06 2012 10-Q
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________
 FORM 10-Q
___________________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2012
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)
 
(I.R.S. Employer
Identification No.)
111 North Wall Street, Spokane, Washington 99201
(Address of principal executive offices) (Zip Code)
(509) 358-8097
(Registrant’s telephone number, including area code)
___________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
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 (§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  ý    No  ¨
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
  
Accelerated filer
 
x
 
 
 
 
 
Non-accelerated filer
 
¨
(Do not check if a smaller reporting company)
  
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
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
Class
 
Outstanding as of July 31, 2012
Common Stock
 
62,127,106


Table of Contents

TABLE OF CONTENTS
June 30, 2012
 
 
 
Page
PART I - Financial Information
Item 1
Financial Statements (Unaudited)
 
 
 
 
 
Item 2
Item 3
Item 4
PART II - Other Information
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6
 



Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except shares)
 
 
June 30,
2012
 
December 31,
2011
ASSETS:
 
 
 
Cash and cash equivalents:
 
 
 
Interest bearing
$
320,860

 
$
382,330

Noninterest bearing
95,772

 
88,269

Total cash and cash equivalents
416,632

 
470,599

Restricted cash
38,060

 
20,629

Investments and mortgage-backed securities (“MBS”):
 
 
 
Available for sale
2,119,008

 
2,547,876

Held to maturity
1,726

 
1,747

Loans held for sale (at fair value: $199,879 and $223,638)
226,907

 
273,957

Loans receivable, net
5,926,575

 
5,341,179

Accrued interest receivable
31,306

 
32,826

Other real estate owned, net (“OREO”)
55,801

 
81,910

Properties and equipment, net
86,556

 
84,015

Bank-owned life insurance (“BOLI”)
176,593

 
174,512

Goodwill
22,577

 
0

Other intangible assets, net
22,656

 
12,078

Mortgage servicing rights, net
26,516

 
23,102

Deferred tax asset, net
285,141

 
0

Other assets, net
163,459

 
128,807

Total assets
$
9,599,513

 
$
9,193,237

LIABILITIES:
 
 
 
Deposits:
 
 
 
Noninterest bearing
$
1,539,786

 
$
1,211,628

Interest bearing
5,256,988

 
5,274,190

Total deposits
6,796,774

 
6,485,818

Advances from Federal Home Loan Bank (“FHLB”)
205,470

 
405,609

Securities sold under repurchase agreements and funds purchased
1,006,324

 
1,055,763

Junior subordinated debentures
245,292

 
245,290

Accrued interest payable
5,981

 
22,575

Accrued expenses and other liabilities
118,878

 
99,625

Total liabilities
8,378,719

 
8,314,680

SHAREHOLDERS’ EQUITY:
 
 
 
Preferred stock, 10,000,000 shares authorized; no shares outstanding
0

 
0

Common stock, 151,515,151 shares authorized; 62,124,551 and 62,057,645 shares outstanding, respectively
1,966,307

 
1,964,234

Accumulated other comprehensive income
67,102

 
61,115

Accumulated deficit
(812,615
)
 
(1,146,792
)
Total shareholders’ equity
1,220,794

 
878,557

Total liabilities and shareholders’ equity
$
9,599,513

 
$
9,193,237


See notes to consolidated financial statements.
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Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except share amounts)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Interest income:
 
 
 
 
 
 
 
Loans
$
85,537

 
$
79,735

 
$
165,378

 
$
160,122

MBS
12,936

 
19,928

 
28,271

 
39,962

Investments and cash equivalents
2,517

 
2,684

 
5,306

 
5,500

Total interest income
100,990

 
102,347

 
198,955

 
205,584

Interest expense:
 
 
 
 
 
 
 
Deposits
9,921

 
15,216

 
21,023

 
32,510

Short-term borrowings
1,825

 
111

 
4,031

 
190

Long-term borrowings
10,334

 
12,213

 
20,638

 
24,334

Total interest expense
22,080

 
27,540

 
45,692

 
57,034

Net interest income
78,910

 
74,807

 
153,263

 
148,550

Provision for credit losses
4,000

 
10,000

 
8,000

 
20,000

Net interest income after provision for credit losses
74,910

 
64,807

 
145,263

 
128,550

Noninterest income:
 
 
 
 
 
 
 
Fees and service charges
14,131

 
12,946

 
26,871

 
25,507

Mortgage banking operations
24,652

 
10,794

 
40,816

 
21,121

Loan servicing fees
(471
)
 
