09 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 SEPTEMBER 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 October 31, 2013
Common Stock
 
62,310,878

Table of Contents

TABLE OF CONTENTS
September 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)
 
 
September 30,
2013
 
December 31,
2012
ASSETS:
 
 
 
Cash and cash equivalents:
 
 
 
Interest bearing
$
223,338

 
$
173,962

Noninterest bearing
119,690

 
125,916

Total cash and cash equivalents
343,028

 
299,878

Restricted cash
6,651

 
31,672

Investments and mortgage-backed securities ("MBS"):
 
 
 
Available for sale
1,498,377

 
1,513,157

Held to maturity
175

 
206

Loans held for sale ($190,635 and $465,983 at fair value)
245,783

 
465,983

Loans receivable, net ($26,931 and $23,177 at fair value)
7,024,326

 
6,101,749

Accrued interest receivable
29,614

 
28,019

Other real estate owned, net ("OREO")
17,464

 
25,042

Properties and equipment, net
100,370

 
93,850

Bank-owned life insurance ("BOLI")
189,906

 
179,828

Goodwill
36,633

 
22,577

Other intangible assets, net
16,154

 
19,072

Mortgage servicing rights, net
57,030

 
32,420

Deferred tax asset, net
282,561

 
292,082

Other assets, net
136,264

 
131,375

Total assets
$
9,984,336

 
$
9,236,910

LIABILITIES:
 
 
 
Deposits:
 
 
 
Noninterest bearing
$
1,818,194

 
$
1,702,740

Interest bearing
5,036,248

 
4,733,377

Total deposits
6,854,442

 
6,436,117

Advances from Federal Home Loan Bank ("FHLB")
1,027,807

 
605,330

Securities sold under repurchase agreements
534,669

 
586,867

Junior subordinated debentures
245,298

 
245,294

Accrued interest payable
4,202

 
4,229

Accrued expenses and other liabilities
102,037

 
141,150

Total liabilities
8,768,455

 
8,018,987

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

 
0

Common stock, 151,515,151 shares authorized; 62,314,862 and 62,207,529 shares outstanding, respectively
1,972,021

 
1,968,025

Accumulated other comprehensive income
29,919

 
60,712

Accumulated deficit
(786,059
)
 
(810,814
)
Total shareholders’ equity
1,215,881

 
1,217,923

Total liabilities and shareholders’ equity
$
9,984,336

 
$
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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Interest income:
 
 
 
 
 
 
 
Loans
$
86,099

 
$
83,110

 
$
251,722

 
$
248,488

MBS
8,079

 
10,361

 
22,709

 
38,632

Investments and cash equivalents
2,266

 
2,520

 
6,787

 
7,826

Total interest income
96,444

 
95,991

 
281,218

 
294,946

Interest expense:
 
 
 
 
 
 
 
Deposits
6,041

 
8,981

 
18,386

 
30,004

Short-term borrowings
303

 
2,346

 
1,037

 
6,377

Long-term borrowings
7,552

 
9,356

 
21,939

 
29,994

Total interest expense
13,896

 
20,683

 
41,362

 
66,375

Net interest income
82,548

 
75,308

 
239,856

 
228,571

Provision for credit losses
0

 
2,000

 
0

 
10,000

Net interest income after provision for credit losses
82,548

 
73,308

 
239,856

 
218,571

Noninterest income:
 
 
 
 
 
 
 
Fees and service charges
15,380

 
14,675

 
45,128

 
41,546

Mortgage banking operations
13,494

 
26,410

 
50,468

 
69,135

BOLI
1,640

 
1,660

 
4,621

 
7,175

Gains on sales of securities
0

 
3,129

 
0

 
12,592

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

 
0

 
0

 
(6,819
)
Charge on prepayment of debt
0

 
0

 
0

 
(2,664
)
Gains on other loan sales
1,135

 
476

 
2,354

 
3,887

Other
241

 
348

 
8,888

 
(1,826
)
Total noninterest income
31,890

 
46,698

 
111,459

 
123,026

Noninterest expense
85,334

 
89,408

 
248,941

 
265,664

Income before income taxes
29,104

 
30,598

 
102,374

 
75,933

Income tax (provision) benefit
(8,056
)
 
0

 
(30,887
)
 
