,075     22,873 (B)   (22,873
77,798
)(B)
(C)
  122,873  
Other intangible assets     3,038     14,690     (14,690)
17,412
(B)
(B)
  20,450  
Other assets     156,551     65,643     3,664 (B)   225,858  
   
 
 
 
 
Total assets   $ 4,094,587   $ 1,449,887   $ 63,512   $ 5,607,986  
   
 
 
 
 
LIABILITIES                          

Deposits

 

$

2,393,707

 

$

1,081,010

 

 

 

 

$

3,474,717

 
Advances from FHLB Seattle     995,119     208,000     27,038 (B)   1,230,157  
Securities sold subject to repurchase agreements and funds purchased     276,958                 276,958  
Other borrowings     139,782     27,305           167,087  
Other liabilities     42,678     12,095     12,507 (B)   67,280  
   
 
 
 
 
Total liabilities     3,848,244     1,328,410     39,545     5,216,199  
   
 
 
 
 
SHAREHOLDERS' EQUITY                          

Common stock

 

$

14,781

 

$

70

 

$

5,358
(70)

(D)
(E)

$

20,139

 
Additional paid-in capital     180,825     33,832     (33,832
140,086
(E)
(D)
  320,911  
Retained earnings     51,682     86,183     (86,183 )(E)   51,682  
Unearned MRDP and ESOP shares           (3,031 )   2,201
830
(E)
(E)
     
Accumulated other comprehensive income (loss), net of tax effect     (945 )   4,423     (4,423 )(E)   (945 )
   
 
 
 
 
  Total shareholders' equity     246,343     121,477     23,967     391,787  
   
 
 
 
 
Total liabilities and shareholders' equity   $ 4,094,587   $ 1,449,887   $ 63,512   $ 5,607,986  
   
 
 
 
 

68



STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

Unaudited Pro Forma Combined Condensed Consolidated Statement of Income

 
  For the Year Ended
   
   
 
 
  December 31, 2002
  September 30, 2002
   
   
 
 
  Sterling
Historical(A)

  Klamath
Historical(A)

  Pro Forma
Adjustments

  Pro Forma
Combined

 
 
  (Dollars in thousands, except shares and per share data)

 
Interest income:                          
  Loans   $ 159,278   $ 52,179   $     $ 211,457  
  Asset-backed securities     33,539     26,369           59,908  
  Investments     4,354     7,972           12,326  
  Other     142     773           915  
   
 
 
 
 
    Total interest income     197,313     87,293           284,606  
   
 
 
 
 
Interest expense:                          
  Deposits     43,632     29,783           73,415  
  Borrowed funds     53,333     11,171 (J)   (5,040) (F)   59,464  
   
 
 
 
 
    Total interest expense     96,965     40,954     (5,040 )   132,879  
   
 
 
 
 
    Net interest income     100,348     46,339     5,040     151,727  

Provision for losses on loans

 

 

(11,867

)

 

(156

)

 

 

 

 

(12,023

)
   
 
 
 
 
  Net interest income after provision for losses on loans     88,481     46,183     5,040     139,704  
   
 
 
 
 
Other operating income:                          
  Net gains on sales of securities     2,925     1,707           4,632  
  Fee and other     26,155     10,907           37,062  
   
 
 
 
 
    Total non-interest income     29,080     12,614           41,694  
   
 
 
 
 
Non-interest expense                          
  General and administrative expense:                          
    Compensation and benefits     42,861     22,125     113 (K)   65,099  
    Occupancy and equipment and other     37,438     21,102 (J)         58,540  
  Amortization of intangibles     644     5,521     1,741 (G)   7,906  
   
 
 
 
 
  Total non-interest expense     80,943     48,748     1,854     131,545  
   
 
 
 
 

Income before income tax expense

 

 

36,618

 

 

10,049

 

 

3,186

 

 

49,853

 
Income tax expense     (11,031 )   (3,260 )   (1,147) (L)   (15,438 )
   
 
 
 
 
Net income   $ 25,587   $ 6,789   $ 2,039   $ 34,415  
   
 
 
 
 
Earnings per share:                          
  Basic   $ 1.96   $ 1.06         $ 1.92  
  Diluted     1.91     1.05           1.87  

Weighted average common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic     13,027,884     6,411,351           17,964,624 (I)
  Diluted     13,432,770     6,495,498           18,434,303 (I)

69



STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

Unaudited Pro Forma Combined Condensed Consolidated Statement of Income

 
  For the Six Months Ended
   
   
 
 
  June 30, 2003
  March 31, 2003
   
   
 
 
  Sterling
Historical(A)

  Klamath
Historical(A)

  Pro Forma
Adjustments

  Pro Forma
Combined

 
 
  (Dollars in thousands, except shares and per share data)

 
Interest income:                          
  Loans   $ 82,715   $ 22,714   $     $ 105,429  
  Asset-backed securities     19,186     11,043           30,229  
  Investments     2,235     3,044           5,279  
  Other           197           197  
   
 
 
 
 
    Total interest income     104,136     36,998           141,134  
   
 
 
 
 
Interest expense:                          
  Deposits     18,513     10,248           28,761  
  Borrowed funds     27,012     6,164 (J)   (2,520 )(F)   30,656  
   
 
 
 
 
    Total interest expense     45,525     16,412     (2,520 )   59,417  
   
 
 
 
 
    Net interest income     58,611     20,586     2,520     81,717  

Provision for losses on loans

 

 

(4,800

)

 

 

 

 

 

 

 

(4,800

)
   
 
 
 
 
  Net interest income after provision for losses on loans     53,811     20,586     2,520     76,917  
   
 
 
 
 
Other operating income:                          
  Net gains on sales of securities     3,037     885           3,922  
  Fee and other     13,761     7,232           20,993  
   
 
 
 
 
    Total non-interest income     16,798     8,117           24,915  
   
 
 
 
 
Non-interest expense                          
  General and administrative expense:                          
    Compensation and benefits     23,955     12,083     116 (K)   36,154  
    Occupancy and equipment and other     19,955     10,676 (J)         30,631  
  Amortization of intangibles     105     1,824     871 (G)   2,800  
   
 
 
 
 
  Total non-interest expense     44,015     24,583     987     69,585  
   
 
 
 
 

Income before income tax expense

 

 

26,594

 

 

4,120

 

 

1,533

 

 

32,247

 
Income tax expense     (9,294 )   (1,273 )   (552 )(L)   (11,119 )
   
 
 
 
 
Net income   $ 17,300   $ 2,847   $ 981   $ 21,128  
   
 
 
 
 
Earnings per share:                          
  Basic   $ 1.21   $ 0.44         $ 1.10  
  Diluted     1.18     0.43           1.07  

Weighted average common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic     14,244,227     6,440,579           19,203,473 (I)
  Diluted     14,602,015     6,592,859           19,678,516 (I)

70



PRO FORMA FINANCIAL INFORMATION

STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

Notes to Unaudited Pro Forma Combined
Condensed Consolidated Financial Statements
December 31, 2002 and June 30, 2003

(A)
Basis of Presentation

        Sterling's fiscal year end is December 31 and Klamath's fiscal year end is September 30. Therefore, the information presented below for the twelve months includes Sterling's year ended December 31, 2002 and Klamath's year ended September 30, 2002. The six-month periods presented below include Sterling's six months ended June 30, 2003 and Klamath's six months ended March 31, 2003.

        The unaudited pro forma combined condensed consolidated statement of financial condition of Sterling and subsidiaries and Klamath and subsidiaries at June 30, 2003 has been prepared as if the merger had been consummated on that date. The unaudited pro forma combined condensed consolidated statements of income for the year ended December 31, 2002 and the six months ended June 30, 2003 have been prepared as if the merger had been consummated as of January 1, 2002 and carried through the interim period. The unaudited pro forma combined condensed consolidated financial statements are based on the historical financial statements of Sterling and Klamath after giving effect to the merger under the purchase method of accounting and the assumptions and adjustments in the notes that follow.

        Assumptions relating to the pro forma adjustments set forth in the unaudited pro forma combined condensed consolidated financial statements are summarized as follows:

        Certain reclassifications have been made to Klamath's historical financial information in order to conform to Sterling's financial presentation.

71


(B)
Purchase accounting adjustments are estimated as follows:

 
  (Dollars in thousands)
 
Klamath's net assets—historical at June 30, 2003   $ 121,477  

Adjustments to Klamath's statement of condition:

 

 

 

 
  Termination of Klamath's ESOP     2,201  
  Elimination of Klamath's intangible assets     (37,563 )
Fair value adjustment(1)        
  Core deposit intangible     17,412  
  Advances from FHLB Seattle     (27,038 )
  Tax effect of fair value adjustments     3,664  
Accrued transaction costs(2)     (12,507 )
   
 
Net assets acquired   $ 67,646  
   
 


 
  (Dollars in thousands)
 
Merger-related compensation and severance   $ 9,720  
Data processing and other contract terminations     6,600  
Professional services     2,638  
Other costs     283  
   
 
  Subtotal     19,241  
  Tax effect     (6,734 )
   
 
  Estimated transaction cost, net of tax   $ 12,507  
   
 
(C)
The excess of cost over the fair value of net assets acquired is set forth below:

 
  (Dollars in thousands)
Total cost in stock   $ 145,444
Net assets acquired     67,646
   
Goodwill acquired   $ 77,798
   
(D)
Total consideration for Klamath shares is as follows:

 
  Value of
Stock

Klamath's total common shares outstanding(1)(2)   $ 142,249
Value of Klamath's vested stock options(3)     3,195
   
    $ 145,444
   

72


(E)
Purchase accounting adjustments to eliminate Klamath's shareholder's equity accounts.

(F)
Pro-forma adjustments to interest expense for the year ended December 31, 2002 are $5.0 million and for the six months ended June 30, 2003 are $2.5 million. The adjustments represent the amortization of the premium related to the FHLB advances.

(G)
The core deposit premium intangible asset is amortized over 10 years on a straight-line basis which approximates the interest method.

(H)
The following table summarizes the estimated impact of the amortization of the purchase accounting adjustments made in connection with the merger on Sterling's results of operations for the following years:

Projected Future Amounts
for the Years Ended
December 31

  Interest
Expense

  Core Deposit
Intangible

  Stock
Compensation
Expense(1)

  Net (Increase)
Decrease
in Income
Before Taxes

 
2004   (5,028 ) 1,741   232   (3,055 )
2005   (4,947 ) 1,741   232   (2,974 )
2006   (4,857 ) 1,741   232   (2,884 )
2007   (4,757 ) 1,741   0   (3,016 )
2008   (4,471 ) 1,741   0   (2,730 )
2009 and thereafter   (2,979 ) 8,705   0   5,726  

(I)
Basic and fully diluted weighted average number of common shares and common stock equivalents utilized for the calculation of earnings per share for the periods presented were calculated using Sterling's historical weighted average common shares and common stock equivalents plus Klamath's historical weighted average common shares and common stock equivalents multiplied by the exchange ratio of 0.77.

(J)
Includes certain amounts that have been reclassified to conform to Sterling's form of presentation.

(K)
Reflects the estimated compensation expense, based on estimated fair value, associated with the Klamath stock options that were not vested as of the acquisition date.

(L)
Reflects the tax effect of the pro forma adjustments.

73



LEGAL MATTERS

        The validity of the Sterling common stock to be issued to Klamath shareholders in the merger will be passed upon by Witherspoon, Kelley, Davenport & Toole, P.S. Witherspoon, Kelley, Davenport & Toole, P.S. will also deliver to Sterling and Silver, Freedman & Taff, LLP will deliver to Klamath opinions concerning certain federal tax consequences of the merger. Ned M. Barnes, the Secretary and a Director of Sterling, is a principal in the firm of Witherspoon, Kelley, Davenport & Toole, P.S. Witherspoon, Kelley, Davenport & Toole, P.S. received approximately $1.7 million, $2.2 million and $1.3 million, exclusive of amounts paid by customers of Sterling, for legal services rendered to Sterling and its subsidiaries during 2002, 2001 and 2000, respectively.


EXPERTS

        The financial statements of Sterling incorporated into this joint proxy statement/prospectus by reference to Sterling's Annual Report on Form 10-K for the year ended December 31, 2002 have been incorporated into this joint proxy statement/prospectus by reference in reliance upon the report of BDO Seidman, LLP, independent auditors, given upon their authority as experts in accounting and auditing.

        The financial statements of Sterling incorporated into this joint proxy statement/prospectus by reference to Sterling's Annual Report on Form 10-K for the year ended December 31, 2000 have been incorporated by reference in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given upon their authority as experts in and auditing and accounting.

        The consolidated financial statements of Klamath First Bancorp, Inc. as of September 30, 2002 and 2001, and for each of the three years in the period ended September 30, 2002, incorporated by reference in this joint proxy statement/prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report, which is incorporated by reference herein, and have been so incorporated in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.


SHAREHOLDER PROPOSALS

        It is anticipated that the next annual meeting of shareholders of Sterling will be held on Tuesday, April 20, 2004. As indicated in Sterling's definitive proxy statement filed with the SEC on March 21, 2003, in order for any shareholder proposal to be considered for inclusion in the proxy materials of Sterling for the 2004 annual meeting of shareholders, such proposal must be submitted, in accordance with the rules and regulations of the SEC, in writing to the Secretary of Sterling at Sterling's corporate offices by November 20, 2003.

        Klamath will hold a 2003 annual meeting of shareholders in 2004 only if the merger is not completed before the time of that meeting. As indicated in Klamath's definitive proxy filed with the SEC on December 27, 2002, any Klamath shareholder who intends to present a proposal at Klamath's 2003 annual meeting of shareholders for inclusion in the proxy statement and form of proxy relating to that meeting must have submitted the proposal to Klamath on or before August 29, 2003. Klamath will not be required to include in its proxy statement a form of proxy or shareholder proposal that is received after that date or that otherwise fails to meet the requirements for shareholder proposals established by regulations of the SEC.

        Klamath's articles of incorporation provide that in order for a shareholder to make nominations for the election of directors or proposals for business to be brought before a meeting of shareholders, a shareholder must deliver written notice of such nominations and/or proposals to the Secretary not less than 30 nor more than 60 days prior to the date of the meeting; provided that if less than 31 days' notice of the meeting is given to shareholders, such notice must be delivered not later than the close of

74



the tenth day following the day on which notice of the meeting was mailed to shareholders. As specified in the articles of incorporation, the written notice with respect to nominations for election of directors must set forth certain information regarding each nominee for election as a director, including such person's written consent to being named in the proxy statement as a nominee and to serving as a director, if elected, and certain information regarding the shareholder giving such notice. The notice with respect to business proposals to be brought before the meeting must state the shareholder's name, address and number of shares of common stock held, and briefly discuss the business to be brought before the meeting, the reasons for conducting such business at the meeting and any interest of the shareholder in the proposal.


