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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(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, 1998
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 0-20800
STERLING FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1572822
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
111 North Wall Street, Spokane, Washington 99201
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (509) 458-2711
Securities registered pursuant to Section 12(b) of the Act:
None None
(Title of class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($1.00 par value)
8.75% Subordinated Notes Due 2000
9.50% Cumulative Capital Securities Due 2027
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of February 26, 1999, the aggregate market value of the common equity held by
non-affiliates of the registrant, computed by reference to the average of the
bid and asked prices on such date as reported by the Nasdaq National Market, was
$130,735,508.
The number of shares outstanding of the Registrant's Common Stock, par value
$1.00 per share, as of February 26, 1999 was 8,072,021.
DOCUMENTS INCORPORATED BY REFERENCE
Specific portions of the Registrant's Proxy Statement dated March 26, 1999 are
incorporated by reference into Part III hereof.
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.[X]
STERLING FINANCIAL CORPORATION
DECEMBER 31, 1998 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
----
PART I............................................................................................. 1
Item 1. Business............................................................................... 1
General.................................................................................... 1
Growth and Acquisition Strategies.......................................................... 2
Lending Activities......................................................................... 2
Investments and Mortgage-Backed Securities................................................. 13
Sources of Funds........................................................................... 14
Subsidiaries............................................................................... 20
Competition................................................................................ 20
Personnel.................................................................................. 21
Regulation................................................................................. 21
Item 2. Properties............................................................................. 29
Item 3. Legal Proceedings...................................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders.................................... 29
PART II............................................................................................ 30
Item 5. Market for the Registrant's Stock and Related Shareholder Matters...................... 30
Item 6. Selected Financial Data................................................................ 31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 33
General.................................................................................... 33
Net Interest Income........................................................................ 33
Asset and Liability Management............................................................. 36
Financial Position......................................................................... 39
Results of Operations for the Years Ended December 31, 1998 and 1997....................... 40
Results of Operations for the Six Months Ended December 31, 1996 and 1995.................. 42
Results of Operations for Fiscal Years Ended June 30, 1996 and 1995........................ 45
Liquidity and Sources of Funds............................................................. 47
Capital Resources.......................................................................... 48
New Accounting Standards................................................................... 49
Year 2000 Issues........................................................................... 50
Effects of Inflation and Changing Prices................................................... 51
Item 7. A. Quantitative and Qualitative Disclosures About Market Risk.......................... 51
Item 8. Financial Statements and Supplementary Data............................................ 51
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 51
PART III........................................................................................... 51
Item 10. Directors and Executive Officers of the Registrant.................................... 51
Item 11. Executive Compensation................................................................ 51
Item 12. Security Ownership of Certain Beneficial Owners and Management........................ 51
Item 13. Certain Relationships and Related Transactions........................................ 51
PART IV............................................................................................ 52
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 52
SIGNATURES......................................................................................... 54
Any trend or forward-looking information discussed in this report is
subject to numerous possible risks and uncertainties. These include but are not
limited to: the possibility of adverse economic developments which may, among
other things, increase default and delinquency risks in Sterling's loan
portfolios; shifts in interest rates which may result in lower interest rate
margins; changes in accounting policies; changes in the monetary and fiscal
policies of the federal government; changes in the regulatory and competitive
environment, and other risks. Sterling's future results may differ materially
from historical results as well as from any trend or forward-looking information
included in this report.
PART I
Item 1. Business
General
Sterling Financial Corporation ("Sterling") is a unitary savings and
loan holding company, the significant operating subsidiary of which is Sterling
Savings Bank ("Sterling Savings Bank"), formerly Sterling Savings Association.
The significant operating subsidiaries of Sterling Savings Bank are Action
Mortgage Company ("Action Mortgage"), INTERVEST-Mortgage Investment Company
("INTERVEST") and Harbor Financial Services, Inc. ("Harbor Financial").
Sterling Savings Bank commenced operations in 1983 as a State of Washington-
chartered, federally insured stock savings and loan association headquartered in
Spokane, Washington.
Sterling endeavors to provide personalized, quality financial services
to its customers as exemplified by its "Hometown Helpful" philosophy. Sterling
believes that this dedication to personalized service has enabled it to maintain
a stable retail deposit base. Sterling, with $2.31 billion in total assets at
December 31, 1998, attracts Federal Deposit Insurance Corporation ("FDIC")
insured deposits from the general public through 77 retail branches located
primarily in rural and suburban communities in Washington, Oregon, Idaho and
Montana. Sterling originates loans through its branch offices as well as ten
Action Mortgage residential loan production offices in the metropolitan areas of
Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho; and four
INTERVEST commercial real estate lending offices located in the metropolitan
areas of Spokane and Seattle, Washington; and Portland, Oregon. Sterling also
markets tax-deferred annuities, mutual funds and other financial products
through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its business banking, consumer and construction
lending while increasing its retail deposits. Sterling's revenues are derived
primarily from interest earned on loans, investments and mortgage-backed
securities ("MBS"), from fees and service charges and from mortgage banking
operations. The operations of Sterling Savings Bank, and savings institutions
generally, are influenced significantly by general economic conditions and by
policies of its primary regulatory authorities, the Office of Thrift Supervision
("OTS"), the FDIC and the State of Washington Department of Financial
Institutions ("Washington Supervisor"). See "Regulation."
To further enhance its presence in the Pacific Northwest market,
Sterling has been working to expand its community bank delivery system, focusing
primarily on deposit gathering and lending. Sterling completed the acquisition
of Big Sky Bancorp, Inc. ("Big Sky") and its subsidiary, First Federal Savings
and Loan Association of Montana ("First Federal"), on November 13, 1998. On
that date, First Federal had approximately $66 million in total assets and
deposits of approximately $50 million. The merger with Big Sky was accounted
for as a pooling of interests; and accordingly, all historical amounts have been
restated to include the results of Big Sky.
On June 15, 1998, Sterling acquired 33 branch offices in Washington,
Idaho and Oregon from KeyBank National Association ("KeyBank"). The purchase
included $518 million of deposit balances and $125 million of loan balances.
Upon acquisition, the weighted average interest rate on deposits assumed was
3.42%. Sterling incurred an approximate $57 million intangible asset associated
with the acquisition. Sterling is amortizing the intangible asset over a period
of 15 years using the straight-line method. With the net cash received from the
branch acquisition, Sterling repaid approximately $322 million of certain
reverse repurchase borrowings and Federal Home Loan Bank of Seattle ("FHLB
Seattle") advances.
Sterling changed its fiscal year-end from June 30 to December 31,
effective December 31, 1996. Accordingly, results of operations included herein
have been presented for the years ended December 31, 1998 and 1997, six months
ended December 31, 1996 and 1995 and the fiscal year ended June 30, 1996. See
Note 1 of "Notes to Consolidated Financial Statements" included herein.
1
Growth and Acquisition Strategies
Sterling intends to continue to pursue an aggressive growth strategy,
which may include acquiring other financial institutions or branches thereof or
other substantial assets or deposit liabilities. Sterling may not be successful
in identifying further acquisition candidates, integrating acquired institutions
or preventing deposit erosion or loan quality deterioration at acquired
institutions. There is significant competition for acquisitions in Sterling's
market area, and Sterling may not be able to acquire other institutions on
attractive terms. Furthermore, the success of Sterling's growth strategy will
depend on increasing and maintaining sufficient levels of regulatory capital,
obtaining necessary regulatory approvals, generating appropriate growth and
favorable economic and market conditions. There can be no assurance that
Sterling will be successful in implementing its growth strategy.
Lending Activities
Focus on Community Lending. In recent years, Sterling has focused its
efforts on becoming more like a community retail bank. Accordingly, Sterling is
increasing its business banking, consumer and construction lending. Business
banking, consumer and construction loans generally produce higher yields than
residential mortgage loans. Such loans, however, generally involve a higher
degree of risk than the financing of residential real estate.
Business Banking Lending. Sterling has a Business Banking Group which
provides a full range of credit products to small- and medium-sized businesses,
including consumer, private banking and agriculture loans. Credit products
include lines of credit, receivables and inventory financing, equipment loans,
and permanent and construction real restate financing. Loans may be made on an
unsecured, partially-secured or fully-secured basis. The credit product line
for both businesses and individuals includes standardized products as well as
customized, individual accommodations.
Sterling has established minimum underwriting standards which
delineate criteria for sources of repayment, financial strength and credit
enhancements such as guarantees. Typically, the primary source of repayment is
recurring cash flow of the borrower or cash flow from the business or project
being financed. Depending on the type of loan, underwriting standards include
minimum financial requirements, maximum loan-to-collateral value ratios, minimum
cash flow coverage of debt service, debt-to-income ratios and minimum liquidity
requirements. Exceptions to the minimum underwriting standards may be made
depending upon the type of loan and financial strength of the borrower. All
exceptions are reported to the Sterling Senior Loan Committee and in some cases
are reported to Sterling's Board of Directors. Common forms of collateral
pledged to secure business banking loans include real estate, accounts
receivable, inventory, equipment, agricultural crops or livestock and marketable
securities. Most loans have maximum terms of one to seven years and loan-to-
value ratios in the range of 65% to 80%, based on an analysis of the collateral
pledged.
Sterling's Consumer Lending Group provides loans for home
improvements, automobiles, personal lines of credit, boats and certain other
purposes. Generally, consumer loans are originated for terms ranging from six
months to ten years. Interest rates are either fixed or adjustable monthly,
quarterly or semiannually, based on a contractual formula at a margin over an
established external index. Sterling also makes loans collateralized by savings
accounts and second mortgage loans collateralized by real estate. Fixed-rate
secured financing is available with amortization terms up to 15 years.
Sterling's Private Banking Group provides services to higher-net-worth
and higher-income borrowers by originating a variety of consumer and business
banking loans. Such loans generally but do not always meet the same
underwriting requirements as general consumer loans of the same type. Private
banking loans typically involve larger balances and may have nonstandard terms.
Sterling's Agriculture Lending Group offers agriculture loans to a
variety of agricultural producers. In connection with such loans, Sterling
endeavors to appropriately evaluate the borrowers' financial, production,
marketing and management abilities. Such loans may include annual operating
loans and term loans to finance the purchase of machinery, equipment, production
livestock and real estate. Such loans also may be made to cover interim
operating and family living expenses.
2
Sterling actively participates in the transportation finance market,
primarily through consumer indirect auto loans (sales finance contracts).
Sterling also makes direct (branch originated) auto loans and marine and
recreational vehicle loans. Most applicants for these credit products are
assigned a credit score which is designed to indicate the relative probability
of repayment. The credit scoring models are validated as to their predictive
power on a periodic basis. The Consumer Lending Group includes in its credit
criteria other judgmental factors, such as the advance rate and debt-to-income
ratio, which are used to augment this credit score. However, all credit
decisions made contrary to an established cut-off score are required to be
supported and documented by a credit officer with the appropriate approval
authority. Consumer loans, especially those originated through dealers,
generally have greater inherent risks than other types of loans. At December
31, 1998, consumer direct and indirect loans were 14.0% and 4.0%, respectively,
of Sterling's total loan portfolio.
Business banking loans generally involve a higher degree of risk than
the financing of real estate, primarily because collateral is more difficult to
appraise, security interests in the collateral are more difficult to perfect and
the collateral may be difficult to obtain or liquidate following an uncured
default. Business banking loans, however, typically offer relatively higher
yields and variable interest rates. The availability of such loans enables
potential depositors to establish full-service banking relationships with
Sterling. Sterling is permitted to hold 20% of its assets in certain business
banking loans. At December 31, 1998, certain business banking loans subject to
this limit were approximately 8% of total assets. At December 31, 1998, all
business banking loans were 19.6% of Sterling's total loan portfolio.
One- to Four-Family Residential Lending. Sterling originates fixed-
rate and adjustable rate mortgages ("ARMs"), which have interest rates that
adjust annually or every three, five and seven years and are indexed to a
variety of market indices. Sterling also originates one- to four-family
residential construction loans.
