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

Show all filings for STERLING FINANCIAL CORP /WA/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for STERLING FINANCIAL CORP /WA/


7-Aug-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 June 30, 2013, Sterling had assets of $9.94 billion and operated 169 depository branches in Washington, Oregon, Idaho and California.

Overview

Net income for the three and six months ended June 30, 2013 was $27.8 million and $50.4 million, respectively, compared with $320.9 million and $334.2 million for the respective 2012 periods. The changes in operating results over the periods presented included an increase in net interest income and net interest margin, and lower credit costs. The results for the 2012 periods include an income tax benefit of $288.8 million resulting from the release of the deferred tax asset valuation allowance.

The net interest margin expanded to 3.70% for both the three and six months ended June 30, 2013, from 3.56% and 3.47% for the three and six months ended June 30, 2012 respectively, 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 for the three and six months ended June 30, 2013 expanded by $1.5 million and $4.0 million respectively over the 2012 comparative periods, reflecting the decline in funding costs that exceeded the decline in interest income.

During the three and six months ended June 30, 2013, there was no provision for credit losses, compared with a $4.0 million and $8.0 million provision during the respective 2012 periods, reflecting the decline in nonperforming assets. At June 30, 2013, nonperforming assets to total assets was 1.70% compared to 3.35% at June 30, 2012.

On February 28, 2013, Sterling completed the acquisition of 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. On May 10, 2013, Sterling paid $123.0 million to acquire the Puget Sound operations of Boston Private Bank & Trust Company ("Boston Private"), which added $278.5 million of performing loans and $168.2 million of deposits.


Table of Contents

Selected Financial Data
                                        Three Months Ended                 Six Months Ended
                                             June 30,                          June 30,
                                      2013              2012             2013             2012
Basic earnings per share         $       0.45       $      5.17     $       0.81      $      5.38
Diluted earnings per share       $       0.44       $      5.13     $       0.80      $      5.33
Return on average assets                 1.17 %           13.74 %           1.09 %           7.20 %
Return on average equity                  9.0 %           138.7 %            8.2 %           73.7 %
Net interest margin (tax
equivalent)                              3.70 %            3.56 %           3.70 %           3.47 %
Efficiency ratio (1)                     63.1 %            66.1 %           67.6 %           72.4 %
Net charge-offs to average loans
(annualized)                             0.29 %            0.32 %           0.28 %           0.81 %


                                      June 30, 2013     December 31, 2012
Book value per share                 $       19.36     $           19.58
Tangible book value per share        $       18.49     $           18.91
Market value per share               $       23.78     $           20.90
Tier 1 leverage ratio (consolidated)          12.2 %                12.1 %
Loan loss allowance to total loans            2.02 %                2.47 %
Nonperforming assets to total assets          1.70 %                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, other-than-temporary impairment losses on securities, charge on prepayment of debt, gain on branch divestitures 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
                                         June 30, 2013                            June 30, 2012
                                              Interest                                 Interest
                                Average        Income/     Yields/       Average        Income/     Yields/
                                Balance        Expense      Rates        Balance        Expense      Rates
                                                             (in thousands)
ASSETS:
Loans:
Mortgage                     $ 4,257,888     $  48,278       4.54 %   $ 3,863,940     $  49,486       5.12 %
Commercial and consumer        2,863,458        36,296       5.08 %     2,540,930        36,147       5.72 %
Total loans (1)                7,121,346        84,574       4.76 %     6,404,870        85,633       5.36 %
MBS (2)                        1,218,352         7,333       2.41 %     1,984,471        12,936       2.61 %
Investments and cash (2)         379,665         3,125       3.30 %       549,590         3,422       2.50 %
FHLB stock                        96,936             0       0.00 %        99,227             0       0.00 %
Total interest earning
assets                         8,816,299        95,032       4.32 %     9,038,158       101,991       4.52 %
Noninterest earning assets
(3)                              681,771                                  352,130
Total average assets         $ 9,498,070                              $ 9,390,288
LIABILITIES and EQUITY:
Deposits:
Interest bearing transaction $   748,977            68       0.04 %   $   666,243            93       0.06 %
Savings and MMDA               2,396,010           806       0.13 %     2,285,426         1,025       0.18 %
Time deposits                  1,743,611         5,164       1.19 %     2,380,453         8,803       1.49 %
Total interest bearing
deposits                       4,888,598         6,038       0.50 %     5,332,122         9,921       0.75 %
Borrowings                     1,543,552         7,565       1.97 %     1,486,167        12,159       3.29 %
Total interest bearing
liabilities                    6,432,150        13,603       0.85 %     6,818,289        22,080       1.30 %
Noninterest bearing
transaction                    1,713,809             0       0.00 %     1,510,591             0       0.00 %
Total funding liabilities      8,145,959        13,603       0.67 %     8,328,880        22,080       1.07 %
Other noninterest bearing
liabilities                      110,797                                  131,031
Total average liabilities      8,256,756                                8,459,911
Total average equity           1,241,314                                  930,377
Total average liabilities
and equity                   $ 9,498,070                              $ 9,390,288
Net interest income and
spread (4)                                   $  81,429       3.47 %                   $  79,911       3.22 %
Net interest margin (4)                                      3.70 %                                   3.56 %
Deposits:
Total interest bearing
deposits                     $ 4,888,598     $   6,038       0.50 %   $ 5,332,122     $   9,921       0.75 %
Noninterest bearing
transaction                    1,713,809             0       0.00 %     1,510,591             0       0.00 %
Total deposits               $ 6,602,407     $   6,038       0.37 %   $ 6,842,713     $   9,921       0.58 %