709

 
1,909

 
1,810

BOLI
3,769

 
1,578

 
5,515

 
3,310

Gains on sales of securities
9,321

 
8,297

 
9,463

 
14,298

Other-than-temporary impairment credit losses on securities (1)
(6,819
)
 
0

 
(6,819
)
 
0

Charge on prepayment of debt
(2,664
)
 
0

 
(2,664
)
 
0

Gains (losses) on other loan sales
2,811

 
471

 
3,411

 
(879
)
Other
11

 
(460
)
 
(2,174
)
 
(850
)
Total noninterest income
44,741

 
34,335

 
76,328

 
64,317

Noninterest expense
87,607

 
91,587

 
176,256

 
179,895

Income before income taxes
32,044

 
7,555

 
45,335

 
12,972

Income tax benefit
288,842

 
0

 
288,842

 
0

Net income
$
320,886

 
$
7,555

 
$
334,177

 
$
12,972

Earnings per share - basic
$
5.17

 
$
0.12

 
$
5.38

 
$
0.21

Earnings per share - diluted
$
5.13

 
$
0.12

 
$
5.33

 
$
0.21

Weighted average shares outstanding - basic
62,112,936

 
61,943,851

 
62,095,670

 
61,937,353

Weighted average shares outstanding - diluted
62,610,054

 
62,312,224

 
62,648,152

 
62,320,028


(1) The other-than-temporary impairment recognized in earnings during the second quarter of 2012 did not have a portion recognized in accumulated other comprehensive income. See Note 3.
 


See notes to consolidated financial statements.
4

Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
320,886

 
$
7,555

 
$
334,177

 
$
12,972

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in unrealized gains on investments and MBS available for sale
7,714

 
36,651

 
12,312

 
38,594

Realized net gains reclassified from other comprehensive income
(2,502
)
 
(8,297
)
 
(2,644
)
 
(14,298
)
Less deferred income tax provision
(3,681
)
 
(3,826
)
 
(3,681
)
 
(2,384
)
Net other comprehensive income (loss)
1,531

 
24,528

 
5,987

 
21,912

Comprehensive income
$
322,417

 
$
32,083

 
$
340,164

 
$
34,884




See notes to consolidated financial statements.
5

Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Six Months Ended June 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
334,177

 
$
12,972

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
8,000

 
20,000

Net gain on sales of loans
(42,969
)
 
(13,434
)
Net gain on sales of investments and MBS
(9,463
)
 
(14,298
)
Net gain on mortgage servicing rights
(1,143
)
 
(5,115
)
Other-than-temporary impairment on securities
6,819

 
0

Stock based compensation
1,837

 
1,959

(Gain) loss on OREO
(1,605
)
 
10,564

Release of DTA valuation allowance
(288,842
)
 
0

Increase in cash surrender value of BOLI
(5,390
)
 
(3,310
)
Depreciation and amortization
22,192

 
19,122

Change in:
 
 
 
Accrued interest receivable
5,050

 
2,069

Prepaid expenses and other assets
(32,479
)
 
1,742

Accrued interest payable
(16,728
)
 
2,801

Accrued expenses and other liabilities
7,276

 
(10,257
)
Proceeds from sales of loans originated for sale
1,205,473

 
871,842

Loans originated for sale
(1,158,269
)
 
(828,385
)
Net cash provided by operating activities
33,936

 
68,272

Cash flows from investing activities:
 
 
 
Change in restricted cash
(17,431
)
 
249

Net change in loans
(243,657
)
 
(169,304
)
Proceeds from sales of loans
20,515

 
31,899

Purchase of investment securities
(2,534
)
 
(2,000
)
Proceeds from maturities of investment securities
17,505

 
294

Proceeds from sale of investment securities
179,235

 
30,987

Purchase of MBS
(72,032
)
 
(242,841
)
Principal payments received on MBS
314,414

 
229,210

Proceeds from sales of MBS
183,636

 
353,444

Office properties and equipment, net
(4,647
)
 
(9,595
)
Improvements and other changes to OREO
(1,250
)
 
(5,061
)
Proceeds from sales of OREO
51,515

 
155,566

Net change in cash and cash equivalents from acquisitions
121,098

 
0

Net cash provided by investing activities
546,367

 
372,848

Cash flows from financing activities:
 
 
 
Net change in deposits
(384,963
)
 
