UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q
 

(Mark One)

 

ý

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

 

 

 

FOR THE QUARTERLY PERIOD ENDED September 30, 2003

 

 

 

OR

 

 

o

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

 

 

 

FOR THE TRANSITION PERIOD FROM                       TO                      

 

 

 

Commission File Number.....0-20800

 

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Washington

 

91-1572822

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

111 North Wall Street, Spokane, Washington 99201

(Address of principal executive offices) (Zip Code)

 

(509) 458-2711

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý  No o

 

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

 

Class

 

Outstanding as of October 31, 2003

 

 

 

Common Stock ($1.00 par value)

 

14,811,661

 

 



 

STERLING FINANCIAL CORPORATION

 

FORM 10-Q

For the Quarter Ended September 30, 2003

 

TABLE OF CONTENTS

 

 

PART I - Financial Information

 

 

 

 

Item 1 -

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Consolidated Balance Sheets

 

 

 

 

 

 

 

Consolidated Statements of Income

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

 

 

 

 

 

Item 2 -

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

 

 

Item 3 -

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

 

Item 4 -

Controls and Procedures

 

 

 

 

 

PART II - Other Information

 

 

 

 

 

 

Item 1 -

Legal Proceedings

 

 

 

 

 

 

Item 2 -

Changes in Securities and Use of Proceeds

 

 

 

 

 

 

Item 3 -

Defaults Upon Senior Securities

 

 

 

 

 

 

Item 4 -

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

 

Item 5 -

Other Information

 

 

 

 

 

 

Item 6 -

Exhibits and Reports on Form 8-K

 

 

 

Signatures

 

 



 

PART I - Financial Information

Item 1 - Financial Statements

STERLING FINANCIAL CORPORATION

Consolidated Balance Sheets

(Unaudited)

 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

(Dollars in thousands)

 

ASSETS:

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Interest bearing

 

$

2,505

 

$

2,525

 

Non-interest bearing and vault

 

70,986

 

74,540

 

Restricted

 

1,700

 

1,526

 

Investments and asset-backed securities (“ABS”):

 

 

 

 

 

Available for sale

 

1,010,084

 

826,692

 

Held to maturity

 

2,821

 

3,476

 

Loans receivable, net

 

2,761,174

 

2,390,263

 

Loans held for sale

 

22,754

 

22,549

 

Accrued interest receivable

 

15,794

 

14,625

 

Real estate owned, net

 

3,108

 

3,953

 

Office properties and equipment, net

 

52,385

 

47,745

 

Bank-owned life insurance (“BOLI”)

 

72,168

 

59,399

 

Goodwill

 

45,075

 

43,977

 

Other intangible assets

 

2,960

 

0

 

Mortgage servicing rights, net

 

3,272

 

1,680

 

Prepaid expenses and other assets, net

 

8,664

 

13,114

 

Total assets

 

$

4,075,450

 

$

3,506,064

 

 

 

 

 

 

 

LIABILITIES:

 

 

 

 

 

Deposits

 

$

2,421,043

 

$

2,014,096

 

Advances from Federal Home Loan Bank of Seattle (“FHLB Seattle”)

 

964,140

 

874,515

 

Securities sold subject to repurchase agreements and funds purchased

 

259,107

 

249,769

 

Other borrowings

 

136,782

 

127,682

 

Cashiers checks issued and payable

 

16,393

 

13,371

 

Borrowers’ reserves for taxes and insurance

 

2,565

 

1,401

 

Accrued interest payable

 

8,377

 

6,344

 

Accrued expenses and other liabilities

 

18,166

 

15,230

 

Total liabilities

 

3,826,573

 

3,302,408

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

Preferred stock, $1 par value; 10,000,000 shares authorized;
no shares issued and outstanding

 

0

 

0

 

Common stock, $1 par value; 40,000,000 shares authorized;
14,811,661 and 11,958,948 shares issued and outstanding

 

14,812

 

11,959

 

Additional paid-in capital

 

181,036

 

125,177

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

Unrealized gains (losses) on investments and ABS available-for-sale, net of deferred income taxes of $3,919 and ($1,852)

 

(7,278

)

3,439

 

Retained earnings

 

60,307

 

63,081

 

 

 

 

 

 

 

Total shareholders’ equity

 

248,877

 

203,656

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

4,075,450

 

$

3,506,064

 

 

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

 

1



 

STERLING FINANCIAL CORPORATION

Consolidated Statements of Income

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

43,179

 

$

40,260

 

$

125,894

 

$

118,340

 

ABS

 

10,558

 

8,797

 

29,744

 

24,384

 

Investments and cash equivalents

 

959

 

1,052

 

3,194

 

3,252

 

Total interest income

 

54,696

 

50,109

 

158,832

 

145,976

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

9,322

 

11,175

 

27,835

 

34,025

 

Short-term borrowings

 

3,260

 

2,144

 

8,727

 

5,419

 

Long-term borrowings

 

9,786

 

10,926

 

31,331

 

33,911

 

Total interest expense

 

22,368

 

24,245

 

67,893

 

73,355

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

32,328

 

25,864

 

90,939

 

72,621

 

 

 

 

 

 

 

 

 

 

 

Provision for losses on loans

 

(2,850

)

(3,277

)

(7,650

)

(7,590

)

Net interest income after provision for losses on loans

 

29,478

 

22,587

 

83,289

 

65,031

 

 

 

 

 

 

 

 

 

 

 

Other income:

 

 

 

 

 

 

 

 

 

Fees and service charges

 

5,052

 

4,352

 

14,260

 

12,281

 

Mortgage banking operations

 

2,185

 

1,307

 

6,898

 

3,663

 

Loan servicing fees

 

518

 

271

 

449

 

865

 

Net gains (losses) on sales of securities

 

(308

)

1,399

 

2,729

 

1,796

 

Real estate owned operations

 

125

 

(8

)

(84

)

(202

)

Charge related to early repayment of debt

 

0

 

0

 

(1,464

)

0

 

BOLI

 

979

 

731

 

2,769

 

2,433

 

Other noninterest income (expense)

 

(155

)

15

 

(363

)

(195

)

 

 

 

 

 

 

 

 

 

 

Total other income

 

8,396

 

8,067

 

25,194

 

20,641

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

24,655

 

21,119

 

68,670

 

60,538

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

13,219

 

9,535

 

39,813

 

25,134

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

(4,594

)

(2,906

)

(13,888

)

(7,188

)

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,625

 

$

6,629

 

$

25,925

 

$

17,946

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic

 

$

0.58

 

$

0.50

 

$

1.80

 

$

1.38

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - diluted

 

$

0.57

 

$

0.49

 

$

1.75

 

$

1.34

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

14,791,399

 

13,145,696

 

14,428,622

 

12,985,287

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - diluted

 

15,220,484

 

13,439,003

 

14,818,023

 

13,398,551

 

 

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

 

2



 

STERLING FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

25,925

 

$

17,946

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provisions for losses on loans and real estate owned

 

7,830

 

7,828

 

Stock dividends on FHLB Seattle stock

 

(3,590

)

(1,808

)

Net gain on sales of loans, investments and ABS

 

(7,659

)

(5,074

)

Other losses

 

136

 

491

 

Change in cash surrender value of BOLI

 

(2,769

)

(2,555

)

Depreciation and amortization

 

