UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED June 30, 2004
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)
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Washington |
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91-1572822 |
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(State or other jurisdiction of |
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(I.R.S. Employer |
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111 North Wall Street, Spokane, Washington 99201 |
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(Address of principal executive offices) (Zip Code) |
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(509) 458-3711 |
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(Registrant’s telephone number, including area code) |
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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:
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Class |
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Outstanding as of July 30, 2004 |
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Common Stock ($1.00 par value) |
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22,638,002 |
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STERLING FINANCIAL CORPORATION
FORM 10-Q
For the Quarter Ended June 30, 2004
TABLE OF CONTENTS
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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PART I - Financial Information
STERLING FINANCIAL CORPORATION
Consolidated Balance Sheets
(Unaudited)
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June 30, |
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December 31, |
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(Dollars in thousands) |
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ASSETS: |
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Cash and cash equivalents: |
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Interest bearing |
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$ |
1 |
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$ |
1 |
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Non-interest bearing and vault |
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92,593 |
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65,478 |
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Restricted |
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1,303 |
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1,504 |
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Investments and asset-backed securities (“ABS”): |
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Available for sale |
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2,015,243 |
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1,070,955 |
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Held to maturity |
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2,228 |
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2,229 |
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Loans receivable, net |
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3,721,991 |
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2,906,426 |
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Loans held for sale |
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39,497 |
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14,616 |
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Accrued interest receivable |
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24,151 |
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16,531 |
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Real estate owned, net |
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4,629 |
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4,226 |
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Office properties and equipment, net |
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77,570 |
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54,620 |
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Bank-owned life insurance (“BOLI”) |
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91,703 |
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73,141 |
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Goodwill |
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128,110 |
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45,075 |
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Other intangible assets |
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20,959 |
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2,881 |
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Mortgage servicing rights, net |
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3,472 |
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3,500 |
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Prepaid expenses and other assets, net |
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35,661 |
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18,138 |
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Total assets |
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$ |
6,259,111 |
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$ |
4,279,321 |
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LIABILITIES: |
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Deposits |
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$ |
3,600,639 |
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$ |
2,455,076 |
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Advances from Federal Home Loan Bank of Seattle (“FHLB Seattle”) |
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1,336,439 |
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1,026,031 |
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Securities sold subject to repurchase agreements and funds purchased |
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659,262 |
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363,137 |
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Other borrowings |
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169,134 |
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137,998 |
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Cashiers checks issued and payable |
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18,985 |
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17,624 |
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Borrowers’ reserves for taxes and insurance |
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3,570 |
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1,347 |
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Accrued interest payable |
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11,641 |
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8,223 |
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Accrued expenses and other liabilities |
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51,219 |
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19,537 |
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Total liabilities |
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5,850,889 |
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4,028,973 |
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Commitments and Contingencies |
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SHAREHOLDERS’ EQUITY: |
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Preferred stock, $1 par value; 10,000,000 shares authorized; no shares issued and outstanding |
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0 |
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0 |
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Common stock, $1 par value; 40,000,000 shares authorized; 22,614,706 and 14,863,917 shares issued and outstanding |
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22,615 |
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14,864 |
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Additional paid-in capital |
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384,654 |
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181,382 |
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Accumulated other comprehensive income (loss): |
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Unrealized gains (losses) on investments and ABS available-for-sale, net of deferred income taxes of $16,877 and $8,181 |
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(31,342 |
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(15,193 |
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Retained earnings |
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32,295 |
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69,295 |
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Total shareholders’ equity |
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408,222 |
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250,348 |
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Total liabilities and shareholders’ equity |
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$ |
6,259,111 |
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$ |
4,279,321 |
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The accompanying notes are an integral part of the consolidated financial statements.
1
STERLING FINANCIAL CORPORATION
Consolidated Statements of Income
(Unaudited)
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Three Months Ended |
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Six Months Ended |
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2004 |
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2003 |
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2004 |
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2003 |
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(Dollars in thousands, except per share data) |
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Interest income: |
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Loans |
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$ |
55,725 |
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$ |
42,376 |
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$ |
108,059 |
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$ |
82,715 |
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ABS |
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20,055 |
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9,214 |
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39,343 |
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19,186 |
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Investments and cash equivalents |
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1,460 |
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1,061 |
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3,229 |
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2,235 |
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Total interest income |
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77,240 |
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52,651 |
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150,631 |
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104,136 |
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Interest expense: |
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Deposits |
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12,386 |
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9,493 |
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24,537 |
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18,513 |
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Short-term borrowings |
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4,877 |
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2,695 |
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8,711 |
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5,466 |
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Long-term borrowings |
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11,253 |
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10,423 |
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22,970 |
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21,546 |
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Total interest expense |
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28,516 |
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22,611 |
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56,218 |
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45,525 |
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Net interest income |
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48,724 |
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30,040 |
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94,413 |
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58,611 |
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Provision for losses on loans |
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(3,000 |
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(2,550 |
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(5,850 |
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(4,800 |
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Net interest income after provision for losses on loans |
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45,724 |
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27,490 |
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88,563 |
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53,811 |
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Other income: |
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Fees and service charges |
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8,434 |
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4,909 |
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16,720 |
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9,208 |
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Mortgage banking operations |
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1,769 |
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2,496 |
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2,963 |
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4,713 |
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Loan servicing fees (costs) |
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160 |
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(153 |
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306 |
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(69 |
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Net gains on sales of securities |
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848 |
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1,677 |
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3,307 |
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3,037 |
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Real estate owned operations |
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(341 |
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(180 |
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(316 |
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(209 |
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BOLI |
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1,084 |
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968 |
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2,253 |
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1,790 |
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Charge related to early repayment of debt |
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0 |
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0 |
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0 |
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(1,464 |
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Other noninterest income (expense) |
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(145 |
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(28 |
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(526 |
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(208 |
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Total other income |
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11,809 |
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9,689 |
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24,707 |
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16,798 |
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Operating expenses |
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37,088 |
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22,604 |
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74,807 |
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44,015 |
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Income before income taxes |
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20,445 |
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14,575 |
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38,463 |
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26,594 |
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Income tax provision |
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(6,962 |
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(5,058 |
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(12,996 |
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(9,294 |
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Net income |
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$ |
13,483 |
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$ |
9,517 |
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$ |
25,467 |
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$ |
17,300 |
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Earnings per share - basic |
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$ |
0.60 |
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$ |
0.59 |
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$ |
1.13 |
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$ |
1.10 |
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Earnings per share - diluted |
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$ |
0.58 |
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$ |
0.57 |
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$ |
1.10 |
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$ |
1.08 |
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Weighted average shares outstanding - basic |
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22,589,109 |
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16,248,879 |
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22,471,725 |
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15,668,650 |
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Weighted average shares outstanding - diluted |
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23,100,053 |
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16,624,743 |
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23,051,526 |
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16,026,438 |
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The accompanying notes are an integral part of the consolidated financial statements.
