06 2013 10-Q
Table of Contents

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, 2013
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) 358-8097
(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  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data 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  þ    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
 
þ
 
 
 
 
 
Non-accelerated filer
 
¨
(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  þ
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 31, 2013
Common Stock
 
62,314,862

Table of Contents

TABLE OF CONTENTS
June 30, 2013
 
 
 
Page
PART I - Financial Information
 
Item 1
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
Item 3
Item 4
PART II - Other Information
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6
 
 


Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except shares)
 
 
June 30,
2013
 
December 31,
2012
ASSETS:
 
 
 
Cash and cash equivalents:
 
 
 
Interest bearing
$
221,192

 
$
173,962

Noninterest bearing
87,870

 
125,916

Total cash and cash equivalents
309,062

 
299,878

Restricted cash
16,648

 
31,672

Investments and mortgage-backed securities ("MBS"):
 
 
 
Available for sale
1,538,880

 
1,513,157

Held to maturity
185

 
206

Loans held for sale, at fair value
307,511

 
465,983

Loans receivable, net ($36,338 and $23,177 at fair value)
6,868,866

 
6,101,749

Accrued interest receivable
31,013

 
28,019

Other real estate owned, net ("OREO")
26,511

 
25,042

Properties and equipment, net
98,483

 
93,850

Bank-owned life insurance ("BOLI")
188,178

 
179,828

Goodwill
36,633

 
22,577

Other intangible assets, net
17,830

 
19,072

Mortgage servicing rights, net
52,430

 
32,420

Deferred tax asset, net
290,377

 
292,082

Other assets, net
156,966

 
131,375

Total assets
$
9,939,573

 
$
9,236,910

LIABILITIES:
 
 
 
Deposits:
 
 
 
Noninterest bearing
$
1,702,022

 
$
1,702,740

Interest bearing
4,926,437

 
4,733,377

Total deposits
6,628,459

 
6,436,117

Advances from Federal Home Loan Bank ("FHLB")
1,197,857

 
605,330

Securities sold under repurchase agreements
527,925

 
586,867

Junior subordinated debentures
245,297

 
245,294

Accrued interest payable
4,084

 
4,229

Accrued expenses and other liabilities
129,615

 
141,150

Total liabilities
8,733,237

 
8,018,987

SHAREHOLDERS’ EQUITY:
 
 
 
Preferred stock, 10,000,000 shares authorized; no shares outstanding
0

 
0

Common stock, 151,515,151 shares authorized; 62,297,712 and 62,207,529 shares outstanding, respectively
1,970,229

 
1,968,025

Accumulated other comprehensive income
30,751

 
60,712

Accumulated deficit
(794,644
)
 
(810,814
)
Total shareholders’ equity
1,206,336

 
1,217,923

Total liabilities and shareholders’ equity
$
9,939,573

 
$
9,236,910


See notes to consolidated financial statements.
3
Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
 
2012
 
2013
 
2012
Interest income:
 
 
 
 
 
 
 
Loans
$
84,436

 
$
85,537

 
$
165,623

 
$
165,378

MBS
7,333

 
12,936

 
14,630

 
28,271

Investments and cash equivalents
2,248

 
2,517

 
4,521

 
5,306

Total interest income
94,017

 
100,990

 
184,774

 
198,955

Interest expense:
 
 
 
 
 
 
 
Deposits
6,038

 
9,921

 
12,345

 
21,023

Short-term borrowings
288

 
1,825

 
734

 
4,031

Long-term borrowings
7,277

 
10,334

 
14,387

 
20,638

Total interest expense
13,603

 
22,080

 
27,466

 
45,692

Net interest income
80,414

 
78,910

 
157,308

 
153,263

Provision for credit losses
0

 
4,000

 
0

 
8,000

Net interest income after provision for credit losses
80,414

 
74,910

 
157,308

 
145,263

Noninterest income:
 
 
 
 
 
 
 
Fees and service charges
15,618

 
14,131

 
29,748

 
26,871

Mortgage banking operations
23,180

 
24,181

 
36,974

 
42,725

BOLI
1,424

 
3,769

 
2,981

 
5,515

Gains on sales of securities
0

 
9,321

 
0

 
9,463

Other-than-temporary impairment credit losses on securities (1)
0

 
(6,819
)
 
0

 
(6,819
)
Charge on prepayment of debt
0

 
(2,664
)
 
