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STSA > SEC Filings for STSA > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for STERLING FINANCIAL CORP /WA/


7-May-2013

Quarterly Report


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

This report contains forward-looking statements. For a discussion about such statements, including the risks and uncertainties inherent therein, see "Forward-Looking Statements." Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in Sterling's 2012 annual report on Form 10-K.

General

Sterling Financial Corporation, with headquarters in Spokane, Washington, was organized under the laws of Washington State in 1992 as the bank holding company for Sterling Savings Bank, which commenced operations in 1983. References to "Sterling," "the Company," "we," "our," or "us" 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 that operates under the registered trade names of Sterling Bank and in California as Sonoma Bank and Borrego Springs Bank. Sterling Bank offers retail and commercial banking products and services, mortgage lending and wealth management to individuals, small businesses, commercial organizations and corporations. As of March 31, 2013, Sterling had assets of $9.26 billion and operated 171 depository branches in Washington, Oregon, Idaho and California.

Overview

Net income for the three months ended March 31, 2013 was $22.7 million, compared with $13.3 million for the three months ended March 31, 2012. The changes in operating results over the periods presented included an increase in net interest income and net interest margin, lower credit costs, higher fees and service charges, lower mortgage banking income, a bargain purchase gain, lower noninterest expense, and a provision for income taxes.

Net interest margin expanded to 3.69% for the three months ended March 31, 2013, from 3.38% for the three months ended March 31, 2012, driven by a decline in funding costs. The decline in funding costs reflected a shift in mix and repricing within deposits, as well as a lower balance of wholesale borrowings from securities sold under repurchase agreements. Net interest income expanded by $2.5 million over the periods presented, reflecting the decline in funding costs that exceeded the decline in interest income.

During the three months ended March 31, 2013, there was no provision for credit losses, compared with a $4.0 million provision during the first quarter of 2012, reflecting the decline in nonperforming assets. At March 31, 2013, nonperforming assets to assets was 2.29% compared to 3.68% at March 31, 2012.

Fees and service charges increased $1.4 million over the periods presented, reflecting new business acquired on February 29, 2012, in the purchase and assumption transaction with First Independent Investment Group, Inc. and its wholly-owned subsidiary, First Independent Bank ("First Independent"). Mortgage banking income declined $4.8 million over the periods presented, reflecting a decline in margin on loan sales.

On February 28, 2013, Sterling acquired American Heritage Holdings, the holding company for Borrego Springs Bank, N.A. ("Borrego"), for $8.7 million in cash consideration, adding an aggregate of $103.7 million of gross loans and $117.7 million of deposits. A bargain purchase gain of $7.5 million was recorded in connection with the acquisition, reflecting the fair value of net assets acquired in excess of the purchase price.


Table of Contents

Selected Financial Data
                                                 Three Months Ended
                                                     March 31,
                                                  2013          2012
Basic earnings per share                      $    0.36       $ 0.21
Diluted earnings per share                    $    0.36       $ 0.21
Return on average assets                           1.00 %       0.58 %
Return on average equity                            7.5 %        6.0 %
Net interest margin (tax equivalent)               3.69 %       3.38 %
Efficiency ratio (1)                               72.5 %       79.7 %
Net charge-offs to average loans (annualized)      0.28 %       1.33 %


                                        March 31, 2013     December 31, 2012
Book value per share                   $       19.86      $           19.58
Tangible book value per share          $       19.21      $           18.91
Market value per share                 $       21.69      $           20.88
Tier one leverage ratio (consolidated)          12.8 %                 12.1 %
Loan loss allowance to total loans              2.31 %                 2.47 %
Nonperforming assets to total assets            2.29 %                 2.28 %

(1) The efficiency ratio is noninterest expense, excluding OREO and amortization of other intangible assets, divided by net interest income (tax equivalent) plus noninterest income, excluding gains on sales of securities, charge on prepayment of debt, net gain on MT branch divestiture and bargain purchase gain.

Results of Operations

The most significant component of earnings for Sterling is net interest income, which is the difference between interest income, earned primarily from loans, MBS and investment securities, and interest expense on deposits and borrowings. Net interest spread refers to the difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. Net interest margin refers to net interest income divided by total average interest earning assets and is influenced by the level and relative mix of interest earning assets and interest bearing liabilities. The following table sets forth, on a tax equivalent basis, information with regard to Sterling's net interest income, net interest spread and net interest margin:


Table of Contents

                                                           Three Months Ended
                                         March 31, 2013                           March 31, 2012
                                              Interest                                 Interest
                                Average        Income/     Yields/       Average        Income/     Yields/
                                Balance        Expense      Rates        Balance        Expense      Rates
                                                             (in thousands)
ASSETS:
Loans:
Mortgage                     $ 4,134,204     $  47,999       4.65 %   $ 3,544,106     $  44,083       4.98 %
Commercial and consumer        2,667,145        33,304       5.06 %     2,540,330        35,857       5.68 %
Total loans (1)                6,801,349        81,303       4.81 %     6,084,436        79,940       5.27 %
MBS (2)                        1,221,283         7,297       2.39 %     2,225,040        15,335       2.76 %
Investments and cash (2)         433,022         3,151       2.95 %       582,753         3,819       2.64 %
FHLB stock                        97,484             0       0.00 %        99,057             0       0.00 %
Total interest earning
assets                         8,553,138        91,751       4.32 %     8,991,286        99,094       4.42 %
Noninterest earning assets
(3)                              638,824                                  291,245
Total average assets         $ 9,191,962                              $ 9,282,531
LIABILITIES and EQUITY:
Deposits:
Interest bearing transaction $   727,102            67       0.04 %   $   559,643           104       0.07 %
Savings and MMDA               2,341,096           758       0.13 %     2,185,621         1,191       0.22 %
Time deposits                  1,718,381         5,482       1.29 %     2,562,754         9,807       1.54 %
Total interest bearing
deposits                       4,786,579         6,307       0.53 %     5,308,018        11,102       0.84 %
Borrowings                     1,359,836         7,556       2.25 %     1,625,916        12,510       3.09 %
Total interest bearing
liabilities                    6,146,415        13,863       0.91 %     6,933,934        23,612       1.37 %
Noninterest bearing
transaction                    1,697,314             0       0.00 %     1,326,770             0       0.00 %
Total funding liabilities      7,843,729        13,863       0.72 %     8,260,704        23,612       1.15 %
Other noninterest bearing
liabilities                      121,322                                  127,498
Total average liabilities      7,965,051                                8,388,202
Total average equity           1,226,911                                  894,329
Total average liabilities
and equity                   $ 9,191,962                              $ 9,282,531
Net interest income and
spread (4)                                   $  77,888       3.41 %                   $  75,482       3.05 %
Net interest margin (4)                                      3.69 %                                   3.38 %
Deposits:
Total interest bearing
deposits                     $ 4,786,579     $   6,307       0.53 %   $ 5,308,018     $  11,102       0.84 %
Noninterest bearing
transaction                    1,697,314             0       0.00 %     1,326,770             0       0.00 %
Total deposits               $ 6,483,893     $   6,307       0.39 %   $ 6,634,788     $  11,102       0.67 %

(1) Includes gross nonaccrual loans.

(2) Does not include market value adjustments on available for sale securities.

(3) Includes charge-offs on nonperforming loans ("confirmed losses") and the allowance for loan losses.

(4) Interest income on certain loans and securities are presented gross of their applicable tax savings using a 37% effective tax rate.


Table of Contents

Net Interest Income. Sterling's net interest income increased $2.5 million for the three months ended March 31, 2013 compared with the three months ended March 31, 2012, as a result of the decline in funding costs exceeding the decline in interest income. Funding costs declined as a result of a shift in the mix of, and repricing within, deposits, as well as a lower balance of wholesale borrowings from securities sold under repurchase agreements. Total interest income declined 7% as a result of a lower average balance in the securities portfolio, which was net of a 2% increase in interest income on loans reflecting higher average loan balances.

Provision for Credit Losses. During the three months ended March 31, 2013, there was no provision for credit losses, compared with a $4.0 million provision in the comparative 2012 period. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans and charge-offs.

Noninterest Income. Noninterest income was as follows for the periods presented:

                                         Three Months Ended March 31,
                                        2013             2012      % Change
                                          (in thousands)
Fees and service charges          $    14,130         $ 12,740         11  %
Mortgage banking operations            13,794           18,544        (26 )%
BOLI                                    1,557            1,746        (11 )%
Gains on sales of securities, net           0              142       (100 )%
Gains on other loan sales                  25              600        (96 )%
Other                                   8,060           (2,185 )     (469 )%
Total noninterest income          $    37,566         $ 31,587         19  %

The growth in fees and service charges was primarily due to increased activity related to the addition of the First Independent accounts. The decline in mortgage banking income reflected lower margins on loan sales, as well as a decline in activity. Included in income from mortgage banking operations was a $2.8 million valuation increase on mortgage servicing rights, compared with a $2.2 million increase during the 2012 quarter. Other noninterest income for the three months ended March 31, 2013 included a $7.5 million bargain purchase gain in connection with the Borrego acquisition. For the first quarter of 2012, other noninterest income included $1.3 million of charges associated with branch consolidations.