Sterling continues to originate conventional and government-insured
residential loans for sale into the secondary mortgage market. Within the
secondary mortgage market for conventional loans, Sterling sells its residential
loans primarily on a servicing-released basis to others. Sterling also sells
loans to the Federal Home Loan Mortgage Corporation (the "FHLMC") and the
Federal National Mortgage Association (the "FNMA"). Sterling endeavors to
underwrite residential loans in compliance with FHLMC and FNMA underwriting
standards. Loans sold into the secondary market are all sold without recourse
to Sterling, except that Sterling may be obligated to repurchase any loans which
are not underwritten in accordance with FHLMC and FNMA or applicable investor
underwriting guidelines. At December 31, 1998, 21.3% of Sterling's total loan
portfolio consisted of conventional one- to four-family residential loans.
Conventional residential mortgage loans are originated for up to 95%
of the appraised value or selling price of the mortgaged property, whichever is
less. Borrowers must purchase private mortgage insurance from approved third
parties so that Sterling's risk is limited to approximately 80% of the appraised
value on all loans with loan-to-value ratios in excess of 80%. Sterling's
residential lending programs are designed to comply with all applicable
regulatory requirements. For a discussion of Sterling's management of interest
rate risk ("IRR") on conventional loans, see "- Secondary Market Activities."
Sterling makes residential construction loans on custom homes, presold
homes and homes that are built for sale. Construction financing is generally
considered to involve a higher degree of risk than long-term financing on
improved, occupied real estate. Sterling's risk of loss on construction loans
depends largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated cost
(including interest) of construction. If the estimate of construction costs
proves to be inaccurate, Sterling might have to advance funds beyond the amount
originally committed to permit completion of the development and to protect its
security position. Sterling also might be confronted, at or prior to maturity
of the loan, with a project with insufficient value to ensure full repayment.
Sterling's underwriting, monitoring and disbursement practices with respect to
construction financing are intended to ensure that sufficient funds are
available to complete construction projects. Sterling endeavors to limit its
risk through its underwriting procedures by using only approved, qualified
appraisers and by dealing only with qualified builders/borrowers.
3
At December 31, 1998, 12.8% of Sterling's total loan portfolio
consisted of one- to four-family residential construction loans, approximately
74% of which were for properties that were built for sale. Further,
approximately 63% of Sterling's one- to four-family residential construction
loan portfolio was concentrated in the Portland, Oregon market which is served
by one loan production office. A reduction in the demand for residential
housing, particularly in that market, could have a negative impact on Sterling.
Multifamily Residential and Commercial Property Lending. Sterling
offers multifamily residential and commercial real estate loans as both
construction and permanent loans collateralized by real property primarily in
the Pacific Northwest. Construction loans on such properties typically have
terms of 12 to 18 months and provide for variable interest rates. Permanent
loans on existing properties typically have maturities of three to ten years.
Multifamily residential and commercial property loans generally involve a higher
degree of risk than the financing of one- to four-family residential real estate
because they typically involve large loan balances to single borrowers or groups
of related borrowers. The payment experience on such loans typically is
dependent on the successful operation of the real estate project and is subject
to certain risks not present in one- to four-family residential mortgage
lending. These risks include excessive vacancy rates or inadequate operating
cash flows. Construction lending is subject to risks such as construction
delays, cost overruns, insufficient values and an inability to obtain permanent
financing in a timely manner. Sterling attempts to reduce its exposure to these
risks, typically by investigating the borrowers' finances and, depending on the
circumstances, requiring annual financial statements from the borrowers,
requiring operating statements on the properties or acquiring personal
guarantees from the borrowers. At December 31, 1998, 9.5% of Sterling's total
loan portfolio consisted of multifamily residential construction and commercial
property construction loans.
4
The following table sets forth information on loan origination
and sale activities for the periods indicated.
Years Ended December 31, Six Months Ended December 31,
---------------------------------- -------------------------------- Fiscal Year Ended
1998 1997 1996 1995 June 30, 1996
----------------- --------------- --------------- --------------- ---------------
Amount % Amount % Amount % Amount % Amount %
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family residential.. $ 241,725 24.0 $179,297 22.2 $ 75,036 23.5 $126,051 35.5 $221,110 32.0
Multifamily residential.......... 83,904 8.3 29,015 3.6 2,200 0.7 9,875 2.8 11,429 1.6
Commercial property.............. 34,735 3.5 36,410 4.5 16,865 5.3 25,861 7.3 28,861 4.2
Mortgage - construction:
One- to four-family residential.. 226,025 22.5 217,973 26.9 94,765 29.7 76,199 21.5 177,838 25.8
Multifamily residential.......... 47,809 4.8 62,356 7.7 12,735 4.0 29,303 8.2 68,169 9.9
Commercial property.............. 42,301 4.2 10,825 1.3 10,925 3.5 17,455 4.9 35,234 5.1
Non-mortgage:
Consumer - direct................ 99,449 9.8 79,448 9.8 33,535 10.5 26,226 7.4 49,473 7.2
Consumer - indirect.............. 51,958 5.2 20,955 2.6 0 0.0 0 0.0 0 0.0
Business banking................. 178,209 17.7 173,014 21.4 72,676 22.8 44,015 12.4 97,822 14.2
---------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans originated........... $1,006,115 100.0 $809,293 100.0 $318,737 100.0 $354,985 100.0 $689,936 100.0
========== ===== ======== ===== ======== ===== ======== ===== ======== =====
One- to four-family residential
mortgage loans sold............. $ 110,151 $108,004 $ 77,856 $122,797 $232,061
========== ======== ======== ======== ========
5
Loan Portfolio Analysis. The following table sets forth the
composition of Sterling's loan portfolio by type of loan at the dates indicated.
December 31,
---------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family
residential............... $ 342,757 21.3 $ 313,792 26.0 $ 304,216 28.4
Multifamily residential.... 124,656 7.7 68,697 5.7 73,455 6.9
Commercial property........ 177,912 11.1 120,068 10.0 104,372 9.7
Land and other............. 0 0.0 434 0.0 385 0.0
---------- ----- ---------- ----- ---------- -----
645,325 40.1 502,991 41.7 482,428 45.0
---------- ----- ---------- ----- ---------- -----
Mortgage - construction:
One- to four-family
residential............... 206,139 12.8 179,495 14.9 148,786 13.9
Multifamily residential.... 98,934 6.2 97,059 8.0 77,743 7.3
Commercial property........ 53,641 3.3 26,386 2.2 37,875 3.5
---------- ----- ---------- ----- ---------- -----
358,714 22.3 302,940 25.1 264,404 24.7
---------- ----- ---------- ----- ---------- -----
Total mortgage loans....... 1,004,039 62.4 805,931 66.8 746,832 69.7
Consumer - direct.......... 224,651 14.0 139,666 11.6 124,529 11.6
Consumer - indirect........ 64,764 4.0 19,016 1.6 0 0.0
Business banking........... 315,614 19.6 241,808 20.0 199,848 18.7
---------- ----- ---------- ----- ---------- -----
Total loans receivable..... 1,609,068 100.0 1,206,421 100.0 1,071,209 100.0
---------- ===== ---------- ===== ---------- =====
Undisbursed portion of
loans in process......... (125,147) (91,048) (92,151)
Deferred loan origination
(fees) and costs.......... (2,309) 232 156
Premium (discount) on loans
acquired pursuant to
purchase transactions.... 1,545 (380) (629)
Allowance for loan losses.. (14,623) (9,486) (8,389)
---------- ---------- ----------
Loans receivable, net...... $1,468,534 $1,105,739 $ 970,196
========== ========== ==========
June 30,
---------------------------------------------------------
1996 1995 1994
----------------- ----------------- -----------------
Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
Mortgage - permanent:
One- to four-family
residential............... $ 332,819 31.9 $ 632,062 53.8 $607,551 64.9
Multifamily residential.... 68,154 6.5 63,977 5.5 49,414 5.3
Commercial property........ 103,480 9.9 88,554 7.5 82,131 8.8
Land and other............. 398 0.0 2,301 0.2 2,734 0.3
---------- ----- ---------- ----- -------- -----
504,851 48.3 786,894 67.0 741,830 79.3
---------- ----- ---------- ----- -------- -----
Mortgage - construction:
One- to four-family
residential............... 138,030 13.2 113,761 9.7 37,760 4.0
Multifamily residential.... 79,048 7.6 42,158 3.6 31,856 3.4
Commercial property........ 40,003 3.8 22,630 1.9 833 0.1
---------- ----- ---------- ----- -------- -----
257,081 24.6 178,549 15.2 70,449 7.5
---------- ----- ---------- ----- -------- -----
Total mortgage loans....... 761,932 72.9 965,443 82.2 812,279 86.8
Consumer - direct.......... 112,811 10.8 109,373 9.3 70,429 7.5
Consumer - indirect........ 0 0.0 0 0.0 0 0.0
Business banking........... 169,830 16.3 99,528 8.5 52,700 5.7
---------- ----- ---------- ----- -------- -----
Total loans receivable..... 1,044,573 100.0 1,174,344 100.0 935,408 100.0
---------- ===== ---------- ===== -------- -----
Undisbursed portion of
loans in process......... (112,493) (73,761) (44,377)
Deferred loan origination
(fees) and costs.......... 556 2,803 1,748
Premium (discount) on loans
acquired pursuant to
purchase transactions.... (776) (1,122) (1,508)
Allowance for loan losses.. (8,366) (7,796) (6,133)
---------- ---------- --------
Loans receivable, net...... $ 923,494 $1,094,468 $885,138
========== ========== ========
6
Contractual Principal Payments. The following table sets forth the
scheduled contractual principal repayments for Sterling's loan portfolio at
December 31, 1998. 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, unearned discounts and
premiums, deferred loan origination costs and fees, or allowances for loan
losses.
Principal Payments
Contractually
Balance Due in Fiscal Years
Outstanding at ---------------------------
December 31, 1998 1999 2000-2003 Thereafter
----------------- ------ --------- ----------
(Dollars in thousands)
Mortgage - permanent:
Fixed rate............. $ 354,608 $ 14,442 $ 50,037 $290,129
Variable rate.......... 290,717 12,463 57,636 220,618
Mortgage - construction.. 358,714 302,008 46,218 10,488
Consumer - direct........ 224,651 39,373 82,822 102,456
Consumer - indirect...... 64,764 11,021 48,255 5,488
Business banking......... 315,614 98,443 77,698 139,473
---------- -------- -------- --------
$1,609,068 $477,750 $362,666 $768,652
========== ======== ======== ========
Loan Servicing. Sterling services its own loans as well as loans
owned by others. Loan servicing includes collecting and remitting loan
payments, accounting for principal and interest, holding escrow funds for the
payment of real estate taxes and insurance premiums, contacting delinquent
borrowers and supervising foreclosures in the event of unremedied defaults.
For residential mortgage loans serviced for other investors, Sterling
receives a fee, generally ranging from 0.25% to 0.375% of the unpaid principal
balance of each loan, to compensate for the costs of performing the servicing
function. At December 31, 1998 and 1997, Sterling serviced for itself and for
other investors residential mortgage loans totaling $985.6 million and $1.1
billion, respectively. Of such mortgage loans, Sterling serviced $193.2 million
and $379.4 million, respectively, at these dates for the FHLMC and the FNMA.
Sterling's ability to continue as a seller/servicer for the FHLMC and the FNMA
is dependent upon meeting the qualifications of these agencies. Sterling
currently meets all applicable requirements.
From time to time, Sterling sells portfolios of servicing rights
primarily to improve earnings and to increase its regulatory capital ratios.
During the year ended December 31, 1998 and the fiscal year ended June 30, 1996,
Sterling sold, in bulk, rights to service conventional loans for others of
approximately $117.6 million and $172.2 million, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" (hereafter referred to as "Management's Discussion and Analysis") -
Results of Operations - Other Income."
Secondary Market Activities. Sterling has developed correspondent
relationships with a number of mortgage companies and financial institutions to
facilitate the origination or purchase and sale of mortgage loans in the
secondary market on either a participation or whole loan basis. Substantially
all of such purchased loans or participations are secured by real estate. Those
agents who present loans to Sterling for purchase are required to provide a
processed loan package prior to commitment. Sterling then underwrites the loan
in accordance with its established lending standards.
In originating one- to four-family residential mortgage loans for sale
in the secondary market, Sterling incurs market risk from the time of the loan
commitments until such time as the loans are sold. To help minimize this risk,
Sterling typically obtains simultaneous commitments from investors to purchase
such loans at specified yields.
In recent years, the majority of conventional, Federal Housing
Administration ("FHA") and Veteran's Administration ("VA") insured loans have
been sold into the secondary market on a loan-by-loan servicing-released basis.
