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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended JUNE 30, 2011

OR

 

¨	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 001-34696

 

 

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) 458-3711

(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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		x  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

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 July 29, 2011
Common Stock		61,956,219

 

 

 

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TABLE OF CONTENTS

June 30, 2011

 

				Page
PART I - Financial Information					1
Item 1		Financial Statements (Unaudited)			1
		Consolidated Balance Sheets			2
		Consolidated Statements of Operations			3
		Consolidated Statements of Comprehensive Income			4
		Consolidated Statements of Cash Flows			5
		Notes to Consolidated Financial Statements			7
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3		Quantitative and Qualitative Disclosures About Market Risk			45
Item 4		Controls and Procedures			45
PART II - Other Information					46
Item 1		Legal Proceedings			46
Item 1A		Risk Factors			47
Item 2		Unregistered Sales of Equity Securities and Use of Proceeds			47
Item 3		Defaults Upon Senior Securities			47
Item 4		(Removed And Reserved)			47
Item 5		Other Information			47
Item 6		Exhibits			47
Signatures					48

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STERLING FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands)

 

		June 30, 2011				December 31, 2010
ASSETS:
Cash and cash equivalents:
Interest bearing		$	495,523			$	341,425
Non-interest bearing			76,255				70,158
Total cash and cash equivalents			571,778				411,583
Restricted cash			15,432				15,681
Investments and mortgage-backed securities (“MBS”):
Available for sale			2,494,002				2,825,010
Held to maturity			2,054				13,464
Loans held for sale			197,643				222,216
Loans receivable, net			5,387,714				5,379,081
Accrued interest receivable			32,018				34,087
Other real estate owned, net (“OREO”)			101,406				161,653
Properties and equipment, net			83,923				81,094
Bank-owned life insurance (“BOLI”)			172,774				169,288
Core deposit intangible assets, net			14,480				16,929
Mortgage servicing rights, net			23,880				20,604
Prepaid expenses and other assets, net			144,491				142,479
Total assets		$	9,241,595			$	9,493,169
LIABILITIES:
Deposits:
Noninterest bearing		$	1,067,637			$	992,368
Interest bearing			5,536,361				5,918,639
Total deposits			6,603,998				6,911,007
Advances from Federal Home Loan Bank (“FHLB”)			407,071				407,211
Securities sold under repurchase agreements and funds purchased			1,058,694				1,032,512
Junior subordinated debentures			245,287				245,285
Accrued interest payable			20,060				17,259
Accrued expenses and other liabilities			98,875				109,128
Total liabilities			8,433,985				8,722,402
SHAREHOLDERS’ EQUITY:
Preferred stock, 10,000,000 shares authorized; no shares outstanding			0				0
Common stock, 151,515,151 shares authorized; 61,952,072 and 61,926,187 shares outstanding			1,962,830				1,960,871
Accumulated other comprehensive income (loss)			17,733				(4,179	)
Accumulated deficit			(1,172,953	)			(1,185,925	)
Total shareholders’ equity			807,610				770,767
Total liabilities and shareholders’ equity		$	9,241,595			$	9,493,169

See notes to consolidated financial statements.

 

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STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share amounts)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Interest income:
Loans		$	79,735			$	93,885			$	160,122			$	190,861
MBS			19,928				18,616				39,962				38,442
Investments and cash equivalents			2,684				2,708				5,500				5,398
Total interest income			102,347				115,209				205,584				234,701
Interest expense:
Deposits			15,216				25,063				32,510				52,514
Short-term borrowings			111				2,103				190				4,214
Long-term borrowings			12,213				14,948				24,334				29,988
Total interest expense			27,540				42,114				57,034				86,716
Net interest income			74,807				73,095				148,550				147,985
Provision for credit losses			10,000				70,781				20,000				159,337
Net interest income (expense) after provision for credit losses			64,807				2,314				128,550				(11,352	)
Noninterest income:
Fees and service charges			12,946				14,233				25,507				27,268
Mortgage banking operations			10,794				11,713				21,121				22,945
Loan servicing fees			709				(408	)			1,810				738
BOLI			1,578				1,560				3,310				3,855
Gains on sales of securities, net			8,297				15,349				14,298				17,260
Other			11				(1,219	)			(1,729	)			(5,541	)
Total noninterest income			34,335				41,228				64,317				66,525
Noninterest expense			91,587				97,315				179,895				193,292
Income (loss) before income taxes			7,555				(53,773	)			12,972				(138,119	)
Income tax expense			0				0				0				0
Net income (loss)			7,555				(53,773	)			12,972				(138,119	)
Preferred stock dividend			0				(4,469	)			0				(8,881	)
Net income (loss) available to common shareholders		$	7,555			$	(58,242	)		$	12,972			$	(147,000	)
Earnings (loss) per share - basic (1)		$	0.12			$	(73.91	)		$	0.21			$	(186.60	)
Earnings (loss) per share - diluted (1)		$	0.12			$	(73.91	)		$	0.21			$	(186.60	)
Weighted average shares outstanding - basic (1)			61,943,851				788,020				61,937,353				787,799
Weighted average shares outstanding - diluted (1)			62,312,224				788,020				62,320,028				787,799

 

(1)	Reflects the 1-for-66 reverse stock split in November 2010.

See notes to consolidated financial statements.

 

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STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(in thousands)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Net income (loss)		$	7,555			$	(53,773	)		$	12,972			$	(138,119	)
Other comprehensive income (loss):
Change in unrealized gains on investments and MBS available-for-sale			36,651				23,201				38,594				41,239
Less deferred income tax provision			(3,826	)			(2,915	)			(2,384	)			(8,901	)
Realized net gains reclassified from other comprehensive income			(8,297	)			(15,349	)			(14,298	)			(17,260	)
Net other comprehensive income			24,528				4,937				21,912				15,078
Comprehensive income (loss)		$	32,083			$	(48,836	)		$	34,884			$	(123,041	)

See notes to consolidated financial statements.

