09 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 SEPTEMBER 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 October 31, 2012
Common Stock
 
62,148,022


Table of Contents

TABLE OF CONTENTS
September 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)
 
 
September 30,
2012
 
December 31,
2011
ASSETS:
 
 
 
Cash and cash equivalents:
 
 
 
Interest bearing
$
145,522

 
$
382,330

Noninterest bearing
86,691

 
88,269

Total cash and cash equivalents
232,213

 
470,599

Restricted cash
31,671

 
20,629

Investments and mortgage-backed securities (“MBS”):
 
 
 
Available for sale
2,049,961

 
2,547,876

Held to maturity
1,716

 
1,747

Loans held for sale (at fair value: $320,823 and $223,638)
320,823

 
273,957

Loans receivable, net
5,990,365

 
5,341,179

Accrued interest receivable
32,031

 
32,826

Other real estate owned, net (“OREO”)
46,575

 
81,910

Properties and equipment, net
92,987

 
84,015

Bank-owned life insurance (“BOLI”)
178,279

 
174,512

Goodwill
22,577

 
0

Other intangible assets, net
20,864

 
12,078

Mortgage servicing rights, net
26,819

 
23,102

Deferred tax asset, net
280,373

 
0

Other assets, net
145,183

 
128,807

Total assets
$
9,472,437

 
$
9,193,237

LIABILITIES:
 
 
 
Deposits:
 
 
 
Noninterest bearing
$
1,709,612

 
$
1,211,628

Interest bearing
5,030,298

 
5,274,190

Total deposits
6,739,910

 
6,485,818

Advances from Federal Home Loan Bank (“FHLB”)
155,401

 
405,609

Securities sold under repurchase agreements and funds purchased
942,547

 
1,055,763

Junior subordinated debentures
245,293

 
245,290

Accrued interest payable
6,592

 
22,575

Accrued expenses and other liabilities
131,207

 
99,625

Total liabilities
8,220,950

 
8,314,680

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

 
0

Common stock, 151,515,151 shares authorized; 62,150,650 and 62,057,645 shares outstanding, respectively
1,967,562

 
1,964,234

Accumulated other comprehensive income
75,263

 
61,115

Accumulated deficit
(791,338
)
 
(1,146,792
)
Total shareholders’ equity
1,251,487

 
878,557

Total liabilities and shareholders’ equity
$
9,472,437

 
$
9,193,237


See notes to consolidated financial statements.
3

Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Interest income:
 
 
 
 
 
 
 
Loans
$
83,110

 
$
82,010

 
$
248,488

 
$
242,132

MBS
10,361

 
16,719

 
38,632

 
56,681

Investments and cash equivalents
2,520

 
2,650

 
7,826

 
8,150

Total interest income
95,991

 
101,379

 
294,946

 
306,963

Interest expense:
 
 
 
 
 
 
 
Deposits
8,981

 
14,135

 
30,004

 
46,645

Short-term borrowings
2,346

 
657

 
6,377

 
847

Long-term borrowings
9,356

 
11,751

 
29,994

 
36,085

Total interest expense
20,683

 
26,543

 
66,375

 
83,577

Net interest income
75,308

 
74,836

 
228,571

 
223,386

Provision for credit losses
2,000

 
6,000

 
10,000

 
26,000

Net interest income after provision for credit losses
73,308

 
68,836

 
218,571

 
197,386

Noninterest income:
 
 
 
 
 
 
 
Fees and service charges
14,675

 
12,332

 
41,546

 
37,839

Mortgage banking operations
28,502

 
16,360

 
69,318

 
37,481

Loan servicing fees
(2,092
)
 
(4,694
)
 
(183
)
 
(2,884
)
BOLI
1,660

 
1,612

 
7,175

 
4,922

Gains on sales of securities
3,129

 
0

 
12,592

 
14,298

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

 
0

 
(6,819
)
 
0

Charge on prepayment of debt
0

 
0

 
(2,664
)
 
0

Gains on other loan sales
476

 
2,671

 
3,887

 
1,792

Other
348

 
831

 
(1,826
)
 