Sterling generally receives a fee of approximately 1.0% to 2.0% of the principal
balance of such loans for releasing the servicing.
7
Loan Commitments. Sterling uses written commitments to individual
borrowers and mortgage brokers for the purposes of originating and purchasing
loans. These commitments establish the terms and conditions under which
Sterling will fund the loans. Sterling had outstanding commitments to originate
or purchase loans aggregating $296.7 million at December 31, 1998. Sterling
also had secured and unsecured commercial and personal lines of credit totaling
approximately $166.0 million, of which the undisbursed portion was approximately
$86.5 million at December 31, 1998. See Note 17 of "Notes to Consolidated
Financial Statements."
Classified Assets, Real Estate Owned and Delinquent Loans. To measure
the quality of assets, including loans and real estate owned ("REO"), Sterling
has established guidelines for classifying assets and determining provisions for
anticipated loan and REO losses. Under these guidelines, an allowance for
anticipated loan and REO losses is established when certain conditions exist.
This system for classifying and reserving for loans and REO is administered by
Sterling's Special Assets Department, which is responsible for minimizing loan
deficiencies and losses therefrom. An oversight committee, comprised of senior
management, monitors the activities and progress of the Special Assets
Department and reports results to Sterling's Board of Directors.
Under this system, Sterling classifies loans and other assets it
considers of questionable quality. Sterling's system employs the classification
categories of "substandard," "doubtful" and "loss." Substandard assets have
deficiencies which give rise to the distinct possibility that Sterling will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets and on the basis of currently existing
facts, there is a high probability of loss. An asset classified as loss is
considered uncollectible and of such little value that it should not be included
as an asset of Sterling. Total classified assets decreased to $17.7 million at
December 31, 1998 from $19.4 million at December 31, 1997. As a percentage of
total assets, classified assets were 0.8% and 1.0%, respectively, for these
periods. See "- Major Classified Loans."
Assets classified as substandard or doubtful require the establishment
of general valuation allowances in amounts considered by management to be
adequate under generally accepted accounting principles ("GAAP"). Assets
classified as loss require either a specific valuation allowance of 100% of the
amount classified or a write-off of such amount. At December 31, 1998,
Sterling's assets classified as loss totaled $711,000. Judgments regarding the
adequacy of a general valuation allowance are based on on-going evaluations of
the nature, volume and quality of the loan portfolio, REO and other assets,
specific problem assets and current economic conditions that may affect the
recoverability of recorded amounts.
REO is recorded at the lower of estimated fair value, less estimated
selling expenses, or carrying value at foreclosure. Fair value is defined as the
amount in cash or other consideration that a real estate asset would yield in a
current sale between a willing buyer and a willing seller. Development and
improvement costs relating to the property are capitalized to the extent they
are deemed to be recoverable upon disposal. The carrying value of REO is
continuously evaluated and, if necessary, an allowance is established to reduce
the carrying value to net realizable value (which considers, among other things,
estimated direct holding costs and selling expenses).
The following table sets forth the activity in Sterling's REO for the
periods indicated.
Years Ended Six Months Fiscal Year
December 31, Ended Ended
-------------------- December 31, June 30,
1998 1997 1996 1996
------- ------- ------------ -----------
(Dollars in thousands)
Balance at beginning of period......... $ 8,817 $ 3,974 $ 4,874 $ 5,298
Loan foreclosures and other additions.. 2,394 6,865 1,839 1,628
Capitalized expenses................... 202 627 181 124
Sales and other reductions............. (5,110) (2,476) (2,889) (2,108)
Provisions for losses.................. (71) (173) (31) (68)
------- ------- ------- -------
Balance at end of period............... $ 6,232 $ 8,817 $ 3,974 $ 4,874
======= ======= ======= =======
8
Major Classified Loans. Each of Sterling's classified loans with a
net carrying value at December 31, 1998 of more than $400,000 is described
below.
Sterling holds a residential construction loan secured by 36
individual residential condominium units located in Vancouver, Washington. The
borrower was unable to pay off the loan when it matured in November 1998 and has
had to reduce the unit prices to generate sales. The carrying value of this loan
at December 31, 1998 was $2.5 million. Sterling has classified $300,000 of this
loan as doubtful and allocated $150,000 of its general valuation allowance
against this loan.
Sterling holds a line of credit and various permanent and construction
loans, secured by real estate owned by a Spokane, Washington-based developer.
The borrower filed for Chapter 11 bankruptcy in January 1998. Sterling is
proceeding to obtain a relief of stay from the bankruptcy court in order to
foreclose on these properties. The aggregate carrying value of these loans at
December 31, 1998 was $2.0 million. Sterling has allocated $63,000 of its
general valuation allowance against these loans.
Sterling holds a commercial construction loan secured by two 2-story
office buildings in Richland, Washington. The borrower has filed for Chapter 11
bankruptcy, and Sterling is preparing a motion for relief from stay in order to
foreclose. The carrying value on this loan at December 31, 1998 was
approximately $1.5 million. No specific allowance has been established for this
loan.
Sterling holds several loans to a business based in Spokane,
Washington. These loans, secured by accounts receivable, equipment and
inventory, were current at December 31, 1998, although there has been a history
of delinquent payments on the loans. The aggregate carrying value of these loans
at December 31, 1998 was $481,000. No specific allowance has been established
for these loans.
Sterling holds several loans to a business located in Snohomish
County, Washington. These loans are secured by a first deed of trust on a
commercial property, a residential rental property and a security interest in
equipment. These loans were classified as substandard as a result of recent
operating losses. The aggregate carrying value on these loans at December 31,
1998 was $480,000. No specific allowance has been established for these loans.
Sterling holds three residential construction loans on properties
located in Portland, Oregon and Vancouver, Washington. Sterling is proceeding
against the borrower to foreclose on these properties. The aggregate carrying
value at December 31, 1998 was $452,000. No specific allowance has been
established for these loans.
Major Real Estate Owned. Each of Sterling's REO properties with a net
carrying value at December 31, 1998 of more than $400,000 is described below.
Sterling is a 99.5% partner in a partnership which owns a commercial
office building in Renton, Washington acquired through an assignment of interest
from a bankrupt Spokane borrower. The carrying value at December 31, 1998 was
$2.8 million, net of a specific loss allowance of $192,000. The project
consists of a five-story office building with 30,373 square feet of rentable
area and adjoining undeveloped property. The office building is currently
substantially fully leased. Efforts to sell the property have not been
successful but are on-going.
Sterling acquired through foreclosure in April 1998 an
office/warehouse building located in Garland, Texas. The carrying value on this
property at December 31, 1998 was $1.2 million. No specific loss allowance has
been established for this property. Sterling is currently attempting to sell
this property.
Sterling acquired a three-story office building located in Post Falls,
Idaho through foreclosure in October 1997. The office/warehouse building is
currently vacant and efforts to sell the property are on-going. The carrying
value on this property at December 31, 1998 was $717,000, net of a specific loss
allowance of $252,000.
9
Sterling acquired a three-story office/retail/restaurant building
located in Olympia, Washington through foreclosure in August 1991. The
restaurant space has been converted to office space and is currently leased. The
carrying value on this property at December 31, 1998 was $640,000, net of a
specific loss allowance of approximately $245,000. Efforts to sell the property
have not been successful but are on-going.
Delinquent Loan Procedures. Delinquent and problem loans are part of
any lending business. If a borrower fails to make a required payment when due,
Sterling institutes internal collection procedures. For residential mortgage and
consumer loans, Sterling's collection procedures generally require that an
initial request for payment be mailed to the borrower when the loan is 15 days
past due. At 25 days past due, the borrower is contacted by telephone and
payment is requested orally. In most cases, deficiencies are cured promptly. At
30 days past due, Sterling records the loan as a delinquency. In the case of
delinquent residential mortgage loans, a notice of intent to foreclose is mailed
at 45 days past due. If the loan is still delinquent 30 days following the
mailing of the notice of intent to foreclose, Sterling generally initiates
foreclosure proceedings.
For consumer loans, a demand letter is sent when the account becomes
delinquent for two payments. Additional collection work or repossession may
follow. In certain instances, Sterling may modify the loan or grant a limited
moratorium on loan payments to enable the borrower to reorganize his or her
financial affairs. Similar collection procedures to those for consumer and
mortgage loans are followed for business loans with the exception that these
accounts are generally handled as a joint effort between the account loan
officer and the collection department during initial stages of delinquency. On
or before 75 days of delinquency, the collection effort is shifted from the
account loan officer to the collection department with legal action to follow.
The following table summarizes the principal balances of nonperforming
assets at the dates indicated.
December 31, June 30,
--------------------------- ---------------------------
1998 1997 1996 1996 1995 1994
------- ------- ------- ------- ------- -------
(Dollars in thousands)
Nonaccrual loans..................................... $ 3,050 $ 4,755 $ 2,329 $ 3,352 $ 3,395 $ 2,262
Restructured loans................................... 87 150 215 240 254 188
------- ------- ------- ------- ------- -------
Total nonperforming loans............................ 3,137 4,905 2,544 3,592 3,649 2,450
Real estate owned (1)................................ 6,232 8,817 3,974 4,874 5,298 7,298
------- ------- ------- ------- ------- -------
Total nonperforming assets........................... $ 9,369 $13,722 $ 6,518 $ 8,466 $ 8,947 $ 9,748
======= ======= ======= ======= ======= =======
Ratio of total nonperforming assets to total assets.. 0.40% 0.71% 0.41% 0.55% 0.56% 0.68%
Ratio of total nonperforming loans to total loans.... 0.19% 0.41% 0.24% 0.34% 0.31% 0.26%
Ratio of allowance for estimated losses on loans to
total nonperforming loans (2)...................... 462.48% 193.82% 325.21% 238.04% 218.10% 250.45%
- ---------------------
(1) Amount is net of the allowance for REO losses.
(2) Excludes loans classified as loss. Loans classified as loss excluded from
allowance for loan losses were $114,000, $47,000, $262,000, $213,000,
$145,000 and $7,000 at December 31, 1998, 1997 and 1996 and at June 30,
1996, 1995 and 1994, respectively. Loans classified as loss excluded from
total nonperforming loans were $0, $35,000, $45,000, $167,000, $141,000 and
$4,000 at December 31, 1998, 1997 and 1996 and at June 30, 1996, 1995 and
1994, respectively.
Sterling regularly reviews the collectibility of accrued interest
income and generally ceases to accrue interest on a loan when either principal
or interest is past due by 90 days or more. Any accrued and uncollected interest
is eliminated from income at that time. Loans may be placed in nonaccrual status
earlier if, in management's judgment, the loan may be uncollectible. Interest on
such a loan is then recognized as income only if collected or if the loan is
restored to performing status. Additional interest income of $159,000, $258,000,
$86,000, $151,000 and $224,000 would have been recorded during the years ended
December 31, 1998 and 1997, the six months ended December 31, 1996 and 1995 and
the fiscal year ended June 30, 1996, respectively, if nonaccrual and
10
restructured loans had been current in accordance with their original
contractual terms. Interest income of $194,000, $311,000, $8,000, $21,000 and
$62,000 was recorded on these loans during the years ended December 31, 1998 and
1997, the six months ended December 31, 1996 and 1995 and the year ended June
30, 1996, respectively. Sterling's quality control staff also reviews various
aspects of loans originated and acquired by Sterling in an effort to ensure
compliance with appropriate underwriting criteria. These reviews assist Sterling
in monitoring the performance of its personnel and independent appraisers.
Sterling's mortgage loan quality control function is intended to conform to
guidelines and standards established by the FNMA, the FHLMC, and, as applicable,
other private investors.
Allowance for Loan and Real Estate Owned Losses. Generally, Sterling
establishes specific allowances for the difference between the anticipated fair
value (market value less selling costs, foreclosure costs and projected holding
costs), adjusted for other possible sources of repayment, and the book balance
(loan principal and accrued interest or carrying value of REO) of its loans
classified as loss and REO. Each classified loan and REO property is reviewed
at least monthly. Allowances are established or periodically increased, if
necessary, based on the review of information obtained through on-site
inspections, market analysis, appraisals and purchase offers. Management
believes that allowances for loan and REO losses are adequate, although there
can be no assurances in this regard. See Note 6 of "Notes to Consolidated
Financial Statements."