288,842

Net income
$
21,048

 
$
30,598

 
$
71,487

 
$
364,775

Earnings per share - basic
$
0.34

 
$
0.49

 
$
1.15

 
$
5.87

Earnings per share - diluted
$
0.33

 
$
0.49

 
$
1.13

 
$
5.81

Dividends declared per share
$
0.20

 
$
0.15

 
$
0.75

 
$
0.15

Weighted average shares outstanding - basic
62,309,270

 
62,139,833

 
62,280,542

 
62,110,498

Weighted average shares outstanding - diluted
63,461,018

 
62,845,864

 
63,271,060

 
62,745,177



 (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
 
 
September 30,
 
 
2013
 
 
2012
Net income
 
$
21,048

 
 
$
30,598

Beginning balance, accumulated other comprehensive income
$
30,751

 
 
$
67,102

 
Other comprehensive (loss) income:
 
 
 
 
 
Change in unrealized gains on investments and MBS available for sale
 
(1,321
)
 
 
16,235

Realized net gains reclassified from other comprehensive income
 
0

 
 
(3,129
)
Less deferred income tax benefit (provision)
 
489

 
 
(4,945
)
Net other comprehensive (loss) income
 
(832
)
 
 
8,161

Ending balance, accumulated other comprehensive income
$
29,919

 
 
$
75,263

 
Comprehensive income
 
$
20,216

 
 
$
38,759

 
 
 
 
 
 
 
 
Nine Months Ended
 
 
September 30,
 
 
2013
 
 
2012
Net income
 
$
71,487

 
 
$
364,775

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
 
(48,878
)
 
 
28,547

Realized net gains reclassified from other comprehensive income
 
0

 
 
(5,773
)
Less deferred income tax benefit (provision)
 
18,085

 
 
(8,626
)
Net other comprehensive (loss) income
 
(30,793
)
 
 
14,148

Ending balance, accumulated other comprehensive income
$
29,919

 
 
$
75,263

 
Comprehensive income
 
$
40,694

 
 
$
378,923

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)
 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
71,487

 
$
364,775

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

 
10,000

Net gain on sales of loans
(42,719
)
 
(71,482
)
Net gain on sales of investments and MBS
0

 
(12,592
)
Net (gain) loss on mortgage servicing rights
(6,105
)
 
984

Other-than-temporary impairment credit losses on securities
0

 
6,819

Stock based compensation
3,128

 
2,756

Loss on OREO
1,141

 
32

Release of DTA valuation allowance
0

 
(288,842
)
Increase in cash surrender value of BOLI
(4,419
)
 
(6,924
)
Depreciation and amortization
32,452

 
33,871

Bargain purchase gain
(7,544
)
 
0

Change in:
 
 
 
Accrued interest receivable
(785
)
 
4,325

Prepaid expenses and other assets
12,503

 
(23,295
)
Accrued interest payable
(67
)
 
(16,116
)
Accrued expenses and other liabilities
(46,044
)
 
19,606

Proceeds from sales of loans originated for sale
2,278,291

 
1,937,131

Loans originated for sale
(1,964,100
)
 
(2,010,310
)
Net cash provided by (used in) operating activities
327,219

 
(49,262
)
Cash flows from investing activities:
 
 
 
Change in restricted cash
25,021

 
(11,042
)
Net change in loans
(661,835
)
 
(317,773
)
Proceeds from sales of loans
41,272

 
75,689

Purchase of investment securities
0

 
(3,734
)
Proceeds from maturities of investment securities
2,778

 
18,939

Proceeds from sale of investment securities
0

 
179,235

Purchase of MBS
(322,965
)
 
(287,849
)
Principal payments received on MBS
278,527

 
467,792

Proceeds from sales of MBS
0

 
326,915

Proceeds from BOLI death benefits
0

 
3,714

Office properties and equipment, net
(14,568
)
 
(14,144
)
Improvements and other changes to OREO
(321
)
 
(1,214
)
Proceeds from sales of OREO
28,462

 
67,200

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

Net cash (used in) provided by investing activities
$
(739,397
)
 
$
624,826

 
 
 
 

See notes to consolidated financial statements.
6
Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)—cont.
(in thousands)
 