(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

                                                            Six Months Ended
                                         June 30, 2013                            June 30, 2012
                                              Interest                                 Interest
                                Average        Income/     Yields/       Average        Income/     Yields/
                                Balance        Expense      Rates        Balance        Expense      Rates
                                                             (in thousands)
ASSETS:
Loans:
Mortgage                     $ 4,200,974     $  96,281       4.59 %   $ 3,704,023     $  93,548       5.05 %
Commercial and consumer        2,765,929        69,596       5.07 %     2,540,630        72,026       5.70 %
Total loans (1)                6,966,903       165,877       4.78 %     6,244,653       165,574       5.32 %
MBS (2)                        1,219,810        14,630       2.40 %     2,104,755        28,271       2.69 %
Investments and cash (2)         406,196         6,278       3.11 %       566,171         7,242       2.57 %
FHLB stock                        97,209             0       0.00 %        99,142             0       0.00 %
Total interest earning
assets                         8,690,118       186,785       4.31 %     9,014,721       201,087       4.47 %
Noninterest earning assets
(3)                              655,736                                  321,692
Total average assets         $ 9,345,854                              $ 9,336,413
LIABILITIES and EQUITY:
Deposits:
Interest bearing transaction $   738,100           135       0.04 %   $   612,943           198       0.06 %
Savings and MMDA               2,368,705         1,564       0.13 %     2,235,524         2,216       0.20 %
Time deposits                  1,731,066        10,646       1.24 %     2,471,603        18,609       1.51 %
Total interest bearing
deposits                       4,837,871        12,345       0.51 %     5,320,070        21,023       0.79 %
Borrowings                     1,452,202        15,121       2.10 %     1,556,041        24,669       3.19 %
Total interest bearing
liabilities                    6,290,073        27,466       0.88 %     6,876,111        45,692       1.34 %
Noninterest bearing
transaction                    1,705,607             0       0.00 %     1,418,680             0       0.00 %
Total funding liabilities      7,995,680        27,466       0.69 %     8,294,791        45,692       1.11 %
Other noninterest bearing
liabilities                      114,821                                  129,269
Total average liabilities      8,110,501                                8,424,060
Total average equity           1,235,353                                  912,353
Total average liabilities
and equity                   $ 9,345,854                              $ 9,336,413
Net interest income and
spread (4)                                   $ 159,319       3.43 %                   $ 155,395       3.13 %
Net interest margin (4)                                      3.70 %                                   3.47 %
Deposits:
Total interest bearing
deposits                     $ 4,837,871     $  12,345       0.51 %   $ 5,320,070     $  21,023       0.79 %
Noninterest bearing
transaction                    1,705,607             0       0.00 %     1,418,680             0       0.00 %
Total deposits               $ 6,543,478     $  12,345       0.38 %   $ 6,738,750     $  21,023       0.63 %

(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 $1.5 million and $4.0 million for the three and six months ended June 30, 2013 respectively, compared with the three and six months ended June 30, 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 and repricing of deposits, as well as a lower balance of higher cost wholesale borrowings from securities sold under repurchase agreements.