DOCUMENTS INCORPORATED BY REFERENCE INTO THIS JOINT
PROXY STATEMENT/PROSPECTUS

        This joint proxy statement/prospectus incorporates by reference documents that are not presented in or delivered with this document.

        The SEC allows Sterling and Klamath to incorporate by reference information into this joint proxy statement/prospectus, which means that we can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is deemed to be part of this joint proxy statement/prospectus, except for any information superseded by information included in or incorporated by reference from subsequently filed documents into this joint proxy statement/prospectus. This joint proxy statement/prospectus incorporates by reference the description of the common stock of Sterling as set forth in a registration statement under the Securities Exchange Act of 1934, including any amendment or report filed for the purpose of updating such description. This joint proxy statement/prospectus also incorporates by reference the documents listed below that Sterling and Klamath have previously filed with the SEC. These documents (including any amendments thereto) contain important information about Sterling's and Klamath's business and finances.

Sterling Filings

  Period Covered or Date Filed

Annual Report on Form 10-K   Year ended December 31, 2002
Quarterly Reports on Form 10-Q   Quarter ended March 31, 2003
Quarter ended June 30, 2003
Definitive Proxy Statement for the Annual Meeting held on April 23, 2003   March 26, 2003
Current Reports on Form 8-K    

       

Klamath Filings

  Period Covered or Date Filed

Annual Report on Form 10-K   Year ended September 30, 2002
Quarterly Reports on Form 10-Q   Quarter ended December 31, 2002
Quarter ended March 31, 2003
Quarter ended June 30, 2003
Definitive Proxy Statement for the Annual Meeting held on January 29, 2003   December 27, 2002
Current Reports on Form 8-K    

        We also incorporate by reference any additional documents that Sterling or Klamath files with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, after the date of this joint proxy statement/prospectus and before the date of the special meetings.

        This joint proxy statement/prospectus is dated [October    , 2003]. You should not assume that the information contained in this joint proxy statement/prospectus is accurate as of any other date, and neither the mailing of the joint proxy statement/prospectus to shareholders nor the issuance of Sterling

75



common stock in the merger shall create any implication to the contrary. Please note that Sterling has supplied all information contained or incorporated by reference into this joint proxy statement/prospectus relating to Sterling. Klamath has supplied all information contained or incorporated by reference into this joint proxy statement/prospectus relating to Klamath. You should rely only on the information contained in this document or in documents to which we have referred you. We have not authorized anyone to provide you with different information.


WHERE YOU CAN FIND MORE INFORMATION

        On your written or oral request, Sterling or Klamath will provide you, without charge, with a copy of any of the documents incorporated by reference into this joint proxy statement/prospectus, not including exhibits to the information unless those exhibits are specifically incorporated by reference. You should make any request for documents by [December 1, 2003] to ensure timely delivery of the documents.

        Requests for documents should be directed to Sterling and Klamath at the following addresses, respectively:

Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
Attn:
(509)458-2711
  Klamath First Bancorp, Inc.
540 Main Street
Klamath Falls, Oregon 97601
Attn:
(541)882-3444

        Both Sterling and Klamath file annual, quarterly and special reports, proxy statements and other information with the SEC. Copies of Sterling's and Klamath's reports, proxy statements and other information may be inspected and copied at the public reference room of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. You may call the SEC at 1-800-SEC-0330 for further information about the public reference room. In addition, Sterling and Klamath file reports and other information with the SEC electronically, and the SEC maintains a website located at http://www.sec.gov containing this information. The common stock of Sterling and Klamath is listed on the Nasdaq National Market and Sterling's and Klamath's reports and other information may also be inspected at the offices of the Nasdaq National Market, 1735 K Street, N.W., Washington, D.C. 20006. Sterling maintains a website at http://www.sterlingsavingsbank.com. Klamath maintains a website at www.Klamathfirst.com. The information on Sterling's and Klamath's websites is not part of this joint proxy statement/prospectus.

        Sterling has filed a registration statement on Form S-4 to register with the SEC the Sterling common stock to be issued to Klamath's shareholders in the merger. This joint proxy statement/prospectus is part of that registration statement. As allowed by SEC rules, this joint proxy statement/prospectus does not contain all of the information you can find in the registration statement or the exhibits to the registration statement. You may inspect and copy the registration statement at any of the addresses listed above.


FORWARD-LOOKING INFORMATION

        Except for historical information, all other information in this filing consists of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about (i) the benefits of the merger between Sterling Financial Corporation ("Sterling") and Klamath First Bancorp, Inc. ("Klamath"), including future financial and operating results, cost savings enhancements to revenue and accretion to reported earnings that may be realized from the merger; (ii) Sterling's and Klamath's plans, objectives, expectations and intentions and other statements contained in this presentation that are not historical facts; and (iii) other statements identified by words such as "expects," "anticipates," "intends," "plans,"

76



"believes," "seeks," "estimates," or words of similar meaning generally intended to identify forward-looking statements. These forward-looking statements are based upon the current beliefs and expectations of the management of Sterling and Klamath and 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 anticipated results discussed in these forward-looking statements because of numerous possible uncertainties.

        The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: (1) the businesses of Sterling and Klamath may not be combined successfully, or such combination may take longer, be more difficult, time-consuming or costly to accomplish than expected; (2) the expected growth opportunities or cost savings from the merger may not be fully realized or may take longer to realize than expected; (3) operating costs, customer losses and business disruption following the merger, including adverse effects on relationships with employees, may be greater than expected; (4) governmental approvals of the merger may not be obtained, or adverse regulatory conditions may be imposed in connection with governmental approvals of the merger; (5) the shareholders of Sterling or Klamath may fail to approve the merger; (6) adverse governmental or regulatory policies may be enacted; (7) the interest rate environment may further compress margins and adversely affect net interest income; (8) results may be adversely affected by continued diversification of assets and adverse changes to credit quality; (9) competition from other financial services companies in Sterling's and Klamath's markets may increase significantly and could adversely affect operations; and (10) an economic slowdown, either nationally or in the market in which Sterling does business, could adversely affect credit quality and loan originations. Additional factors, that could cause actual results to differ materially from those expressed in the forward-looking statements, are discussed in Sterling's and Klamath's reports (such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K) filed with the Securities and Exchange Commission (the "SEC") and available on the SEC's Internet site (http://www.sec.gov). In addition, documents filed with the SEC by Sterling can be obtained, without charge, by directing a request to Sterling Financial Corporation, 111 North Wall Street, Spokane, Washington 99201, Attn: Heidi B. Stanley, telephone (509) 358-6160. In addition, documents filed with the SEC by Klamath can be obtained, without charge, by directing a request to Klamath First Bancorp, Inc., 540 Main Street, Klamath Falls, Oregon 97601, Attn: Craig M Moore, Corporate Secretary, telephone (541) 882-3444.

        Sterling and Klamath caution that the foregoing list of factors is not exclusive. All subsequent written and oral forward-looking statements concerning the proposed transaction or other matters attributable to Sterling or Klamath or any person acting on their behalf are expressly qualified in their entirety by the cautionary statements above. Sterling and Klamath do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

77


ANNEX A



AGREEMENT AND PLAN OF MERGER

BY AND BETWEEN

STERLING FINANCIAL CORPORATION

AND

KLAMATH FIRST BANCORP, INC.


AGREEMENT AND PLAN OF MERGER
BY AND BETWEEN
STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC.

TABLE OF CONTENTS

 
   
  Page
ARTICLE I

THE MERGER

 

A-1
1.1   THE MERGER   A-1
1.2   EFFECTIVE TIME   A-1
1.3   EFFECTS OF THE MERGER   A-1
1.4   CONVERSION OF KLAMATH COMMON STOCK   A-2
1.5   STERLING COMMON STOCK   A-2
1.6   OPTIONS   A-2
1.7   RESERVATION OF SHARES AND SECURITIES FILINGS   A-3
1.8   ARTICLES OF INCORPORATION   A-3
1.9   BYLAWS   A-3
1.10   DIRECTORS AND OFFICERS   A-3
1.11   TAX CONSEQUENCES   A-3
1.12   ACCOUNTING TREATMENT   A-3

ARTICLE II

EXCHANGE OF SHARES

 

A-4
2.1   STERLING TO MAKE SHARES AVAILABLE   A-4

ARTICLE III

REPRESENTATIONS AND WARRANTIES OF KLAMATH

 

A-5
3.1   CORPORATE ORGANIZATION   A-5
3.2   CAPITALIZATION   A-6
3.3   AUTHORITY; NO VIOLATION   A-7
3.4   CONSENTS AND APPROVALS   A-8
3.5   REPORTS   A-9
3.6   FINANCIAL STATEMENTS; EXCHANGE ACT FILINGS; BOOK AND RECORDS   A-9
3.7   BROKER'S FEES   A-10
3.8   ABSENCE OF CERTAIN CHANGES OR EVENTS   A-10
3.9   LEGAL PROCEEDINGS   A-10
3.10   TAXES AND TAX RETURNS   A-10
3.11   EMPLOYEE PLANS   A-11
3.12   CERTAIN CONTRACTS   A-12
3.13   REGULATORY AGREEMENTS   A-13
3.14   STATE TAKEOVER LAWS   A-13
3.15   ENVIRONMENTAL MATTERS   A-13
3.16   ALLOWANCES FOR LOSSES   A-14
3.17   PROPERTIES AND ASSETS   A-14
3.18   INSURANCE   A-15
3.19   COMPLIANCE WITH APPLICABLE LAWS   A-15
3.20   LOANS   A-15
3.21   UNDISCLOSED LIABILITIES   A-16
         

A-i


3.22   INTELLECTUAL PROPERTY RIGHTS   A-16
3.23   INDEMNIFICATION   A-16
3.24   INSIDER INTERESTS   A-17
3.25   FAIRNESS OPINION   A-17
3.26   TAX TREATMENT OF MERGER   A-17
3.27   KLAMATH INFORMATION   A-17

ARTICLE IV

REPRESENTATIONS AND WARRANTIES OF STERLING

 

A-17
4.1   CORPORATE ORGANIZATION   A-17
4.2   CAPITALIZATION   A-18
4.3   AUTHORITY; NO VIOLATION   A-19
4.4   CONSENTS AND APPROVALS   A-20
4.5   REPORTS   A-20
4.6   FINANCIAL STATEMENTS; EXCHANGE ACT FILINGS; BOOKS AND RECORDS   A-20
4.7   BROKER'S FEES   A-21
4.8   ABSENCE OF CERTAIN CHANGES OR EVENTS   A-21
4.9   LEGAL PROCEEDINGS   A-21
4.10   TAXES AND TAX RETURNS   A-22
4.11   REGULATORY AGREEMENTS   A-22
4.12   STATE TAKEOVER LAWS   A-22
4.13   COMPLIANCE WITH APPLICABLE LAWS   A-22
4.14   UNDISCLOSED LIABILITIES   A-22
4.15   FAIRNESS OPINION   A-22
4.16   TAX TREATMENT OF MERGER   A-23
4.17   STERLING INFORMATION   A-23

ARTICLE V

COVENANTS RELATING TO CONDUCT OF BUSINESS

 

A-23
5.1   COVENANTS OF KLAMATH   A-23
5.2   COVENANTS OF STERLING   A-26
5.3   MERGER COVENANTS   A-27

ARTICLE VI

ADDITIONAL AGREEMENTS

 

A-27
6.1   REGULATORY MATTERS   A-27
6.2   ACCESS TO INFORMATION   A-28
6.3   SHAREHOLDERS MEETINGS   A-29
6.4   LEGAL CONDITIONS TO MERGER   A-29
6.5   STOCK EXCHANGE LISTING   A-30
6.6   EMPLOYEES   A-30
6.7   INDEMNIFICATION   A-31
6.8   SUBSEQUENT INTERIM AND ANNUAL FINANCIAL STATEMENTS   A-32
6.9   ADDITIONAL AGREEMENTS   A-32
6.10   ADVICE OF CHANGES   A-32
6.11   CURRENT INFORMATION   A-32
         

A-ii


6.12   EXECUTION AND AUTHORIZATION OF INSTITUTION MERGER AGREEMENT   A-32
6.13   CHANGE IN STRUCTURE   A-33
6.14   TRANSACTION EXPENSES OF KLAMATH   A-33
6.15   AFFILIATE AGREEMENTS   A-33
6.16   BOARD OF DIRECTORS   A-33

ARTICLE VII

CONDITIONS PRECEDENT

 

A-33
7.1   CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER   A-33
7.2   CONDITIONS TO OBLIGATIONS OF STERLING   A-34
7.3   CONDITIONS TO OBLIGATIONS OF KLAMATH   A-35

ARTICLE VIII

TERMINATION AND AMENDMENT

 

A-35
8.1   TERMINATION   A-35
8.2   EFFECT OF TERMINATION   A-37
8.3   AMENDMENT   A-38
8.4   EXTENSION; WAIVER   A-38

ARTICLE IX

GENERAL PROVISIONS

 

A-39
9.1   CLOSING   A-39
9.2   NONSURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS   A-39
9.3   EXPENSES   A-39
9.4   NOTICES   A-39
9.5   INTERPRETATION   A-40
9.6   COUNTERPARTS   A-40
9.7   ENTIRE AGREEMENT   A-40
9.8   GOVERNING LAW   A-40
9.9   ENFORCEMENT OF AGREEMENT   A-40
9.10   SEVERABILITY   A-40
9.11   PUBLICITY   A-41
9.12   ASSIGNMENT; LIMITATION OF BENEFITS   A-41

EXHIBITS

 

 

A

 

Institution Merger Agreement

 

 
B   Klamath First Bancorp, Inc. Disclosure Schedule    
C(1)   Oregon Articles of Merger    
C(2)   Washington Articles of Merger    
D   Form of Agreement of Klamath Affiliates    
E   Shareholders Agreement    
F   Index Group    

A-iii



AGREEMENT AND PLAN OF MERGER

        This AGREEMENT AND PLAN OF MERGER, dated as of July 14, 2003 (this "Agreement"), is entered into by and between Sterling Financial Corporation, a Washington corporation ("Sterling") and Klamath First Bancorp, Inc., an Oregon corporation ("Klamath").

        WHEREAS, the Boards of Directors of Sterling and Klamath have determined that it is in the best interests of their respective companies and shareholders to consummate the business combination transaction provided for herein in which Klamath will, subject to the terms and conditions set forth herein, merge with and into Sterling, with Sterling being the surviving corporation in such merger (the "Merger");

        WHEREAS, prior to the consummation of the Merger, Sterling and Klamath will respectively cause Sterling Savings Bank, a Washington State-chartered savings and loan association and wholly-owned subsidiary of Sterling ("Sterling Savings Bank"), and Klamath First Federal Savings and Loan Association, a federal stock savings and loan association and wholly-owned subsidiary of Klamath ("Klamath First Federal"), to enter into a merger agreement, in the form attached hereto as Exhibit A (the "Institution Merger Agreement"), providing for the merger (the "Institution Merger") of Klamath First Federal with and into Sterling Savings Bank, with Sterling Savings Bank, a Washington State-chartered savings and loan association, being the "Surviving Institution" of the Institution Merger;

        WHEREAS, the Merger is intended to be treated as a "reorganization" within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"); and

        WHEREAS, the parties desire to make certain representations, warranties and agreements in connection with the Merger and also to prescribe certain conditions to the Merger;

        NOW, THEREFORE, in consideration of the mutual covenants, representations, warranties and agreements contained herein, and intending to be legally bound hereby, the parties agree as follows:


ARTICLE I
THE MERGER

1.1
THE MERGER.

        Subject to the terms and conditions of this Agreement, at the Effective Time (as defined in Section 1.2 hereof), Klamath shall merge with and into Sterling, with Sterling being the surviving corporation (hereinafter sometimes called the "Surviving Corporation") in the Merger. Upon consummation of the Merger, the corporate existence of Klamath shall cease and the Surviving Corporation shall continue to exist as a Washington corporation.

