Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the year ended DECEMBER 31, 2011

OR

 

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

For the transition period from             to             

COMMISSION FILE NUMBER 001-34696

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Washington   91-1572822

(State or other jurisdiction of

incorporation or organization)

  (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) 358-8097

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

 

Common Stock   Nasdaq
(Title of each class)   (Name of each exchange on which registered)

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

(Title of class) None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨        No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨         No  x

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  x        No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x         No  ¨

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.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer    ¨   Accelerated filer    x    Non-accelerated filer    ¨   Smaller Reporting Company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨         No  x

As of June 30, 2011, 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 Capital Market, was $569 million.

The number of shares outstanding of the registrant’s common stock as of January 31, 2012 was 62,082,017.

DOCUMENTS INCORPORATED BY REFERENCE

Specific portions of the registrant’s Proxy Statement for its 2011 annual meeting of shareholders are incorporated by reference into Part III hereof.

 

 

 


Table of Contents

STERLING FINANCIAL CORPORATION

DECEMBER 31, 2011 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

PART I

     1   

Item 1.

  

Business

     1   

Item 1A.

  

Risk Factors

     21   

Item 1B.

  

Unresolved Staff Comments

     28   

Item 2.

  

Properties

     28   

Item 3.

  

Legal Proceedings

     29   

Item 4.

  

Mine Safety Disclosures

     30   
PART II      31   

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     31   

Item 6.

  

Selected Financial Data

     33   

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

     58   

Item 8.

  

Financial Statements and Supplementary Data

     58   

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     58   

Item 9A.

  

Controls and Procedures

     59   

Item 9B.

  

Other Information

     61   
PART III      62   

Item 10.

  

Directors, Executive Officers and Corporate Governance

     62   

Item 11.

  

Executive Compensation

     62   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     62   

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

     62   

Item 14.

  

Principal Accounting Fees and Services

     62   
PART IV      63   

Item 15.

  

Exhibits, Financial Statement Schedules

     63   
SIGNATURES      64   


Table of Contents

PART I

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of the risks and uncertainties inherent in such statements, see “BusinessForward-Looking Statements” and “Risk Factors.”

 

Item 1. Business

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 Savings Bank” refer to our subsidiary Sterling Savings Bank, a Washington state-chartered commercial bank. Sterling Savings Bank operates in California as Sonoma Bank. In 2012, Sterling Savings Bank intends to operate as Sterling Bank in all of the markets it serves, except California. Sterling Savings Bank offers retail and commercial banking products and services, mortgage lending and investment products to individuals, small businesses, commercial organizations and corporations. As of December 31, 2011, Sterling had assets of $9.19 billion and operated 175 depository branches in Washington, Oregon, Idaho, Montana, and California.

Recent Developments

For the year ended December 31, 2011, net income available to common shareholders was $39.1 million, compared to a net loss applicable to common shareholders of $756.1 million for 2010. The 2010 results include noncash accounting adjustments totaling $520.3 million related to the 2010 recapitalization. During 2011, Sterling returned to profitability, primarily as a result of a decline in loan losses. Improvements in asset quality are reflected in a decline in nonperforming assets of $447.2 million, or 55%, during 2011, and a decline in net loan charge-offs of $248.9 million, or 72%, compared with 2010. In addition to the improvements in asset quality, a reduction in deposit funding costs contributed to expansion in both net interest income and margin. Loan originations grew to $3.40 billion during 2011, compared with $2.93 billion in 2010. In November 2011, Sterling announced that Sterling Savings Bank entered into a Purchase and Assumption Agreement with First Independent Investment Group, Inc for the purchase of certain assets and operations of its First Independent Bank subsidiary, with closing anticipated during the first quarter of 2012. On January 25, 2012, Sterling announced that the Federal Deposit Insurance Corporation (“FDIC”) and the Washington Department of Financial Institutions (“WDFI”) had terminated the memorandum of understanding Sterling Savings Bank had entered into with its regulators.

Business Strategy

Sterling’s goal is to be one of America’s great community banks by offering customers a range of highly personalized financial products and services. This strategy centers on bringing the full product suite of a large regional institution to consumer and commercial customers with the personalized service of a local community bank. The four tenets of this philosophy are:

 

   

Knowledgeable bankers—Employee development, training and compensation initiatives designed to enable our talented team of bankers to capably serve our customers across our footprint.

 

   

Fair pricing—Offer a meaningful value proposition for our customers, while providing competitive funding and returns.

 

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Convenience and ease of use—We operate 175 retail banking locations and 33 mortgage loan origination offices; we provide customer-oriented hours, full-service internet banking and on-line bill pay.

 

   

Competitive products and services—We offer a full range of consumer, small business, commercial, corporate, wealth management and mortgage banking products and services across our five-state footprint. Our treasury management products include an advanced and easy to use Remote Deposit Capture system that is comparable to those of the largest banks operating in our area.

Our banking model is built around core customer relationships, and reflects our belief that every customer deserves a banking relationship built on trust and a superior experience with every interaction. In addition to organic growth based upon the tenets outlined above, an integral part of Sterling’s strategy includes acquiring other financial institutions or branches thereof, or other substantial assets or deposit liabilities. There is no assurance that Sterling will be successful in completing any such acquisitions.

Profitability Drivers

The following strategies are integral to our profitability:

 

   

Improving the mix and cost of deposits;

 

   

Reducing our balance sheet risk through resolution of the remaining asset quality issues, while generating prudently underwritten loan growth;

 

   

Building on our banking foundation by strengthening relationships with our customers; and

 

   

Improving noninterest expense management efforts.

We continue to shift our deposit mix towards lower cost transaction, savings and money market deposit accounts (“MMDA”). An asset quality focus is reflected by our robust underwriting and credit approval functions, and the realized progress in asset quality metrics. We are focused on expanding full relationship banking products and services. In addition, initiatives directed towards controlling our expenses and improvements in operating efficiency are core to our profitability strategy. Sterling believes these strategies, combined with our initiatives to manage risk, will contribute to high quality, consistent earnings, and build shareholder value. The effect of these strategies on Sterling’s financial results is discussed further in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).

Segments

For 2011, Sterling changed its reporting segments to reflect the integration of Golf Savings Bank into Sterling Savings Bank and other organizational realignments. Sterling’s operations for 2011 are divided into three primary business segments that represent its core businesses:

 

   

Commercial Real Estate—originating and servicing of multifamily real estate, commercial real estate and construction loans.

 

   

Community Banking—providing traditional banking services through the retail banking, private banking and commercial banking groups.

 

   

Home Loan Division—originating and selling residential real estate loans through its mortgage banking operations, on both a servicing-retained and servicing-released basis.

The results of operations are reported by segment in Note 22 of “Notes to Consolidated Financial Statements.”

 

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Lending Activities

A description of Sterling’s lending products and activities are as follows:

Commercial Real Estate Lending.    Sterling offers commercial real estate loans for investor non-owner occupied, multifamily, and construction projects, collateralized by real property. Permanent fixed- and adjustable-rate loans on existing properties typically have maturities of three to 30 years. Construction loans typically have terms of 12 to 24 months and have variable interest rates. In general, commercial real estate loans involve a higher degree of risk than one- to four-family residential real estate loans, because they typically involve large loan balances to single borrowers or groups of related borrowers. Currently, the number of new, viable construction projects that meet Sterling’s underwriting standards is limited, due to the contraction in the housing market. The performance on such loans is subject to certain risks not present in one- to four-family residential mortgage lending, including: excessive vacancy rates, inadequate operating cash flows, construction delays, cost overruns, insufficient values, environmental rules and an inability to obtain permanent financing in a timely manner.

Commercial Lending.    Sterling provides a full range of credit and financial services products to small- and medium-sized businesses. These products include commercial and industrial (“C&I”) lending such as: lines of credit, receivable and inventory financing, and equipment loans; and term financing for owner occupied commercial real estate properties. These loans are at fixed or adjustable rate structures, typically with terms of 12 months to 15 years. Loans may be fully secured, partially secured or unsecured, based on certain credit criteria. The product line for businesses includes standardized products, including access to the Small Business Administration (“SBA”) guaranteed lending program, as well as customized solutions, including cash flow and treasury management services.

Consumer Lending.    Consumer loans and lines of credit are originated directly through Sterling’s retail branches and private banking teams, and indirectly through Sterling’s dealer banking department. Sterling finances the purchase of consumer goods, including automobiles, boats and recreational vehicles, and lines of credit for personal use. Generally, consumer loans have fixed or adjustable rate structures, and are at terms ranging from six months to 10 years. Sterling also makes loans secured by borrowers’ savings accounts and equity loans collateralized by residential real estate. Equity loans may have maturities of up to 20 years.

One- to Four-Family Residential Lending.    Sterling originates residential mortgages that are generally underwritten to conform with Fannie Mae and Freddie Mac guidelines, guidelines established by government insured loan programs (HUD or VA), or guidelines established by investors (correspondent banks). Loans are originated through Sterling’s network of retail mortgage offices and depository branches. Products include: a) fixed-rate residential mortgages; b) adjustable-rate residential mortgages (“ARMs”), which have interest rates that adjust annually with a fixed period of three, five, seven or 10 years and are indexed to a variety of market indices; and c) interest only residential mortgages underwritten to amortizing payment standards. Sterling focuses its residential lending efforts on originating traditional amortizing loans for owner occupied homes, second homes and investment properties. Generally, conventional and government guaranteed residential mortgage loans are originated for up to 80% of the appraised value or selling price of the mortgaged property, whichever is less. Borrowers must purchase mortgage insurance from approved third parties so that Sterling’s risk is limited to approximately 80% of the appraised value on most loans with loan-to-value ratios in excess of 80%. Sterling’s residential lending programs are designed to comply with all applicable regulatory requirements.

Loan Servicing and Secondary Market Activities.    Sterling sells mortgage loans on a servicing-retained basis to Fannie Mae and Freddie Mac, or on a servicing-released basis to correspondent

 

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banks. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, holding and disbursing escrow funds for the payment of real estate taxes and insurance premiums, contacting delinquent borrowers and supervising foreclosures in the event of unremedied defaults. For sales of loans on a servicing-retained basis, Sterling records a servicing asset, while for sales of loans on a servicing-released basis, Sterling receives a fee. Loans sold into the secondary market are sold with limited recourse against Sterling, meaning that Sterling may be obligated to repurchase or otherwise reimburse the investor for incurred losses on any loans that suffer an early payment default, are not underwritten in accordance with investor guidelines or are determined to have post-closing borrower misrepresentations. Sterling maintains a reserve for unfunded credit commitments to cover the costs associated with these potential repurchases.

Sterling also purchases and sells nonresidential loans in the secondary market. Agents who present loans to Sterling for purchase are required to provide a processed loan package prior to commitment. Sterling then underwrites each loan in accordance with its established lending standards. Nonresidential loan sales provide Sterling with fee income, and assist with managing portfolio concentration risks.

Credit Quality Management

Details of Sterling’s problem asset classifications and allowance for credit losses are as follows:

Classified and Nonperforming Assets.    To measure the quality of loans and other real estate owned (“OREO”), Sterling has established guidelines for classifying and determining provisions for anticipated losses. Sterling’s system employs the risk rating categories of “substandard,” “doubtful” and “loss” for its classified assets. 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 same weaknesses as substandard assets, and on the basis of currently existing facts, are also deemed to have a high probability of loss. The portion of the asset considered uncollectible and of such little value that it should not be included as an asset of Sterling is classified as a loss. In such cases, Sterling establishes a specific valuation reserve.

The credit administration group focuses on identifying and resolving potential problem credits before they become classified. When an asset becomes classified, management of the relationship is assumed by Sterling’s special assets department. Sterling actively engages the borrower and guarantor to remedy the situation by requesting updated financial information from the borrower(s) and guarantor(s) to determine a course of action. In addition, updated collateral values are obtained in order for Sterling’s management to perform evaluations for regulatory and decision making purposes and updated title information is obtained to determine the status of encumbrances on the collateral. When possible, Sterling will require the borrower to provide additional collateral. In conjunction with the receipt of additional collateral, Sterling will sometimes modify the terms of the loan. Often the modified terms of the loan are consistent with terms that Sterling would offer a new borrower. If the borrower is having financial difficulties and the modification of terms is considered concessionary, Sterling classifies the loan as a “troubled debt restructure” and reports it as a nonperforming loan. Loans classified as troubled debt restructurings may be declassified and returned to accrual status after the borrower performs in accordance with the modified loan terms, generally for a period of at least six months, unless the modification includes an interest rate concession.

Sterling also may consider allowing a borrower to sell the underlying collateral for less than the outstanding balance on the loan if the current collateral evaluation supports the offer price. These transactions are known as “short sales.” In such situations, Sterling typically requires the borrower to sign a new note or bring cash to closing for the resulting deficiency.

 

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If Sterling and a borrower are unable to achieve an acceptable resolution, Sterling may take a deed in lieu of foreclosure or initiate foreclosure on the underlying collateral. Under such circumstances, Sterling also simultaneously evaluates legal action for recovery against the borrowers and guarantors. After obtaining the collateral, Sterling actively works to sell the collateral.

Allowance for Credit Losses.    Sterling regularly reviews its classified assets for impairment. If a loan is determined to be impaired, Sterling performs a valuation analysis on the loan. Valuation analysis compares the estimated fair value (market value less selling costs, foreclosure costs and projected holding costs), and the book balance (loan principal and accrued interest or carrying value of OREO). For loans that are considered collateral-dependent, the difference between the fair value and the book value is generally charged off as a confirmed loss. During times of declining real estate values, a specific reserve may be recorded on collateral-dependent impaired loans to recognize market declines since the last appraisal. For certain non-collateral-dependent loans, Sterling generally establishes a specific reserve for the difference between fair value and book value of these loans, as the loss is not defined as a confirmed loss because it is not based solely on collateral values. Allowances are established and periodically adjusted, if necessary, based on the review of information obtained through on-site inspections, market analysis, appraisals and purchase offers.

Sterling maintains an allowance for credit losses at a level deemed appropriate by management to provide for probable losses related to specifically identified loans and probable losses in the remaining portfolio, as well as unfunded commitments. The allowance is based upon historical loss experience, loan migration analysis, delinquency trends, portfolio size, concentrations of risk, prevailing and anticipated economic conditions, industry experience, estimated collateral values, management’s assessment of credit risk inherent in the portfolio, specific problem loans and other relevant factors. The portfolio is grouped into standard industry categories for homogeneous loans based on characteristics such as loan class, borrower and collateral. Loan migration to loss data is used to determine the annual “probability of default.” The annual probability of default is adjusted for the estimated loss emergence period and may be further adjusted based on an assessment of qualitative factors. Currently, Sterling is establishing the expected loss rate on loans using the losses on charged-off and foreclosed loans from the most recent 12 months to estimate the amount that would be lost if a default were to occur, which is termed the “loss given default.” The adjusted probability of default is multiplied by the loss given default to calculate the expected losses for each loan class.