Sterling is currently evaluating its loan loss allowance in
conjunction with its review of Year 2000 issues. This review includes an
evaluation of (i) Sterling's large borrowers' abilities to respond to their
internal Year 2000 issues; (ii) the effect, if any, this will have on such
borrowers' abilities to make timely payments and ultimately to repay their
obligations and (iii) the potential effect of increased delinquencies and loan
losses on Sterling. The loan loss allowance may or may not increase, depending
upon Sterling's findings. See "Management's Discussion and Analysis - Year 2000
Issues."
Management believes that the allowance for loan losses is adequate
given the composition and risks of the loan portfolio, although there can be no
assurance that the allowance will be adequate to cover all contingencies. The
following table sets forth information regarding changes in Sterling's allowance
for estimated losses on loans for the periods indicated.
Six Months
Years Ended Ended Fiscal Years Ended
December 31, December 31, June 30,
----------------- --------------- ---------------------------
1998 1997 1996 1996 1995 1994
------- ------- --------------- ------- ------- ------
(Dollars in thousands)
Balance at beginning of
period....................... $ 9,486 $ 8,389 $ 8,366 $ 7,796 $ 6,133 $5,070
Charge-offs:
Mortgage - permanent....... (252) (219) (767) (752) (795) (566)
Mortgage - construction.... (28) (202) (7) 0 0 0
Consumer - direct.......... (1,048) (999) (384) (412) (220) (61)
Consumer - indirect........ (738) (29) 0 0 0 0
Business banking........... (325) (119) (19) (5) (9) (3)
------- ------- ------- ------- ------- ------
Total charge-offs............. (2,391) (1,568) (1,177) (1,169) (1,024) (630)
------- ------- ------- ------- ------- ------
Recoveries:
Mortgage - permanent....... 34 58 30 23 61 39
Consumer - direct.......... 106 96 41 49 27 11
Consumer - indirect........ 42 6 0 0 0 0
Business banking........... 21 23 8 24 5 0
------- ------- ------- ------- ------- ------
Total recoveries.............. 203 183 79 96 93 50
------- ------- ------- ------- ------- ------
Net charge-offs............... (2,188) (1,385) (1,098) (1,073) (931) (580)
Provisions for loan losses.... 5,325 2,482 1,121 1,643 1,642 1,643
Allowance for losses on
assets acquired.............. 2,000 0 0 0 952 0
------- ------- ------- ------- ------- ------
Balance at end of period...... $14,623 $ 9,486 $ 8,389 $ 8,366 $ 7,796 $6,133
======= ======= ======= ======= ======= ======
Allowances allocated to
loans classified as loss..... $ 114 $ 47 $ 262 $ 213 $ 145 $ 7
Ratio of net charge-offs
to average loans
outstanding during the
period....................... 0.17% 0.13% 0.11% 0.10% 0.09% 0.08%
11
Allowances are provided for individual loans when management considers
ultimate collection to be questionable. Such allowances are based, among other
factors, upon the estimated net realizable value of the collateral of the loan
or guarantees, if applicable. The following table sets forth the allowances for
estimated losses on loans by loan category and summarizes the percentage of
gross loans in each category to total gross loans.
December 31, June 30,
------------------------------------------------------- ---------------------------------------------------------
1998 1997 1996 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Loans in Loans in Loans in Loans in Loans in Loans in
Category Category Category Category Category Category
as a as a as a as a as a as a
Percentage Percentage Percentage Percentage Percentage Percentage
of Total of Total of Total of Total of Total of Total
Gross Gross Gross Gross Gross Gross
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ----------
(Dollars in thousands)
Mortgage
- permanent..... $ 4,535 40.1% $3,800 41.7% $3,589 45.0% $3,462 48.3% $3,754 67.0% $3,652 79.3%
Mortgage
- construction.. 3,199 22.3 3,108 25.1 2,380 24.7 1,969 24.6 1,369 15.2 969 7.5
Consumer
- direct........ 3,113 14.0 400 11.6 399 11.6 465 10.8 422 9.3 409 7.5
Consumer
- indirect...... 650 4.0 153 1.6 0 0.0 0 0.0 0 0.0 0 0.0
Business
banking......... 2,626 19.6 1,200 20.0 1,196 18.7 1,075 16.3 856 8.5 660 5.7
Unallocated...... 500 N/A 825 N/A 825 N/A 1,395 N/A 1,395 N/A 443 N/A
------- ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$14,623 100.0% $9,486 100.0% $8,389 100.0% $8,366 100.0% $7,796 100.0% $6,133 100.0%
======= ===== ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
12
Investments and Mortgage-Backed Securities
Investments and MBS that management has the positive intent and
ability to hold to maturity are classified as held to maturity and carried at
amortized cost. Unrealized gains and losses on such investments and MBS are not
reported in the Consolidated Financial Statements as these investments and MBS
are held for investment purposes. See "Management's Discussion and Analysis -
Results of Operations - Other Income" and Note 2 of "Notes to Consolidated
Financial Statements."
Sterling classifies specific investments and MBS as available for
sale. Investments classified as available for sale are carried at fair value.
Unrealized gains and losses are excluded from earnings and are reported net of
deferred income tax as a separate component of shareholders' equity until such
investments and MBS mature or are actually sold. These investments and MBS may
be sold in response to changes in market interest rates and related changes in
prepayment risk, needs for liquidity, changes in the availability of and the
yield on alternative investments and changes in funding sources and terms.
At December 31, 1998 and 1997, investments and MBS classified as
available for sale were $566.4 million and $666.5 million, respectively. The
carrying value of these investments and MBS at December 31, 1998 includes an
unrealized gain of $788,000 (net of a $424,000 related income tax provision) and
an unrealized loss of $706,000 (net of a $351,000 related income tax benefit),
respectively. The improvement in fair value since December 31, 1997 is due
primarily to a decrease in long-term interest rates.
Sterling invests primarily in MBS issued by the FHLMC and the FNMA and
agency obligations. Such investments provide Sterling with a relatively liquid
source of interest income and collateral which can be used to secure borrowings.
Sterling invests primarily in investment-grade investments and MBS.
The following table provides the carrying values, contractual
maturities and weighted average yields of Sterling's investment and MBS
portfolio at December 31, 1998.
Maturity
----------------------------------------------------
Less than One to Five to Over Ten
One Year Five Years Ten Years Years Total
-------- -------- -------- -------- --------
(Dollars in thousands)
MBS
Balance.............................. $ 836 $ 8,311 $52,915 $343,663 $405,725
Weighted average yield............... 7.87% 6.36% 6.00% 6.14% 6.13%
U.S. government and agency obligations
Balance.............................. $10,157 $102,154 $ 345 $ 250 $112,906
Weighted average yield............... 6.13% 6.06% 6.13% 7.05% 6.07%
FHLB Seattle stock
Balance.............................. $ 0 $ 0 $ 0 $ 32,318 $ 32,318
Weighted average yield (1)........... 0.00% 0.00% 0.00% 7.50% 7.50%
Municipal bonds (2)
Balance.............................. $ 2,538 $ 8,517 $ 1,992 $ 0 $ 13,047
Weighted average yield............... 4.07% 4.47% 4.39% 0.00% 4.38%
Other (3)
Balance.............................. $ 96 $ 95 $ 0 $ 22,218 $ 22,409
Weighted average yield............... 5.51% 6.13% 0.00% 6.38% 6.37%
Total carrying value.................... $13,627 $119,077 $55,252 $398,449 $586,405
======= ======== ======= ======== ========
Weighted average yield.................. 5.85% 5.97% 5.94% 6.26% 6.16%
- ----------------------
(1) The weighted average yield on FHLB Seattle stock is based upon the
dividends received for the year ended December 31, 1998.
(2) The weighted average yields on municipal bonds reflect the actual yields
on the bonds and are not presented on a tax-equivalent basis.
(3) Other investments relate primarily to trust-preferred securities.
13
The following table sets forth the carrying values and classifications
for financial statement reporting purposes of Sterling's investment and MBS
portfolio at the dates indicated.
December 31,
-------------------
1998 1997
-------- --------
(Dollars in thousands)
MBS..................................... $405,725 $477,513
U.S. government and agency obligations.. 112,906 169,749
FHLB Seattle stock...................... 32,318 29,949
Municipal bonds......................... 13,047 13,033
Other................................... 22,409 695
-------- --------
Total............................... $586,405 $690,939
======== ========
Available-for-sale...................... $566,372 $666,476
Held-to-maturity........................ 20,033 24,463
-------- --------
Total............................... $586,405 $690,939
======== ========
Weighted average yield.................. 6.16% 6.55%
Sources of Funds
General. Sterling's primary sources of funds for use in lending and
for other general business purposes are deposits, loan repayments, FHLB Seattle
advances, secured lines of credit and other borrowings, proceeds from sales of
investments and MBS and proceeds from sales of loans. Scheduled loan repayments
are a relatively stable source of funds, while other sources of funds are
influenced significantly by prevailing interest rates, interest rates available
on other borrowings and other economic conditions. Borrowings also may be used
on a short-term basis to compensate for reductions in other sources of funds
(such as deposit inflows at less than projected levels). Borrowings may also be
used on a longer-term basis to support expanded lending activities and to match
repricing intervals of assets. See "Lending Activities" and "Investments and
Mortgage-Backed Securities."
Deposit Activities. Sterling offers a variety of accounts for
depositors designed to attract both short-term and long-term deposits from the
general public. These accounts include money market demand accounts ("MMDA") and
checking accounts in addition to more traditional savings accounts and
certificates of deposit ("CDs") accounts. Sterling offers both interest- and
noninterest-bearing checking accounts. The interest-bearing checking accounts
are subject to monthly service charges, unless a minimum balance is maintained.
MMDA, CDs and savings accounts earn interest at rates established by management
and are based on a competitive market analysis. The method of compounding varies
from simple interest credited at maturity to daily compounding, depending on the
type of account.
With the exception of certain promotional CDs and variable-rate, 18-
month Individual Retirement Account ("IRA") certificates, all CDs carry a fixed
rate of interest for a defined term from the opening date of the account.
Substantial penalties are imposed if principal is withdrawn from most CDs prior
to maturity.
Sterling supplements its retail deposit gathering by soliciting funds
from public entities. Public funds were 6.4% and 8.7% of deposits at December
31, 1998 and 1997, respectively. Public funds are generally obtained by
competitive bidding among qualifying financial institutions. Sterling had no
brokered deposits at December 31, 1998.
14
The primary retail deposit vehicles being utilized by Sterling's
customers are CDs with terms of one year or less, regular savings accounts,
money market accounts and negotiable order of withdrawal ("NOW") accounts. The
following table presents the average balance outstanding and weighted average
interest rate paid for each major category of deposits for the periods
indicated.
Fiscal Year
Years Ended December 31, Six Months Ended December 31, Ended June 30,
--------------------------------------- ---------------------------------------- ------------------
1998 1997 1996 1995 1996
------------------- ------------------- ------------------- ------------------- -------------------
Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average
Average Interest Average Interest Average Interest Average Interest Average Interest
Balance Rate Balance Rate Balance Rate Balance Rate Balance Rate
---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- --------
(Dollars in thousands)
Certificates of deposit...... $ 791,311 5.46% $ 655,120 5.70% $614,734 5.64% $666,821 5.99% $647,555 5.88%
Regular savings accounts
and money market accounts... 351,759 3.62 246,218 3.89 233,144 3.78 187,235 3.66 205,698 3.69
Checking accounts:
NOW accounts............... 145,335 1.14 81,985 1.38 74,726 1.46 70,561 1.55 71,628 1.57
Noninterest-bearing
demand accounts............ 72,828 0.00 29,569 0.00 25,398 0.00 26,552 0.00 24,517 0.00
---------- ---------- -------- -------- --------
$1,361,233 4.23% $1,012,892 4.74% $948,002 4.70% $951,169 5.04% $949,398 4.93%
========== ========== ======== ======== ========
15
The following table shows the amounts and maturities of CDs that had
balances of $100,000 or more at December 31, 1998.
