UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

 

ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the year ended December 31, 2002

 

 

 

OR

 

 

o

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   0-20800

 

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Washington

 

91-1572822

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer Identification No.)

 

 

 

111 North Wall Street, Spokane, Washington 99201

(Address of principal executive offices) (Zip code)

 

 

 

Registrant’s telephone number, including area code: (509) 458-2711

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

None

(Title of class)

 

(Name of each exchange on which registered)

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock ($1.00 par value)

9.50% Cumulative Capital Securities

(Title of class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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 ý    No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 Yes ý  No o

 

As of March 5, 2003, the aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked prices on such date as reported by the Nasdaq National Market, was $243,540,046.

 

The number of shares outstanding of the Registrant’s Common Stock, par value $1.00 per share, as of March 5, 2003 was 13,417,281.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Specific portions of the Registrant’s Proxy Statement dated March 21, 2003 are incorporated by reference into Part III hereof.

 

 



 

STERLING FINANCIAL CORPORATION

 

DECEMBER 31, 2002 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

PART I

 

 

 

Item 1. Business

 

 

 

General

 

 

 

Growth and Acquisition Strategies

 

 

 

Empire Transaction

 

 

 

Lending Activities

 

 

 

Investments and Asset-Backed Securities

 

 

 

Sources of Funds

 

 

 

Subsidiaries

 

 

 

Competition

 

 

 

Personnel

 

 

 

Environmental Laws

 

 

 

Regulation

 

 

 

Forward-Looking Statements

 

 

 

Where You Can Find More Information

 

 

Item 2. Properties

 

 

Item 3. Legal Proceedings

 

 

Item 4. Submission of Matters to a Vote of Security Holders

 

 

 

 

PART II

 

 

 

Item 5. Market for the Registrant’s Common Equity and Related Shareholder Matters

 

 

 

Stock Market and Dividend Information

 

 

 

Equity Compensation Plan Information

 

 

Item 6. Selected Financial Data

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

General

 

 

 

Critical Accounting Policies

 

 

 

Net Interest Income

 

 

 

Asset and Liability Management

 

 

 

Financial Position

 

 

 

Results of Operations for the Years Ended December 31, 2002 and 2001

 

 

 

Results of Operations for the Years Ended December 31, 2001 and 2000

 

 

 

Liquidity and Sources of Funds

 

 

 

Capital Resources

 

 

 

Goodwill Litigation

 

 

 

New Accounting Policies

 

 

 

Effects of Inflation and Changing Prices

 

 

Item 7.A. Quantitative and Qualitative Disclosures About Market Risk

 

 

Item 8. Financial Statements and Supplementary Data

 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

 

 

PART III

 

 

 

Item 14. Controls and Procedures

 

 

 

Evaluation of Disclosure Controls and Procedures

 

 

 

Changes in Internal Controls

 

 

 

 

 

PART IV

 

 

 

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

 

 

 

 

SIGNATURES

 

 

 

CERTIFICATIONS

 

 



 

PART I

 

Item 1.   Business

 

General

 

Sterling Financial Corporation (“Sterling”) is a unitary savings and loan holding company, the significant operating subsidiary of which is Sterling Savings Bank (“Sterling Savings Bank”).  The significant operating subsidiaries of Sterling Savings Bank are Action Mortgage Company (“Action Mortgage”), INTERVEST-Mortgage Investment Company (“INTERVEST”) and Harbor Financial Services, Inc. (“Harbor Financial”). Sterling Savings Bank commenced operations in 1983 as a Washington State-chartered, federally insured stock savings and loan association headquartered in Spokane, Washington.

 

Sterling provides personalized, quality financial services to its customers as exemplified by its “Hometown Helpful” philosophy.  Sterling believes that this dedication to personalized service has enabled it to maintain a stable retail deposit base.  With $3.51 billion in total assets at December 31, 2002, Sterling attracts Federal Deposit Insurance Corporation (“FDIC”) insured deposits from the general public through 79 retail branches located primarily in rural and suburban communities in Washington, Oregon, Idaho and Montana.  Sterling originates loans through its branch offices, as well as Action Mortgage residential loan production offices in the metropolitan areas of Spokane and Seattle, Washington; Portland and Bend, Oregon; and Boise, Idaho, and through INTERVEST commercial real estate lending offices located in the metropolitan areas of Spokane and Seattle, Washington; and Portland, Oregon.  Sterling also markets tax-deferred annuities, mutual funds and other financial products through Harbor Financial.

 

Sterling continues to enhance its presence as a community bank by increasing its commercial real estate, business banking, consumer and construction lending while increasing its retail deposits, particularly transaction accounts.  Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential loans.  Management believes that a community bank mix of assets and liabilities will enhance its net interest income (“NII”) (the difference between the interest earned on loans and investments and the interest paid on liabilities) and other fee income will increase, although there can be no assurance in this regard.  Such loans, however, generally involve a higher degree of risk than financing residential real estate.  Sterling’s revenues are derived primarily from interest earned on loans, investments and asset-backed securities (“ABS”), from fees and service charges and from mortgage banking operations.  The operations of Sterling Savings Bank, and savings institutions generally, are influenced significantly by general economic conditions and by policies of its primary regulatory authorities, the Office of Thrift Supervision (“OTS”), the FDIC, and the State of Washington Department of Financial Institutions (“Washington Supervisor”).  See “Regulation.”

 

Growth and Acquisition Strategies

 

Sterling intends to continue to pursue an aggressive growth strategy, which may include acquiring other financial institutions, businesses or branches thereof or other substantial assets or deposit liabilities.  Sterling may not be successful in identifying further acquisition candidates, integrating acquired businesses or preventing deposit erosion or asset quality deterioration of acquired businesses.  There is significant competition for acquisitions in Sterling’s market area, and Sterling may not be able to acquire other institutions or businesses on attractive terms.  Furthermore, the success of Sterling’s growth strategy will depend on increasing and maintaining sufficient levels of regulatory capital, obtaining necessary regulatory approvals, generating appropriate growth, and favorable economic and market conditions.  There can be no assurance that Sterling will be successful in implementing its growth strategy.

 

Empire Transaction

 

In September 2002, Sterling announced that it had entered into an Agreement and Plan of Merger with Montana-based Empire Federal Bancorp, Inc. (“Empire”).  On February 28, 2003, Empire was merged with and into Sterling, with Sterling being the surviving corporation in the merger.  Empire’s wholly-owned subsidiary, Empire Bank, was merged with and into Sterling’s wholly-owned subsidiary, Sterling Savings Bank, with Sterling Savings Bank being the surviving institution.

 

Under the terms of the Empire merger, each share of Empire common stock was converted into the right to receive $19.25 per share in the form of Sterling common

 

1



 

stock.  Sterling issued .9392 of a share of Sterling common stock for each share of Empire common stock outstanding.  Total shares issued were approximately 1.4 million.  The merger was structured as a tax-free reorganization.   See Note 26 of “Notes to Consolidated Financial Statements.”

 

Lending Activities

 

Focus on Community Lending.  In recent years, Sterling has focused its efforts on becoming more like a community bank. Accordingly, Sterling is increasing its commercial real estate, business banking, consumer and construction lending.  Commercial real estate, business banking, consumer and construction loans generally produce higher yields than residential permanent mortgage loans.  Such loans, however, generally involve a higher degree of risk than the financing of residential real estate.

 

Business Banking Lending.  Sterling’s Business Banking Group provides a full range of credit products to small- and medium-sized businesses and individuals.  Credit products include lines of credit, receivables and inventory financing, equipment loans and permanent and construction real restate financing.  Loans may be made on an unsecured, partially-secured or fully-secured basis.  The credit product line for both businesses and individuals includes standardized products as well as customized, individual accommodations.

 

Sterling’s Private Banking Group provides services to higher-net-worth and higher-income borrowers by originating a variety of consumer and business banking loans.  Such loans generally, but do not always, meet the same underwriting requirements as general consumer loans of the same type.  Private banking loans typically involve larger balances and may have nonstandard terms.