9,176

 

8,276

 

Change in:

 

 

 

 

 

Accrued interest receivable

 

(898

)

(170

)

Prepaid expenses and other assets

 

10,940

 

(6,633

)

Cashiers checks issued and payable

 

1,087

 

(2,041

)

Accrued interest payable

 

1,542

 

(159

)

Accrued expenses and other liabilities

 

(1,334

)

(3,815

)

Proceeds from sales of loans

 

355,920

 

184,406

 

Real estate loans originated for sale

 

(350,990

)

(181,128

)

Net cash provided by operating activities

 

45,316

 

15,564

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Change in restricted cash

 

(174

)

(290

)

Loans funded

 

(1,690,900

)

(1,140,121

)

Loan principal received

 

1,377,648

 

984,737

 

Purchase of investments

 

(11,819

)

(32,039

)

Proceeds from maturities of investments

 

1,630

 

29,929

 

Proceeds from sales of available-for-sale investments

 

16,083

 

1,410

 

Cash and cash equivalents acquired as part of acquisitions

 

143,631

 

0

 

Purchase of BOLI

 

(10,000

)

(25,000

)

Purchase of ABS

 

(1,053,060

)

(592,031

)

Principal payments on ABS

 

243,476

 

142,560

 

Proceeds from sales of ABS

 

612,676

 

345,290

 

Purchase of office properties and equipment

 

(3,880

)

(2,216

)

Improvements and other changes to real estate owned

 

69

 

(866

)

Proceeds from sales and liquidation of real estate owned

 

3,415

 

6,065

 

 

 

 

 

 

 

Net cash used in investing activities

 

(371,205

)

(282,572

)

 

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

 

3



 

 

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

 

 

(Dollars in thousands)

 

Cash flows from financing activities:

 

 

 

 

 

Net change in checking, passbook and money market deposits

 

$

147,403

 

$

157,785

 

Proceeds from issuance of certificates of deposit

 

1,147,741

 

858,652

 

Payments for maturing certificates of deposit

 

(1,098,262

)

(884,527

)

Interest credited to deposits

 

25,842

 

32,978

 

Advances from FHLB Seattle

 

446,102

 

221,875

 

Repayment of FHLB Seattle advances

 

(365,988

)

(116,843

)

Net change in securities sold subject to repurchase agreements and funds purchased

 

9,338

 

3,410

 

Proceeds from other borrowings

 

54,000

 

0

 

Repayment of other borrowings

 

(44,900

)

(5,000

)

Payments for fractional shares

 

(30

)

(19

)

Proceeds from exercise of stock options, net of repurchases

 

825

 

851

 

Deferred financing costs

 

(732

)

0

 

Other

 

976

 

1,382

 

Net cash provided by financing activities

 

322,315

 

270,544

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(3,574

)

3,536

 

Cash and cash equivalents, beginning of period

 

77,065

 

65,654

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

73,491

 

$

69,190

 

 

 

 

 

 

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

66,601

 

$

49,629

 

Income taxes

 

13,805

 

8,798

 

 

 

 

 

 

 

Noncash financing and investing activities:

 

 

 

 

 

Loans converted into real estate owned

 

1,758

 

7,570

 

Common stock dividend

 

28,699

 

23,809

 

Common stock issued upon business combination

 

29,523

 

0

 

 

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

 

4



 

STERLING FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

8,625

 

$

6,629

 

$

25,925

 

$

17,946

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Change in unrealized gains (losses) on investments and ABS available-for-sale

 

(9,743

)

4,450

 

(16,488

)

13,094

 

Less deferred income taxes

 

3,410

 

(1,558

)

5,771

 

(4,582

)

 

 

 

 

 

 

 

 

 

 

Net other comprehensive income (loss)

 

(6,333

)

2,892

 

(10,717

)

8,512

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

2,292

 

$

9,521

 

$

15,208

 

$

26,458

 

 

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

 

5



 

STERLING FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

1.                                      Basis of Presentation:

The foregoing unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission.  Accordingly, these financial statements do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.  These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2002.  In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.

 

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

 

2.                                      Other Borrowings:

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

 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

 

 

 

 

Term note payable(1)

 

$

22,000

 

$

25,000

 

Sterling obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated deferrable interest debentures of Sterling(2)

 

78,000

 

64,000

 

Floating Rate Notes Due 2006(3)

 

30,000

 

30,000

 

Other(4)

 

6,782

 

8,682

 

 

 

 

 

 

 

Total other borrowings

 

$

136,782

 

$

127,682

 

 


(1)          Sterling has a variable-rate term note with U.S. Bank, N.A. (“U.S. Bank”).  This note matures on September 17, 2007.  Interest accrues at the 30-day London Interbank Offering Rate (“LIBOR”) plus 2.50% (3.61% at September 30, 2003) and is payable monthly.  Principal payments are due in annual installments of $3.0 million each September, with the entire unpaid balance due at maturity.  This note is collateralized by a majority of the Common and Preferred Stock of Sterling Savings Bank.

 

(2)          Sterling raises capital from time to time through the formation of trusts (“Sterling Capital Trusts”), which issue capital securities (“Trust Preferred Securities”) to investors. The Sterling Capital Trusts are business trusts in which Sterling owns all of the common equity.  The proceeds from the sale of the Trust Preferred Securities are used to purchase junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”) issued by Sterling.  Sterling’s obligations under the Junior Subordinated Debentures and related

 

6



 

documents, taken together, constitute a full and unconditional guarantee by Sterling of Sterling Capital Trusts’ obligations under the Trust Preferred Securities.  The Trust Preferred Securities are treated as debt of Sterling.  Although Sterling, as a savings and loan holding company, is not subject to the Federal Reserve capital requirements for bank holding companies, the Trust Preferred Securities have been structured to qualify as Tier 1 capital, subject to certain limitations, if Sterling were to become regulated as a bank holding company.  The Junior Subordinated Debentures and related Trust Preferred Securities generally mature 30 years after issuance and are redeemable at the option of Sterling under certain conditions.  Interest is paid quarterly or semi-annually.  Details of the Trust Preferred Securities are as follows:

 

Subsidiary Issuer

 

Issue
Date

 

Maturity
Date

 

Call Date

 

Mandatorily
Redeemable
Capital Security

 

Rate at
September 30,
2003

 

Amount
(in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling Capital Trust VI

 

June 2003

 

April 2033

 

Sept 2008

 

Floating Rate Capital Securities

 

4.32

%

$

10,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling Capital Statutory Trust V

 

May 2003

 

May 2033

 

June 2008

 

Floating Rate Capital Securities

 

4.38

%

20,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling Capital Trust IV

 

May 2003

 

May 2033

 

May 2008

 

Floating Rate Preferred Securities

 

4.44

%

10,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling Capital Trust III

 

April 2003

 

Sept 2033

 

April 2008

 

Floating Rate Capital Securities

 

4.37

%

14,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sterling Capital Trust II

 

July 2001

 

July 2031

 

June 2006

 

10.25% Cumulative Capital Securities

 

10.25

%

24,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

78,000

 

 

(3)          Sterling has outstanding $30.0 million of Floating Rate Notes Due 2006.  These notes are unsecured general obligations of Sterling and are subordinated to certain other existing and future indebtedness.  Under the terms of the notes, Sterling is limited in the amount of certain long-term debt that it may incur, and the notes restrict Sterling, under certain circumstances, as to the amount of cash dividends on its preferred or common stock and capital distributions which can be made.  At September 30, 2003, Sterling could have incurred approximately $62.1 million of additional long-term debt.  At September 30, 2003, Sterling could have paid up to approximately $36.7 million in additional dividends.  Interest accrues at the 90-day LIBOR plus 2.50% (3.64% at September 30, 2003) and is adjustable and payable quarterly.  The notes mature in 2006 and may be redeemed under certain conditions.