(Dollars in thousands)
Remaining maturity:
Less than three months................................................... $ 117,660
Three to six months...................................................... 40,700
Six to 12 months......................................................... 47,767
Over 12 months........................................................... 22,364
----------
$ 228,491
========
The following table presents the types of deposit accounts offered by
Sterling Savings Bank and the balance in such accounts:
December 31, 1998
----------------------------------------------------
Percentage
Minimum Minimum of Total Interest Rate
Term Category Balances Amount Deposits Offered
- ------- ---------------------- ---------- ------------ ------- -------------
(Dollars in thousands, except minimum amounts)
Transaction Accounts:
None NOW checking........................... $ 100 $ 193,114 12.5% 1.39%
None Commercial checking.................... 100 104,176 6.7 0.00
None Regular savings........................ 100 102,927 6.7 1.50
None Money market demand.................... 2,500 330,251 21.4 1.00
---------- -----
730,468 47.3
---------- -----
Certificates of Deposit:
3 months Fixed term, fixed rate................ 500 5,783 0.4 3.97
6 months Fixed term, fixed rate................ 500 87,086 5.6 4.35
9 months Fixed term, adjustable rate........... 5,000 38,725 2.5 4.41
12 months Fixed term, fixed rate................ 500 260,444 16.8 4.65
12 months Fixed term, fixed rate................ 5,000 257 0.0 2.75
12 months Fixed term, adjustable rate(1)........ 500 3 0.0 N/A
12 months Fixed term, adjustable rate........... 5,000 2,426 0.2 4.27
15 months Fixed term, adjustable rate........... 5,000 35,575 2.3 4.31
18 months Fixed term, fixed rate................ 500 67,239 4.3 4.51
24 months Fixed term, fixed rate................ 500 116,739 7.5 4.41
36 months Fixed term, fixed rate................ N/A 21,352 1.4 4.41
36 months Zero coupon, fixed term(1)............ N/A 19 0.0 N/A
18 months Variable rate, IRA.................... 100 7,454 0.5 5.20
18 months Fixed rate, IRA....................... 500 2,949 0.2 4.51
36 months Variable rate, IRA.................... 2,000 13,701 0.9 4.31
7 days Fixed term, fixed rate................ 500 1,841 0.1 3.15
7 days Mini-jumbos........................... N/A 5,369 0.4 4.70
7 days Jumbos................................ 100,000 147,995 9.6 4.60
---------- -----
814,957 52.7
---------- -----
Total deposits...................................... $1,545,425 100.0%
========== =====
(1) Not currently offered.
16
The following table sets forth the composition of Sterling's deposit
accounts at the dates indicated.
December 31,
----------------------------------------------
1998 1997
----------------------------------------------
Percentage Percentage
of Total of Total
Amount Deposits Amount Deposits
------- --------- ------ ----------
(Dollars in thousands)
NOW checking................. $ 193,114 12.5 $ 92,281 8.5
Commercial checking.......... 104,176 6.7 31,230 2.9
Regular savings.............. 102,927 6.7 71,484 6.6
Money market demand.......... 330,251 21.4 184,795 17.0
Variable-rate certificates:
9-36 months.................. 97,884 6.3 5,729 0.6
Fixed-rate certificates:
1-11 months.................. 248,074 16.1 314,513 29.0
12-35 months................. 447,628 28.9 284,559 26.2
36-240 months................ 21,371 1.4 99,854 9.2
---------- ----- ---------- -----
Total deposits............... $1,545,425 100.0 $1,084,445 100.0
========== ===== ========== =====
Substantially all of Sterling's depositors are residents of the states
of Washington, Idaho, Montana and Oregon.
Sterling is a member of The Exchange, an automated teller machine
("ATM") system that allows participating customers to deposit or withdraw from
NOW accounts, money market demand accounts and savings accounts at over 18,000
Exchange system machines located throughout the United States and Canada.
Sterling is also a member of the Plus System ATM network, with numerous
locations in the United States and internationally. Sterling has 52 ATMs to
better serve customers in those markets. Customers also can access the system
through ATMs operated by other financial institutions.
Borrowings. Deposit accounts are Sterling's primary source of funds.
Sterling does, however, rely upon advances from the FHLB Seattle and reverse
repurchase agreements to supplement its funding and to meet deposit withdrawal
requirements. See "Management's Discussion and Analysis Liquidity and Sources
of Funds."
The FHLB Seattle is part of a system, which consists of 12 regional
Federal Home Loan Banks (the "FHL Banks") each subject to Federal Housing
Finance Board supervision and regulation, that functions as a central reserve
bank providing credit to savings institutions. As a member, Sterling is
required to own stock of the FHLB Seattle in an amount determined by a formula
based upon Sterling's loans outstanding and advances from the FHLB Seattle. At
December 31, 1998, Sterling exceeded its FHLB Seattle stock ownership
requirement of $22.3 million by $10.0 million. The stock of the FHLB Seattle
has always been redeemable at par value, but there can be no assurance that this
will always be the case.
As a member of the FHLB Seattle, Sterling is authorized to apply for
advances on the security of its FHLB Seattle stock and certain of its mortgage
loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States or its agencies), provided certain standards
related to creditworthiness are met. Each credit program has its own interest
rate and range of maturities. At December 31, 1998, Sterling had advances
totaling $319.5 million from the FHLB Seattle which mature from fiscal years
1999 through 2015 at interest rates ranging from 4.34% to 8.40%. See
"Management's Discussion and Analysis Liquidity and Sources of Funds" and Note
9 "Notes to Consolidated Financial Statements."
17
Sterling also borrows funds under reverse repurchase agreements
pursuant to which it sells investments (generally U.S. agency and MBS) 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. Sterling uses these borrowings to supplement deposit
gathering for funding the origination of loans. Sterling had $195.1 million and
$180.1 million in reverse repurchase agreements outstanding at December 31, 1998
and 1997, respectively. Sterling enters into short-term repurchase agreements
with selected retail customers. The balance of such short-term repurchase
agreements was $6.8 million at December 31, 1998. The use of reverse repurchase
agreements may expose Sterling to certain risks not associated with other
borrowings, including IRR and the possibility that additional collateral may
have to be provided if the market value of the pledged collateral declines. For
additional information regarding reverse repurchase agreements, see
"Management's Discussion and Analysis Asset and Liability Management,"
"Management's Discussion and Analysis Liquidity and Sources of Funds" and Note
10 of "Notes to Consolidated Financial Statements."
On June 4, 1997, Sterling issued $41.2 million of 9.50% junior
subordinated deferrable interest debentures (The "Junior Subordinated
Debentures") to Sterling Capital Trust I (the "Trust"), a Delaware business
trust, of which Sterling owns all of the common equity. The sole asset of the
Trust is the Junior Subordinated Debentures. The Trust issued $40.0 million of
9.50% Cumulative Capital Securities (the "Trust Preferred Securities") to
investors. The indenture governing the Junior Subordinated Debentures limits the
ability of Sterling under certain circumstances to pay dividends or make other
capital distributions. The Trust Preferred Securities are treated as debt of
Sterling. The Trust Preferred Securities mature on June 30, 2027 and are
redeemable at the option of Sterling on June 30, 2002, or earlier in the event
the deduction of related interest for federal income taxes is prohibited,
treatment as Tier 1 capital is no longer permitted, or certain other
contingencies arise.
Sterling has outstanding $17.2 million of 8.75% Subordinated Notes
which are due on January 31, 2000 ("the Subordinated Notes"). The Subordinated
Notes are unsecured general obligations of Sterling and are subordinated to
certain other existing and future indebtedness. Under the terms of the
Subordinated Notes, Sterling is limited by the amount of certain long-term debt
that it may incur. Sterling is limited and is restricted, under certain
circumstances, from paying cash dividends and from making other capital
distributions. At December 31, 1998, Sterling had the authority to incur
approximately $78.0 million of additional long-term debt notwithstanding such
restriction. Interest on the Subordinated Notes is due the first day of each
month. Sterling may, at its option, redeem the Subordinated Notes in whole or
in part at par plus accrued interest. See Note 11 of "Notes to Consolidated
Financial Statements."
In addition to the borrowings described above, at December 31, 1998
Sterling had a $40.0 million one-year variable-rate line of credit outstanding
with KeyBank. This line of credit matures June 1, 1999, but may be renewed for
an additional six months. Interest is payable quarterly on this loan. The
interest rate is adjustable monthly and accrues at the London InterBank Offering
Rate ("LIBOR") plus 2% (7.6875% at December 31, 1998). Sterling also had a $5.0
million line-of-credit agreement with KeyBank. Advances under the line of
credit accrue interest at KeyBank's prime interest rate plus 0.50% (8.25% at
December 31, 1998) and the line of credit matures in June 1999. Management
expects that the line of credit will be renewed at that time on substantially
the same terms, although there can be no assurance in this regard. Borrowings
under this line of credit are secured by a pledge of certain shares of Sterling
Savings Bank Preferred and Common Stock which are owned by Sterling. No amounts
were outstanding on this line of credit at December 31, 1998 and 1997.
Sterling Savings Bank has an unsecured $10.0 million line-of-credit
agreement with KeyBank. Advances under the line of credit accrue interest at
KeyBank's federal funds rate plus an incremental negotiated rate (5.875% at
December 31, 1998) and the line matures in June 1999. Management expects that
the line of credit will be renewed at that time on substantially the same terms,
although there can be no assurance in this regard. No amounts were outstanding
on this line of credit at December 31, 1998 and 1997.
18
The following table sets forth certain information regarding
Sterling's short-term borrowings as of and for the periods indicated.
Years Ended
December 31, Six Months Fiscal Year
-------------- Ended Ended
1998 1997 December 31, 1996 June 30, 1996
---- ---- ----------------- -------------
(Dollars in thousands)
Maximum amount outstanding at any month-end during the period:
Short-term reverse repurchase agreements....................... $336,734 $273,573 $232,885 $195,785
Short-term advances............................................ 353,879 353,847 95,000 171,000
Average amount outstanding during the period:
Short-term reverse repurchase agreements....................... 123,659 185,698 213,560 156,578
Short-term advances............................................ 198,042 207,931 90,833 140,917
Weighted average interest rate paid during the period:
Short-term reverse repurchase agreements....................... 5.56% 5.68% 5.60% 5.91%
Short-term advances............................................ 6.08% 5.90% 5.79% 5.88%
Weighted average interest rate paid at end of period:
Short-term reverse repurchase agreements....................... 5.58% 5.71% 5.62% 5.57%
Short-term advances............................................ 5.96% 5.99% 5.75% 6.42%
The following table sets forth certain information concerning
Sterling's outstanding borrowings.
December 31,
----------------------------------
1998 1997
--------------- ---------------
Amount % Amount %
-------- ---- -------- ----
(Dollars in thousands)
FHLB Seattle advances:
Short-term........................ $ 95,000 15.6 $353,847 49.7
Long-term......................... 224,540 36.7 106,238 14.9
Securities sold subject to reverse
repurchase agreements:
Short-term........................ 49,274 8.1 180,077 25.3
Long-term......................... 145,800 23.8 0 0.0
Subordinated Notes payable.......... 17,240 2.8 17,240 2.4
Advances under line of credit....... 40,000 6.5 0 0.0
Trust Preferred Securities.......... 40,000 6.5 40,000 5.6
Term note payable................... 0 0.0 15,000 2.1
-------- ----- -------- -----
Total borrowings.................... $611,854 100.0 $712,402 100.0
======== ===== ======== =====
Weighted average interest rate...... 5.71% 6.25%
19
Subsidiaries
Sterling's principal subsidiary is Sterling Savings Bank. Sterling
Savings Bank has three principal subsidiaries which have been previously
described: Action Mortgage, Harbor Financial and INTERVEST. Additionally,
Sterling and Sterling Savings Bank have the following wholly owned subsidiaries
that are either inactive or exist solely for the purpose of holding and owning
specific assets or properties:
Sterling Financial Corporation.
(1) Tri-Cities Mortgage Corporation was obtained as part of an acquisition
in April 1988. The corporation's principal asset is a 99.5%
partnership interest in Renton Plaza Investors (a partnership which
owns a five-story office building near Renton, Washington). See
"Lending Activities Major Real Estate Owned."
(2) Sterling Capital Trust I was organized in May 1997 as a Delaware
business trust. Sterling owns all the common equity of the Trust. The
sole asset of the Trust is the Junior Subordinated Debentures issued
by Sterling.
Sterling Savings Bank.
(1) Fidelity Service Corporation was organized in 1983 to acquire and sell
real and personal property in eastern Washington and Idaho. The
corporation's assets consist principally of office furniture and
equipment used by Sterling Savings Bank.