0

 
(2,664
)
Gains on other loan sales
1,194

 
2,811

 
1,219

 
3,411

Other
587

 
11

 
8,647

 
(2,174
)
Total noninterest income
42,003

 
44,741

 
79,569

 
76,328

Noninterest expense
81,678

 
87,607

 
163,607

 
176,256

Income before income taxes
40,739

 
32,044

 
73,270

 
45,335

Income tax (provision) benefit
(12,978
)
 
288,842

 
(22,831
)
 
288,842

Net income
$
27,761

 
$
320,886

 
$
50,439

 
$
334,177

Earnings per share - basic
$
0.45

 
$
5.17

 
$
0.81

 
$
5.38

Earnings per share - diluted
$
0.44

 
$
5.13

 
$
0.80

 
$
5.33

Dividends declared per share
$
0.55

 
$
0.00

 
$
0.55

 
$
0.00

Weighted average shares outstanding - basic
62,289,437

 
62,112,936

 
62,265,941

 
62,095,670

Weighted average shares outstanding - diluted
63,107,913

 
62,610,054

 
63,076,481

 
62,648,152



 (1) The other-than-temporary impairment recognized in earnings during the second quarter of 2012 did not have a portion recognized in accumulated other comprehensive income. See Note 3.


See notes to consolidated financial statements.
4
Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
 
 
 
Three Months Ended
 
 
June 30,
 
 
2013
 
 
2012
Net income
 
$
27,761

 
 
$
320,886

Beginning balance, accumulated other comprehensive income
$
56,076

 
 
$
65,571

 
Other comprehensive (loss) income:
 
 
 
 
 
Change in unrealized gains on investments and MBS available for sale
 
(40,198
)
 
 
7,714

Realized net gains reclassified from other comprehensive income
 
0

 
 
(2,502
)
Less deferred income tax benefit (provision)
 
14,873

 
 
(3,681
)
Net other comprehensive (loss) income
 
(25,325
)
 
 
1,531

Ending balance, accumulated other comprehensive income
$
30,751

 
 
$
67,102

 
Comprehensive income
 
$
2,436

 
 
$
322,417

 
 
 
 
 
 
 
 
Six Months Ended
 
 
June 30,
 
 
2013
 
 
2012
Net income
 
$
50,439

 
 
$
334,177

Beginning balance, accumulated other comprehensive income
$
60,712

 
 
$
61,115

 
Other comprehensive (loss) income:
 
 
 
 
 
Change in unrealized gains on investments and MBS available for sale
 
(47,557
)
 
 
12,312

Realized net gains reclassified from other comprehensive income
 
0

 
 
(2,644
)
Less deferred income tax benefit (provision)
 
17,596

 
 
(3,681
)
Net other comprehensive (loss) income
 
(29,961
)
 
 
5,987

Ending balance, accumulated other comprehensive income
$
30,751

 
 
$
67,102

 
Comprehensive income
 
$
20,478

 
 
$
340,164

For the periods presented, accumulated other comprehensive income was comprised solely of unrealized market value adjustments on available for sale securities. The realized portion reclassified out of other comprehensive income is reflected on the income statement in gains on sales of securities and other-than-temporary impairment.


See notes to consolidated financial statements.
5
Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Six Months Ended June 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
50,439

 
$
334,177

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
0

 
8,000

Net gain on sales of loans
(30,621
)
 
(42,969
)
Net gain on sales of investments and MBS
0

 
(9,463
)
Net gain on mortgage servicing rights
(5,614
)
 
(1,143
)
Other-than-temporary impairment credit losses on securities
0

 
6,819

Stock based compensation
1,791

 
1,837

Loss (gain) on OREO
241

 
(1,605
)
Release of DTA valuation allowance
0

 
(288,842
)
Increase in cash surrender value of BOLI
(2,920
)
 
(5,390
)
Depreciation and amortization
21,740

 
22,192

Bargain purchase gain
(7,544
)
 
0

Change in:
 
 
 
Accrued interest receivable
(2,184
)
 
5,050

Prepaid expenses and other assets
(9,060
)
 
(32,479
)
Accrued interest payable
(185
)
 
(16,728
)
Accrued expenses and other liabilities
(40,262
)
 
7,276

Proceeds from sales of loans originated for sale
1,601,564

 
1,205,473

Loans originated for sale
(1,417,216
)
 