(307,009
)
Repayment of advances from FHLB
(200,104
)
 
(98
)
Net change in securities sold under repurchase agreements and funds purchased
(49,439
)
 
26,182

Proceeds from stock issuance, net
236

 
0

Net cash used in financing activities
(634,270
)
 
(280,925
)

See notes to consolidated financial statements.
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Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)—cont.
(in thousands)
 
Six Months Ended June 30,
 
2012
 
2011
Net change in cash and cash equivalents
$
(53,967
)
 
$
160,195

Cash and cash equivalents, beginning of period
470,599

 
411,583

Cash and cash equivalents, end of period
$
416,632

 
$
571,778

Supplemental disclosures:
 
 
 
Cash paid during the period for:
 
 
 
Interest
62,287

 
54,233

Income taxes, net
56

 
0

Noncash financing and investing activities:
 
 
 
Foreclosed real estate acquired in settlement of loans
22,551

 
100,822




See notes to consolidated financial statements.
7

Table of Contents

STERLING FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012

1.
Basis of Presentation:

The foregoing unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements as disclosed in the annual report on Form 10-K for the year ended December 31, 2011. References to “Sterling,” in this report are to Sterling Financial Corporation, a Washington corporation, and its consolidated subsidiaries on a combined basis, unless otherwise specified or the context otherwise requires. References to “Sterling Bank” refer to our subsidiary Sterling Savings Bank, a Washington state-chartered commercial bank.
In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of Sterling’s consolidated financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of Sterling’s consolidated financial position and results of operations.

During 2012, Sterling identified an error related to the classification of the loss on foreclosure amounts reported in the Consolidated Statement of Cash Flows for the quarter ended March 31, 2012, and for the years ended December 31, 2011 and 2010, and the interim periods therein. The loss on foreclosure amounts were previously included in the cash flows from operating activities in the Loss on OREO line item, instead of the cash flows from investing activities in the Net change in loans line item. In accordance with the SEC Staff Accounting Bulletin (SAB) No. 99, "Materiality," and SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements," management evaluated the materiality of the error from qualitative and quantitative perspectives and concluded that the error was immaterial to prior periods. Consequently, the Consolidated Statement of Cash Flows contained in this Report has been revised for the six months ended June 30, 2011. This change resulted in a decrease of $29.3 million to cash flows from operating activities and an increase of the same amount to cash flows from investing activities for the six months ended June 30, 2011. This change did not impact net income, the balance sheet, or shareholders' equity for any period.

In addition to other established accounting policies, the following is a discussion of recent accounting pronouncements:

In April 2011, the FASB issued Accounting Standards Update ("ASU") 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” This update to codification topic 860 revises the assessment of effective control for purposes of determining if a reverse repurchase agreement should be accounted for as a sale, compared with a secured borrowing. ASU 2011-03 became effective for Sterling on January 1, 2012, and did not have a material effect on Sterling’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” This update to codification topic 820 clarifies the application of existing fair value measurement and disclosure requirements, and implements changes to the codification that align U.S. GAAP and IFRS. This update became effective for Sterling on January 1, 2012. See Note 12.

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet: Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 adds certain additional disclosure requirements about financial instruments and derivatives instruments that are subject to netting arrangements. The new disclosures are required for annual reporting periods beginning on or after January 1, 2013, and interim periods within those periods. This standard could add additional disclosures if applicable to Sterling. However, it is not expected to have a material impact on Sterling’s consolidated financial statements.


8

Table of Contents

In September 2011, the FASB issued ASU 2011-08, “Intangibles-Goodwill and Other: Testing Goodwill for Impairment.” ASU 2011-08 is intended to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of a business that contains recorded goodwill unless it concludes, based on the qualitative assessment, that it is more likely than not that the fair value of that business is less than its book value. If such a decline in fair value is deemed more likely than not to have occurred, then the quantitative goodwill impairment test that exists under current GAAP must be completed; otherwise, goodwill is deemed to be not impaired and no further testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business). The amended goodwill impairment guidance does not affect the manner in which a company estimates fair value. ASU 2011-08 became effective for Sterling on January 1, 2012, and did not have a material effect on Sterling’s consolidated financial statements.