 

Sterling’s Corporate Banking Group provides a full line of financial services to middle market companies in its service area.  Credit products include lines of credit, receivables and inventory financing, equipment loans and permanent and construction financing.  Loans may be made on an unsecured, partially-secured or fully-secured basis.  The Corporate Banking Group also serves the needs of the owners and key employees of its business customers.

 

Sterling has established minimum underwriting standards which delineate criteria for sources of repayment, financial strength and credit enhancements such as guarantees.  Typically, the primary source of repayment is recurring cash flow of the borrower or cash flow from the business or project being financed.  Depending on the type of loan, underwriting standards include minimum financial requirements, maximum loan-to-collateral value ratios, minimum cash flow coverage of debt service, debt-to-income ratios and minimum liquidity requirements.  Exceptions to the minimum underwriting standards may be made depending upon the type of loan and financial strength of the borrower.  Exceptions are reported to the appropriate level of authority up to and including the board of directors.  Common forms of collateral pledged to secure business banking loans include real estate, accounts receivable, inventory, equipment, agricultural crops or livestock and marketable securities. Most loans have maximum terms of one to seven years and loan-to-value ratios in the range of 65% to 80%, based on an analysis of the collateral pledged.

 

Business, private and corporate banking loans generally involve a higher degree of risk than the financing of real estate, primarily because collateral is more difficult to appraise, security interests in the collateral are more difficult to perfect, the collateral may be difficult to obtain or liquidate following an uncured default and it is difficult to accurately predict the borrower’s ability to generate future cash flows.  These loans, however, typically offer relatively higher yields and variable interest rates.  The availability of such loans enables potential depositors to establish full-service banking relationships with Sterling.  At December 31, 2002, business, private and corporate banking loans were 26.9% of Sterling’s total loan and lease portfolio.

 

Consumer Lending.  Consumer loans and lines of credit are originated directly through Sterling’s retail branches and Private Banking Group, and indirectly through Sterling’s Dealer Banking Department.  Sterling finances purchases of consumer goods including automobiles, boats, and recreational vehicles and lines of credit for personal use.  Generally, consumer loans are originated for terms ranging from six months to ten years.  Interest rates may be either fixed or adjustable based on a contractual formula tied to established external indices.  Sterling also makes loans secured by the borrowers’ savings accounts and equity loans collateralized by residential real estate.  Equity loans may have amortizations and maturities of up to 15 years.  As of December 31, 2002, consumer direct and indirect loans were 10.2% and 2.5%, respectively, of Sterling’s total loan and lease portfolio.

 

2



 

One- to Four-Family Residential Lending.  Sterling originates fixed-rate and adjustable rate mortgages (“ARMs”), which have interest rates that adjust annually or every three, five and seven years and are indexed to a variety of market indices.

 

Sterling continues to originate conventional and government-insured residential loans for sale into the secondary mortgage market.  Within the secondary mortgage market for conventional loans, Sterling sells its residential loans primarily on a servicing-released, and servicing-retained basis to others.  Sterling also sells loans to the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”). Sterling endeavors to underwrite residential loans in compliance with FHLMC and FNMA underwriting standards.  Loans sold into the secondary market are all sold without recourse to Sterling, except that Sterling may be obligated to repurchase any loans which are not underwritten in accordance with FHLMC and FNMA or applicable investor underwriting guidelines.  At December 31, 2002, 14.8% of Sterling’s total loan and lease portfolio consisted of conventional one- to four-family residential loans.

 

Conventional residential mortgage loans are originated for up to 103% of the appraised value or selling price of the mortgaged property, whichever is less.  Borrowers must purchase private mortgage insurance from approved third parties so that Sterling’s risk is limited to approximately 80% of the appraised value on all loans with loan-to-value ratios in excess of 80%.  Sterling’s residential lending programs are designed to comply with all applicable regulatory requirements.  For a discussion of Sterling’s management of interest rate risk (“IRR”) on conventional loans, see “Secondary Market Activities.”

 

Sterling originates residential construction loans on custom homes, presold homes and spec homes.  Sterling also provides acquisition and development loans for residential subdivisions.  Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied real estate.  Sterling’s risk of loss on construction loans depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction.  If the estimate of construction costs proves to be inaccurate, Sterling might have to advance funds beyond the amount originally committed to permit completion of the development and to protect its security position.  Sterling also might be confronted, at or prior to maturity of the loan, with a project with insufficient value to ensure full repayment. Sterling’s underwriting, monitoring and disbursement practices with respect to construction financing are intended to ensure that sufficient funds are available to complete construction projects.  Sterling endeavors to limit its risk through its underwriting procedures by using only approved, qualified appraisers and by dealing only with qualified builders/borrowers.  The properties that serve as underlying collateral for these construction loans are located primarily in the States of Washington, Oregon, Idaho and Montana.

 

At December 31, 2002, 11.6% of Sterling’s total loan and lease portfolio consisted of one- to four-family residential construction loans, approximately 48.4% of which were for spec properties.  Further, approximately 43.4% of Sterling’s one- to four-family residential construction loan portfolio was concentrated in the Portland, Oregon market which is served by two loan production offices.  A reduction in market values or in the demand for residential housing, particularly in the Portland market, could lead to higher delinquencies and foreclosures and have a negative impact on Sterling.

 

Multifamily Residential and Commercial Real Estate Lending.  Sterling offers multifamily residential and commercial real estate loans as both construction and permanent loans collateralized by real property primarily in the Pacific Northwest.  Construction loans on such properties typically have terms of 12 to 18 months and have variable interest rates. Permanent loans on existing properties typically have maturities of three to ten years. Multifamily residential and commercial real estate loans generally involve a higher degree of risk than the financing of one- to four-family residential real estate because they typically involve large loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans typically is dependent on the successful operation of the real estate project and is subject to certain risks not present in one- to four-family residential mortgage lending.  These risks include excessive vacancy rates or inadequate operating cash flows.  Construction lending is subject to risks such as construction delays, cost overruns, insufficient values and an inability to obtain permanent financing in a timely manner.  Sterling attempts to reduce its exposure to these risks by closely monitoring the construction disbursement process and by investigating the borrowers’ finances and, depending on the circumstances, requiring annual financial statements from the borrowers, requiring operating statements on the properties or acquiring personal guarantees from the borrowers.  At December 31, 2002, 8.3% of Sterling’s total loan and lease portfolio consisted of multifamily residential

 

3



 

construction and commercial real estate construction loans.  At December 31, 2002, 25.6% of Sterling’s total loan and lease portfolio consisted of multifamily residential and commercial real estate permanent loans.

 

The following table sets forth information on loan originations for the periods indicated.

 

 

 

Years Ended December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

 

 

(Dollars in thousands)

 

Mortgage - permanent:

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

350,973

 

19.2

 

$

204,503

 

14.0

 

$

95,527

 

9.4

 

Multifamily residential

 

77,761

 

4.3

 

50,111

 

3.4

 

55,465

 

5.4

 

Commercial real estate

 

66,492

 

3.6

 

146,391

 

10.0

 

51,797

 

5.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage - construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

481,328

 

26.3

 

351,824

 

24.0

 

310,065

 

30.3

 

Multifamily residential

 

62,498

 

3.4

 

53,470

 

3.6

 

48,112

 

4.7

 

Commercial real estate

 

54,621

 

3.0

 

80,875

 

5.5

 

84,053

 

8.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer - direct

 

146,575

 

8.0

 

129,133

 

8.8

 

88,364

 

8.6

 

Consumer - indirect

 

64,333

 

3.5

 

62,374

 

4.2

 

45,991

 

4.5

 

Corporate banking

 

121,348

 

6.6

 

0

 

 

0

 

 

Business and private banking

 

403,181

 

22.1

 

389,470

 

26.5

 

242,916

 

23.8

 

Total loans originated

 

$

1,829,110

 

100.0

 

$

1,468,151

 

100.0

 

$

1,022,290

 

100.0

 

 

4



 

Loan and Lease Portfolio Analysis.  The following table sets forth the composition of Sterling’s loan and lease portfolio by type of loan at the dates indicated.