(1,158,269
)
Net cash provided by operating activities
160,169

 
33,936

Cash flows from investing activities:
 
 
 
Change in restricted cash
15,024

 
(17,431
)
Net change in loans
(428,774
)
 
(243,657
)
Proceeds from sales of loans
22,170

 
20,515

Purchase of investment securities
0

 
(2,534
)
Proceeds from maturities of investment securities
1,176

 
17,505

Proceeds from sale of investment securities
0

 
179,235

Purchase of MBS
(280,490
)
 
(72,032
)
Principal payments received on MBS
200,823

 
314,414

Proceeds from sales of MBS
0

 
183,636

Office properties and equipment, net
(9,125
)
 
(4,647
)
Improvements and other changes to OREO
(776
)
 
(1,250
)
Proceeds from sales of OREO
18,318

 
51,515

Net change in cash and cash equivalents from acquisitions
(115,768
)
 
121,098

Net cash (used in) provided by investing activities
$
(577,422
)
 
$
546,367

 
 
 
 

See notes to consolidated financial statements.
6
Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)—cont.
(in thousands)
 
Six Months Ended June 30,
 
2013
 
2012
Cash flows from financing activities:
 
 
 
Net change in deposits
$
(94,126
)
 
$
(384,963
)
Advances from FHLB
1,060,000

 
0

Repayment of advances from FHLB
(468,440
)
 
(200,104
)
Net change in short term repurchase agreements
(8,942
)
 
561

Payments under structured repurchase agreements
(50,000
)
 
(50,000
)
Proceeds from stock issuance, net
413

 
236

Cash dividend paid
(12,468
)
 
0

Net cash provided by (used in) financing activities
426,437

 
(634,270
)
Net change in cash and cash equivalents
9,184

 
(53,967
)
Cash and cash equivalents, beginning of period
299,878

 
470,599

Cash and cash equivalents, end of period
$
309,062

 
$
416,632

Supplemental disclosures:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
27,611

 
$
62,287

Income taxes, net
692

 
56

Noncash financing and investing activities:
 
 
 
Foreclosed real estate acquired in settlement of loans
14,847

 
22,551

Common stock cash dividend accrued
21,801

 
0




See notes to consolidated financial statements.
7
Table of Contents

STERLING FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2013

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, 2012. References to "Sterling" in this report are to Sterling Financial Corporation, a Washington corporation, and its consolidated subsidiaries on a combined basis, unless otherwise specified or the context otherwise requires. References to "Sterling Bank" refer to our subsidiary Sterling Savings Bank, a Washington state-chartered commercial bank.
In the opinion of management, the unaudited interim consolidated financial statements furnished herein include 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’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 February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-04, "Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date." ASU 2013-04 provides guidance for the recognition, measurement, and disclosure of such obligations. ASU 2013-04 is effective for fiscal years beginning after December 15, 2013, and is not expected to have a material impact on Sterling's consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." ASU 2013-11 provides guidance on the presentation of unrecognized tax benefits related to any disallowed portion of net operating loss carryforwards, similar tax losses, or tax credit carryforwards, if they exist. ASU 2013-11 is effective for fiscal years beginning after December 15, 2013, and is not expected to have a material impact on Sterling's consolidated financial statements.


8
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2. Business Combinations:

Boston Private Bank and Trust Company. On May 10, 2013, Sterling paid $123.0 million in cash to acquire the Puget Sound operations of Boston Private Bank & Trust Company ("Boston Private"), a wholly owned subsidiary of Boston Private Financial Holdings, Inc. The Boston Private Puget Sound offices are located in Seattle, Bellevue and Redmond, Washington. The following table summarizes the amounts recorded at closing:

 
May 10, 2013
 
(in thousands)
Cash and cash equivalents
$
340

Loans receivable, net
273,353

Goodwill
14,056

Core deposit intangible
1,674

Other assets
2,721

Total assets acquired
$
292,144

Deposits
$
168,246

Other liabilities
913

Total liabilities assumed
169,159

Net assets acquired
$
122,985


The recorded goodwill represents the inherent value of the Boston Private transaction, which expands Sterling's presence in the Puget Sound market through the addition of two branch offices and the associated customer relationships. The additional branches are along the I-5 corridor, which has been identified by Sterling as its primary focus for future growth. The amount of goodwill deductible for income tax purposes is approximately equivalent to the recorded book value. The core deposit intangible has an amortization period of approximately ten years and will be amortized on an accelerated basis.