2. Business Combination:

On February 29, 2012, Sterling Bank completed its acquisition of the operations of First Independent Bank, by acquiring certain assets and assuming certain liabilities, including all deposits for a net purchase price of $40.6 million, comprised of $28.9 million of cash paid at closing and contingent consideration with a fair value of $11.7 million at acquisition date. As of June 30, 2012, the fair value of this contingent consideration was estimated at $13.3 million, with the increase reflected as a charge against earnings. The contingent consideration is payable in two installments at 12 and 18 months from the date of closing, in an amount ranging from zero to $17 million. The contingent consideration payments will be determined based on certain performance metrics relating to core deposit retention, loan charge-offs, and wealth management revenues. As a result of this transaction, Sterling now offers trust services, and has 14 additional branches in the Portland/Vancouver market. The following table summarizes the amounts recorded at closing:
 
February 29, 2012
 
(in thousands)
Cash and cash equivalents
$
150,045

Investments and MBS
187,465

Loans receivable, net
349,990

Goodwill
22,577

Core deposit intangible
11,974

Fixed assets
4,038

Other assets
10,886

Total assets acquired
$
736,975

Deposits
$
695,919

Other liabilities
409

Total liabilities assumed
696,328

Net assets acquired
$
40,647


The recorded goodwill of $22.6 million represents the inherent long-term value anticipated from synergies expected to be achieved as a result of the transaction. The amount recorded for goodwill includes subsequent adjustments, primarily from updated appraisals on fixed assets. The amount of goodwill deductible for income tax purposes is approximately equivalent to the recorded book value. The core deposit intangible has a weighted average amortization period of ten years and will be amortized on an accelerated basis. The following table presents certain First Independent stand alone amounts and pro forma Sterling and First Independent combined amounts as if the transaction had occurred on January 1, 2011. Cost savings estimates are not included in the pro forma combined results, nor are certain credit impaired loans and associated losses excluded from the purchase and assumption transaction.

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Table of Contents

 
First Independent (stand alone)
 
Pro Forma Combined
 
Pro Forma Combined
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
June 30, 2012
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
 
(in thousands, except per share data)
Net interest income
$
7,859

 
$
11,100

 
$
78,910

 
$
82,633

 
$
159,744

 
$
164,716

Noninterest income
1,678

 
2,181

 
44,741

 
36,628

 
77,333

 
69,031

Net income
3,901

 
6,008

 
320,886

 
10,368

 
338,391

 
20,406

Earnings per share - basic
0.06

 
0.10

 
5.17

 
0.17

 
5.45

 
0.33

Earnings per share - diluted
$
0.06

 
$
0.10

 
$
5.13

 
$
0.17

 
$
5.40

 
$
0.33

 
 
 
 
 
 
 
 
 
 
 
 

Although the majority of First Independent's credit impaired loans were excluded from the transaction, certain loans acquired were deemed to exhibit evidence of credit deterioration since origination. The purchased impaired loans are accounted for under Accounting Standards Codification ("ASC") 310-30 (Receivables - Loan and Debt Securities Acquired with Deteriorated Credit Quality), with periodic updates to the loans' cash flow expectations reflected in interest income over the life of the loans as accretable yield. For purchased impaired loans (ASC 310-30 loans), details as of the acquisition date were as follows:
 
February 29, 2012
 
(in thousands)
Contractual cash flows
$
24,408

Expected prepayments and credit losses
7,220

Expected cash flows
17,188

Present value of expected cash flows
15,265

Accretable yield
$
1,923

As of June 30, 2012, no allowance for credit losses was recorded in connection with these loans, and the unpaid principal balance and carrying amount of the purchased impaired loans were $20.4 million and $13.3 million, respectively. The following table presents a roll forward of activity for the accretable yield for the purchased impaired loans:
 
Three Months Ended
Six Months Ended
 
June 30, 2012
 
 
(in thousands)
Beginning balance
$
1,909

$
0

Additions
0

1,923

Accretion to interest income
(308
)
(322
)
Reclassifications
730

730

Ending balance
$
2,331

$
2,331



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As of February 29, 2012, the unpaid principal balance and contractual interest ("contractual cash flows") on purchased loans that had not exhibited evidence of credit deterioration was $403.8 million. Sterling estimated that $12.7 million of these cash flows would be uncollectable, resulting in a discount of $21.8 million being recorded on these loans. As of June 30, 2012, the following table presents the related five-year projected accretion of the discount which will be recognized as an increase to interest income:
 
Amount
Remainder of 2012
$
4,022

Years ended December 31,
 
2013
4,210

2014
2,796

2015
1,724

2016
1,031

2017
679




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3. Investments and MBS:

The carrying and fair values of investments and MBS are summarized as follows:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
June 30, 2012
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
1,839,894

 
$
57,416

 
$
0

 
$
1,897,310

Municipal bonds
188,776

 
15,535

 
(774
)
 
203,537

Other
18,156

 
6

 
(1
)
 
18,161

Total
$
2,046,826

 
$
72,957

 
$
(775
)
 
$
2,119,008

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
1,726

 
$
0

 
$
0

 
$
1,726

Total
$
1,726

 
$
0

 
$
0

 
$
1,726

December 31, 2011
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
2,265,207

 
$
55,760

 
$
(33
)
 
$
2,320,934

Municipal bonds
195,512

 
13,338

 
(1,394
)
 
207,456

Other
24,923

 
2

 
(5,439
)
 
19,486

Total
$
2,485,642

 
$
69,100

 
$
(6,866
)
 
$
2,547,876

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
1,747

 
$
0

 
$
0

 
$
1,747

Total
$
1,747

 
$
0

 
$
0

 
$
1,747


Sterling’s MBS portfolio is comprised primarily of residential agency securities. Other available for sale securities consist of a single issuer trust preferred security. Total sales of Sterling’s securities during the periods ended June 30, 2012 and 2011 are summarized as follows:

 
Proceeds from
Sales
 
Gross Realized
Gains
 
Gross Realized
Losses
 
(in thousands)
Six Months Ended
 
 
 
 
 
June 30, 2012
$
362,871

 
$
9,537

 
$
(74
)
June 30, 2011
384,431

 
16,605

 
(2,307
)


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Table of Contents

The following table summarizes Sterling’s investments and MBS that had a market value below their amortized cost as of June 30, 2012 and December 31, 2011, segregated by those investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer:
 
 
Less than 12 months
 
12 months or longer
 
Total
 
Market Value
 
Unrealized
Losses
 
Market Value
 
Unrealized
Losses
 
Market Value
 
Unrealized
Losses
 
(in thousands)
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
MBS
$
0

 
$
0

 
$
0

 
$
0

 
$
0

 
$
0

Municipal bonds
0

 
0

 
14,609

 
(774
)
 
14,609

 
(774
)
Other
0

 
0

 
0

 
0

 
0

 
0

Total
$
0

 
$
0

 
$
14,609

 
$
(774
)
 
$
14,609

 
$
(774
)
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
MBS
$
1,419

 
$
(12
)
 
$
24,726

 
$
(21
)
 
$
26,145

 
$
(33
)
Municipal bonds
0

 
0

 
17,289

 
(1,394
)
 
17,289

 
(1,394
)
Other
0

 
0

 
19,479

 
(5,439
)
 
19,479

 
(5,439
)
Total
$
1,419

 
$
(12
)
 
$
61,494

 
$
(6,854
)
 
$
62,913

 
$
(6,866
)

The following table presents the amortized cost and fair value of available for sale and held to maturity securities as of June 30, 2012, grouped by contractual maturity. Actual maturities for MBS will differ from contractual maturities as a result of the level of prepayments experienced on the underlying mortgages.  
 
Held to maturity
 
Available for sale
 
Amortized Cost
 
Estimated Fair
Value
 
Amortized Cost
 
Estimated Fair
Value
 
(in thousands)
Due within one year
$
0

 
$
0

 
$
0

 
$
0

Due after one year through five years
0

 
0

 
780

 
780

Due after five years through ten years
0

 
0

 
136,113

 
139,905

Due after ten years
1,726

 
1,726

 
1,909,933

 
1,978,323

Total
$
1,726

 
$
1,726

 
$
2,046,826

 
$
2,119,008


Management evaluates investment securities for other-than-temporary declines in fair value each quarter. If the fair value of investment securities falls below the amortized cost and the decline is deemed to be other-than temporary, the securities are written down to current market value, resulting in the recognition of an other-than-temporary impairment ("OTTI"). As of June 30, 2012, Sterling held a single issuer trust preferred security issued by JP Morgan Chase with a par value of $27.5 million, and a market value of $18.2 million. Although the security was downgraded during the second quarter of 2012 to Baa2 by Moody's, interest payments have not been deferred. Sterling intends to sell the security prior to its scheduled maturity or recovery of its amortized cost basis, and accordingly recognized an OTTI charge on the security during the second quarter of 2012. The following table presents a rollforward of OTTI for the periods presented:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
OTTI, beginning balance
$
0