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 be a confirmed loss. Because the allowance for credit losses is based on management’s estimate, ultimate losses may materially differ from the estimates.

Investments and Mortgage-Backed Securities ("MBS")

Sterling invests primarily in Freddie Mac, Fannie Mae and the Government National Mortgage Association ("Ginnie Mae") MBS. Sterling also has investments in municipal bonds and nonagency collateralized mortgage obligations. Such investments provide Sterling with a relatively liquid source of interest income and collateral, which can be used to secure borrowings, and assist with managing the interest rate risk and credit risk of Sterling’s balance sheet.

Sources of Funds

Sterling’s primary sources of funds are: retail, public and brokered deposits; the collection of principal and interest from loans and MBS; the sale of loans into the secondary market in connection with Sterling’s mortgage banking activities and other loan sale activities; borrowings from the Federal Home Loan Bank ("FHLB") and the Federal Reserve; and borrowings from commercial banks (including

 

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reverse repurchase agreements). The availability and volume of these funds are influenced significantly by prevailing interest rates and other economic conditions, as well as regulatory statutes. Borrowings 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.

Deposit Activities.    Sterling offers a wide variety of deposit products and related services to businesses, individuals, and public sector entities throughout its primary market areas. Deposit accounts include transaction (checking) accounts, savings accounts, MMDA, and certificates of deposit ("CDs"). These deposit products and services are marketed by its 175 depository banking offices and each of its private and commercial banking offices. Sterling offers both interest- and noninterest bearing checking accounts, MMDA, CDs and savings accounts that 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 products, most CDs carry a fixed rate of interest for a defined term from the opening date of the account. Penalties are imposed if principal is withdrawn from most CDs prior to maturity.

Sterling competes with other financial institutions and financial intermediaries in attracting deposits. There is strong competition for transaction, money market and time deposit balances from commercial banks, credit unions and nonbank corporations, such as securities brokerage companies, mutual funds and other diversified companies, some of which have nationwide networks of offices. Many of Sterling’s marketing efforts have been directed toward attracting additional deposit customer relationships and balances. Sterling provides electronic banking products, including debit card, online banking, bill pay, merchant services and treasury management services, which include remote deposit capture. All of these products and services are intended to enhance customer relationships and attract and increase retail deposit balances.

Sterling has 172 automated teller machines (“ATM”). Customers also can access ATMs operated by other financial institutions. Sterling is a member of an ATM network that allows its participating customers to deposit or withdraw funds at numerous locations in the United States and internationally.

Sterling supplements its retail deposit gathering by soliciting funds from public entities and through the acquisition of brokered deposits. Public funds are generally obtained by competitive bidding among qualifying financial institutions, and usually require Sterling to provide the public entities with collateral in the form of qualifying securities for any portion of the deposit that exceeds FDIC deposit insurance limits.

Borrowings.    Although deposits are Sterling’s primary source of funds, Sterling also uses other borrowings to supplement its deposit gathering efforts. These borrowings include advances from the FHLB, reverse repurchase agreements, primary credits and term auction facilities from the Federal Reserve, and federal funds purchased. See “MD&A—Liquidity and Capital Resources.

The FHLB of Seattle is part of a system that consists of 12 regional Federal Home Loan Banks that provide secured credit to financial institutions. As a condition of membership in the FHLB of Seattle, Sterling Savings Bank is required to own stock of the FHLB of Seattle, with the amount determined as the greater of either a percentage of Sterling’s total mortgage related assets, or a percentage of Sterling’s total advances outstanding from the FHLB of Seattle. At December 31, 2011, Sterling Savings Bank held more than the minimum FHLB of Seattle stock ownership requirement.

Sterling also borrows funds under reverse repurchase agreements with major broker/dealers and financial entities pursuant to which it sells investments (generally, U.S. agency obligations and MBS)

 

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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 MBS sold. The use of reverse repurchase agreements and other secured borrowings may expose Sterling to certain risks, including the possibility that additional collateral may have to be provided if the market value of the pledged collateral declines.

Subsidiaries

Sterling’s principal operating subsidiary is Sterling Savings Bank. See exhibit 21.1 for a complete list of subsidiaries for Sterling and Sterling Savings Bank.

Competition

Sterling faces strong competition, both in attracting deposits and in originating, purchasing and selling loans, from commercial banks, savings and loan associations, mutual savings banks, credit unions and other institutions, many of which have greater resources than Sterling. Sterling also faces strong competition in marketing financial products such as annuities, mutual funds and other financial products and in pursuing acquisition opportunities. Some or all of these competitive businesses operate in Sterling’s market areas. As of June 30, 2011, Sterling Savings Bank’s deposit market share was as follows:

 

Washington

 

County

   Branches      Rank      Market Share  

Adams

     2         3                   24.4

Asotin

     2         2         21.5

Benton

     4         7         6.2

Clallam

     2         11         3.8

Clark

     1         15         0.9

Columbia

     1         1         33.3

Douglas

     1         3         13.0

Franklin

     1         8         6.5

Garfield

     1         1         45.9

Grant

     2         5         8.8

Grays Harbor

     5         4         11.0

King

     15         16         1.0

Kitsap

     1         14         0.9

Kittitas

     2         3         16.0

Klickitat

     2         2         32.2

Lewis

     4         2         18.4

Okanogan

     2         2         22.8

Pierce

     2         12         1.6

Snohomish

     2         11         2.3

Spokane

     9         2         13.9

Thurston

     4         5         7.2

Walla Walla

     2         4         6.7

Whatcom

     3         11         3.2

Whitman

     1         8         2.0

Oregon

 

County

   Branches      Rank      Market Share  

Baker

     1         1                   30.2

Benton

     1         8         2.7

Clackamas

     2         17         0.6

Clatsop

     2         6         7.2

Columbia

     1         3         17.4

Coos

     5         2         26.5

Curry

     3         1         29.6

Deschutes

     4         11         2.6

Douglas

     1         7         1.3

Harney

     1         2         26.2

Grant

     1         3         23.8

Jackson

     5         8         5.1

Josephine

     2         11         2.7

Klamath

     5         2         26.4

Lake

     1         3         29.6

Lane

     5         14         1.5

Linn

     1         10         2.7

Malheur

     3         3         22.1

Marion

     2         13         0.8

Multnomah

     4         9         1.0

Polk

     1         7         5.5

Tillamook

     3         2         34.0

Umatilla

     4         7         5.7

Union

     1         6         6.7

Wallowa

     1         2         24.6

Washington

     3         14         1.1

Yamhill

     2         9         2.7
 

 

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Idaho

 

County

   Branches      Rank      Market Share  

Ada

     2         20         0.6

Adams

     1         2                   41.1

Benewah

     1         4         15.3

Idaho

     3         1         50.4

Kootenai

     3         10         3.2

Latah

     3         2         25.6

Nez Perce

     3         2         19.7

Valley

     2         3         25.6

California

 

County

   Branches      Rank      Market Share  

Contra Costa

     2         17         0.5

Marin

     2         12         1.0

Sonoma

     9         5         6.8

Montana

 

County

   Branches      Rank      Market Share  

Gallatin

     1         10         2.5

Missoula

     2         10         1.9

Park

     1         4         10.4

Ravalli

     1         7         4.0

Sweet Grass

     1         3         17.9

Yellowstone

     1         8         1.1
 

 

These deposit metrics were obtained from SNL Financial, which compiled the data published by the FDIC.

Personnel

As of December 31, 2011, Sterling had 2,496 full-time equivalent employees. Employees are not represented by a collective bargaining unit.

Regulation

The following is a summary of some of the more significant provisions of laws applicable to Sterling and its subsidiaries. This regulatory framework is designed to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. To the extent that the information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Further, such statutes, regulations and policies are continually under review by Congress and state legislatures, and federal and state regulators. A change in statutes, regulations or regulatory policies applicable to Sterling, including changes in interpretation or implementation thereof, could have a material effect on Sterling’s business.

General.    As a bank holding company, Sterling is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and by the WDFI. Our subsidiary Sterling Savings Bank is a Washington state-chartered commercial bank, and its deposits are insured by the FDIC. It is subject to regulation, examination and supervision by the FDIC and the WDFI. Numerous federal and state laws, as well as regulations promulgated by the Federal Reserve, the FDIC and state banking regulators, govern almost all aspects of the operation of Sterling Savings Bank, and Sterling’s non-bank subsidiaries are also subject to regulation by applicable federal and state regulators for the states in which they conduct business.

 

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Bank Holding Company Regulation.    The BHCA limits a bank holding company’s business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the Federal Reserve’s approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5% of the voting shares of such bank; (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of any additional banks. Subject to certain state laws, such as age and contingency restrictions, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state banks and out-of-state banks. With certain exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve determines that the activities of such company are incidental or closely related to the business of banking. If a bank holding company is well-capitalized and meets certain criteria specified by the Federal Reserve, it may engage de novo in certain permissible non-banking activities without prior Federal Reserve approval.

A number of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), a few of which are described here, affect the regulation and operations of banks and bank holding companies. Pursuant to the Dodd-Frank Act, the FDIC is given back-up supervisory authority over bank holding companies engaging in conduct that poses a foreseeable and material risk to the Deposit Insurance Fund ("DIF"), and the Federal Reserve gains heightened authority to examine, prescribe regulations and take action with respect to all of a bank holding company’s subsidiaries. A newly created agency, the Office of Financial Research, has authority to collect data from all financial institutions for the purpose of studying threats to U.S. financial stability. Banks and bank holding companies with $10 billion or more in assets will also be required to conduct and publish the results of annual capital stress tests. In December 2011, the Federal Reserve released a proposed rule to implement this stress testing requirement, but the rule has not yet been finalized.

Holding companies of banks chartered under Washington law are subject to applicable provisions of Washington’s banking laws and to the examination, supervision and enforcement powers of the WDFI. Among other powers, the WDFI has the authority to issue and enforce cease and desist orders on such holding companies and to bring actions to remove their directors, officers and employees.

Change in Control.    Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring “control” of a bank or bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of an institution’s voting securities and either that institution has registered securities under Section 12 of the Exchange Act or no other person owns a greater percentage of that class of voting securities immediately after the transaction. In certain cases, a company may also be presumed to have control under the Bank Holding Company Act if it acquires 5% or more of any class of voting securities.

On September 22, 2008, the Federal Reserve issued a policy statement on minority equity investments in banks and bank holding companies that permits investors—without triggering the various regulatory requirements associated with control—to (1) acquire up to 33% of the total equity of a target bank or bank holding company, subject to certain conditions including (but not limited to) the condition that the investing firm does not acquire 15% or more of any class of voting securities, and (2) designate at least one director to serve on the board of directors.

Pursuant to the Dodd-Frank Act, a bank holding company may acquire control of an out-of-state bank only if the bank holding company is well-capitalized and well-managed, and interstate merger

 

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transactions are prohibited unless the resulting bank would be well-capitalized and well-managed following the transaction. Washington state law requires that the WDFI be given notice at least 30 days in advance of any proposed change of control of a Washington state-chartered bank. Washington law defines "control" of an entity to mean directly or indirectly, alone or in concert with others, to own, control or hold the power to vote 25% or more of the outstanding stock or voting power of the entity.

Capital Requirements.    The Federal Reserve has adopted guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company such as Sterling, and in analyzing applications under the BHCA. The FDIC has adopted similar guidelines to assess the adequacy of capital in state-chartered non-member banks such as Sterling Savings Bank. These guidelines include quantitative measures that assign risk weightings to assets and off-balance sheet items and that define and set minimum regulatory capital requirements. The definitions of capital and the tests for measuring the adequacy of capital required by the Federal Reserve for bank holding companies and by the FDIC for state-chartered non-member banks are similar, but not identical.

In general, all bank holding companies are required to maintain a tier 1 leverage ratio of at least 3%, tier 1 risk-based capital ratio of at least 4%, and total risk-based capital ratio (the sum of tier 1 capital and tier 2 capital) of at least 8%.

Under FDIC regulations, all insured depository institutions are assigned to one of the following capital categories:

 

   

Well-Capitalized—A well-capitalized insured depository institution: (1) has a total risk-based capital ratio of 10% or greater; (2) has a tier 1 risk-based capital ratio of 6% or greater; (3) having a leverage capital ratio of 5% or greater; and (4) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

 

   

Adequately Capitalized—An adequately capitalized insured depository institution: (1) has a total risk-based capital ratio of 8% or greater; (2) has a tier 1 risk-based capital ratio of 4% or greater; and (3) has a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

 

   

Undercapitalized—An undercapitalized insured depository institution: (1) has a total risk-based capital ratio of less than 8%; (2) has a tier 1 risk-based capital ratio of less than 4%; or (3) has a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMELS rating system, a leverage capital ratio of less than 3%.

 

   

Significantly Undercapitalized—A significantly undercapitalized insured depository institution: (1) has a total risk-based capital ratio of less than 6%; (2) has a tier 1 risk-based capital ratio of less than 3%; or (3) a leverage capital ratio of less than 3%.

 

   

Critically Undercapitalized—A critically undercapitalized institution: has a ratio of tangible equity to total assets that is equal to or less than 2%.

The regulations permit the appropriate federal banking regulator to downgrade an institution to the next lower category if the regulator determines that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination. Supervisory actions by the appropriate federal banking regulator depend upon an institution’s classification within the five regulatory capital categories. For the purposes of these tests, tier 1 capital generally consists of common equity, retained earnings and a limited amount of qualifying preferred stock, less accumulated other comprehensive income (loss), goodwill and certain core deposit intangibles. Tier 2 capital consists of non-qualifying preferred stock, certain types of debt and a limited amount of other items.

 

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In measuring the adequacy of risk-based capital, assets are weighted for risk at rates that range from zero percent to 100%. Certain assets, such as cash and U.S. government securities, have a zero percent risk weighting. Others, such as certain commercial and consumer loans, have a 100% risk weighting. Risk weightings and asset equivalent factors are also assigned for off-balance sheet items such as loan commitments. The various items are multiplied by the appropriate risk-weighting to determine risk-adjusted assets for the capital calculations. For the leverage ratio mentioned above, assets are not risk-weighted.

In December 2010, the Basel Committee published new capital standards commonly referred to as “Basel III.” The standards will, when implemented, among other things, impose more restrictive eligibility requirements for tier 1 and tier 2 capital; increase the minimum tier 1 common equity ratio to 4.5%, net of regulatory deductions, and introduce a capital conservation buffer of an additional 2.5% of common equity to risk-weighted assets, raising the target minimum common equity ratio to 7%; increase the minimum tier 1 capital ratio to 8.5% inclusive of the capital conservation buffer; increase the minimum total capital ratio to 10.5% inclusive of the capital buffer; and introduce a countercyclical capital buffer of up to 2.5% of common equity or other fully loss absorbing capital for periods of excess credit growth. Basel III also introduces a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards. U.S. banking supervisors have not yet released proposed rules to implement the Basel III requirements, and it is uncertain at this time whether the proposed rules, when released, will apply Basel III’s requirements to Sterling or Sterling Savings Bank.