2
STERLING FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Unaudited)
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Six Months Ended |
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2004 |
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2003 |
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(Dollars in thousands) |
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Cash flows from operating activities: |
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Net income |
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$ |
25,467 |
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$ |
17,300 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Provisions for losses on loans and real estate owned |
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5,855 |
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4,945 |
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Stock dividends on FHLB Seattle stock |
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(1,373 |
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(2,928 |
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Net gain on sales of loans, investments and ABS |
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(4,526 |
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(6,387 |
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Other losses |
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83 |
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113 |
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Change in cash surrender value of BOLI |
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(2,253 |
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(1,790 |
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Depreciation and amortization |
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7,475 |
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5,806 |
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Change in: |
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Accrued interest receivable |
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(1,109 |
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(1,309 |
) |
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Prepaid expenses and other assets |
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4,143 |
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6,578 |
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Cashiers checks issued and payable |
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1,361 |
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(1,888 |
) |
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Accrued interest payable |
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1,304 |
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323 |
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Accrued expenses and other liabilities |
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(7,542 |
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777 |
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Proceeds from sales of loans |
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85,820 |
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209,735 |
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Loans originated for sale |
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(84,601 |
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(206,385 |
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Net cash provided by operating activities |
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30,104 |
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24,890 |
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Cash flows from investing activities: |
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Change in restricted cash |
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201 |
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(7,439 |
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Loans funded |
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(1,304,323 |
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(1,074,374 |
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Loan principal received |
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1,023,869 |
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828,734 |
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Purchase of investments |
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(229,460 |
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(11,853 |
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Proceeds from maturities of investments |
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225,285 |
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1,531 |
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Proceeds from sales of available-for-sale investments |
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95,603 |
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10,681 |
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Cash and cash equivalents acquired as part of mergers |
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44,894 |
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143,631 |
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Purchase of BOLI |
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0 |
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(10,000 |
) |
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Purchase of ABS |
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(710,378 |
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(991,720 |
) |
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Principal payments on ABS |
|
188,378 |
|
166,722 |
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Proceeds from sales of ABS |
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259,308 |
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581,160 |
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Purchase of office properties and equipment |
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(5,996 |
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(2,150 |
) |
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Improvements and other changes to real estate owned |
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213 |
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123 |
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Proceeds from sales and liquidation of real estate owned |
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1,633 |
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1,875 |
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Net cash used in investing activities |
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(410,773 |
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(363,079 |
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The accompanying notes are an integral part of the consolidated financial statements.
3
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Six Months Ended |
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2004 |
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2003 |
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(Dollars in thousands) |
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Cash flows from financing activities: |
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Net change in checking, regular savings and money market deposits |
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$ |
97,568 |
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$ |
54,404 |
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Proceeds from issuance of time deposits |
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1,068,064 |
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785,335 |
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Payments for maturing time deposits |
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(1,031,191 |
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(661,334 |
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Interest credited to deposits |
|
23,258 |
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16,983 |
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Advances from FHLB Seattle |
|
518,464 |
|
296,102 |
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Repayment of FHLB Seattle advances |
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(569,823 |
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(185,072 |
) |
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Net change in securities sold subject to repurchase agreements and funds purchased |
|
296,125 |
|
27,189 |
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Proceeds from other borrowings |
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0 |
|
54,000 |
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Repayment of other borrowings |
|
(280 |
) |
(41,900 |
) |
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Payments for fractional shares and certain merger costs |
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(240 |
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(30 |
) |
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Proceeds from exercise of stock options, net of repurchases |
|
3,914 |
|
583 |
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Deferred financing costs |
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0 |
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(732 |
) |
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Other |
|
1,925 |
|
236 |
|
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Net cash provided by financing activities |
|
407,784 |
|
345,764 |
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Net change in cash and cash equivalents |
|
27,115 |
|
7,575 |
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Cash and cash equivalents, beginning of period |
|
65,479 |
|
77,065 |
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Cash and cash equivalents, end of period |
|
$ |
92,594 |
|
$ |
84,640 |
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Supplemental disclosures: |
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Cash paid during the period for: |
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Interest |
|
$ |
52,800 |
|
$ |
46,299 |
|
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Income taxes |
|
11,105 |
|
9,457 |
|
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Noncash financing and investing activities: |
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|
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Loans converted into real estate owned |
|
1,794 |
|
1,309 |
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Common stock dividend |
|
62,468 |
|
28,699 |
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Common stock issued upon business combination |
|
145,166 |
|
28,107 |
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The accompanying notes are an integral part of the consolidated financial statements.
4
STERLING FINANCIAL CORPORATION
Consolidated Statements of Comprehensive Income
(Unaudited)
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|
Three Months Ended |
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Six Months Ended |
|
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|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
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|
(Dollars in thousands) |
|
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|
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|
|
|
|
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|
||||
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Net income |
|
$ |
13,483 |
|
$ |
9,517 |
|
$ |
25,467 |
|
$ |
17,300 |
|
|
|
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|
||||
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Other comprehensive income: |
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|
|
|
|
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|
||||
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Change in unrealized gains (losses) on investments and ABS available-for-sale |
|
(55,670 |
) |
(6,943 |
) |
(24,845 |
) |
(6,745 |
) |
||||
|
Less deferred income taxes |
|
19,485 |
|
2,430 |
|
8,696 |
|
2,361 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Net other comprehensive income (loss) |
|
(36,185 |
) |
(4,513 |
) |
(16,149 |
) |
(4,384 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Comprehensive income (loss) |
|
$ |
(22,702 |
) |
$ |
5,004 |
|
$ |
9,318 |
|
$ |
12,916 |
|
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, 2003. 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):
|
|
|
June 30, |
|
December 31, |
|
||
|
|
|
|
|
|
|
||
|
Term note payable(1) |
|
$ |
22,000 |
|
$ |
22,000 |
|
|
Advances on revolving line of credit(2) |
|
0 |
|
0 |
|
||
|
Sterling obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated deferrable interest debentures of Sterling(3) |
|
109,282 |
|
80,415 |
|
||
|
Floating Rate Notes Due 2006(4) |
|
30,000 |
|
30,000 |
|
||
|
Other(5) |
|
7,852 |
|
5,583 |
|
||
|
Total |
|
$ |
169,134 |
|
$ |
137,998 |
|
(1) Sterling has a $22.0 million 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 2.00% (for a total of 3.11% at June 30, 2004) 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 has a $5.0 million revolving line of credit with U.S. Bank. This line of credit expires on September 15, 2004. The interest rate is adjustable monthly at the 30-day LIBOR plus 2.00% and is payable monthly. This line of credit is collateralized by a majority of the Common and Preferred Stock of Sterling Savings Bank. At June 30, 2004, no amount was outstanding on this line of credit.