Nine Months Ended September 30,
 
2013
 
2012
Cash flows from financing activities:
 
 
 
Net change in deposits
$
131,857

 
$
(441,827
)
Advances from FHLB
1,385,000

 
50,000

Repayment of advances from FHLB
(963,472
)
 
(300,157
)
Net change in short term repurchase agreements
(2,198
)
 
(13,216
)
Payments under structured repurchase agreements
(50,000
)
 
(100,000
)
Proceeds from stock issuance, net
868

 
572

Cash dividends paid
(46,727
)
 
(9,322
)
Net cash provided by (used in) financing activities
455,328

 
(813,950
)
Net change in cash and cash equivalents
43,150

 
(238,386
)
Cash and cash equivalents, beginning of period
299,878

 
470,599

Cash and cash equivalents, end of period
$
343,028

 
$
232,213

Supplemental disclosures:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
41,389

 
$
82,358

Income taxes, net
634

 
81

Noncash financing and investing activities:
 
 
 
Foreclosed real estate acquired in settlement of loans
17,329

 
30,683




See notes to consolidated financial statements.
7
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STERLING FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 were located in Seattle, Bellevue and Redmond, Washington. Upon acquisition, the Boston Private Seattle branch was consolidated into one of Sterling's existing Seattle branches. 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 Sterling identified as its primary focus for growth. The amount of goodwill deductible for income tax purposes is approximately equivalent to the recorded book value. The core deposit intangible will be amortized on an accelerated basis over approximately ten years.

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
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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 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 nine months ended September 30, 2013. The core deposit intangible will be amortized for 11 years 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.


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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. As of September 30, 2013, the contingent consideration was paid in full. 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 expanded Sterling's presence in the Vancouver and Portland markets. 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
 
Nine Months Ended
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2012
 
(in thousands, except per share data)
Net interest income
$
5,104

 
$
16,204

 
$
75,308

 
$
235,052

Noninterest income
1,247

 
3,428

 
46,698

 
124,031

Net income
2,630

 
8,638

 
30,598

 
368,989

Earnings per share - basic
0.04

 
0.14

 
0.49

 
5.94

Earnings per share - diluted
$
0.04

 
$
0.14

 
$
0.49

 
$
5.89



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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)
September 30, 2013
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
1,300,288

 
$
20,362

 
$
(15,194
)
 
$
1,305,456

Municipal bonds
185,907

 
7,767

 
(925
)
 
192,749

Other
162

 
10

 
0

 
172

Total
$
1,486,357

 
$
28,139

 
$
(16,119
)
 
$
1,498,377

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
175

 
$
0

 
$
0

 
$
175

Total
$
175

 
$
0

 
$
0

 
$
175

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 September 30, 2013 and 2012 are summarized as follows:

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

 
$
0

 
$
0

September 30, 2012
506,150

 
12,666

 
(74
)


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The following table summarizes Sterling’s investments and MBS that had a market value below their amortized cost as of September 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)
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
MBS
$
497,736

 
$
(15,194
)
 
$
0

 
$
0

 
$
497,736

 
$
(15,194
)
Municipal bonds
4,763

 
(157
)
 
12,551

 
(768
)
 
17,314

 
(925
)
Other
0

 
0

 
0

 
0

 
0

 
0

Total
$
502,499

 
$
(15,351
)
 
$
12,551

 
$
(768
)
 
$
515,050

 
$
(16,119
)
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 nine months ended September 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 September 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

 
9,404

 
9,954

Due after five years through ten years
0

 
0

 
90,788

 
90,357

Due after ten years
175

 
175

 
1,386,165

 
1,398,066

Total
$
175

 
$
175

 
$
1,486,357

 
$
1,498,377



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:
 
 
September 30,
2013
 
December 31,
2012
 
(in thousands)
Residential real estate
$
1,052,381

 
$
806,722

Commercial real estate ("CRE"):
 
 
 
Investor CRE
1,125,477

 
1,219,847

Multifamily
2,029,820

 
1,580,289

Construction
52,929

 
74,665

Total CRE
3,208,226

 
2,874,801

Commercial:
 
 
 