 
$
0

 
$
0

 
$
0

Additions
6,819

 
0

 
6,819

 
0

Ending Balance
$
6,819

 
$
0

 
$
6,819

 
$
0




13

Table of Contents

4. Loans Receivable and Allowance for Credit Losses:

The following table presents the composition of Sterling’s loan portfolio as of the balance sheet dates:
 
 
June 30,
2012
 
December 31,
2011
 
(in thousands)
Residential real estate
$
785,482

 
$
688,020

Commercial real estate (CRE):
 
 
 
Investor CRE
1,324,917

 
1,275,667

Multifamily
1,311,247

 
1,001,479

Construction
111,550

 
174,608

Total CRE
2,747,714

 
2,451,754

Commercial:
 
 
 
Owner occupied CRE
1,309,587

 
1,272,461

Commercial & Industrial (C&I)
504,396

 
431,693

Total commercial
1,813,983

 
1,704,154

Consumer
736,397

 
674,961

Gross loans receivable
6,083,576

 
5,518,889

Deferred loan costs (fees), net
1,243

 
(252
)
Allowance for loan losses
(158,244
)
 
(177,458
)
Net loans receivable
$
5,926,575

 
$
5,341,179

 
Gross loans pledged as collateral for borrowings from the FHLB and the Federal Reserve totaled $3.27 billion and $4.02 billion as of June 30, 2012 and December 31, 2011, respectively. As of June 30, 2012 and December 31, 2011, the unamortized portion of discounts on acquired loans was $28.5 million and $4.3 million, respectively.


14

Table of Contents

The following table sets forth details by segment for Sterling’s loan portfolio and related allowance as of the balance sheet dates:
 
 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
11,504

 
$
103,709

 
$
69,373

 
$
930

 
$
0

 
$
185,516

Collectively evaluated for impairment
773,978

 
2,644,005

 
1,744,610

 
735,467

 
0

 
5,898,060

Total loans receivable, gross
$
785,482

 
$
2,747,714

 
$
1,813,983

 
$
736,397

 
$
0

 
$
6,083,576

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
365

 
$
3,646

 
$
6,142

 
$
43

 
$
0

 
$
10,196

Collectively evaluated for impairment
12,016

 
63,206

 
34,128

 
16,916

 
21,782

 
148,048

Total allowance for loan losses
$
12,381

 
$
66,852

 
$
40,270

 
$
16,959

 
$
21,782

 
$
158,244

December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
18,301

 
$
149,578

 
$
74,041

 
$
1,192

 
$
0

 
$
243,112

Collectively evaluated for impairment
669,719

 
2,302,176

 
1,630,113

 
673,769

 
0

 
5,275,777

Total loans receivable, gross
$
688,020

 
$
2,451,754

 
$
1,704,154

 
$
674,961

 
$
0

 
$
5,518,889

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
872

 
$
11,170

 
$
4,206

 
$
57

 
$
0

 
$
16,305

Collectively evaluated for impairment
14,325

 
80,552

 
33,840

 
13,370

 
19,066

 
161,153

Total allowance for loan losses
$
15,197

 
$
91,722

 
$
38,046

 
$
13,427

 
$
19,066

 
$
177,458


15

Table of Contents


The following tables present a roll forward by segment of the allowance for credit losses for the periods presented:
 
 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
2012 quarterly activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
$
12,242

 
$
80,614

 
$
34,483

 
$
14,160

 
$
19,774

 
$
161,273

Provisions
(377
)
 
(9,905
)
 
6,222

 
4,052

 
2,008

 
2,000

Charge-offs
(157
)
 
(9,481
)
 
(3,606
)
 
(1,643
)
 
0

 
(14,887
)
Recoveries
673

 
5,624

 
3,171

 
390

 
0

 
9,858

Ending balance, June 30
12,381

 
66,852

 
40,270

 
16,959

 
21,782

 
158,244

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
3,802

 
1,608

 
2,461

 
1,282

 
875

 
10,028

Provisions
2,595

 
(910
)
 
889

 
228

 
(802
)
 
2,000

Charge-offs
(4,076
)
 
0

 
0

 
0

 
0

 
(4,076
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Total credit allowance
$
14,702

 
$
67,550

 
$
43,620

 
$
18,469

 
$
21,855

 
$
166,196

2011 quarterly activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
$
18,512

 
$
113,027

 
$
57,384

 
$
13,056

 
$
30,965

 
$
232,944

Provisions
5,921

 
14,404

 
(7,637
)
 