(19
)
Total noninterest income
46,698

 
29,112

 
123,026

 
93,429

Noninterest expense
89,408

 
86,620

 
265,664

 
266,515

Income before income taxes
30,598

 
11,328

 
75,933

 
24,300

Income tax benefit
0

 
0

 
288,842

 
0

Net income
$
30,598

 
$
11,328

 
$
364,775

 
$
24,300

Earnings per share - basic
$
0.49

 
$
0.18

 
$
5.87

 
$
0.39

Earnings per share - diluted
$
0.49

 
$
0.18

 
$
5.81

 
$
0.39

Dividends declared per share
$
0.15

 
$
0.00

 
$
0.15

 
$
0.00

Weighted average shares outstanding - basic
62,139,833

 
61,958,183

 
62,110,498

 
61,944,392

Weighted average shares outstanding - diluted
62,845,864

 
62,041,203

 
62,745,177

 
62,236,465


(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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
30,598

 
$
11,328

 
$
364,775

 
$
24,300

Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized gains on investments and MBS available for sale
16,235

 
39,564

 
28,547

 
78,158

Realized net gains reclassified from other comprehensive income
(3,129
)
 
0

 
(5,773
)
 
(14,298
)
Less deferred income tax provision
(4,945
)
 
0

 
(8,626
)
 
(2,384
)
Net other comprehensive income
8,161

 
39,564

 
14,148

 
61,476

Comprehensive income
$
38,759

 
$
50,892

 
$
378,923

 
$
85,776




See notes to consolidated financial statements.
5

Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
364,775

 
$
24,300

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
10,000

 
26,000

Net gain on sales of loans
(71,482
)
 
(33,754
)
Net gain on sales of investments and MBS
(12,592
)
 
(14,298
)
Net loss (gain) on mortgage servicing rights
984

 
(4,253
)
Other-than-temporary impairment credit losses on securities
6,819

 
0

Stock based compensation
2,756

 
2,949

Loss on OREO
32

 
17,380

Release of DTA valuation allowance
(288,842
)
 
0

Increase in cash surrender value of BOLI
(6,924
)
 
(4,804
)
Depreciation and amortization
33,871

 
30,161

Change in:
 
 
 
Accrued interest receivable
4,325

 
469

Prepaid expenses and other assets
(23,295
)
 
4,246

Accrued interest payable
(16,116
)
 
3,893

Accrued expenses and other liabilities
19,606

 
(1,279
)
Proceeds from sales of loans originated for sale
1,937,131

 
1,394,273

Loans originated for sale
(2,010,310
)
 
(1,399,822
)
Net cash (used in) provided by operating activities
(49,262
)
 
45,461

Cash flows from investing activities:
 
 
 
Change in restricted cash
(11,042
)
 
(3,514
)
Net change in loans
(317,773
)
 
(254,078
)
Proceeds from sales of loans
75,689

 
39,320

Purchase of investment securities
(3,734
)
 
(9,857
)
Proceeds from maturities of investment securities
18,939

 
478

Proceeds from sale of investment securities
179,235

 
30,987

Purchase of MBS
(287,849
)
 
(264,156
)
Principal payments received on MBS
467,792

 
341,827

Proceeds from sales of MBS
326,915

 
353,444

Proceeds from BOLI death benefits
3,714

 
0

Office properties and equipment, net
(14,144
)
 
(13,069
)
Improvements and other changes to OREO
(1,214
)
 
(5,357
)
Proceeds from sales of OREO
67,200

 
197,528

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

 
0

Net cash provided by investing activities
$
624,826

 
$
413,553

 
 
 
 

See notes to consolidated financial statements.
6

Table of Contents

STERLING FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)—cont.
(in thousands)
 
Nine Months Ended September 30,
 
2012
 
2011
Cash flows from financing activities:
 
 
 
Net change in deposits
$
(441,827
)
 
$
(431,767
)
Advances from FHLB
50,000

 
0

Repayment of advances from FHLB
(300,157
)
 
(148
)
Net change in securities sold under repurchase agreements and funds purchased
(113,216
)
 
23,840

Proceeds from stock issuance, net
572

 
0

Cash dividend paid
(9,322
)
 
0

Net cash used in financing activities
(813,950
)
 
(408,075
)
Net change in cash and cash equivalents
(238,386
)
 
50,939

Cash and cash equivalents, beginning of period
470,599

 
411,583

Cash and cash equivalents, end of period
$
232,213

 
$
462,522

Supplemental disclosures:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
82,358

 
$
79,684

Income taxes, net
81

 
0

Noncash financing and investing activities:
 
 
 
Foreclosed real estate acquired in settlement of loans
30,683

 
159,464




See notes to consolidated financial statements.
7

Table of Contents

STERLING FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 nine months ended September 30, 2011. This change resulted in a decrease of $44.2 million to cash flows from operating activities and an increase of the same amount to cash flows from investing activities for the nine months ended September 30, 2011. This change did not affect 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, and did not have a material effect on Sterling's consolidated financial statements.