1.2
EFFECTIVE TIME.

        The Merger shall become effective on the Closing Date (as defined in Section 9.1 hereof), as set forth in the articles of merger (the "Oregon Articles of Merger") in the form attached as Exhibit C(1) hereto which shall be filed with the Secretary of State of the State of Oregon on the Closing Date and the articles of merger (the "Washington Articles of Merger") in the form attached as Exhibit C(2) hereto which shall be filed with the Secretary of State of the State of Washington on the Closing Date. The term "Effective Time" shall be the date and time when the Merger becomes effective on the Closing Date.

1.3
EFFECTS OF THE MERGER.

        At and after the Effective Time, the Merger shall have the effects set forth in Section 60.497 of the Oregon Business Corporation Act (the "OBCA") and Section 23B.11.060 of the Washington Business Corporation Act (the "WBCA").

A-1



1.4
CONVERSION OF KLAMATH COMMON STOCK.
1.5
STERLING COMMON STOCK.

        Each share of Sterling Common Stock issued and outstanding immediately prior to the Effective Time shall be unchanged and shall remain issued and outstanding as common stock of the Surviving Corporation.

1.6
OPTIONS.

        At the Effective Time, each option granted by Klamath, pursuant to the Klamath First Bancorp, Inc. 1996 Stock Option Plan (the "Klamath Stock Option Plan"), to purchase shares of Klamath Common Stock (a "Klamath Option") which is outstanding and unexercised immediately prior thereto shall be automatically converted into an option to purchase shares of Sterling Common Stock

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in an amount and at an exercise price determined as provided below and otherwise subject to the terms of the Klamath Stock Option Plan under which such option was granted:

1.7
RESERVATION OF SHARES AND SECURITIES FILINGS.

        At all times after the Effective Time, Sterling shall reserve for issuance such number of shares of Sterling Common Stock as necessary so as to permit the exercise of Klamath Options converted under Section 1.6 of this Agreement. Sterling shall make all filings required under federal and state securities laws promptly after the Effective Time so as to permit the exercise of such converted Klamath Options and the sale of the Sterling Common Stock received by the optionee upon such exercise at and after the Effective Time.

1.8
ARTICLES OF INCORPORATION.

        At the Effective Time, the Articles of Incorporation of Sterling, as in effect at the Effective Time, shall be the Articles of Incorporation of the Surviving Corporation.

1.9
BYLAWS.

        At the Effective Time, the Bylaws of Sterling, as in effect immediately prior to the Effective Time, shall be the Bylaws of the Surviving Corporation.

1.10
DIRECTORS AND OFFICERS.

        Subject to Section 6.16, the directors and officers of Sterling immediately prior to the Effective Time shall continue to be directors and officers of the Surviving Corporation.

1.11
TAX CONSEQUENCES.

        It is intended that the Merger, either alone or in conjunction with the Institution Merger, shall constitute a reorganization within the meaning of Section 368(a) of the Code, and that this Agreement shall constitute a "plan of reorganization" for the purposes of the Code.

1.12
ACCOUNTING TREATMENT.

        It is intended that the Merger shall be accounted for as a "purchase" under accounting principles generally accepted in the United States of America ("GAAP").

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ARTICLE II
EXCHANGE OF SHARES

2.1
STERLING TO MAKE SHARES AVAILABLE.

        At or prior to the Effective Time, Sterling shall deposit, or shall cause to be deposited, with Sterling's transfer agent, Mellon Investor Services, LLC, or such other similarly-qualified bank, trust company or transfer agent as Sterling may select (the "Exchange Agent"), for the benefit of the holders of Certificates, for exchange in accordance with this Article II, certificates representing the shares of Sterling Common Stock and the cash in lieu of fractional shares (such cash and certificates for shares of Sterling Common Stock, being hereinafter referred to as the "Exchange Fund") to be issued pursuant to Section 1.4 and paid pursuant to Section 2.2(a) hereof in exchange for outstanding shares of Klamath Common Stock.

2.2
EXCHANGE OF SHARES; CONVERSION OF OPTIONS.

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ARTICLE III
REPRESENTATIONS AND WARRANTIES OF KLAMATH

        Klamath hereby makes the following representations and warranties to Sterling, each of which is being relied upon by Sterling as a material inducement to Sterling to enter into and perform this Agreement.

3.1
CORPORATE ORGANIZATION.

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3.2
CAPITALIZATION.

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3.3
AUTHORITY; NO VIOLATION.

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3.4
CONSENTS AND APPROVALS.

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3.5
REPORTS.

        Except as set forth on Schedule 3.5 of the Klamath Disclosure Schedule, since October 1, 1999, Klamath and its Subsidiaries have timely filed all reports, registrations and statements, together with any amendments required to be made with respect thereto, that they have been required to file with all Governmental Entities. As of its respective filing date (subject to any subsequent amendment thereto), each such report, registration, statement and amendment complied in all material respects with all rules and regulations promulgated by the applicable Governmental Entity and did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Except for normal examinations conducted by a Governmental Entity in the regular course of the business of Klamath and its Subsidiaries, no Governmental Entity is conducting, or has conducted, any proceeding or investigation into the business or operations of Klamath or any of its Subsidiaries since October 1, 1999. There is no material unresolved violation, criticism or exception by any Governmental Entity with respect to any report or statement relating to any examinations of Klamath or any of its Subsidiaries.

3.6
FINANCIAL STATEMENTS; EXCHANGE ACT FILINGS; BOOKS AND RECORDS.

        Klamath has previously made available to Sterling true, correct and complete copies of (i) the audited consolidated balance sheets of Klamath and its Subsidiaries as of September 30, 2002 and 2001 and the related audited consolidated statements of income, shareholders' equity and comprehensive income and cash flows for the fiscal years 2002, 2001 and 2000, inclusive, as reported in Klamath's Annual Report on Form 10-K for the fiscal year ended September 30, 2002 filed with the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in each case accompanied by the audit report of Deloitte & Touche LLP, independent public accountants with respect to Klamath and (ii) the unaudited consolidated balance sheets of Klamath and its Subsidiaries as of March 31, 2003 and December 31, 2002 and the related unaudited consolidated statements of income, shareholders' equity and comprehensive income and cash flows for the three-month period ended March 31, 2003, as reported on Klamath's Quarterly Report on Form 10-Q for the period ended March 31, 2003 filed with the SEC under the Exchange Act. Klamath will deliver as soon as is reasonably practicable, a draft of the consolidated balance sheet of Klamath and its Subsidiaries as of June 30, 2003 and the related consolidated statements of income, shareholders' equity and comprehensive income and cash flows for the quarter ended June 30, 2003, in the form Klamath expects to file under the Exchange Act in connection with its Form 10-Q for the quarter ended June 30, 2003. The financial statements referred to in this Section 3.6 (including the related notes, where applicable but excluding the draft statements referred to herein) fairly present, and the financial statements referred to in Section 6.8 hereof will fairly present (subject, in the case of the unaudited statements, to normal recurring audit adjustments), the results of the consolidated operations and consolidated financial condition of Klamath and its Subsidiaries for the respective fiscal periods or as of the respective dates therein set forth; each of such statements (including the related notes, where applicable) comply, and the financial statements referred to in Section 6.8 hereof will comply, in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto and each of such statements (including the related notes, where applicable) has been, and the financial statements referred to in Section 6.8 hereof will be prepared in accordance with GAAP consistently applied during the periods involved, except in each case as indicated in such statements or in the notes thereto or, in the case of unaudited statements, as permitted by Form 10-Q. Klamath's Annual Report on Form 10-K for the fiscal year ended September 30, 2002 and all reports subsequently filed under the Exchange Act (the "Klamath Exchange Act Reports") comply (or, in the case of Klamath Exchange Act Reports filed

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subsequent to the date hereof, will comply) in all material respects with the appropriate requirements for such reports under the Exchange Act, and Klamath has previously delivered or made available to Sterling true, correct and complete copies of the reports filed prior to the date hereof. The books and records of Klamath and its Subsidiaries have been, and are being, maintained in all material respects in accordance with GAAP and any other applicable legal and accounting requirements.

3.7
BROKER'S FEES.

        Neither Klamath nor any of its Subsidiaries nor any of their respective officers or directors has employed any broker or finder or incurred any liability for any broker's fees, commissions or finder's fees in connection with any of the transactions contemplated by this Agreement or the Institution Merger Agreement, except that Klamath has engaged, and will pay a fee to D.A. Davidson & Co. ("Davidson") in accordance with the terms of a letter agreement between Davidson and Klamath, dated November 26, 2002, as amended on May 28, 2003, a true, complete and correct copy of which is set forth in Section 3.7 of the Klamath Disclosure Schedule.

3.8
ABSENCE OF CERTAIN CHANGES OR EVENTS.
3.9
LEGAL PROCEEDINGS.
3.10
TAXES AND TAX RETURNS.

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        For the purposes of this Agreement, "Taxes" shall mean all taxes, charges, fees, levies, penalties or other assessments imposed by any United States federal, state, local or foreign taxing authority having jurisdiction over Klamath or its Subsidiaries, including, but not limited to, income, excise, property, sales, transfer, franchise, payroll, withholding, social security or other taxes, including any interest, penalties or additions attributable thereto.

        For purposes of this Agreement, "Tax Return" shall mean any return, report, information return or other document (including any related or supporting information) with respect to Taxes.

3.11
EMPLOYEE PLANS.

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3.12
CERTAIN CONTRACTS.

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3.13
REGULATORY AGREEMENTS.

        Neither Klamath nor any of its Subsidiaries is subject to any cease-and-desist or other order issued by, or is a party to any written agreement, consent agreement or memorandum of understanding with, or is a party to any commitment letter or similar undertaking to, or is subject to any order or directive by, or has been a recipient of any extraordinary supervisory letter from, or has adopted any board resolutions (each of the foregoing, a "Regulatory Agreement"), at the request of any Governmental Entity that restricts the conduct of its business or that in any manner relates to its capital adequacy, its credit policies, its management or its business, nor has Klamath or any of its Subsidiaries been advised by any Governmental Entity that it is considering issuing or requesting any Regulatory Agreement.

3.14
STATE TAKEOVER LAWS.

        Klamath and its Board of Directors have taken all necessary action so that the provisions of Section 60.835 of the OBCA and any applicable provisions of the takeover laws of any other state (and any comparable provisions of Klamath's Articles of Incorporation and Bylaws) do not and will not apply to this Agreement, the Merger or the transactions contemplated hereby or thereby.

3.15
ENVIRONMENTAL MATTERS.

        Except as set forth in Schedule 3.15, there are no legal, administrative, arbitral or other proceedings, claims, actions, causes of action, private environmental investigations or remediation activities or governmental investigations of any nature seeking to impose, or that reasonably could be expected to result in the imposition, on Klamath or any of its Subsidiaries of any liability or obligation arising under common law standards relating to environmental protection, human health or safety, or under any local, state or federal environmental statute, regulation or ordinance, including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (collectively, the "Environmental Laws"), pending or, to the knowledge of Klamath, threatened against Klamath or any of its Subsidiaries, which liability or obligation would have or would reasonably be expected to have a Material Adverse Effect on Klamath. To the knowledge of Klamath, there is no reasonable basis for any such proceeding, claim, action or governmental investigation that would impose any liability or obligation that would have or would reasonably be expected to have a Material Adverse Effect on Klamath. To the knowledge of Klamath, during or prior to the period of (i) its or any of its Subsidiaries' ownership or operation of any of their respective current properties, (ii) its or any of its Subsidiaries' participation in the management of any property, or (iii) its or any of its Subsidiaries' holding of a security interest or other interest in any property, there were no releases or threatened releases of hazardous, toxic, radioactive or dangerous materials or other materials

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regulated under Environmental Laws in, on, under or affecting any such property which would reasonably be expected to have a Material Adverse Effect on Klamath. Neither Klamath nor any of its Subsidiaries is subject to any agreement, order, judgment, decree, letter or memorandum by or with any court, governmental authority, regulatory agency or third party imposing any material liability or obligation pursuant to or under any Environmental Law that would have or would reasonably be expected to have a Material Adverse Effect on Klamath.

3.16
ALLOWANCES FOR LOSSES.

        All allowances for losses reflected in Klamath's most recent financial statements referred to in Section 3.6 complied with all Laws and are reported in accordance with GAAP. Neither Klamath nor any of its Subsidiaries has been notified by any Governmental Entity or by Klamath's independent auditor, in writing or otherwise, that: (i) such allowances are inadequate, (ii) the practices and policies of Klamath or any of its Subsidiaries in establishing such allowances and in accounting for non-performing and classified assets generally fail to comply with applicable accounting or regulatory requirements, or (iii) such allowances are inadequate or inconsistent with the historical loss experience of Klamath or any of its Subsidiaries. Section 3.16 of the Klamath Disclosure Schedule sets forth a complete list of all extensions of credit and other real estate owned ("OREO") that have been classified as special mention, substandard, doubtful, loss or words of similar import. All OREO, if any, held by Klamath or any of its Subsidiaries is being carried at fair value in accordance with GAAP.