 

(4)          During 2002, Sterling financed the sale of certain loans to an unrelated party.  Since the underlying sold loans were collateral on the loan to the purchaser, this sale was accounted for as a financing.  At September 30, 2003, $6.8 million remained outstanding on the financing.

 

7



 

3.                                      Earnings Per Share:

The following table presents the basic and diluted earnings per share computations including the effect of the 10% stock dividend which was paid in May 2003:

 

 

 

Three Months Ended September 30,

 

 

 

2003

 

2002

 

 

 

Net
Income

 

Weighted
Avg. Shares

 

Per Share
Amount

 

Net
Income

 

Weighted
Avg. Shares

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic computations

 

$

8,625,000

 

14,791,399

 

$

0.58

 

$

6,629,000

 

13,145,696

 

$

0.50

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock options

 

0

 

429,085

 

(0.01

)

0

 

293,307

 

(0.01

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted computations

 

$

8,625,000

 

15,220,484

 

$

0.57

 

$

6,629,000

 

13,439,003

 

$

0.49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Antidilutive options not included in diluted earnings per share

 

 

 

0

 

 

 

 

 

0

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

2003

 

2002

 

 

 

Net
Income

 

Weighted
Avg. Shares

 

Per Share
Amount

 

Net
Income

 

Weighted
Avg. Shares

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic computations

 

$

25,925,000

 

14,428,622

 

$

1.80

 

$

17,946,000

 

12,985,287

 

$

1.38

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock options

 

0

 

389,401

 

(0.05

)

0

 

302,875

 

(0.03

)

Convertible subordinated debt

 

0

 

0

 

0

 

43,000

 

110,389

 

(0.01

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted computations

 

$

25,925,000

 

14,818,023

 

$

1.75

 

$

17,989,000

 

13,398,551

 

$

1.34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Antidilutive options not included in diluted earnings per share

 

 

 

0

 

 

 

 

 

0

 

 

 

 

8



 

4.                                      Operating Expenses:

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

 

 

 

Three Months Ended
September 30,

 

Nine  Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Employee compensation and benefits

 

$

13,683

 

$

11,076

 

$

37,638

 

$

32,103

 

Occupancy and equipment

 

3,641

 

3,152

 

10,805

 

9,320

 

Depreciation

 

1,266

 

1,047

 

3,667

 

3,173

 

Amortization of identifiable intangible assets

 

79

 

0

 

183

 

644

 

Advertising

 

1,685

 

1,553

 

3,734

 

3,050

 

Data processing

 

1,737

 

1,597

 

4,963

 

4,626

 

Insurance

 

199

 

159

 

549

 

431

 

Legal and accounting

 

773

 

621

 

1,686

 

1,479

 

Travel and entertainment

 

622

 

464

 

1,881

 

1,513

 

Goodwill litigation costs

 

236

 

270

 

550

 

790

 

Acquisition and merger costs

 

167

 

0

 

355

 

0

 

Other

 

567

 

1,180

 

2,659

 

3,409

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

$

24,655

 

$

21,119

 

$

68,670

 

$

60,538

 

 

5.                                      Segment Information:

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

 

                  The Community Banking segment consists of the operations conducted by Sterling’s subsidiary, Sterling Savings Bank.

 

                  The Residential Mortgage Banking segment originates and sells servicing-retained and servicing-released residential loans through loan production offices in the Spokane and Seattle, Washington; Portland and Bend, Oregon and Boise, Idaho metropolitan areas primarily through Action Mortgage Company.

 

                  The Commercial Mortgage Banking segment originates, sells and services commercial real estate loans and participation interests in commercial real estate loans through offices in the metropolitan areas of Portland, Oregon; Spokane, Washington; and the Puget Sound region primarily through INTERVEST-Mortgage Investment Company.

 

                  The Insurance and Retail Brokerage segment markets tax-deferred annuities, mutual funds, insurance and other financial products through sales representatives within the Sterling Savings Bank branch network primarily through Harbor Financial Services, Inc. and Dime Insurance Agency.

 

                  The Eliminations and Other segment represents the parent company expenses and intercompany eliminations of revenue and expenses.

 

9



 

The following table presents certain financial information regarding Sterling’s segments and provides a reconciliation to Sterling’s consolidated totals for the three and nine months ended September 30, 2003 and 2002:

 

 

 

As of and for the Three Months Ended September 30, 2003

 

 

 

Community
Banking

 

Residential
Mortgage
Banking

 

Commercial
Mortgage
Banking

 

Insurance/
Retail
Brokerage

 

Eliminations
and
Other

 

Total

 

 

 

(Dollars in thousands)

 

Interest income

 

$

50,674

 

$

2,551

 

$

1,472

 

$

(1

)

$

0

 

$

54,696

 

Interest expense

 

20,667

 

0

 

0

 

0

 

1,701

 

22,368

 

Net interest income (expense)

 

30,007

 

2,551

 

1,472

 

(1

)

(1,701

)

32,328

 

Provision for losses on loans

 

(2,850

)

0

 

0

 

0

 

0

 

(2,850

)

Noninterest income

 

9,244

 

2,747

 

301

 

555

 

(4,451

)

8,396

 

Noninterest expense

 

21,003

 

2,971

 

669

 

418

 

(406

)

24,655

 

Income before income taxes

 

$

15,398

 

$

2,327

 

$

1,104

 

$

136

 

$

(5,746

)

$

13,219

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

4,123,879

 

$

21,240

 

$

14,474

 

$

1,664

 

$

(85,807

)

$

4,075,450

 

 

 

 

As of and for the Three Months Ended September 30, 2002

 

 

 

Community
Banking

 

Residential
Mortgage
Banking

 

Commercial
Mortgage
Banking

 

Insurance/
Retail
Brokerage

 

Eliminations
and
Other

 

Total

 

 

 

(Dollars in thousands )

 

Interest income

 

$

46,742

 

$

2,075

 

$

1,292

 

$

0

 

$

0

 

$

50,109

 

Interest expense

 

22,050

 

0

 

0

 

0

 

2,195

 

24,245

 

Net interest income (expense)

 

24,692

 

2,075

 

1,292

 

0

 

(2,195

)

25,864

 

Provision for losses on loans

 

(3,277

)

0

 

0

 

0

 

0

 

(3,277

)

Noninterest income

 

9,235

 

1,665

 

297

 

520

 

(3,650

)

8,067

 

Noninterest expense

 

18,499

 

1,762

 

670

 

318

 

(130

)

21,119

 

Income before income taxes

 

$

12,151

 

$

1,978

 

$

919

 

$

202

 

$

(5,715

)

$

9,535

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,372,420

 

$

15,785

 

$

14,631

 

$

964

 

$

(74,225

)

$

3,329,575

 