 

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STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

		Six Months Ended June 30,
		2011				2010
Cash flows from operating activities:
Net income (loss)		$	12,972			$	(138,119	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Provision for credit losses			20,000				159,337
Net gain on sales of loans			(18,549	)			(22,385	)
Net gain on sales of investments and MBS			(14,298	)			(17,337	)
Stock based compensation			1,959				726
Loss on OREO			39,835				46,388
Increase in cash surrender value of BOLI			(3,310	)			(3,855	)
Depreciation and amortization			19,122				16,524
Change in:
Accrued interest receivable			2,069				8,855
Prepaid expenses and other assets			1,742				(1,141	)
Accrued interest payable			2,801				(3,926	)
Accrued expenses and other liabilities			(10,257	)			9,170
Proceeds from sales of loans originated for sale			871,842				1,105,740
Loans originated for sale			(828,385	)			(1,216,103	)
Net cash provided by (used in) operating activities			97,543				(56,126	)
Cash flows from investing activities:
Change in restricted cash			249				(5,357	)
Loans funded			(803,655	)			(382,977	)
Loans purchased			(111,034	)			0
Loan principal received			716,114				1,092,544
Proceeds from sales of loans			31,899				296,532
Purchase of investment securities			(2,000	)			(2,501	)
Proceeds from maturities of investment securities			294				4,951
Proceeds from sale of investment securities			30,987				17,192
Purchase of MBS			(242,841	)			(642,574	)
Principal payments received on MBS			229,210				336,583
Proceeds from sales of MBS			353,444				542,367
Office properties and equipment, net			(9,595	)			(1,321	)
Improvements and other changes to OREO			(5,061	)			(2,005	)
Proceeds from sales of OREO			155,566				70,027
Net cash provided by investing activities			343,577				1,323,461

 

See notes to consolidated financial statements.

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STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - cont.

(in thousands)

 

		Six Months Ended June 30,
		2011				2010
Cash flows from financing activities:
Net change in deposits		$	(307,009	)		$	(534,421	)
Advances from FHLB			0				495,750
Repayment of advances from FHLB			(98	)			(957,593	)
Net change in securities sold under repurchase agreements and funds purchased			26,182				(26,119	)
Net cash used in financing activities			(280,925	)			(1,022,383	)
Net change in cash and cash equivalents			160,195				244,952
Cash and cash equivalents, beginning of period			411,583				564,783
Cash and cash equivalents, end of period		$	571,778			$	809,735
Supplemental disclosures:
Cash paid on interest during the period		$	54,233			$	90,642
Cash received on income tax refunds during the period			0				49,390
Noncash financing and investing activities:
Loans converted into OREO			130,093				166,371
Preferred stock cash dividend accrued			0				7,815

See notes to consolidated financial statements.

 

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STERLING FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

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 as disclosed in the annual report on Form 10-K for the year ended December 31, 2010. 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.

In addition to other established accounting policies, the following is a discussion of recent accounting pronouncements:

In July 2010, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2010-20,”Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This update amends codification topic 310 on receivables to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. This guidance was phased in, with the new disclosure requirements for period end balances effective as of December 31, 2010, and the new disclosure requirements for activity during the reporting period effective March 31, 2011. The troubled debt restructuring disclosures in this ASU have been delayed by ASU 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” which was issued in January 2011. See Note 3.

In April 2011, the FASB issued ASU 2011-2, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This update to codification topic 310 provides guidance for what constitutes a concession and whether a debtor is experiencing financial difficulties. The amendments in this update are effective for Sterling on July 1, 2011, with retrospective application from January 1, 2011. This update is not expected to have a material effect on Sterling’s consolidated financial statements.

In April 2011, the FASB issued ASU 2011-3, “Reconsideration of Effective Control for Repurchase Agreements.” This update to codification topic 860 revises the assessment of effective control for purposes of determining if a reverse repurchase agreement should be accounted for as a sale, as compared with a secured borrowing. ASU 2011-3 will be effective for Sterling on January 1, 2012, and is not expected to have a material effect on Sterling’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-4, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” This update to codification topic 820 clarifies the application of existing fair value measurement and disclosure requirements, and implements changes to the codification that align U.S. GAAP and IFRS. This update will be effective for Sterling on January 1, 2012, and is not expected to have a material effect on Sterling’s consolidated financial statements.

 

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In June 2011, the FASB issued ASU 2011-5, “Presentation of Comprehensive Income.” This update to codification topic 220 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity, and requires a presentation of comprehensive income either on the face of the income statement, or on a separate schedule immediately following the income statement. This update will be effective for Sterling on January 1, 2012, and is not expected to have a material effect on Sterling’s consolidated financial statements.

2. Investments and MBS:

The carrying and fair values of investments and MBS are summarized as follows:

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
		(in thousands)
June 30, 2011
Available for sale
MBS			2,262,128			$	31,822			$	(11,453	)			2,282,497
Municipal bonds			188,752				4,176				(3,281	)			189,647
Other			24,871				3				(3,016	)			21,858
Total		$	2,475,751			$	36,001			$	(17,750	)		$	2,494,002
Held to maturity
Tax credits		$	2,054			$	0			$	0			$	2,054
Total		$	2,054			$	0			$	0			$	2,054
December 31, 2010
Available for sale
MBS		$	2,598,086			$	30,017			$	(25,493	)		$	2,602,610
Municipal bonds			208,588				949				(8,394	)			201,143
Other			24,821				2				(3,566	)			21,257
Total		$	2,831,495			$	30,968			$	(37,453	)		$	2,825,010
Held to maturity
Tax credits		$	13,464			$	0			$	0			$	13,464
Total		$	13,464			$	0			$	0			$	13,464

Other available for sale securities primarily consist of a single issuer trust preferred security at both June 30, 2011 and December 31, 2010. During the second quarter of 2011, Sterling sold $10.5 million of tax credit investments in low income housing partnerships. Until recently, there was not a liquid market for these investments. The sale was driven by the absence of a current tax burden for Sterling, combined with monthly expenses associated with the tax credits. The tax credit investments carrying balance were being systematically reduced over their projected life. The sale resulted in a loss of $2.2 million. Total sales of Sterling’s securities during the periods ended June 30, 2011 and 2010 are summarized as follows:

 

		Proceeds from Sales				Gross Realized Gains				Gross Realized (Losses)
		(in thousands)
Six months ended:
June 30, 2011		$	384,431			$	16,605			$	(2,307	)
June 30, 2010			559,559				23,681				(6,421	)

 

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The following table summarizes Sterling’s investments and MBS that had a market value below their amortized cost as of June 30, 2011 and December 31, 2010, segregated by those investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer:

 

		Less than 12 months								12 months or longer								Total
		Market Value				Unrealized Losses				Market Value				Unrealized Losses				Market Value				Unrealized Losses
		(in thousands)
June 30, 2011
Municipal bonds		$	28,525			$	(753	)		$	25,573			$	(2,528	)		$	54,098			$	(3,281	)
MBS			931,786				(11,453	)			0				0				931,786				(11,453	)
Other			0				0				21,850				(3,016	)			21,850				(3,016	)
Total		$	960,311			$	(12,206	)		$	47,423			$	(5,544	)		$	1,007,734			$	(17,750	)
December 31, 2010
Municipal bonds		$	89,364			$	(3,193	)		$	47,101			$	(5,201	)		$	136,465			$	(8,394	)
MBS			1,460,173				(25,493	)			0				0				1,460,173				(25,493	)
Other			0				0				21,250				(3,566	)			21,250				(3,566	)
Total		$	1,549,537			$	(28,686	)		$	68,351			$	(8,767	)		$	1,617,888			$	(37,453	)

The following table presents the amortized cost and fair value of available-for-sale and held-to-maturity securities as of June 30, 2011, grouped by contractual maturity. Actual maturities for MBS will differ from contractual maturities as a result of the level of prepayments experienced on the underlying mortgages. As of June 30, 2011, the weighted average life of the MBS portfolio was 4.5 years, and its effective duration was 3.4%. This compares with a weighted average life of 5.0 years, and an effective duration of 3.6% at December 31, 2010.

