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STSA > SEC Filings for STSA > Form 10-Q on 7-Nov-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-Nov-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. Sterling Savings Bank does business as Sterling Bank in Washington, Oregon and Idaho, and as Argent Bank in California, offering retail and commercial banking products and services, mortgage lending and trust and investment products to individuals, small businesses, commercial organizations and corporations. As of September 30, 2013, Sterling had assets of $9.98 billion and operated 169 depository branches in Washington, Oregon, Idaho and California.

Overview

Net income for the three and nine months ended September 30, 2013 was $21.0 million and $71.5 million, respectively, compared with $30.6 million and $364.8 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. Net income for the three months ended September 30, 2013, compared with the three months ended September 30, 2012, also reflected lower mortgage banking income and an income tax provision, while the change during the nine month comparative periods primarily reflected the income tax benefit of $288.8 million in the 2012 period from reversing substantially all of the deferred tax asset valuation allowance.

The net interest margin expanded to 3.59% and 3.66% for the three and nine months ended September 30, 2013, from 3.43% and 3.46% for the three and nine months ended September 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 nine months ended September 30, 2013 expanded by $7.2 million and $11.3 million respectively over the 2012 comparative periods, reflecting the decline in funding costs and an increase in interest income on loans, partially offset by a decline in interest income on MBS.

During the three and nine months ended September 30, 2013, there was no provision for credit losses, compared with a $2.0 million and $10.0 million provision during the respective 2012 periods, reflecting the decline in nonperforming assets. At September 30, 2013, nonperforming assets to total assets was 1.36% compared to 2.73% at September 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.

During the third quarter of 2013, Sterling received regulatory approval for the acquisition of Newport Beach, Calif.-based Commerce National Bank ("CNB"). Subsequent to period end, on October 1, 2013, Sterling paid $42.9 million in cash to acquire CNB. At closing, Commerce National Bank had assets of $259.9 million, loans of $161.0 million, and deposits of $189.6 million.

On September 11, 2013, Sterling entered into a definitive agreement to merge (the "Merger") with and into Umpqua Holdings Corporation ("Umpqua"), with headquarters in Portland, Oregon. Immediately after the Merger, Sterling Savings Bank will merge (the "Bank Merger") with and into Umpqua Bank, an Oregon state chartered bank and wholly owned subsidiary of Umpqua. Upon completion of the merger, the combined company will operate under the Umpqua Bank name and brand. The


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transaction is expected to be completed in the first half of 2014, subject to shareholder and regulatory approval and other customary closing conditions. Under the terms of the agreement, Sterling shareholders will receive 1.671 shares of Umpqua common stock and $2.18 cash for each share of Sterling common stock.

Selected Financial Data
                                        Three Months Ended                 Nine Months Ended
                                          September 30,                      September 30,
                                      2013              2012             2013             2012
Basic earnings per share         $       0.34       $      0.49     $       1.15      $      5.87
Diluted earnings per share       $       0.33       $      0.49     $       1.13      $      5.81
Return on average assets                 0.84 %            1.28 %           1.00 %           5.18 %
Return on average equity                  6.9 %             9.8 %            7.8 %           45.5 %
Net interest margin (tax
equivalent)                              3.59 %            3.43 %           3.66 %           3.46 %
Efficiency ratio (1)                     70.8 %            69.7 %           68.7 %           71.5 %
Net charge-offs to average loans
(annualized)                             0.06 %            0.37 %           0.21 %           0.66 %


                                      September 30, 2013      December 31, 2012
Book value per share                 $           19.51       $           19.58
Tangible book value per share        $           18.66       $           18.91
Market value per share               $           28.65       $           20.90
Tier 1 leverage ratio (consolidated)              11.9 %                  12.1 %
Loan loss allowance to total loans                1.94 %                  2.47 %
Nonperforming assets to total assets              1.36 %                  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:


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                                                            Three Months Ended
                                        September 30, 2013                       September 30, 2012
                                               Interest                                 Interest
                                 Average        Income/     Yields/       Average        Income/     Yields/
                                 Balance        Expense      Rates        Balance        Expense      Rates
                                                              (in thousands)
ASSETS:
Loans:
Mortgage                      $ 4,495,451     $  49,689       4.42 %   $ 3,863,670     $  47,757       4.94 %
Commercial and consumer         2,933,727        36,558       4.94 %     2,583,756        35,479       5.46 %
Total loans (1)                 7,429,178        86,247       4.63 %     6,447,426        83,236       5.15 %
MBS (2)                         1,313,728         8,079       2.46 %     1,762,950        10,361       2.35 %
Investments and cash (2)          404,134         3,132       3.07 %       529,407         3,392       2.55 %
FHLB stock                         95,923             0       0.00 %        99,160             0       0.00 %
Total interest earning assets   9,242,963        97,458       4.20 %     8,838,943        96,989       4.38 %
Noninterest earning assets
(3)                               643,496                                  681,587
Total average assets          $ 9,886,459                              $ 9,520,530
LIABILITIES and EQUITY:
Deposits:
Interest bearing transaction  $   745,131            66       0.04 %   $   684,906            73       0.04 %
Savings and MMDA                2,489,950           865       0.14 %     2,284,749           884       0.15 %
Time deposits                   1,769,741         5,110       1.15 %     2,168,056         8,024       1.47 %
Total interest bearing
deposits                        5,004,822         6,041       0.48 %     5,137,711         8,981       0.70 %
Borrowings                      1,777,268         7,855       1.75 %     1,358,348        11,702       3.43 %
Total interest bearing
liabilities                     6,782,090        13,896       0.81 %     6,496,059        20,683       1.27 %
Noninterest bearing
transaction                     1,787,716             0       0.00 %     1,656,318             0       0.00 %
Total funding liabilities       8,569,806        13,896       0.64 %     8,152,377        20,683       1.01 %
Other noninterest bearing
liabilities                       109,839                                  130,948
Total average liabilities       8,679,645                                8,283,325
Total average equity            1,206,814                                1,237,205
Total average liabilities and
equity                        $ 9,886,459                              $ 9,520,530
Net interest income and
spread (4)                                    $  83,562       3.39 %                   $  76,306       3.11 %
Net interest margin (4)                                       3.59 %                                   3.43 %
Deposits:
Total interest bearing
deposits                      $ 5,004,822     $   6,041       0.48 %   $ 5,137,711     $   8,981       0.70 %
Noninterest bearing
transaction                     1,787,716             0       0.00 %     1,656,318             0       0.00 %
Total deposits                $ 6,792,538     $   6,041       0.35 %   $ 6,794,029     $   8,981       0.53 %

(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.


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                                                             Nine Months Ended
                                        September 30, 2013                       September 30, 2012
                                               Interest                                 Interest
                                 Average        Income/     Yields/       Average        Income/     Yields/
                                 Balance        Expense      Rates        Balance        Expense      Rates
                                                              (in thousands)
ASSETS:
Loans:
Mortgage                      $ 4,299,901     $ 145,969       4.53 %   $ 3,757,341     $ 141,306       5.01 %
Commercial and consumer         2,822,125       106,154       5.03 %     2,555,147       107,504       5.62 %
Total loans (1)                 7,122,026       252,123       4.73 %     6,312,488       248,810       5.26 %
MBS (2)                         1,251,460        22,709       2.42 %     1,989,989        38,632       2.59 %
Investments and cash (2)          405,501         9,411       3.09 %       553,827        10,634       2.56 %
FHLB stock                         96,775             0       0.00 %        99,148             0       0.00 %
Total interest earning assets   8,875,762       284,243       4.27 %     8,955,452       298,076       4.44 %
Noninterest earning assets
(3)                               652,291                                  442,691
Total average assets          $ 9,528,053                              $ 9,398,143
LIABILITIES and EQUITY:
Deposits:
Interest bearing transaction  $   740,469           201       0.04 %   $   637,106           271       0.06 %
Savings and MMDA                2,409,564         2,430       0.13 %     2,252,052         3,101       0.18 %
Time deposits                   1,744,099        15,755       1.21 %     2,369,682        26,632       1.50 %
Total interest bearing
deposits                        4,894,132        18,386       0.50 %     5,258,840        30,004       0.76 %
Borrowings                      1,561,668        22,976       1.97 %     1,489,663        36,371       3.26 %
Total interest bearing
liabilities                     6,455,800        41,362       0.86 %     6,748,503        66,375       1.31 %
Noninterest bearing
transaction                     1,733,277             0       0.00 %     1,498,471             0       0.00 %
Total funding liabilities       8,189,077        41,362       0.68 %     8,246,974        66,375       1.08 %
Other noninterest bearing
liabilities                       114,681                                   80,176
Total average liabilities       8,303,758                                8,327,150
Total average equity            1,224,295                                1,070,993
Total average liabilities and
equity                        $ 9,528,053                              $ 9,398,143
Net interest income and
spread (4)                                    $ 242,881       3.41 %                   $ 231,701       3.13 %
Net interest margin (4)                                       3.66 %                                   3.46 %
Deposits:
Total interest bearing
deposits                      $ 4,894,132     $  18,386       0.50 %   $ 5,258,840     $  30,004       0.76 %
Noninterest bearing
transaction                     1,733,277             0       0.00 %     1,498,471             0       0.00 %
Total deposits                $ 6,627,409     $  18,386       0.37 %   $ 6,757,311     $  30,004       0.59 %