Owner occupied CRE
1,404,006

 
1,276,591

Commercial & Industrial ("C&I")
681,666

 
540,499

Total commercial
2,085,672

 
1,817,090

Consumer
807,964

 
754,621

Gross loans receivable
7,154,243

 
6,253,234

Deferred loan costs (fees), net
8,781

 
2,860

Allowance for loan losses
(138,698
)
 
(154,345
)
Net loans receivable
$
7,024,326

 
$
6,101,749

 
As of September 30, 2013 and December 31, 2012, loans pledged as collateral for borrowings from the FHLB and the Federal Reserve were $4.93 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 September 30, 2013, 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 $30.5 million and $18.2 million, respectively. The following table presents a roll-forward of accretable yield over the periods presented:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Beginning balance
$
2,748

 
$
2,331

 
$
1,332

 
$
0

Additions
0

 
0

 
1,774

 
1,923

Accretion to interest income
(454
)
 
(223
)
 
(1,156
)
 
(545
)
Reclassifications
209

 
(678
)
 
553

 
52

Ending balance
$
2,503

 
$
1,430

 
$
2,503

 
$
1,430



14
Table of Contents

As of September 30, 2013 and December 31, 2012, net loans receivable included unamortized discounts on acquired loans of $25.6 million and $21.3 million, respectively. The following table presents, as of September 30, 2013, the five-year projected loan discount accretion to be recognized as interest income:

 
Amount
 
(in thousands)
Remainder of 2013
$
1,620

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)
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
0

 
$
55,583

 
$
38,884

 
$
0

 
$
0

 
$
94,467

Collectively evaluated for impairment
1,052,381

 
3,152,643

 
2,046,788

 
807,964

 
0

 
7,059,776

Total loans receivable, gross
$
1,052,381

 
$
3,208,226

 
$
2,085,672

 
$
807,964

 
$
0

 
$
7,154,243

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
0

 
$
1,444

 
$
3,169

 
$
0

 
$
0

 
$
4,613

Collectively evaluated for impairment
17,276

 
39,669

 
39,442

 
25,220

 
12,478

 
134,085

Total allowance for loan losses
$
17,276

 
$
41,113

 
$
42,611

 
$
25,220

 
$
12,478

 
$
138,698

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

Loans collectively evaluated for impairment include purchased credit impaired loans, which were $18.2 million as of September 30, 2013, and $11.2 million as of December 31, 2012.

15
Table of Contents

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 third quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
$
18,989

 
$
41,587

 
$
39,524

 
$
27,744

 
$
14,105

 
$
141,949

Provisions
(1,270
)
 
(659
)
 
2,820

 
(1,364
)
 
(1,627
)
 
(2,100
)
Charge-offs
(752
)
 
(1,219
)
 
(1,051
)
 
(1,466
)
 
0

 
(4,488
)
Recoveries
309

 
1,404

 
1,318

 
306

 
0

 
3,337

Ending balance, September 30
17,276

 
41,113

 
42,611

 
25,220

 
12,478

 
138,698

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
3,142

 
507

 
2,552

 
3,247

 
57

 
9,505

Provisions
1,721

 
237

 
342

 
(206
)
 
6

 
2,100

Charge-offs
(1,064
)
 
0

 
0

 
0

 
0

 
(1,064
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
3,799

 
744

 
2,894

 
3,041

 
63

 
10,541

Total credit allowance
$
21,075

 
$
41,857

 
$
45,505

 
$
28,261

 
$
12,541

 
$
149,239

2012 third quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
$
12,381

 
$
66,852

 
$
40,270

 
$
16,959

 
$
21,782

 
$
158,244

Provisions
(129
)
 
(8,349
)
 
2,762

 
4,652

 
3,064

 
2,000

Charge-offs
(1,641
)
 
(4,898
)
 
(2,058
)
 
(1,882
)
 
0

 
(10,479
)
Recoveries
137

 
3,573

 
541

 
263

 
0

 
4,514

Ending balance, September 30
10,748

 
57,178

 
41,515

 
19,992

 
24,846

 
154,279

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Provisions
66

 
(427
)
 
(1
)
 
165

 
197

 
0

Charge-offs
(181
)
 
0

 
0

 
0

 
0

 
(181
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
2,206

 
271

 
3,349

 
1,675

 
270

 
7,771

Total credit allowance
$
12,954

 
$
57,449

 
$
44,864

 
$
21,667

 
$
25,116

 
$
162,050


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
(524
)
 