 

		Held-to-maturity								Available-for-sale
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(in thousands)
Due within one year		$	0			$	0			$	482			$	482
Due after one year through five years			0				0				0				0
Due after five years through ten years			0				0				222,773				224,979
Due after ten years			2,054				2,054				2,252,496				2,268,541
Total		$	2,054			$	2,054			$	2,475,751			$	2,494,002

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 are written down to current market value, resulting in a loss. There were no investment securities that management identified to be other-than-temporarily impaired at June 30, 2011, because Sterling expects the return of all principal and interest on all securities within its investment and MBS portfolio pursuant to the contractual terms, has the ability and intent to hold these investments, has no intent to sell securities that are deemed to have a market value impairment, and believes it is unlikely that Sterling would be required to sell these investments before a recovery in market price occurs, or until maturity. As of June 30, 2011, Sterling held nonagency collateralized mortgage obligations with an amortized book value of $27.0 million, and a net unrealized gain of $361,000. All nonagency collateralized mortgage obligations are internally monitored monthly and independently stress-tested quarterly for both credit quality and collateral strength, and are AAA rated according to at least one major rating agency. The vintage, or year of issuance, for these nonagency securities ranges from 2003 to 2005. Additionally as of June 30, 2011, Sterling held municipal bonds with an amortized book value of $188.8 million, and a net unrealized gain of $895,000. Sterling reviews its municipal bonds for impairment at least quarterly. Approximately 90% of Sterling’s municipal bonds are general obligation bonds.

 

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3. Loans Receivable and Allowance for Credit Losses:

The following table presents the composition of Sterling’s loan portfolio as of the balance sheet dates:

 

		June 30, 2011				December 31, 2010
		(in thousands)
Residential real estate		$	712,638			$	758,410
Multifamily real estate			811,917				517,022
Commercial real estate (1)			1,324,058				1,314,657
Construction:
Residential			67,789				156,853
Multifamily			49,908				90,518
Commercial			190,576				278,297
Total construction			308,273				525,668
Consumer			703,675				744,068
Commercial banking (2)			1,741,819				1,770,426
Gross loans receivable			5,602,380				5,630,251
Deferred loan fees, net			(2,578	)			(4,114	)
Allowance for loan losses			(212,088	)			(247,056	)
Net loans receivable		$	5,387,714			$	5,379,081

 

(1)	Comprised of non owner-occupied commercial real estate (“CRE”).

(2)	Comprised of commercial and industrial (“C&I”), and owner-occupied CRE.

Gross loans pledged as collateral for borrowings from the FHLB and the Federal Reserve totaled $1.34 billion and $1.52 billion as of June 30, 2011 and December 31, 2010, respectively. As of June 30, 2011 and December 31, 2010, the unamortized portion of discounts on acquired loans was $4.8 million and $5.3 million, respectively.

 

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The following table sets forth details by segment for Sterling’s loan portfolio and related allowance as of the balance sheet dates:

 

		Real Estate																				Commercial Banking
		Residential				Multifamily				Commercial				Construction				Consumer								Unallocated				Total
		(in thousands)
June 30, 2011
Loans receivable, gross:
Individually evaluated for impairment		$	34,604			$	8,506			$	53,247			$	174,406			$	1,851			$	77,950			$	0			$	350,564
Collectively evaluated for impairment			678,034				803,411				1,270,811				133,867				701,824				1,663,869				0				5,251,816
Total loans receivable, gross		$	712,638			$	811,917			$	1,324,058			$	308,273			$	703,675			$	1,741,819			$	0			$	5,602,380
Allowance for loan losses:
Individually evaluated for impairment		$	(2,146	)		$	(626	)		$	(3,028	)		$	(19,013	)		$	(114	)		$	(5,260	)		$	0			$	(30,187	)
Collectively evaluated for impairment			(18,680	)			(10,625	)			(43,421	)			(25,894	)			(13,686	)			(41,342	)			(28,253	)			(181,901	)
Total allowance for loan losses		$	(20,826	)		$	(11,251	)		$	(46,449	)		$	(44,907	)		$	(13,800	)		$	(46,602	)		$	(28,253	)		$	(212,088	)
December 31, 2010
Loans receivable, gross:
Individually evaluated for impairment		$	74,994			$	23,541			$	103,389			$	332,287			$	4,852			$	80,880			$	0			$	619,943
Collectively evaluated for impairment			683,416				493,481				1,211,268				193,381				739,216				1,689,546				0				5,010,308
Total loans receivable, gross		$	758,410			$	517,022			$	1,314,657			$	525,668			$	744,068			$	1,770,426			$	0			$	5,630,251
Allowance for loan losses:
Individually evaluated for impairment		$	(1,239	)		$	(1,158	)		$	(7,859	)		$	(20,676	)		$	(33	)		$	(6,689	)		$	0			$	(37,654	)
Collectively evaluated for impairment			(16,068	)			(8,510	)			(41,503	)			(45,201	)			(14,612	)			(50,262	)			(33,246	)			(209,402	)
Total allowance for loan losses		$	(17,307	)		$	(9,668	)		$	(49,362	)		$	(65,877	)		$	(14,645	)		$	(56,951	)		$	(33,246	)		$	(247,056	)

 

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The following table presents a roll forward by segment of the allowance for credit losses for the three and six months ended June 30, 2011 and 2010:

 