(2) Evergreen Environmental Development Corporation was organized to
engage in real estate development and was obtained as part of an
acquisition in December 1988. This corporation's assets include a 33%
interest in the Grapetree Partnership, which owns a parcel of raw land
in Spokane, Washington that it intends to develop into single-family
residential lots. Sterling Savings Bank's investment in the Grapetree
Partnership has been deemed by its primary federal regulators to be an
impermissible investment. Accordingly, Sterling Savings Bank's
investment has been deducted from core and risk-based capital.
(3) Tri-West Mortgage, Inc. was obtained as part of an acquisition in 1988
and was originally engaged in mortgage banking. The corporation's sole
asset consists of commercial property in Spokane, Washington acquired
through foreclosure. See "Lending Activities - Major Real Estate
Owned."
(4) Evergreen First Service Corporation was obtained as part of an
acquisition in 1988 and owns all of the outstanding capital stock of
Harbor Financial, through which Sterling offers tax-deferred
annuities, mutual funds and other financial products.
Competition
Sterling faces strong competition, both in attracting deposits and in
originating, purchasing and selling real estate and other loans, from savings
and loan associations, mutual savings banks, credit unions, commercial banks 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 institutions operate in
Sterling's market areas.
Adequately capitalized and well-managed bank holding companies are
allowed by law to acquire banks in any state, subject to certain conditions,
regardless of whether such acquisitions would be prohibited by applicable state
law. Interstate merger transactions are allowed except in certain states which
have opted not to participate in interstate merger transactions. Sterling's
competitors may be able to conduct extensive interstate banking operations and
thereby gain competitive advantages over Sterling.
20
Personnel
As of December 31, 1998, Sterling, including its subsidiaries, had 746
full-time equivalent employees. Employees are not represented by a collective
bargaining unit. Sterling believes its relationship with its employees is
excellent.
Regulation
Introduction. The following is not intended to be a complete
discussion but is intended to be a summary of some of the most significant
provisions of laws applicable to Sterling and its subsidiaries.
Sterling is a savings and loan holding company and as such is subject
to OTS regulations, examinations and reporting requirements. Sterling Savings
Bank is chartered by the State of Washington and its savings deposits are
insured by the FDIC. Sterling Savings Bank is subject to comprehensive
regulation, examination and supervision by the OTS, the FDIC and the Washington
Supervisor. Furthermore, certain transactions and savings deposits are subject
to regulations and controls promulgated by the Federal Reserve Board (the
"Fed").
Savings and Loan Holding Company Regulation. Sterling is registered
as a savings and loan holding company under the Home Owners' Loan Act (the
"HOLA"). The HOLA generally permits a savings and loan holding company to
engage in activities which are unrelated to the operation of a savings and loan
association, provided the holding company controls only one savings and loan
association and such savings and loan association meets the Qualified Thrift
Lender Test (the "QTL Test"). Sterling presently controls only one savings and
loan association, Sterling Savings Bank, which at December 31, 1998 met the QTL
Test.
If Sterling Savings Bank fails to meet the QTL Test in the future,
Sterling will become subject to restrictions on the activities in which it may
engage. Such activities would generally be limited to any activity that the Fed
by regulation has determined is permissible for bank holding companies pursuant
to Section 4(c) of the Bank Holding Company Act of 1956, as amended (unless
limited or prohibited by the OTS by regulation), and certain other limited
services and activities. Sterling currently has no plans to engage in any new
activity that would be restricted if Sterling Savings Bank were to fail to meet
the QTL Test in the future. Although Sterling Savings Bank expects to remain in
compliance with the QTL Test in the future, there can be no assurance in this
regard.
Under the HOLA, no person may acquire control of a savings association
or a savings and loan holding company without the prior approval of the OTS. As
a savings and loan holding company, Sterling is prohibited from acquiring (i)
control of another savings association or a savings and loan holding company
without the prior approval of the OTS; (ii) the assets of another savings
association or savings and loan holding company by merger, consolidation or
purchase, without the prior approval of the OTS; (iii) more than 5% of the
voting shares of a savings association or a savings and loan holding company
which is not a subsidiary of Sterling or (iv) control of a depository
institution, the accounts of which are not insured by the FDIC.
The HOLA authorizes the OTS to issue a directive to a savings and loan
holding company and any of its subsidiaries if the OTS determines that there is
reasonable cause to believe that the continuation by the holding company of any
activity constitutes a serious risk to the financial safety, soundness or
stability of the holding company's subsidiary savings association. The OTS may
impose restrictions through such directive to limit such risk, including
limiting (i) the payment of dividends by the savings association, (ii)
transactions between the savings association, the holding company and the
subsidiaries or affiliates of either and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its other affiliates may be imposed on the savings association.
Such a directive has the same effect as a final cease and desist order. The
issuance of the directive can be appealed to the Director of the OTS.
21
The Federal Deposit Insurance Corporation Improvement Act of 1991.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
provides for expanded regulation of depository institutions and their
affiliates, including parent holding companies. FDICIA further provides the OTS
with broad powers to take "prompt corrective action" to resolve problems of
insured depository institutions. The extent of these powers depends upon
whether the institution in question is "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized."
Under OTS regulations which implement the "prompt corrective action"
system mandated by FDICIA, an institution is "well capitalized" if its total
risk-based capital ratio (the ratio of qualifying total capital to risk-weighted
assets) is 10% or more, its Tier 1 risked-based capital ratio (the ratio of Tier
1 core capital to risk-weighted assets) is 6% or more, its leverage ratio (the
ratio of core capital to total assets) is 5% or more and it is not subject to
any written agreement, order or directive to meet a specified capital level. At
December 31, 1998, Sterling Savings Bank met the standards for a "well
capitalized" institution.
An institution which is "undercapitalized" must submit a capital
restoration plan to the OTS. The plan may be approved only if the OTS
determines it is likely to succeed in restoring the institution's capital and
will not appreciably increase the risks to which the institution is exposed.
The institution's performance under the plan must be guaranteed by any company
which controls the institution, up to a maximum of 5% of the institution's
assets. The OTS may also require an undercapitalized institution to take
various actions deemed appropriate to minimize the potential losses to the
deposit insurance fund. Institutions that are "significantly undercapitalized"
or "critically undercapitalized" are subject to additional sanctions.
FDICIA directs each bank regulatory agency and the OTS to review its
capital standards every two years to determine whether those standards require
sufficient capital to facilitate prompt corrective action to prevent or minimize
loss to the deposit insurance funds. FDICIA, as amended, also requires the OTS
to prescribe minimum operational and managerial standards and standards for
asset quality, earnings and stock valuation for savings institutions. Any
savings institution which fails to meet the standards may be required to submit
a plan for corrective action. If a savings institution fails to submit or
implement an acceptable plan, the OTS may require the institution to take any
action the OTS determines will best carry out the purpose of prompt corrective
action.
Under FDICIA, only a "well capitalized" depository institution may
accept brokered deposits without prior regulatory approval. FDICIA also
requires annual examinations of all insured depository institutions by the
appropriate federal banking agency, with some exceptions for small, well
capitalized institutions and state-chartered institutions examined by state
regulators. The federal banking agencies are required to set compensation
standards for insured depository institutions that prohibit excessive
compensation, fees or benefits to officers, directors, employees and principal
shareholders. FDICIA also contains a number of consumer banking provisions,
including disclosure requirements and substantive contractual limitations with
respect to deposit accounts. FDICIA also greatly expanded the range of merger,
purchase and assumption, and deposit transfer transactions involving banks and
savings associations that are exempt from payment of exit and entry fees as
transfers of deposits between the FDIC's Bank Insurance Fund ("BIF") and its
Savings Association Insurance Fund ("SAIF"). Many of the provisions of FDICIA
have been implemented through the adoption of regulations by the federal banking
agencies.
Regulatory Capital Requirements. Pursuant to the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), the OTS
adopted regulations implementing new capital standards applicable to all savings
associations, including Sterling Savings Bank. Such capital standards require
that savings associations maintain (i) tangible capital of not less than 1.5% of
adjusted total assets, (ii) core capital of not less than 3.0% of adjusted
total assets and (iii) risk-based capital of not less than 8.0% of risk-weighted
assets. As of December 31, 1998, Sterling Savings Bank met all regulatory
capital requirements. For additional information, see "Management's Discussion
and Analysis-Liquidity and Sources of Funds" and "Management's Discussion and
Analysis-Capital Resources."
22
Tangible Capital. Tangible capital consists of common shareholders'
equity, including retained earnings; non-cumulative perpetual preferred stock;
certain non-withdrawable and pledged deposits; and minority interests in equity
accounts of fully consolidated subsidiaries. In calculating tangible capital,
certain items must be deducted. These items are goodwill and other intangible
assets, nonqualifying purchased mortgage servicing rights and investments
(whether debt or equity) in subsidiaries engaged as of April 1989 in activities
which were permissible for national banks. With respect to purchased mortgage
servicing rights, the amount that qualifies to be included in tangible capital
is the lower of (a) 90% of fair market value if determinable, (b) 90% of
original cost or (c) the current amortized book value. See "Lending Activities-
Classified Assets, Real Estate Owned and Delinquent Loans-Major Real Estate
Owned" and "Subsidiaries."
Leverage (or Core) Capital. Core capital generally consists of
tangible capital plus certain other qualifying intangible assets (which may
comprise up to 25% of core capital).
Risk-Based Capital. The risk-based capital requirement is an amount
equal to 8% of risk-adjusted assets. A risk weight is assigned to both the on-
balance sheet assets and off-balance sheet commitments of a savings association.
Risk weights range from zero to 100% depending on the type of asset.
Both core capital and "supplementary capital" may be used to meet the
risk-based capital requirement, although supplementary capital cannot be used in
an amount greater than 100% of core capital. For purposes of the risk-based
capital requirement, supplementary capital includes permanent capital
instruments such as cumulative perpetual preferred stock, perpetual or mandatory
convertible subordinated debt, maturing capital instruments such as subordinated
debt, intermediate-term preferred stock, commitment notes and certain grand-
fathered mandatory redeemable preferred stock (although the amount included
declines as the instrument approaches maturity), and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted assets. The
risk-based capital requirement was equal to 8.00% of risk-weighted assets at
December 31, 1998.
The following tables set forth Sterling Savings Bank's core, Tier 1-
risk-based and total risk-based capital positions as reported on the quarterly
Thrift Financial Report at December 31, 1998.
Core Capital Ratio
----------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total shareholders' equity:................ $206,008 9.17%
Adjustment:
Unrealized gains on securities............. (788) (0.04)
Less:
Intangibles................................ 61,180 2.72
Excess qualifying purchased mortgage loan
servicing................................ 18 0.00
Investment in non-includable subsidiaries.. 353 0.02
-------- -----
Total core capital......................... 143,669 6.39
Core capital requirement................... 89,900 4.00
-------- -----
Core capital excess........................ $ 53,769 2.39%
======== =====
Core (Tier 1)
Risk-based
Capital Ratio
----------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core (Tier 1) capital:.................. $143,669 9.40%
Core (Tier 1) risk-based capital requirement.. 61,127 4.00
-------- ----
Core (Tier 1) risk-based capital excess....... $ 82,542 5.40%
======== ====
23
Total Risk-based Capital
------------------------
Dollars Ratio(1)
-------- --------
(Dollars in thousands)
Total core (Tier 1) capital:.... $143,669 9.40%
General valuation allowances.... 14,508 0.95
Assets required to be deducted.. (804) (0.05)
-------- -----
Total risk-based capital........ 157,373 10.30
Risk-based capital requirement.. 122,254 8.00
-------- -----
Risk-based capital excess....... $ 35,119 2.30%
======== =====
- --------------------
(1) Ratio of core capital to adjusted total assets for core capital ratio and
ratio of core and total capital to risk-weighted assets for Tier 1 risk-
based and total risk-based capital.
The OTS has adopted a regulation that adds an IRR component to the
risk-based capital requirement for savings institutions like Sterling Savings
Bank. The OTS may waive or defer inclusion of the IRR component on a case-by-
case basis. Under the rule, institutions meeting or exceeding a base level of
interest rate exposure must deduct an IRR component from the total capital
available to meet their risk-based capital requirement. That deduction is equal
to one-half of the difference between the institution's actual measured exposure
and the base level of exposure. The institution's actual measured IRR is
expressed as the change that occurs in its net present value ("NPV") as a result
of a hypothetical 200 basis point increase or decrease in interest rates
(whichever leads to the lower NPV) divided by the estimated economic value of
its assets. The base level of IRR, which would require inclusion of a capital
component, is defined as a decline in NPV which exceeds 2.0% of an institution's
assets expressed in terms of economic value. Using a computer model, the OTS
will calculate changes in each institution's NPV based on financial data the
institution submits on its Thrift Financial Report. The OTS then will advise
each institution of its required IRR deduction. The OTS, using December 31,
1998 financial information, has calculated that no IRR component deduction is
required to be added to Sterling Savings Bank's risk-based capital.