6
(3) Sterling raises capital from time to time through the formation of trusts (“Sterling Capital Trusts”), which issue capital securities (“Trust Preferred Securities”) to investors. Sterling also acquired two trusts in connection with a merger in January 2004. 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 documents, taken together, constitute a full and unconditional guarantee by Sterling of Sterling Capital Trusts’ obligations under the Trust Preferred Securities. In accordance with Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities” (“FIN No. 46R”), the trusts are not consolidated and the Trust Preferred Securities and related amounts 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 |
|
Maturity |
|
Call Date |
|
Mandatorily |
|
Rate at |
|
Amount |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sterling Capital Trust VI |
|
June 2003 |
|
Sept 2033 |
|
Sept 2008 |
|
Floating Rate Capital Securities |
|
4.72 |
% |
$ |
10,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sterling Capital Statutory Trust V |
|
May 2003 |
|
May 2033 |
|
June 2008 |
|
Floating Rate Capital Securities |
|
4.84 |
% |
20,619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sterling Capital Trust IV |
|
May 2003 |
|
May 2033 |
|
May 2008 |
|
Floating Rate Preferred Securities |
|
4.40 |
% |
10,310 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sterling Capital Trust III |
|
April 2003 |
|
April 2033 |
|
April 2008 |
|
Floating Rate Capital Securities |
|
4.43 |
% |
14,433 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Klamath First Capital Trust II |
|
April 2002 |
|
April 2032 |
|
April 2007 |
|
Floating Rate Capital Securities |
|
5.07 |
% |
13,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Klamath First Capital Trust I |
|
July 2001 |
|
July 2031 |
|
June 2006 |
|
Floating Rate Capital Securities |
|
4.96 |
% |
15,403 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sterling Capital Trust II |
|
July 2001 |
|
July 2031 |
|
June 2006 |
|
10.25% Cumulative Capital Securities |
|
10.25 |
% |
24,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
109,282 |
|
(4) 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 June 30, 2004, Sterling could have incurred approximately $164.7 million of additional long-term debt. At June 30, 2004, Sterling could have paid up to approximately $52.9 million in additional dividends.
7
Interest accrues at the 90-day LIBOR plus 2.50% (for a total of 4.02% at June 30, 2004) and is adjustable and payable quarterly. The notes mature in 2006 and may be redeemed under certain conditions.
(5) During the quarter ended June 30, 2004 and in 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, these sales were accounted for as financings. At June 30, 2004, $7.9 million remained outstanding on the financings.
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 on May 28, 2004. All per share amounts presented reflect this dividend.
|
|
|
Three Months Ended June 30, |
|
||||||||||||||
|
|
|
2004 |
|
2003 |
|
||||||||||||
|
|
|
Net |
|
Weighted |
|
Per Share |
|
Net |
|
Weighted |
|
Per Share |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Basic computations |
|
$ |
13,483,000 |
|
22,589,109 |
|
$ |
0.60 |
|
$ |
9,517,000 |
|
16,248,879 |
|
$ |
0.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Common stock options |
|
0 |
|
510,944 |
|
(0.02 |
) |
0 |
|
375,864 |
|
(0.02 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Diluted computations |
|
$ |
13,483,000 |
|
23,100,053 |
|
$ |
0.58 |
|
$ |
9,517,000 |
|
16,624,743 |
|
$ |
0.57 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Antidilutive options not included in diluted earnings per share |
|
|
|
11,000 |
|
|
|
|
|
0 |
|
|
|
||||
|
|
|
Six Months Ended June 30, |
|
||||||||||||||
|
|
|
2004 |
|
2003 |
|
||||||||||||
|
|
|
Net |
|
Weighted |
|
Per Share |
|
Net |
|
Weighted |
|
Per Share |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Basic computations |
|
$ |
25,467,000 |
|
22,471,725 |
|
$ |
1.13 |
|
$ |
17,300,000 |
|
15,668,650 |
|
$ |
1.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Common stock options |
|
0 |
|
579,801 |
|
(0.03 |
) |
0 |
|
357,788 |
|
(0.02 |
) |
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Diluted computations |
|
$ |
25,467,000 |
|
23,051,526 |
|
$ |
1.10 |
|
$ |
17,300,000 |
|
16,026,438 |
|
$ |
1.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Antidilutive options not included in diluted earnings per share |
|
|
|
11,000 |
|
|
|
|
|
0 |
|
|
|
||||
8
4. Operating Expenses:
The following table details the components of Sterling’s total operating expenses:
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(Dollars in thousands) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Employee compensation and benefits |
|
$ |
19,118 |
|
$ |
11,997 |
|
$ |
38,324 |
|
$ |
23,955 |
|
|
Occupancy and equipment |
|
5,929 |
|
3,657 |
|
11,147 |
|
7,164 |
|
||||
|
Depreciation |
|
1,785 |
|
1,241 |
|
3,523 |
|
2,401 |
|
||||
|
Amortization of identifiable intangible assets |
|
555 |
|
79 |
|
1,111 |
|
105 |
|
||||
|
Advertising |
|
1,840 |
|
1,689 |
|
3,707 |
|
2,049 |
|
||||
|
Data processing |
|
2,826 |
|
1,615 |
|
4,899 |
|
3,226 |
|
||||
|
Insurance |
|
289 |
|
183 |
|
567 |
|
350 |
|
||||
|
Legal and accounting |
|
1,019 |
|
409 |
|
1,598 |
|
913 |
|
||||
|
Travel and entertainment |
|
1,073 |
|
721 |
|
1,936 |
|
1,259 |
|
||||
|
Goodwill litigation costs |
|
25 |
|
64 |
|
140 |
|
314 |
|
||||
|
Merger and acquisition costs |
|
922 |
|
45 |
|
4,835 |
|
188 |
|
||||
|
Other |
|
1,707 |
|
904 |
|
3,020 |
|
2,091 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total operating expenses |
|
$ |
37,088 |
|
$ |
22,604 |
|
$ |
74,807 |
|
$ |
44,015 |
|
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 Washington, Oregon, Idaho and Montana primarily through Action Mortgage Company (“Action Mortgage”).
• The Commercial Mortgage Banking segment originates, sells and services commercial real estate loans and participation interests in commercial real estate loans through offices in Washington, Oregon and Arizona primarily through INTERVEST-Mortgage Investment Company.