As of May 10, 2013, the unpaid principal balance and contractual interest ("contractual cash flows") on purchased loans was $280.7 million. Sterling estimated that $3.5 million of these cash flows would be uncollectable, resulting in a combined credit and interest rate discount of $5.1 million being recorded on these loans. As of the acquisition date, none of the loans purchased from Boston Private exhibited evidence of credit deterioration.


9
Table of Contents

American Heritage Holdings. On February 28, 2013, Sterling paid $6.5 million in cash and paid off an existing note payable of $2.2 million for a total of $8.7 million in consideration to acquire American Heritage Holdings, the holding company for Borrego Springs Bank, N.A. ("Borrego"). Immediately following the acquisition, Borrego was merged with and into Sterling's principal operating subsidiary, Sterling Bank, with Borrego's operations continuing under the registered trade name of Borrego Springs Bank. As a result of this transaction, Sterling has expanded its SBA lending platform and added depository branches in Southern California. The following table summarizes the amounts recorded at closing:
 
February 28, 2013
 
(in thousands)
Cash and cash equivalents
15,626

Investments and MBS
1,030

Loans receivable, net
97,262

Core deposit intangible
453

Other assets
27,197

Total assets acquired
$
141,568

Deposits
$
118,221

Other liabilities
7,054

Total liabilities assumed
125,275

Net assets acquired
16,293

Consideration paid
8,749

Bargain purchase gain
$
7,544

Sterling recognized a bargain purchase gain of $7.5 million in the transaction for the net assets acquired in excess of the purchase price, primarily due to a limited market for Borrego's assets, as well as Borrego's regulatory and capital constraints. The bargain purchase gain is included in other noninterest income on the income statement for the six months ended June 30, 2013. The core deposit intangible has an amortization period of 11 years and will be amortized on an accelerated basis. On the acquisition date of February 28, 2013, the contractual cash flows of purchased impaired loans, which are described in Note 4, from Borrego were $16.1 million, cash flows expected to be collected $13.6 million, and the fair value of the loans $11.9 million, with $9.8 million of these loans being guaranteed by government agencies.

As of February 28, 2013, the contractual cash flows on purchased loans that had not exhibited evidence of credit deterioration was $83.3 million. Sterling estimated that $3.9 million of these cash flows would be uncollectable, resulting in a combined credit and interest rate discount of $4.5 million being recorded on these loans.


10
Table of Contents

First Independent Bank. On February 29, 2012, Sterling Bank completed its acquisition of the operations of First Independent Bank ("First Independent") of Vancouver, Washington, by acquiring certain assets and assuming certain liabilities, including all deposits for a net purchase price of $40.6 million, comprised of $28.9 million of cash paid at closing and contingent consideration with a fair value of $11.7 million at acquisition date. During the six months ended June 30, 2013, the first of two scheduled contingent payments was made in the amount of $6.8 million. At June 30, 2013, the fair value estimate of the remaining contingent consideration was $9.9 million. See Note 13. The following table summarizes the amounts recorded at closing:
 
February 29, 2012
 
(in thousands)
Cash and cash equivalents
$
150,045

Investments and MBS
187,465

Loans receivable, net
349,990

Goodwill
22,577

Core deposit intangible
11,974

Fixed assets
4,038

Other assets
10,886

Total assets acquired
$
736,975

Deposits
$
695,919

Other liabilities
409

Total liabilities assumed
696,328

Net assets acquired
$
40,647


The recorded goodwill of $22.6 million represents the inherent long-term value anticipated from synergies expected to be achieved as a result of the transaction. The First Independent transaction expands Sterling's presence in the Vancouver and Portland markets, which are also within the I-5 corridor. The amount recorded for goodwill includes subsequent adjustments, primarily from updated appraisals on fixed assets. The amount of goodwill deductible for income tax purposes is approximately equivalent to the recorded book value. The core deposit intangible has a weighted average amortization period of ten years and will be amortized on an accelerated basis. On the acquisition date of February 29, 2012, the contractual cash flows of purchased impaired loans from First Independent were $24.4 million, cash flows expected to be collected $17.2 million, and the fair value of the loans $15.3 million.