As of December 31, 2011, Sterling and Sterling Savings Bank’s capital levels were above those currently required to be deemed “well-capitalized.” As noted, capital requirements will likely be increasing over the next several years as a result of the implementation of the Dodd-Frank Act and the U.S. federal banking regulators’ implementation of the Basel III standards. If a depository institution fails to remain well-capitalized, it becomes subject to a variety of enforcement remedies that increase as the capital condition worsens.

Commitments to Subsidiary Bank.    Under Federal Reserve policy, Sterling is expected to act as a source of financial strength to Sterling Savings Bank, and to commit resources to support Sterling Savings Bank in circumstances when we might not do so absent such policy. The Dodd-Frank Act requires this Federal Reserve policy to be implemented into formal regulations, which have not yet been proposed. Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary. Further, the Federal Reserve has discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the Federal Reserve determines that any such divestiture may aid the depository institution’s financial condition. In addition, any capital loans by Sterling to Sterling Savings Bank would be subordinate in right of payment to depositors and to certain other indebtedness of Sterling Savings Bank.

If Sterling were to enter bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of Sterling Savings Bank would generally be assumed by the bankruptcy trustee and entitled to a priority of payment. However, recent case law has held that, under certain circumstances, the assumption by the trustee and the priority of payment may be disallowed. It is not clear what impact, if any, this case law would have on our obligations in such an event.

Prompt Corrective Action.    The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established a system of prompt corrective action to resolve the problems of undercapitalized insured depository institutions. Under this system, the federal banking regulators are

 

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required to rate insured depository institutions on the basis of five capital categories as described above under "Capital Requirements." The federal banking regulators are also required to take mandatory supervisory actions and are authorized to take other discretionary actions with respect to insured depository institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the insured depository institution is assigned. Generally, subject to a narrow exception, FDICIA requires the banking regulators to appoint a receiver or conservator for an insured depository institution that is critically undercapitalized. The federal banking regulations specify the relevant capital level for each category.

FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a dividend, or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. See “Dividends.” “Undercapitalized” depository institutions are also subject to restrictions on borrowing from the Federal Reserve System, may not accept brokered deposits absent a waiver from the FDIC, and are subject to growth limitations. In addition, a depository institution’s holding company must guarantee a capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Federal banking regulators may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

“Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

Washington state law gives the WDFI powers similar to those granted to the FDIC under the prompt corrective action provisions of FDICIA.

Dividends.    Sterling is a legal entity separate and distinct from Sterling Savings Bank and other subsidiaries. The principal source of funds for Sterling’s payment of dividends on its capital stock and principal and interest on its debt is dividends from Sterling Savings Bank. Various federal and state statutory provisions and regulations limit the amount of dividends, if any, Sterling, Sterling Savings Bank and certain other subsidiaries may pay without regulatory approval.

Under the Federal Reserve guidance reissued on February 24, 2009 the Federal Reserve may restrict Sterling’s ability to pay dividends on any class of capital stock or any other tier 1 capital instrument if it is not deemed to have a strong capital position. In addition, dividends may have to be reduced or eliminated if:

 

   

Sterling’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;

 

   

Sterling’ Savings Bank’s prospective rate of earnings retention is not consistent with the holding company’s capital needs and overall current and prospective financial condition; or

 

   

Sterling will not meet, or is in danger of not meeting, Sterling’s minimum regulatory capital adequacy ratios.

Federal bank regulators have the authority to prohibit Sterling Savings Bank from engaging in unsafe or unsound practices in conducting its business, and the payment of dividends, depending on the bank’s financial condition, could be deemed an unsafe or unsound practice. The ability of Sterling Savings Bank to pay dividends in the future will continue to be influenced by bank regulatory policies and capital guidelines, and is subject to regulatory approval.

 

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FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a dividend, or paying any management fee to its holding company if the institution would thereafter be undercapitalized. In addition, federal and state banking regulations applicable to us and our bank subsidiaries require minimum levels of capital that limit the amounts available for payment of dividends.

Under the terms of Sterling’s junior subordinated notes and the trust documents relating to its junior subordinated debentures, Sterling is allowed to defer payments of interest for up to 20 consecutive quarterly periods without default. During the deferral period, however, Sterling generally may not pay cash dividends on or repurchase common stock until all accrued interest payments are paid and regularly scheduled interest payments are resumed. Through December 31, 2011, Sterling was in deferral on the payment of interest relating to the junior subordinated debentures.

Deposit Insurance and Assessments.    Deposits held by Sterling Savings Bank are insured by the DIF as administered by the FDIC. The Dodd-Frank Act raised the standard maximum deposit insurance amount to $250,000 per depositor, per insured depository institution for each account ownership category. Effective December 31, 2010, and continuing through December 31, 2012, the Dodd-Frank Act provides unlimited FDIC insurance for all noninterest-bearing transaction accounts, regardless of amount.

The FDIC maintains the DIF by assessing each depository institution an insurance premium. The amount of the FDIC assessments paid by a DIF member institution is based on its relative risk of default as measured by the company’s FDIC supervisory rating, and other various measures, such as the level of brokered deposits, secured debt and debt issuer ratings.

In February 2011, the FDIC redefined the deposit insurance assessment base, and updated the assessment rates. The DIF assessment base rate currently ranges from 2.5 to 45 basis points for institutions that do not trigger factors for brokered deposits and unsecured debt, and higher rates for those that do trigger those risk factors.

The Dodd-Frank Act effects further changes to the law governing deposit insurance assessments. There is no longer an upper limit for the reserve ratio designated by the FDIC each year, and the maximum reserve ratio may not be less than 1.35% of insured deposits, or the comparable percentage of the assessment base. Under prior law the maximum reserve ratio was 1.15%. The Dodd-Frank Act permits the FDIC until September 30, 2020 to raise the reserve ratio, which is currently negative, to 1.35%. The FDIC is required to offset the effect of increased assessments necessitated by the Dodd-Frank Act on insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also eliminates requirements under prior law that the FDIC pay dividends to member institutions if the reserve ratio exceeds certain thresholds. In lieu of dividends, the FDIC will adopt lower rate schedules when the reserve ratio exceeds certain thresholds.

All FDIC-insured depository institutions must pay a quarterly assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, which are referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation. Sterling paid 0.00165 cents per $100 of DIF-assessable assets during the fourth quarter of 2011.

Transactions with Affiliates and Insiders.    A variety of legal limitations restrict Sterling Savings Bank from lending or otherwise supplying funds or in some cases transacting business with Sterling or its nonbank subsidiaries. Sterling Savings Bank is subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A places limits on the amount of covered transactions which include loans or extensions of credit to, investments in or certain other transactions

 

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with, affiliates as well as the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited to 10% of the bank’s capital and surplus for any one affiliate and 20% for all affiliates. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements ranging from 100% to 130%. Also, banks are prohibited from purchasing low quality assets from an affiliate.

Section 23B, among other things, prohibits an institution from engaging in certain transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with nonaffiliated companies. Except for limitations on low quality asset purchases and transactions that are deemed to be unsafe or unsound, Regulation W generally excludes affiliated depository institutions from treatment as affiliates. Transactions between a bank and any of its subsidiaries that are engaged in certain financial activities may be subject to the affiliated transaction limits. The Federal Reserve also may designate bank subsidiaries as affiliates.

Banks are also subject to quantitative restrictions on extensions of credit to executive officers, directors, principal shareholders, and their related interests. In general, such extensions of credit (1) may not exceed certain dollar limitations, (2) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (3) must not involve more than the normal risk of repayment or present other unfavorable features. Certain extensions of credit also require the approval of a bank’s board of directors.

The Dodd-Frank Act expands the 23A and 23B affiliate transaction rules. Among other things, upon the statutory changes’ effective date, the scope of the definition of “covered transaction” under 23A will expand, collateral requirements will increase and certain exemptions will be eliminated.

Standards for Safety and Soundness.    The Federal Deposit Insurance Act requires the federal bank regulators to prescribe the operational and managerial standards for all insured depository institutions relating to: (1) internal controls; (2) information systems and audit systems; (3) loan documentation; (4) credit underwriting; (5) interest rate risk exposure; and (6) asset quality.

The regulators also must prescribe standards for earnings, and stock valuation, as well as standards for compensation, fees and benefits. The Interagency Guidelines Prescribing Standards for Safety and Soundness set forth the safety and soundness standards used to identify and address problems at insured depository institutions before capital becomes impaired. Under the rules, if a regulator determines that a bank fails to meet any standards prescribed by the guidelines, the regulator may require the bank to submit an acceptable plan to achieve compliance, consistent with deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination.    Federal and state banking regulators mandate that Sterling and Sterling Savings Bank provide audited financial statements in compliance with minimum standards and procedures. Sterling and Sterling Savings Bank must undergo regular on-site examinations by the appropriate banking agency. A bank regulator conducting an examination has complete access to the books and records of the examined institution. The results of the examination are confidential. The cost of examinations may be assessed against the examined institution as the agency deems necessary or appropriate.

State Law and Regulation.    Sterling Savings Bank as a Washington state-chartered institution, is subject to regulation by the WDFI, which conducts regular examinations to ensure that its operations and policies conform with applicable law and safe and sound banking practices. Among other things, state law regulates the amount of credit that can be extended to any one borrower and the amount of

 

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money that can be invested in various types of assets. Sterling Savings Bank generally cannot extend credit to any one borrower in an amount greater than 20% of Sterling Savings Bank’s capital and surplus. State law also regulates the types of loans Sterling Savings Bank can make. With the WDFI’s approval, Sterling Savings Bank can currently invest up to 10% of its total assets or 50% of its net worth (whichever is less) in other corporations, whether or not such corporations are engaged in activities related to Sterling Savings Bank’s business, but such authority is subject to restrictions imposed by federal law. Sterling Savings Bank also operates depository branches within the states of Oregon, Idaho, California and Montana and therefore its operations in these states are subject to the supervision of the Oregon Department of Consumer and Business Services, the Idaho Department of Finance, the California Department of Financial Institutions and the Montana Department of Finance, as applicable. Sterling and its subsidiaries are also required to comply with the applicable laws and regulations for the various states in which it does business.

Community Reinvestment Act.    The Community Reinvestment Act (the "CRA") requires that the appropriate federal bank regulator evaluate the record of our banking subsidiary in meeting the credit needs of its local community, including low and moderate income neighborhoods. These evaluations are considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could result in additional requirements and limitations on the bank. As of Sterling’s last CRA regulatory exam during the fourth quarter of 2011, Sterling Savings Bank received a rating of “satisfactory.”

Consumer Protection Regulations.    Retail activities of banks are subject to a variety of statutes and regulations designed to protect consumers. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”) that, together with the statute’s changes to consumer protection laws such as limits on debit card interchange fees and provisions on mortgage-related matters, will likely increase the compliance costs of consumer banking operations. Interest and other charges collected or contracted for by banks are subject to state usury laws and federal laws concerning interest rates. In January 2012, a director was appointed to lead the CFPB and the CFPB began exercising its full range of powers. The CFPB has exclusive authority to require reports and conduct examinations, for purposes of ensuring compliance with federal consumer financial laws and related matters, of insured depository institutions with more than $10 billion of assets. For insured depository institutions with assets of $10 billion or less, the CFPB can require reports and conduct examinations on a sample basis.

Loan operations are also subject to federal laws applicable to credit transactions, such as:

 

   

the federal Truth-In-Lending Act and Regulation Z issued by the Federal Reserve, governing disclosures of credit terms to consumer borrowers;

 

   

the Home Mortgage Disclosure Act and Regulation C issued by the Federal Reserve, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

   

the Equal Credit Opportunity Act and Regulation B issued by the Federal Reserve, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

   

the Fair Credit Reporting Act and Regulation V issued by the Federal Reserve, governing the use and provision of information to consumer reporting agencies;

 

   

the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

   

the guidance of the various federal agencies charged with the responsibility of implementing such federal laws.

 

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Deposit operations also are subject to:

 

   

the Truth in Savings Act and Regulation DD issued by the Federal Reserve, which requires disclosure of deposit terms to consumers;

 

   

Regulation CC issued by the Federal Reserve, which relates to the availability of deposit funds to consumers;

 

   

the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

 

   

the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of ATMs and other electronic banking services.

Commercial Real Estate Lending.    Lending operations that involve concentrations of commercial real estate loans are subject to enhanced scrutiny by federal banking regulators. The regulators have advised financial institutions of the risks posed by commercial real estate lending concentrations. Such loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for examiners to help identify institutions that are potentially exposed to excessive risk concentrations and may warrant greater supervisory scrutiny:

 

   

total construction and land development loans represent 100% or more of the institution’s total risk-based capital (the ratio was 29% for Sterling Savings Bank at December 31, 2011, compared with 66% at December 31, 2010), or

 

   

total commercial real estate loans, as defined, represent 300% or more of the institution’s total risk-based capital (the ratio was 251% for Sterling Savings Bank at December 31, 2011, compared with 246% at December 31, 2010), and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.

The Dodd-Frank Act contains provisions on credit risk retention that require federal banking regulators to adopt regulations mandating the retention of 5% of the credit risk of certain assets transferred, sold or conveyed through issuances of asset-backed securities. Implementing regulations will provide for the allocation of the risk retention obligation between securitizers and originators of loans.

Branching.    The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

Washington enacted “opting in” legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain “aging” requirements. Once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank’s assets, the out-of-state bank may open additional branches within the state. In addition, an out-of-state bank may establish a de novo branch in Washington or acquire a branch in Washington if the out-of-state bank’s home state gives Washington banks substantially the same or more favorable rights to establish and maintain branches in that state.

 

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Anti-Tying Restriction.    In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for products and services on the condition that (1) the customer obtain or provide some additional credit, property, or services from or to the bank or bank holding company or their subsidiaries, or (2) the customer not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. A bank may, however, offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products. Also, certain foreign transactions are exempt from the general rule.

Anti-Money Laundering.    Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and the periodic testing of the program. Sterling Savings Bank is prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence in dealings with foreign financial institutions and foreign customers. We also must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money requirements have been substantially strengthened as a result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”), enacted in 2001 and renewed in 2006 and extended, in part, in 2011. Bank regulators routinely examine institutions for compliance with these requirements and must consider compliance in connection with the regulatory review of applications.