3.17
PROPERTIES AND ASSETS.

        Section 3.17 of the Klamath Disclosure Schedule lists as of the date of this Agreement (i) all real property owned by Klamath and its Subsidiaries; (ii) each real property lease, sublease or installment purchase arrangement to which Klamath or any of its Subsidiaries is a party; (iii) a description of each contract for the purchase, sale, or development of real estate to which Klamath or any of its Subsidiaries is a party; and (iv) all items of Klamath's or any of its Subsidiaries' tangible personal property and equipment with a net book value of $30,000 or more or having any annual lease payment of $25,000 or more. Except for (a) items reflected in Klamath's consolidated financial statements as of September 30, 2002 referred to in Section 3.6 hereof, (b) exceptions to title that do not interfere materially with Klamath's or any of its Subsidiaries' use and enjoyment of owned or leased real property (other than OREO), (c) liens for current real estate taxes not yet delinquent, or being contested in good faith, properly reserved against, (d) properties and assets sold or transferred in the ordinary course of business consistent with past practices since September 30, 2002, and (e) items listed in Section 3.17 of the Klamath Disclosure Schedule, Klamath and its Subsidiaries have good and, as to owned real property, marketable and insurable title to all their properties and assets, free and clear of all material liens, claims, charges and other encumbrances. Klamath and its Subsidiaries, as lessees, have the right under valid and subsisting leases to occupy, use and possess all property leased by them. All properties and fixed assets used by Klamath and its Subsidiaries are in good operating condition and repair (subject to ordinary wear and tear) suitable for the purposes for which they are currently utilized and, to the knowledge of Klamath, comply in all material respects with all Laws relating thereto now in effect. Klamath and its Subsidiaries enjoy peaceful and undisturbed possession under all leases for the use of all property under which they are the lessees, and all leases to which Klamath or any of its Subsidiaries is a party are valid and binding obligations of Klamath or any of its Subsidiaries in accordance with the terms thereof. Neither Klamath nor any of its Subsidiaries is in material default with respect to any such lease, and there has occurred no default by Klamath or any of its Subsidiaries or event which with the lapse of time or the giving of notice, or both, would constitute a material default by Klamath or any of its Subsidiaries under any such lease. To the knowledge of Klamath, there are no Laws, conditions of record, or other impediments which materially interfere with the intended use by Klamath or any of its Subsidiaries of any of the property owned, leased, or occupied by them.

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3.18
INSURANCE.
3.19
COMPLIANCE WITH APPLICABLE LAWS.

        Each of Klamath and its Subsidiaries has complied and is in compliance in all material respects with all Laws applicable to it or to the operation of its business. Neither Klamath nor its Subsidiaries have received any notice of any material alleged or threatened claim, violation or liability under any such Laws that has not heretofore been cured and for which there is no remaining liability.

3.20
LOANS.

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3.21
UNDISCLOSED LIABILITIES.

        Except for (i) those liabilities that are accrued for or recorded in the Klamath Exchange Act Reports or (ii) liabilities incurred in the ordinary course of business consistent with past practice since the latest Klamath Exchange Act Report, neither Klamath nor any of its Subsidiaries has incurred any liability of any nature whatsoever (whether absolute, accrued or contingent or otherwise and whether due or to become due) that, either alone or when combined with all similar liabilities, has had, or would be reasonably expected to have, a Material Adverse Effect on Klamath.

3.22
INTELLECTUAL PROPERTY RIGHTS.

        Except as set forth in Schedule 3.22 of the Klamath Disclosure Schedule, Klamath and each of its Subsidiaries owns or possesses all legal rights, or is licensed or otherwise has the right to use, all proprietary rights, including without limitation all trademarks, trade names, service marks and copyrights, that are material to the conduct of their existing businesses. Neither Klamath nor any of its Subsidiaries is bound by or a party to any options, licenses or agreements of any kind with respect to any trademarks, service marks or trade names which it claims to own. Neither Klamath nor any of its Subsidiaries has received any communications alleging that any of them has violated any of the patents, trademarks, service marks, trade names, copyrights or trade secrets or any other proprietary rights of any other person or entity.

3.23
INDEMNIFICATION.

        Klamath has no knowledge of any action or failure to take action by any director, officer, employee or agent of Klamath or any Klamath Subsidiary which would give rise to a claim or a potential claim by any such person for indemnification from Klamath or any Klamath Subsidiary under the Certificate or Articles of Incorporation, Bylaws or Laws applicable to Klamath or any Klamath Subsidiary.

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3.24
INSIDER INTERESTS.

        All outstanding Loans and other contractual arrangements (including deposit relationships) between Klamath or any Klamath Subsidiary and any officer, director, employee or greater than five-percent shareholder of Klamath (or any affiliate of any of them) of Klamath or any Klamath Subsidiary conform to applicable Laws. Except as disclosed in Section 3.24 of the Klamath Disclosure Schedule, no officer, director or employee of Klamath or any Klamath Subsidiary has an outstanding Loan from Klamath or any of its Subsidiaries or any material interest in any property, real or personal, tangible or intangible, used in or pertaining to the business of Klamath or any Klamath Subsidiary.

3.25
FAIRNESS OPINION.

        Klamath has received an opinion from Davidson dated as of the date hereof to the effect that, in its opinion, the Exchange Ratio pursuant to this Agreement is fair to the holders of Klamath Common Stock from a financial point of view.

3.26
TAX TREATMENT OF MERGER.

        As of the date of this Agreement, Klamath is not aware of any fact or state of affairs relating to Klamath that could cause the Merger not to be treated as a "reorganization" under Section 368(a) of the Code.

3.27
KLAMATH INFORMATION.

        The information relating to Klamath and its Subsidiaries to be contained in the Registration Statement, the Proxy Statement/Prospectus, any filings or approvals under applicable state securities laws, any filing pursuant to Rule 165 or Rule 425 under the Securities Act of 1933, as amended (the "Securities Act"), or Rule 14a-12 under the Exchange Act, or in any other document filed with any other Governmental Entity in connection herewith, will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances in which they are made, not misleading and will comply in all material respects with the provisions of the Exchange Act and the rules and regulations thereunder. The representations and warranties contained in this Article III, as modified by the Klamath Disclosure Schedule, do not contain any untrue statement of a material fact or omit to state any material fact necessary to make the statements and information contained in this Article III not misleading.


ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF STERLING

        Sterling hereby makes the following representations and warranties to Klamath, each of which is being relied upon by Klamath as a material inducement to Klamath to enter into and perform this Agreement.

4.1
CORPORATE ORGANIZATION.

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4.2
CAPITALIZATION.

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4.3
AUTHORITY; NO VIOLATION.

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4.4
CONSENTS AND APPROVALS.
4.5
REPORTS.

        Since January 1, 2000, Sterling and its Subsidiaries have timely filed all reports, registrations and statements, together with any amendments required to be made with respect thereto, that they have been required to file with any Governmental Entities. As of its respective filing date (subject to any subsequent amendment thereto), each such report, registration, statement and amendment complied in all material respects with all rules and regulations promulgated by the applicable Governmental Entity and did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Except for normal examinations conducted by a Governmental Entity in the regular course of the business of Sterling and its Subsidiaries, no Governmental Entity is conducting, or has conducted, any proceeding or investigation into the business or operations of Sterling since December 31, 2002. There is no material unresolved violation, criticism or exception by any Governmental Entity with respect to any report or statement relating to any examinations of Sterling or any of its Subsidiaries.

4.6
FINANCIAL STATEMENTS; EXCHANGE ACT FILINGS; BOOKS AND RECORDS.

        Sterling has previously made available to Klamath true, correct and complete copies of (i) the audited consolidated balance sheets of Sterling and its Subsidiaries as of December 31, 2002 and 2001 and the related audited consolidated statements of income, changes in shareholders' equity and comprehensive income and cash flows for the years 2002, 2001 and 2000, inclusive, as reported in Sterling's Annual Report on Form 10-K for the year ended December 31, 2002 filed with the SEC under the Exchange Act, in each case accompanied by the audit report of BDO Seidman, LLP, independent public accountants with respect to Sterling; and (ii) the unaudited consolidated balance sheets of Sterling and its Subsidiaries as of March 31, 2003 and the related unaudited consolidated statements of income, changes in shareholders' equity and comprehensive income and cash flows for the three-month period ended March 31, 2003 and 2002, as reported on Sterling's Quarterly Report on Form 10-Q for the period ended March 31, 2003 filed with the SEC under the Exchange Act. Sterling will deliver as soon as is reasonably practicable, a draft of the consolidated balance sheet of Sterling and its Subsidiaries as of June 30, 2003 and the related consolidated statements of income, shareholders' equity and comprehensive income and cash flows for the quarter ended June 30, 2003, in the form Sterling expects to file under the Exchange Act in connection with its Form 10-Q for the quarter ended June 30, 2003. The financial statements referred to in this Section 4.6 (including the related notes, where applicable but excluding the draft statements referred to herein) fairly present, and the financial statements referred to in Section 6.8 hereof will fairly present (subject, in the case of the unaudited statements, to normal recurring audit adjustments), the results of the consolidated operations and consolidated financial condition of Sterling and its Subsidiaries for the respective fiscal

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periods or as of the respective dates therein set forth; each of such statements (including the related notes, where applicable) comply, and the financial statements referred to in Section 6.8 hereof will comply, in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto and each of such statements (including the related notes, where applicable) has been, and the financial statements referred to in Section 6.8 hereof will be prepared in accordance with GAAP consistently applied during the periods involved, except in each case as indicated in such statements or in the notes thereto or, in the case of unaudited statements, as permitted by Form 10-Q. Sterling's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 and all reports subsequently filed under the Exchange Act (the "Sterling Exchange Act Reports") comply in all material respects with the appropriate requirements for such reports under the Exchange Act, and Sterling has previously delivered or made available to Klamath true, correct and complete copies of such reports. The books and records of Sterling and its Subsidiaries have been, and are being, maintained in all material respects in accordance with GAAP and any other applicable legal and accounting requirements.

4.7
BROKER'S FEES.

        Neither Sterling nor any of its Subsidiaries nor any of their respective officers or directors has employed any broker or finder or incurred any liability for any broker's fees, commissions or finder's fees in connection with any of the transactions contemplated by this Agreement or the Institution Merger Agreement, except that Sterling has engaged, and will pay a fee to Sandler O'Neill & Partners, L.P. ("Sandler") in accordance with the terms of a letter agreement between Sandler and Sterling, dated June 3, 2003, a true, complete and correct copy of which has been furnished to Klamath.

4.8
ABSENCE OF CERTAIN CHANGES OR EVENTS.
4.9
LEGAL PROCEEDINGS.

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4.10
TAXES AND TAX RETURNS.

        Each of Sterling and its Subsidiaries, during the past seven years, has duly filed all material Federal, state, local and foreign Tax Returns required to be filed by it on or prior to the date hereof (all such returns being accurate and complete in all material respects) and has duly paid or made provisions for the payment of all material Taxes which have been incurred or are due or claimed to be due from it by Federal, state, local and foreign taxing authorities on or prior to the date hereof. All liability with respect to the income Tax Returns of Sterling and its Subsidiaries has been satisfied for all years to and including 2002. Neither the IRS nor any other Governmental Entity has notified Sterling of, or otherwise asserted, that there are any material deficiencies with respect to the income Tax Returns of Sterling. There are no material disputes pending, or claims asserted for, Taxes or assessments upon Sterling or any of its Subsidiaries, nor has Sterling or any of its Subsidiaries been requested to give any waivers extending the statutory period of limitation applicable to any Federal, state or local income Tax Return for any period.

4.11
REGULATORY AGREEMENTS.

        Neither Sterling nor any of its Subsidiaries is subject to any Regulatory Agreement at the request of any Governmental Entity that restricts the conduct of its business or that in any manner relates to its capital adequacy, its credit policies, its management or its business, nor has Sterling or any of its Subsidiaries been advised by any Governmental Entity that it is considering issuing or requesting any Regulatory Agreement.

4.12
STATE TAKEOVER LAWS.

        Sterling and its Board of Directors have taken all necessary action so that the provisions of Section 23B.19 of the WBCA and any applicable provisions of the takeover laws of any other state (and any comparable provisions of Sterling's Articles of Incorporation and Bylaws) do not and will not apply to this Agreement, the Merger or the transactions contemplated hereby or thereby.

4.13
COMPLIANCE WITH APPLICABLE LAWS.

        Sterling and each Sterling Subsidiary has complied and is in compliance in all material respects with all Laws applicable to it or to the operation of its business. Neither Sterling nor any Sterling Subsidiary has received any notice of any material alleged or threatened claim, violation of or liability under any such Laws that has not heretofore been cured and for which there is no remaining liability.

4.14
UNDISCLOSED LIABILITIES.

        Except for (i) those liabilities that are accrued for or recorded in the Sterling Exchange Act Reports or (ii) liabilities incurred in the ordinary course of business consistent with past practice since the latest Sterling Exchange Act Report, neither Sterling nor any of its Subsidiaries has incurred any liability of any nature whatsoever (whether absolute, accrued or contingent or otherwise and whether due or to become due) that, either alone or when combined with all similar liabilities, has had, or would be reasonably expected to have, a Material Adverse Effect on Sterling.

4.15
FAIRNESS OPINION.

        Sterling has received an opinion from Sandler dated as of the date hereof to the effect that, in its opinion, the merger consideration pursuant to this Agreement is fair to Sterling from a financial point of view.

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4.16
TAX TREATMENT OF MERGER.

        As of the date of this Agreement, Sterling is not aware of any fact or state of affairs relating to Sterling that could cause the Merger not to be treated as a "reorganization" under Section 368(a) of the Code.

4.17
STERLING INFORMATION.

        The information relating to Sterling and its Subsidiaries to be contained in the Proxy Statement/Prospectus, the Registration Statement, any filings or approvals under applicable state securities laws, any filing pursuant to Rule 165 or Rule 425 under the Securities Act or Rule 14a-12 under the Exchange Act, or in any other document filed with any other Governmental Entity in connection herewith, will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances in which they are made, not misleading and will comply in all material respects with the provisions of the Exchange Act and the rules and regulations thereunder. The representations and warranties contained in this Article IV do not contain any untrue statement of a material fact or omit to state any material fact necessary to make the statements and information contained in this Article IV not misleading.


ARTICLE V
COVENANTS RELATING TO CONDUCT OF BUSINESS

5.1
COVENANTS OF KLAMATH.

        During the period from the date of this Agreement and continuing until the Effective Time, except as expressly contemplated or permitted by this Agreement or the Institution Merger Agreement, or with the prior written consent of Sterling, Klamath and Klamath First Federal shall carry on their respective businesses in the ordinary course consistent with past practices and consistent with prudent banking practices. Klamath will use its reasonable best efforts to (x) preserve its business organization and that of Klamath First Federal intact, (y) keep available to itself and Sterling the present services of the employees of Klamath and Klamath First Federal and (z) preserve for itself and Sterling the goodwill of the customers of Klamath and Klamath First Federal and others with whom business relationships exist. Without limiting the generality of the foregoing, and except as set forth in the Klamath Disclosure Schedule or as otherwise contemplated by this Agreement or consented to by Sterling in writing, Klamath shall not, and shall not permit Klamath First Federal to:

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        The consent of Sterling to any action by Klamath or Klamath First Federal that is not permitted by any of the preceding paragraphs shall be evidenced only by a writing signed by the President or any Executive or Senior Vice President of Sterling. With respect to any written request by Klamath for Sterling's consent to any non-permitted action of Klamath or Klamath First Federal described in this Section 5.1, Sterling shall not unreasonably withhold its consent, and Klamath shall be entitled to conclusively presume that Sterling has consented to any such action unless Klamath has received Sterling's written objection to such action within five business days after the date of delivery of such written request to Sterling.