The following table presents components of mortgage banking operations for the periods presented:

                                                Three Months Ended March 31,
                                                  2013                 2012
                                                       (in thousands)
Residential loan sales                      $      787,377       $      567,100
Change in warehouse and interest rate locks       (136,948 )             95,010
Total mortgage banking activity             $      650,429       $      662,110
Margin on residential loan sales                      1.63 %               2.34 %

The margin on residential loan sales, which includes fair value adjustments, was 1.63% for the first quarter of 2013, down from 2.34% for the first quarter of 2012. The margin on residential loan sales for the first quarter of 2013 was adversely impacted by actual loan sale execution margins being lower than the associated recorded fair values for both residential loans held for sale and interest rate lock commitments at December 31, 2012. Although Sterling hedges both its residential loans held for sale and interest rate lock commitments for valuation exposure due to changes in market interest rates, any value in excess of normal market margins are not hedged.


Table of Contents

Noninterest Expense. Noninterest expense was as follows for the periods presented:

                                                Three Months Ended March 31,
                                               2013             2012       % change
                                                (in thousands)
Employee compensation and benefits      $    42,436           $ 47,381      (10 )%
OREO operations                               2,030              1,992        2  %
Occupancy and equipment                       9,859             10,287       (4 )%
Data processing                               6,577              6,430        2  %
FDIC insurance                                1,930              1,856        4  %
Professional fees                             5,952              2,989       99  %
Depreciation                                  2,934              2,913        1  %
Advertising                                   2,436              3,154      (23 )%
Travel and entertainment                      1,171              1,064       10  %
Merger and acquisition                        1,036              6,135      (83 )%
Amortization of other intangible assets       1,659              1,405       18  %
Other                                         3,909              3,043       28  %
Total noninterest expense               $    81,929           $ 88,649       (8 )%

Employee compensation and benefits during the three months ended March 31, 2012 included severance costs related to a reduction in force, and a higher level of commissions from increased loan production levels. The increase in professional fees for the three months ended March 31, 2013 compared with the 2012 period is principally related to ongoing litigation and other legal matters. Advertising expense during the three months ended March 31, 2012 included costs related to the rebranding of Sterling Savings Bank as Sterling Bank, with no rebranding charges recognized during the three months ended March 31, 2013. Merger and acquisition expense during the three months ended March 31, 2012 reflected costs associated with the First Independent transaction. For the first quarter of 2013, other noninterest expense included a $1.5 million charge in connection with a tentative settlement of a class action wage and hours claim.

Income Tax Provision. During the three months ended March 31, 2013, Sterling recognized income tax expense of $9.9 million, reflecting a 30% effective tax rate, while no income tax expense was recognized in the comparable 2012 period. The effective tax rate for the three months ended March 31, 2013 reflected permanent differences between book income and tax income, from the Borrego acquisition bargain purchase gain, in addition to tax exempt municipal bond and BOLI income. As of March 31, 2013, the net deferred tax asset was $288.8 million, including $267.9 million of net operating loss and tax credit carry-forwards, compared with $292.1 million as of December 31, 2012, including $274.0 million of net operating loss and tax credit carry-forwards.

Financial Position

Assets. At March 31, 2013, Sterling's assets were $9.26 billion, an increase of $19.5 million from December 31, 2012. A decline in loans held for sale was offset by an increase in loans held for investment, with gross loans receivable increasing 4%. Investment and MBS declined 3% during the quarter from prepayments and maturities being greater than purchases. On March 31, 2013, the investment and MBS portfolio had an unrealized net gain of $53.5 million versus $60.9 million at December 31, 2012. The Borrego acquisition during the first quarter 2013 added total assets of $141.6 million.


Table of Contents

Loans Receivable. The following table sets forth the composition of Sterling's loan portfolio by class of loan at the dates indicated:

                                   March 31, 2013         December 31, 2012
                                   Amount         %         Amount         %
                                                (in thousands)
Residential real estate         $   857,864      13     $    806,722      13
Commercial real estate ("CRE"):
Investor CRE                      1,163,821      18        1,219,847      20
Multifamily                       1,725,403      27        1,580,289      25
Construction                         71,213       1           74,665       1
Total CRE                         2,960,437      46        2,874,801      46
Commercial:
Owner occupied CRE                1,372,949      21        1,276,591      20
Commercial & Industrial ("C&I")     533,955       8          540,499       9
Total commercial                  1,906,904      29        1,817,090      29
Consumer                            752,292      12          754,621      12
Gross loans receivable            6,477,497     100 %      6,253,234     100 %
Deferred loan fees, net               6,736                    2,860
Allowance for loan losses          (149,673 )               (154,345 )
Loans receivable, net           $ 6,334,560             $  6,101,749

The acquisition of Borrego during the first quarter 2013 added $97.3 million in loans, which were primarily SBA loans that have been included in the table above in owner occupied CRE. Excluding loans acquired in the Borrego transaction, during the quarter, loans expanded at an annualized rate of 8%.