 

 

 

December 31,

 

 

 

2002

 

2001

 

2000

 

1999

 

1998

 

 

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage - permanent:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

358,359

 

14.8

 

$

315,242

 

14.8

 

$

409,592

 

20.6

 

$

396,565

 

21.9

 

$

342,757

 

23.1

 

Multifamily residential

 

161,547

 

6.7

 

155,250

 

7.3

 

163,675

 

8.2

 

137,835

 

7.6

 

124,656

 

8.4

 

Commercial real estate

 

458,712

 

18.9

 

438,594

 

20.5

 

347,654

 

17.5

 

317,565

 

17.6

 

177,912

 

12.0

 

Land and other

 

0

 

 

925

 

 

956

 

 

0

 

 

0

 

 

 

 

978,618

 

40.4

 

910,011

 

42.6

 

921,877

 

46.3

 

851,965

 

47.1

 

645,325

 

43.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage - construction:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

280,514

 

11.6

 

214,849

 

10.1

 

215,844

 

10.9

 

184,081

 

10.2

 

141,288

 

9.5

 

Multifamily residential

 

96,297

 

4.0

 

88,977

 

4.2

 

80,728

 

4.1

 

71,024

 

3.9

 

45,794

 

3.1

 

Commercial real estate

 

104,108

 

4.3

 

92,089

 

4.3

 

81,347

 

4.1

 

32,018

 

1.8

 

46,485

 

3.1

 

 

 

480,919

 

19.9

 

395,915

 

18.6

 

377,919

 

19.1

 

287,123

 

15.9

 

233,567

 

15.7

 

Total mortgage loans

 

1,459,537

 

60.3

 

1,305,926

 

61.2

 

1,299,796

 

65.4

 

1,139,088

 

63.0

 

878,892

 

59.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer - direct

 

246,578

 

10.2

 

244,097

 

11.4

 

235,423

 

11.8

 

223,286

 

12.4

 

224,651

 

15.1

 

Consumer - indirect

 

62,896

 

2.5

 

65,169

 

3.1

 

17,682

 

0.9

 

96,602

 

5.3

 

66,539

 

4.5

 

Business, private and corporate banking

 

652,794

 

26.9

 

515,587

 

24.1

 

435,284

 

21.9

 

348,941

 

19.3

 

315,614

 

21.2

 

Commercial leases

 

2,774

 

0.1

 

5,279

 

0.2

 

0

 

 

0

 

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans and leases receivable

 

2,424,579

 

100.0

 

2,136,058

 

100.0

 

1,988,185

 

100.0

 

1,807,917

 

100.0

 

1,485,696

 

100.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred loan origination fees net of costs

 

(6,450

)

 

 

(5,980

)

 

 

(5,518

)

 

 

(4,543

)

 

 

(2,539

)

 

 

Gross loans receivable

 

2,418,129

 

 

 

2,130,078

 

 

 

1,982,667

 

 

 

1,803,374

 

 

 

1,483,157

 

 

 

Allowance for loan and lease losses

 

(27,866

)

 

 

(20,599

)

 

 

(16,740

)

 

 

(15,603

)

 

 

(14,623

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans and leases receivable, net

 

$

2,390,263

 

 

 

$

2,109,479

 

 

 

$

1,965,927

 

 

 

$

1,787,771

 

 

 

$

1,468,534

 

 

 

 

5



 

Contractual Principal Payments.  The following table sets forth the scheduled contractual principal repayments for Sterling’s loan and lease portfolio at December 31, 2002.  Demand loans, loans having no stated repayment schedule and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances do not include undisbursed loan proceeds, deferred loan origination costs and fees, or allowances for loan and lease losses.

 

 

 

Balance
Outstanding at

 

Principal Payments
Contractually Due in Fiscal Years

 

 

 

December 31, 2002

 

2003

 

2004-2007

 

Thereafter

 

 

 

(Dollars in thousands)

 

Mortgage - permanent:

 

 

 

 

 

 

 

 

 

Fixed rate

 

$

419,119

 

$

9,856

 

$

60,093

 

$

349,170

 

Variable rate

 

559,499

 

17,500

 

138,389

 

403,610

 

Mortgage - construction

 

480,919

 

384,031

 

91,705

 

5,183

 

Consumer - direct

 

246,578

 

128,791

 

82,616

 

35,171

 

Consumer - indirect

 

62,896

 

10,298

 

43,469

 

9,129

 

Business, private and corporate banking

 

652,794

 

287,216

 

196,403

 

169,175

 

Commercial leases

 

2,774

 

1,811

 

963

 

0

 

 

 

$

2,424,579

 

$

839,503

 

$

613,638

 

$

971,438

 

 

Loan Servicing.  Sterling services its own loans as well as loans owned by others.  Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, holding escrow funds for the payment of real estate taxes and insurance premiums, contacting delinquent borrowers and supervising foreclosures in the event of unremedied defaults.  Sterling generally receives a fee based on the unpaid principal balance of each loan to compensate for the costs of performing the servicing function.

 

For residential mortgage loans serviced for other investors, Sterling receives a fee, generally ranging from 0.25% to 0.375% of the unpaid principal balance.  At December 31, 2002 and 2001, Sterling serviced for itself and for other investors residential mortgage loans totaling $718.5 million and $671.5 million, respectively.  Of such mortgage loans, Sterling serviced $198.3 million and $198.8 million, respectively, at these dates for FHLMC and FNMA. Sterling’s ability to continue as a seller/servicer for FHLMC and FNMA is dependent upon meeting the qualifications of these agencies.  Sterling currently meets all applicable requirements.

 

Sterling receives a fee for servicing commercial real estate loans for other investors.  This fee generally ranges from 0.10% to 0.25% of the unpaid principal balance.  At December 31, 2002 and 2001, Sterling serviced for itself and other investors commercial real estate loans totaling $698.6 million and $653.1 million, respectively.

 

Sterling also receives a fee of 0.50% of the unpaid principal balance of each loan for servicing automobile loans for other investors.  At December 31, 2002 and 2001, Sterling serviced $54.4 million and $51.1 million of such loans, respectively.

 

Secondary Market Activities.  Sterling has developed correspondent relationships with a number of mortgage companies and financial institutions to facilitate the origination or purchase and sale of mortgage loans in the secondary market on either a participation or whole loan basis.  Substantially all of such purchased loans or participations are secured by real estate.  Those agents who present loans to Sterling for purchase are required to provide a processed loan package prior to commitment.  Sterling then underwrites the loan in accordance with its established lending standards.

 

Sterling, from time to time, sells participations in certain commercial real estate loans to investors on a servicing-retained basis.  During the years ended December 31, 2002, 2001 and 2000, Sterling sold approximately $65.1 million, $51.5 million and $21.4 million in loans under participation agreements, resulting in net gains of $618,000, $380,000 and $294,000, respectively.

 

In originating one- to four-family residential mortgage loans for sale in the secondary market, Sterling incurs market risk from the time of the loan commitments until such time as the loans are sold.  To help minimize this risk, Sterling typically obtains simultaneous commitments from investors to purchase such loans at specified yields.

 

6



 

Sterling generally receives a fee of approximately 1.0% to 2.0% of the principal balance of such loans for releasing the servicing.  In 2002, 66.3% of Sterling’s sales of conventional, Federal Housing Administration (“FHA”) and Veteran’s Administration (“VA”) insured loans have been sold into the secondary market on a loan-by-loan servicing-released basis. In 2001, 42.3% of such sales were sold on a servicing-released basis.