The USA Patriot Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. The statute also creates enhanced information collection tools and enforcement mechanics for the U.S. government, including: (1) requiring standards for verifying customer identification at account opening; (2) promulgating rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (3) requiring reports by nonfinancial trades and businesses filed with the Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (4) mandating the filing of suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations. The statute also requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

The Federal Bureau of Investigation may send bank regulators lists of the names of persons suspected of involvement in terrorist activities. Sterling may be subject to a request for a search of its records for any relationships or transactions with persons on those lists and may be required to report any identified relationships or transactions. Furthermore, the Office of Foreign Assets Control (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, bank regulators lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.

Privacy and Credit Reporting.    Financial institutions are required to disclose their policies for collecting and protecting confidential customer information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties, with some exceptions, such as the processing of transactions requested by the consumer. Financial institutions generally may not disclose certain consumer or account information to any nonaffiliated

 

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third party for use in telemarketing, direct mail marketing or other marketing. Federal and state bank regulators have prescribed standards for maintaining the security and confidentiality of consumer information, and we are subject to such standards, as well as certain federal and state laws or standards for notifying consumers in the event of a security breach.

Sterling Savings Bank utilizes credit bureau data for loan underwriting purposes. Use of such data is regulated under the Fair Credit Reporting Act and Regulation V on a uniform, nationwide basis, including credit reporting, prescreening, sharing of information between affiliates and the use of credit data. The Fair and Accurate Credit Transactions Act, which amended the Fair Credit Reporting Act, permits states to enact identity theft laws that are consistent with the conduct required by the provisions of that Act.

Enforcement Powers.    Banks and their “institution-affiliated parties,” including directors, management, employees, agents, independent contractors and consultants, such as attorneys and accountants, and others who participate in the conduct of the institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. Violations can include failure to timely file required reports, filing false or misleading information or submitting inaccurate reports. Civil penalties may be as much as $1 million a day for such violations and criminal penalties for some financial institution crimes may include imprisonment for 20 years. Regulators have flexibility to commence enforcement actions against institutions and institution-affiliated parties, and the FDIC has the authority to terminate deposit insurance. When issued by a banking regulator, cease-and-desist orders or other regulatory agreements may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions determined to be appropriate by the ordering agency. Federal and state banking regulators also may remove a director or officer from an insured depository institution (or bar them from the industry) if a violation is willful or reckless.

Corporate Governance.    The Dodd-Frank Act contains a number of provisions that will require changes to financial institutions’ corporate governance and executive compensation practices, including proxy access for publicly-traded banks’ director nominations, clawback of incentive-based compensation from executive officers and increased disclosure on compensation arrangements. Publicly-traded bank holding companies with more than $10 billion in assets will also be required to have risk committees with a number of independent directors to be determined by the Federal Reserve and that include at least one risk management expert. The Federal Reserve released proposed rules to implement these risk committee requirements in December 2011, but the rules have not yet been finalized.

Monetary Policy and Economic Controls.    Our earnings are affected by the policies of regulatory authorities, including the monetary policy of the Federal Reserve. An important function of the Federal Reserve is to promote orderly economic growth by influencing interest rates and the supply of money and credit. Among the methods that have been used to achieve this objective are open market operations in U.S. government securities, changes in the discount rate for bank borrowings, expanded access to funds for nonbanks and changes in reserve requirements against bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, interest rates on loans and securities, and rates paid for deposits. In recent years, in response to the financial crisis, the Federal Reserve has created several innovative programs to stabilize certain financial institutions and to ensure the availability of credit. The effects of the various Federal Reserve policies on our future business prospects and earnings cannot be predicted.

 

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Depositor Preference Statute.    Federal law provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded priority over other general unsecured claims against such institution, including federal funds and letters of credit, in the liquidation or other resolution of the institution by any receiver.

Environmental Laws.    Hazards related to the environment have become a source of high risk and potentially unlimited liability for financial institutions relative to their loans. Contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high clean-up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean-up costs, and liability to the institution for clean-up costs if it forecloses on the contaminated property or becomes involved in the management of the property. To minimize this risk, Sterling may require an environmental examination and report with respect to the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. This examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, with the costs of such examinations and reports being the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with Sterling. Sterling is not aware of any borrower who is currently subject to any environmental investigation or clean-up proceeding that is likely to have a material adverse effect on the financial condition or results of operations of Sterling.

Forward-Looking Statements

This annual report on Form 10-K contains forward-looking statements that are not historical facts and that are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about Sterling’s plans, objectives, expectations, strategies and intentions and other statements contained in this report that are not historical facts and pertain to Sterling’s future operating results and capital position, including Sterling’s ability to complete recovery plans, and Sterling’s ability to reduce future loan losses, execute its asset resolution initiatives, improve its deposit mix, execute its lending initiatives, contain costs and potential liabilities, realize operating efficiencies, execute its business strategy, compete in the marketplace, and provide increased customer support and service. When used in this report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements.

Actual results may differ materially from the results discussed in these forward-looking statements because such statements are inherently subject to significant assumptions, risks and uncertainties, many of which are difficult to predict and are generally beyond Sterling’s control. These include but are not limited to:

 

   

the possibility of continued adverse economic developments that may, among other things, increase default and delinquency risks in Sterling’s loan portfolios;

 

   

shifts in market interest rates that may result in lower interest rate margins;

 

   

shifts in the demand for loans and other products;

 

   

changes in the monetary and fiscal policies of the federal government;

 

   

changes in laws, regulations and the competitive environment;

 

   

lower-than-expected revenue or cost savings or other issues in connection with mergers and acquisitions;

 

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exposure to material litigation;

 

   

Sterling’s ability to comply with regulatory actions and agreements; and

 

   

changes in accounting rules.

Other factors that could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements may be found under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below, as updated periodically in Sterling’s filings with the SEC. Unless legally required, Sterling disclaims any obligation to update any forward-looking statements. You should consider any forward-looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

Where You Can Find More Information

The periodic reports Sterling files with the SEC are available on Sterling’s website at www.SterlingFinancialCorporation-Spokane.com after the reports are filed with the SEC. The SEC maintains a website located at www.sec.gov that also contains this information. The information on Sterling’s website and the SEC’s website is not part of this annual report on Form 10-K. Sterling will provide you with copies of these reports, without charge, upon request made to:

Investor Relations

Sterling Financial Corporation

111 North Wall Street

Spokane, Washington 99201

(509) 458-3711

 

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Item 1A. Risk Factors

Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.

The risks described below are not the only ones facing our company. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, results of operations or prospects could be materially and adversely affected by any of these risks. The trading price of, and market for, shares of Sterling common stock could decline due to any of these risks.

Our allowance for loan losses, or the amount of capital we hold, may be insufficient.    We maintain an allowance for credit losses, with the level of the allowance reflecting estimates as to future losses. The determination of the appropriate level of the allowance for credit losses inherently involves a high degree of subjectivity and requires management to make significant estimates and judgments regarding current credit risks and future trends, all of which may undergo material changes. If our estimates prove to be incorrect, our allowance for credit losses may not be adequate to cover our actual loan losses. Bank regulatory agencies periodically review the adequacy of our allowance for credit losses as part of their examination process, and may require an increase therein. We are required to maintain a certain level of capital. The level of required capital to hold may change through new regulations such as Basel III. Also, the level of capital we hold changes, based on our financial performance, and balance sheet size and composition. We may be required to raise capital in the future, and it may be at a time that the capital is not available to us or not available at favorable terms.

Credit risk concentrations could have a material adverse effect on our business, financial condition, and results of operations.    A large portion of our loan portfolio is secured by real estate, which is primarily located in the Pacific Northwest and California, areas that have some of the highest unemployment rates in the United States. In addition, a significant portion of our multifamily loans originated during 2011 are secured by properties located in the greater Los Angeles and San Francisco markets. Deterioration in the economic conditions or a prolonged delay in economic recovery in our primary market areas could result in the following consequences, any of which could materially and adversely affect our business: collateral for loans, especially real estate, may decline further in value, in turn reducing customers’ borrowing power and further reducing the value of assets and collateral associated with our existing loans; loan delinquencies may increase; problem assets and foreclosures may increase; demand for our products and services may decrease; and access to low cost or noninterest bearing deposits may decrease.

Approximately 44% of our loan portfolio was comprised of commercial real estate loans as of December 31, 2011. Included in commercial real estate loans are investor real estate loans, which may have a higher degree of risk than some other loan types, as they typically are dependent on the cash flows generated from the underlying property. Continued increases in commercial and consumer delinquency levels or continued declines in real estate market values would require increased net charge-offs and increases in the provision for credit losses, which could have a material adverse effect on our business, financial condition and results of operations and prospects. Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also have a negative impact on our financial condition. In addition, we may face risks associated with our real estate lending under various federal, state and local environmental laws that impose certain requirements on the owner or operator of a property.

Interest rate risk is inherently present in our business.    As a financial institution, the majority of our assets and liabilities are subject to interest rate risk, which affects both the life and value of our interest earning assets and interest bearing liabilities, such as loans, investments and MBS, mortgage

 

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servicing rights, deposits and borrowings. The level of sensitivity for these interest earning assets and interest bearing liabilities to changes in interest rates is measured by duration, with duration mismatches combined with changes from both shifts and twists in the yield curve affecting both our future net interest income and the current economic value of Sterling’s equity. Exposure to interest rate risk may have an adverse effect on our profitability, financial condition and liquidity, including a decline in our net interest margin, fair value charges on certain assets, such as mortgage servicing rights and requests for additional collateral on certain of our secured borrowings. Increases in interest rates may shorten the life of certain of our liabilities, and we would have to replace these funds with alternative funds at a higher cost to us, or sell assets at potentially depressed values to meet the liquidity requirement. Decreases in interest rates may shorten the life of certain of our assets, and we would be faced with reinvesting the funds at lower rates or retiring certain of our funding liabilities at prices unfavorable to us.

General economic conditions and developments affect our operating results and financial condition.    Our business is affected by conditions outside our control, including the rate of economic growth in general, the level of unemployment, increases in inflation and the level of interest rates. Economic conditions affect the level of demand for and the profitability of our products and services. A slowdown in the general economic recovery, particularly in the Western United States, could negatively impact our business. The fiscal and monetary policies of the United States government and its level of indebtedness may have an impact on interest rates and inflation, which may adversely affect our profitability and financial condition. Our profitability is greatly dependent upon our earning a positive interest spread between our loan and securities portfolio, and our funding deposits and borrowings. Changes in the level of interest rates, or a prolonged unfavorable interest rate environment, or a decrease in our level of deposits that increases our cost of funds could negatively affect our profitability and financial condition. Although we hold no direct investments in them, defaults by European sovereigns may have a negative impact on the rate of growth in the global economy, and consumer confidence.

Our ability to realize the benefit of our fully reserved deferred tax assets may be materially impaired.    As of December 31, 2011, we had a fully reserved net deferred tax asset of approximately $327 million, including approximately $285 million of net operating loss and tax credit carry-forwards. Our ability to use our deferred tax assets to offset future taxable income will be limited if we experience an “ownership change” as defined in Section 382 of the Code. Due to the complexity of Section 382 and the limited knowledge any public company has about the ownership of its publicly-traded stock, it is difficult to conclude with certainty at any given point in time whether an “ownership change” has occurred. Nonetheless, as a result of the recapitalization, we believe that we are close to the “ownership change” threshold, but we do not believe that we have experienced an “ownership change.” Sterling has not obtained an opinion of counsel or any other interpretive guidance, such as a private letter ruling from the Internal Revenue Service (“IRS”), in determining that it has not undergone an “ownership change.” As a result of our recapitalization in 2010, we are currently close to the “ownership change” threshold. In general, an ownership change will occur if there is a cumulative increase in our ownership by “5-percent shareholders” (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. A corporation that experiences an ownership change will generally be subject to an annual limitation on the use of its pre-ownership change deferred tax assets equal to the equity value of the corporation immediately before the ownership change, multiplied by the applicable long-term tax-exempt rate. While we have implemented measures to reduce the likelihood that future transactions in our common stock will result in an ownership change, such an ownership change could occur in the future, which would have a materially adverse effect on our results of operations, financial condition and shareholder value. More specifically, while Sterling has adopted a shareholder rights plan, as well as a protective amendment to its Restated Articles of Incorporation that are intended to discourage or prevent transfers of Sterling shares that would increase a shareholder’s ownership to 5% or more of our Common Stock or that would increase

 

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the percentage of our Common Stock owned by a shareholder already deemed to be a “5-percent shareholder,” these restrictions might not deter a shareholder from increasing its ownership interests beyond these limits. Such an increase could adversely affect our ownership change calculations.

Our calculations regarding our current cumulative change and the likelihood of a future ownership change are based on current law. Any change in applicable law may result in an ownership change.

We are currently subject to certain pending litigation, and may be subject to litigation in the future.    A securities class action lawsuit has been filed against Sterling and certain of our current and former officers alleging that the defendants violated sections 10(b) and 20(a) of the U.S. Exchange Act and SEC Rule 10b-5 by making false and misleading statements concerning our business and financial results. A shareholder derivative suit also has been filed against certain of our current and former officers and directors, and Sterling as a nominal defendant, alleging breaches of fiduciary duty, waste of corporate assets, and unjust enrichment. A class action lawsuit is also pending against Sterling, and certain current and former officers and directors of Sterling, alleging violations of ERISA, by breaching their fiduciary duties to participants in the Sterling Savings Bank Employee Savings and Investment Plan and Trust. These lawsuits are all premised on similar allegations that: 1) the defendants failed to adequately disclose the extent of Sterling’s delinquent commercial real estate, construction and land development loans, properly record losses for impaired loans, properly reserve for loan losses, and properly account for goodwill and deferred tax assets, thereby causing Sterling’s stock price to be artificially inflated during the purported class period; or 2) the defendants failed to prevent Sterling from issuing improper financial statements, maintain a sufficient allowance for loan and lease losses, and establish effective credit risk management and oversight mechanisms. It is possible that additional suits will be filed with respect to these same matters and also naming Sterling and/or its current and former officers and directors.

These lawsuits could divert the attention and resources of our management and cause us to incur significant expenses for legal fees and costs, including those associated with our advancement of fees and costs on behalf of our current and former officers and directors. We cannot predict the outcome of any of these lawsuits. Since the legal responsibility and financial impact with respect to these lawsuits and claims, if any, cannot currently be ascertained, we have not established any reserves for any potential liability relating to these lawsuits. An unfavorable outcome in any of these lawsuits could result in the payment of substantial damages in connection with a settlement or judgment and have a material adverse effect on our business, financial condition, results of operations or cash flows. See Item 3 “Legal Proceedings.”

We are subject to extensive regulation, which may affect our business operations or require us to raise additional capital.    We are subject to extensive regulation under federal and state laws, including regulation and supervision by the Federal Reserve, FDIC, WDFI and the SEC. These laws and regulations are primarily intended to protect customers, depositors and the Deposit Insurance Fund rather than shareholders. Sterling is also subject to the listing standards of the NASDAQ Capital Market, which impose additional requirements on us.