		Real Estate																				Commercial Banking
		Residential				Multifamily				Commercial				Construction				Consumer								Unallocated				Total
		(in thousands)
2011 quarterly activity
Allowance for loan losses:
Beginning balance, April 1		$	18,512			$	9,554			$	48,564			$	54,909			$	13,056			$	57,384			$	30,965			$	232,944
Chargeoffs			(4,210	)			(457	)			(9,269	)			(19,019	)			(2,117	)			(3,908	)			0				(38,980	)
Recoveries			603				1,167				875				1,879				337				763				0				5,624
Provisions			5,921				987				6,279				7,138				2,524				(7,637	)			(2,712	)			12,500
Ending balance, June 30			20,826				11,251				46,449				44,907				13,800				46,602				28,253				212,088
Allowance for unfunded commitments:
Beginning balance, April 1			3,285				0				0				3,390				1,101				1,386				1,479				10,641
Chargeoffs			(710	)			0				0				0				0				0				0				(710	)
Recoveries			0				0				0				0				0				0				0				0
Provisions			(226	)			0				0				(835	)			1,262				(631	)			(2,070	)			(2,500	)
Ending balance, June 30			2,349				0				0				2,555				2,363				755				(591	)			7,431
Total credit allowance		$	23,175			$	11,251			$	46,449			$	47,462			$	16,163			$	47,357			$	27,662			$	219,519
2010 quarterly activity
Allowance for loan losses:
Beginning balance, April 1		$	25,139			$	9,069			$	47,999			$	125,752			$	17,615			$	66,888			$	2,336			$	294,798
Chargeoffs			(11,340	)			(1,566	)			(14,587	)			(73,113	)			(4,558	)			(3,677	)			0				(108,841	)
Recoveries			483				0				401				5,390				453				265				0				6,992
Provisions			1,110				(2,467	)			21,711				45,721				2,543				(1,854	)			5,137				71,901
Ending balance, June 30			15,392				5,036				55,524				103,750				16,053				61,622				7,473				264,850
Allowance for unfunded commitments:
Beginning balance, April 1			1,080				0				189				7,146				1,273				1,816				819				12,323
Chargeoffs			(252	)			0				0				0				0				0				0				(252	)
Recoveries			0				0				0				0				0				0				0				0
Provisions			666				1				(188	)			(370	)			(158	)			(372	)			(699	)			(1,120	)
Ending balance, June 30			1,494				1				1				6,776				1,115				1,444				120				10,951
Total credit allowance		$	16,886			$	5,037			$	55,525			$	110,526			$	17,168			$	63,066			$	7,593			$	275,801

 

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		Real Estate																				Commercial Banking
		Residential				Multifamily				Commercial				Construction				Consumer								Unallocated				Total
		(in thousands)
2011 year to date
Allowance for loan losses:
Beginning balance, January 1		$	17,307			$	9,668			$	49,362			$	65,877			$	14,645			$	56,951			$	33,246			$	247,056
Chargeoffs			(11,024	)			(667	)			(10,917	)			(28,360	)			(4,263	)			(13,492	)			0				(68,723	)
Recoveries			853				1,167				1,452				5,567				958				1,258				0				11,255
Provisions			13,690				1,083				6,552				1,823				2,460				1,885				(4,993	)			22,500
Ending balance, June 30			20,826				11,251				46,449				44,907				13,800				46,602				28,253				212,088
Allowance for unfunded commitments:
Beginning balance, January 1			3,103				0				31				4,126				1,113				1,306				1,028				10,707
Chargeoffs			(776	)			0				0				0				0				0				0				(776	)
Recoveries			0				0				0				0				0				0				0				0
Provisions			22				0				(31	)			(1,571	)			1,250				(551	)			(1,619	)			(2,500	)
Ending balance, June 30			2,349				0				0				2,555				2,363				755				(591	)			7,431
Total credit allowance		$	23,175			$	11,251			$	46,449			$	47,462			$	16,163			$	47,357			$	27,662			$	219,519
2010 year to date
Allowance for loan losses:
Beginning balance, January 1		$	28,319			$	8,984			$	42,296			$	185,222			$	19,198			$	59,135			$	289			$	343,443
Chargeoffs			(16,060	)			(11,945	)			(22,077	)			(177,622	)			(8,279	)			(16,717	)			0				(252,700	)
Recoveries			604				0				417				11,680				957				658				0				14,316
Provisions			2,529				7,997				34,888				84,470				4,177				18,546				7,184				159,791
Ending balance, June 30			15,392				5,036				55,524				103,750				16,053				61,622				7,473				264,850
Allowance for unfunded commitments:
Beginning balance, January 1			712				0				0				9,228				1,481				1,665				(1,119	)			11,967
Chargeoffs			(562	)			0				0				0				0				0				0				(562	)
Recoveries			0				0				0				0				0				0				0				0
Provisions			1,344				1				1				(2,452	)			(366	)			(221	)			1,239				(454	)
Ending balance, June 30			1,494				1				1				6,776				1,115				1,444				120				10,951
Total credit allowance		$	16,886			$	5,037			$	55,525			$	110,526			$	17,168			$	63,066			$	7,593			$	275,801

 

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In establishing its allowance for loan losses, Sterling groups its loan portfolio into standard industry categories for homogeneous loans. The groups are further segregated based on internal risk ratings. Both qualitative and quantitative data are considered in determining the probability of default and loss given default for each group of loans. The probability of default and loss given default are used to calculate an expected loss rate which is multiplied by the loan balance in each category to determine the general allowance for loan losses. If a loan is determined to be impaired, Sterling performs an individual evaluation of the loan. The individual evaluation compares the present value of the expected future cash flows or the fair value of the underlying collateral to the recorded investment in the loan. The results of the individual impairment evaluation could determine the need to record a confirmed loss or a specific reserve.

Sterling assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

 

•

Pass – asset is considered of sufficient quality to preclude a Special Mention or an adverse rating. Pass assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral.

 

•

Special Mention – asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in Sterling’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

•

Substandard – asset is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified have well-defined weaknesses. They are characterized by the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected.

 

•

Doubtful/Loss – a Doubtful asset has the weaknesses of those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. An asset classified Loss is considered uncollectible and/or of such little value that its continuance as an asset, without establishment of a specific valuation allowance or charge-off, is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value; but rather, it is not practical or desirable to defer writing off an asset that is no longer deemed to have financial value, even though partial recovery may be recognized in the future.

 

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The following table presents credit quality indicators for Sterling’s loan portfolio as of June 30, 2011 and December 31, 2010 grouped according to internally assigned risk ratings and payment activity:

 