• The Insurance and Retail Brokerage segment markets fixed income and equity products, mutual funds, fixed and variable annuities, insurance and other financial products through sales representatives within the Sterling Savings Bank branch network primarily through Harbor Financial Services, Inc.
• 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 periods presented:
|
|
|
As of and for the Three Months Ended June 30, 2004 |
|
||||||||||||||||
|
|
|
Community |
|
Residential |
|
Commercial |
|
Retail |
|
Other and |
|
Total |
|
||||||
|
|
|
(Dollars in thousands) |
|
||||||||||||||||
|
Interest income |
|
$ |
73,094 |
|
$ |
2,253 |
|
$ |
1,666 |
|
$ |
0 |
|
$ |
227 |
|
$ |
77,240 |
|
|
Interest expense |
|
26,521 |
|
0 |
|
0 |
|
0 |
|
1,995 |
|
28,516 |
|
||||||
|
Net interest income (expense) |
|
46,573 |
|
2,253 |
|
1,666 |
|
0 |
|
(1,768 |
) |
48,724 |
|
||||||
|
Provision for loan losses |
|
(3,000 |
) |
0 |
|
0 |
|
0 |
|
0 |
|
(3,000 |
) |
||||||
|
Noninterest income |
|
11,536 |
|
2,063 |
|
831 |
|
903 |
|
(3,524 |
) |
11,809 |
|
||||||
|
Noninterest expense |
|
31,874 |
|
3,448 |
|
1,002 |
|
721 |
|
43 |
|
37,088 |
|
||||||
|
Income before income taxes |
|
$ |
23,235 |
|
$ |
868 |
|
$ |
1,495 |
|
$ |
182 |
|
$ |
(5,335 |
) |
$ |
20,445 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Total assets |
|
$ |
6,295,133 |
|
$ |
18,488 |
|
$ |
16,111 |
|
$ |
1,345 |
|
$ |
(71,966 |
) |
$ |
6,259,111 |
|
|
|
|
As of and for the Three Months Ended June 30, 2003 |
|
||||||||||||||||
|
|
|
Community |
|
Residential |
|
Commercial |
|
Retail |
|
Other and |
|
Total |
|
||||||
|
|
|
(Dollars in thousands) |
|
||||||||||||||||
|
Interest income |
|
$ |
48,964 |
|
$ |
2,258 |
|
$ |
1,428 |
|
$ |
1 |
|
$ |
0 |
|
$ |
52,651 |
|
|
Interest expense |
|
20,697 |
|
0 |
|
0 |
|
0 |
|
1,914 |
|
22,611 |
|
||||||
|
Net interest income (expense) |
|
28,267 |
|
2,258 |
|
1,428 |
|
1 |
|
(1,914 |
) |
30,040 |
|
||||||
|
Provision for loan losses |
|
(2,550 |
) |
0 |
|
0 |
|
0 |
|
0 |
|
(2,550 |
) |
||||||
|
Noninterest income |
|
10,462 |
|
2,523 |
|
618 |
|
508 |
|
(4,422 |
) |
9,689 |
|
||||||
|
Noninterest expense |
|
19,263 |
|
2,550 |
|
620 |
|
399 |
|
(228 |
) |
22,604 |
|
||||||
|
Income before income taxes |
|
$ |
16,916 |
|
$ |
2,231 |
|
$ |
1,426 |
|
$ |
110 |
|
$ |
(6,108 |
) |
$ |
14,575 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Total assets |
|
$ |
4,135,402 |
|
$ |
19,211 |
|
$ |
13,298 |
|
$ |
1,417 |
|
$ |
(72,326 |
) |
$ |
4,097,002 |
|
10
|
|
|
As of and for the Six Months Ended June 30, 2004 |
|
||||||||||||||||
|
|
|
Community |
|
Residential |
|
Commercial |
|
Retail |
|
Other and |
|
Total |
|
||||||
|
|
|
(Dollars in thousands) |
|
||||||||||||||||
|
Interest income |
|
$ |
142,483 |
|
$ |
4,282 |
|
$ |
3,413 |
|
$ |
1 |
|
$ |
452 |
|
$ |
150,631 |
|
|
Interest expense |
|
52,227 |
|
0 |
|
0 |
|
0 |
|
3,991 |
|
56,218 |
|
||||||
|
Net interest income (expense) |
|
90,256 |
|
4,282 |
|
3,413 |
|
1 |
|
(3,539 |
) |
94,413 |
|
||||||
|
Provision for loan losses |
|
(5,850 |
) |
0 |
|
0 |
|
0 |
|
0 |
|
(5,850 |
) |
||||||
|
Noninterest income |
|
23,744 |
|
3,847 |
|
1,214 |
|
1,859 |
|
(5,957 |
) |
24,707 |
|
||||||
|
Noninterest expense |
|
64,252 |
|
6,633 |
|
2,157 |
|
1,471 |
|
294 |
|
74,807 |
|
||||||
|
Income before income taxes |
|
$ |
43,898 |
|
$ |
1,496 |
|
$ |
2,470 |
|
$ |
389 |
|
$ |
(9,790 |
) |
$ |
38,463 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Total assets |
|
$ |
6,295,133 |
|
$ |
18,488 |
|
$ |
16,111 |
|
$ |
1,345 |
|
$ |
(71,966 |
) |
$ |
6,259,111 |
|
|
|
|
As of and for the Six Months Ended June 30, 2003 |
|
||||||||||||||||
|
|
|
Community |
|
Residential |
|
Commercial |
|
Retail |
|
Other and |
|
Total |
|
||||||
|
|
|
(Dollars in thousands) |
|
||||||||||||||||
|
Interest income |
|
$ |
96,969 |
|
$ |
4,309 |
|
$ |
2,857 |
|
$ |
1 |
|
$ |
0 |
|
$ |
104,136 |
|
|
Interest expense |
|
41,514 |
|
0 |
|
0 |
|
0 |
|
4,011 |
|
45,525 |
|
||||||
|
Net interest income (expense) |
|
55,455 |
|
4,309 |
|
2,857 |
|
1 |
|
(4,011 |
) |
58,611 |
|
||||||
|
Provision for loan losses |
|
(4,800 |
) |
0 |
|
0 |
|
0 |
|
0 |
|
(4,800 |
) |
||||||
|
Noninterest income |
|
19,972 |
|
5,135 |
|
606 |
|
966 |
|
(9,881 |
) |
16,798 |
|
||||||
|
Noninterest expense |
|
37,730 |
|
4,650 |
|
1,363 |
|
725 |
|
(453 |
) |
44,015 |
|
||||||
|
Income before income taxes |
|
$ |
32,897 |
|
$ |
4,794 |
|
$ |
2,100 |
|
$ |
242 |
|
$ |
(13,439 |
) |
$ |
26,594 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
|
Total assets |
|
$ |
4,135,402 |
|
$ |
19,211 |
|
$ |
13,298 |
|
$ |
1,417 |
|
$ |
(72,326 |
) |
$ |
4,097,002 |
|
11
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 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.