5.2
COVENANTS OF STERLING.

        During the period from the date of this Agreement and continuing until the Effective Time, except as expressly contemplated or permitted by this Agreement or with Klamath's prior written consent, Sterling shall not, and shall not permit Sterling Savings Bank to:

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        The consent of Klamath to any action by Sterling or Sterling Savings Bank that is not permitted by any of the preceding paragraphs shall be evidenced only by a writing signed by the President or any Executive or Senior Vice President of Klamath.

5.3
MERGER COVENANTS.


ARTICLE VI
ADDITIONAL AGREEMENTS

6.1
REGULATORY MATTERS.

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6.2
ACCESS TO INFORMATION.

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6.3
SHAREHOLDERS MEETINGS.

6.4
LEGAL CONDITIONS TO MERGER.

        Subject to the terms and conditions of this Agreement, each of Sterling and Klamath shall use their reasonable best efforts (a) to take, or cause to be taken, all actions reasonably necessary, proper or advisable to comply promptly with all legal requirements which may be imposed on such party with respect to the Merger and to consummate the transactions contemplated by this Agreement and (b) to obtain (and to cooperate with the other party to obtain) any consent, authorization, order or approval of, or any exemption by, any Governmental Entity and any other third party which is required to be obtained by Klamath or Sterling in connection with the Merger and the other transactions contemplated by this Agreement.

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6.5
STOCK EXCHANGE LISTING.

        Sterling shall use its reasonable best efforts to cause the shares of Sterling Common Stock to be issued in the Merger and pursuant to options referred to herein to be approved for quotation on NASDAQ prior to or at the Effective Time.

6.6
EMPLOYEES.

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6.7
INDEMNIFICATION.

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6.8
SUBSEQUENT INTERIM AND ANNUAL FINANCIAL STATEMENTS.

        As soon as reasonably available, but in no event later than the SEC filing deadlines, Sterling will deliver to Klamath and Klamath will deliver to Sterling their respective Exchange Act Reports.

6.9
ADDITIONAL AGREEMENTS.

        In case at any time after the Effective Time any further action is necessary or desirable to carry out the purposes of this Agreement, or to vest the Surviving Corporation or the Surviving Institution with full title to all properties, assets, rights, approvals, immunities and franchises of any of the parties to the Merger, or the constituent parties to the Institution Merger, as the case may be, the proper officers and directors of each party to this Agreement and Sterling's Subsidiaries and Klamath First Federal shall take all such necessary action as may be reasonably requested by Sterling.

6.10
ADVICE OF CHANGES.

        Sterling and Klamath shall promptly advise the other party of any change or event that, individually or in the aggregate, has had or would be reasonably certain to have a Material Adverse Effect on it or to cause or constitute a material breach of any of its representations, warranties or covenants contained herein. From time to time prior to the Effective Time, each party will promptly supplement or amend its disclosure schedule delivered in connection with the execution of this Agreement to reflect any matter which, if existing, occurring or known at the date of this Agreement, would have been required to be set forth or described in such disclosure schedule or which is necessary to correct any information in such disclosure schedule which has been rendered inaccurate thereby. No supplement or amendment to such disclosure schedule shall have any effect for the purpose of determining satisfaction of the conditions set forth in Sections 7.2(a) or 7.3(a) hereof, as the case may be, or the compliance by Klamath or Sterling, as the case may be, with the respective covenants set forth in Sections 5.1 and 5.2 hereof.

6.11
CURRENT INFORMATION.

        During the period from the date of this Agreement to the Effective Time, Klamath will cause one or more of its designated representatives to confer on a regular and frequent basis (not less than monthly) with representatives of Sterling and to report the general status of the ongoing operations of Klamath. Each party will promptly notify the other party of any material change in the normal course of business or in the operation of the properties of itself or any of its Subsidiaries and of any governmental complaints, investigations or hearings (or communications indicating that the same may be contemplated), or the institution or the threat of litigation involving itself or any of its Subsidiaries, and will keep the other party fully informed of such events.

6.12
EXECUTION AND AUTHORIZATION OF INSTITUTION MERGER AGREEMENT.

        Prior to the Effective Time, (a) Sterling and Klamath shall each approve the Institution Merger Agreement as the sole shareholder of Sterling Savings Bank and Klamath First Federal, respectively, and (b) Klamath First Federal and Sterling Savings Bank shall execute and deliver the Institution Merger Agreement.

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6.13
CHANGE IN STRUCTURE.

        Sterling may elect to modify the structure of the transactions contemplated by this Agreement as noted herein so long as (i) there are no adverse tax consequences to the Klamath shareholders as a result of such modification, (ii) the consideration to be paid to the Klamath shareholders under this Agreement is not thereby changed or reduced in amount, and (iii) such modification will not delay or jeopardize receipt of any Requisite Regulatory Approvals. In the event that the structure of the Merger is modified pursuant to this Section 6.13, the parties agree to modify this Agreement and the various exhibits hereto to reflect such revised structure. In such event, Sterling shall prepare appropriate amendments to this Agreement and the exhibits hereto for execution by the parties hereto. Klamath agrees to cooperate fully with Sterling to effect such amendments.

6.14
TRANSACTION EXPENSES OF KLAMATH.

        As promptly as practicable after the execution of this Agreement, Klamath will provide to Sterling an estimate of the expenses Klamath expects to incur in connection with the Merger, and shall keep Sterling reasonably informed of material changes in such estimate.

6.15
AFFILIATE AGREEMENTS.
6.16
BOARD OF DIRECTORS.

        At or promptly following the Effective Time, Sterling shall take all action necessary to appoint one member of Klamath's Board of Directors, selected by Sterling to Sterling's Board of Directors and two members of Klamath's Board of Directors selected by Sterling to Sterling Savings Bank's Board of Directors.


ARTICLE VII
CONDITIONS PRECEDENT

7.1
CONDITIONS TO EACH PARTY'S OBLIGATION TO EFFECT THE MERGER.

        The respective obligation of each party to effect the Merger shall be subject to the satisfaction at or prior to the Effective Time of the following conditions:

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7.2
CONDITIONS TO OBLIGATIONS OF STERLING.

        The obligation of Sterling to effect the Merger is also subject to the satisfaction or waiver by Sterling at or prior to the Effective Time of the following conditions:

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7.3
CONDITIONS TO OBLIGATIONS OF KLAMATH.

        The obligation of Klamath to effect the Merger is also subject to the satisfaction or waiver by Klamath at or prior to the Effective Time of the following conditions:


ARTICLE VIII
TERMINATION AND AMENDMENT

8.1
TERMINATION.

        This Agreement may be terminated (based upon action of the appropriate Board of Directors) at any time prior to the Effective Time:

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        For purposes of this Section 8.1(h), the following terms have the meanings indicated below:

        "Trading Day" means a day that Sterling Common Stock is traded on NASDAQ as reported on the website of www.nasdaq.com.

        "Determination Date" shall mean the Trading Day five business days prior to the Closing Date.

        "Daily Sales Price" for any Trading Day means the daily closing price per share of Sterling Common Stock on NASDAQ.

        "Sterling Determination Price" shall mean the average of the Daily Sales Prices of Sterling Common Stock on the ten consecutive Trading Days ending on and including the Determination Date.

        "Final Index Price" means the weighted average of the Final Prices for each company comprising the Index Group.

        "Final Price," with respect to any company belonging to the Index Group, means the closing sales price of a share of common stock of such company, as reported on the consolidated transaction reporting system for the market or exchange on which such common stock is principally traded, on the Determination Date.

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        "Index Group" means the 20 financial institution holding companies listed on Exhibit F attached hereto. In the event that the common stock of any such company ceases to be publicly traded or a proposal to acquire any such company is announced at any time during the period beginning on the date of this Agreement and ending on the Determination Date, such company will be removed from the Index Group, and the weights attributed to the remaining companies will be adjusted proportionately for purposes of determining the Final Index Price and the Initial Index Price. The 20 financial institution holding companies and the weights attributed to them are listed on Exhibit F.

        "Initial Index Price" means the sum of each per share closing price of the common stock of each company comprising the Index Group multiplied by the applicable weighting, as such prices are reported on the consolidated transactions reporting system for the market or exchange on which such common stock principally traded on June 13, 2003. (See Exhibit F.)

        If Sterling declares or effects a stock dividend, reclassification, recapitalization, split-up, combination, exchange of shares or similar transaction between the date of this Agreement and the Determination Date, the prices for the Sterling Common Stock shall be appropriately adjusted for the purposes of applying this Section 8.1(h).

        If Klamath elects to exercise its termination right pursuant to this Section 8.1(h), it shall give written notice to Sterling within two business days after the Determination Date, such termination will be effective on the third business day after the giving of such notice (the "Effective Termination Date"); provided that within two business days after Sterling's receipt of such notice, Sterling shall have the option to increase the consideration to be received by holders of Klamath Common Stock hereunder by multiplying the Exchange Ratio by the Exchange Ratio Adjustment Factor (as defined below) to create the Adjusted Exchange Ratio (as defined below) such that Klamath would not be entitled to terminate this Agreement pursuant to this Section 8.1(h). If Sterling so elects, it shall timely give written notice to Klamath of such election and the Adjusted Exchange Ratio whereupon no termination shall be deemed to have occurred pursuant to Section 8.1(h) and this Agreement shall remain in full force and effect in accordance with its terms (except as the Exchange Ratio shall have been so modified).

        "Exchange Ratio Adjustment Factor" means the lessor of:

        divided by

        "Adjusted Exchange Ratio" means the Exchange Ratio multiplied by the Exchange Ratio Adjustment Factor.

8.2
EFFECT OF TERMINATION.

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8.3
AMENDMENT.

        Subject to compliance with applicable Law, this Agreement may be amended by the parties hereto, by action taken or authorized by their respective Boards of Directors, at any time before or after approval of the matters presented in connection with the Merger by the shareholders of Klamath; provided, however, that after any approval of the transactions contemplated by this Agreement by Klamath's shareholders, there may not be, without further approval of such shareholders, any amendment of this Agreement which reduces the amount or changes the form of the consideration to be delivered to Klamath shareholders hereunder other than as contemplated by this Agreement. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto.

8.4
EXTENSION; WAIVER.

        At any time prior to the Effective Time, the parties hereto, by action taken or authorized by their respective Boards of Directors, may, to the extent legally allowed, (a) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (b) waive any inaccuracies in the representations and warranties contained herein or in any document delivered pursuant hereto, and (c) waive compliance with any of the agreements or conditions contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in a written instrument signed on behalf of such party, but such extension or waiver or failure to insist on strict compliance with an obligation, covenant, agreement or condition shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure.

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ARTICLE IX
GENERAL PROVISIONS

9.1
CLOSING.

        Subject to the terms and conditions of this Agreement, the closing of the Merger (the "Closing") will be on the day the Washington Articles of Merger are filed with the Washington Secretary of State and the Oregon Articles of Merger are filed with the Oregon Secretary of State and will take place on a date, on or after January 2, 2004, that is specified in writing by Sterling to Klamath at least seven business days prior to such Closing or such other date, place and time as the parties may agree (the "Closing Date"). The parties shall use their reasonable best efforts to cause the Closing to occur on January 2, 2004 and to cause all conditions to the Closing to be satisfied (or, if applicable, waived) on or before December 31, 2003.

9.2
NONSURVIVAL OF REPRESENTATIONS, WARRANTIES AND AGREEMENTS.

        None of the representations, warranties, covenants and agreements in this Agreement or in any instrument delivered pursuant to this Agreement shall survive the Effective Time, except for those covenants and agreements contained herein or therein which by their terms apply in whole or in part after the Effective Time.

9.3
EXPENSES.

        All costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expense.

9.4
NOTICES.

        All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally, mailed by registered or certified mail (return receipt requested) or delivered by an express courier (with confirmation) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice):

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9.5
INTERPRETATION.

        When a reference is made in this Agreement to Sections, Exhibits or Schedules, such reference shall be to a Section of or an Exhibit or Schedule to this Agreement unless otherwise indicated. The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. Whenever the words "include," "includes" or "including" are used in this Agreement, they shall be deemed to be followed by the words "without limitation." No provision of this Agreement shall be construed to require Sterling, Klamath or any of their respective Subsidiaries or affiliates to take any action that would violate any applicable Law, rule or regulation.

9.6
COUNTERPARTS.

        This Agreement may be executed in counterparts, all of which shall be considered one and the same agreement and shall become effective when counterparts have been signed by each of the parties and delivered to the other parties, it being understood that all parties need not sign the same counterpart.

9.7
ENTIRE AGREEMENT.

        This Agreement (including the disclosure schedules, documents and the instruments referred to herein) constitutes the entire agreement and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof, other than the Confidentiality Agreement.

9.8
GOVERNING LAW.

        This Agreement shall be governed and construed in accordance with the laws of the State of Washington, without regard to any applicable conflicts of law rules.

9.9
ENFORCEMENT OF AGREEMENT.

        The parties hereto agree that irreparable damage would occur in the event that the provisions of this Agreement were not performed in accordance with its specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an Injunction or Injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions thereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity.

9.10
SEVERABILITY.

        Any term or provision of this Agreement which is declared invalid or unenforceable by a court of competent jurisdiction in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. If any provision of this Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only so broad as is enforceable.

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9.11
PUBLICITY.

        Except as otherwise required by Law or the rules of NASDAQ (or such other exchange on which the Sterling Common Stock may become listed), so long as this Agreement is in effect, neither Sterling nor Klamath shall, or shall permit any of Sterling's Subsidiaries or Klamath First Federal to, issue or cause the publication of any press release or other public announcement with respect to, or otherwise make any public statement concerning, the transactions contemplated by this Agreement or the Institution Merger Agreement without the consent of the other party, which consent shall not be unreasonably withheld.

9.12
ASSIGNMENT; LIMITATION OF BENEFITS.

        Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto (whether by operation of Law or otherwise) without the prior written consent of the other parties. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of and be enforceable by the parties and their respective successors and assigns. Except as otherwise specifically provided in Section 6.7 hereof, this Agreement (including the documents and instruments referred to herein) is not intended to confer upon any person other than the parties hereto any rights or remedies hereunder, and the covenants, undertakings and agreements set out herein shall be solely for the benefit of, and shall be enforceable only by, the parties hereto and their permitted assigns.

        Sterling and Klamath have caused this Agreement to be executed and delivered by their respective officers thereunto duly authorized as of the date first above written.

STERLING FINANCIAL CORPORATION   KLAMATH FIRST BANCORP, INC.

By:

 

 

By:

 
  /s/  HAROLD B. GILKEY      
Harold B. Gilkey
Chairman and Chief Executive Officer
    /s/  KERMIT K. HOUSER      
Kermit K. Houser
President and Chief Executive Officer

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Form of Shareholders Agreement

        This Shareholders Agreement (the "Shareholders Agreement"), dated as of July 14, 2003, is made by each of the Persons listed on the signature pages attached hereto (individually, a "Shareholder," and collectively the "Shareholders"), and Sterling Financial Corporation ("Sterling").