 

10



 

 

 

As of and for the Nine Months Ended September 30, 2003

 

 

 

Community
Banking

 

Residential
Mortgage
Banking

 

Commercial
Mortgage
Banking

 

Insurance/
Retail
Brokerage

 

Eliminations
and
Other

 

Total

 

 

 

(Dollars in thousands )

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

147,643

 

$

6,860

 

$

4,329

 

$

0

 

$

0

 

$

158,832

 

Interest expense

 

62,181

 

0

 

0

 

0

 

5,712

 

67,893

 

Net interest income (expense)

 

85,462

 

6,860

 

4,329

 

0

 

(5,712

)

90,939

 

Provision for losses on loans

 

(7,650

)

0

 

0

 

0

 

0

 

(7,650

)

Noninterest income

 

29,216

 

7,882

 

907

 

1,521

 

(14,332

)

25,194

 

Noninterest expense

 

58,733

 

7,621

 

2,032

 

1,143

 

(859

)

68,670

 

Income before income taxes

 

$

48,295

 

$

7,121

 

$

3,204

 

$

378

 

$

(19,185

)

$

39,813

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

4,123,879

 

$

21,240

 

$

14,474

 

$

1,664

 

$

(85,807

)

$

4,075,450

 

 

 

 

As of and for the Nine Months Ended September 30, 2002

 

 

 

Community
Banking

 

Residential
Mortgage
Banking

 

Commercial
Mortgage
Banking

 

Insurance/
Retail
Brokerage

 

Eliminations
and
Other

 

Total

 

 

 

(Dollars in thousands )

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

136,974

 

$

5,434

 

$

3,568

 

$

0

 

$

0

 

$

145,976

 

Interest expense

 

66,637

 

0

 

0

 

0

 

6,718

 

73,355

 

Net interest income (expense)

 

70,337

 

5,434

 

3,568

 

0

 

(6,718

)

72,621

 

Provision for losses on loans

 

(7,590

)

0

 

0

 

0

 

0

 

(7,590

)

Noninterest income

 

23,193

 

3,870

 

1,371

 

1,246

 

(9,039

)

20,641

 

Noninterest expense

 

53,020

 

5,109

 

1,725

 

829

 

(145

)

60,538

 

Income before income taxes

 

$

32,920

 

$

4,195

 

$

3,214

 

$

417

 

$

(15,612

)

$

25,134

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,372,420

 

$

15,785

 

$

14,631

 

$

964

 

$

(74,225

)

$

3,329,575

 

 

6.                                      Stock Options:

As allowed by SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), Sterling has elected to retain the compensation measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and its related interpretations, for stock options.  Under APB No. 25, compensation cost is recognized at the measurement date in the amount, if any, that the quoted market price of Sterling’s common stock exceeds the option exercise price.  The measurement date is the date at which both the number of options and the exercise price for each option are known.

 

11



 

Sterling has chosen not to record compensation expense using fair value measurement provisions in the statement of income.  Had compensation cost for Sterling’s plans been determined based on the fair value at the grant dates for awards under the plans, Sterling’s reported net income and earnings per share would have been changed to the pro forma amounts indicated below:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Reported net income

 

$

8,625

 

$

6,629

 

$

25,925

 

$

17,946

 

Add back:  Stock-based employee compensation expense, net of related tax effects

 

0

 

0

 

0

 

0

 

Deduct:  Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(548

)

(387

)

(1,644

)

(1,159

)

Pro forma

 

$

8,077

 

$

6,242

 

$

24,281

 

$

16,787

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Reported earnings per share

 

$

0.58

 

$

0.50

 

$

1.80

 

$

1.38

 

Stock-based employee compensation, fair value

 

(0.04

)

(0.03

)

(0.11

)

(0.09

)

Pro forma earnings per share

 

$

0.54

 

$

0.47

 

$

1.69

 

$

1.29

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Reported earnings per share

 

$

0.57

 

$

0.49

 

$

1.75

 

$

1.34

 

Stock-based employee compensation, fair value

 

(0.04

)

(0.03

)

(0.11

)

(0.09

)

Pro forma earnings per share

 

$

0.53

 

$

0.46

 

$

1.64

 

$

1.25

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the periods above: dividend yield of 0% in each period, expected stock price volatility of 85% to 132% each period, risk-free interest rates of 2.98% to 6.52% and expected lives of four to ten years, respectively.

 

7.                                      New Accounting Policies:

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards on the classification and measurement of certain financial instruments with characteristics of both liabilities and equity.   SFAS No. 150 is effective for financial instruments other than minority interests entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003.   Sterling does not believe that the adoption of SFAS No.150 will have a material effect on Sterling’s consolidated financial statements.

 

8.                                      Hedging Activities and Derivatives:

As of January 1, 2001, Sterling adopted the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS Nos. 137 and 138.  This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Statement requires that Sterling recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of the derivatives are reported in either earnings or other comprehensive income (loss), depending on the use of the derivative and whether or not it qualifies for hedge accounting.

 

12



 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS No. 149 is effective for all contracts created or modified after June 30, 2003 except for hedging relationships designated after June 30, 2003.  In addition, except as stated below, all provisions of SFAS No. 149 should be applied prospectively.  Sterling does not believe that the adoption of this standard will have a material effect on Sterling’s consolidated financial statements.

 

Sterling periodically uses financial options and other contractual instruments for the purpose of hedging interest rate risk relative to its investment and ABS portfolios and to its mortgage lending operations. Sterling invests in ABS tranches that perform in concert with the underlying mortgages or assets; i.e., improving in value with falling interest rates and declining in value with rising interest rates. Sterling typically does not invest in “derivative products” that are structured to perform in a way that magnifies the normal impact of changes in interest rates or in a way dissimilar to the movement in value of the underlying assets.  However, Sterling may invest in such products in the future.

 

As a normal part of its operations, Action Mortgage incurs interest rate risk from the date it closes a loan to the date the loan is sold in the secondary market.  Additionally, Action Mortgage incurs interest rate risk from the date it commits to make a loan to the date the loan closes in those cases where it sells interest rate lock commitments (“rate locks”) to the prospective borrower.  Traditionally, Action Mortgage has endeavored to hedge interest rate risk by entering into non-binding (“best-efforts”) forward sales agreements with third parties.  In July 2003, in an effort to improve the spread on loans sold into the secondary market, Action Mortgage began hedging interest rate risk by entering into mandatory forward sales agreements on ABS with third parties.

 

The risks inherent in such mandatory forward sales agreements include the risk that, if for any reason Action Mortgage does not close and sell the loans in question, it is nonetheless obligated to deliver ABS to the counterparty on the agreed terms.  Action Mortgage could incur significant costs in acquiring replacement loans or ABS and such costs could have a material adverse impact on mortgage banking operations in future periods, especially in rising interest rate environments.

 

Rate locks and forward sales agreements are considered to be derivatives under SFAS No. 133. Sterling has recorded the estimated fair values of the rate locks and forward sales agreements on its balance sheet in either other assets or other liabilities. Changes in the fair values of these derivative instruments are recorded in net gain on sales of mortgage loans in the income statement as the changes occur.