2,524

 
(2,712
)
 
12,500

Charge-offs
(4,210
)
 
(28,745
)
 
(3,908
)
 
(2,117
)
 
0

 
(38,980
)
Recoveries
603

 
3,921

 
763

 
337

 
0

 
5,624

Ending balance, June 30
20,826

 
102,607

 
46,602

 
13,800

 
28,253

 
212,088

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, April 1
3,285

 
3,390

 
1,386

 
1,101

 
1,479

 
10,641

Provisions
(140
)
 
(835
)
 
(462
)
 
1,007

 
(2,070
)
 
(2,500
)
Charge-offs
(710
)
 
0

 
0

 
0

 
0

 
(710
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,435

 
2,555

 
924

 
2,108

 
(591
)
 
7,431

Total credit allowance
$
23,261

 
$
105,162

 
$
47,526

 
$
15,908

 
$
27,662

 
$
219,519


16

Table of Contents

 
Residential Real Estate
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
2012 year to date
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
15,197

 
$
91,722

 
$
38,046

 
$
13,427

 
$
19,066

 
$
177,458

Provisions
(1,357
)
 
(12,729
)
 
10,680

 
6,690

 
2,716

 
6,000

Charge-offs
(2,344
)
 
(20,999
)
 
(13,139
)
 
(4,095
)
 
0

 
(40,577
)
Recoveries
885

 
8,858

 
4,683

 
937

 
0

 
15,363

Ending balance, June 30
12,381

 
66,852

 
40,270

 
16,959

 
21,782

 
158,244

 
 
 
 
 
 
 
 
 
 
 
 
Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
3,828

 
$
2,321

 
$
1,796

 
$
1,787

 
$
297

 
$
10,029

Provisions
2,570

 
(1,623
)
 
1,554

 
(277
)
 
(224
)
 
2,000

Charge-offs
(4,077
)
 
0

 
0

 
0

 
0

 
(4,077
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Total credit allowance
$
14,702

 
$
67,550

 
$
43,620

 
$
18,469

 
$
21,855

 
$
166,196

 
 
 
 
 
 
 
 
 
 
 
 
2011 year to date
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
17,307

 
$
124,907

 
$
56,951

 
$
14,645

 
$
33,246

 
$
247,056

Provisions
13,690

 
9,458

 
1,885

 
2,460

 
(4,993
)
 
22,500

Charge-offs
(11,024
)
 
(39,944
)
 
(13,492
)
 
(4,263
)
 
0

 
(68,723
)
Recoveries
853

 
8,186

 
1,258

 
958

 
0

 
11,255

Ending balance, June 30
20,826

 
102,607

 
46,602

 
13,800

 
28,253

 
212,088

 
 
 
 
 
 
 
 
 
 
 
 
Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1
$
3,189

 
$
4,157

 
$
1,515

 
$
817

 
$
1,029

 
$
10,707

Provisions
22

 
(1,602
)
 
(591
)
 
1,291

 
(1,620
)
 
(2,500
)
Charge-offs
(776
)
 
0

 
0

 
0

 
0

 
(776
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, June 30
2,435

 
2,555

 
924

 
2,108

 
(591
)
 
7,431

Total credit allowance
$
23,261

 
$
105,162

 
$
47,526

 
$
15,908

 
$
27,662

 
$
219,519



17

Table of Contents

In establishing its allowance for loan losses, Sterling groups its loan portfolio into segments for homogeneous loans. The groups are further segregated based on internal risk ratings. Both qualitative and quantitative data are considered in determining the probability of default and loss given default for each group of loans. The probability of default and loss given default are used to calculate an expected loss rate which is multiplied by the loan balance in each category to determine the general allowance for loan losses. If a loan is determined to be impaired, Sterling performs an individual evaluation of the loan.
The individual evaluation compares the present value of the expected future cash flows or the fair value of the underlying collateral to the recorded investment in the loan. The results of the individual impairment evaluation could determine the need to record a charge-off or a specific reserve.

Sterling assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:
Pass-asset is considered of sufficient quality to preclude a Special Mention or an adverse rating. Pass assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral.
Special Mention-asset has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in Sterling's credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard-asset is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified have well-defined weaknesses. They are characterized by the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected.
Doubtful/Loss-a Doubtful asset has the weaknesses of those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. An asset classified Loss is considered uncollectible and/or of such little value that its continuance as an asset, without establishment of a specific valuation allowance or charge-off, is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value; but rather, it is not practical or desirable to defer writing off an asset that is no longer deemed to have financial value, even though partial recovery may be recognized in the future.