		Real Estate																				Commercial Banking								% of total
		Residential				Multifamily				Commercial				Construction				Consumer								Total
		(in thousands)
June 30, 2011
Pass		$	643,819			$	773,610			$	1,148,668			$	70,214			$	690,743			$	1,498,007			$	4,825,061				86	%
Special mention			25,994				17,467				81,502				51,056				5,747				95,740				277,506				5	%
Substandard			42,820				20,840				93,882				186,158				7,185				141,901				492,786				9	%
Doubtful/Loss			5				0				6				845				0				6,171				7,027				0	%
Total		$	712,638			$	811,917			$	1,324,058			$	308,273			$	703,675			$	1,741,819			$	5,602,380				100	%
Restructured		$	19,080			$	0			$	6,287			$	33,193			$	0			$	25,717			$	84,277				2	%
Nonaccrual			35,330				9,115				50,121				142,616				5,565				69,085				311,832				6	%
Nonperforming			54,410				9,115				56,408				175,809				5,565				94,802				396,109				8	%
Performing			658,229				802,802				1,267,650				132,464				698,109				1,647,017				5,206,271				92	%
Total		$	712,639			$	811,917			$	1,324,058			$	308,273			$	703,674			$	1,741,819			$	5,602,380				100	%
December 31, 2010
Pass		$	638,273			$	446,363			$	1,047,239			$	68,099			$	718,831			$	1,474,312			$	4,393,117				78	%
Special mention			15,670				29,566				91,870				89,524				7,074				89,680				323,384				6	%
Substandard			104,467				41,093				175,548				368,045				18,163				205,354				912,670				16	%
Doubtful/Loss			0				0				0				0				0				1,080				1,080				0	%
Total		$	758,410			$	517,022			$	1,314,657			$	525,668			$	744,068			$	1,770,426			$	5,630,251				100	%
Restructured		$	20,569			$	0			$	10,856			$	57,662			$	119			$	19,298			$	108,504				2	%
Nonaccrual			70,842				23,541				95,229				277,992				7,854				70,675				546,133				10	%
Nonperforming			91,411				23,541				106,085				335,654				7,973				89,973				654,637				12	%
Performing			666,999				493,481				1,208,572				190,014				736,095				1,680,453				4,975,614				88	%
Total		$	758,410			$	517,022			$	1,314,657			$	525,668			$	744,068			$	1,770,426			$	5,630,251				100	%

 

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Aging by class for Sterling’s loan portfolio as of June 30, 2011 and December 31, 2010 was as follows:

 

		Real Estate																				Commercial Banking								% of total
		Residential				Multifamily				Commercial				Construction				Consumer								Total
		(in thousands)
June 30, 2011
30 - 59 days past due		$	10,154			$	2,076			$	13,385			$	2,896			$	5,949			$	20,188			$	54,648				1	%
60 - 89 days past due			5,452				0				7,517				1,799				2,082				8,052				24,902				0	%
> 90 days past due			24,188				6,621				27,506				154,523				4,558				59,495				276,891				5	%
Total past due			39,794				8,697				48,408				159,218				12,589				87,735				356,441				6	%
Current			672,844				803,220				1,275,650				149,055				691,086				1,654,084				5,245,939				94	%
Total Loans		$	712,638			$	811,917			$	1,324,058			$	308,273			$	703,675			$	1,741,819			$	5,602,380				100	%
> 90 days and accruing		$	0			$	0			$	0			$	0			$	0			$	0			$	0
December 31, 2010
30 - 59 days past due		$	10,273			$	3,235			$	4,251			$	27,251			$	5,650			$	12,994			$	63,654				1	%
60 - 89 days past due			4,179				6,146				7,089				15,419				1,837				4,099				38,769				1	%
> 90 days past due			35,544				6,428				34,517				232,140				4,834				52,497				365,960				6	%
Total past due			49,996				15,809				45,857				274,810				12,321				69,590				468,383				8	%
Current			708,414				501,213				1,268,800				250,858				731,747				1,700,836				5,161,868				92	%
Total Loans		$	758,410			$	517,022			$	1,314,657			$	525,668			$	744,068			$	1,770,426			$	5,630,251				100	%
> 90 days and accruing		$	0			$	0			$	0			$	0			$	0			$	0			$	0

 

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Sterling considers its nonperforming loans to be impaired loans, which include $45.6 million and $34.7 million of homogeneous and small balance loans which were collectively evaluated for impairment on June 30, 2011 and December 31, 2010, respectively. Impaired loans by class were as follows at June 30, 2011 and December 31, 2010:

 

										Book balance												Three Months Ended June 30, 2011								Six Months Ended June 30, 2011
		Unpaid principal balance				Charge-offs				without specific reserve				with specific reserve				Specific reserve				Average book balance				Interest income recognized				Average book balance				Interest income recognized
		(in thousands)
June 30, 2011
Residential real estate		$	70,225			$	15,815			$	41,169			$	13,241			$	2,146			$	58,572			$	320			$	72,911			$	320
Multifamily real estate			10,496				1,381				8,507				608				626				15,075				95				16,328				623
Commercial real estate			78,047				21,639				35,454				20,954				3,028				60,416				908				81,247				1,228
Construction			269,647				93,839				31,265				144,544				19,013				206,881				14				255,732				44
Consumer			9,315				3,750				4,703				862				114				6,048				0				6,769				0
Commercial banking			145,864				51,061				61,612				33,190				5,260				89,596				709				92,388				1,431
Total		$	583,594			$	187,485			$	182,710			$	213,399			$	30,187			$	436,588			$	2,046			$	525,375			$	3,646
December 31, 2010
Residential real estate		$	114,401			$	22,990			$	27,956			$	63,455			$	1,239
Multifamily real estate			30,464				6,923				8,326				15,215				1,158
Commercial real estate			135,366				29,281				30,400				75,685				7,859
Construction			539,330				203,674				65,618				270,037				20,676
Consumer			12,740				4,767				4,353				3,620				33
Commercial banking			142,111				52,138				46,948				43,024				6,689
Total		$	974,412			$	319,773			$	183,601			$	471,036			$	37,654

 

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At the applicable foreclosure date, OREO is recorded at the fair value of the real estate, less the estimated costs to sell. The carrying value of OREO is periodically evaluated and, if necessary, an allowance is established to reduce the carrying value to net realizable value. Changes in this allowance were as follows for the periods presented:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Allowance for OREO losses:		(in thousands)
Balance, beginning of period		$	14,667			$	12,036			$	21,799			$	8,204
Provision			8,646				9,447				12,855				16,110
Charge-offs			(5,469	)			(7,415	)			(16,810	)			(10,246	)
Balance, end of period		$	17,844			$	14,068			$	17,844			$	14,068

The increase in charge-offs during the first half of 2011 was due to the increase in OREO sales, which totaled $157.2 million for the six months ended June 30, 2011 compared to $69.4 million during the same period in 2010.