Savings associations that fail to meet the tangible, core or risk-
based capital requirements are subject to a number of sanctions or restrictions.
Under FIRREA, the OTS must prohibit any asset growth, except that the OTS may
permit growth in an amount not in excess of net interest credited to the savings
association's deposit liabilities, if (i) the savings association obtains the
prior approval of the OTS; (ii) any increase in assets is accompanied by an
increase in tangible capital in an amount not less than 3.0% of the increase in
assets; (iii) any increase in assets is accompanied by an increase in capital
not less in percentage amount than required under the risk-based capital
standards then applicable; (iv) any increase in assets is invested in low-risk
assets and (v) the savings association's ratio of core capital to total assets
is not less than the ratio existing on January 1, 1991.
The OTS also may require any savings association not in compliance
with capital standards (including any individual minimum capital requirement) to
comply with a capital directive issued by the OTS. Such capital directive may
order the savings association to (a) achieve its minimum capital requirements by
a specified date; (b) adhere to a compliance schedule for achieving its minimum
capital requirements; (c) submit and adhere to a capital plan acceptable to the
OTS and/or (d) take other actions including reducing its assets or rate of
liability growth and/or restricting its payment of dividends in order to reach
the required capital levels. The OTS, by such capital directive, enforcement
proceedings or otherwise, may require an association not in compliance with the
capital requirements to (i) increase the amount of its regulatory capital to a
specified level; (ii) convene a meeting with the OTS supervision staff for the
purpose of accomplishing the objectives of the regulations; (iii) reduce or
limit the rate of interest that may be paid on savings accounts; (iv) limit the
receipt of deposits to those made to existing accounts; (v) cease or limit
lending or the making of a particular loan or category of loan; (vi) cease or
limit the purchase of loans or the making of specified other investments; (vii)
limit operational expenditures to specific levels; (viii) increase liquid assets
and maintain such increased liquidity at specified levels or (ix) take such
other action or actions as the OTS may deem necessary or appropriate for the
safety and soundness of the savings
24
association or the protection of its depositors. The material failure of a
savings association to comply with any plan, regulation, written agreement,
order or directive issued will be treated as an unsafe or unsound practice which
could result in the imposition of certain penalties or sanctions including, but
not limited to, the assessment of civil monetary penalties, the issuance of a
cease and desist order or the appointment of a conservator or receiver.
Any savings association which does not meet its regulatory capital
requirements may not accept brokered deposits if such deposits, together with
any existing brokered deposits outstanding, would exceed 5.0% of the
association's total deposits, without a written waiver from the OTS. In
addition, the FDIC prohibits, with certain exceptions, an "insolvent
institution" from accepting any brokered deposits. An insolvent institution is
defined as any insured depository institution which does not meet the minimum
capital requirements applicable with respect to such institution. This
prohibition includes any renewal of an account in any insolvent institution and
any rollover of any amount on deposit. The FDIC may waive this restriction upon
application by an insured depository institution and a finding that the
acceptance of such deposits does not constitute an unsafe or unsound practice
with respect to such institution. Sterling had no brokered deposits at December
31, 1998.
A savings association which is not in compliance with its capital
requirements may apply to the OTS for an exemption from the sanctions and
penalties imposed upon a savings association for failure to comply with its
minimum capital standards. Pursuant to FIRREA, the OTS may approve an
application for a capital exemption if such exemption would pose no significant
risk to the affected insurance fund, the savings association's management is
competent, the savings association is in compliance with all applicable
statutes, regulations, orders and supervisory agreements and directives and the
savings association's management has not engaged in insider dealing, speculative
practices or any other activities that could have jeopardized the association's
safety and soundness or contributed to impairing the association's capital. Any
application for a capital exemption must be accompanied by an acceptable capital
plan. If a savings association receives approval of capital exemption and
operates in accordance with an acceptable capital plan, it will be deemed to be
in compliance with its capital standards for purposes of OTS capital regulation
only. The savings association must request and receive approval of specific,
express exemptions from the provisions of other rules, regulations and policy
statements as part of the accepted capital plan to be deemed in capital
compliance for purposes of such other rules, regulations and policy statements.
Federal Deposit Insurance Corporation. Sterling's deposits are insured
up to $100,000 per insured depositor (as defined by law and regulations) by the
FDIC through the SAIF. The SAIF is administered and managed by the FDIC. The
FDIC is authorized to conduct examinations of and to require reporting by SAIF
member institutions. The FDIC may prohibit any SAIF member institution from
engaging in any activity the FDIC determines by regulation or order poses a
serious threat to the SAIF. The FDIC also has the authority to initiate
enforcement actions against savings associations.
On September 30, 1996, federal legislation was enacted which included
provisions regarding the recapitalization of the SAIF. The new legislation
required SAIF-insured savings institutions, like Sterling Savings Bank, to pay a
one-time special assessment based on deposits as of March 31, 1995. Sterling's
SAIF assessment resulted in a pre-tax charge to earnings of $6.1 million during
the six months ended December 31, 1996. The special assessment capitalized the
SAIF up to the prescribed 1.25% of SAIF-insured deposits.
Deposits insured by SAIF are currently assessed at the rate of zero
for well capitalized institutions displaying little risk to the SAIF, to $0.27
per $100 of domestic deposits for undercapitalized institutions displaying high
risk. The SAIF assessment rate may increase or decrease as is necessary to
maintain the designated SAIF reserve ratio of 1.25% of insured deposits.
All FDIC-insured depository institutions must pay an annual assessment
to provide funds for the payment of interest on bonds (the "FICO Bonds") issued
by the Financing Corporation, a federal corporation chartered under the
authority of the Federal Housing Finance Board. The FICO Bonds were issued to
capitalize the Federal Savings and Loan Insurance Corporation. Until December
31, 1999 or when the last savings and loan association ceases to exist,
whichever occurs first, depository institutions will be required to pay
approximately $0.064 per $100 of SAIF-assessable deposits and approximately
$0.013 per $100 of BIF-assessable deposits. Hence, the financial burden on SAIF
member institutions like Sterling Savings is currently greater than it is on BIF
member institutions.
25
Sterling Savings Bank may be required to convert its charter to either
a national bank charter, a state depository institution charter or a newly
designed charter. Sterling also may become regulated at the holding company
level by the Fed rather than by the OTS. Regulation by the Fed could subject
Sterling to capital requirements that are not currently applicable to Sterling
as a thrift holding company under OTS regulations and may result in statutory
limitations on the type of business activities in which Sterling may engage at
the holding company level, which business activities currently are not
restricted. At this time, Sterling Savings Bank is unable to predict whether a
charter change will be required and, if it is, whether the charter change will
significantly impact Sterling Savings Bank's operations.
The FDIC is empowered to initiate a termination of insurance
proceeding in cases where the FDIC determines that an insured depository
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated an applicable law,
regulation, order or condition imposed by the FDIC. The FDIC may deem failure
to comply with applicable regulatory capital requirements an unsafe and unsound
practice. If the FDIC terminates a savings association's deposit insurance,
funds then on deposit continue to be insured for at least six months and up to
two years after notice of such termination is provided to the account holders.
Furthermore, if the FDIC initiates an insurance termination proceeding against a
savings association that has no tangible capital, the FDIC may issue a temporary
order immediately suspending deposit insurance on all deposits received by such
savings association.
Loans to Affiliates. FIRREA amended the statutory provisions
governing transactions between a savings association and its affiliates. Such
transactions are subject to the restrictions of Sections 23A and 23B of the
Federal Reserve Act (the "FRA") in the same manner and to the same extent as if
the savings association were a member bank as defined in the FRA, except that a
savings association may not (i) extend credit to any affiliate engaged in
activities that are impermissible for a bank holding company or (ii) purchase or
invest in any securities of an affiliate other than shares of a subsidiary.
Section 23A of the FRA limits the aggregate amount of "covered
transactions" with any one affiliate to 10% of the capital stock and surplus of
the member bank. "Covered transactions" are defined in Section 23A to include
extending credit to, purchasing the assets of, issuing a guarantee, acceptance
or letter of credit on behalf of, or investing in the stock or securities of,
any affiliate. Section 23A also requires a bank to obtain specified levels of
collateral for any extension of credit to an affiliate. Section 23B, in general,
requires that any transaction with an affiliate be on terms and conditions no
less favorable to the member bank than those applicable to transactions with
unaffiliated entities. The OTS has recently adopted regulations further defining
and clarifying the applicability of Section 23A and 23B to savings associations.
The OTS has the authority to impose any additional restrictions on any
transaction between a savings association and an affiliate that it determines
are necessary to protect the safety and soundness of the association.
In addition, FIRREA provides that extensions of credit to executive
officers, directors and principal shareholders of a savings association are
governed by the FRA. The FRA requires prior approval by the board of directors
of the bank before a loan can be made to an executive officer, director or 10%
shareholder. In addition, such loan or extension of credit must be made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unaffiliated persons and
may not involve more than the normal risk of repayment or present other
unfavorable features. The FRA also prohibits any loan or extension of credit to
an executive officer or a controlling shareholder if such loan or extension of
credit (when aggregated with the amount of all other loans or extensions of
credit then outstanding to such individual) would exceed the limits on loans to
a single borrower applicable to national banks. The OTS may impose additional
restrictions for safety and soundness reasons.
Liquidity. All savings associations, including Sterling Savings Bank,
are required to maintain an average daily balance of liquid assets equal to a
certain percentage of the sum of average daily balances of net withdrawable
deposit accounts and borrowings payable in one year or less. The liquidity
requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations. At the
present time, the required liquid asset ratio is 4%. In addition to meeting the
required liquid asset ratio, savings associations, including Sterling Savings
Bank, must maintain sufficient liquidity to ensure safe and sound operations.
Sterling Savings Bank's liquidity ratios at December 31, 1998 and 1997 were
11.5% and 14.3%, respectively.
26
Loans-to-One-Borrower. Under FIRREA, the permissible amount of loans-
to-one-borrower follows the national bank standard for all loans made by savings
associations (except that loans-to-one-borrower not in excess of $500,000 may be
made in any event). OTS regulations generally do not permit loans-to-one-
borrower to exceed 15% of unimpaired capital and unimpaired surplus. Loans in
an amount equal to an additional 10% of unimpaired capital and unimpaired
surplus also may be made to a borrower if the loans are fully secured by readily
marketable collateral. In addition, institutions which meet applicable capital
requirements may make domestic residential housing development loans in an
amount up to the lesser of $30.0 million or 30% of the institution's unimpaired
capital and unimpaired surplus, subject to certain conditions. At December 31,
1998, Sterling's loans-to-one-borrower limit was $21.6 million, which management
believes is adequate to allow for loan originations.
Qualified Thrift Lender. Under the QTL Test, as revised by FDICIA, an
institution generally is required to invest at least 65% of its portfolio assets
(as defined in the OTS regulations) in "qualified thrift investments" on a
monthly average basis in nine out of every twelve months. Qualified thrift
investments include, in general, loans, securities and other investments that
are related to housing. At December 31, 1998, Sterling's qualified thrift
investments were 74.1% of portfolio assets. An institution's failure to remain
a qualified thrift lender ("QTL") may result in: (1) limitations on new
investments and activities; (2) imposition of branching restrictions; (3) loss
of borrowing privileges at the FHLB Seattle and (4) limitations on the payment
of dividends.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"),
as implemented by the OTS regulations, a savings institution has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of a financial institution,
to assess the institution's record of meeting the credit needs of its community
and to take such record into account in its evaluation of certain applications
by such institutions. The CRA requires public disclosure of an institution's
CRA rating and requires the OTS to provide a written evaluation of an
institution's CRA performance utilizing a four-tiered descriptive rating system
of "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." Sterling's current CRA rating is "satisfactory."