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 |
|
Six Months Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(Dollars in thousands, except per share amounts) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Reported net income |
|
$ |
13,483 |
|
$ |
9,517 |
|
$ |
25,467 |
|
$ |
17,300 |
|
|
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 |
|
(1,009 |
) |
(548 |
) |
(2,018 |
) |
(1,097 |
) |
||||
|
Pro forma |
|
$ |
12,474 |
|
$ |
8,969 |
|
$ |
23,449 |
|
$ |
16,203 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Basic earnings per share: |
|
|
|
|
|
|
|
|
|
||||
|
Reported earnings per share |
|
$ |
0.60 |
|
$ |
0.59 |
|
$ |
1.13 |
|
$ |
1.10 |
|
|
Stock-based employee compensation, fair value |
|
(0.05 |
) |
(0.04 |
) |
(0.09 |
) |
(0.07 |
) |
||||
|
Pro forma earnings per share |
|
$ |
0.55 |
|
$ |
0.55 |
|
$ |
1.04 |
|
$ |
1.03 |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Diluted earnings per share: |
|
|
|
|
|
|
|
|
|
||||
|
Reported earnings per share |
|
$ |
0.58 |
|
$ |
0.57 |
|
$ |
1.10 |
|
$ |
1.08 |
|
|
Stock-based employee compensation, fair value |
|
(0.04 |
) |
(0.03 |
) |
(0.08 |
) |
(0.07 |
) |
||||
|
Pro forma earnings per share |
|
$ |
0.54 |
|
$ |
0.54 |
|
$ |
1.02 |
|
$ |
1.01 |
|
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% during each period, risk-free interest rates of 2.86% to 6.52% and expected lives of four to ten years, respectively.
7. New Accounting Policies:
In December 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No. 46R, which provides further guidance on the accounting for variable interest entities. Sterling adopted FIN No. 46R as of December 31, 2003 and Sterling has applied the provisions of FIN No. 46R beginning in the first quarter of 2004 by deconsolidating its subsidiary statutory trusts that issue Trust Preferred Securities to investors. The amounts payable to these trusts continue to be treated as other borrowings. The adoption of FIN No. 46R did not have a material effect on Sterling’s consolidated financial statements.
12
In December 2003, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP No. 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP No. 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. Sterling believes the implementation of SOP No. 03-3 will not have a material effect on its consolidated financial statements.
8. Derivatives and Hedging:
Sterling, through its subsidiary Action Mortgage, enters into interest rate lock commitments (“rate locks”) to prospective residential mortgage borrowers. Action Mortgage hedges interest rate risk (“IRR”) by entering into non-binding (“best-efforts”) forward sales agreements with third parties. In addition, to improve and protect the profit margin on loans sold into the secondary market, Action Mortgage hedges IRR 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. Sterling has recorded the estimated fair values of 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. The estimated fair value of rate locks was an asset of $357,356 and the estimated fair value of forward sales agreements was a liability of $195,469 at June 30, 2004.
9. Business Combinations:
On January 2, 2004, Klamath First Bancorp, Inc. (“Klamath”), an Oregon corporation, was 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, was merged with and into Sterling’s wholly-owned subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.
10. Stock Dividend:
On May 28, 2004, Sterling paid a 10% stock dividend. Accordingly, all weighted average shares outstanding and per share amounts have been restated to reflect this common stock dividend.
11. Subsequent Event:
In July 2004, Sterling sold substantially all the assets of The Dime Service Corporation (“Dime”) and exited the property and casualty insurance business. The assets and liabilities of Dime were not material to the consolidated financial statements and there was no material gain or loss recorded on the sale.
13
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operation
STERLING FINANCIAL CORPORATION
Comparison of the Three and Six Months Ended June 30, 2004 and 2003
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 2003 annual report on Form 10-K.
General
Sterling Financial Corporation (“Sterling”) is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank. The principal operating subsidiaries of Sterling Savings Bank are Action Mortgage Company (“Action Mortgage”), INTERVEST-Mortgage Investment Company (“INTERVEST”) and Harbor Financial Services, Inc. (“Harbor Financial”). Sterling Savings Bank commenced operations in 1983 as a Washington State-chartered, federally insured stock savings and loan association headquartered in Spokane, Washington.
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 grow both its retail deposit base and its lending portfolio in the Pacific Northwest region. With $6.26 billion in total assets at June 30, 2004, Sterling attracts Federal Deposit Insurance Corporation (“FDIC”) insured deposits from the general public through 135 retail branches located in Washington, Oregon, Idaho and Montana. Sterling originates loans through its branch offices, including nine in-store branches, as well as Action Mortgage residential loan production offices in the four-state area and through INTERVEST commercial real estate lending offices in Washington, Oregon and Arizona. Sterling also markets fixed income and equity products, mutual funds, fixed and variable annuities and many other financial products through Harbor Financial.
Sterling continues to enhance its presence as a leading 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 will increase other fee income, 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”), fees and service charges and 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”).
Executive Summary and Highlights
Net income for the three months ended June 30, 2004 increased 42% to $13.5 million, or $0.58 per diluted share, compared with net income of $9.5 million, or $0.57 per diluted share, for last year’s comparable period. Net income for the six months ended June 30, 2004 increased 47% to $25.5 million, or $1.10 per diluted share, compared with net income of $17.3 million, or $1.08 per diluted share, for last year’s comparable period. The increase in earnings primarily reflected continued increases in NII and other income that were primarily due to the recent merger (the “Merger”) with Klamath First Bancorp, Inc. (“Klamath”).
14
Other highlights for the quarter ended June 30, 2004 are as follows:
• Earnings per diluted share were $0.58 for the quarter ended June 30, 2004, compared to $0.57 per diluted share for the same period in 2003.
• NII increased 62% over the second quarter of 2003.
• Total loan originations increased to a record $786.4 million for the three months ended June 30, 2004, a 19% increase over the second quarter of 2003.
• Nonperforming assets to total assets decreased to 27 basis points from 77 basis points at June 30, 2003.
• Sterling paid a 10% stock dividend effective May 28, 2004.
Company Growth
In January 2004, Klamath was 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, was merged with and into Sterling’s wholly-owned subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.