 

9.                                      Business Combinations:

On February 28, 2003, Sterling merged with Empire Federal Bancorp, Inc. (“Empire”).  The results of Empire’s operations have been included in the consolidated financial statements since that date.  The acquisition allowed Sterling to expand into Montana markets both on a lending and depository basis.  The acquisition strengthened Sterling’s capital base, adding approximately $29.2 million in capital.  Sterling also acquired approximately $143.6  million in cash, $67.3 million in loans and $184.2 million in deposits as a result of the merger.

 

The aggregate purchase price was $29.2 million which was comprised of 1,401,370 shares of the common stock of Sterling.  Sterling recorded a deposit intangible in the amount of $3.1 million related to the acquisition of Empire.  The deposit intangible is amortized over an estimated life of 10 years.  Sterling also recorded goodwill related to the transaction of $1.0 million.  This asset is subject to SFAS No. 142 accounting rules, which include annual impairment testing.  Any estimated impairment would result in Sterling recording an impairment loss.

 

13



 

On July 15, 2003, Sterling announced that it had entered into an Agreement and Plan of Merger (the “Klamath Merger”) with Klamath First Bancorp, Inc., an Oregon corporation (“Klamath”).  Klamath will be merged with and into Sterling, with Sterling being the surviving corporation in the merger.  Klamath’s wholly-owned subsidiary, Klamath First Federal Savings and Loan Association (“Klamath First Federal”), will be merged with and into Sterling’s wholly-owned subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.  As of September 30, 2003, Klamath had 59 branches in Oregon and Washington, with a presence in 26 of Oregon’s 36 counties.  As of September 30, 2003, Klamath reported approximately $1.5 billion in total assets including $557.6 million in loans, $1.1 billion in deposits and $121.1 million of equity.  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.

 

Under the terms of the Klamath Merger, each share of Klamath common stock will be converted into 0.77 shares of Sterling common stock, subject to certain conditions.  Based upon the closing price for Sterling on October 31, 2003 of $31.31 per share, the consideration is equivalent to $24.11 per share of Klamath common stock.   The merger will be structured as a tax-free reorganization and is expected to be completed in the first quarter of 2004, subject to shareholder and regulatory approval.  Additional information on the proposed transaction can be found in Sterling’s public filings with the Securities and Exchange Commission at www.sec.gov.

 

14



 

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operation

 

STERLING FINANCIAL CORPORATION

Comparison of the Three and Nine Months Ended September 30, 2003 and 2002

 

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

 

General

 

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 $4.08 billion in total assets at September 30, 2003, Sterling attracts Federal Deposit Insurance Corporation insured deposits from the general public through 84 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.

 

Sterling continues to enhance its presence as a community bank by increasing its commercial real estate, business banking, consumer and construction lending while increasing its retail deposits, particularly transaction accounts.  Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential loans.  Management believes that a community bank mix of assets and liabilities will enhance its net interest income (“NII”) (the difference between the interest earned on loans and investments and the interest paid on liabilities) and other fee income will increase, although there can be no assurance in this regard.  Such loans, however, generally involve a higher degree of risk than financing residential real estate.  Sterling’s revenues are derived primarily from interest earned on loans and asset-backed securities (“ABS”), from fees and service charges and from mortgage banking operations.  The operations of Sterling Savings Bank, and savings institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities, the Office of Thrift Supervision (“OTS”), the FDIC and the State of Washington Department of Financial Institutions (“Washington Supervisor”).

 

On February 28, 2003, Sterling acquired Empire Federal Bancorp, Inc.  Empire was merged with and into Sterling, with Sterling being the surviving corporation in the merger.  Sterling issued 1,401,370 shares of common stock in exchange for all of the stock of Empire.  Sterling acquired approximately $143.6 million of cash, $67.3 million of loans, $184.2 million of deposits and $29.2 million of capital in the transaction.  See Note 9 of “Notes to Consolidated Financial Statements.”

 

On July 15, 2003, Sterling announced that it had entered into an Agreement and Plan of Merger (the “Klamath Merger”) with Klamath First Bancorp, Inc., an Oregon corporation (“Klamath”).  Klamath will be merged with and into Sterling, with Sterling being the surviving corporation in the merger.  Klamath’s wholly-owned subsidiary, Klamath First Federal Savings and Loan Association, will be merged with and into Sterling’s wholly-owned subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.

 

15



 

Under the terms of the Klamath Merger, each share of Klamath common stock will be converted into 0.77 shares of Sterling common stock subject to certain conditions.  The merger will be structured as a tax-free reorganization and is expected to be completed in the first quarter of 2004, subject to shareholder and regulatory approval.  Additional information on the proposed transaction can be found in Sterling’s public filings with the Securities and Exchange Commission at www.sec.gov.  See Note 9 of “Notes to Consolidated Financial Statements.”

 

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

 

Critical Accounting Policies

 

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

 

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

 

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

 

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

 

16



 

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

 

There can be no assurance that the allowance for loan losses will be adequate to cover all losses, but management believes the allowance for loan losses was adequate at September 30, 2003. While management uses available information to provide for loan losses, the ultimate collectibility of a substantial portion of the loan portfolio and the need for future additions to the allowance will be based on changes in economic conditions and other relevant factors. A slowdown in economic activity could adversely affect cash flows for both commercial and individual borrowers, as a result of which Sterling could experience increases in nonperforming assets, delinquencies and losses on loans.

 

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

 

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

 

Management evaluates investment securities for other than temporary declines in fair value on a quarterly basis.  If the fair value of investment securities falls below their amortized cost and the decline is deemed to be other than temporary, the securities will be written down to current market value and the write down will be deducted from earnings under realized losses. There were no investment securities which management identified to be other-than-temporarily impaired for the nine months ended September 30, 2003.  Charges to income could occur in future periods due to a change in management’s intent to hold the investments to maturity, a change in management’s assessment of credit risk, or a change in regulatory or accounting requirements.

 

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

 

Sterling performed the annual test of its goodwill assets as of June 30, 2003, and concluded that the recorded value of goodwill was not impaired. There are many assumptions and estimates underlying the determination of impairment. Another estimate using different, but still reasonable, assumptions could produce a significantly different result. Additionally, future events could cause management to conclude that Sterling’s goodwill is impaired, which would result in Sterling recording an impairment loss. Any resulting impairment loss could have a material adverse impact on Sterling’s financial condition and results of operations.

 

17



 

Other intangible assets consisting of core-deposit intangibles with definite lives are amortized over the estimated life of the acquired depositor relationships (generally eight to ten years).

 

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

 

An allowance for losses on real estate owned is designed to include amounts for estimated losses as a result of impairment in value of the real property after repossession.  Sterling reviews its real estate owned for impairment in value whenever events or circumstances indicate that the carrying value of the property may not be recoverable.  In performing the review, if expected future undiscounted cash flow from the use of the property or the fair value, less selling costs, from the disposition of the property is less than its carrying value, an impairment loss is recognized.  As a result of changes in the real estate markets in which these properties are located, it is reasonably possible that the carrying values could be reduced in the near term.

 

Results of Operations

 

Overview.  Sterling recorded net income of $8.6 million, or $0.57 per diluted share, for the three months ended September 30, 2003, compared with net income of $6.6 million, or $0.49 per diluted share, for the three months ended September 30, 2002.  Sterling recorded net income of $25.9 million, or $1.75 per diluted share for the nine months ended September 30, 2003, compared with $17.9 million, or $1.34 per diluted share.  The increase in net income for both periods reflected an increase in net interest income and other income.