 

In 2002, 33.7% of Sterling’s sales of conventional, FHA and VA insured loans were sold into the secondary market on a loan-by-loan servicing retained basis.  This compares with 57.7% in 2001.  Sterling records a valuation of approximately 1.05% to 1.35% of the principal balance of such loans for retaining the servicing.  At December 31, 2002, Sterling had recorded as an asset $1.7 million in servicing rights.  See Note 3 of “Notes to Consolidated Financial Statements.”

 

Loan Commitments.  Sterling uses written commitments to individual borrowers and mortgage brokers for the purposes of originating and purchasing loans.  These commitments establish the terms and conditions under which Sterling will fund the loans.  Sterling had outstanding commitments to originate or purchase loans aggregating $683.2 million at December 31, 2002.  Sterling also enters into forward sales commitments to deliver loans to third-party investors.  Such commitments are intended to mitigate the risk of fluctuating interest rates to Sterling.  These commitments are considered derivatives.  The fair value of these derivatives was $51,000 as of December 31, 2002.  Sterling also had secured and unsecured commercial and personal lines of credit totaling approximately $541.2 million, of which the undisbursed portion was approximately $240.2 million at December 31, 2002.  See Note 17 of “Notes to Consolidated Financial Statements.”

 

Classified Assets, Real Estate Owned and Delinquent Loans and Leases.  To measure the quality of assets, including loans, leases and real estate owned (“REO”), Sterling has established guidelines for classifying assets and determining provisions for anticipated loan, lease and REO losses. Under these guidelines, an allowance for anticipated loan, lease and REO losses is established when certain conditions exist. This system for classifying and reserving for loans, leases and REO is administered by Sterling’s Special Assets Department, which is responsible for minimizing loan deficiencies and losses therefrom.  An oversight committee, comprised of senior management, monitors the activities of the Special Assets Department and reports results to Sterling’s Board of Directors.

 

Under this system, Sterling classifies loans, leases and other assets it considers of questionable quality.  Sterling’s system employs the classification categories of “substandard,” “doubtful” and “loss.” Substandard assets have deficiencies which give rise to the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets, and on the basis of currently existing facts, there is a high probability of loss.  An asset classified as loss is considered uncollectible and of such little value that it should not be included as an asset of Sterling.  Total classified assets increased to $84.7 million at December 31, 2002 from $55.1 million at December 31, 2001.  As a percentage of total assets, classified assets were 2.4% and 1.8% at December 31, 2002 and 2001, respectively.  See “Major Classified Loans.

 

Assets classified as substandard or doubtful require the establishment of valuation allowances in amounts considered by management to be adequate under accounting principles generally accepted in the United States of America (“GAAP”).  Assets classified as loss require either a specific valuation allowance of 100% of the amount classified or a write-off of such amount.  At December 31, 2002, Sterling’s assets classified as loss totaled $4.0 million compared to $3.0 million at December 31, 2001.  Judgments regarding the adequacy of a valuation allowance are based on on-going evaluations of the nature, volume and quality of the loan and lease portfolio, REO and other assets, specific problem assets and current economic conditions that may affect the recoverability of recorded amounts.

 

REO is recorded at the lower of estimated fair value, less estimated selling expenses, or carrying value at foreclosure. Fair value is defined as the amount in cash or other consideration that a real estate asset would yield in a current sale between a willing buyer and a willing seller.  Development and improvement costs relating to the property are capitalized to the extent they are deemed to be recoverable upon disposal.  The carrying value of REO is continuously evaluated and, if necessary, an allowance is established to reduce the carrying value to net realizable value which considers, among other things, estimated direct holding costs and selling expenses.

 

7



 

The following table sets forth the activity in Sterling’s REO for the periods indicated.

 

 

 

Years Ended December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

$

2,982

 

$

6,407

 

$

7,299

 

Loan foreclosures and other additions

 

7,876

 

5,599

 

5,966

 

Improvements and other changes

 

715

 

(211

)

1,028

 

Sales

 

(7,382

)

(8,354

)

(7,886

)

Provisions for losses

 

(238

)

(459

)

0

 

 

 

 

 

 

 

 

 

Balance at end of period

 

$

3,953

 

$

2,982

 

$

6,407

 

 

Major Classified Loans and Leases.  Sterling’s classified loans with a net carrying value at December 31, 2002 of more than $4.0 million include the following which together constitute 28.2% of classified assets:

 

Sterling holds two income property construction loans and small commercial line of credit secured by a hotel in western Washington.  The aggregate carrying value of these three loans at December 31, 2002 was $5.7 million.  The loan was classified due to lack of stabilization, insufficient debt service coverage, and payment and property tax defaults.  As of December 31, 2002, the loan continues to be closely monitored for adherence to the negotiated forbearance agreement.

 

Sterling holds an income property loan originated to fund the construction of a specialized care facility located in Arizona.  The aggregate carrying value of this loan at December 31, 2002 was $8.1 million.  A performance agreement has been entered into which expires June 30, 2003.

 

Sterling holds an income property loan originated to fund the construction of a specialized care facility located in western Washington.  The aggregate carrying value of this loan at December 31, 2002 was $5.4 million.  This facility has failed to reach stabilized occupancy or satisfactory debt service coverage.  This loan continues to perform as agreed and continues to be closely monitored.

 

Sterling holds an income property loan originated to fund the construction of a specialized care facility located in western Washington.  The aggregate carrying value of this loan at December 31, 2002 was $4.7 million.  This loan has a history of delinquent interest payments, delinquent property taxes, and inadequate debt service coverage.  As of December 31, 2002, the loan is performing as agreed.

 

Major Real Estate Owned.  At December 31, 2002, there were no REO properties with a carrying value of more than $1.0 million.

 

Delinquent Loan and Lease Procedures.  Delinquent and problem loans and leases are part of any lending business. If a borrower fails to make a required payment when due, Sterling institutes internal collection procedures. For residential mortgage and consumer loans, Sterling’s collection procedures generally require that an initial request for payment be mailed to the borrower when the loan or lease is 15 days past due. At 25 days past due, the borrower is contacted by telephone and payment is requested orally.  At 30 days past due, Sterling records the loan or lease as a delinquency. In the case of delinquent residential mortgage loans, a notice of intent to foreclose is mailed at 45 days past due. If the loan is still delinquent 30 days following the mailing of the notice of intent to foreclose, Sterling generally initiates foreclosure proceedings.

 

For consumer loans, a demand letter is sent when the account becomes delinquent for two payments. Additional collection work or repossession may follow. In certain instances, Sterling may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs. Similar collection procedures to those for consumer and mortgage loans are followed for business loans with the exception that these accounts are generally handled as a joint effort between the originating loan officer and the collection department during initial stages of delinquency. On or before 75 days of delinquency, the collection effort is typically shifted from the originating loan officer to the collection department with legal action to follow.

 

8



 

The following table summarizes the principal balances of nonperforming assets at the dates indicated.

 

 

 

December 31,

 

 

 

2002

 

2001

 

2000

 

1999

 

1998

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans and leases

 

$

16,278

 

$

21,102

 

$

8,385

 

$

9,259

 

$

3,050

 

Restructured loans and leases

 

594

 

886

 

0

 

66

 

87

 

Total nonperforming loans and leases

 

16,872

 

21,988

 

8,385

 

9,325

 

3,137

 

Real estate owned(1)

 

3,953

 

2,982

 

6,407

 

7,299

 

6,232

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets(2)

 

$

20,825

 

$

24,970

 

$

14,792

 

$

16,624

 

$

9,369

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of total nonperforming assets to total assets

 

0.59

%

0.82

%

0.56

%

0.65

%

0.40

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of total nonperforming loans and leases to gross loans and leases

 

0.71

%

1.03

%

0.42

%

0.52

%

0.21

%

Ratio of allowance for estimated losses on loans and leases to total nonperforming loans and leases(3)

 

160.3

%

82.9

%

190.1

%

164.4

%

462.5

%

 


(1)     Amount is net of the allowance for REO losses.