4. Junior Subordinated Debentures:

Sterling has raised regulatory capital through the formation of trust subsidiaries and the assumption of similar obligations through mergers with other financial institutions. The trusts are business trusts in which Sterling owns all of the common equity. The proceeds from the sale of the securities were used to purchase 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 the trusts’ obligations. The junior subordinated debentures are treated as debt of Sterling. The junior subordinated debentures generally mature 30 years after issuance and are redeemable at the option of Sterling under certain conditions, including, with respect to certain of the trusts, payment of call premiums. During the third quarter of 2009, Sterling elected to defer regularly scheduled interest payments on these securities, and has continued to defer these payments through June 30, 2011. As of June 30, 2011 and December 31, 2010, the accrued deferred interest was $12.5 million and $9.4 million, respectively. Sterling is allowed to defer payments of interest on the junior subordinated debentures for up to 20 consecutive quarterly periods without triggering an event of default. Details of the junior subordinated debentures are as follows:

 

Subsidiary Issuer

Issue Date

Maturity Date

Next Call Date

Rate at June 30, 2011

Amount

(in thousands)

Sterling Capital Trust IX

July 2007

Oct 2037

Oct 2012

Floating

1.70

%

$

46,392

Sterling Capital Trust VIII

Sept 2006

Sept 2036

Dec 2011

Floating

1.88

51,547

Sterling Capital Trust VII

June 2006

June 2036

Sept 2011

Floating

1.77

56,702

Lynnwood Capital Trust II

June 2005

June 2035

Sept 2011

Floating

2.05

10,310

Sterling Capital Trust VI

June 2003

Sept 2033

Sept 2011

Floating

3.45

10,310

Sterling Capital Statutory Trust V

May 2003

May 2033

Sept 2011

Floating

3.50

20,619

Sterling Capital Trust IV

May 2003

May 2033

Aug 2011

Floating

3.41

10,310

Sterling Capital Trust III

April 2003

April 2033

July 2011

Floating

3.52

14,433

Lynnwood Capital Trust I

Mar 2003

Mar 2033

Sept 2011

Floating

3.40

9,449

Klamath First Capital Trust I

July 2001

July 2031

July 2011

Floating

4.20

15,215

2.39

%*

$

245,287

 

*	Weighted average rate

 

 

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5. Earnings (Loss) Per Share:

The following table presents the basic and diluted earnings per common share computations:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
		(in thousands, except shares and per share amounts)
Numerator:
Net income (loss) available to common shareholders		$	7,555			$	(58,242	)		$	12,972			$	(147,000	)
Denominator:
Weighted average shares outstanding - basic			61,943,851				788,020				61,937,353				787,799
Dilutive securities outstanding			368,373				0				382,675				0
Weighted average shares outstanding - diluted			62,312,224				788,020				62,320,028				787,799
Earnings (loss) per share - basic		$	0.12			$	(73.91	)		$	0.21			$	(186.60	)
Earnings (loss) per share - diluted		$	0.12			$	(73.91	)		$	0.21			$	(186.60	)
Antidilutive securities outstanding (weighted average):
Stock options			16,493				21,799				17,093				21,799
Warrants			0				97,541				0				97,541
Restricted shares			22,752				2,555				50,798				2,555
Total antidilutive securities outstanding			39,245				121,894				67,891				121,894

Prior period share and per share amounts disclosed in this footnote, as well as all other prior period share and per share amounts disclosed in these financial statements, have been restated to reflect the 1-for-66 reverse stock split that was effected in November 2010.

6. Noninterest Expense:

The following table details the components of Sterling’s noninterest expense:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
		(in thousands)
Employee compensation and benefits		$	41,836			$	40,858			$	85,686			$	80,917
OREO operations			14,452				17,206				25,852				28,129
Occupancy and equipment			10,156				9,798				19,978				19,744
Data processing			6,608				5,359				12,688				10,464
Insurance			4,170				10,191				8,675				22,876
Professional fees			3,352				2,786				6,410				9,166
Depreciation			3,014				3,372				6,026				6,940
Advertising			2,768				3,327				4,727				5,910
Travel and entertainment			1,359				960				2,595				1,676
Amortization of core deposit intangibles			1,224				1,224				2,449				2,449
Other			2,648				2,234				4,809				5,021
Total noninterest expense		$	91,587			$	97,315			$	179,895			$	193,292

 

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7. Income Taxes:

Sterling uses an estimate of future earnings and an evaluation of its loss carryback ability and tax planning strategies to determine whether it is more likely than not that it will realize the benefit of its net deferred tax asset. Sterling determined that it did not meet the required threshold as of June 30, 2011 and December 31, 2010, and accordingly, had a full valuation allowance against its net deferred tax assets. As of June 30, 2011, the reserved net deferred tax asset was approximately $350 million, including approximately $279 million of net operating loss carry-forwards. This is compared with a reserved net deferred tax asset of approximately $359 million, including approximately $263 million of net operating loss carry-forwards, as of December 31, 2010.

With regard to the deferred tax asset, the benefits of Sterling’s accumulated tax losses would be reduced in the event of an “ownership change,” as determined under Section 382 of the Internal Revenue Code. During 2010, in order to preserve the benefits of these tax losses, Sterling’s shareholders approved a protective amendment to the restated articles of incorporation and Sterling’s board adopted a tax preservation rights plan, both of which restrict certain stock transfers that would result in an investor acquiring more than 4.95% of Sterling’s total outstanding common stock.

 

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8. Stock-Based Compensation:

The following table presents a summary of stock option and restricted stock activity during the six months ended June 30, 2011:

 

		Stock Options								Restricted Stock
		Number				Weighted Average Exercise Price				Number				Weighted Average Grant Price
Balance, January 1, 2011			18,920			$	1,357.97				368,805			$	18.24
Granted			0				0.00				99,792				17.94
Exercised/vested			0				0.00				(26,579	)			31.35
Cancelled/expired			(2,491	)			1,196.76				(10,543	)			16.39
Outstanding, June 30, 2011			16,429			$	1,382.41				431,475			$	17.41
Exercisable, June 30, 2011			14,396			$	1,496.74

Prior period share and per share amounts disclosed in this footnote, as well as all other prior period share and per share amounts disclosed in these financial statements, have been restated to reflect the 1-for-66 reverse stock split that was effected in November 2010. The following presents the weighted average remaining contractual life and the aggregate intrinsic value for stock options as of the dates indicated:

 

Stock Options

Outstanding

Exercisable

Weighted Average Life

Intrinsic Value

Weighted Average Life

Intrinsic Value

December 31, 2010

2.8 years

$

0

2.6 years

$

0

June 30, 2011

2.6 years

0

2.5 years

0

As of June 30, 2011, a total of 5,515,720 shares remained available for grant under Sterling’s 2003, 2007 and 2010 Long-Term Incentive Plans. The stock options granted under these plans have terms of four, six, eight and ten years. Restricted shares granted during 2011 have vesting schedules that vary, ranging from vesting immediately upon grant to vesting up to three years after the grant date.

Stock-based compensation expense recognized during the periods presented was as follows:

 

		Six Months Ended June 30,
		2011				2010
		(in thousands)
Stock options		$	172			$	386
Restricted stock			1,792				322
Total		$	1,964			$	708

As of June 30, 2011, unrecognized equity compensation expense totaled $6.3 million, as the underlying outstanding awards had not yet been earned. This amount will be recognized over a weighted average period of 1.7 years. During the six months ended June 30, 2011, 156 stock options were forfeited, and 10,543 shares of restricted stock were forfeited.