As of February 29, 2012, the contractual cash flows on purchased loans that had not exhibited evidence of credit deterioration was $403.8 million. Sterling estimated that $12.7 million of these cash flows would be uncollectable, resulting in a discount of $21.8 million being recorded on these loans.

The following table presents certain First Independent stand alone amounts and pro forma Sterling and First Independent combined amounts as if the transaction had occurred on January 1, 2012. Cost savings estimates are not included in the pro forma combined results, nor are certain credit impaired loans and associated losses excluded from the purchase and assumption transaction.
 
First Independent (stand alone)
 
Pro Forma Combined
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012
 
(in thousands, except per share data)
Net interest income
$
7,859

 
$
11,100

 
$
78,910

 
$
159,744

Noninterest income
1,678

 
2,181

 
44,741

 
77,333

Net income
3,901

 
6,008

 
320,886

 
338,391

Earnings per share - basic
0.06

 
0.10

 
5.17

 
5.45

Earnings per share - diluted
$
0.06

 
$
0.10

 
$
5.13

 
$
5.40


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3. 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, 2013
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
1,337,908

 
$
18,264

 
$
(12,991
)
 
$
1,343,181

Municipal bonds
187,468

 
9,139

 
(1,077
)
 
195,530

Other
162

 
7

 
0

 
169

Total
$
1,525,538

 
$
27,410

 
$
(14,068
)
 
$
1,538,880

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
185

 
$
0

 
$
0

 
$
185

Total
$
185

 
$
0

 
$
0

 
$
185

December 31, 2012
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
1,263,786

 
$
45,052

 
$
0

 
$
1,308,838

Municipal bonds
188,467

 
16,452

 
(613
)
 
204,306

Other
5

 
8

 
0

 
13

Total
$
1,452,258

 
$
61,512

 
$
(613
)
 
$
1,513,157

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
206

 
$
0

 
$
0

 
$
206

Total
$
206

 
$
0

 
$
0

 
$
206


Sterling’s MBS portfolio is comprised primarily of residential agency securities. Total sales of Sterling’s securities during the periods ended June 30, 2013 and 2012 are summarized as follows:

 
Proceeds from
Sales
 
Gross Realized
Gains
 
Gross Realized
Losses
 
(in thousands)
Six Months Ended:
 
 
 
 
 
June 30, 2013
$
0

 
$
0

 
$
0

June 30, 2012
362,871

 
9,537

 
(74
)


12
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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, 2013 and December 31, 2012, 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, 2013
 
 
 
 
 
 
 
 
 
 
 
MBS
$
505,378

 
$
(12,991
)
 
$
0

 
$
0

 
$
505,378

 
$
(12,991
)
Municipal bonds
1,550

 
(11
)
 
14,551

 
(1,066
)
 
16,101

 
(1,077
)
Other
0

 
0

 
0

 
0

 
0

 
0

Total
$
506,928

 
$
(13,002
)
 
$
14,551

 
$
(1,066
)
 
$
521,479

 
$
(14,068
)
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
MBS
$
0

 
$
0

 
$
0

 
$
0

 
$
0

 
$
0

Municipal bonds
0

 
0

 
12,921

 
(613
)
 
12,921

 
(613
)
Other
0

 
0

 
0

 
0

 
0

 
0

Total
$
0

 
$
0

 
$
12,921

 
$
(613
)
 
$
12,921

 
$
(613
)

Management evaluates investment securities for other-than-temporary declines in fair value each quarter. If the fair value of investment securities falls below the amortized cost and the decline is deemed to be other-than temporary, the securities are written down to current market value, resulting in the recognition of an other-than-temporary impairment ("OTTI"). During the six months ended June 30, 2013, no securities were determined to be other-than-temporarily impaired, while during the comparative 2012 period, $6.8 million of OTTI was recognized on a single issuer trust preferred security. The security is no longer owned by Sterling.

The following table presents the amortized cost and fair value of available for sale and held to maturity securities as of June 30, 2013, 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.  