(3,948
)
 
3,029

 
3,193

 
(6,450
)
 
(4,700
)
Charge-offs
(2,878
)
 
(6,778
)
 
(5,151
)
 
(4,613
)
 
0

 
(19,420
)
Recoveries
831

 
3,745

 
2,859

 
1,038

 
0

 
8,473

Ending balance, September 30
17,276

 
41,113

 
42,611

 
25,220

 
12,478

 
138,698

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

 
405

 
2,806

 
2,118

 
443

 
8,002

Provisions
3,730

 
339

 
88

 
923

 
(380
)
 
4,700

Charge-offs
(2,161
)
 
0

 
0

 
0

 
0

 
(2,161
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
3,799

 
744

 
2,894

 
3,041

 
63

 
10,541

Total credit allowance
$
21,075

 
$
41,857

 
$
45,505

 
$
28,261

 
$
12,541

 
$
149,239

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
(1,486
)
 
(21,078
)
 
13,442

 
11,342

 
5,780

 
8,000

Charge-offs
(3,985
)
 
(25,897
)
 
(15,197
)
 
(5,977
)
 
0

 
(51,056
)
Recoveries
1,022

 
12,431

 
5,224

 
1,200

 
0

 
19,877

Ending balance, September 30
10,748

 
57,178

 
41,515

 
19,992

 
24,846

 
154,279

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

 
2,321

 
1,796

 
1,787

 
297

 
10,029

Provisions
2,636

 
(2,050
)
 
1,553

 
(112
)
 
(27
)
 
2,000

Charge-offs
(4,258
)
 
0

 
0

 
0

 
0

 
(4,258
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
2,206

 
271

 
3,349

 
1,675

 
270

 
7,771

Total credit allowance
$
12,954

 
$
57,449

 
$
44,864

 
$
21,667

 
$
25,116

 
$
162,050


In establishing the allowance for loan losses, Sterling groups its loan portfolio into classes of 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 estimated inherent loss rate. This calculated estimated loss for each loan class is compared to the actual one-year and three-year (annualized) losses. Sterling evaluates the results of this analysis, and based on qualitative factors, one of the three loss rates may be used to better reflect the inherent losses for those loan classes.


17
Table of Contents

If a loan is determined to be impaired, Sterling prepares an individual evaluation of the loan. The individual evaluation compares the present value of 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.

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)
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
968,158

 
$
580,017

 
$
1,940,743

 
$
17,017

 
$
727,604

 
$
450,283

 
$
780,264

 
$
5,464,086

 
76
%
Marginal
53,331

 
448,165

 
76,840

 
30,515

 
571,100

 
192,527

 
15,689

 
1,388,167

 
19
%
Special mention
8,816

 
71,575

 
10,894

 
1,159

 
63,805

 
20,792

 
6,103

 
183,144

 
3
%
Substandard
21,789

 
24,428

 
1,343

 
4,086

 
39,349

 
18,061

 
5,908

 
114,964

 
2
%
Doubtful/Loss
287

 
1,292

 
0

 
152

 
2,148

 
3

 
0

 
3,882

 
0
%
Total
$
1,052,381

 
$
1,125,477

 
$
2,029,820

 
$
52,929

 
$
1,404,006

 
$
681,666

 
$
807,964

 
$
7,154,243

 
100
%
Restructured
$
22,153

 
$
7,351

 
$
1,216

 
$
2,101

 
$
19,035

 
$
678

 
$
22

 
$
52,556

 
1
%
Nonaccrual
15,657

 
16,669

 
357

 
3,588

 
22,434

 
2,043

 
4,662

 
65,410

 
1
%
Nonperforming
37,810

 
24,020

 
1,573

 
5,689

 
41,469

 
2,721

 
4,684

 
117,966

 
2
%
Performing
1,014,571

 
1,101,457

 
2,028,247

 
47,240

 
1,362,537

 
678,945

 
803,280

 
7,036,277

 
98
%
Total
$
1,052,381

 
$
1,125,477

 
$
2,029,820

 
$
52,929

 
$
1,404,006

 
$
681,666

 
$
807,964

 
$
7,154,243

 
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

 
$