 

The annualized return on average assets was 0.83% and 0.82% for the three months ended September 30, 2003 and 2002, respectively.  For the nine months ended September 30, 2003 and 2002, the annualized return on average assets was 0.89% and 0.77%, respectively.  The annualized return on average equity was 13.6% and 13.8% for the three months ended September 30, 2003 and 2002, respectively.  The decrease primarily reflected a higher balance of average shareholders’ equity relative to last years comparable period.  The annualized return on average equity was 14.5% and 13.4% for the nine months ended September 30, 2003 and 2002, respectively.  The increase in the ratio was primarily due to the increase in net income.

 

Net Interest Income.  The most significant component of earnings for a financial institution typically is NII, which is the difference between interest income, primarily from loan, ABS and investment portfolios, and interest expense, primarily on deposits and borrowings.  During the three months ended September 30, 2003 and 2002, NII was $32.3 million and $25.9 million, respectively, an increase of approximately 25%.  For the nine months ended September 30, 2003 and 2002, NII was $90.9 million and $72.6 million, an increase of approximately 25%.  The increases in NII during the three and nine months ended September 30, 2003, compared to the same periods in 2002, were primarily due to the increases in average loan and ABS volumes and a decrease in the cost of deposits and borrowings.

 

Changes in NII result from changes in volume, net interest spread and net interest margin.  Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities.  Net interest spread refers to the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities.  Net interest margin refers to NII divided by total interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.

 

Average interest-earning assets for the three months ended September 30, 2003 and 2002 were $3.88 billion and $2.98 billion, respectively.  Average loans increased by $561.9 million, while average investments and ABS increased by $337.5 million over the 2002 amounts.  Net interest spread during these periods was 3.26% and 3.44%, respectively.  The net interest margin for the three months ended September 30, 2003 and 2002 was 3.31% and 3.44%, respectively.  The decrease in net interest margin reflects the decrease in prevailing interest rates and a greater decrease in the yield on loans than in the cost of deposits.  Sterling has been asset sensitive during these periods.  Net interest spread decreased primarily because the yield on loans declined slightly more than the

 

18



 

cost of deposits, reflecting continued refinancing activity in the residential and commercial real estate portfolios and competition for deposits.

 

Average interest-earning assets for the nine months ended September 30, 2003 and 2002 were $3.66 billion and $2.90 billion, respectively.  Average loans increased by $470.8 million, while average investments and ABS increased by $291.2 million over the prior comparable period.  The net interest spread for the nine months ended September 30, 2003 and 2002 was 3.28% and 3.35%, respectively, while the net interest margin for the same periods was 3.32% and 3.35%, respectively.  Net interest spread decreased due to a greater decrease in the yields on average interest-earning assets relative to the cost of funds, also reflecting continued refinancing activity.  However, the increase in the average volume of loans and ABS offset this, generating the increase in NII.

 

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

 

Sterling recorded provisions for losses on loans of $2.9 million and $3.3 million for the three months ended September 30, 2003 and 2002, respectively.  Sterling recorded provisions for losses on loans of $7.7 million and $7.6 million for the nine months ended September 30, 2003 and 2002, respectively.  The current provision reflects the analysis and assessment of the relevant factors mentioned in the preceding paragraph.  Management anticipates that its provisions for losses on loans will continue to increase, reflecting Sterling’s strategic direction of originating more commercial real estate, construction, business banking and consumer loans which have a somewhat higher loss profile than the traditional thrift institution mix of loans.

 

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

 

 

 

Nine Months Ended September 30,

 

 

 

2003

 

2002

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Balance at January 1

 

$

27,866

 

$

20,599

 

Allowance for loan losses acquired

 

869

 

0

 

Provision for losses on loans

 

7,650

 

7,590

 

Amounts written off net of recoveries and other

 

(2,644

)

(4,074

)

Balance at September 30

 

$

33,741

 

$

24,115

 

 

At September 30, 2003, Sterling’s total classified assets were $69.3 million, compared with $72.3 million at September 30, 2002.  Total nonperforming assets were $25.5 million at September 30, 2003, compared with $25.9 million at September 30, 2002.  The decrease in nonperforming assets and classified assets was primarily attributable to an improvement in the status of certain income property loans.  Excluding the nonperforming assets acquired from Empire and the increase in nonperforming assets of Source since the acquisition date, nonperforming assets would have been $17.5 million or 0.43% of total assets.  At September 30, 2003, Sterling’s loan delinquency rate (60 days or more) as a percentage of total loans was 0.87%, compared with 0.82% at September 30, 2002.  Excluding delinquent loans from Empire and Source, the delinquency ratio at September 30, 2003 would have been 0.64%, compared with 0.53% at September 30, 2002.

 

Other Income.  Other income was $8.4 million and $8.1 million for the three months ended September 30, 2003 and 2002, respectively.  Other income was $25.2 million and $20.6 million for the nine months ended September 30, 2003 and 2002, respectively.  The increase for the three and nine months ended September 30, 2003,

 

19



 

compared with the three and nine months ended September 30, 2002 was primarily due to an increase in income from mortgage banking operations and increases in fees and service charges.

 

Fees and service charge income increased by 16% to $5.1 million for the three months ended September 30, 2003 from $4.4 million for the same period last year.  For the nine months ended September 30, 2003 and 2002, fees and service charge income also increased by 16% to $14.3 million from $12.3 million for the same period last year.  This increase primarily reflects the increase in corporate banking activities that generate transaction accounts.  The number of business checking accounts have increased year over year, along with a wider range of business services being offered for a fee.

 

The increase in income from mortgage banking operations for the three and nine months ended September 30, 2003 compared to the same periods in 2002, was primarily due to increased refinancing activity and loan sales, reflecting the low interest rate environment.  The following table summarizes loan originations and sales of loans and serviced mortgage loans for the periods indicated.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

Originations of one- to four-family permanent mortgage loans

 

$

146.9

 

$

87.6

 

$

425.6

 

$

203.7

 

Sales of residential loans

 

129.5

 

49.3

 

317.7

 

121.7

 

Sales of commercial real estate loans

 

11.2

 

0.0

 

33.3

 

59.5

 

Principal balances of residential loans serviced for others at period end

 

300.9

 

94.3

 

300.9

 

94.3

 

Principal balances of commercial real estate loans serviced for others at period end

 

155.8

 

271.5

 

155.8

 

271.5

 

 

As a normal part of its operations, Action Mortgage incurs interest rate risk from the date it closes a loan to the date the loan is sold in the secondary market.  Additionally, Action Mortgage incurs interest rate risk from the date it commits to make a loan to the date the loan closes in those cases where it sells a rate lock to the prospective borrower.  Traditionally, Action Mortgage has endeavored to hedge interest rate risk by entering into best-efforts forward sales agreements with third parties.  In July 2003, in an effort to improve the spread on loans sold into the secondary market, Action Mortgage also began hedging interest rate risk by entering into mandatory forward sales agreements on ABS with third parties.

 

The risks inherent in such mandatory forward sales agreements include the risk that, if for any reason Action Mortgage does not close and sell the loans in question, it is nonetheless obligated to deliver ABS to the counterparty on the agreed terms.  Action Mortgage could incur significant costs in acquiring replacement ABS and such costs could have a material adverse impact on mortgage banking operations in future periods, especially in rising interest rate environments.