(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.


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Net Interest Income. Sterling's net interest income increased $7.2 million and $11.3 million for the three and nine months ended September 30, 2013 respectively, compared with the three and nine months ended September 30, 2012, as a result of the decline in funding costs and an increase in interest income on loans, partially offset by a decline in interest income on MBS. Funding costs declined as a result of the decline in time deposits, as well as a lower balance of higher cost wholesale borrowings from securities sold under repurchase agreements. Average loan balances increased 15% and 13% for the three and nine months ended September 30, 2013 respectively, compared with the three and nine months ended September 30, 2012, while average MBS balances declined 25% and 37% over the same comparable periods. The decline in average MBS balances reflected sales during 2012 to fund the reduction in repurchase agreements.

Provision for Credit Losses. During the three and nine months ended September 30, 2013, there was no provision for credit losses, compared with $2.0 million and $10.0 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 September 30,              Nine Months Ended September 30,
                                      2013           2012      % Change           2013              2012       % Change
                                                                     (in thousands)
Fees and service charges         $     15,380     $ 14,675          5  %   $     45,128          $  41,546          9  %
Mortgage banking operations            13,494       26,410        (49 )%         50,468             69,135        (27 )%
BOLI                                    1,640        1,660         (1 )%          4,621              7,175        (36 )%
Gains on sales of securities,
net                                         0        3,129       (100 )%              0             12,592       (100 )%
Other-than-temporary impairment
losses on securities                        0            0          0  %              0             (6,819 )     (100 )%
Charge on prepayment of debt                0            0          0  %              0             (2,664 )     (100 )%
Gains on other loan sales               1,135          476        138  %          2,354              3,887        (39 )%
Other                                     241          348        (31 )%          8,888             (1,826 )        *
Total noninterest income         $     31,890     $ 46,698        (32 )%   $    111,459          $ 123,026         (9 )%


* 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 nine months ended September 30, 2012 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 with gains of $3.1 million and $12.6 million for the three and nine month respective 2012 periods. Also, during the nine months ended September 30, 2012, 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 2013 periods. 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 nine months ended September 30, 2013 included a $7.5 million bargain purchase gain in connection with the Borrego acquisition. The sale of three branches during the nine months ended September 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 $1.7 million. Other noninterest income for the nine months ended September 30, 2012 also included a negative valuation adjustment of $600,000 on interest rate swaps.

Mortgage banking income for the three and nine months ended September 30, 2013 declined 49% and 27%, respectively, over the comparative 2012 periods, reflecting lower margins and volumes. During 2013, mortgage rates have increased over 100 basis points, and subsequently, mortgage refinance originations have declined 50% from the second quarter 2013. Included in income from mortgage banking operations for the three and nine months ended September 30, 2013 was a $491,000 and $6.1 million valuation increase on mortgage servicing rights, respectively, compared with write-downs of $2.1 million and $984,000, respectively, during the three and nine months ended September 30, 2012. During the nine months ended September 30, 2013, income from mortgage banking also included a $790,000 reduction in the fair value of a pool of portfolio residential mortgage loans that were previously classified as held for sale.