As a regulated bank holding company, we are subject to minimum capital and leverage standards. If our regulators determine that we have failed to meet these standards, we could be required to raise additional capital, which would result in the dilution of our existing shareholders. Although Sterling Savings Bank was recently informed that the previously disclosed memorandum of understanding with the FDIC and WDFI was terminated, as of the date of this report, Sterling remained subject to a previously disclosed written agreement with the Federal Reserve. If our regulators determine in the future that we have failed to comply with our regulatory requirements, we could become subject to additional regulatory enforcement actions. The imposition of enforcement actions could result in material limitations on our business operations or growth, management changes, requirements to raise additional equity, or more severe actions.

 

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The financial services industry is undergoing major changes, and we cannot anticipate the impact of future laws and regulations on our business.    Regulation of the financial services industry is undergoing major changes. The Dodd-Frank Act significantly revises and expands the rulemaking, supervisory and enforcement authority of federal bank regulators. Although the statute will initially have a greater impact on larger institutions than regional bank holding companies such as Sterling, many of its provisions will apply to us at the outset.

The Dodd-Frank Act, among other things, limits the amount of debit card interchange fees that can be charged for banks over $10 billion of assets in size and Sterling’s assets are close to this level. The Dodd-Frank Act also imposes new stress testing and corporate governance requirements on banking entities with $10 billion of assets. If our assets rose above $10 billion, we would be subject to these requirements, which we may find difficult to comply with.

Some of these changes are effective immediately, though most will be phased in gradually. In addition, the statute in many instances calls for future rulemaking to implement its provisions, so the precise contours of the law and its effects on us cannot yet be fully understood. The provisions of the Dodd-Frank Act and the subsequent exercise by regulators of their revised and expanded powers thereunder could materially impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk. Legislators and regulators are also considering a wide range of proposals beyond the Dodd-Frank Act that, if enacted, could result in major changes to the way banking operations are regulated.

We may be subject to more stringent capital and liquidity requirements.    The Dodd-Frank Act requires the federal banking agencies to establish stricter risk-based capital requirements and leverage limits for banks and bank holding companies. In addition, Basel III, when implemented in the United States, will lead to significantly higher capital requirements and more restrictive leverage and liquidity ratios. The Basel III guidelines, which were finalized in December 2010, are designed to address many of the weaknesses identified in the banking sector as contributing factors to the financial crisis of 2008 to 2010. These include increasing minimum capital requirements, the quality of capital, the risk coverage of the regulatory capital framework and standards for supervisory review and public disclosure.

Federal banking agencies have not yet released proposed rules to implement the Basel III requirements, and it is uncertain at this time whether the proposed rules, when released, will apply Basel III’s requirements to Sterling or Sterling Savings Bank. If we become subject to these rules, we could be required to raise additional capital which could dilute existing shareholders.

Acquisitions present many risks, and we may not realize the financial and strategic goals that are contemplated.    Our growth strategy includes an intent to acquire other banks. During the fourth quarter of 2011, we announced our agreement to acquire certain assets and operations of First Independent Bank, which is expected to be completed during the first quarter of 2012. This acquisition and any future acquisitions and related transition and integration activities may disrupt our ongoing business and divert management’s attention. In addition, an acquisition may not further our corporate strategy as we expected, we may pay more than the acquired banks or assets are ultimately worth or we may not integrate an acquired bank or assets as successfully as we expected, which could adversely affect our business, results of operations and financial condition. We may be adversely affected by liabilities (disclosed or undisclosed) or pre-existing contractual relationships that we assume and may also fail to anticipate or accurately estimate litigation or other exposure, unfavorable accounting consequences, increases in taxes due or a loss of anticipated tax benefits. Other potential adverse consequences include higher than anticipated costs associated with the acquired bank or assets or integration activities. The use of cash to pay for acquisitions may limit our use of cash for

 

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other potential activities, such as dividends. The use of equity securities to pay for acquisitions could significantly dilute existing shareholders. If we use debt to finance acquisitions, we may significantly increase our expenses, leverage and debt service requirements. The occurrence of any of these risks could have a material adverse effect on our business, results of operations, financial condition or cash flows, particularly in the case of a large acquisition or several concurrent acquisitions.

The liquidity of our common stock may be impeded by transfer restrictions.    Immediately following our recapitalization in August 2010, approximately 98% of our common stock was held by investors subject to certain transfer restrictions. These restrictions are designed to prevent (a) any person from acquiring ownership, for relevant tax purposes, of 5% or more of our shares and (b) the disposition of shares by any person that owns 5% or more of our shares, subject to certain exceptions. We have also amended our restated articles of incorporation to impose these transfer restrictions on all holders of our common stock. These restrictions may adversely affect the ability of certain shareholders to resell our common stock by rendering any transactions in violation of this prohibition void.

In addition, Sterling has adopted a shareholder rights plan (the “Rights Plan”), which is described in our Form 8-K filed on April 15, 2010. In December of 2010, we amended the Rights Plan to extend the expiration of the plan until August 26, 2013. The purpose of the Rights Plan is to minimize the likelihood of an “ownership change,” as defined in Section 382 of the Code, and thus to protect our ability to use our net operating loss carry-forward and certain built-in losses to offset future income. The Rights Plan provides an economic disincentive for any one person or group to become a Threshold Holder (as defined therein, generally an owner of 5% or more of our stock) and for any existing Threshold Holder to acquire more than a specified amount of additional shares, and so may adversely affect one’s ability to resell our common stock and negatively affect the trading price of our common stock. These restrictions may limit the ability of shareholders to resell Sterling shares.

These transfer restrictions and our Rights Plan may discourage, delay, or prevent a change in control of Sterling and make it more difficult for a potential acquirer to consummate an acquisition of Sterling. In addition, these provisions could limit the price that investors would be willing to pay in the future for our securities and may limit a shareholder’s ability to dispose of our securities by reducing the class of potential acquirers for such securities.

As a result of our 2010 recapitalization, a limited number of shareholders are substantial holders of our stock.    As of January 31, 2012, certain Thomas H. Lee funds (collectively, “THL”) and Warburg Pincus Private Equity X, L.P. (“Warburg Pincus”) each beneficially own approximately 23% of our outstanding common stock. Each has a representative on our Board of Directors. Accordingly, THL and Warburg Pincus have substantial influence over the election of directors to our board and over corporate policy, including decisions to enter into mergers or other extraordinary transactions. In pursuing its economic interests, THL and Warburg Pincus may make decisions with respect to fundamental corporate transactions that may not be aligned with the interests of other shareholders.

As a result of our 2010 recapitalization, the U.S. Department of the Treasury beneficially owns approximately 9% of our outstanding common stock. In addition, a number of private placement investors, in addition to THL and Warburg Pincus, acquired, and may continue to hold, shares of our common stock that, for each investor, may approach 5% of our outstanding common stock. The large portion of our shares that are held by a relatively small number of shareholders could result in a material impact on the trading volume and price per share of our stock, if any of these shareholders decide to sell a significant portion of their holdings.

We may suffer substantial losses due to our agreements to indemnify certain investors against a broad range of potential claims.    We have agreed to indemnify THL and Warburg Pincus, along

 

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with the other private placement investors in the 2010 recapitalization, for a broad range of claims, including any losses arising out of or resulting from any legal, administrative or other proceedings arising in connection with the recapitalization transactions. While these indemnities are capped at the aggregate amount of capital raised of $730 million, if all or some claims were successfully brought against Sterling, it could potentially result in significant losses.

We rely on certain key personnel, whose loss could materially adversely affect us.    Certain of our employees and executives are key contributors to our financial success, including, but not limited to, the generation and identification of lending and deposit customer relationships, and the management of our company. Our ability to retain these individuals is a large factor in our ability to be successful, and any failure to do so could have a materially adverse effect on our business.

We could be materially and adversely affected if we or any of our officers or directors fail to comply with bank and other laws and regulations.    Sterling and Sterling Savings Bank are subject to extensive regulation by U.S. federal and state regulatory agencies and face risks associated with investigations and proceedings by regulatory agencies, including those that we may believe to be immaterial. Like any corporation, we are also subject to risk arising from potential employee misconduct, including non-compliance with our policies. Any interventions by authorities may result in adverse judgments, settlements, fines, penalties, injunctions, suspension or expulsion of our officers or directors from the banking industry or other relief. In addition to the monetary consequences, these measures could, for example, impact our ability to engage in, or impose limitations on, certain of our businesses. The number of these investigations and proceedings, as well as the amount of penalties and fines sought, has increased substantially in recent years with regard to many firms in the industry. Significant regulatory action against us or our officers or directors could materially and adversely affect our business, financial condition or results of operations or cause us significant reputational harm.

We may have reduced access to wholesale funding sources.    As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments, maturities and sales of loans and investments. Our financial flexibility will be severely constrained if we are unable to maintain sufficient collateral or access to funding on acceptable terms. If we are required to rely more heavily on more expensive funding sources, and our revenues do not increase in proportion with our costs, our profitability will be impacted.

A decline in the value of our Federal Home Loan Bank (“FHLB”) common stock may occur, resulting in an other-than-temporary impairment (“OTTI”) charge which would cause our earnings and shareholders’ equity to decrease.    We own common stock of the FHLB in order to qualify for membership in the FHLB system, which enables us to borrow funds under the FHLB advance program. The carrying value of our FHLB common stock was approximately $100 million as of December 31, 2011, the substantial majority of which was with the FHLB of Seattle. The FHLB of Seattle has experienced losses from credit-related charges associated with projected losses on its investments in nonagency MBS, and is currently unable to repurchase or redeem capital stock or to pay dividends. FHLB stock does not have a readily determinable fair value and the equity ownership rights are more limited than would be the case for ownership rights in a public company.

The FHLB of Seattle has experienced losses from credit-related charges associated with projected losses on their investments in nonagency MBS, and is currently unable to repurchase or redeem capital stock or to pay dividends. FHLB stock does not have a readily determinable fair value and the equity ownership rights are more limited than would be the case for ownership rights in a public company. FHLB stock is viewed as a long term investment and as a restricted investment security carried at cost.

 

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The level of our liquidity and our ability to repay indebtedness, pay dividends and repurchase shares depends upon the results of operations and financial condition of Sterling Savings Bank.    Sterling is a separate and distinct legal entity from its subsidiaries, and receives substantially all of its revenue from dividends paid by Sterling Savings Bank. There are legal limitations on the extent to which Sterling Savings Bank may extend credit, pay dividends or otherwise supply funds to, or engage in transactions with Sterling. A prolonged inability to receive dividends from Sterling Savings Bank would reduce liquidity available to Sterling, which could adversely affect Sterling’s financial condition.

Various statutory provisions restrict the amount of dividends Sterling Savings Bank can pay to Sterling without regulatory approval. Sterling Savings Bank may not pay cash dividends if those payments could reduce the amount of its capital below that necessary to meet the “adequately capitalized” level in accordance with regulatory capital requirements. It is also possible that, depending upon the financial condition of Sterling Savings Bank and other factors, regulatory authorities could assert that payment of dividends or other payments, including payments to Sterling, is an unsafe or unsound practice. Under Washington banking law, Sterling Savings Bank may not pay a dividend greater than its retained earnings without WDFI approval. As of December 31, 2011, Sterling Savings Bank had an accumulated deficit, and therefore, would require WDFI approval prior to paying a dividend.

Our OTTI assessment may change in the future resulting in impairment losses being incurred in future periods.    We evaluate our investment securities and MBS portfolios and other assets for declines in fair value. These valuation declines may be deemed to be other-than-temporary in nature, as defined in the accounting guidance. As of December 31, 2011, our determination was that no OTTI impairments have occurred. In the future, we may determine that an OTTI impairment has occurred, which would lead to accounting charges that could have an adverse effect on our results of operations and financial condition.

Our business relies heavily on technology and our ability to manage the operational risks associated with technology.    We depend on internal and outsourced technology to support all aspects of our business operations. Interruption or failure of these systems creates a risk of business loss as a result of adverse customer experiences, damage claims and civil fines. Risk management programs are expensive to maintain and will not protect us from all risks associated with maintaining the security of customer information, proprietary data, external and internal intrusions, disaster recovery and failures in the controls used by vendors. Our computer systems could be vulnerable to unforeseen problems. Because we conduct part of our business over the Internet and outsource several critical functions to third parties, operations will depend on our ability, as well as the ability of third-party service providers, to protect computer systems and network infrastructure against damage from fire, power loss, telecommunications failure, physical break-ins or similar catastrophic events. Any damage or failure that causes interruptions in operations could have a material adverse effect on our business, financial condition and results of operations.

In addition, a significant barrier to online financial transactions is the secure transmission of confidential information over public networks. Our Internet banking system relies on encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms our third-party service providers use to protect customer transaction data. If any such compromise of security were to occur, it could have a material adverse effect on our business, financial condition and results of operations.

We depend, and will continue to depend, to a significant extent, on a number of relationships with third-party service providers. Specifically, we receive core systems processing, essential web hosting and

 

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other Internet systems and deposit and other transaction processing services from third-party service providers. If these third-party service providers experience difficulties or terminate their services, and we are unable to replace them with other service providers, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be materially and adversely affected.

Our internal control systems could fail to detect certain events.    We are subject to certain operational risks, including but not limited to data processing system failures and errors and customer or employee fraud. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.

We could be held responsible for environmental liabilities of properties we acquire.    We may acquire real property for various reasons, including, for example, as a result of foreclosing on a defaulted mortgage loan to recover our investment, or in connection with acquiring the assets and operations of other banks. We may be subject to environmental liabilities related to the real property as a result of hazardous substances or wastes, contaminants, pollutants or sources thereof that may be discovered on such properties during our ownership or after a sale to a third party. The amount of environmental liability could exceed the value of the real property because we may be fully liable for the entire cost of any removal and clean-up on an acquired property, the cost of removal and clean-up may exceed the value of the property, and we may be unable to recover costs from any third party. In addition, we may find it difficult or impossible to sell the property prior to or following any environmental remediation.

The financial services industry in general is highly competitive.    Our industry is highly competitive in regard to the pricing and features of existing products and services, growth opportunities from the acquisition of other companies in whole or in part, and the building of new customer relationships. A number of our competitors are significantly larger than we are and may have certain advantages from a greater access to capital and other resources, as well as larger lending limits and branch systems, and a wider array of banking services. Many of our nonbank competitors are not subject to the same extensive regulations that apply to financial institutions. As a result, these non-bank competitors have advantages over us in providing certain services. Our growth and opportunities for growth are greatly affected by this competitive environment.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Sterling owns the building in which its headquarters are located in Spokane, Washington. As of December 31, 2011, Sterling also owned 101 of its 175 depository banking offices, while leasing the remainder of the properties. These facilities are located throughout Sterling’s banking network, primarily in the Pacific Northwest. Additionally, Sterling operates 33 non-depository loan production offices throughout the western United States, the majority of which are leased. The properties that Sterling occupies are used for corporate purposes across all of its business segments. See Note 6 of "Notes to Consolidated Financial Statements.”