 

During the quarter ended September 30, 2003, Sterling Savings Bank sold $37.2 million in investments and ABS, compared with $141.8 million for the quarter ended September 30, 2002.  Sterling recognized a net loss of $0.3 million during the quarter ended September 30, 2003, compared to a net gain of $1.4 million for the same period last year.  During the nine months ended September 30, 2003, Sterling sold $626.0 million in investments and ABS compared with $373.4 million for the same period in 2002.  Sterling recognized a net gain of $2.7 million for the nine months ended September 30, 2003, compared with $1.8 million for the nine months ended September 30, 2002.  The increase in sales of investments and ABS for the nine-month period compared to the prior years comparable period reflected an acceleration of the maturity structure of the portfolio.

 

Operating Expenses.  Operating expenses were $24.7 million and $21.1 million for the three months ended September 30, 2003 and 2002, respectively.  Operating expenses were $68.7 million and $60.5 million for the nine

 

20



 

months ended September 30, 2003 and 2002, respectively.  The higher level of operating expenses was primarily a result of expanded staffing in Sterling’s branch delivery network, occupancy costs and advertising.

 

Employee compensation and benefits were $13.7 million and $11.1 million for the three months ended September 30, 2003 and 2002, respectively.  Employee compensation and benefits were $37.6 million and $32.1 million for the nine months ended September 30, 2003 and 2002, respectively.  The employee costs reflected increased staffing from Empire, increased mortgage banking staff and additional staff for Sterling’s Seattle and Portland Corporate Banking Centers.  In addition, Sterling has begun hiring loan officers in anticipation of the pending merger with Klamath.  At September 30, 2003, full-time-equivalent employees were 1,104, compared with 940 at September 30, 2002.

 

Occupancy and equipment expenses were $3.6 million and $3.2 million for the three months ended September 30, 2003 and 2002, respectively.  Occupancy and equipment expenses were $10.8 million and $9.3 million for the nine months ended September 30, 2003 and 2002, respectively.  The increase was primarily due to expenses associated with the Portland and Seattle Corporate Banking Centers, the new Empire branches, expanded mortgage banking branches and higher equipment costs.

 

Advertising expenses were $1.7 million and $1.6 million for the three months ended September 30, 2003 and 2002, respectively.  Advertising expenses were $3.7 million and $3.1 million for the nine months ended September 30, 2003 and 2002, respectively.  The increase was primarily due to an increase in costs associated with Sterling’s new image campaign, partially influenced by the pending merger with Klamath.

 

Other operating expenses were $0.6 million and $1.2 million for the three months ended September 30, 2003 and 2002, respectively.  Other operating expenses were $2.7 million and $3.4 million for the nine months ended September 30, 2003 and 2002, respectively.  The decrease in other operating expenses was the result of a refund of state excise taxes.

 

Income Tax Provision.  Sterling recorded federal and state income tax provisions of $4.6 million and $2.9 million for the three months ended September 30, 2003 and 2002, respectively.  For the nine months ended September 30, 2003 and 2002, Sterling recorded federal and state income tax provisions of $13.9 million and $7.2 million, respectively.  The income tax provisions in 2003 reflect an increase in taxable earnings.  The effective tax rates for these periods were 34.8%, 30.5%, 34.9% and 28.6%, respectively.  The increase in the effective tax rates compared to the September 30, 2002 periods was primarily due to the effect of a lower portion of tax-preferred income in income before taxes.

 

Financial Position

 

Assets.  At September 30, 2003, Sterling’s assets were $4.08 billion, up $0.57 billion from $3.51 billion at December 31, 2002.

 

Investments and ABS.  Sterling’s investment and ABS portfolio at September 30, 2003 was $1.01 billion, an increase of $179.8 million from the December 31, 2002 balance of $830.2 million.  The increase was primarily due to net purchases of ABS.

 

Loans Receivable.  At September 30, 2003, net loans receivable were $2.76 billion, up $370 million from $2.39 billion at December 31, 2002.  The increase was primarily due to $67.3 million in loans from the Empire transaction, as well as net increases in business and private banking, corporate banking, and residential construction loans.  During the nine months ended September 30, 2003, total loan originations were $1.74 billion compared with $1.28 billion for the prior year’s comparable quarter.  Approximately 67% of these were construction, business banking, corporate banking and consumer loans.

 

21



 

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

 

 

 

September 30, 2003

 

December 31, 2002

 

 

 

Amount

 

%

 

Amount

 

%

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

$

377,459

 

13.47

 

$

358,359

 

14.78

 

Multifamily real estate

 

161,830

 

5.78

 

161,547

 

6.66

 

Commercial real estate

 

478,386

 

17.07

 

458,712

 

18.92

 

Real estate construction

 

549,641

 

19.62

 

480,919

 

19.84

 

Consumer - direct

 

294,520

 

10.51

 

246,578

 

10.17

 

Consumer - indirect

 

91,488

 

3.27

 

62,896

 

2.59

 

Business and private banking

 

681,586

 

24.32

 

549,593

 

22.67

 

Corporate banking

 

167,123

 

5.96

 

105,975

 

4.37

 

Gross loans receivable

 

2,802,033

 

100.00

 

2,424,579

 

100.00

 

Net deferred origination fees

 

(7,118

)

 

 

(6,450

)

 

 

Allowance for losses on loans

 

(33,741

)

 

 

(27,866

)

 

 

Loans receivable, net

 

$

2,761,174

 

 

 

$

2,390,263

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average yield at end of period

 

5.86

%

 

 

6.38

%

 

 

 

The following table sets forth Sterling’s loan originations for the periods indicated.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

% Change

 

2003

 

2002

 

% Change

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

$

146,908

 

$

87,556

 

67.8

 

$

425,601

 

$

203,684

 

109.0

 

Multifamily real estate

 

23,693

 

14,929

 

58.7

 

54,135

 

32,737

 

65.4

 

Commercial real estate

 

12,435

 

15,167

 

(18.0

)

97,838

 

46,892

 

108.7

 

Real estate construction

 

218,072

 

169,567

 

28.6

 

542,363

 

455,260

 

19.1

 

Consumer - direct

 

69,127

 

30,593

 

126.0

 

163,067

 

106,573

 

53.0

 

Consumer - indirect

 

24,081

 

17,059

 

41.2

 

53,943

 

50,345

 

7.2

 

Business and private banking

 

93,014

 

116,464

 

(20.1

)

290,457

 

291,719

 

(0.4

)

Corporate banking

 

16,055

 

24,318

 

(34.0

)

114,685

 

92,681

 

23.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans originated

 

$

603,385

 

$

475,653

 

26.9

 

$

1,742,089

 

$

1,279,891

 

36.1

 

 

BOLI.  Bank-owned life insurance (“BOLI”) increased to $72.2 million at September 30, 2003 from $59.4 million at December 31, 2002.  The increase was primarily due to the purchase of $10.0 million in BOLI.  Sterling purchases BOLI to fund employee benefit costs.  Through the purchase of BOLI, Sterling becomes the beneficiary of life insurance policies on certain officers who consent to the issuance of the policies.