Total interest income declined 7% for both the second quarter and six months ended June 30, 2013 compared with the comparable 2012 periods, as a result of a lower securities portfolio average balance. Interest income on loans was flat over the periods presented, with higher average loan balances offsetting a decline in average yield.

Provision for Credit Losses. During the three and six months ended June 30, 2013, there was no provision for credit losses, compared with $4.0 million and $8.0 million for the comparative 2012 periods, respectively. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans.

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

                                        Three Months Ended June 30,                Six Months Ended June 30,
                                       2013            2012      % Change        2013          2012      % Change
                                                                  (in thousands)
Fees and service charges         $    15,618        $ 14,131         11  %   $   29,748     $ 26,871         11  %
Mortgage banking operations           23,180          24,181         (4 )%       36,974       42,725        (13 )%
BOLI                                   1,424           3,769        (62 )%        2,981        5,515        (46 )%
Gains on sales of securities,
net                                        0           9,321       (100 )%            0        9,463       (100 )%
Other-than-temporary impairment
losses on securities                       0          (6,819 )     (100 )%            0       (6,819 )     (100 )%
Charge on prepayment of debt               0          (2,664 )     (100 )%            0       (2,664 )     (100 )%
Gains on other loan sales              1,194           2,811        (58 )%        1,219        3,411        (64 )%
Other                                    587              11          *           8,647       (2,174 )        *
Total noninterest income         $    42,003        $ 44,741         (6 )%   $   79,569     $ 76,328          4  %


* Not meaningful

Fees and service charges increased over the periods presented due to an increase in deposit fee income and loan prepayment penalties. BOLI income during the 2012 periods included $2.4 million relating to a death benefit. For the 2013 periods, Sterling had no gains or losses on the sale of securities, compared to a gain of $9.3 million for the second quarter of 2012. Also, during the 2012 periods, Sterling recognized an other-than-temporary impairment charge of $6.8 million, and a prepayment of debt charge of $2.7 million. There were no similar charges in the first and second quarters of 2013. Gains on other loan sales during the 2013 periods were due to SBA lending activity, while the 2012 gains on other loan sales were primarily related to the sale of nonperforming loans at a premium to carrying value.

Other noninterest income during the six months ended June 30, 2013 included a $7.5 million bargain purchase gain in connection with the Borrego acquisition. The sale of three branches during the six months ended June 30, 2013 resulted in a gain of $893,000, before associated expenses of $254,000 that are included in other noninterest expenses. In the comparable 2012 period, branch consolidations resulted in a loss of $1.6 million. Other noninterest income for the six months ended June 30, 2012 also included a negative valuation adjustment of $680,000 on interest rate swaps.

Mortgage banking income for the three and six months ended June 30, 2013 declined 4% and 13%, respectively, over the comparative 2012 periods, reflecting lower margins on loan sales. Included in income from mortgage banking operations for the three and six months ended June 30, 2013 was a $2.8 million and $5.6 million valuation increase on mortgage servicing rights, respectively, compared with a $1.1 million write-down and a $1.1 million increase, respectively, during the three and six months ended June 30, 2012. During the second quarter of 2013, income from mortgage banking also included a $1.0 million reduction in the fair value of a pool of portfolio residential mortgage loans.


Table of Contents

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

                                         Three Months Ended June 30,          Six Months Ended June 30,
                                           2013               2012              2013             2012
                                                                (in thousands)
Residential loan sales               $     791,942       $     576,545     $   1,579,318     $ 1,140,571
Change in warehouse and interest
rate locks                                   7,419             220,252          (132,292 )       312,581
Total mortgage banking activity      $     799,361       $     796,797     $   1,447,026     $ 1,453,152
Margin on residential loan sales              2.35 %              3.07 %            2.03 %          2.75 %