 

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Item 3. Legal Proceedings

Securities Class Action Litigation.    On December 11, 2009, a putative securities class action was filed in the United States District Court for the Eastern District of Washington against Sterling and certain of our current and former officers. The court appointed a lead plaintiff on March 9, 2010. On June 18, 2010, the lead plaintiff filed a consolidated complaint (the “Complaint”). The Complaint purports to be brought on behalf of a class of persons who purchased or otherwise acquired Sterling’s stock during the period from July 23, 2008 to October 15, 2009. The Complaint alleges that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by failing to disclose the extent of Sterling’s delinquent commercial real estate, construction and land development loans, properly record losses for impaired loans, and properly reserve for loan losses, thereby causing Sterling’s stock price to be artificially inflated during the purported class period. Plaintiffs seek unspecified damages and attorneys’ fees and costs. Sterling believes the lawsuit is without merit and intends to defend against it vigorously. On August 30, 2010, Sterling moved to dismiss the Complaint. On March 2, 2011, after complete briefing, the court held a hearing on the motion to dismiss. The court has not yet issued an order on the motion. Failure by Sterling to obtain a favorable resolution of the claims set forth in the complaint could have a material adverse effect on our business, results of operations and financial condition. Currently, a loss resulting from these claims is not considered probable or reasonably estimable in amount.

ERISA Class Action Litigation.    On January 20 and 22, 2010, two putative class action complaints were filed in the United States District Court for the Eastern District of Washington against Sterling Financial Corporation and Sterling Savings Bank (collectively, “Sterling”), as well as certain of Sterling’s current and former officers and directors. The two complaints were merged in a Consolidated Amended Complaint (the “Complaint”) filed on July 16, 2010 in the same court. The Complaint does not name all of the individuals named in the prior complaints, but it is expected that additional defendants will be added. The Complaint alleges that the defendants breached their fiduciary duties under sections 404 and 405 of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), with respect to the Sterling Savings Bank Employee Savings and Investment Plan (the “401(k) Plan”) and the FirstBank Northwest Employee Stock Ownership Plan (“ESOP”) (collectively, the "Plans”). Specifically, the Complaint alleges that the defendants breached their duties by investing assets of the Plans in Sterling’s securities when it was imprudent to do so, and by investing such assets in Sterling securities when defendants knew or should have known that the price of those securities was inflated due to misrepresentations and omissions about Sterling’s business practices. The business practices at issue include alleged over-reliance on risky construction loans; alleged inadequate loan reserves; alleged spiking increases in nonperforming assets, nonperforming loans, classified assets, and 90+-day delinquent loans; alleged inadequate accounting for rising loan payment shortfalls; alleged unsafe and unsound banking practices; and a capital base that was allegedly inadequate to withstand the significant deterioration in the real estate markets. The putative class periods are October 22, 2007 to the present for the 401(k) Plan class, and October 22, 2007 to November 14, 2008 for the ESOP class. The Complaint seeks damages of an unspecified amount and attorneys’ fees and costs. Sterling believes the lawsuit is without merit and intends to defend against it vigorously. A hearing on the motion to dismiss occurred on March 22, 2011, with the court indicating that it would take the motion under submission. The court has not yet issued an order on the motion. Failure by Sterling to obtain a favorable resolution of the claims set forth in the Complaint could have a material adverse effect on Sterling’s business, results of operations, and financial condition. Currently, a loss resulting from these claims is not considered probable or reasonably estimable in amount.

Derivative Litigation.    On February 10, 2010, a shareholder derivative action was filed in the Superior Court for Spokane County, Washington, purportedly on behalf of and for the benefit of Sterling, against certain of our current and former officers and directors. On August 2, 2010, plaintiff filed an amended complaint (the “Complaint”) alleging, among other claims, breach of fiduciary duty,

 

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aiding and abetting breach of fiduciary duty, and unjust enrichment. The Complaint alleges that the individual defendants failed to prevent Sterling from issuing improper financial statements, maintain a sufficient allowance for loan and lease losses, and establish effective credit risk management and oversight mechanisms regarding Sterling’s commercial real estate, construction and land development loans, losses and reserves recorded for impaired loans, and accounting for goodwill and deferred tax assets. The Complaint seeks unspecified damages, restitution, disgorgement of profits, equitable and injunctive relief, attorneys’ fees, accountants’ and experts’ fees, costs, and expenses. Because the Complaint is derivative in nature, it does not seek monetary damages from Sterling. However, Sterling may be required throughout the pendency of the action to advance the legal fees and costs incurred by the defendant officers and directors. On September 13, 2010, Sterling moved to dismiss the Complaint. The hearing on Sterling’s motion to dismiss was held on January 14, 2011. On February 25, 2011, the court issued an order denying Sterling’s motion to dismiss in its entirety. On April 12, 2011, Sterling filed a request for discretionary review with the Washington Court of Appeals, which was denied on June 1, 2011. Currently, a loss resulting from these claims is not considered probable or reasonably estimable in amount, and, due to the nature of the claim, any such loss would be payable, in part, to Sterling.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Sterling’s common stock is listed on the NASDAQ Capital Market under the symbol “STSA.” As of January 31, 2012, Sterling’s common stock was held by 1,409 shareholders of record. On November 18, 2010, Sterling effected a 1-for-66 reverse stock split. All prior per share amounts have been restated to reflect this split. The following table sets forth certain per share information for Sterling’s common stock for the periods indicated:

 

     2011 Quarters Ended  
     December 31      September 30      June 30      March 31  

Dividends declared per common share

   $ 0.00       $ 0.00       $ 0.00       $ 0.00   

Dividends paid per common share

     0.00         0.00         0.00         0.00   

Market price per share:

           

High

     16.90         17.48         19.00         22.62   

Low

     12.18         11.61         15.50         16.30   

Quarter end

     16.70         12.38         16.07         16.75   
     2010 Quarters Ended  
     December 31      September 30      June 30      March 31  

Dividends declared per common share

   $ 0.00       $ 0.00       $ 0.00       $ 0.00   

Dividends paid per common share

     0.00         0.00         0.00         0.00   

Market price per share:

           

High

     46.20         49.51         133.99         61.39   

Low

     14.85         32.34         30.36         28.38   

Quarter end

     18.97         42.90         36.30         37.62   

The board of directors of Sterling from time to time evaluates the payment of cash dividends. The timing and amount of any future dividends will depend upon earnings, cash and capital requirements, the financial condition of Sterling and its subsidiaries, applicable government regulations and other factors deemed relevant by Sterling’s board of directors. During the third quarter of 2009, Sterling elected to defer regularly scheduled interest payments on its junior subordinated debentures. Sterling is allowed to defer payments of interest on the junior subordinated debentures for up to 20 consecutive quarterly periods without triggering an event of default. As of December 31, 2011 and 2010, the accrued deferred interest was $15.6 million and $9.4 million, respectively. Sterling is precluded from paying dividends on its common stock without first paying the accrued interest on these junior subordinated debentures.

Information concerning securities authorized for issuance under equity compensation plans is set forth under the caption “Equity Compensation Plan Information” in Sterling’s Proxy Statement and is incorporated herein by reference.

 

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The following graph, which is “furnished,” not “filed,” compares the cumulative return of our common stock during the five years ended December 31, 2011, with the Russell 2000 Index and the SNL Bank NASDAQ Index. The presentation assumes an initial investment of $100 and the reinvestment of dividends.

 

LOGO

 

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Item 6. Selected Financial Data

The following selected financial data is derived from Sterling’s audited financial statements. The information below is not necessarily indicative of our future results of operations and should be read in conjunction with Item 1A, “Risk Factors,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K in order to fully understand the factors that may affect the comparability of the information presented below.

 

     Years Ended December 31,  
     2011      2010     2009     2008     2007  
     (In thousands, except per share amounts)  

Income Statement Data:

           

Interest income

   $ 404,292       $ 445,133      $ 599,347      $ 715,062      $ 766,978   

Interest expense

     109,097         161,106        255,370        355,510        411,618   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     295,195         284,027        343,977        359,552        355,360   

Provision for credit losses

     30,000         250,229        681,371        333,597        25,088   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for credit losses

     265,195         33,798        (337,394     25,955        330,272   

Noninterest income

     126,328         136,965        123,814        91,895        93,406   

Noninterest expense before impairment charge

     352,390         395,045        369,974        305,517        285,465   

Goodwill impairment

     0         0        227,558        223,765        0   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     352,390         395,045        597,532        529,282        285,465   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     39,133         (224,282     (811,112     (411,432     138,213   

Income tax (provision) benefit

     0         0        (26,982     75,898        (44,924
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     39,133         (224,282     (838,094     (335,534     93,289   

Preferred stock dividend

     0         (11,598     (17,369     (1,208     0   

Other shareholder allocations(1)

     0         (520,263     0        0        0   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) applicable to common shareholders

   $ 39,133       $ (756,143   $ (855,463   $ (336,742   $ 93,289   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per common share:

           

Basic(2)

   $ 0.63       $ (53.05   $ (1,087.41   $ (429.70   $ 123.67   

Diluted(2)

     0.63         (53.05     (1,087.41     (429.70     122.61   

Dividends declared per common share(2)

   $ 0.00       $ 0.00      $ 0.00      $ 19.80      $ 23.10   

Weighted average shares outstanding:

           

Basic(2)

     61,955,659         14,253,869        786,701        783,662        754,339   

Diluted(2)

     62,231,208         14,253,869        786,701        783,662        760,871   

Other Data:

           

Book value per common share(2)

   $ 14.16       $ 12.45      $ 36.80      $ 1,075.14      $ 1,520.64   

Tangible book value per common share(2)

   $ 13.96       $ 12.17      $ 9.21      $ 752.98      $ 898.26   

Return on average assets

     0.42%         -2.21%        -6.81%        -2.65%        0.83%   

Return on average common equity

     4.8%         -297.2%        -129.8%        -28.8%        8.6%   

Dividend payout ratio

     0%         0%        0%        -5%        19%   

Shareholders’ equity to total assets

     9.6%         8.1%        3.0%        8.9%        9.8%   

Tangible common equity to tangible assets(3)

     9.4%         8.0%        0.1%        4.7%        6.0%   

Operating efficiency(4)

     75%         82%        69%        62%        62%   

Tax equivalent net interest margin

     3.29%         2.83%        2.92%        3.08%        3.42%   

Nonperforming assets to total assets

     4.01%         8.83%        9.08%        4.77%        1.11%   

Employees (full-time equivalents)

     2,496         2,498        2,641        2,481        2,571   

Depository branches

     175         178        178        178        178   

 

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Item 6. Selected Financial Data (Continued)

 

     December 31,  
     2011      2010      2009      2008      2007  
     (In thousands)  

Balance Sheet Data:

              

Total assets

   $ 9,193,237       $ 9,493,169       $ 10,877,423       $ 12,790,716       $ 12,149,775   

Loans receivable, net

     5,341,179         5,379,081         7,344,199         8,807,094         8,948,307   

Investments and MBS—available for sale

     2,547,876         2,825,010         2,160,325         2,639,290         1,853,271   

Investments—held to maturity

     1,747         13,464         17,646         175,830         132,793   

Deposits

     6,485,818         6,911,007         7,775,190         8,350,407         7,677,772   

FHLB advances

     405,609         407,211         1,337,167         1,726,549         1,687,989   

Securities sold under repurchase agreements and funds purchased

     1,055,763         1,032,512         1,049,146         1,163,023         1,178,845   

Other borrowings

     245,290         245,285         248,281         248,276         273,015   

Shareholders’ equity

     878,557         770,767         323,249         1,141,036         1,185,330   

Regulatory Capital Ratios:

              

Sterling

              

Tier 1 leverage ratio

     11.4%         10.1%         3.5%         9.2%         8.7%   

Tier 1 risk-based capital ratio

     17.8%         16.2%         4.9%         11.7%         10.1%   

Total risk-based capital ratio

     19.1%         17.5%         7.9%         13.0%         11.3%   

Sterling Savings Bank

              

Tier 1 leverage ratio

     11.1%         9.8%         4.2%         8.3%         8.5%   

Tier 1 risk-based capital ratio

     17.4%         15.7%         5.9%         10.6%         9.8%   

Total risk-based capital ratio

     18.7%         17.0%         7.3%         11.8%         11.0%   

 

(1) 

The August 26, 2010 conversion of Series C preferred stock into common stock resulted in an increase in income available to common shareholders. The October 22, 2010 conversion of Series B and D preferred stock into common stock resulted in a decrease in income available to common shareholders.

 

(2) 

Reflects the 1-for-66 reverse stock split in November 2010.

 

(3) 

Common shareholders’ equity less core deposit intangibles divided by assets less core deposit intangibles.

 

(4)

Operating efficiency ratio calculated as noninterest expense, excluding OREO, amortization of core deposit intangibles, and goodwill impairment, divided by net interest income (tax equivalent) plus noninterest income, excluding gain on sales of securities.

 

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

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto presented elsewhere in this report. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a discussion of the risks and uncertainties inherent in such statements, see “Business—Forward-Looking Statements” and “Risk Factors.”

Executive Summary

For the year ended December 31, 2011, net income available to common shareholders was $39.1 million, compared to a net loss applicable to common shareholders of $756.1 million for 2010. The 2010 results include noncash accounting adjustments totaling $520.3 million related to the 2010 recapitalization. During 2011, Sterling returned to profitability, primarily as a result of a decline in loan losses. Improvements in asset quality are reflected in a decline in nonperforming assets of $447.2 million, or 55%, during 2011, and a decline in net loan charge-offs of $248.9 million, or 72%, compared with 2010. In addition to the improvements in asset quality, a reduction in deposit funding costs contributed to expansion in both net interest income and margin. Loan originations grew to $3.40 billion during 2011, compared with $2.93 billion in 2010.