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 ("First Independent"), 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 September 30, 2012 and because of favorable performance, the fair value of this contingent consideration was estimated at $14.1 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.

9

Table of Contents

 
First Independent (stand alone)
 
Pro Forma Combined
 
Pro Forma Combined
 
Three Months Ended
 
Nine Months Ended
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2012
 
September 30, 2012
 
September 30, 2011
 
September 30, 2012
 
September 30, 2011
 
(in thousands, except per share data)
Net interest income
$
5,104

 
$
16,204

 
$
75,308

 
$
82,639

 
$
235,052

 
$
247,355

Noninterest income
1,247

 
3,428

 
46,698

 
31,662

 
124,031

 
100,693

Net income
2,630

 
8,638

 
30,598

 
13,556

 
368,989

 
33,962

Earnings per share - basic
0.04

 
0.14

 
0.49

 
0.22

 
5.94

 
0.55

Earnings per share - diluted
$
0.04

 
$
0.14

 
$
0.49

 
$
0.22

 
$
5.89

 
$
0.55


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 and therefore, were classified as impaired. The accounting for purchased impaired loans is periodically updated for changes in the loans' cash flow expectations, and reflected in interest income over the life of the loans as accretable yield. For purchased impaired 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 September 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 $18.4 million and $11.3 million, respectively. The following table presents a roll-forward of activity for the accretable yield for the purchased impaired loans:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2012
 
(in thousands)
Beginning balance
$
2,331

 
$
0

Additions
0

 
1,923

Accretion to interest income
(223
)
 
(545
)
Reclassifications
(678
)
 
52

Ending balance
$
1,430

 
$
1,430


10

Table of Contents

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. The following table presents the related five-year projected accretion of the discount which will be recognized as an increase to interest income as of September 30, 2012:
 
Amount
Remainder of 2012
1,600

Years ended December 31,
 
2013
4,210

2014
2,796

2015
1,724

2016
1,031

2017
679


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)
September 30, 2012
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
MBS
$
1,757,584

 
$
67,864

 
$
0

 
$
1,825,448

Municipal bonds
188,579

 
17,354

 
(528
)
 
205,405

Other
18,251

 
857

 
0

 
19,108

Total
$
1,964,414

 
$
86,075

 
$
(528
)
 
$
2,049,961

Held to maturity
 
 
 
 
 
 
 
Tax credits
$
1,716

 
$
0

 
$
0

 
$
1,716

Total
$
1,716

 
$
0

 
$
0

 
$
1,716

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.






11

Table of Contents

Total sales of Sterling’s securities during the periods ended September 30, 2012 and 2011 are summarized as follows:

 
Proceeds from
Sales
 
Gross Realized
Gains
 
Gross Realized
Losses
 
(in thousands)
Nine Months Ended
 
 
 
 
 
September 30, 2012
$
506,150

 
$
12,666

 
$
(74
)
September 30, 2011
384,431

 
16,605

 
(2,307
)

The following table summarizes Sterling’s investments and MBS that had a market value below their amortized cost as of September 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)
September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
MBS
$
0

 
$
0

 
$
0

 
$
0

 
$
0

 
$
0

Municipal bonds
0

 
0

 
12,664

 
(528
)
 
12,664

 
(528
)
Other
0

 
0

 
0

 
0

 
0

 
0

Total
$
0

 
$
0

 
$
12,664

 
$
(528
)
 
$
12,664

 
$
(528
)
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 September 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

 
0

 
0

Due after five years through ten years
0

 
0

 
134,019

 
138,991

Due after ten years
1,716

 
1,716

 
1,830,395

 
1,910,970

Total
$
1,716

 
$
1,716

 
$
1,964,414

 
$
2,049,961


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 September 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 fair value of $19.1 million. During the second quarter of 2012, Sterling recognized an OTTI charge on the security of $6.8 million, resulting in a new amortized cost basis of $18.2 million. The security is rated 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.