Under the terms of the Merger, each share of Klamath common stock was converted into 0.77 shares of Sterling common stock. Sterling issued 5,431,067 shares of common stock in exchange for all of the stock of Klamath. As a result of the Merger, Sterling acquired approximately $988 million in deposits, $778 million in investments and ABS, $564 million in loans and $145 million in capital, while adding approximately 450 employees to its work force. In addition, Sterling added 48 retail branches and significantly increased its deposit market share in Oregon from 0.5% to over 4.0%. See Note 9 of “Notes to Consolidated Financial Statements.”
With this expanded branch network, Sterling has strengthened its position as a leading regional community bank. This merger is consistent with Sterling’s strategy to become the leading community bank in the Pacific Northwest. Klamath’s strong deposit base has complemented Sterling’s asset growth strategy, while the combined branch network and access to capital have given Sterling the opportunity to continue its growth in the region.
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 the existence of 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.
15
Income Recognition. Sterling recognizes interest income by methods that conform to general accounting practices within the banking industry. In the event management believes collection of all or a portion of contractual interest on a loan has become doubtful, which generally occurs after the loan is 90 days past due, Sterling discontinues the accrual of interest and any previously accrued interest recognized in income deemed uncollectible is reversed. Interest received on nonperforming loans is included in income only if principal recovery is reasonably assured. A nonperforming loan is restored to accrual status when it is brought current, has performed in accordance with contractual terms for a reasonable period of time, and the collectibility of the total contractual principal and interest is no longer in doubt.
Allowance For Loan Losses. In general, determining the amount of the allowance for loan losses requires significant judgment and the use of estimates by management. Sterling maintains an allowance for loan losses to absorb probable losses in the loan portfolio based on a quarterly analysis of the portfolio and expected future losses. This analysis is designed to determine an appropriate level and allocation of the allowance for losses among loan types by considering factors affecting loan losses, including specific losses, levels and trends in impaired and nonperforming loans, historical loan loss experience, current national and local economic conditions, volume, growth and composition of the portfolio, regulatory guidance and other relevant factors. Management monitors the loan portfolio to evaluate the adequacy of the allowance. The allowance can increase or decrease each quarter based upon the results of management’s analysis.
The amount of the allowance for the various loan types represents management’s estimate of expected losses from existing loans based upon specific allocations for individual lending relationships and historical loss experience for each category of homogeneous loans. The allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation requires management to make estimates of the amounts and timing of future cash flows on impaired loans, which consist primarily of non-accrual and restructured loans.
Individual loan reviews are based upon specific quantitative and qualitative criteria, including the size of the loan, loan quality ratings, value of collateral, repayment ability of borrowers, and historical experience factors. The historical experience factors utilized 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 June 30, 2004. 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 ABS. Assets 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
16
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 three and six months ended June 30, 2004. 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 Assets. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Sterling’s goodwill relates to value inherent in the banking business and the value is dependent upon Sterling’s ability to provide quality, cost effective services in a competitive market place. As such, goodwill value is supported ultimately by revenue that is generated by the volume of business transacted. A decline in earnings as a result of a lack of growth or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods.
Sterling’s management performed the annual test of its goodwill and other intangible assets as of June 30, 2004, and concluded that the recorded values were not impaired. There are many assumptions and estimates underlying the determination of impairment. Another estimate using different but still reasonable assumptions could produce a significantly different result. Additionally, future events could cause management to conclude that Sterling’s goodwill is impaired, which would result in Sterling recording an impairment loss. Any resulting impairment loss could have a material adverse impact on Sterling’s financial condition and results of operations. Other intangible assets consisting of core-deposit intangibles with definite lives are amortized over the estimated life of the acquired depositor relationships (generally eight to ten years).
Real Estate Owned. 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.
Results of Operations
Overview. Sterling recorded net income of $13.5 million, or $0.58 per diluted share, for the three months ended June 30, 2004, compared with net income of $9.5 million, or $0.57 per diluted share, for the three months ended June 30, 2003. Sterling recorded net income of $25.5 million, or $1.10 per diluted share, for the six months ended June 30, 2004, compared with $17.3 million, or $1.08 per diluted share, for the six months ended June 30, 2003. The increases in net income for both periods reflect an increase in NII and other income.
The annualized return on average assets (“ROA”) was 0.86% and 0.98% for the three months ended June 30, 2004 and 2003, respectively, while ROA was 0.84% and 0.92% for the six months ended June 30, 2004 and 2003, respectively. The annualized return on average equity (“ROE”) was 12.4% and 15.5% for the three months ended June 30, 2004 and 2003, respectively. ROE was 12.2% and 15.0% for the six months ended June 30, 2004 and 2003, respectively. The decreases in ROA primarily reflected a higher balance of average assets relative to last
17
year’s comparable period. The decreases in ROE were primarily due to the increase in shareholder’s equity. The lower-yielding assets acquired in the Merger also decreased Sterling’s ROA and ROE.
Net Interest Income. The most significant component of earnings for a financial institution typically is NII, which is the difference between interest income, primarily from loan, ABS and investment portfolios, and interest expense, primarily on deposits and borrowings. During the three months ended June 30, 2004 and 2003, NII was $48.7 million and $30.0 million, respectively, an increase of 62%. For the six months ended June 30, 2004 and 2003, NII was $94.4 million and $58.6 million, an increase of 61%. The increase in NII during the three and six months ended June 30, 2004, compared to the same periods in 2003, was primarily due to the increases in average loan and ABS volumes following the Merger 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 June 30, 2004 and 2003 were $5.77 billion and $3.64 billion, respectively. Average loans increased by $1.05 billion, while average investments and ABS increased by $1.08 billion over the 2003 amounts. Net interest spread during these periods was 3.37% and 3.26%, respectively. Net interest margin for the three months ended June 30, 2004 and 2003 was 3.40% and 3.31%, respectively. Net interest spread increased due to a greater decrease in the cost of funds relative to the yield on average interest-earning assets. The increase in the net interest margin reflected a greater volume of average earning assets compared to the second quarter of 2003.
Average interest-earning assets for the six months ended June 30, 2004 and 2003 were $5.64 billion and $3.55 billion, respectively. Average loans increased by $1.06 billion, while average investments and ABS increased by $1.03 billion over the prior comparable period. Net interest spread for the six months ended June 30, 2004 and 2003 was 3.35% and 3.29%, respectively, while the net interest margin for the same periods was 3.36% and 3.33%, respectively. The increase in the net interest spread during the six months ended June 30, 2004 was due to the same factors that influenced the three month change. The increase in the net interest margin for the six month period reflected a higher average volume of loans and ABS, generating the increase in NII, thereby increasing the margin compared to the same period in 2003. However, Sterling acquired lower-yielding loans and securities from the Merger that partially offset the increase in the ratios during the first six months of 2004.