 
Held to maturity
 
Available for sale
 
Amortized Cost
 
Fair
Value
 
Amortized Cost
 
Fair
Value
 
(in thousands)
Due within one year
$
0

 
$
0

 
$
0

 
$
0

Due after one year through five years
0

 
0

 
9,907

 
10,539

Due after five years through ten years
0

 
0

 
74,756

 
74,895

Due after ten years
185

 
185

 
1,440,875

 
1,453,446

Total
$
185

 
$
185

 
$
1,525,538

 
$
1,538,880



13
Table of Contents

4. 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,
2013
 
December 31,
2012
 
(in thousands)
Residential real estate
$
964,872

 
$
806,722

Commercial real estate ("CRE"):
 
 
 
Investor CRE
1,172,433

 
1,219,847

Multifamily
1,962,919

 
1,580,289

Construction
69,796

 
74,665

Total CRE
3,205,148

 
2,874,801

Commercial:
 
 
 
Owner occupied CRE
1,411,576

 
1,276,591

Commercial & Industrial ("C&I")
636,727

 
540,499

Total commercial
2,048,303

 
1,817,090

Consumer
783,601

 
754,621

Gross loans receivable
7,001,924

 
6,253,234

Deferred loan costs (fees), net
8,891

 
2,860

Allowance for loan losses
(141,949
)
 
(154,345
)
Net loans receivable
$
6,868,866

 
$
6,101,749

 
As of June 30, 2013 and December 31, 2012, loans pledged as collateral for borrowings from the FHLB and the Federal Reserve were $4.82 billion and $4.15 billion, respectively. Loans receivable include purchased impaired loans, which are loans acquired that are deemed to exhibit evidence of credit deterioration since origination and therefore, are classified as impaired.

The accounting for purchased impaired loans is updated quarterly for changes in the loans' cash flow expectations, and reflected in interest income over the life of the loans as accretable yield. As of June 30, 2013 and December 31, 2012, no allowance for credit losses was recorded in connection with purchased impaired loans, and the unpaid principal balance and carrying amount of these loans were $32.5 million and $19.9 million, respectively. The following table presents a roll-forward of accretable yield over the periods presented:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Beginning balance
$
3,061

 
$
1,909

 
$
1,332

 
$
0

Additions
0

 
0

 
1,774

 
1,923

Accretion to interest income
(497
)
 
(308
)
 
(702
)
 
(322
)
Reclassifications
184

 
730

 
344

 
730

Ending balance
$
2,748

 
$
2,331

 
$
2,748

 
$
2,331



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Table of Contents

As of June 30, 2013 and December 31, 2012, net loans receivable included unamortized discounts on acquired loans of $28.2 million and $21.3 million, respectively. The following table presents, as of June 30, 2013, the five-year projected loan discount accretion to be recognized as interest income:

 
Amount
 
(in thousands)
Remainder of 2013
$
3,463

Years ended December 31,
 
2014
4,589

2015
2,982

2016
1,856

2017
1,284

2018
924


The following table sets forth details by segment for Sterling’s loan portfolio and related allowance as of the balance sheet dates: 
 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
0

 
$
62,018

 
$
43,336

 
$
0

 
$
0

 
$
105,354

Collectively evaluated for impairment
964,872

 
3,143,130

 
2,004,967

 
783,601

 
0

 
6,896,570

Total loans receivable, gross
$
964,872

 
$
3,205,148

 
$
2,048,303

 
$
783,601

 
$
0

 
$
7,001,924

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
0

 
$
1,793

 
$
2,739

 
$
0

 
$
0

 
$
4,532

Collectively evaluated for impairment
18,989

 
39,794

 
36,785

 
27,744

 
14,105

 
137,417

Total allowance for loan losses
$
18,989

 
$
41,587

 
$
39,524

 
$
27,744

 
$
14,105

 
$
141,949

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9,134

 
$
68,317

 
$
48,312

 
$
494

 
$
0

 
$
126,257

Collectively evaluated for impairment
797,588

 
2,806,484

 
1,768,778

 
754,127

 
0

 
6,126,977

Total loans receivable, gross
$
806,722

 
$
2,874,801

 
$
1,817,090

 
$
754,621

 
$
0

 
$
6,253,234

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
365

 
$
3,182

 
$
4,916

 
$
0

 
$
0

 
$
8,463

Collectively evaluated for impairment
19,482

 
44,912

 
36,958

 
25,602

 
18,928

 
145,882

Total allowance for loan losses
$
19,847

 
$
48,094

 
$
41,874

 
$
25,602

 
$
18,928

 
$
154,345



15
Table of Contents

Loans collectively evaluated for impairment include purchased credit impaired loans, which were $19.9 million as of June 30, 2013, and $11.2 million as of December 31, 2012.