 

(2)     Includes $3.2 million and $4.4 million in nonperforming assets acquired from Source Capital outstanding at December 31, 2002 and 2001, respectively.

 

(3)     Excludes loans and leases classified as loss. Loans and leases classified as loss that are excluded from allowance for loan and lease losses were $2,067,000, $1,843,000, $803,000, $275,000 and $114,000 at December 31, 2002, 2001, 2000, 1999 and 1998, respectively.  There were no loans classified as loss that are excluded from total nonperforming loans in any of the periods.

 

Sterling regularly reviews the collectibility of accrued interest and generally ceases to accrue interest on a loan when either principal or interest is past due by 90 days or more. Any accrued and uncollected interest is reversed from income at that time. Loans may be placed in nonaccrual status earlier if, in management’s judgment, the loan may be uncollectible. Interest on such a loan is then recognized as income only if collected or if the loan is restored to performing status. Additional interest income of $778,000, $762,000 and $722,000 would have been recorded during the years ended December 31, 2002, 2001 and 2000, respectively, if nonaccrual and restructured loans had been current in accordance with their original contractual terms. Interest income of $1,103,000, $707,000 and $890,000 was recorded on these loans during the years ended December 31, 2002, 2001 and 2000, respectively.

 

Allowance for Loan, Lease and Real Estate Owned Losses.  Generally, Sterling establishes specific allowances for the difference between the anticipated fair value (market value less selling costs, foreclosure costs and projected holding costs), adjusted for other possible sources of repayment, and the book balance (loan principal and accrued interest or carrying value of REO) of its loans and leases classified as loss and REO.  Each classified loan, lease and REO property is reviewed at least monthly. Allowances are established or periodically adjusted, if necessary, based on the review of information obtained through on-site inspections, market analysis, appraisals and purchase offers.

 

The allowance for loan and lease losses is maintained at a level deemed appropriate by management to adequately provide for known and probable losses and inherent risks in the loan and lease portfolio.  The allowance is based upon a number of factors, including prevailing and anticipated economic trends, industry experience, estimated collateral values, management’s assessment of credit risk inherent in the portfolio, delinquency trends, historical loss experience, specific problem loans and leases and other relevant factors.

 

Additions to the allowance, in the form of provisions, are reflected in current operating results, while charge-offs to the allowance are made when a loss is determined to have occurred.  Because the allowance for loan and lease losses is based on estimates, ultimate losses may materially differ from the estimates.  See Note 5 of “Notes to Consolidated Financial Statements.”

 

9



 

Management believes that the allowance for loan and lease losses is adequate given the composition and risks of the loan and lease portfolios, although there can be no assurance that the allowance will be adequate to cover all contingencies.  The following table sets forth information regarding changes in Sterling’s allowance for estimated losses on loans and leases for the periods indicated.

 

 

 

Years Ended December 31,

 

 

 

2002

 

2001

 

2000

 

1999

 

1998

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

$

20,599

 

$

16,740

 

$

15,603

 

$

14,623

 

$

9,486

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

Mortgage - permanent

 

(48

)

(270

)

(209

)

(483

)

(252

)

Mortgage - construction

 

(868

)

(756

)

(618

)

(227

)

(28

)

Consumer - direct

 

(954

)

(1,011

)

(1,181

)

(1,434

)

(1,048

)

Consumer - indirect

 

(407

)

(544

)

(1,048

)

(925

)

(738

)

Business, private and corporate banking

 

(2,776

)

(2,016

)

(835

)

(103

)

(325

)

Total charge-offs

 

(5,053

)

(4,597

)

(3,891

)

(3,172

)

(2,391

)

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

Mortgage - permanent

 

19

 

9

 

27

 

16

 

34

 

Mortgage - construction...

 

2

 

31

 

1

 

0

 

0

 

Consumer - direct

 

208

 

203

 

165

 

76

 

106

 

Consumer - indirect

 

170

 

184

 

209

 

152

 

42

 

Business, private and corporate banking

 

54

 

29

 

26

 

8

 

21

 

Total recoveries

 

453

 

456

 

428

 

252

 

203

 

Net charge-offs

 

(4,600

)

(4,141

)

(3,463

)

(2,920

)

(2,188

)

Provisions for loan and lease losses

 

11,867

 

8,000

 

4,600

 

3,900

 

5,325

 

Allowance for losses on assets acquired

 

0

 

0

 

0

 

0

 

2,000

 

Balance at end of period

 

$

27,866

 

$

20,599

 

$

16,740

 

$

15,603

 

$

14,623

 

Allowances allocated to loans and leases classified as loss

 

$

2,067

 

$

1,843

 

$

803

 

$

275

 

$

114

 

Ratio of net charge-offs to average loans and leases outstanding during the period

 

0.21

%

0.21

%

0.18

%

0.17

%

0.17

%

 

10



 

Allowances are provided for individual loans and leases when management considers ultimate collection to be questionable. Such allowances are based, among other factors, upon the estimated net realizable value of the collateral of the loan or guarantees, if applicable. The following table sets forth the allowances for estimated losses on loans and leases by category and summarizes the percentage of total loans and leases in each category to total loans and leases.

 

 

 

December 31,

 

 

 

2002

 

2001

 

2000

 

1999

 

1998

 

 

 

Allowance
Amount

 

Loans and
Leases in
Category
as a
Percentage
of Total
Loans

 

Allowance
Amount

 

Loans and
Leases in
Category
as a
Percentage
of Total
Loans

 

Allowance
Amount

 

Loans and
Leases in
Category
as a
Percentage
of Total
Loans

 

Allowance
Amount

 

Loans and
Leases in
Category
as a
Percentage
of Total
Loans

 

Allowance
Amount

 

Loans and
Leases in
Category
as a
Percentage
of Total
Loans

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage - permanent

 

$

2,881

 

40.4

 

$

2,285

 

42.6

 

$

3,801

 

46.3

 

$

4,837

 

47.1

 

$

4,535

 

43.5

 

Mortgage - construction

 

6,199

 

19.9

 

3,601

 

18.6

 

3,903

 

19.1

 

3,336

 

15.9

 

3,199

 

15.7

 

Consumer - direct

 

2,986

 

10.2

 

2,812

 

11.4

 

2,907

 

11.8

 

2,397

 

12.4

 

3,113

 

15.1

 

Consumer - indirect

 

1,349

 

2.5

 

1,202

 

3.1

 

760

 

0.9

 

938

 

5.3

 

650

 

4.5

 

Business, private and corporate banking

 

14,014

 

26.9

 

10,211

 

24.1

 

5,166

 

21.9

 

3,595

 

19.3

 

2,626

 

21.2

 

Commercial leases

 

0

 

0.1

 

0

 

0.2

 

0

 

 

0

 

 

0

 

 

Unallocated

 

437

 

N/A

 

488

 

N/A

 

203

 

N/A

 

500

 

N/A

 

500

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

27,866

 

100.0

 

$

20,599

 

100.0

 

$

16,740

 

100.0

 

$

15,603

 

100.0

 

$

14,623

 

100.0

 

 

11



 

Investments and Asset-Backed Securities

 

Investments and ABS that management has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost.  At December 31, 2002 and 2001, investments and ABS classified as held to maturity were $3.5 million and $7.1 million, respectively.  Unrealized gains and losses on such investments and ABS are not reported in the Consolidated Financial Statements, as these investments and ABS are held for investment purposes.

 

Sterling classifies specific investments and ABS as available for sale.  Investments classified as available for sale are carried at fair value. Unrealized gains and losses that are considered to be temporary are excluded from earnings and are reported net of deferred income tax as a separate component of accumulated comprehensive income (loss) in shareholders’ equity until such investments and ABS mature or are actually sold.  These investments and ABS may be sold in response to changes in market interest rates and related changes in prepayment risk, needs for liquidity, changes in the availability of and the yield on alternative investments and changes in funding sources and terms.