 

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Results of Operations

The most significant component of earnings for Sterling is net interest income, which is the difference between interest income, primarily from loans, MBS and investment securities portfolios, and interest expense, primarily 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:

 

    Years Ended December 31,  
    2011     2010     2009  
    Average
Balance
    Income/
Expense
    Average
Yield/
Rate
    Average
Balance
    Income/
Expense
    Average
Yield/
Rate
    Average
Balance
    Income/
Expense
    Average
Yield/
Rate
 
    (In thousands)  

ASSETS:

 

Loans:

                 

Mortgage

  $ 3,484,108      $ 177,992        5.11%      $ 4,188,338      $ 185,214        4.42%      $ 5,321,761      $ 266,150        5.00%   

Commercial and consumer

    2,481,470        144,892        5.84%        2,951,479        174,896        5.93%        3,685,058        213,828        5.80%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans(1)

    5,965,578        322,884        5.41%        7,139,817        360,110        5.04%        9,006,819        479,978        5.33%   

MBS(2)

    2,375,515        71,216        3.00%        2,004,864        74,806        3.73%        2,310,582        108,513        4.70%   

Investments and cash(2)

    676,677        14,659        2.17%        965,615        15,005        1.55%        530,479        15,647        2.95%   

FHLB stock

    99,531        0        0.00%        100,409        0        0.00%        100,565        0        0.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    9,117,301        408,759        4.48%        10,210,705        449,921        4.41%        11,948,445        604,138        5.06%   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Noninterest-earning assets(3)

    186,238            (42,376         357,766       
 

 

 

       

 

 

       

 

 

     

Total average assets

  $ 9,303,539          $ 10,168,329          $ 12,306,211       
 

 

 

       

 

 

       

 

 

     

LIABILITIES and EQUITY:

                 

Deposits:

                 

Interest-bearing transaction

  $ 503,091        504        0.10%      $ 809,351        1,918        0.24%      $ 844,154        2,534        0.30%   

Savings and MMDA

    1,994,335        7,004        0.35%        1,656,816        10,180        0.61%        1,758,678        15,941        0.91%   

Time deposits

    3,063,679        52,126        1.70%        3,774,891        82,609        2.19%        4,718,946        150,786        3.20%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    5,561,105        59,634        1.07%        6,241,058        94,707        1.52%        7,321,778        169,261        2.31%   

Borrowings

    1,703,782        49,463        2.90%        2,309,294        66,399        2.88%        2,893,477        86,109        2.98%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    7,264,887        109,097        1.50%        8,550,352        161,106        1.88%        10,215,255        255,370        2.50%   

Noninterest-bearing transaction

    1,093,252        0        0.00%        999,857        0        0.00%        980,021        0        0.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total funding liabilities

    8,358,139        109,097        1.31%        9,550,209        161,106        1.69%        11,195,276        255,370        2.28%   

Other noninterest-bearing liabilities

    126,435        0        0.00%        172,338        0        0.00%        158,666        0        0.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total average liabilities

    8,484,574        109,097        1.29%        9,722,547        161,106        1.66%        11,353,942        255,370        2.25%   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Total average shareholders’ equity

    818,965            445,782            952,269       
 

 

 

       

 

 

       

 

 

     

Total average liabilities and equity

  $ 9,303,539          $ 10,168,329          $ 12,306,211       
 

 

 

       

 

 

       

 

 

     

Net interest spread (tax equivalent)(4)

    $ 299,662        2.98%        $ 288,815        2.52%        $ 348,768        2.56%   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Net interest margin (tax equivalent)(4)

        3.29%            2.83%            2.92%   
     

 

 

       

 

 

       

 

 

 

Deposits

                 

Total interest-bearing deposits

  $ 5,561,105      $ 59,634        1.07%      $ 6,241,058      $ 94,707        1.52%      $ 7,321,778      $ 169,261        2.31%   

Noninterest-bearing transaction

    1,093,252        0        0.00%        999,857        0        0.00%        980,021        0        0.00%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total deposits

  $ 6,654,357      $ 59,634        0.90%      $ 7,240,915      $ 94,707        1.31%      $ 8,301,799      $ 169,261        2.04%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes gross nonaccrual loans.

 

(2) 

Does not include market value adjustments on available for sale securities that are included in accumulated other comprehensive income.

 

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(3) 

Includes charge-offs on nonperforming loans (“confirmed losses”) and the allowance for credit losses.

 

(4) 

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

Changes in Sterling’s net interest income are a function of changes in both rates and volumes of interest-earning assets and interest-bearing liabilities. Volume refers to the dollar level of interest-earning assets and interest-bearing liabilities. The following table presents the composition of the change in net interest income, on a tax equivalent basis, for the periods presented. Interest income from municipal loans and bonds is presented gross of applicable tax savings. For each category of interest-earning assets and interest-bearing liabilities, the following table provides information on changes attributable to:

 

   

Volume—changes in volume multiplied by comparative period rate;

 

   

Rate—changes in rate multiplied by comparative period volume; and

 

   

Rate/volume—changes in rate multiplied by changes in volume.

 

    December 31, 2011
Increase (Decrease) Due to:
    December 31, 2010
Increase (Decrease) Due to:
 
    Volume     Rate     Rate/
Volume
    Total     Volume     Rate     Rate/
Volume
    Total  
    (In thousands)  

Interest income:

               

Loans:

               

Mortgage

  $ (31,142   $ 28,754      $ (4,834   $ (7,222   $ (47,525   $ (54,422   $ 21,005      $ (80,942

Commercial and consumer

    (27,851     (2,561     408        (30,004     (42,783     4,767        (909     (38,925
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    (58,993     26,193        (4,426     (37,226     (90,308     (49,655     20,096        (119,867

MBS

    13,830        (14,702     (2,718     (3,590     (12,157     (24,269     2,719        (33,707

Investment and cash equivalents

    (4,579     6,092        (1,859     (346     9,496        (5,531     (4,608     (643
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    (49,742     17,583        (9,003     (41,162     (92,969     (79,455     18,207        (154,217
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

               

Deposits

    (14,216     (23,851     2,994        (35,073     (31,137     (53,233     9,816        (74,554

Borrowings

    (17,410     642        (168     (16,936     (17,737     4,240        (6,213     (19,710
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    (31,626     (23,209     2,826        (52,009     (48,874     (48,993     3,603        (94,264
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Changes in net interest income on a tax equivalent basis

  $ (18,116   $ 40,792      $ (11,829   $ 10,847      $ (44,095   $ (30,462   $ 14,604      $ (59,953
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2011 versus 2010

Net Interest Income.    Sterling’s net interest income was $295.2 million for the year ended December 31, 2011, an increase of 4% compared with $284.0 million for the year ended December 31, 2010, reflecting the decline in nonperforming loans and lower funding costs, partially offset by lower average loan balances. Net interest margin expanded to 3.29% for the year ended December 31, 2011, compared with 2.83% for 2010, due to the decline in nonperforming loans and the reduced cost of deposits. The reversal of interest income on nonperforming loans reduced the net interest margin by 37 basis points for 2011, compared with a reduction of 76 basis points for 2010.

Provision for Credit Losses.    A valuation allowance for estimated losses is established by charging corresponding provisions against income. The evaluation of the adequacy of specific and general valuation allowances is an ongoing process. This process includes information derived from many factors, including

 

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historical loss trends, trends in classified assets, trends in delinquent and nonaccrual loans, trends in portfolio volume, diversification as to type of loan, size of individual credit exposure, current and anticipated economic conditions, loan policies, collection policies and effectiveness, quality of credit evaluation, effectiveness of policies, procedures and practices, and recent loss experience of peer banking institutions.

Sterling recorded provisions for credit losses of $30.0 million for the year ended December 31, 2011, compared with $250.2 million for 2010. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans and charge-offs.

Noninterest Income.    Non-interest income was as follows for the years presented:

 

     Years Ended December 31,  
     2011     2010     %
Change
 
     (In thousands)        

Fees and service charges

   $ 50,073      $ 54,740        -9%   

Mortgage banking operations

     52,376        62,564        -16%   

Gains on sales of securities

     16,236        25,745        -37%   

Bank-owned life insurance

     6,448        7,307        -12%   

Loan servicing fees

     (3,213     3,762        185%   

Gains (losses) on other loan sales

     4,442        (4,928     190%   

Charge on prepayment of debt

     0        (11,296     100%   

Other

     (34     (929     -96%   
  

 

 

   

 

 

   

Total noninterest income

   $ 126,328      $ 136,965        -8%   
  

 

 

   

 

 

   

The reduction in fees and service charges income was primarily related to lower non-sufficient funds fees. The decline in income from mortgage banking operations reflected a lower level of residential loan originations and sales. Fluctuation in loan servicing fees is mainly attributable to market value adjustments to mortgage servicing rights and growth in the balance of the loan servicing portfolio. Due to a decline in prevailing interest rates, Sterling recorded a fair value valuation adjustment of $6.2 million to write down its mortgage servicing rights during 2011, compared with a recovery of previous valuation adjustments of $1.1 million in 2010. Losses on portfolio loan sales during 2010 included $3.4 million on the sale of $218.5 million of consumer indirect auto loans, with 2011 activity primarily related to the management of credit concentrations and premium capture. During 2010, a charge of $11.3 million was incurred on the early repayment of FHLB borrowings.

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

 

     Years Ended December 31,  
     2011      2010  
     (In thousands)  

Loan originations—residential real estate for sale

   $ 2,009,653       $ 2,454,874   

Loan sales—residential

     2,059,351         2,455,144   

Margin on residential loan sales

     2.45%         2.40%   

The decline in residential loan originations and sales during 2011 as compared with 2010 reflected both a lower demand for this loan type for new home purchases and refinancings, as well as a greater internal focus on portfolio lending initiatives.

 

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

 

     Years Ended December 31,  
     2011      2010      %
Change
 
     (In thousands)         

Employee compensation and benefits

   $ 171,643       $ 168,793         2%   

OREO operations

     41,500         62,578         -34%   

Occupancy and equipment

     39,878         39,643         1%   

Insurance

     16,471         34,704         -53%   

Data processing

     24,171         23,116         5%   

Professional fees

     13,902         22,394         -38%   

Depreciation

     12,184         13,391         -9%   

Advertising

     10,017         11,536         -13%   

Amortization of core deposit intangibles

     4,851         4,898         -1%   

Travel and entertainment

     5,420         3,975         36%   

Other

     12,353         10,017         23%   
  

 

 

    

 

 

    

Total noninterest expense

   $ 352,390       $ 395,045         -11%   
  

 

 

    

 

 

    

The decrease in noninterest expense during 2011 was primarily due to lower OREO expenses, lower insurance expense from FDIC premiums, and lower professional fees. During 2010, professional fees included services related to the recapitalization. During 2011, Sterling converted to a new core operating system that is expected to support future growth and reduce associated operating expenses. Other noninterest expense for 2011 included a charge of $3.5 million recognized to establish a reserve for the tentative settlement of a class action claim, subject to confirmatory discovery and court approval. For additional information on this matter, see Note 18 of Notes to Consolidated Financial Statements.

Income Tax Provision.    During 2011 and 2010, Sterling did not recognize any federal or state tax expense or benefit, as the income tax provision was offset by changes in the deferred tax valuation allowance. As of December 31, 2011, the reserved net deferred tax asset was approximately $327 million, including approximately $285 million of net operating loss and tax credit carry-forwards. See Note 14 of Notes to Consolidated Financial Statements.

2010 versus 2009

Net Interest Income.    Net interest income for the year ended December 31, 2010 declined by 17% compared with the level during the year ended December 31, 2009, mainly due to a 25% decrease in interest income on loans. The decline in interest income on loans reflected a decline in average loan balances, and an increase in the amount of interest income reversed on nonperforming loans. Average loan balances declined by 21% compared to 2009, reflecting weak loan demand, credit resolutions, including charge-offs and foreclosures, and low capital levels in the first half of 2010. Interest income reversed on nonperforming loans increased by 27% over 2009, and reduced net interest margin by 76 basis points during 2010, and 51 basis points during 2009. Partially offsetting these effects was a decline in total funding costs to 1.69% for 2010, compared to 2.28% for 2009.

Provision for Credit Losses.    Sterling recorded provisions for credit losses of $250.2 million and $681.4 million for the years ended December 31, 2010 and 2009, respectively. The decline in the level of the provision over these periods primarily relates to the reduction in the level of classified loans, particularly in the construction portfolio, and the amount of losses previously recognized on these classified loans.

 

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Table of Contents

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

 

     Years Ended December 31,  
     2010     2009     %
Change
 
     (In thousands)        

Fees and service charges

   $ 54,740      $ 58,326        -6%   

Mortgage banking operations

     62,564        47,298        32%   

Gains on sales of securities

     25,745        13,467        91%   

Bank-owned life insurance

     7,307        6,954        5%   

Loan servicing fees

     3,762        2,378        58%   

Charge on prepayment of debt

     (11,296     0        N/A   

Other

     (5,857     (4,609     27%   
  

 

 

   

 

 

   

Total noninterest income

   $ 136,965      $ 123,814        11%   
  

 

 

   

 

 

   

Increases in income from mortgage banking operations and securities sales were partially offset by an $11.3 million prepayment charge on the early retirement of FHLB borrowings. Sterling expects to recapture this charge through lower interest expense in future periods. The increase in mortgage banking operations reflects a higher margin on loan sales during 2010 compared with 2009. Securities sales during 2010 were driven both from the realization of certain valuations, and rebalancing within the portfolio. The change in loan servicing income included market adjustments to mortgage servicing rights. The reduction in fees and service charges income primarily relates to lower non-sufficient funds fees and loan fees. Included in other noninterest income were losses on portfolio loan sales during 2010 of $3.4 million on the sale of $218.5 million of consumer indirect auto loans. The following table presents components of mortgage banking income for the periods presented:

 

     Years Ended December 31,  
     2010      2009  
     (In thousands)  

Residential loan sales

   $ 2,455,144       $ 2,843,057   

Margin on residential loan sales

     2.40%         1.53%   

Improvements in the pricing execution of residential loan sales during 2010 reflected an increase in the percentages of loans that were delivered to agencies on a mandatory basis.

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

 

     Years Ended December 31,  
     2010      2009      %
Change
 
     (In thousands)         

Employee compensation and benefits

   $ 168,793       $ 164,198         3%   

OREO operations

     62,578         48,041         30%   

Occupancy and equipment

     39,643         42,668         -7%   

Insurance

     34,704         30,585         13%   

Data processing

     23,116         20,779         11%   

Professional fees

     22,394         18,464         21%   

Depreciation

     13,391         14,041         -5%   

Advertising

     11,536         12,576         -8%   

Amortization of core deposit intangibles

     4,898         4,898         0%   

Travel and entertainment

     3,975         4,758         -16%   

Other

     10,017         8,966         12%   
  

 

 

    

 

 

    

Noninterest expense before impairment charge

     395,045         369,974         7%   

Goodwill impairment

     0         227,558         100%   
  

 

 

    

 

 

    

Total noninterest expense

   $ 395,045       $ 597,532         -34%   
  

 

 

    

 

 

    

 

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The increase in noninterest expense before impairment charge was primarily due to a higher level of OREO operating expenses and valuation write-downs as a result of increased levels of OREO. Professional fees increased primarily as a result of advisory costs related to Sterling’s recapitalization and ongoing litigation, as well as higher fees paid to members of the board of directors. Insurance, which is primarily comprised of FDIC deposit insurance premiums, showed an increase in 2010 due to the higher assessment rates applicable to Sterling Savings Bank prior to its returning to a well-capitalized status. Noninterest expense for 2009 included a writeoff of the remaining balance of goodwill.