9. Derivatives and Hedging:

From time to time, Sterling may enter into interest rate swap transactions with loan customers. The interest rate risk on these swap transactions is managed by entering into offsetting interest rate swap agreements with various unaffiliated counterparties (“broker-dealers”). Both customer and broker-dealer related interest rate derivatives are carried at fair value by Sterling.

As part of its mortgage banking activities, Sterling makes commitments to prospective borrowers on residential mortgage loan applications, which may have the interest rates locked for a period of 10 to 60 days (“interest rate lock commitments”). These interest rate lock commitments, and loans held for sale that have not been committed to investors, give rise to interest rate risk. Sterling hedges the interest rate risk arising from these mortgage banking activities by entering into forward sales agreements on MBS with third parties (“forward commitments”).

 

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Residential mortgage loans held for sale that were not committed to investors were $138.9 million and $207.0 million as of June 30, 2011 and December 31, 2010, respectively. The following table summarizes the off-balance sheet portions of Sterling’s mortgage banking operations, as well as Sterling’s interest rate swaps:

 

		June 30, 2011
						Fair Value
		Notional				Asset				Liability
		(in thousands)
Interest rate lock commitments		$	162,893			$	2,836			$	—
Forward commitments			292,569				0				1,090
Interest rate swaps - broker-dealer			45,847				0				4,205
Interest rate swaps - customer			48,477				4,416				0
		December 31, 2010
						Fair Value
		Notional				Asset				Liability
		(in thousands)
Interest rate lock commitments		$	118,589			$	1,869			$	—
Forward commitments			285,300				3,770				0
Interest rate swaps - broker-dealer			47,815				0				4,426
Interest rate swaps - customer			50,467				4,877				0

The fair value of these derivatives are included in other assets and liabilities, respectively. Gains and losses on Sterling’s mortgage banking derivative transactions are included in mortgage banking income, while gains and losses on Sterling’s interest rate swap transactions are included in other noninterest income, and were as follows for the periods presented:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
		(in thousands)
Mortgage banking operations			(4,664	)			(6,888	)			(7,504	)			(7,568	)
Other noninterest income			30				88				37				77

10. Fair Value:

Fair value estimates are determined as of a specific date using quoted market prices, where available, or various assumptions and estimates. As the assumptions underlying these estimates change, the fair value of the financial instruments will change. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. Accordingly, the aggregate fair value amounts presented do not represent and should not be construed to represent the full underlying value of Sterling.

 

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The carrying amounts and fair values of financial instruments as of the periods indicated were as follows. Other assets are comprised of FHLB stock and derivatives, while other liabilities are comprised of derivatives:

 

		June 30, 2011								December 31, 2010
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
Financial assets:			(in thousands)
Cash and cash equivalents		$	587,210			$	587,210			$	427,264			$	427,264
Investments and MBS:
Available for sale			2,494,002				2,494,002				2,825,010				2,825,010
Held to maturity			2,054				2,054				13,464				13,464
Loans held for sale			197,643				197,643				222,216				222,216
Loans receivable, net			5,387,714				5,148,479				5,379,081				5,078,157
Accrued interest receivable			32,018				32,018				34,087				34,087
Other assets			106,763				106,763				106,717				106,717
Financial liabilities:
Non-maturity deposits			3,506,712				3,260,938				3,376,188				3,123,840
Deposits with stated maturities			3,097,286				3,130,533				3,534,819				3,588,051
Borrowings			1,711,052				1,685,227				1,685,008				1,660,387
Accrued interest payable			20,060				20,060				17,259				17,259
Other liabilities			5,660				5,660				6,176				6,176

Companies have the option of carrying financial assets and liabilities at fair value, which can be implemented on all or individually selected financial instruments. The framework for defining and measuring fair value requires that one of three valuation methods be used to determine fair market value: the market approach, the income approach or the cost approach. To increase consistency and comparability in fair value measurements and related disclosures, the standard also creates a fair value hierarchy to prioritize the inputs to these valuation methods into the following three levels:

 

•

Level 1 inputs are a select class of observable inputs, based upon the quoted prices for identical instruments in active markets that are accessible as of the measurement date, and are to be used whenever available.

 

•

Level 2 inputs are other types of observable inputs, such as quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are inactive; or other inputs that are observable or can be derived from or supported by observable market data. Level 2 inputs are to be used whenever Level 1 inputs are not available.

 

•

Level 3 inputs are substantially unobservable, reflecting the reporting entity’s own assumptions regarding what market participants would assume when pricing a financial instrument. Level 3 inputs are to be used only when Level 1 and Level 2 inputs are unavailable.

The methods and assumptions used to estimate the fair value of each class of financial instruments are as follows:

Cash and Cash Equivalents

The carrying value of cash and cash equivalents approximates fair value due to the relatively short-term nature of these instruments.

Investments and MBS

The fair value of investments and MBS has been valued using a matrix pricing technique based on quoted prices for similar instruments, which Sterling validates with non-binding broker quotes, in depth collateral analysis and cash flow stress testing.

 

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Loans Held for Sale

Sterling has elected to carry loans held for sale at fair value. The fair values are based on investor quotes in the secondary market based upon the fair value of options and commitments to sell or issue mortgage loans. The fair value election was made to match changes in the value of these loans with the value of their economic hedges. Loan origination fees, costs and servicing rights, which were previously deferred on these loans, are now recognized as part of the loan value at origination.

Loans Receivable

The fair value of performing loans is estimated by discounting the cash flows using interest rates that consider the current credit and interest rate risk inherent in the loans and current economic and lending conditions and does not incorporate the exit price concept of fair value. The fair value of nonperforming collateral dependent loans is estimated based upon the value of the underlying collateral. The fair value of other nonperforming loans is estimated by discounting management’s current estimate of future cash flows using a rate estimated to be commensurate with the risks involved. In addition, a liquidity discount has been applied against the entire portfolio to reflect the uncertainty surrounding the timing of when a sale may occur.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated using a discounted cash flow model to arrive at the present value of future expected earnings from the servicing of the loans. Model inputs include prepayment speeds, market interest rates, contractual interest rates on the loans being serviced, and the amount of other fee income generated over the servicing contract.

OREO

The fair value of OREO is estimated using third party appraisals, subject to updates to reflect comparable market transactions, with appraisals ordered for “as is” or “disposal value.”

Deposits

The fair values of deposits subject to immediate withdrawal such as interest and noninterest bearing checking, regular savings, and money market deposit accounts, are equal to the amounts payable on demand at the reporting date, net of a core deposit intangible. Fair values for time deposits are estimated by discounting future cash flows using interest rates currently offered on time deposits with similar remaining maturities.