 

At December 31, 2002 and 2001, investments and ABS classified as available for sale were $826.7 million and $687.0 million, respectively.  The carrying value of these investments and ABS at December 31, 2002 and 2001 includes unrealized gains of $3.4 million (net of a $1.9 million related income tax benefit) and unrealized losses of $4.6 million (net of a $2.5 million related income tax benefit), respectively.  Fluctuations in prevailing interest rates continue to cause volatility in this component of accumulated comprehensive income and may continue to do so in future periods.

 

Sterling invests primarily in ABS issued by FHLMC and FNMA and other agency obligations.  Such investments provide Sterling with a relatively liquid source of interest income and collateral which can be used to secure borrowings. Sterling invests primarily in investment-grade investments and ABS.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) –Results of Operations – Other Income” and Note 1 of “Notes to Consolidated Financial Statements.”

 

12



 

The following table provides the carrying values, contractual maturities and weighted average yields of Sterling’s investment and ABS portfolio at December 31, 2002.  Actual maturities may differ from the contractual maturities, because issuers may have the right to call or prepay obligations with or without prepayment penalties.

 

 

 

Maturity

 

 

 

Less than
One Year

 

One to
Five Years

 

Over Five to
Ten Years

 

Over Ten
Years

 

Total

 

 

 

(Dollars in thousands)

 

Asset-backed securities

 

 

 

 

 

 

 

 

 

 

 

Balance

 

$

12

 

$

1,516

 

$

124,744

 

$

617,338

 

$

743,610

 

Weighted average yield

 

9.00

%

11.98

%

4.31

%

4.63

%

4.59

%

U.S. government and agency obligations

 

 

 

 

 

 

 

 

 

 

 

Balance

 

$

0

 

$

13,666

 

$

0

 

$

0

 

$

13,666

 

Weighted average yield

 

0.00

%

3.90

%

0.00

%

0.00

%

3.90

%

FHLB Seattle stock, at cost

 

 

 

 

 

 

 

 

 

 

 

Balance

 

$

0

 

$

0

 

$

0

 

$

42,213

 

$

42,213

 

Weighted average yield (1)

 

0.00

%

0.00

%

0.00

%

6.00

%

6.00

%

Municipal bonds

 

 

 

 

 

 

 

 

 

 

 

Balance

 

$

1,122

 

$

1,946

 

$

284

 

$

0

 

$

3,352

 

Weighted average yield (2)

 

4.56

%

4.33

%

3.83

%

0.00

%

4.37

%

Other (3)

 

 

 

 

 

 

 

 

 

 

 

Balance

 

$

0

 

$

521

 

$

5,249

 

$

21,557

 

$

27,327

 

Weighted average yield

 

0.00

%

6.35

%

6.36

%

4.19

%

4.65

%

 

 

 

 

 

 

 

 

 

 

 

 

Total carrying value

 

$

1,134

 

$

17,649

 

$

130,277

 

$

681,108

 

$

830,168

 

Weighted average yield

 

4.61

%

4.71

%

4.39

%

4.70

%

4.65

%

 


(1)          The weighted average yield on Federal Home Loan Bank of Seattle (“FHLB Seattle”) stock is based upon the dividends received for the year ended December 31, 2002.

(2)          The weighted average yields on municipal bonds reflect the actual yields on the bonds and are not presented on a tax-equivalent basis.

(3)          Other investments relate primarily to trust-preferred securities.

 

The following table sets forth the carrying values and classifications for financial statement reporting purposes of Sterling’s investment and ABS portfolio at the dates indicated.

 

 

 

December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Asset-backed securities

 

$

743,610

 

$

617,569

 

$

314,434

 

U.S. government and agency obligations

 

13,666

 

7,178

 

94,358

 

FHLB Seattle stock

 

42,213

 

39,699

 

37,082

 

Municipal bonds

 

3,352

 

6,879

 

9,632

 

Other

 

27,327

 

22,723

 

30,676

 

 

 

 

 

 

 

 

 

Total

 

$

830,168

 

$

694,048

 

$

486,182

 

 

 

 

 

 

 

 

 

Available for sale

 

826,692

 

686,995

 

476,732

 

Held to maturity

 

3,476

 

7,053

 

9,450

 

 

 

 

 

 

 

 

 

Total

 

$

830,168

 

$

694,048

 

$

486,182

 

 

 

 

 

 

 

 

 

Weighted average yield

 

4.65

%

5.76

%

6.47

%

 

13



 

Sources of Funds

 

General.  Sterling’s primary sources of funds for use in lending and for other general business purposes are deposits, loan repayments, FHLB Seattle advances, secured lines of credit and other borrowings, proceeds from sales of investments and ABS and proceeds from sales of loans. Scheduled loan repayments are a relatively stable source of funds, while other sources of funds are influenced significantly by prevailing interest rates, interest rates available on other borrowings and other economic conditions. Borrowings also may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Borrowings may also be used on a longer-term basis to support expanded lending activities and to match repricing intervals of assets. See “Lending Activities” and “Investments and ABS.”

 

Deposit Activities.  As a community bank, Sterling offers a variety of accounts for depositors designed to attract both short-term and long-term deposits from the general public. These accounts include money market demand accounts (“MMDA”) and checking accounts in addition to more traditional savings accounts and certificates of deposit (“CDs”) accounts. Sterling offers both interest- and noninterest-bearing checking accounts. The interest-bearing checking accounts can be subject to monthly service charges, unless a minimum balance is maintained. MMDA, CDs and savings accounts earn interest at rates established by management and are based on a competitive market analysis. The method of compounding varies from simple interest credited at maturity to daily compounding, depending on the type of account.

 

With the exception of certain promotional CDs and variable-rate 18-month Individual Retirement Account (“IRA”) certificates, all CDs carry a fixed rate of interest for a defined term from the opening date of the account. Substantial penalties are imposed if principal is withdrawn from most CDs prior to maturity.

 

Sterling supplements its retail deposit gathering by soliciting funds from public entities and acquiring brokered deposits. Public funds were 14.2% and 15.7% of deposits at December 31, 2002 and 2001, respectively. Public funds are generally obtained by competitive bidding among qualifying financial institutions. Sterling had $19.6 million and $0 of brokered deposits at December 31, 2002 and 2001, respectively.

 

The primary deposit vehicles being utilized by Sterling’s customers are CDs with terms of one year or less, regular savings accounts, money market accounts and negotiable order of withdrawal (“NOW”) accounts. The following table presents the average balance outstanding and weighted average interest rate paid for each major category of deposits for the periods indicated.

 

 

 

Years Ended December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

Average
Balance

 

Weighted
Average
Interest
Rate

 

Average
Balance

 

Weighted
Average
Interest
Rate

 

Average
Balance

 

Weighted
Average
Interest
Rate

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Certificates of deposit

 

$

1,052,792

 

3.44

%

$

981,243

 

5.35

%

$

968,109

 

5.94

%

Regular savings  and money market accounts

 

364,823

 

1.62

 

406,551

 

2.42

 

392,456

 

3.79

 

Checking accounts:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW accounts

 

335,003

 

0.44

 

209,020

 

0.52

 

193,026

 

0.87

 

Noninterest-bearing demand accounts

 

206,323

 

0.00

 

129,096

 

0.00

 

114,315

 

0.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,958,941

 

2.23

%

$

1,725,910

 

3.68

%

$

1,667,906

 

4.44

%

 

14



 

The following table shows the amounts and remaining maturities of CDs that had balances of $100,000 or more at December 31, 2002 and 2001.

 

 

 

December 31,

 

 

 

2002

 

2001

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Less than three months

 

$

175,647

 

$

210,749

 

Three to six months

 

102,134

 

48,546

 

Six to twelve months

 

149,151

 

200,651

 

Over twelve months

 

59,248

 

34,638

 

 

 

 

 

 

 

 

 

$

486,180

 

$

494,584

 

 

15



 

The following table presents the types of deposit accounts and the rates offered by Sterling Savings Bank and the balance in such accounts as of the specified dates.