Income Tax Provision.    During 2010, Sterling did not recognize any federal or state tax expense or benefit, as the income tax provision was offset by changes in the deferred tax valuation allowance. The tax provision for 2009 included impairment charges on Sterling’s deferred tax asset. See Note 14 of Notes to Consolidated Financial Statements.

Financial Position

Assets.    At December 31, 2011, Sterling’s assets were $9.19 billion, down $299.9 million from $9.49 billion at December 31, 2010, primarily as a result of a decline in investments and MBS. A decrease of certain loan types within the loan portfolio as a result of de-risking efforts was largely offset by new loan originations.

Investments and MBS.    Sterling’s investment and MBS portfolio at December 31, 2011 was $2.55 billion, compared with $2.84 billion at December 31, 2010, with sales, prepayments and maturities outpacing purchases during the period. Securities sales during 2011 were partly due to rebalancing the portfolio to adjust duration levels to manage interest rate risk. On December 31, 2011, the investment and MBS portfolio had an unrealized net gain of $62.2 million versus an unrealized net loss of $6.8 million at December 31, 2010. The following table sets forth the carrying values and classifications of Sterling’s investment and MBS portfolio as of the dates indicated:

 

     December 31,  
     2011      2010      2009  
     (In thousands)  

MBS

   $ 2,320,934       $ 2,602,610       $ 1,944,989   

Municipal bonds

     207,456         201,143         195,282   

Other

     21,233         34,721         37,700   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,549,623       $ 2,838,474       $ 2,177,971   
  

 

 

    

 

 

    

 

 

 

Available for sale

   $ 2,547,876       $ 2,825,010       $ 2,160,325   

Held to maturity

     1,747         13,464         17,646   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,549,623       $ 2,838,474       $ 2,177,971   
  

 

 

    

 

 

    

 

 

 

 

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The following table provides the carrying value and weighted average yield of Sterling’s investment and MBS portfolio by contractual maturity. Actual maturities for MBS will differ from contractual maturities from the level of prepayments experienced on the underlying mortgages.

 

     December 31, 2011  
     One Year
or Less
     After One
through
Five Years
     After Five
through
Ten Years
     After Ten
Years
     Total  
     (In thousands)  

MBS

              

Balance

   $ 0       $ 0       $ 166,718       $ 2,154,216       $ 2,320,934   

Weighted average yield

     0.00%         0.00%         2.23%         2.72%         2.68%   

Municipal bonds

              

Balance

   $ 457       $ 0       $ 29,297       $ 177,702       $ 207,456   

Weighted average yield(1)

     0.00%         0.00%         4.57%         4.27%         4.30%   

Other

              

Balance

   $ 0       $ 0       $ 0       $ 21,233       $ 21,233   

Weighted average yield

     0.00%         0.00%         0.00%         2.16%         2.16%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total carrying value

   $ 457       $ 0       $ 196,015       $ 2,353,151       $ 2,549,623   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average yield

     0.00%         0.00%         2.58%         2.83%         2.81%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

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

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

 

    December 31,  
    2011     2010     2009     2008     2007  
    Amount     %     Amount     %     Amount     %     Amount     %     Amount     %  
    (In thousands)  

Residential real estate

  $ 688,020        12%      $ 758,410        13%      $ 839,170        11%      $ 867,384        10%      $ 703,826        8%   

Commercial real estate (CRE):

                   

Investor CRE

    1,275,667        23        1,314,657        24        1,403,560        18        1,364,885        15        1,223,036        13   

Multifamily

    1,001,479        18        517,022        9        517,408        7        477,615        5        389,388        4   

Construction

    174,608        3        525,668        9        1,516,108        20        2,534,695        28        2,944,911        32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CRE

    2,451,754        44        2,357,347        42        3,437,076        45        4,377,195        48        4,557,335        49   

Commercial:

                   

Owner occupied CRE

    1,272,461        24        1,238,744        23        1,424,980        18        1,534,282        17        1,500,418        17   

C&I

    431,693        8        531,682        9        876,964        11        997,876        11        1,138,778        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

    1,704,154        32        1,770,426        32        2,301,944        29        2,532,158        28        2,639,196        30   

Consumer

    674,961        12        744,068        13        1,116,522        15        1,248,520        14        1,175,456        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross loans receivable

    5,518,889        100%        5,630,251        100%        7,694,712        100%        9,025,257        100%        9,075,813        100%   
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Net deferred origination fees

    (252       (4,114       (7,070       (9,798       (16,480  

Allowance for losses on loans

    (177,458       (247,056       (343,443       (208,365       (111,026  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Loans receivable, net

  $ 5,341,179        $ 5,379,081        $ 7,344,199        $ 8,807,094        $ 8,948,307     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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Sterling’s multifamily lending initiatives, which were launched during the fourth quarter of 2010, reflect the growth in multifamily loan balances during 2011. The de-risking of the balance sheet is reflected in the decline of construction loan balances over the periods presented. The following table sets forth the loan loss allowance by category and the percentage of loans in each category to total loans:

 

    December 31,  
    2011     2010     2009     2008     2007  
    Allowance
Amount
    Loans in
Category
as a
Percentage
of Total
Loans
    Allowance
Amount
    Loans in
Category
as a
Percentage
of Total
Loans
    Allowance
Amount
    Loans in
Category
as a
Percentage
of Total
Loans
    Allowance
Amount
    Loans in
Category
as a
Percentage
of Total
Loans
    Allowance
Amount
    Loans in
Category
as a
Percentage
of Total
Loans
 
    (In thousands)  

Residential real estate

  $ 15,197        12%      $ 17,307        13%      $ 28,319        11%      $ 8,147        10%      $ 965        8%   

Commercial real estate:

                   

Investor CRE

    55,876        23        49,362        23        42,296        18        13,712        15        6,553        13   

MultiFamily

    13,491        18        9,668        9        8,984        7        4,795        5        659        4   

Construction

    22,355        3        65,877        10        185,222        19        118,279        28        50,109        32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total CRE

    91,722        44        124,907        42        236,502        44        136,786        48        57,321        49   

Commercial:

                   

Owner occupied CRE

    20,636        23        34,282        23        28,248        19        11,008        17        14,692        18   

C&I

    17,410        8        22,669        9        30,887        11        29,019        11        23,829        13   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

    38,046        31        56,951        32        59,135        30        40,027        28        38,521        30   

Consumer

    13,427        12        14,645        13        19,198        15        14,608        14        12,330        13   

Unallocated

    19,066        N/A        33,246        N/A        289        N/A        8,797        N/A        1,889        N/A   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 177,458        100%      $ 247,056        100%      $ 343,443        100%      $ 208,365        100%      $ 111,026        100%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The decline in the allowance for loan losses on construction loans during the periods presented was due to the decline in construction loan balances from charge-offs, maturities, and a decline in the level of new construction originations. The increase in multifamily loan balances and related allowance for loan losses was due to Sterling’s multifamily lending initiatives.

 

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

 

     Years Ended December 31,  
     2011     2010     2009     2008     2007  
     (In thousands)  

Allowance for loan losses:

  

Beginning balance, January 1

   $ 247,056      $ 343,443      $ 208,365      $ 111,026      $ 77,849   

Provision

     28,500        250,591        690,738        318,585        24,632   

Charge-offs:

          

Residential real estate

     (18,553     (37,347     (31,401     (6,187     (30

Commercial real estate

          

Investor CRE

     (25,779     (26,943     (25,947     0        0   

Multifamily

     (1,703     (18,039     (3,510     (30     0   

Construction

     (45,896     (238,596     (420,539     (178,033     (3,430
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     (73,378     (283,578     (449,996     (178,063     (3,430
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial

          

Owner occupied CRE

     (19,177     (22,482     (24,786     (9,238     (70

C&I

     (9,192     (18,683     (45,085     (20,015     (1,000
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

     (28,369     (41,165     (69,871     (29,253     (1,070
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer

     (8,869     (14,765     (15,396     (9,821     (3,152
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (129,169     (376,855     (566,664     (223,324     (7,682
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Residential real estate

     1,419        2,131        306        66        5   

Commercial real estate

          

Investor CRE

     2,629        259        0        0        0   

Multifamily

     1,853        189        5        0        0   

Construction

     16,583        20,213        6,803        221        3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     21,065        20,661        6,808        221        3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial

          

Owner occupied CRE

     1,523        1,052        348        69        41   

C&I

     5,233        4,164        1,875        86        128   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

     6,756        5,216        2,223        155        169   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consumer

     1,831        1,869        1,667        1,636        756   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     31,071        29,877        11,004        2,078        933   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (98,098     (346,978     (555,660     (221,246     (6,749

Acquired

     0        0        0        0        15,294   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, December 31

     177,458        247,056        343,443        208,365        111,026   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reserve for unfunded credit commitments:

          

Beginning balance, January 1

     10,707        11,967        21,334        6,306        5,840   

Provision

     1,500        (360     (9,367     15,012        466   

Charge-offs

     (2,178     (900     0        16        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, December 31

     10,029        10,707        11,967        21,334        6,306   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total credit allowance

   $ 187,487      $ 257,763      $ 355,410      $ 229,699      $ 117,332   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowances on specific impaired loans

   $ 16,305      $ 37,654      $ 27,129      $ 1,980      $ 8,678   

Ratio of net charge-offs to average loans

     1.64%        4.86%        6.17%        2.37%        0.08%   

 

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The following table sets forth the contractual principal repayments of Sterling’s loan portfolio, as well as sensitivities of these loans to changes in interest rates. 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 credit losses.

 

     Balance
Outstanding at

December 31, 2011
     Principal Payments
Contractually Due in Fiscal Years
 
        2012      2013-2016      Thereafter  
     (In thousands)  
     fixed      variable      fixed      variable      fixed      variable      fixed      variable  

Residential real estate

   $ 338,957       $ 349,063       $ 75,945       $ 25,289       $ 92,494       $ 37,391       $ 170,518       $ 286,383   

Commercial real estate

                       

Investor CRE

     382,935         892,732         85,536         96,528         229,495         319,562         67,904         476,642   

Multifamily

     118,418         883,061         5,501         43,273         40,805         120,845         72,112         718,943   

Contruction

     41,185         133,423         38,266         123,970         1,823         5,904         1,096         3,549   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate

     542,538         1,909,216         129,303         263,771         272,123         446,311         141,112         1,199,134   

Commercial:

                       

Owner occupied CRE

     420,102         852,359         50,834         172,157         170,442         259,367         198,826         420,835   

C&I

     158,607         273,086         52,175         204,339         79,400         49,656         27,032         19,091   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     578,709         1,125,445         103,009         376,496         249,842         309,023         225,858         439,926   

Consumer

     340,761         334,200         45,206         11,207         120,328         57,042         175,227         265,951   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,800,965       $ 3,717,924       $ 353,463       $ 676,763       $ 734,787       $ 849,767       $ 712,715       $ 2,191,394   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth Sterling’s loan originations for the periods indicated:

 

     Years Ended December 31,  
     2011      2010      2009      2008      2007  
     (In thousands)  

Loan originations:

              

Residential real estate

   $ 2,098,894       $ 2,562,553       $ 3,047,380       $ 1,464,673       $ 1,492,026   

Commercial real estate:

              

Investor CRE

     42,551         98,172         176,256         326,853         163,315   

Multifamily

     720,192         29,369         82,696         170,975         35,870   

Construction

     19,557         20,084         64,660         602,051         2,191,620   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate

     782,300         147,625         323,612         1,099,879         2,390,805   

Commercial:

              

Owner occupied CRE

     158,347         50,428         131,919         265,594         554,881   

C&I

     217,723         80,548         186,625         276,384         440,851   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     376,070         130,976         318,544         541,978         995,732   

Consumer

     138,203         87,817         291,602         516,940         601,647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans originated

     3,395,467         2,928,971         3,981,138         3,623,470         5,480,210   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loan purchases:

              

Residential real estate

     13,417         0         0         0         0   

Commercial real estate:

              

Investor CRE

     48,584         0         0         0         0   

Multifamily

     2,896         82,702         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate

     51,480         82,702         0         0         0   

Commercial:

              

Owner Occupied CRE

     74,716         0         0         0         0   

C&I

     0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     74,716         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loan purchases

     139,613         82,702         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loan originations and purchases

   $ 3,535,080       $ 3,011,673       $ 3,981,138       $ 3,623,470       $ 5,480,210   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Growth in loan originations during 2011 was most notable in the multifamily portfolio, with $720.2 million of new loans originated compared to $29.4 million for 2010. Sterling’s multifamily initiative is due to the historical credit performance, risk weighting, and demand for this product, and has transacted primarily in California and the Puget Sound. In addition, Sterling increased commercial loan originations, comprised of owner-occupied commercial real estate loans and C&I loans, with total originations of $376.1 million for 2011, compared to $131.0 million for 2010.

The following table presents classified assets, which are comprised of performing and nonperforming substandard loans, doubtful/loss loans and OREO:

 

     December 31,  
     2011      2010      2009      2008      2007  
     (In thousands)  

Residential real estate

   $ 30,918       $ 104,467       $ 128,561       $ 34,333       $ 711   

Commercial real estate:

              

Investor CRE

     75,304         173,444         154,859         37,890         3,224   

Multifamily

     15,995         43,331         44,258         16,741         248   

Construction

     98,773         375,647         949,877         667,732         120,990   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate

     190,072         592,422         1,148,994         722,363         124,462   

Commercial:

              

Owner occupied CRE

     94,660         149,567         202,804         68,728         52,129   

C&I

     21,029         72,558         66,717         75,020         43,332   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     115,689         222,125         269,521         143,748         95,461   

Consumer

     7,157         18,868         11,996         4,556         2,627   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total classified loans

     343,836         937,882         1,559,072         905,000         223,261   

OREO

     81,910         161,653         83,272         62,320         11,075   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total classified assets

   $ 425,746       $ 1,099,535       $ 1,642,344       $ 967,320       $ 234,336   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Classified loans/total loans

     6.2%         16.7%         20.3%         10.0%         2.5%   

Classified assets/total assets

     4.6%         11.6%         15.1%         7.6%         1.9%   

 

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Classified assets declined $673.8 million, or 61% during 2011. The reductions were due to resolutions of nonperforming loans, sales of OREO, upgraded risk ratings and charge-offs. Nonperforming assets, a subset of classified assets that includes nonperforming loans and OREO, and related information are summarized in the following table as of the dates indicated:

 

     December 31,  
     2011     2010     2009     2008     2007  
     (In thousands)  

Past due 90 days or more and accruing

   $ 0      $ 0      $