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

                                        Three Months Ended September 30,          Nine Months Ended September 30,
                                            2013                 2012                 2013                 2012
                                                                     (in thousands)
Residential loan sales               $       672,604       $       728,642     $      2,251,923       $  1,869,213
Change in warehouse and interest
rate locks                                  (198,389 )              36,018             (330,681 )          348,600
Total mortgage banking activity      $       474,215       $       764,660     $      1,921,242       $  2,217,813
Margin on residential loan sales                2.31 %                3.68 %               2.10 %             3.07 %

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

                                  Three Months Ended September 30,             Nine Months Ended September 30,
                                  2013            2012        % change         2013            2012        % change
                                                                 (in thousands)
Employee compensation and
benefits                     $      47,058     $  45,636         3  %     $     135,297     $ 139,502        (3 )%
Occupancy and equipment              9,959        11,034       (10 )%            29,385        32,253        (9 )%
Data processing                      7,252         7,137         2  %            20,300        20,600        (1 )%
Professional fees                    3,093         4,929       (37 )%            12,030        12,718        (5 )%
Depreciation                         3,358         2,918        15  %             9,350         8,754         7  %
Merger and acquisition               3,896         1,584       146  %             7,200         9,981       (28 )%
OREO operations                      1,877         4,008       (53 )%             6,456         9,337       (31 )%
Advertising                          1,830         3,442       (47 )%             6,025        10,370       (42 )%
FDIC insurance                       1,129         2,159       (48 )%             4,693         6,005       (22 )%
Amortization of other
intangible assets                    1,676         1,792        (6 )%             5,046         4,988         1  %
Travel and entertainment             1,467         1,420         3  %             4,151         4,019         3  %
Other                                2,739         3,349       (18 )%             9,008         7,137        26  %
Total noninterest expense    $      85,334     $  89,408        (5 )%     $     248,941     $ 265,664        (6 )%

Employee compensation and benefits during the three months ended September 30, 2013 included acquisition related activity and new employees added in Southern California, while the nine months ended September 30, 2012 included severance costs related to a reduction in force, and a higher level of commissions from increased loan production levels. Occupancy and equipment have declined from the 2012 comparable periods, as a result of branch consolidations and sales. OREO operations also declined from the comparable periods, as a result of a lower level of OREO properties. Advertising expense during 2012 included costs related to the rebranding of Sterling Savings Bank as Sterling Bank. Merger and acquisition expense for the three months ended September 30, 2013 primarily related to the pending Umpqua Merger. Merger and acquisition expense for the nine months ended September 30, 2012 was comprised primarily of expenses related to the First Independent transaction. For the nine months ended September 30, 2012, other noninterest expense included a $1.9 million Washington State Business and Occupation tax refund.

Income Tax Provision. During the three months ended September 30, 2013, Sterling recognized income tax expense of $8.1 million, reflecting a 28% effective tax rate, and during the nine months ended September 30, 2013, income tax expense of $30.9 million, reflecting a 30% effective tax rate. The nine month comparable 2012 period 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 September 30, 2013, the net deferred tax asset was $282.6 million, including $245.3 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.


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Financial Position

Assets. At September 30, 2013, Sterling's assets were $9.98 billion, an increase
of $747.4 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 in the second quarter of 2013 added total assets of $292.1 million.
The other primary contributor to the increase in assets was organic loan growth.

Loans Receivable. The following table sets forth the composition of Sterling's
loan portfolio by class of loan at the dates indicated:
                                   September 30, 2013        December 31, 2012
                                     Amount          %         Amount         %
                                                 (in thousands)
Residential real estate         $    1,052,381      15     $    806,722      13
Commercial real estate ("CRE"):
Investor CRE                         1,125,477      16        1,219,847      20
Multifamily                          2,029,820      28        1,580,289      25
Construction                            52,929       1           74,665       1
Total CRE                            3,208,226      45        2,874,801      46
Commercial:
. . .
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