 

 

 

 

 

December 31, 2002

 

December 31, 2001

 

Minimum
Term

 

Category

 

Minimum
Balances

 

Amount

 

Percentage
of Total
Deposits

 

Interest Rate
Offered

 

Minimum
Balances

 

Amount

 

Percentage
of Total
Deposits

 

Interest Rate
Offered

 

 

 

 

 

(Dollars in thousands, except minimum amounts)

 

Transaction Accounts:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

None

 

NOW checking

 

$

100

 

$

367,391

 

18.2

 

0.10

%

$

100

 

$

227,982

 

12.3

 

0.25

%

None

 

Commercial checking

 

100

 

239,033

 

11.9

 

0.00

 

100

 

140,654

 

7.6

 

0.00

 

None

 

Regular savings

 

100

 

89,474

 

4.4

 

0.50

 

100

 

82,259

 

4.4

 

0.75

 

None

 

Money market demand

 

1,000

 

311,865

 

15.5

 

1.17

 

1,000

 

340,400

 

18.4

 

1.17

 

 

 

Total transaction accounts

 

 

 

1,007,763

 

50.0

 

 

 

 

 

791,295

 

42.7

 

 

 

Certificates of Deposit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 90 days

 

Fixed term, fixed rate

 

5,000

 

2,035

 

0.1

 

0.63

 

N/A

 

0

 

0.0

 

N/A

(1)

3 months

 

Fixed term, fixed rate

 

500

 

4,099

 

0.2

 

1.00

 

500

 

16,964

 

0.9

 

1.49

 

6 months

 

Fixed term, fixed rate

 

500

 

123,750

 

6.2

 

1.14

 

500

 

66,845

 

3.6

 

1.49

 

9 months

 

Fixed term, adjustable rate

 

5,000

 

60,291

 

3.0

 

1.98

 

5,000

 

77,737

 

4.2

 

2.47

 

11 months

 

Fixed term, fixed rate

 

500

 

70,238

 

3.5

 

1.24

 

500

 

19,234

 

1.0

 

1.59

 

12 months

 

Fixed term, fixed rate

 

500

 

43,484

 

2.2

 

1.29

 

500

 

101,423

 

5.5

 

1.88

 

12 months

 

Fixed term, fixed rate

 

N/A

 

0

 

0.0

 

N/A

(1)

N/A

 

119

 

0.0

 

N/A

(1)

12 months

 

Fixed term, adjustable rate

 

N/A

 

0

 

0.0

 

N/A

(1)

N/A

 

4

 

0.0

 

N/A

(1)

12 months

 

Fixed term, adjustable rate

 

N/A

 

1

 

0.0

 

N/A

(1)

N/A

 

702

 

0.0

 

N/A

(1)

15 months

 

Fixed term, adjustable rate

 

5,000

 

37,625

 

1.9

 

1.39

 

5,000

 

173,301

 

9.4

 

1.88

 

18 months

 

Fixed term, fixed rate

 

500

 

38,806

 

1.9

 

1.49

 

500

 

52,753

 

2.8

 

1.98

 

24 months

 

Fixed term, fixed rate

 

500

 

28,765

 

1.4

 

1.98

 

500

 

37,045

 

2.0

 

2.67

 

36 months

 

Fixed term, fixed rate

 

500

 

123,439

 

6.1

 

2.72

 

500

 

65,870

 

3.6

 

3.69

 

36 months

 

Zero coupon, fixed term

 

N/A

 

0

 

0.0

 

N/A

 

N/A

 

6

 

0.0

 

N/A

(1)

Greater than 36 months

 

Fixed term, fixed rate

 

500

 

139,259

 

6.9

 

3.30

 

500

 

89,136

 

4.8

 

4.57

 

18 months

 

Variable rate, IRA

 

100

 

4,911

 

0.2

 

1.79

 

100

 

9,057

 

0.5

 

2.38

 

18 months

 

Fixed rate, IRA

 

500

 

2,427

 

0.1

 

1.39

 

500

 

5,288

 

0.3

 

1.98

 

36 months

 

Variable rate, IRA

 

2,000

 

13,401

 

0.7

 

N/A

(1)

2,000

 

7,926

 

0.4

 

3.06

 

9 months

 

Mini-jumbos

 

80,000

 

6,257

 

0.3

 

1.20

 

N/A

 

0

 

0.0

 

N/A

(1)

6 months

 

Jumbos

 

100,000

 

287,910

 

14.3

 

1.30

 

N/A

 

0

 

0.0

 

N/A

(1)

Less than 1 year

 

Brokered

 

N/A

 

19,635

 

1.0

 

1.65

 

N/A

 

0

 

0.0

 

N/A

(1)

7 days

 

Fixed term, fixed rate

 

N/A

 

0

 

0.0

 

N/A(1

)

5,000

 

2,340

 

0.1

 

0.88

 

7 days

 

Mini-jumbos

 

N/A

 

0

 

0.0

 

N/A(1

)

80,000

 

11,207

 

0.6

 

1.90

 

7 days

 

Jumbos

 

N/A

 

0

 

0.0

 

N/A(1

)

100,000

 

325,284

 

17.6

 

2.00

 

 

 

Total CDs

 

 

 

1,006,333

 

50.0

 

 

 

 

 

1,062,241

 

57.3

 

 

 

 

 

Total deposits

 

 

 

$

2,014,096

 

100.0

 

 

 

 

 

$

1,853,536

 

100.0

 

 

 

 


(1)  Not currently offered

 

16



 

The following table sets forth the composition of Sterling’s deposit accounts at the dates indicated.

 

 

 

December 31,

 

 

 

2002

 

2001

 

 

 

Amount

 

Percentage
of Total
Deposits

 

Amount

 

Percentage
of Total
Deposits

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

NOW checking

 

$

367,391

 

18.2

 

$

227,982

 

12.3

 

Commercial checking

 

239,033

 

11.9

 

140,654

 

7.6

 

Regular savings

 

89,474

 

4.4

 

82,259

 

4.4

 

Money market demand

 

311,865

 

15.5

 

340,400

 

18.4

 

 

 

 

 

 

 

 

 

 

 

Variable-rate certificates:

 

 

 

 

 

 

 

 

 

9-36 months

 

116,229

 

5.8

 

268,728

 

14.5

 

 

 

 

 

 

 

 

 

 

 

Fixed-rate certificates:

 

 

 

 

 

 

 

 

 

0-11 months

 

513,924

 

25.5

 

441,874

 

23.8

 

12-35 months

 

113,482

 

5.6

 

196,627

 

10.6

 

36-240 months

 

262,698

 

13.1

 

155,012

 

8.4

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

2,014,096

 

100.0

 

$

1,853,536

 

100.0

 

 

Substantially all of Sterling’s depositors are residents of the States of Washington, Idaho, Montana and Oregon.  Sterling has 63 automated teller machines (“ATM”) to better serve customers in those markets. Customers also can access ATMs operated by other financial institutions. Sterling is a member of The Exchange, an ATM system that allows participating customers to deposit or withdraw funds from NOW accounts, money market demand accounts and savings accounts throughout the United States and Canada. Sterling is also a member of the Plus System ATM network, with numerous locations in the United States and internationally.

 

Borrowings.  Deposit accounts are Sterling’s primary source of funds. Sterling does, however, rely upon advances from the FHLB Seattle and reverse repurchase agreements to supplement its funding and to meet deposit withdrawal requirements.  See “Management’s Discussion and Analysis – Liquidity and  Sources of Funds.”

 

The FHLB Seattle is part of a system, which consists of 12 regional Federal Home Loan Banks (the “FHL Banks”) each subject to Federal Housing Finance Board supervision and regulation, that functions as a central reserve bank providing credit to savings institutions.  As a condition of membership in the FHLB Seattle, Sterling is required to own stock of the FHLB Seattle in an amount determined by a formula based upon Sterling’s total mortgages outstanding or total advances from the FHLB Seattle.  At December 31, 2002, Sterling exceeded its FHLB Seattle stock ownership requirement.  The stock of the FHLB Seattle always has been redeemable at par value, but there can be no assurance that this always will be the case.