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 $3.0 million and $2.6 million for the three months ended June 30, 2004 and 2003, respectively. Sterling recorded provisions for losses on loans of $5.9 million and $4.8 million for the six months ended June 30, 2004 and 2003, 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.
18
The following table summarizes loan loss allowance activity for the periods indicated:
|
|
|
Six Months Ended June 30, |
|
||||
|
|
|
2004 |
|
2003 |
|
||
|
|
|
(Dollars in thousands) |
|
||||
|
|
|
|
|
|
|
||
|
Balance at January 1 |
|
$ |
35,605 |
|
$ |
27,866 |
|
|
Allowance for loan losses acquired |
|
6,722 |
|
869 |
|
||
|
Provision for losses on loans |
|
5,850 |
|
4,800 |
|
||
|
Amounts written off net of recoveries and other |
|
(2,926 |
) |
(1,501 |
) |
||
|
Balance at June 30 |
|
$ |
45,251 |
|
$ |
32,034 |
|
At June 30, 2004, Sterling’s total classified assets were 1.29% of total assets, compared with 1.96% of total assets at June 30, 2003. Nonperforming assets were 0.27% of total assets at June 30, 2004, compared with 0.77% of total assets at June 30, 2003. The decreases in classified and nonperforming assets primarily reflected the sale of certain real estate owned properties, as well as improvements in the status of certain business banking, commercial real estate and construction loans. Sterling does not anticipate significant losses in these classified assets, although there can be no assurances in this regard. At June 30, 2004, the loan delinquency ratio was 0.43% of total loans compared to 1.13% of total loans at June 30, 2003. The decrease in the ratio primarily reflected lower volumes of delinquent consumer and commercial real estate loans.
Other Income. Other income was $11.8 million and $9.7 million for the three months ended June 30, 2004 and 2003, respectively. Other income was $24.7 million and $16.8 million for the six months ended June 30, 2004 and 2003, respectively. The increase was primarily due to an increase in fees and service charges.
Fees and service charge income increased by 72% to $8.4 million for the three months ended June 30, 2004 from $4.9 million for the same period last year. For the six months ended June 30, 2004 and 2003, fees and service charge income increased by 82%, or $7.5 million. This increase was primarily due to an increase in the number of transaction accounts, fees for new overdraft protection services and strong growth in the number of transaction accounts. Sterling had 145,641 transaction accounts at June 30, 2004, an increase of 61,713 accounts from June 30, 2003. Most of this increase was from accounts acquired in the Merger.
The following table summarizes loan originations, sales of loans and the balance of serviced mortgage loans for the periods indicated:
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||
|
|
|
2004 |
|
2003 |
|
2004 |
|
2003 |
|
||||
|
|
|
(Dollars in millions) |
|
||||||||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Originations of one- to four-family permanent mortgage loans |
|
$ |
91.9 |
|
$ |
146.4 |
|
$ |
162.7 |
|
$ |
278.7 |
|
|
Sales of residential loans |
|
55.0 |
|
92.8 |
|
82.3 |
|
188.1 |
|
||||
|
Principal balances of residential loans serviced for others |
|
206.3 |
|
213.5 |
|
206.3 |
|
213.5 |
|
||||
|
Principal balances of commercial real estate loans serviced for others |
|
291.0 |
|
196.5 |
|
291.0 |
|
196.5 |
|
||||
Mortgage banking operations (“MBO”) income was $1.8 million and $2.5 million, respectively, for the three months ended June 30, 2004 and 2003, respectively. MBO income was $3.0 million and $4.7 million for the six months ended June 30, 2004 and 2003, respectively. The decrease primarily reflected an industry wide slow-down in residential refinancing activity. Increased revenues from Sterling’s commercial mortgage banking segment partially offset the decreases in the residential mortgage banking segment, particularly in the June 2004 quarter. During the quarter ended June 30, 2004, the commercial mortgage banking segment provided 34% of total MBO income, as compared with 13% for the March 2004 quarter.
19
During the quarter ended June 30, 2004, Sterling sold $77.4 million in investments and ABS, compared with $373.5 million for the quarter ended June 30, 2003. Sterling recognized a net gain of $0.8 million and $1.7 million for the three months ended June 30, 2004 and 2003, respectively. During the six months ended June 30, 2004, Sterling sold $344.2 million in investments and ABS compared with $588.8 million for the same period in 2003. Sterling recognized a net gain of $3.3 million and $3.0 million for the six months ended June 30, 2004 and 2003, respectively. The decrease in net gains on sales of investments and ABS for the three months ended June 30, 2004 compared to the prior year’s comparable period primarily reflected the decrease in the volume of sales of investments and ABS.
Operating Expenses. Operating expenses were $37.1 million and $22.6 million for the three months ended June 30, 2004 and 2003, respectively. Operating expenses were $74.8 million and $44.0 million for the six months ended June 30, 2004 and 2003, respectively. The higher level of operating expenses was primarily due to increases in personnel, occupancy, and data processing expenses and merger and acquisition costs.
Employee compensation and benefits were $19.1 million and $12.0 million for the three months ended June 30, 2004 and 2003, respectively. Employee compensation and benefits were $38.3 million and $24.0 million for the six months ended June 30, 2004 and 2003, respectively. Full-time equivalent employees have increased year-over-year to 1,552 full-time equivalents at June 30, 2004, an increase of 494 full-time equivalents. The majority of this year-over-year increase can be attributed to the personnel acquired in the Merger.
Occupancy and equipment expenses were $5.9 million and $3.7 million for the three months ended June 30, 2004 and 2003, respectively. Occupancy and equipment expenses were $11.1 million and $7.2 million for the six months ended June 30, 2004 and 2003, respectively. The increase for the period reflected higher costs related to additional occupied space and additional staff equipment costs associated with Sterling’s acquisition of 48 additional branch locations as a result of the Merger.
Data processing expenses were $2.8 million and $1.6 million for the three months ended June 30, 2004 and 2003, respectively. Data processing expenses were $4.9 million and $3.2 million for the six months ended June 30, 2004 and 2003, respectively. The increases for both periods reflected the increase in data processing volume due to increases in the number of transactions, deposits and employees as a result of the Merger.
Merger and acquisition costs were $922,000 and $45,000 for the three months ended June 30, 2004 and 2003, respectively. Merger and acquisition costs were $4.8 million and $188,000 for the six months ended June 30, 2004 and 2003, respectively. The increase in merger and acquisition costs for the six month period resulted from the Merger. Management does not anticipate material costs associated with the Merger for the remainder of the year.