The following tables present a roll-forward by segment of the allowance for credit losses for the periods presented:
 
 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
2013 second quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
$
19,968

 
$
45,135

 
$
39,596

 
$
25,817

 
$
19,157

 
$
149,673

Provisions
(214
)
 
(2,198
)
 
1,819

 
3,045

 
(5,052
)
 
(2,600
)
Charge-offs
(1,107
)
 
(2,636
)
 
(2,512
)
 
(1,503
)
 
0

 
(7,758
)
Recoveries
342

 
1,286

 
621

 
385

 
0

 
2,634

Ending balance, June 30
18,989

 
41,587

 
39,524

 
27,744

 
14,105

 
141,949

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
1,909

 
355

 
2,433

 
2,722

 
571

 
7,990

Provisions
2,318

 
152

 
119

 
525

 
(514
)
 
2,600

Charge-offs
(1,085
)
 
0

 
0

 
0

 
0

 
(1,085
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
3,142

 
507

 
2,552

 
3,247

 
57

 
9,505

Total credit allowance
$
22,131

 
$
42,094

 
$
42,076

 
$
30,991

 
$
14,162

 
$
151,454

2012 second quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
$
12,242

 
$
80,614

 
$
34,483

 
$
14,160

 
$
19,774

 
$
161,273

Provisions
(377
)
 
(9,905
)
 
6,222

 
4,052

 
2,008

 
2,000

Charge-offs
(157
)
 
(9,481
)
 
(3,606
)
 
(1,643
)
 
0

 
(14,887
)
Recoveries
673

 
5,624

 
3,171

 
390

 
0

 
9,858

Ending balance, June 30
12,381

 
66,852

 
40,270

 
16,959

 
21,782

 
158,244

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
3,802

 
1,608

 
2,461

 
1,282

 
875

 
10,028

Provisions
2,595

 
(910
)
 
889

 
228

 
(802
)
 
2,000

Charge-offs
(4,076
)
 
0

 
0

 
0

 
0

 
(4,076
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Total credit allowance
$
14,702

 
$
67,550

 
$
43,620

 
$
18,469

 
$
21,855

 
$
166,196


16
Table of Contents

 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
2013 year to date
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
19,847

 
$
48,094

 
$
41,874

 
$
25,602

 
$
18,928

 
$
154,345

Provisions
746

 
(3,289
)
 
209

 
4,557

 
(4,823
)
 
(2,600
)
Charge-offs
(2,126
)
 
(5,559
)
 
(4,100
)
 
(3,147
)
 
0

 
(14,932
)
Recoveries
522

 
2,341

 
1,541

 
732

 
0

 
5,136

Ending balance, June 30
18,989

 
41,587

 
39,524

 
27,744

 
14,105

 
141,949

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
2,230

 
405

 
2,806

 
2,118

 
443

 
8,002

Provisions
2,009

 
102

 
(254
)
 
1,129

 
(386
)
 
2,600

Charge-offs
(1,097
)
 
0

 
0

 
0

 
0

 
(1,097
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
3,142

 
507

 
2,552

 
3,247

 
57

 
9,505

Total credit allowance
$
22,131

 
$
42,094

 
$
42,076

 
$
30,991

 
$
14,162

 
$
151,454

2012 year to date
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
15,197

 
$
91,722

 
$
38,046

 
$
13,427

 
$
19,066

 
$
177,458

Provisions
(1,357
)
 
(12,729
)
 
10,680

 
6,690

 
2,716

 
6,000

Charge-offs
(2,344
)
 
(20,999
)
 
(13,139
)
 
(4,095
)
 
0

 
(40,577
)
Recoveries
885

 
8,858

 
4,683

 
937

 
0

 
15,363

Ending balance, June 30
12,381

 
66,852

 
40,270

 
16,959

 
21,782

 
158,244

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
3,828

 
2,321

 
1,796

 
1,787

 
297

 
10,029

Provisions
2,570

 
(1,623
)
 
1,554

 
(277
)
 
(224
)
 
2,000

Charge-offs
(4,077
)
 
0

 
0

 
0

 
0

 
(4,077
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Total credit allowance
$
14,702

 
$
67,550

 
$
43,620

 
$
18,469

 
$
21,855

 
$
166,196


In establishing the allowance for loan losses, Sterling groups its loan portfolio into classes for loans collectively evaluated for impairment. 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. This calculated expected loss for each loan class is compared to the actual one-year and three-year (annualized) losses. If the calculated expected loss rate is less than either the actual one or three year loss rates, then the expected loss rate may be set at the greater of the actual one or three year loss rates. Sterling evaluates the results of this analysis, and based on qualitative factors, the highest of the three loss rates may be used to better reflect the inherent losses for those loan classes.