RECITALS

        A.    Sterling and Klamath First Bancorp, Inc., an Oregon corporation ("Klamath"), have entered into an Agreement and Plan of Merger as of July 14, 2003 (the "Merger Agreement"). The Merger Agreement is hereby incorporated by reference herein. All capitalized terms used but not otherwise defined herein shall have the meanings given to such terms in the Merger Agreement.

        B.    Each Shareholder owns shares of Klamath Common Stock and/or Klamath Options.

        C.    In connection with the Merger Agreement, in furtherance of its purposes and as an inducement to Sterling to enter into the Merger Agreement, the Shareholders desire to enter into and perform the obligations under this Shareholders Agreement.

        NOW, THEREFORE, in consideration of the foregoing and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:

        1.     REPRESENTATIONS AND WARRANTIES.

        Each Shareholder hereby represents and warrants that from the date hereof until the termination of this Shareholders Agreement pursuant to Section 7 hereof;

        2.     DEFINITIONS.

        For purposes of this Shareholders Agreement, the following terms shall have the following meanings:

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        3.     SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS.

        All representations, warranties and covenants contained herein shall survive the execution of this Shareholders Agreement and the consummation of the transactions contemplated hereby.

        4.     SUCCESSORS AND ASSIGNS.

        This Shareholders Agreement shall be binding upon, and inure to the benefit of, the parties hereto and their respective heirs, personal representatives, successors, assigns and Affiliates, but shall not be assignable by any Shareholder without the prior written consent of Sterling.

        5.     AMENDMENT.

        This Shareholders Agreement may not be amended except by an instrument in writing duly signed on behalf of each of the parties hereto.

        6.     GOVERNING LAW.

        This Shareholders Agreement shall be governed by, and construed and enforced in accordance with, the laws of the State of Washington, without giving effect to the principles of conflict of laws thereof. No provision of this Shareholders Agreement shall be construed to require Sterling, Klamath or any of their respective Subsidiaries or affiliates or any Shareholder to take any action that would violate any applicable Laws.

        7.     TERMINATION.

        This Shareholders Agreement shall automatically terminate and be of no further force and effect upon the first to occur of (a) termination of the Merger Agreement in accordance with its terms, (b) Closing of the Merger, or (c) mutual agreement in writing of the parties hereto providing for termination hereof, provided however that no Shareholder shall be relieved or released from any liability or damage arising out of a willful breach of this Shareholders Agreement prior to the termination hereof.

        8.     ENTIRE AGREEMENT.

        This Shareholders Agreement constitutes the entire agreement and supersedes all other and prior agreements and understandings, both written and oral, among the parties hereto other than the Shareholders Agreement and the agreements referred to therein.

        9.     EXPENSES.

        Each party hereto shall pay its own expenses incident to preparing for, entering into and carrying out this Shareholders Agreement and the consummation of the transactions contemplated hereby.

        10.   ENFORCEMENT OF AGREEMENT.

        The parties hereto agree that irreparable damage would occur in the event that the provisions of this Shareholders Agreement were not performed in accordance with its specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an Injunction or Injunctions to prevent breaches of this Shareholders Agreement and to enforce specifically the terms and provisions thereof as provided in Section 8 hereof, this being in addition to any other remedy to which they are entitled at law or in equity.

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        11.   SEVERABILITY.

        Any term or provision of this Shareholders Agreement which is declared invalid or unenforceable by a court of competent jurisdiction in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Shareholders Agreement or affecting the validity or enforceability of any of the terms or provisions of this Shareholders Agreement in any other jurisdiction. If any provision of this Shareholders Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only so broad as is enforceable.

        12.   COUNTERPARTS.

        This Shareholders Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which shall constitute one and the same instrument.

        The parties hereto have executed this Shareholders Agreement as of the date first written above.

    STERLING FINANCIAL CORPORATION

 

 

By:

 
     
    Title:  
     

 

 

KLAMATH SHAREHOLDERS:

 

 



 

 



 

 



 

 



 

 



 

 



 

 



 

 



 

 


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FORM OF AGREEMENT OF KLAMATH AFFILIATES

                        , 2003

KLAMATH FIRST BANCORP, INC.
540 Main Street
Klamath Falls, OR 97601
Attn: Kermit K. Houser
President & Chief Executive Officer

STERLING FINANCIAL CORPORATION
N. 111 Wall Street
Spokane, WA 99201
Attn: Daniel G. Byrne
Senior Vice President—Finance

Ladies and Gentlemen:

        I have been advised that I may be deemed to be, but do not admit that I am, an "affiliate" of Klamath First Bancorp, Inc., an Oregon corporation ("Klamath"), as that term is defined in Rule 145 promulgated by the Securities and Exchange Commission (the "SEC") under the Securities Act of 1933, as amended (the "Securities Act"), and/or SEC Accounting Series Releases 130 and 135. I understand that pursuant to the terms of the Agreement and Plan of Merger, dated as of July 14, 2003 (the "Merger Agreement"), by and between Klamath and Sterling Financial Corporation, a Washington corporation ("Sterling"), Klamath plans to merge with and into Sterling (the "Merger").

        I further understand that as a result of the Merger, I may receive shares of common stock, par value $1.00 per share, of Sterling ("Sterling Common Stock") in exchange for shares of Klamath Common Stock. I have been advised that the issuance of Sterling Common Stock to me pursuant to the Merger will be registered with the SEC pursuant to a Registration Statement on Form S-4. However, I have been advised that because (a) at the time the Merger will be submitted to a vote of the shareholders of Klamath, I may be deemed an affiliate of Klamath, and (b) the distribution by me of the Sterling Common Stock has not been registered under the Securities Act, I cannot sell, transfer or otherwise dispose of the Sterling Common Stock except in compliance with the Securities Act.

        I have carefully read this letter and reviewed the Merger Agreement and discussed the requirements and other applicable limitations upon my ability to sell, transfer, or otherwise dispose of Sterling Common Stock and Klamath Common Stock, to the extent I felt necessary, with my counsel or counsel for Klamath.

        I represent, warrant and covenant with and to Sterling that in the event I receive any Sterling Common Stock as a result of the Merger:

        1.     I shall not make any sale, transfer, or other disposition of such Sterling Common Stock in violation of the Securities Act or the rules and regulations thereunder and unless (i) such sale, transfer or other disposition has been registered under the Securities Act, (ii) such sale, transfer or other disposition is made in conformity with the volume and other limitations of Rule 145 under the Securities Act (as such rule may be amended from time to time), or (iii) in the opinion of counsel in form and substance reasonably satisfactory to Sterling, or under a "no-action" letter obtained by me from the staff of the SEC, such sale, transfer or other disposition will not violate or is otherwise exempt from registration under the Securities Act.

        2.     I understand that Sterling is under no obligation to register the sale, transfer or other disposition of shares of Sterling Common Stock held by me or on my behalf under the Securities Act

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or to take any other action necessary in order to make compliance with an exemption from such registration available.

        3.     I understand that stop transfer instructions will be given to Sterling's transfer agent with respect to shares of Sterling Common Stock issued to me as a result of the Merger and that there will be placed on the certificates for such shares, or any substitutions therefore, a legend stating in substance:

        4.     I understand that, unless a transfer by me of the Sterling Common Stock issued to me as a result of the Merger has been registered under the Securities Act or such transfer is made in conformity with the provisions of Rule 145(d) under the Securities Act, Sterling reserves the right, in its sole discretion, to place the following legend on the certificates issued to my transferee:

        It is understood and agreed that the legends set forth in paragraphs (3) and (4) above shall be removed by delivery of substitute certificates without such legends if I shall have delivered to Sterling (i) an opinion of counsel in form and substance reasonably satisfactory to Sterling, to the effect that such legend is not required for purposes of the Act, or (ii) evidence or representations satisfactory to Sterling that the Sterling Common Stock represented by such certificates is being or has been sold in conformity with the provisions of Rule 145(d).

        I further understand and agree that this letter agreement shall only apply to shares of Sterling Common Stock that I receive in the Merger and am deemed to beneficially own pursuant to applicable federal securities law.

        This letter agreement may be signed in one or more counterparts, each of which shall be deemed an original, but all of which taken together will constitute one and the same document. Capitalized terms used in this letter agreement which are not defined herein shall have the meaning ascribed to such terms in the Merger Agreement.

    Very truly yours,

 

 

By

 
     
Name:

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Accepted this            day of            , 2003

KLAMATH FIRST BANCORP, INC.  

By:

 

 

 
   
 
Title:      
   
 

STERLING FINANCIAL CORPORATION

 

By:

 

 

 
   
 
Title:      
   
 

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ANNEX B



FAIRNESS OPINION

OF

SANDLER O'NEILL & PARTNERS, L.P.


[LETTERHEAD OF SANDLER O'NEILL & PARTNERS, L.P.]

July 14, 2003

Board of Directors
Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201

Gentlemen:

        Sterling Financial Corporation ("Sterling") and Klamath First Bancorp, Inc. ("Klamath") have entered into an Agreement and Plan of Merger, dated as of July 14, 2003 (the "Agreement"), pursuant to which Klamath will merge with and into Sterling (the "Merger"). Under the terms of the Agreement, upon consummation of the Merger, each share of Klamath's common stock, par value $.01 per share, issued and outstanding immediately prior to the Merger, other than certain shares specified in the Agreement, will be converted into the right to receive 0.77 shares of Sterling common stock, par value $1.00 per share (the "Exchange Ratio"). The terms and conditions of the Merger are more fully set forth in the Agreement. You have requested our opinion as to the fairness, from a financial point of view, of the Exchange Ratio to Sterling.

        Sandler O'Neill & Partners, L.P., as part of its investment banking business, is regularly engaged in the valuation of financial institutions and their securities in connection with mergers and acquisitions and other corporate transactions. In connection with this opinion, we have reviewed, among other things: (i) the Agreement and certain of the exhibits thereto; (ii) certain publicly available financial statements and other historical financial information of Sterling that we deemed relevant; (iii) certain publicly available financial statements and other historical financial information of Klamath that we deemed relevant; (iv) internal financial projections for Sterling for the years ending December 31, 2003 and 2004 furnished by management of Sterling and earnings per share estimates for Sterling for the years ending December 31, 2003 and 2004 published by I/B/E/S; (v) internal financial projections for Klamath for the years ending December 31, 2003 and 2004 furnished by management of Klamath and reviewed with managements of Klamath and Sterling and earnings per share estimates for Klamath for the fiscal years ending September 30, 2003 and 2004 published by I/B/E/S; (vi) the pro forma financial impact of the Merger on Sterling, based on assumptions relating to transaction expenses, purchase accounting adjustments and cost savings determined by senior managements of Sterling and Klamath; (vii) the relative contributions of assets, liabilities, equity and earnings of Sterling and Klamath to the resulting institution; (viii) the publicly reported historical price and trading activity for Sterling's and Klamath's common stock, including a comparison of certain financial and stock market information for Sterling and Klamath with similar publicly available information for certain other companies the securities of which are publicly traded; (ix) the financial terms of certain recent business combinations in the savings institutions industry, to the extent publicly available; (x) the current market environment generally and the banking environment in particular; and (xi) such other information, financial studies, analyses and investigations and financial, economic and market criteria as we considered relevant. We also discussed with certain members of Sterling's senior management the business, financial condition, results of operations and prospects of Sterling and held similar discussions with certain members of senior management of Klamath regarding the business, financial condition, results of operations and prospects of Klamath.

        In performing our review, we have relied upon the accuracy and completeness of all of the financial and other information that was available to us from public sources, that was provided to us by Sterling or Klamath or their respective representatives or that was otherwise reviewed by us and have assumed such accuracy and completeness for purposes of rendering this opinion. We have further relied

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on the assurances of management of Sterling and Klamath that they are not aware of any facts or circumstances that would make any of such information inaccurate or misleading. We have not been asked to and have not undertaken an independent verification of any of such information and we do not assume any responsibility or liability for the accuracy or completeness thereof. We did not make an independent evaluation or appraisal of the specific assets, the collateral securing assets or the liabilities (contingent or otherwise) of Sterling or Klamath, or the collectibility of any such assets, nor have we been furnished with any such evaluations or appraisals. We did not make an independent evaluation of the adequacy of the allowance for loan losses of Sterling or Klamath nor have we reviewed any individual credit files relating to Sterling or Klamath. We have assumed, with your consent, that the respective allowances for loan losses for both Sterling and Klamath are adequate to cover such losses and will be adequate on a pro forma basis for the combined entity. With respect to such estimates and projections and all projections of transaction costs, purchase accounting adjustments and expected cost savings prepared by and/or reviewed with Sterling's management and used by Sandler O'Neill in its analyses, Sandler O'Neill assumed, with your consent, that they reflected the best currently available estimates and judgments of Sterling's management of the respective future financial performances of Sterling and Klamath and that such performances will be achieved. We express no opinion as to such estimates or projections or the assumptions on which they are based. We have also assumed that there has been no material change in Sterling's or Klamath's assets, financial condition, results of operations, business or prospects since the date of the most recent financial statements made available to us. We have assumed in all respects material to our analysis that Sterling and Klamath will remain as going concerns for all periods relevant to our analyses, that all of the representations and warranties contained in the Agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under such agreements, that the conditions precedent in the Agreement are not waived and that the Merger will qualify as a tax-free reorganization for federal income tax purposes.

        Our opinion is necessarily based on financial, economic, market and other conditions as in effect on, and the information made available to us as of, the date hereof. Events occurring after the date hereof could materially affect this opinion. We have not undertaken to update, revise, reaffirm or withdraw this opinion or otherwise comment upon events occurring after the date hereof. We are expressing no opinion herein as to what the value of Sterling's common stock will be when issued to Klamath's shareholders pursuant to the Agreement or the prices at which Sterling's or Klamath's common stock may trade at any time.

        We have acted as Sterling's financial advisor in connection with the Merger and will receive a fee for our services, a substantial portion of which is contingent upon consummation of the Merger. We will also receive a fee for rendering this opinion. As you are aware, we have also provided certain other investment banking services to Sterling in the past. As we have previously advised you, we have in the past provided certain investment banking services to Klamath and have received compensation for such services.

        In the ordinary course of our business as a broker-dealer, we may purchase securities from and sell securities to Sterling and Klamath or their affiliates. We may also actively trade the debt and/or equity securities of Sterling and Klamath or their affiliates for our own account and for the accounts of our customers and, accordingly, may at any time hold a long or short position in such securities.

        Our opinion is directed to the Board of Directors of Sterling in connection with its consideration of the Merger. Our opinion is directed only to the fairness of the Exchange Ratio to Sterling from a

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financial point of view and does not address the underlying business decision of Sterling to engage in the Merger, the relative merits of the Merger as compared to any other alternative business strategies that might exist for Sterling or the effect of any other transaction in which Sterling might engage. Our opinion is not to be quoted or referred to, in whole or in part, in a registration statement, prospectus, proxy statement or in any other document, nor shall this opinion be used for any other purposes, without Sandler O'Neill's prior written consent.

        Based upon and subject to the foregoing, it is our opinion that, as of the date hereof, the Exchange Ratio is fair to Sterling from a financial point of view.