 

As a member of the FHLB Seattle, Sterling Savings Bank can apply for advances on the security of its FHLB Seattle stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States or its agencies), provided certain standards related to creditworthiness, including a minimum ratio of total capital assets of at least five percent, are met.  Each available credit program has its own interest rate and range of maturities.  At December 31, 2002, Sterling had advances totaling $874.5 million from the FHLB Seattle which mature from 2003 through 2015 at interest rates ranging from 1.20% to 8.40%.  See “Management’s Discussion and Analysis – Liquidity and Sources of Funds” and Note 9 of “Notes to Consolidated Financial Statements.”

 

Sterling also borrows funds under reverse repurchase agreements pursuant to which it sells investments (generally U.S. agency and ABS) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the investments and ABS sold. Sterling uses these borrowings to supplement deposit gathering for funding the origination of loans. Sterling had $249.8 million and $218.5 million in wholesale and retail reverse repurchase agreements outstanding at December 31, 2002 and 2001, respectively.  The use of reverse repurchase agreements may expose Sterling to certain risks not associated with other

 

17



 

borrowings, including IRR and the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines. For additional information regarding reverse repurchase agreements, see “Management’s Discussion and Analysis – Asset and Liability Management,” “Management’s Discussion and Analysis – Liquidity and Sources of Funds” and Note 10 of “Notes to Consolidated Financial Statements.”

 

Other Borrowings.  Sterling has a variable-rate term note with U.S. Bank, N.A. (“U.S. Bank”) with a balance of $25.0 million outstanding at December  31, 2002.  This note matures on September 17, 2007.  Interest accrues at the 30-day London Interbank Offering Rate (“LIBOR”) plus 2.50% and is payable monthly.  Sterling also has a $5.0 million revolving line of credit with U.S. Bank.  This line of credit matures on September 15, 2003.  The interest rate is adjustable monthly at the 30-day LIBOR plus 2.50% and is payable monthly.  At December 31, 2002, no amounts were outstanding on the line of credit.  The term note and line of credit are collateralized by a majority of the Common and Preferred Stock of Sterling Savings Bank.  See Note 11 of “Notes to Consolidated Financial Statements.”

 

Sterling has outstanding $41.2 million of 9.50% junior subordinated deferrable interest debentures (“Junior Subordinated Debentures-I”) to Sterling Capital Trust (“Trust-I”), a Delaware business trust, of which Sterling owns all of the common equity.  The sole asset of Trust-I is the Junior Subordinated Debentures-I.  Trust-I issued $40.0 million of 9.5% Cumulative Capital Securities (“Trust-I Preferred Securities”) to investors.  Sterling’s obligations under the Junior Subordinated Debentures-I and related documents, taken together, constitute a full and unconditional guarantee by Sterling of Trust-I’s obligations under the Trust-I Preferred Securities.  The Trust-I Preferred Securities are treated as debt of Sterling.  Although Sterling, as a savings and loan holding company, is not subject to the Federal Reserve capital requirements for bank holding companies, the Trust-I Preferred Securities have been structured to qualify as Tier 1 capital, subject to certain limitations, if Sterling was to become regulated as a bank holding company.  The Trust–I Preferred Securities mature in 2027 and are redeemable at the option of Sterling under certain conditions.  The Trust-I Preferred Securities must be redeemed upon maturity of the Junior Subordinated Debentures-I in 2027.  See Note 11 of “Notes to Consolidated Financial Statements.”

 

Sterling has outstanding $24.7 million of 10.25% junior subordinated deferrable interest debentures (“Junior Subordinated Debentures-II”) to Sterling Capital Trust II (“Trust-II”), a Delaware business trust, in which Sterling owns all of the common equity.  The sole asset of Trust-II is the Junior Subordinated Debentures-II.  Trust-II issued $24.0 million of 10.25% Cumulative Capital Securities (“Trust-II Preferred Securities”) to investors.  Sterling’s obligations under the Junior Subordinated Debentures-II and related documents, taken together, constitute a full and unconditional guarantee by Sterling of Trust-II’s obligations under the Trust-II Preferred Securities.  The Trust-II Preferred Securities are treated as debt of Sterling.  Although Sterling, as a savings and loan holding company, is not subject to the Federal Reserve capital requirements for bank holding companies, the Trust-II Preferred Securities have been structured to qualify as Tier 1 capital, subject to certain limitations, if Sterling were to become regulated as a bank holding company.  The Junior Subordinated Debentures-II and Trust-II Preferred Securities mature in 2031 and are redeemable at the option of Sterling under certain conditions.  The Trust-II Preferred Securities must be redeemed upon maturity of the Junior Subordinated Debentures-II in 2031.  See Note 11 of “Notes to Consolidated Financial Statements.”

 

Sterling has outstanding $30.0 million of Floating Rate Notes Due 2006.  Interest accrues at the 90-day LIBOR plus 2.50% and is adjustable and payable quarterly.  The notes mature in 2006 and may be redeemed under certain conditions.  See Note 11 of “Notes to Consolidated Financial Statements.”

 

18



 

The following table sets forth certain information regarding Sterling’s short-term borrowings as of and for the periods indicated.

 

 

 

Years Ended December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Maximum amount outstanding at any month-end during the period:

 

 

 

 

 

 

 

Short-term reverse repurchase agreements

 

$

154,769

 

$

115,971

 

$

79,668

 

Short-term advances

 

238,975

 

115,648

 

183,918

 

 

 

 

 

 

 

 

 

Average amount outstanding during the period:

 

 

 

 

 

 

 

Short-term reverse repurchase agreements

 

45,728

 

66,718

 

36,427

 

Short-term advances

 

55,641

 

96,544

 

99,733

 

 

 

 

 

 

 

 

 

Weighted average interest rate paid during the period:

 

 

 

 

 

 

 

Short-term reverse repurchase agreements

 

1.85

%

3.56

%

6.09

%

Short-term advances

 

4.69

%

5.71

%

5.77

%

 

 

 

 

 

 

 

 

Weighted average interest rate paid at end of period:

 

 

 

 

 

 

 

Short-term reverse repurchase agreements

 

1.83

%

2.68

%

5.92

%

Short-term advances

 

3.69

%

5.06

%

5.85

%

 

The following table sets forth certain information concerning Sterling’s outstanding borrowings for the periods indicated.

 

 

 

December 31,

 

 

 

2002

 

2001

 

2000

 

 

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FHLB Seattle advances:

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term

 

$

238,975

 

19.1

 

$

117,376

 

12.0

 

$

84,184

 

11.2

 

Long-term

 

635,540

 

50.8

 

515,678

 

52.6

 

446,468

 

59.5

 

Securities sold subject to reverse repurchase agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term

 

154,769

 

12.3

 

114,999

 

11.7

 

6,776

 

0.9

 

Long-term

 

95,000

 

7.6

 

103,550

 

10.6

 

103,550

 

13.8

 

Convertible Subordinated Debt

 

0

 

 

3,500

 

0.4

 

0

 

 

Floating Rate Notes Due 2006

 

30,000

 

2.4

 

30,000

 

3.1

 

30,000

 

4.0

 

Term note payable

 

25,000

 

2.0

 

30,000

 

3.1

 

0

 

 

Advances under lines of credit

 

0

 

 

0

 

 

40,000

 

5.3

 

Trust Preferred Securities

 

64,000

 

5.1

 

64,000

 

6.5

 

40,000

 

5.3

 

Other

 

8,682

 

0.7

 

0

 

0

 

0

 

0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total borrowings

 

$

1,251,966

 

100.0

 

$

979,103

 

100.0

 

$

750,978

 

100.0