If a loan is determined to be impaired, Sterling prepares 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 would determine the need to record a charge-off or establish a specific reserve.

17
Table of Contents


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

Pass - the asset is considered of sufficient quality to preclude a Marginal 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.
Marginal - the asset is susceptible to deterioration if stressed from a cash flow or earnings shock, with liquidity and leverage possibly below industry norms. The borrower may have few reserves to cover debt service, besides current income. A business generating cash flows that service the debt may be dependent on the successful reception of new products in the marketplace.
Special Mention - the 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 of Sterling's credit position at some future date. Special Mention assets are not adversely classified and do not expose Sterling to sufficient risk to warrant adverse classification.
Substandard - the 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 may sustain some loss if the deficiencies are not corrected.
Doubtful/Loss - the 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 the portion of the asset that is considered uncollectible and/or of such little value that its continuance as an asset, without a charge-off or establishment of a specific reserve, 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.







18
Table of Contents

The following table presents credit quality indicators for Sterling’s loan portfolio grouped according to internally assigned risk ratings and performance status:
 
 
 
 
Commercial Real Estate
 
Commercial
 
 
 
 
 
 
 
Residential Real Estate
 
Investor CRE
 
Multifamily
 
Construction
 
Owner Occupied CRE
 
Commercial & Industrial
 
Consumer
 
Total
 
% of
Total
 
(in thousands)
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
875,419

 
$
652,127

 
$
1,880,798

 
$
13,785

 
$
659,774

 
$
420,985

 
$
754,887

 
$
5,257,775

 
75
%
Marginal
55,340

 
421,988

 
68,210

 
43,640

 
629,299

 
193,252

 
16,337

 
1,428,066

 
20
%
Special mention
8,764

 
66,836

 
9,077

 
2,979

 
73,522

 
16,661

 
4,712

 
182,551

 
3
%
Substandard
25,053

 
30,174

 
4,615

 
9,126

 
46,304

 
5,817

 
7,665

 
128,754

 
2
%
Doubtful/Loss
296

 
1,308

 
219

 
266

 
2,677

 
12

 
0

 
4,778

 
0
%
Total
$
964,872

 
$
1,172,433

 
$
1,962,919

 
$
69,796

 
$
1,411,576

 
$
636,727

 
$
783,601

 
$
7,001,924

 
100
%
Restructured
$
23,290

 
$
7,429

 
$
1,225

 
$
8,814

 
$
20,266

 
$
1,225

 
$
95

 
$
62,344

 
1
%
Nonaccrual
17,205

 
17,843

 
840

 
6,050

 
30,792

 
2,538

 
5,119

 
80,387

 
1
%
Nonperforming
40,495

 
25,272

 
2,065

 
14,864

 
51,058

 
3,763

 
5,214

 
142,731

 
2
%
Performing
924,377

 
1,147,161

 
1,960,854

 
54,932

 
1,360,518

 
632,964

 
778,387

 
6,859,193

 
98
%
Total
$
964,872

 
$
1,172,433

 
$
1,962,919

 
$
69,796

 
$
1,411,576

 
$
636,727

 
$
783,601

 
$
7,001,924

 
100
%
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
714,346

 
$
599,660

 
$
1,486,824

 
$
10,946

 
$
678,916

 
$
349,674

 
$
723,698

 
$
4,564,064

 
73
%
Marginal
53,722

 
472,801

 
74,379

 
42,518

 
454,348

 
146,554

 
17,255

 
1,261,577

 
20
%
Special mention
11,739

 
77,342

 
10,122

 
3,401

 
85,228

 
38,874

 
4,864

 
231,570

 
4
%
Substandard
26,550

 
67,347

 
8,745

 
17,534

 
53,183

 
5,397

 
8,804

 
187,560

 
3
%
Doubtful/Loss
365

 
2,697

 
219

 
266

 
4,916

 
0

 
0

 
8,463

 
0
%
Total
$
806,722

 
$
1,219,847

 
$
1,580,289

 
$
74,665

 
$
1,276,591

 
$
540,499

 
$
754,621