 

Goodwill and Other Intangible Assets.  Goodwill and other intangible assets increased to $48.0 million at September 30, 2003 from $44.0 million at December 31, 2002.  Sterling recorded $1.0 million in goodwill and $3.1 million in other intangible assets in connection with the business combination with Empire.

 

Deposits.  Total deposits increased $406.9 million to $2.42 billion at September 30, 2003 from $2.01 billion at December 31, 2002, primarily due to the acquisition of $184.2 million in deposits from Empire and to increases in money market accounts and time deposits.

 

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The following table sets forth the composition of Sterling’s deposits at the dates indicated.

 

 

 

September 30, 2003

 

December 31, 2002

 

 

 

Amount

 

%

 

Amount

 

%

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Noninterest checking

 

$

315,235

 

13.0

 

$

239,033

 

11.9

 

NOW checking

 

306,622

 

12.7

 

367,391

 

18.2

 

Savings and money market

 

641,771

 

26.5

 

401,339

 

19.9

 

Certificates of deposit

 

1,157,415

 

47.8

 

1,006,333

 

50.0

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

2,421,043

 

100.0

 

$

2,014,096

 

100.0

 

 

 

 

 

 

 

 

 

 

 

Annualized cost of deposits

 

 

 

1.53

%

 

 

1.91

%

 

The shift in the mix of deposits since December 2002 reflects a shift to money market accounts from NOW checking accounts and a strong increase in new business checking deposits.  As of September 30, 2003, the number of business checking accounts has increased by approximately 10% from a year ago.

 

Borrowings.  Deposit accounts are Sterling’s primary source of funds.  Sterling does, however, rely upon advances from the Federal Home Loan Bank of Seattle (“FHLB Seattle”), reverse repurchase agreements and other borrowings to supplement its funding and to meet deposit withdrawal requirements.  At September 30, 2003, the total of such borrowings was $1.36 billion compared with $1.25 billion at December 31, 2002.  See “Liquidity and Sources of Funds.”

 

Asset and Liability Management

 

The results of operations for financial institutions may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates, declines in real estate market values and the monetary and fiscal policies of the federal government.  Like all savings institutions, Sterling’s NII and the net present value of assets, liabilities and off-balance sheet contracts (“NPV”), or estimated fair value, are subject to fluctuations in interest rates.  For example, some of Sterling’s adjustable-rate mortgages (“ARMs”) are indexed to the one-year or five-year U.S. Treasury index or periodic fixed-rate LIBOR and swaps curves. When interest-earning assets such as loans are funded by interest-bearing liabilities such as deposits, FHLB Seattle advances and other borrowings, a changing interest rate environment may have a dramatic effect on Sterling’s earnings.  Currently, Sterling’s interest-earning assets mature or reprice more frequently, or on different terms, than do its interest-bearing liabilities. The fact that assets mature or reprice more frequently on average than liabilities may be beneficial in times of increasing interest rates; however, such an asset/liability structure may result in declining NII during periods of falling interest rates.

 

Additionally, the extent to which borrowers prepay loans is affected by prevailing interest rates.  When interest rates increase, borrowers are less likely to prepay loans; whereas when interest rates decrease, borrowers are more likely to prepay loans.  Prepayments may affect the levels of loans retained in an institution’s portfolio as well as its NII.

 

Sterling maintains an asset and liability management program intended to manage NII through interest rate cycles and to protect its NPV by controlling its exposure to changing interest rates.  Sterling uses a simulation model designed to measure the sensitivity of NII and NPV to changes in interest rates. This simulation model is designed to enable Sterling to generate a forecast of NII and NPV given various interest rate forecasts and alternative strategies. The model is also designed to measure the anticipated impact that prepayment risk, basis risk, customer maturity preferences, volumes of new business and changes in the relationship between long-term and short-term interest rates have on the performance of Sterling.  The model calculates the present value of assets, liabilities, off-balance sheet financial instruments, and equity at current interest rates and at hypothetical higher and lower interest rates at

 

23



 

various intervals.  The present value of each major category of financial instruments is calculated using estimated cash flows based on weighted-average contractual rates and terms, then discounted at the estimated current market interest rate for similar financial instruments.  The present value of longer term fixed-rate financial instruments is more difficult to estimate because such instruments are susceptible to changes in market interest rates. Present value estimates of adjustable-rate financial instruments are more reliable since they represent the difference between the contractual and discounted rates until the next interest rate repricing date.

 

The calculations of present value have certain shortcomings.  The discount rates utilized for loans, investments and ABS are based on estimated nationwide market interest rate levels for similar loans and securities, with prepayment assumptions based on historical experience and market forecasts.  The unique characteristics of Sterling’s loans and ABS may not necessarily parallel those in the model.  The discount rates utilized for deposits and borrowings are based upon available alternative types and sources of funds which are not necessarily indicative of the market value of deposits and FHLB Seattle advances since such deposits and advances are unique to and have certain price and customer relationship advantages for depository institutions.  The present values are determined based on the discounted cash flows over the remaining estimated lives of the financial instruments on the assumption that the resulting cash flows are reinvested in financial instruments with virtually identical terms.

 

The total measurement of Sterling’s exposure to interest-rate risk (“IRR”) as presented in the following table may not be representative of the actual values which might result from a higher or lower interest rate environment.  A higher or lower interest rate environment most likely will result in different investment and borrowing strategies by Sterling designed to further mitigate the effect on the value of and the net earnings generated from Sterling’s net assets from any change in interest rates.

 

Sterling is continuing to pursue strategies to manage the level of its IRR while increasing its NII and NPV: a) through the origination and retention of variable-rate consumer, business banking, construction and commercial real estate loans, which generally have higher yields than residential permanent loans, b) by the sale of certain long-term fixed-rate loans and investments, and c) by increasing the level of its core deposits, which are generally a lower-cost funding source than wholesale borrowings.  There can be no assurance that Sterling will be successful implementing any of these strategies or that, if these strategies are implemented, they will have the intended effect of reducing IRR or increasing NII and NPV.

 

24



 

The following table presents Sterling’s estimates of changes in NPV for the periods indicated.  The results indicate the potential effects of instantaneous, parallel shifts in the market yield curve.  These calculations are highly subjective and technical and are relative measurements of IRR which do not necessarily reflect any expected rate movement.

 

 

 

At September 30, 2003

 

At December 31, 2002

 

Change in
Interest Rate
in Basis Points
(Rate Shock)

 

NPV

 

Ratio of NPV
to the Present
Value of
Total Assets

 

%
Change
in NPV

 

NPV

 

Ratio of NPV
to the Present
Value of
Total Assets

 

%
Change
in NPV

 

 

 

(Dollars in thousands )

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

+300

 

$

205,659

 

5.10

%

(23.7

)

$

223,622

 

6.36

%

4.8

 

+200

 

230,881

 

5.66

 

(14.4

)

229,759

 

6.53

 

7.6

 

+100

 

251,535

 

6.09

 

(6.7

)

234,577

 

6.67

 

9.9

 

Static

 

269,613

 

6.44

 

0

 

213,442

 

6.07

 

0

 

-100

 

216,517

 

5.19

 

(19.7

)

164,741

 

4.68

 

(22.8

)

-200

 

N/A

(1)

N/A

(1)

N/A

(1)

N/A

(1)

N/A

(1)

N/A

(1)

-300

 

N/A

(1)

N/A

(1)

N/A