12

Table of Contents

The following table presents a roll-forward of OTTI for the periods presented:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(in thousands)
OTTI, beginning balance
$
6,819

 
$
0

 
$
0

 
$
0

Additions
0

 
0

 
6,819

 
0

Ending Balance
$
6,819

 
$
0

 
$
6,819

 
$
0


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:
 
 
September 30,
2012
 
December 31,
2011
 
(in thousands)
Residential real estate
$
818,323

 
$
688,020

Commercial real estate ("CRE"):
 
 
 
Investor CRE
1,274,774

 
1,275,667

Multifamily
1,359,506

 
1,001,479

Construction
99,553

 
174,608

Total CRE
2,733,833

 
2,451,754

Commercial:
 
 
 
Owner occupied CRE
1,304,224

 
1,272,461

Commercial & Industrial ("C&I")
517,588

 
431,693

Total commercial
1,821,812

 
1,704,154

Consumer
768,359

 
674,961

Gross loans receivable
6,142,327

 
5,518,889

Deferred loan costs (fees), net
2,317

 
(252
)
Allowance for loan losses
(154,279
)
 
(177,458
)
Net loans receivable
$
5,990,365

 
$
5,341,179

 
Gross loans pledged as collateral for borrowings from the FHLB and the Federal Reserve totaled $3.61 billion and $4.02 billion as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012 and December 31, 2011, the unamortized portion of discounts on acquired loans was $23.4 million and $4.3 million, respectively.


13

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)
September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, gross:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,565

 
$
82,543

 
$
60,510

 
$
827

 
$
0

 
$
152,445

Collectively evaluated for impairment
809,758

 
2,651,290

 
1,761,302

 
767,532

 
0

 
5,989,882

Total loans receivable, gross
$
818,323

 
$
2,733,833

 
$
1,821,812

 
$
768,359

 
$
0

 
$
6,142,327

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
365

 
$
3,660

 
$
6,036

 
$
43

 
$
0

 
$
10,104

Collectively evaluated for impairment
10,383

 
53,518

 
35,479

 
19,949

 
24,846

 
144,175

Total allowance for loan losses
$
10,748

 
$
57,178

 
$
41,515

 
$
19,992

 
$
24,846

 
$
154,279

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




14

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 third quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
$
12,381

 
$
66,852

 
$
40,270

 
$
16,959

 
$
21,782

 
$
158,244

Provisions
(129
)
 
(8,349
)
 
2,762

 
4,652

 
3,064

 
2,000

Charge-offs
(1,641
)
 
(4,898
)
 
(2,058
)
 
(1,882
)
 
0

 
(10,479
)
Recoveries
137

 
3,573

 
541

 
263

 
0

 
4,514

Ending balance, September 30
10,748

 
57,178

 
41,515

 
19,992

 
24,846

 
154,279

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
2,321

 
698

 
3,350

 
1,510

 
73

 
7,952

Provisions
66

 
(427
)
 
(1
)
 
165

 
197

 
0

Charge-offs
(181
)
 
0

 
0

 
0

 
0

 
(181
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
2,206

 
271

 
3,349

 
1,675

 
270

 
7,771

Total credit allowance
$
12,954

 
$
57,449

 
$
44,864

 
$
21,667

 
$
25,116

 
$
162,050

2011 third quarter activity
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
$
20,826

 
$
102,607

 
$
46,602

 
$
13,800

 
$
28,253

 
$
212,088

Provisions
3,250

 
4,823

 
(4,525
)
 
902

 
(450
)
 
4,000

Charge-offs
(4,204
)
 
(26,650
)
 
(7,769
)
 
(2,554
)
 
0

 
(41,177
)
Recoveries
178

 
6,781

 
3,862

 
463

 
0

 
11,284

Ending balance, September 30
20,050

 
87,561

 
38,170

 
12,611

 
27,803

 
186,195

Reserve for unfunded credit commitments:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1
2,435

 
2,555

 
924

 
2,108

 
(591
)
 
7,431

Provisions
624

 
(387
)
 
613

 
(383
)
 
1,533

 
2,000

Charge-offs
(55
)
 