Income Tax Provision. Sterling recorded federal and state income tax provisions of $7.0 million and $5.1 million for the three months ended June 30, 2004 and 2003, respectively. For the six months ended June 30, 2004 and 2003, Sterling recorded federal and state income tax provisions of $13.0 million and $9.3 million, respectively. The effective tax rates for the three month periods were 34.1% and 34.7%, respectively. The effective tax rates for the six month periods were 33.8% and 34.9%, respectively. The decrease in the effective tax rates compared to the periods ended June 30, 2003 were primarily due to the effect of tax credits for investments in certain low income housing developments.
20
Financial Position
Assets. At June 30, 2004, Sterling’s assets were $6.26 billion, up 46% from $4.28 billion at December 31, 2003. For a discussion of the impact of the Merger on Sterling’s consolidated total assets, see “Company Growth.”
Investments and ABS. Sterling’s investment and ABS portfolio at June 30, 2004 was $2.0 billion, an increase of $944.3 million from the December 31, 2003 balance of $1.07 billion. The increase was primarily due to approximately $778 million of investments and ABS acquired from the Merger.
Loans Receivable. At June 30, 2004, net loans receivable were $3.72 billion, up $815.6 million from $2.91 billion at December 31, 2003. The increase was primarily due to approximately $564 million of loans acquired from the Merger, as well as increased loan originations during the most recent quarter. During the three months ended June 30, 2004, total loan originations were $786.4 million compared with $658.8 million for the prior year’s comparable period. During the six months ended June 30, 2004, total loan originations were $1.38 billion compared with $1.14 billion for the prior year’s comparable period. The quarter-over-quarter and year-over-year increases in loan originations were mainly influenced by strong consumer-direct, corporate and business banking lending. These increases were partially offset by a continued decrease in residential real estate loan originations.
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:
|
|
|
June 30, 2004 |
|
December 31, 2003 |
|
||||||
|
|
|
Amount |
|
% |
|
Amount |
|
% |
|
||
|
|
|
(Dollars in thousands) |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
||
|
Residential real estate |
|
$ |
566,218 |
|
15.0 |
|
$ |
407,999 |
|
13.8 |
|
|
Multifamily real estate |
|
185,487 |
|
4.9 |
|
167,220 |
|
5.7 |
|
||
|
Commercial real estate |
|
628,500 |
|
16.6 |
|
463,191 |
|
15.7 |
|
||
|
Real estate construction |
|
572,468 |
|
15.2 |
|
552,965 |
|
18.7 |
|
||
|
Consumer - direct |
|
510,362 |
|
13.5 |
|
309,931 |
|
10.5 |
|
||
|
Consumer - indirect |
|
106,503 |
|
2.8 |
|
99,697 |
|
3.4 |
|
||
|
Business and private banking |
|
875,699 |
|
23.2 |
|
720,071 |
|
24.4 |
|
||
|
Corporate banking |
|
330,540 |
|
8.8 |
|
228,233 |
|
7.8 |
|
||
|
Gross loans receivable |
|
3,775,777 |
|
100.0 |
|
2,949,307 |
|
100.0 |
|
||
|
Net deferred origination fees |
|
(8,535 |
) |
|
|
(7,276 |
) |
|
|
||
|
Allowance for losses on loans |
|
(45,251 |
) |
|
|
(35,605 |
) |
|
|
||
|
Loans receivable, net |
|
$ |
3,721,991 |
|
|
|
$ |
2,906,426 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||
|
Weighted average yield at end of period |
|
5.93 |
% |
|
|
5.71 |
% |
|
|
||
21
The following table sets forth Sterling’s loan originations for the period indicated:
|
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||||||
|
|
|
2004 |
|
2003e |
|
% Chang |
|
2004 |
|
2003 |
|
% Change |
|
||||
|
|
|
(Dollars in thousands) |
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Residential real estate |
|
$ |
91,948 |
|
$ |
146,405 |
|
(37.2 |
) |
$ |
162,677 |
|
$ |
278,693 |
|
(41.6 |
) |
|
Multifamily real estate |
|
21,080 |
|
17,077 |
|
23.4 |
|
36,417 |
|
30,442 |
|
19.6 |
|
||||
|
Commercial real estate |
|
37,755 |
|
48,304 |
|
(21.8 |
) |
98,515 |
|
85,403 |
|
15.4 |
|
||||
|
Real estate construction |
|
213,079 |
|
195,137 |
|
9.2 |
|
388,591 |
|
324,291 |
|
19.8 |
|
||||
|
Consumer - direct |
|
127,792 |
|
61,632 |
|
107.3 |
|
195,924 |
|
93,940 |
|
108.6 |
|
||||
|
Consumer - indirect |
|
11,512 |
|
15,594 |
|
(26.2 |
) |
24,419 |
|
29,862 |
|
(18.2 |
) |
||||
|
Business and private banking |
|
122,621 |
|
122,857 |
|
(0.2 |
) |
265,974 |
|
197,443 |
|
34.7 |
|
||||
|
Corporate banking |
|
160,576 |
|
51,780 |
|
210.1 |
|
203,816 |
|
98,630 |
|
106.7 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
Total loans originated |
|
$ |
786,363 |
|
$ |
658,786 |
|
19.4 |
|
$ |
1,376,333 |
|
$ |
1,138,704 |
|
20.9 |
|
BOLI. Bank-owned life insurance (“BOLI”) increased to $91.7 million at June 30, 2004 from $73.1 million at December 31, 2003. The increase was primarily due to the $16.3 million in BOLI acquired in the Merger. Sterling maintains BOLI to fund employee benefit costs. Through the purchase of BOLI, Sterling becomes the beneficiary of life insurance policies on certain individuals who consent to the issuance of the policies.
Goodwill and Other Intangible Assets. Goodwill and other intangible assets increased to $149.1 million at June 30, 2004 from $48.0 million at December 31, 2003. In January 2004, Sterling recorded $83.2 million in goodwill and $19.2 million in other intangible assets in connection with the Merger.
Deposits. Total deposits increased $1.15 billion to $3.60 billion at June 30, 2004 from $2.46 billion at December 31, 2003, primarily due to the acquisition of approximately $988 million in deposits from the Merger. See “Company Growth.”
The following table sets forth the composition of Sterling’s deposits at the dates indicated:
|
|
|
June 30, 2004 |
|
December 31, 2003 |
|
||||||
|
|
|
Amount |
|
% |
|
Amount |
|
% |
|
||
|
|
|
(Dollars in thousands) |
|
||||||||
|
|
|
|
|
|
|
|
|
|
|
||
|
Noninterest checking |
|
$ |
525,329 |
|
14.6 |
|
$ |
306,456 |
|
12.5 |
|
|
NOW checking |
|
401,066 |
|
11.1 |
|
301,197 |
|||||