    Very truly yours,

 

 

/s/
SANDLER O'NEILL & PARTNERS, L.P.

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ANNEX C



FAIRNESS OPINION

OF

D.A. DAVIDSON & CO.


[LETTERHEAD OF D.A. DAVIDSON & CO.]

July 14, 2003

Board of Directors
Klamath First Bancorp, Inc.
540 Main Street
Klamath Falls, OR 97601

Members of the Board:

        You have requested our opinion as to the fairness, from a financial point of view, to the holders of the common stock (the "Company Common Stock") of Klamath First Bancorp, Inc. (the "Company"), of the Merger Consideration (as defined below) to be received by such holders pursuant to an Agreement and Plan of Merger (the "Merger Agreement") by and between the Company and Sterling Financial Corporation ("Sterling"), dated as of the date hereof. As more fully described in the Merger Agreement, the Company will merge with Sterling, and each outstanding share of the Company Common Stock will be converted into the right to receive consideration (the "Merger Consideration") consisting of 0.77 shares of Sterling common stock (the "Merger"). In addition, the holders of Company stock options will have their options converted into options to buy Sterling common stock as provided in the Merger Agreement. The complete terms of the Merger are described in the Merger Agreement, and this summary is qualified in its entirety by reference thereto.

        In arriving at our opinion, we reviewed (i) the Merger Agreement, and exhibits thereto; (ii) certain financial statements and other historical financial and business information about the Company and Sterling made available to us from published sources and/or from the internal records of the Company and Sterling; (iii) certain financial assumptions and forecasts of the Company reviewed with management of the Company regarding the Company's business, financial condition, results of operations and prospects; (iv) certain financial assumptions and forecasts of Sterling reviewed with management of Sterling regarding Sterling's business, financial condition, results of operations and prospects; (v) the publicly reported historical prices and trading activity for the Company's and Sterling's common stock, including a comparison of certain financial and stock market information for the Company and Sterling with similar publicly available information for certain other companies, the securities of which are publicly traded; (vi) the financial terms of certain other similar transactions recently effected, to the extent publicly available; (vii) the current market environment generally and the banking industry environment in particular; (viii) the pro forma financial impact of the Merger; and (ix) such other information, financial studies, analyses and investigations and financial, economic and market criteria as we considered relevant. In addition, we have had discussions with the management and other representatives and advisors of the Company and Sterling concerning the business, financial condition, results of operations and prospects of the Company and Sterling.

        In arriving at our opinion, we have assumed and relied upon the accuracy and completeness of all information supplied or otherwise made available to us, discussed with or reviewed by or for us, or publicly available, and we have not assumed responsibility for independently verifying such information or undertaken an independent evaluation or appraisal of any of the assets or liabilities (contingent or otherwise) of the Company or Sterling, nor have we been furnished any such evaluation or appraisal. In addition, we have not assumed any obligation to conduct, nor have we conducted any physical inspection of the properties or facilities of the Company or Sterling. With respect to financial projections, we have assumed that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of management of the Company and Sterling as to the future financial performance of the Company, Sterling or the combined entity, as the case may be, and, for purposes of this opinion, we have assumed that the results contemplated in the projections will be

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realized. We have not reviewed individual credit files, and we are not experts in the evaluation of loan portfolios for the purposes of assessing the adequacy of the allowance for loan and lease losses.

        We have also assumed in all respects material to our analysis that all of the representations and warranties contained in the Merger Agreement and all related agreements are true and correct, that each party to such agreements will perform all of the covenants required to be performed by such party under such agreements and that the conditions precedent in the Merger Agreement are not waived and that the Merger will qualify as a tax-free reorganization for federal income tax purposes. In addition, we have assumed that in the course of obtaining necessary regulatory or other consents or approvals (contractual or otherwise) for the Merger, no restrictions, including any divestiture requirements or amendment or modifications, will be imposed that will have a material adverse affect on the contemplated benefits of the Merger. We express no view as to, and our opinion does not in any manner address, Klamath's underlying business decision to proceed with or effect the Merger. Our opinion is necessarily based upon information available to us and economic, market, financial and other conditions as they exist and can be evaluated on the date of this letter. We are expressing no opinion as to what the value of Sterling's common stock will be when issued to Klamath's shareholders pursuant to the Merger Agreement or the prices at which Sterling's or the Company's common stock may trade at any time.

        We have acted as the Company's financial advisor in connection with the Merger and will receive a fee for our services, including rendering this opinion, a significant portion of which is contingent upon the consummation of the Merger. We have in the past provided investment banking services to the Company unrelated to the Merger, for which we have received compensation. We have in the past provided investment banking services to Sterling unrelated to the Merger, including acting as one of the placement agents in connection with a trust preferred securities offering for Sterling, for which we have received compensation.

        Davidson, as part of its investment banking business, is engaged in the valuation of banking and other businesses and their securities in connection with mergers and acquisitions and other corporate transactions. We are familiar with the market for publicly traded banks, savings institutions and bank and savings institution holding companies. In the ordinary course of business as a broker-dealer, we may actively trade or hold securities of both the Company and Sterling, for our own account or for the accounts of our customers and, accordingly, may at any time hold a long or short position in such securities. We make a market in the common stock of the Company and Sterling and publish a research recommendation on Sterling's stock. We do not publish a research recommendation on the Company's stock.

        Based upon and subject to the foregoing, it is our opinion that, as of the date hereof, the Merger Consideration is fair, from a financial point of view, to the shareholders of the Company.

        It is understood that this letter is for the information of the Board of Directors of the Company in connection with its consideration of the Merger and is not intended to be and does not constitute a recommendation of the Merger to the Company or its shareholders, nor does it constitute a recommendation to any shareholder as to how such shareholder should vote on any matter relating to the Merger. This letter is not to be quoted or referred to, in whole or in part, in any statement or document, nor shall this letter be used for any other purposes, without our prior written consent, which

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consent is hereby given to the inclusion of this letter in a proxy or other document filed with the Securities and Exchange Commission or bank regulatory agencies in connection with the Merger.

Very truly yours,    

D.A. DAVIDSON & CO.

 

 

/s/ Albert V. Glowasky

 

 

Albert V. Glowasky
Managing Director

 

 

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PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 20. Indemnification of Directors and Officers.

        Article XII of the Restated Articles of Incorporation of Sterling authorizes Sterling to indemnify any present or former director or officer to the fullest extent not prohibited by the Washington Business Corporation Act ("WBCA"), public policy or other applicable law. Sections 23B.08.510 and .570 of the WBCA authorizes a corporation to indemnify its directors, officers, employees, or agents in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including provisions permitting advances for expenses incurred) arising under the Securities Act of 1933. However, no present or former director or officer shall be indemnified or reimbursed (1) in relation to any matter in such action, suit or proceeding as to which he or she shall finally be adjudged to have been guilty or liable for gross negligence, willful misconduct or criminal acts in the performance of his or her duties to Sterling; or (2) in relation to any matter in such action, suit or proceeding which has been made the subject of a compromise settlement except with the approval of (a) a court of competent jurisdiction, (b) the holders of record of a majority of the outstanding shares of Sterling or (c) the board of directors, acting by vote of a majority of directors not parties to the same or substantially the same action, suit or proceeding, whether or not such majority constitutes a quorum. The foregoing right of indemnification or reimbursement shall not be exclusive of other rights to which such person, his or her heirs, executors or administrators may be entitled as a matter of law. Those persons indemnified hereunder shall be deemed to include the heirs, legal representatives, executors and administrators of such person.

        Sterling maintains directors' and officers' liability insurance under which Sterling's directors and officers are insured against loss (as defined in the policy) resulting from claims brought against them for their wrongful acts in such capacities. Expenses (including attorneys' fees) incurred in defending a civil or criminal action, suit or proceeding shall be paid by Sterling in advance of the final disposition of such action, suit or proceeding. The director, officer, employee or agent must repay such amount, however, if it shall ultimately be determined that he or she is not entitled to be indemnified by Sterling.

        Sterling's Restated Articles of Incorporation also provide that a director of Sterling shall not be personally liable to Sterling or its shareholders for monetary damages for conduct as a director, except for liability of the director for (i) acts or omissions that involve intentional misconduct or a knowing violation of law by the director, (ii) conduct which violates RCW 23B.08.310 of the WBCA pertaining to unpermitted distributions to shareholders or loans to directors or (iii) any transaction from which the director will personally receive a benefit in money, property or services to which the director is not legally entitled. If the WBCA is amended to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of Sterling shall be eliminated or limited to the fullest extent permitted by the WBCA, as so amended. Any repeal or modification of the foregoing paragraph by the shareholders of Sterling shall not adversely affect any right or protection of a director of Sterling existing at the time of such repeal or modification.

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Item 21. List of Exhibits.

Exhibit
Number

  Description
2.1   Agreement and Plan of Merger, by and between Sterling Financial Corporation and Klamath First Bancorp, Inc., dated as of July 14, 2003. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement. Sterling agrees to furnish supplementally to the SEC upon request a copy of any omitted schedule.

3.1

 

Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.1 to Sterling's report on Form 10-Q filed May 15, 2003 and incorporated by reference herein.

3.2

 

Amended and Restated Bylaws of Sterling. Filed as Exhibit 3.3 to Sterling's registration statement on Form S-4 filed December 9, 2002 and incorporated by reference herein.

4.1

 

Reference is made to Exhibits 3.1 and 3.2.

4.2

 

Sterling has outstanding certain long-term debt. None of such debt exceeds 10% of Sterling's total assets; therefore, copies of the constituent instruments defining the rights of the holders of such debt are not included as exhibits. Copies of instruments with respect to such long-term debt will be furnished to the SEC upon request.

5.1

 

Opinion of Witherspoon, Kelley, Davenport & Toole, P.S. (with respect to the validity of the common stock to be issued thereunder). Filed herewith.

8.1

 

Opinion of Witherspoon, Kelley, Davenport & Toole, P.S. (with respect to certain tax matters). Filed herewith.

8.2

 

Opinion of Silver, Freedman & Taff, LLP (with respect to certain tax matters). Filed herewith.

10.1(a)

 

Employment Agreement for Kermit K. Houser filed as Exhibit 10(a).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.1(b)

 

First Amendment to Employment Agreement for Kermit K. Houser filed as Exhibit 10(a).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.1(c)

 

Salary Continuation Agreement for Kermit K. Houser filed as Exhibit 10(a).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(a)

 

Employment Agreement for Marshall J. Alexander filed as Exhibit 10(b).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(b)

 

First Amendment to Employment Agreement for Marshall J. Alexander filed as Exhibit 10(b).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(c)

 

Salary Continuation Agreement for Marshall J. Alexander filed as Exhibit 10(b).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.3(a)

 

Employment Agreement for Ben A. Gay filed as Exhibit 10(c).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.
     

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10.3(b)

 

First Amendment to Employment Agreement for Ben A. Gay filed as Exhibit 10(c).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.3(c)

 

Salary Continuation Agreement for Ben A. Gay filed as Exhibit 10(c).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(a)

 

Employment Agreement for Frank X. Hernandez filed as Exhibit 10(d).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(b)

 

First Amendment to Employment Agreement for Frank X. Hernandez filed as Exhibit 10(d).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(c)

 

Salary Continuation Agreement for Frank X. Hernandez filed as Exhibit 10(d).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(d)

 

First Amendment to Salary Continuation Agreement for Frank X. Hernandez filed as Exhibit 10(d).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(a)

 

Employment Agreement for Craig M Moore filed as Exhibit 10(e).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(b)

 

First Amendment to Employment Agreement for Craig M Moore filed as Exhibit 10(e).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(c)

 

Salary Continuation Agreement for Craig M Moore filed as Exhibit 10(e).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(d)

 

First Amendment to Salary Continuation Agreement for Craig M Moore filed as Exhibit 10(e).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(a)

 

Employment Agreement for James E. Essany filed as Exhibit 10(f).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(b)

 

First Amendment to Employment Agreement for James E. Essany filed as Exhibit 10(f).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(c)

 

Salary Continuation Agreement for James E. Essany filed as Exhibit 10(f).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(d)

 

First Amendment to Salary Continuation Agreement for James E. Essany filed as Exhibit 10(f).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.
     

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10.7(a)

 

Employment Agreement for Walter F. Dodrill filed as Exhibit 10(g).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(b)

 

First Amendment to Employment Agreement for Walter F. Dodrill filed as Exhibit 10(g).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(c)

 

Salary Continuation Agreement for Walter F. Dodrill filed as Exhibit 10(g).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(d)

 

First Amendment to Salary Continuation agreement for Walter F. Dodrill filed as Exhibit 10(g).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(a)

 

Employment Agreement for Nina G. Drake filed as Exhibit 10(h).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(b)

 

First Amendment to Employment Agreement for Nina G. Drake filed as Exhibit 10(h).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(c)

 

Salary Continuation Agreement for Nina G. Drake filed as Exhibit 10(h).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(d)

 

First Amendment to Salary Continuation agreement for Nina G. Drake filed as Exhibit 10(h).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(a)

 

Employment Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(b)

 

First Amendment to Employment Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(c)

 

Salary Continuation Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(d)

 

First Amendment to Salary Continuation Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(a)

 

Director Fee Continuation Agreement for Rodney N. Murray filed as Exhibit 10(j).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(b)

 

Director Fee Continuation Agreement for Bernard Z. Agrons filed as Exhibit 10(j).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.
     

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10.10(c)

 

Director Fee Continuation Agreement for Timothy A. Bailey filed as Exhibit 10(j).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(d)

 

Director Fee Continuation Agreement for James D. Bocchi filed as Exhibit 10(j).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein

10.10(e)

 

Director Fee Continuation Agreement for Donald N. Bauhofer filed as Exhibit 10(j).5 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(f)

 

Director Fee Continuation Agreement for William C. Dalton filed as Exhibit 10(j).6 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(g)

 

Director Fee Continuation Agreement for Dianne E. Spires filed as Exhibit 10(j).7 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(a)

 

Joint Beneficiary Agreement for Kermit K. Houser filed as Exhibit 10(a).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(b)

 

Joint Beneficiary Agreement for Marshall J. Alexander filed as Exhibit 10(b).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(c)

 

Joint Beneficiary Agreement for Ben A. Gay filed as Exhibit 10(c).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(d)

 

Joint Beneficiary Agreement for Frank X. Hernandez filed as Exhibit 10(d).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(e)

 

Joint Beneficiary Agreement for Craig M Moore filed as Exhibit 10(e).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(f)

 

Joint Beneficiary Agreement for James E. Essany filed as Exhibit 10(f).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(g)

 

Joint Beneficiary Agreement for Walter F. Dodrill filed as Exhibit 10(g).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(h)

 

Joint Beneficiary Agreement for Nina G. Drake filed as Exhibit 10(h).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(i)

 

Joint Beneficiary Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.12

 

Form of Shareholders Agreement. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement.
     

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10.13

 

Form of Klamath Affiliates Agreement. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement.