0

 
0

 
0

 
0

 
(55
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
3,004

 
2,168

 
1,537

 
1,725

 
942

 
9,376

Total credit allowance
$
23,054

 
$
89,729

 
$
39,707

 
$
14,336

 
$
28,745

 
$
195,571


15

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
(1,486
)
 
(21,078
)
 
13,442

 
11,342

 
5,780

 
8,000

Charge-offs
(3,985
)
 
(25,897
)
 
(15,197
)
 
(5,977
)
 
0

 
(51,056
)
Recoveries
1,022

 
12,431

 
5,224

 
1,200

 
0

 
19,877

Ending balance, September 30
10,748

 
57,178

 
41,515

 
19,992

 
24,846

 
154,279

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

 
2,321

 
1,796

 
1,787

 
297

 
10,029

Provisions
2,636

 
(2,050
)
 
1,553

 
(112
)
 
(27
)
 
2,000

Charge-offs
(4,258
)
 
0

 
0

 
0

 
0

 
(4,258
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
2,206

 
271

 
3,349

 
1,675

 
270

 
7,771

Total credit allowance
$
12,954

 
$
57,449

 
$
44,864

 
$
21,667

 
$
25,116

 
$
162,050

 
 
 
 
 
 
 
 
 
 
 
 
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
16,941

 
14,280

 
(2,640
)
 
3,362

 
(5,443
)
 
26,500

Charge-offs
(15,230
)
 
(66,595
)
 
(21,261
)
 
(6,817
)
 
0

 
(109,903
)
Recoveries
1,032

 
14,969

 
5,120

 
1,421

 
0

 
22,542

Ending balance, September 30
20,050

 
87,561

 
38,170

 
12,611

 
27,803

 
186,195

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

 
4,157

 
1,515

 
817

 
1,029

 
10,707

Provisions
646

 
(1,989
)
 
22

 
908

 
(87
)
 
(500
)
Charge-offs
(831
)
 
0

 
0

 
0

 
0

 
(831
)
Recoveries
0

 
0

 
0

 
0

 
0

 
0

Ending balance, September 30
3,004

 
2,168

 
1,537

 
1,725

 
942

 
9,376

Total credit allowance
$
23,054

 
$
89,729

 
$
39,707

 
$
14,336

 
$
28,745

 
$
195,571



16

Table of Contents

In establishing the 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 prepares 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 establish 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 Sterling 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 may 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 a charge-off or establishment of a specific reserve, 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.






17

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)
September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
779,226

 
$
1,085,091

 
$
1,337,555

 
$
71,752

 
$
1,160,239

 
$
470,667

 
$
756,162

 
$
5,660,692

 
93
%
Special mention
13,181

 
122,333

 
10,948

 
3,857

 
71,110

 
35,051

 
4,735

 
261,215

 
4
%
Substandard
25,551

 
64,811

 
10,001

 
23,825

 
66,839

 
11,870

 
7,419

 
210,316

 
3
%
Doubtful/Loss
365

 
2,539

 
1,002

 
119

 
6,036

 
0

 
43

 
10,104

 
0
%
Total
$
818,323

 
$
1,274,774

 
$
1,359,506

 
$
99,553

 
$
1,304,224

 
$
517,588

 
$
768,359

 
$
6,142,327

 
100
%
Restructured
$
22,131

 
$
4,339

 
$
3,567

 
$
13,176

 
$
20,689

 
$
1,966

 
$
475

 
$
66,343

 
1
%
Nonaccrual
21,095

 
48,779

 
5,654

 
14,286

 
42,746

 
7,944

 
5,591

 
146,095

 
2
%
Nonperforming
43,226

 
53,118

 
9,221

 
27,462

 
63,435

 
9,910

 
6,066

 
212,438

 
3
%
Performing
775,097

 
1,221,656

 
1,350,285

 
72,091

 
1,240,789

 
507,678

 
762,293

 
5,929,889

 
97
%
Total
$
818,323

 
$
1,274,774

 
$
1,359,506

 
$
99,553

 
$
1,304,224

 
$
517,588

 
$
768,359

 
$
6,142,327

 
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
%


18

Table of Contents

Aging by class for Sterling’s loan portfolio as of September 30, 2012 and December 31, 2011 was as follows:
 
 
 
 
Commercial Real Estate
 
Commercial
 
 
 
 
 
 
 
Residential Real Estate
 
Investor CRE