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

                                      Three Months Ended June 30,                   Six Months Ended June 30,
                                    2013             2012        % change        2013           2012        % change
                                                                  (in thousands)
Employee compensation and
benefits                     $    45,803          $  46,485        (1 )%     $    88,239     $  93,866        (6 )%
Occupancy and equipment            9,567             10,932       (12 )%          19,426        21,219        (8 )%
Data processing                    6,471              7,033        (8 )%          13,048        13,463        (3 )%
Professional fees                  2,985              4,800       (38 )%           8,937         7,789        15  %
Depreciation                       3,058              2,923         5  %           5,992         5,836         3  %
OREO operations                    2,549              3,337       (24 )%           4,579         5,329       (14 )%
Advertising                        1,759              3,774       (53 )%           4,195         6,928       (39 )%
FDIC insurance                     1,634              1,989       (18 )%           3,564         3,846        (7 )%
Amortization of other
intangible assets                  1,711              1,791        (4 )%           3,370         3,196         5  %
Merger and acquisition             2,268              2,262         0  %           3,304         8,397       (61 )%
Travel and entertainment           1,513              1,535        (1 )%           2,684         2,599         3  %
Other                              2,360                746       216  %           6,269         3,788        65  %
Total noninterest expense    $    81,678          $  87,607        (7 )%     $   163,607     $ 176,256        (7 )%

Employee compensation and benefits during the six months ended June 30, 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 six months ended June 30, 2013 compared with the 2012 period is principally related to ongoing litigation and other legal matters. Advertising expense during the six months ended June 30, 2012 included costs related to the rebranding of Sterling Savings Bank as Sterling Bank, with no rebranding charges recognized during the 2013 periods. Merger and acquisition expense during the six months ended June 30, 2012 reflected costs associated with the First Independent transaction. For the six months ended June 30, 2013, other noninterest expense included net charges of $942,000 for legal settlements, after a $750,000 insurance reimbursement, while the 2012 period included a $1.9 million Washington State Business and Occupation tax refund.

Income Tax Provision. During the three months ended June 30, 2013, Sterling recognized income tax expense of $13.0 million, reflecting a 32% effective tax rate, and during the six months ended June 30, 2013, income tax expense of $22.8 million, reflecting a 31% effective tax rate. The comparable 2012 periods included an income tax benefit of $288.8 million, the result of reversing substantially all of Sterling's deferred tax asset valuation allowance. The effective tax rate for the 2013 periods reflect permanent differences between book income and tax income from the Borrego acquisition bargain purchase gain, as well as tax exempt municipal bond and BOLI income. As of June 30, 2013, the net deferred tax asset was $290.4 million, including $260.2 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 June 30, 2013, Sterling's assets were $9.94 billion, an increase of $702.7 million from December 31, 2012. The Borrego acquisition in the first quarter of 2013 added total assets of $141.6 million, while the Boston Private transaction added total assets of $292.1 million. Organic loan growth of $221.8 million accounted for the balance of the growth in assets.


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:

                                    June 30, 2013         December 31, 2012
                                   Amount         %         Amount         %
                                                (in thousands)
Residential real estate         $   964,872      14     $    806,722      13
Commercial real estate ("CRE"):
Investor CRE                      1,172,433      17        1,219,847      20
Multifamily                       1,962,919      28        1,580,289      25
Construction                         69,796       1           74,665       1
Total CRE                         3,205,148      46        2,874,801      46
Commercial:
Owner occupied CRE                1,411,576      20        1,276,591      20
Commercial & Industrial ("C&I")     636,727       9          540,499       9
Total commercial                  2,048,303      29        1,817,090      29
Consumer                            783,601      11          754,621      12
Gross loans receivable            7,001,924     100 %      6,253,234     100 %
Deferred loan fees, net               8,891                    2,860
Allowance for loan losses          (141,949 )               (154,345 )
Loans receivable, net           $ 6,868,866             $  6,101,749

The acquisition of Borrego during the first quarter 2013 added $97.3 million of loans, which were primarily SBA loans that have been included in the table above in owner occupied CRE. The Boston Private transaction during the second quarter of 2013 added $273.4 million of loans, approximately 37% of which were commercial, 36% were CRE, and 26% were residential real estate. Excluding loans acquired in these transactions, gross portfolio loan balances expanded at an annualized rate of 14% during the six months ended June 30, 2013.


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 in the Borrego and Boston Private transactions during 2013, or amounts acquired in the 2012 First Independent transaction:

                                              Three Months Ended                       Six Months Ended
                                       June 30, 2013       June 30, 2012       June 30, 2013       June 30, 2012
Loan originations:                                                  (in thousands)
Residential real estate:
For sale                             $       799,682     $       578,418     $     1,432,587     $     1,155,294
Permanent                                    118,023              46,569             215,337              75,297
Total residential real estate                917,705             624,987           1,647,924           1,230,591
. . .
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