21.1

 

List of Subsidiaries of Registrant. Filed herewith.

23.1

 

Consent of Witherspoon, Kelley, Davenport & Toole, P.S. (included in Exhibit 5.1 to this registration statement).

23.2

 

Consent of Witherspoon, Kelley, Davenport & Toole, P.S. (included in Exhibit 8.1 to this registration statement).

23.3

 

Consent of Silver, Freedman & Taff, LLP (included in Exhibit 8.2 to this registration statement).

23.4

 

Consent of BDO Seidman, LLP (with respect to Sterling Financial Corporation). Filed herewith.

23.5

 

Consent of PricewaterhouseCoopers LLP (with respect to Sterling Financial Corporation). Filed herewith.

23.6

 

Consent of Deloitte & Touche LLP (with respect to Klamath First Bancorp, Inc.). Filed herewith.

23.7

 

Consent of D.A. Davidson & Co. Filed herewith.

23.8

 

Consent of Sandler O'Neill & Partners, L.P. Filed herewith.

24.1

 

Power of Attorney (set forth on the signature pages to this registration statement).

99.1

 

Form of Proxy for Special Meeting of Shareholders of Klamath First Bancorp, Inc. Filed herewith.

99.2

 

Form of Proxy for Special Meeting of Shareholders of Sterling Financial Corporation. Filed herewith.

Item 22. Undertakings.

        (a)   The undersigned registrant hereby undertakes:

II-6


        (b)   The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

        (c)   (1) The undersigned registrant hereby undertakes as follows: that prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this registration statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c), the issuer undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other Items of the applicable form.

        (d)   Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue.

        (e)   The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request.

        (f)    The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective.

II-7



SIGNATURES

        Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Spokane, State of Washington on September 12, 2003.

    STERLING FINANCIAL CORPORATION

 

 

By

/s/  
HAROLD B. GILKEY      
Harold B. Gilkey
Chairman of the Board and Chief Executive Officer


POWER OF ATTORNEY

        KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby grants a power of attorney to Daniel G. Byrne, William R. Basom and Donald J. Lukes and each of them, with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities (including his capacity as a director or officer of Sterling Financial Corporation) to sign for such person, and in such person's name and capacity indicated below, any and all amendments to the registration statement of Sterling Financial Corporation and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or each of them or any substitute therefore may do or cause to be done by virtue hereof.

        Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities indicated on September 12, 2003.

Signature
  Title

 

 

 
/s/  HAROLD B. GILKEY      
Harold B. Gilkey
  Chairman of the Board and Chief Executive Officer

/s/  
WILLIAM W. ZUPPE      
William W. Zuppe

 

President, Chief Operating Officer and Director

/s/  
DANIEL G. BYRNE      
Daniel G. Byrne

 

Senior Vice President-Finance, Assistant Secretary, and Principal Financial Officer

/s/  
WILLIAM R. BASOM      
William R. Basom

 

Vice President, Treasurer and Principal Accounting Officer
     

II-8



/s/  
NED M. BARNES      
Ned M. Barnes

 

Secretary and Director

/s/  
RODNEY W. BARNETT      
Rodney W. Barnett

 

Director

/s/  
THOMAS H. BOONE      
Thomas H. Boone

 

Director

/s/  
JAMES P. FUGATE      
James P. Fugate

 

Director

/s/  
ROBERT D. LARRABEE      
Robert D. Larrabee

 

Director

/s/  
ROBERT E. MEYERS      
Robert E. Meyers

 

Director

/s/  
DAVID O. WALLACE      
David O. Wallace

 

Director

II-9



INDEX TO EXHIBITS

Exhibit
Number

  Description
2.1   Agreement and Plan of Merger, by and between Sterling Financial Corporation and Klamath First Bancorp, Inc., dated as of July 14, 2003. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement. Sterling agrees to furnish supplementally to the SEC upon request a copy of any omitted schedule.

3.1

 

Restated Articles of Incorporation of Sterling. Filed as Exhibit 3.1 to Sterling's report on Form 10-Q filed May 15, 2003 and incorporated by reference herein.

3.2

 

Amended and Restated Bylaws of Sterling. Filed as Exhibit 3.3 to Sterling's registration statement on Form S-4 filed December 9, 2002 and incorporated by reference herein.

4.1

 

Reference is made to Exhibits 3.1 and 3.2.

4.2

 

Sterling has outstanding certain long-term debt. None of such debt exceeds 10% of Sterling's total assets; therefore, copies of the constituent instruments defining the rights of the holders of such debt are not included as exhibits. Copies of instruments with respect to such long-term debt will be furnished to the SEC upon request.

5.1

 

Opinion of Witherspoon, Kelley, Davenport & Toole, P.S. (with respect to the validity of the common stock to be issued thereunder). Filed herewith.

8.1

 

Opinion of Witherspoon, Kelley, Davenport & Toole, P.S. (with respect to certain tax matters). Filed herewith.

8.2

 

Opinion of Silver, Freedman & Taff, LLP (with respect to certain tax matters). Filed herewith.

10.1(a)

 

Employment Agreement for Kermit K. Houser filed as Exhibit 10(a).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.1(b)

 

First Amendment to Employment Agreement for Kermit K. Houser filed as Exhibit 10(a).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.1(c)

 

Salary Continuation Agreement for Kermit K. Houser filed as Exhibit 10(a).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(a)

 

Employment Agreement for Marshall J. Alexander filed as Exhibit 10(b).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(b)

 

First Amendment to Employment Agreement for Marshall J. Alexander filed as Exhibit 10(b).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.2(c)

 

Salary Continuation Agreement for Marshall J. Alexander filed as Exhibit 10(b).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.3(a)

 

Employment Agreement for Ben A. Gay filed as Exhibit 10(c).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.
     


10.3(b)

 

First Amendment to Employment Agreement for Ben A. Gay filed as Exhibit 10(c).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.3(c)

 

Salary Continuation Agreement for Ben A. Gay filed as Exhibit 10(c).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(a)

 

Employment Agreement for Frank X. Hernandez filed as Exhibit 10(d).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(b)

 

First Amendment to Employment Agreement for Frank X. Hernandez filed as Exhibit 10(d).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(c)

 

Salary Continuation Agreement for Frank X. Hernandez filed as Exhibit 10(d).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.4(d)

 

First Amendment to Salary Continuation Agreement for Frank X. Hernandez filed as Exhibit 10(d).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(a)

 

Employment Agreement for Craig M Moore filed as Exhibit 10(e).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(b)

 

First Amendment to Employment Agreement for Craig M Moore filed as Exhibit 10(e).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(c)

 

Salary Continuation Agreement for Craig M Moore filed as Exhibit 10(e).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.5(d)

 

First Amendment to Salary Continuation Agreement for Craig M Moore filed as Exhibit 10(e).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(a)

 

Employment Agreement for James E. Essany filed as Exhibit 10(f).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(b)

 

First Amendment to Employment Agreement for James E. Essany filed as Exhibit 10(f).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(c)

 

Salary Continuation Agreement for James E. Essany filed as Exhibit 10(f).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.6(d)

 

First Amendment to Salary Continuation Agreement for James E. Essany filed as Exhibit 10(f).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(a)

 

Employment Agreement for Walter F. Dodrill filed as Exhibit 10(g).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.
     


10.7(b)

 

First Amendment to Employment Agreement for Walter F. Dodrill filed as Exhibit 10(g).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(c)

 

Salary Continuation Agreement for Walter F. Dodrill filed as Exhibit 10(g).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.7(d)

 

First Amendment to Salary Continuation agreement for Walter F. Dodrill filed as Exhibit 10(g).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(a)

 

Employment Agreement for Nina G. Drake filed as Exhibit 10(h).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(b)

 

First Amendment to Employment Agreement for Nina G. Drake filed as Exhibit 10(h).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(c)

 

Salary Continuation Agreement for Nina G. Drake filed as Exhibit 10(h).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.8(d)

 

First Amendment to Salary Continuation agreement for Nina G. Drake filed as Exhibit 10(h).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(a)

 

Employment Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(b)

 

First Amendment to Employment Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(c)

 

Salary Continuation Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.9(d)

 

First Amendment to Salary Continuation Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(a)

 

Director Fee Continuation Agreement for Rodney N. Murray filed as Exhibit 10(j).1 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(b)

 

Director Fee Continuation Agreement for Bernard Z. Agrons filed as Exhibit 10(j).2 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(c)

 

Director Fee Continuation Agreement for Timothy A. Bailey filed as Exhibit 10(j).3 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(d)

 

Director Fee Continuation Agreement for James D. Bocchi filed as Exhibit 10(j).4 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein
     


10.10(e)

 

Director Fee Continuation Agreement for Donald N. Bauhofer filed as Exhibit 10(j).5 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(f)

 

Director Fee Continuation Agreement for William C. Dalton filed as Exhibit 10(j).6 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.10(g)

 

Director Fee Continuation Agreement for Dianne E. Spires filed as Exhibit 10(j).7 to Klamath's amended report on Form 10-Q/A filed August 15, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(a)

 

Joint Beneficiary Agreement for Kermit K. Houser filed as Exhibit 10(a).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(b)

 

Joint Beneficiary Agreement for Marshall J. Alexander filed as Exhibit 10(b).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(c)

 

Joint Beneficiary Agreement for Ben A. Gay filed as Exhibit 10(c).4 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(d)

 

Joint Beneficiary Agreement for Frank X. Hernandez filed as Exhibit 10(d).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(e)

 

Joint Beneficiary Agreement for Craig M Moore filed as Exhibit 10(e).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(f)

 

Joint Beneficiary Agreement for James E. Essany filed as Exhibit 10(f).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(g)

 

Joint Beneficiary Agreement for Walter F. Dodrill filed as Exhibit 10(g).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(h)

 

Joint Beneficiary Agreement for Nina G. Drake filed as Exhibit 10(h).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.11(i)

 

Joint Beneficiary Agreement for Jeffrey D. Schlenker filed as Exhibit 10(i).5 to Klamath's amended report on Form 10-Q/A filed September 11, 2003 for the period ended June 30, 2003 and incorporated by reference herein.

10.12

 

Form of Shareholders Agreement. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement.
     


10.13

 

Form of Klamath Affiliates Agreement. Incorporated herein by reference to Annex A of the joint proxy statement/prospectus included in this registration statement.

21.1

 

List of Subsidiaries of Registrant. Filed herewith.

23.1

 

Consent of Witherspoon, Kelley, Davenport & Toole, P.S. (included in Exhibit 5.1 to this registration statement).

23.2

 

Consent of Witherspoon, Kelley, Davenport & Toole, P.S. (included in Exhibit 8.1 to this registration statement).

23.3

 

Consent of Silver, Freedman & Taff, LLP (included in Exhibit 8.2 to this registration statement).

23.4

 

Consent of BDO Seidman, LLP (with respect to Sterling Financial Corporation). Filed herewith.

23.5

 

Consent of PricewaterhouseCoopers LLP (with respect to Sterling Financial Corporation). Filed herewith.

23.6

 

Consent of Deloitte & Touche LLP (with respect to Klamath First Bancorp, Inc.). Filed herewith.

23.7

 

Consent of D.A. Davidson & Co. Filed herewith.

23.8

 

Consent of Sandler O'Neill & Partners, L.P. Filed herewith.

24.1

 

Power of Attorney (set forth on the signature pages to this registration statement).

99.1

 

Form of Proxy for Special Meeting of Shareholders of Klamath First Bancorp, Inc. Filed herewith.

99.2

 

Form of Proxy for Special Meeting of Shareholders of Sterling Financial Corporation. Filed herewith.



QuickLinks

REFERENCES TO ADDITIONAL INFORMATION
STERLING FINANCIAL CORPORATION NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD ON DECEMBER 11, 2003
KLAMATH FIRST BANCORP, INC. NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD DECEMBER 11, 2003
TABLE OF CONTENTS
QUESTIONS AND ANSWERS ABOUT THE MERGER
SUMMARY OF THIS JOINT PROXY STATEMENT/PROSPECTUS
The Companies
Summary of the Transaction
Selected Financial Data of Sterling
Selected Financial Data of Klamath
Comparative Stock Price and Dividend Information
Selected Combined Consolidated Unaudited Pro Forma Financial Data (In thousands, except shares and per share amounts)
Selected Combined Consolidated Unaudited Pro Forma Comparative Per Share Data
RISK FACTORS
THE STERLING SPECIAL MEETING
THE KLAMATH SPECIAL MEETING
THE MERGER
Transaction Ratios
Sterling's and Klamath's One-Year Stock Performance
Nationwide & Western Region Transaction Multiples
Earnings Per Share Multiples
Tangible Book Value Per Share Multiples
Earnings Per Share Multiples
Tangible Book Value Per Share Multiples
Pro Forma Merger Analysis
Klamath's Loan Portfolio Composition and Loan/Deposit Ratio
Relative Contributions as of and for the three months ended March 31, 2003
COMPARISON OF RIGHTS OF HOLDERS OF KLAMATH COMMON STOCK AND STERLING COMMON STOCK
SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND DIRECTORS OF STERLING
SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS, MANAGEMENT AND DIRECTORS OF KLAMATH
PRO FORMA FINANCIAL INFORMATION STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC. Unaudited Pro Forma Combined Condensed Consolidated Statement of Financial Condition and Statements of Income
STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC. Unaudited Pro Forma Combined Condensed Consolidated Statement of Financial Condition
STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC. Unaudited Pro Forma Combined Condensed Consolidated Statement of Income
STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC. Unaudited Pro Forma Combined Condensed Consolidated Statement of Income
PRO FORMA FINANCIAL INFORMATION STERLING FINANCIAL CORPORATION AND KLAMATH FIRST BANCORP, INC. Notes to Unaudited Pro Forma Combined Condensed Consolidated Financial Statements December 31, 2002 and June 30, 2003
LEGAL MATTERS
EXPERTS
SHAREHOLDER PROPOSALS
DOCUMENTS INCORPORATED BY REFERENCE INTO THIS JOINT PROXY STATEMENT/PROSPECTUS
WHERE YOU CAN FIND MORE INFORMATION
FORWARD-LOOKING INFORMATION
TABLE OF CONTENTS
AGREEMENT AND PLAN OF MERGER
ARTICLE I THE MERGER
ARTICLE II EXCHANGE OF SHARES
ARTICLE III REPRESENTATIONS AND WARRANTIES OF KLAMATH
ARTICLE IV REPRESENTATIONS AND WARRANTIES OF STERLING
ARTICLE V COVENANTS RELATING TO CONDUCT OF BUSINESS
ARTICLE VI ADDITIONAL AGREEMENTS
ARTICLE VII CONDITIONS PRECEDENT
ARTICLE VIII TERMINATION AND AMENDMENT
ARTICLE IX GENERAL PROVISIONS
PART II INFORMATION NOT REQUIRED IN PROSPECTUS
SIGNATURES
POWER OF ATTORNEY
INDEX TO EXHIBITS