18

Table of Contents

The following table presents credit quality indicators for Sterling’s loan portfolio grouped according to internally assigned risk ratings and performance status:
 
 
 
 
Commercial Real Estate
 
Commercial
 
 
 
 
 
 
 
Residential Real Estate
 
Investor CRE
 
Multifamily
 
Construction
 
Owner Occupied CRE
 
Commercial & Industrial
 
Consumer
 
Total
 
% of
Total
 
(in thousands)
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
747,972

 
$
1,131,163

 
$
1,271,480

 
$
71,016

 
$
1,158,647

 
$
454,235

 
$
723,673

 
$
5,558,186

 
92
%
Special mention
10,150

 
120,171

 
11,795

 
3,251

 
70,369

 
35,048

 
5,553

 
256,337

 
4
%
Substandard
26,995

 
71,120

 
26,943

 
37,129

 
74,755

 
14,787

 
7,128

 
258,857

 
4
%
Doubtful/Loss
365

 
2,463

 
1,029

 
154

 
5,816

 
326

 
43

 
10,196

 
0
%
Total
$
785,482

 
$
1,324,917

 
$
1,311,247

 
$
111,550

 
$
1,309,587

 
$
504,396

 
$
736,397

 
$
6,083,576

 
100
%
Restructured
$
23,102

 
$
25,178

 
$
2,360

 
$
10,396

 
$
25,309

 
$
2,464

 
$
311

 
$
89,120

 
1
%
Nonaccrual
20,457

 
49,196

 
24,148

 
22,446

 
47,796

 
7,899

 
4,278

 
176,220

 
3
%
Nonperforming
43,559

 
74,374

 
26,508

 
32,842

 
73,105

 
10,363

 
4,589

 
265,340

 
4
%
Performing
741,923

 
1,250,543

 
1,284,739

 
78,708

 
1,236,482

 
494,033

 
731,808

 
5,818,236

 
96
%
Total
$
785,482

 
$
1,324,917

 
$
1,311,247

 
$
111,550

 
$
1,309,587

 
$
504,396

 
$
736,397

 
$
6,083,576

 
100
%
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
643,071

 
$
1,116,991

 
$
975,583

 
$
51,284

 
$
1,123,796

 
$
385,643

 
$
663,829

 
$
4,960,197

 
90
%
Special mention
14,031

 
83,372

 
9,901

 
24,578

 
54,009

 
25,334

 
4,166

 
215,391

 
4
%
Substandard
30,046

 
70,412

 
15,279

 
93,185

 
90,613

 
19,355

 
6,909

 
325,799

 
6
%
Doubtful/Loss
872

 
4,892

 
716

 
5,561

 
4,043

 
1,361

 
57

 
17,502

 
0
%
Total
$
688,020

 
$
1,275,667

 
$
1,001,479

 
$
174,608

 
$
1,272,461

 
$
431,693

 
$
674,961

 
$
5,518,889

 
100
%
Restructured
$
17,638

 
$
4,366

 
$
0

 
$
38,833

 
$
13,519

 
$
2,583

 
$
0

 
$
76,939

 
1
%
Nonaccrual
25,265

 
47,827

 
5,867

 
56,385

 
59,752

 
9,296

 
5,829

 
210,221

 
4
%
Nonperforming
42,903

 
52,193

 
5,867

 
95,218

 
73,271

 
11,879

 
5,829

 
287,160

 
5
%
Performing
645,117

 
1,223,474

 
995,612

 
79,390

 
1,199,190

 
419,814

 
669,132

 
5,231,729

 
95
%
Total
$
688,020

 
$
1,275,667

 
$
1,001,479

 
$
174,608

 
$
1,272,461

 
$
431,693

 
$
674,961

 
$
5,518,889

 
100
%


19

Table of Contents

Aging by class for Sterling’s loan portfolio as of June 30, 2012 and December 31, 2011 was as follows:
 
 
 
 
Commercial Real Estate
 
Commercial
 
 
 
 
 
 
 
Residential Real Estate
 
Investor CRE
 
Multifamily
 
Construction
 
Owner Occupied CRE
 
Commercial & Industrial
 
Consumer
 
Total
 
% of
Total
 
(in thousands)
 
 </