Table of Contents

The following table sets forth Sterling's loan originations and purchases for the periods indicated. These amounts do not include the amounts acquired upon completion of the Borrego transaction, which occurred during the three months ended March 31, 2013, and do not include the amounts acquired upon completion of the First Independent transaction, which occurred during the three months ended March 31, 2012:

                                                             Three Months Ended
                                                       March 31,           March 31,
                                                          2013               2012
Loan originations:                                             (in thousands)
Residential real estate:
For sale                                            $      632,905     $       576,876
Permanent                                                   97,314              28,728
Total residential real estate                              730,219             605,604
CRE:
Investor CRE                                                14,442               6,456
Multifamily                                                185,914             172,710
Construction                                                 1,730                 823
Total CRE                                                  202,086             179,989
Commercial:
Owner occupied CRE                                          60,477              28,355
C&I                                                         83,097              53,986
Total commercial                                           143,574              82,341
Consumer                                                    69,227              56,455
Total loan originations                                  1,145,106             924,389
Total portfolio loan originations (excludes
residential real estate for sale)                          512,201             347,513
Loan purchases:
Residential real estate                                        177              37,028
CRE:
Investor CRE                                                 1,849                   0
Multifamily                                                    221                 140
Total CRE                                                    2,070                 140
Commercial:
Owner occupied CRE                                           1,071                   0
C&I                                                              0                   0
Total commercial                                             1,071                   0
Consumer                                                         0                   0
Total loan purchases                                         3,318              37,168
Total loan originations and purchases               $    1,148,424     $       961,557

Loan originations grew over the periods presented by 21%, or $124.6 million for residential, 74%, or $61.2 million for commercial, and 12%, or $22.1 million for commercial real estate. Residential loan purchases during the three months ended March 31, 2012 were comprised primarily of adjustable rate mortgages at yields favorable to MBS.


Table of Contents

The following table presents a roll-forward of the allowance for credit losses for the periods presented:

                                                          Three Months Ended March 31,
                                                            2013                 2012
                                                                 (in thousands)
Allowance for credit losses
Allowance - loans, beginning balance                  $      154,345       $      177,458
Provision                                                          0                4,000
Charge-offs                                                   (7,174 )            (25,690 )
Recoveries                                                     2,502                5,505
Allowance - loans, ending balance                            149,673              161,273
Allowance - unfunded commitments, beginning balance            8,002               10,029
Provision                                                          0                    0
Charge-offs                                                      (12 )                 (1 )
Allowance - unfunded commitments, ending balance               7,990               10,028
Total credit allowance                                $      157,663       $      171,301

See Note 4 of the Notes to Consolidated Financial Statements for further details by loan segment for changes in the allowance for credit losses. The decline in the allowance for credit losses over the periods presented reflects a reduction in the level of classified loans, as well as lower historical loss rates. The following table presents classified assets, which are comprised of loans risk rated as substandard, doubtful or loss, and OREO.

                                   March 31, 2013     December 31, 2012
                                              (in thousands)
Residential real estate           $       27,936     $          26,915
CRE:
Investor CRE                              58,006                70,044
Multifamily                                4,886                 8,964
Construction                              13,289                17,800
Total CRE                                 76,181                96,808
Commercial:
Owner occupied CRE                        63,611                58,119
C&I                                        9,045                 6,006
Total commercial                          72,656                64,125
Consumer                                   8,973                 8,942
Total classified loans                   185,746               196,790
OREO                                      29,056                25,042
Total classified assets           $      214,802     $         221,832
Classified loans to loans                   2.87 %                3.15 %
Classified assets to total assets           2.32 %                2.40 %


Table of Contents

Classified assets declined $7.0 million, or 3% during the three months ended March 31, 2013, despite the addition of $17.2 million of classified assets during this period as a result of the Borrego transaction. Nonperforming assets include nonperforming loans and OREO, are summarized in the following table as of the dates indicated:

                                            March 31,     December 31,
                                              2013            2012
                                                  (in thousands)
Past due 90 days or more and accruing      $       0     $           0
Nonaccrual loans                             113,647           121,113
Restructured loans                            69,484            64,216
Total nonperforming loans                    183,131           185,329
OREO                                          29,056            25,042
Total nonperforming assets                   212,187           210,371
Specific reserve - loans                      (9,726 )          (8,463 )
Net nonperforming assets                   $ 202,461     $     201,908
Guaranteed portion of nonperforming loans  $  20,840     $      10,702
Nonperforming loans to loans                    2.83 %            2.96 %
Nonperforming assets to total assets            2.29 %            2.28 %
Loan loss allowance to nonperforming loans        82 %              83 %

. . .

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