Borrowings

The carrying amounts of short-term borrowings under repurchase agreements, federal funds purchased, short-term FHLB advances and other short-term borrowings approximate their fair values due to the relatively short period of time between the origination of the instruments and the expected payment dates on the instruments. The fair value of advances under lines of credit approximates their carrying value because such advances bear variable rates of interest. The fair value of long-term FHLB advances and other long-term borrowings is estimated using discounted cash flow analyses based on Sterling’s current incremental borrowing rates for similar types of borrowing arrangements with similar remaining terms.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis. The following table presents Sterling’s financial instruments that are measured at fair value on a recurring basis:

 

		Total				Level 1				Level 2				Level 3
		(in thousands)
Balance, June 30, 2011:
Investment securities available-for-sale:
MBS		$	2,282,497			$	0			$	2,282,497			$	0
Municipal bonds			189,647				0				189,647				0
Other			21,858				0				21,858				0
Total investment securities available-for-sale			2,494,002				0				2,494,002				0
Loans held for sale			197,643				0				197,643				0
Other assets - derivatives			7,252				0				7,252				0
Total assets		$	2,698,897			$	0			$	2,698,897			$	0
Other liabilities - derivatives		$	5,660			$	0			$	5,660			$	0
Balance, December 31, 2010:
Investment securities available-for-sale:
MBS		$	2,602,610			$	0			$	2,602,610			$	0
Municipal bonds			201,143				0				201,143				0
Other			21,257				0				21,257				0
Total investment securities available-for-sale			2,825,010				0				2,825,010				0
Loans held for sale			222,216				0				222,216				0
Other assets - derivatives			6,746				0				6,746				0
Total assets		$	3,053,972			$	0			$	3,053,972			$	0
Other liabilities - derivatives		$	6,176			$	0			$	6,176			$	0

Derivatives represent mortgage banking interest rate lock and loan delivery commitments, a common stock warrant carried as a derivative liability, as well as interest rate swaps. Market values on the interest rate swaps equal the present value differential between the fixed interest rate payments, as established in the swap agreement, and the floating interest rate payments, as projected by the forward interest rate curve, over the agreed to term of the swap. See Note 9 for a further discussion of these derivatives. The difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale that are carried at fair value were included in earnings as follows:

 

		Six Months Ended June 30,
		2011				2010
		(in thousands)
Mortgage banking operations		$	4,581			$	6,846

 

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Assets and Liabilities Measured at Fair Value on a Non-recurring Basis. Sterling may be required, from time to time, to measure certain assets at fair value on a non-recurring basis from application of lower of cost or market (“LOCOM”) accounting or write-downs of individual assets. The following table presents the carrying value for these assets as of the dates indicated:

 

		June 30, 2011																Losses During the Six  Months Ended June 30, 2011
		Total Carrying Value				Level 1				Level 2				Level 3
		(in thousands)
Loans		$	216,851			$	0			$	0			$	216,851			$	(29,415	)
OREO			32,369				0				0				32,369				(9,906	)
Mortgage servicing rights			23,880				0				0				23,880				(369	)
																		Gains (Losses) During the Twelve Months Ended December 31, 2010
		December 31, 2010
		Total Carrying Value				Level 1				Level 2				Level 3
Loans		$	549,320			$	0			$	0			$	549,320			$	(181,165	)
OREO			63,586				0				0				63,586				(21,096	)
Mortgage servicing rights			20,604				0				0				20,604				1,115

The loans disclosed above represent the net balance of loans for which a charge against earnings has occurred during the six months ended June 30, 2011, and the year ended December 31, 2010, respectively, with these charges comprised of charge-offs and increases in the specific reserve. OREO represents the carrying value on properties for which a specific reserve was established during the periods presented related to updated appraisals subsequent to foreclosure. In addition to the loan and OREO losses disclosed above, charge-offs at foreclosure for properties held as of period end totaled $18.6 million and $33.9 million for the six months ended June 30, 2011 and the year ended December 31, 2010, respectively. Fair value adjustments to the mortgage servicing rights were mainly due to market derived assumptions associated with mortgage prepayment speeds. Sterling carries its mortgage servicing rights at LOCOM, and they are accordingly measured at fair value on a non-recurring basis.

11. Regulatory Capital:

The following table sets forth the respective regulatory capital positions for Sterling and Sterling Savings Bank as of June 30, 2011:

 

		Actual								Adequately Capitalized								Well- Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
										(in thousands)
Tier 1 leverage ratio
Sterling		$	1,016,939				10.9	%		$	373,753				4.0	%		$	467,192				5.0	%
Sterling Savings Bank			986,113				10.6	%			373,722				4.0	%			467,153				5.0	%
Tier 1 risk-based capital ratio
Sterling			1,016,939				16.9	%			241,107				4.0	%			361,660				6.0	%
Sterling Savings Bank			986,113				16.4	%			240,759				4.0	%			361,138				6.0	%
Total risk-based capital ratio
Sterling			1,094,065				18.2	%			482,213				8.0	%			602,767				10.0	%
Sterling Savings Bank			1,063,131				17.7	%			481,518				8.0	%			601,897				10.0	%

12. Segment Information:

For 2011, Sterling changed its reporting segments to reflect the integration of Golf Savings Bank into Sterling Savings Bank and leadership realignments. The segments for 2011 are as follows:

 

•

Community Banking – a division within Sterling Savings Bank providing traditional banking services through the retail banking, private banking and commercial banking groups.

 

•

Home Loan Division – originating residential real estate loans primarily through the mortgage banking operations of Sterling Savings Bank on both a servicing-retained and servicing-released basis.

 

•

Commercial Real Estate – a division within Sterling Savings Bank focused on the origination and servicing of multifamily real estate, commercial real estate and construction loans.

 

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The Other and Eliminations caption represents intercompany eliminations of revenue and expenses. Segment results for the comparable period presented are grouped according to the original classifications, due to the impracticability of reclassification to current period presentation.

 

		As of and for the Three Months Ended June 30, 2011
		Community Banking				Home Loan Division				Commercial Real Estate				Other and Eliminations				Total
		(in thousands)
Interest income		$	89,179			$	1,537			$	11,861			$	(230	)		$	102,347
Interest expense			24,098				472				3,017				(47	)			27,540
Net interest income			65,081				1,065				8,844				(183	)			74,807
Provision for credit losses			8,623				33				1,344				0				10,000
Noninterest income			23,817				8,716				1,619				183				34,335
Noninterest expense			75,974				10,219				5,394				0				91,587
Income (loss) before income taxes		$	4,301			$	(471	)		$	3,725			$	0			$	7,555
Total assets		$	7,772,328			$	205,799			$	991,242			$	272,226			$	9,241,595

 

As of and for the Three Months Ended June 30, 2010

Community Banking

Residential Construction Lending

Residential Mortgage