Change of Control. Under applicable statutes and regulations, a
person may not acquire control of a savings association without the prior
approval of the OTS and the Washington Supervisor. Control is conclusively
deemed to be acquired when, among other things, a person, either alone or acting
in concert with others, acquires more than 25% of any class of voting stock of a
savings association. Under federal statutes and regulations, a rebuttable
presumption of control arises if a person acquires, either alone or acting in
concert with others, more than ten percent of any class of voting stock of a
savings association and is subject to a "control factor," or acquires more than
25% of any class of stock, and is subject to a "control factor." A person is
subject to a control factor as a result of specified ownership levels of the
savings association's debt or equity or as a result of certain relationships
with the savings association.
As indicated above, if a person's ownership of the savings association
stock is below the threshold levels for control, such person may nevertheless be
deemed to be "acting in concert" with one or more other persons who own stock in
the savings association, in which case all of the stock ownership of each person
acting in concert will be aggregated and attributed to each member of the group,
thereby putting each one over the control threshold. Under certain
circumstances, acquirers will be presumed to be acting in concert. For example:
(i) a company will be presumed to be acting in concert with a controlling
shareholder or management official; (ii) a company controlling or controlled by
another company and companies under common control will be presumed to be acting
in concert and (iii) persons will be presumed to be acting in concert where they
constitute a group under Section 13 or the proxy rules under Section 14 of the
Securities Exchange Act of 1934, as amended.
27
Restrictions on Activities of State-Chartered Associations. FIRREA
prohibits a state-chartered savings association from engaging in any type of
activity or any activity in an amount that is not permissible for a federal
savings association unless (i) the FDIC has determined that such activity poses
no threat to the insurance fund and (ii) the savings association continues to be
in compliance with applicable capital requirements. If the FDIC determines that
the amount of such activity does not pose a significant threat to the insurance
fund, an association which is in compliance with applicable capital requirements
may engage in activities in an amount greater than that permissible for a
federal savings association. FIRREA also prohibits a state-chartered savings
association from acquiring or retaining any equity investment (other than shares
in certain service corporations) of a type or in an amount not permissible for a
federal savings association. A savings association must divest any such equity
investment as quickly as can be prudently done. Pursuant to applicable equity
investment rules, Sterling has excluded its investment in assets totaling
$353,000 from its calculation of risk-based capital as of December 31, 1998.
Sterling is actively marketing these properties. See "Subsidiaries."
Restrictions on Capital Distributions by Savings Associations. The
OTS has adopted a capital distribution regulation which limits the ability of
savings institutions to make capital distributions. Certain factors are
considered by the OTS in determining whether to permit a savings institution to
pay dividends, including, among other things, whether an institution meets
applicable capital requirements. Those savings institutions which meet the
applicable capital requirements have discretion in making capital distributions,
while those with lower capitalization have less discretion in this regard and,
in some cases, are required to seek the approval of the OTS.
Sterling's income is derived primarily from dividends to the extent
they are declared and paid by Sterling Savings Bank. Current OTS regulations
require Sterling Savings Bank to give the OTS 30 days advance notice of any
proposed declaration of dividends to Sterling, as its holding company. The OTS
has approved all of Sterling Savings Bank Preferred Stock dividend payments to
Sterling, but there can be no assurance as to the approval of future dividends.
Federal Reserve System. Sterling Savings Bank is subject to various
regulations promulgated by the Fed, including, among others, Regulation B (Equal
Credit Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund
Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds) and Regulation DD (Truth in Savings). Regulation D requires noninterest-
bearing reserve maintenance in the form of either vault cash or funds on deposit
at the Federal Reserve Bank of San Francisco or another designated depository
institution in an amount calculated by formula. The balances maintained to meet
the reserve requirements imposed by the Fed may be used to satisfy liquidity
requirements.
Under the provisions of the Depository Institutions Deregulation and
Monetary Control Act of 1980, savings and loan associations, like Sterling
Savings Bank, also have authority to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve regulations require associations to
exhaust all FHL Bank sources before borrowing from the Fed.
Federal Taxation. Sterling is subject to federal income taxation
under the Internal Revenue Code of 1986 as amended (the "Code"), in the same
manner as other corporations, except for the application of the bad debt reserve
rules discussed below and certain other provisions. Sterling files consolidated
federal income tax returns on the accrual basis.
Under applicable provisions of the Code, a savings institution that
meets certain definitional tests relating to the composition of its assets and
the sources of its income ("qualifying savings institution") is permitted to
establish reserves for bad debts and to make annual additions thereto under the
experience method, which generally permits an annual deduction based upon the
institution's historical loan loss experience. Alternatively, such an
institution may elect on an annual basis to use the percentage of taxable income
method to compute its allowable addition to its bad-debt reserve on qualifying
real property loans (generally, loans secured by an interest in improved real
property). For qualifying savings associations, these methods generally allow
for greater deductions than other financial institutions such as commercial
banks which are allowed a deduction only for actual bad-debt losses.
28
A savings institution organized in stock form may be subject to
recapture taxes on its reserves if it makes certain types of distributions to
its shareholders. Dividends may be paid out of retained earnings without the
imposition of any tax on the savings institution to the extent that the amounts
paid as dividends do not exceed both the savings institution's current and
accumulated earnings and profits as calculated for federal income tax purposes.
Dividends in excess of the savings institution's current and accumulated
earnings and profits as calculated for federal income tax purposes, and any
redemption or liquidation distributions are, however, deemed under Section
593(e) of the Code to be made from the savings institution's tax bad-debt
reserves to the extent that such reserves exceed the additions that would have
been made under the experience method and thereafter from its supplemental
reserves. The amount of tax that would be payable upon any distribution that is
treated as having been made from the savings institution's tax bad-debt reserves
also is deemed to have been paid from these reserves. As a result,
distributions, if any, that are treated as having been made from Sterling
Savings Bank's bad-debt reserves could result in a federal recapture tax.
State Law and Regulation. Sterling Savings Bank is a State of
Washington-chartered institution and is subject to regulation by the Washington
Supervisor, which conducts regular examinations to ensure that Sterling Savings
Bank's operations and policies conform with sound industry practice. The
liquidity and other requirements set by the Washington Supervisor are generally
no stricter than the liquidity and other requirements set by the OTS. State law
regulates the amount of credit that can be extended to any one person or marital
community and the amount of money that can be invested in any one property.
Without the Washington Supervisor's approval, Sterling Savings Bank currently
cannot extend credit to any one person or marital community in an amount greater
than 2.5% of Sterling Savings Bank's total assets. State law also regulates the
types of loans Sterling Savings Bank can make. Without the Washington
Supervisor's approval, Sterling Savings Bank cannot currently invest more than
10% of its total assets in other corporations. Sterling Savings Bank operates
branches within the states of Oregon, Idaho and Montana and therefore is also
subject to the supervision of the Oregon Department of Consumer and Business
Services, the Idaho Department of Finance and the Montana Department of Finance.
Item 2. Properties
Sterling Savings Bank owns 44 branches and leases 14 branches in
Washington, owns 5 branches in Oregon, owns 9 branches and leases 2 branches in
Idaho and owns 3 branches in Montana. Action Mortgage leases four residential
loan production branches (one in Washington, one in Oregon and two in Idaho).
INTERVEST leases one office in Washington and leases one office in Oregon.
These branches and offices range in size from 500 to 105,000 square feet and
have a total net book value, including leasehold improvements and furniture and
fixtures, of $51.8 million at December 31, 1998. Leases on these properties
expire between January 2000 and December 2014. Sterling believes it will be
able to renew the leases or obtain comparable leases.
Item 3. Legal Proceedings
Periodically, various claims and lawsuits are brought against issues
incident to Sterling's business. In addition, Sterling succeeded to several
claims as a result of past acquisitions by Sterling and its subsidiaries, such
as claims to enforce liens, condemnation proceedings involving properties on
which Sterling holds security interests and claims involving the making and
servicing of loans. No material loss is expected from any of such pending
claims or lawsuits, although there can be no assurance in this regard.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
quarter ended December 31, 1998.
29
PART II
Item 5. Market for the Registrant's Stock and Related Shareholder Matters
Sterling has outstanding one class of Common Stock. As of February
26, 1999, there were 8,072,021 shares of Common Stock outstanding. As of
February 26, 1999, the Common Stock was owned by 844 Shareholders of record.
The Common Stock is quoted on the Nasdaq National Market under the symbol
"STSA." For additional information concerning the payment of dividends, see
"Business - Regulation - Regulatory Capital Requirements," "Management's
Discussion and Analysis - Liquidity and Sources of Funds" and Note 25 of "Notes
to Consolidated Financial Statements."
The following table sets forth the high and low bid prices per share
for the Common Stock for the periods indicated.
High Low
------- -------
Year ended December 31, 1998:
Fourth quarter............... $18-7/8 $13-1/2
Third quarter................ 23-5/8 14-1/4
Second quarter............... 28-1/4 21-7/8
First quarter................ 26-1/2 19-3/4
Year ended December 31, 1997:
Fourth quarter............... $ 23 $ 19
Third quarter................ 20-3/4 17-1/4
Second quarter............... 19-1/4 15-1/4
First quarter................ 17-7/8 13-1/2
30
Item 6. Selected Financial Data /(1)/ /(3)/
Years Ended Six Months Ended Fiscal Years Ended
December 31, December 31, June 30,
-------------------------------- ------------------- -------------------------------
1998 1997 1996 1996 1995 1996 1995 1994
----- ----- ----- ------ ------ ----- ----- -----
(Dollars in thousands, except per share amounts)
Interest income.............$ 155,763 $ 135,885 $ 117,841 $ 59,916 $ 59,874 $ 117,799 $ 111,815 $ 81,422
Interest expense............ (96,558) (88,077) (77,013) (38,626) (41,785) (80,172) (74,108) (46,870)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income......... 59,205 47,808 40,828 21,290 18,089 37,627 37,707 34,552
Provision for loan losses... (5,325) (2,482) (1,942) (1,121) (822) (1,643) (1,642) (1,643)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net interest income after
provision for
loan losses................ 53,880 45,326 38,886 20,169 17,267 35,984 36,065 32,909
Other income................ 12,313 9,474 9,246 4,775 5,062 9,533 11,640 9,028
Merger, acquisition and
conversion costs........... (5,464) 0 0 0 0 0 0 0
Other operating expenses.... (50,827) (38,429) (42,685) (25,807) (16,231) (33,109) (32,793) (27,338)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) before income
taxes...................... 9,902 16,371 5,447 (863) 6,098 12,408 14,912 14,599
Income tax provision........ (3,679) (6,152) (2,577) (162) (2,252) (4,667) (5,039) (5,085)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss)........... 6,223 10,219 2,870 (1,025) 3,846 7,741 9,873 9,514
--------- --------- --------- --------- --------- --------- --------- ---------
Preferred stock dividends
declared................... 0 (940) (1,885) (942) (942) (1,885) (1,885) (272)
--------- ---------- --------- --------- --------- --------- --------- ---------
Net income (loss) applicable
to common shares........... $ 6,223 $ 9,279 $ 985 $ (1,967) $ 2,904 $ 5,856 $ 7,988 $ 9,242
========== ========== ========== ========== ========== ========== ========== ==========
Income (loss) per common share:
Basic..................... $ 0.78 $ 1.40 $ 0.17 $ (0.33) $ 0.50 $ 1.00 $ 1.41 $ 1.67
Diluted................... $ 0.76 $ 1.25 $ 0.17 $ (0.33) $ 0.48 $ 0.97 $ 1.27 $ 1.61
Weighted average common
shares outstanding:
Basic..................... 8,027,537 6,634,599 5,902,991 5,955,387 5,830,804 5,840,359 5,682,650 5,541,007
Diluted................... 8,217,067 8,170,675 8,022,769 8,074,600 7,974,257 8,000,454 7,793,233 5,900,786
Ratios:
Return on average assets... 0.30% 0.58% 0.18% (0.13)% 0.48% 0.49% 0.62% 0.79%
Return on average common
shareholders' equity...... 5.42 11.06 1.39 (5.67) 7.95 8.07 12.75 16.14
Shareholders' equity to
assets at end of period.... 5.14 5.71 6.04 6.04 6.29 6.03 5.98 5.77
Book value per common share
at end of period........... $ 14.77 $ 13.80 $ 11.78 $ 11.78 $ 12.44 $ 11.39 $ 11.90 $ 10.15
Net interest margin........ 3.05% 2.84% 2.75% 2.83% 2.35% 2.51% 2.49% 2.97%
Nonperforming assets to
total assets at end of
period.................... 0.40 0.71 0.41 0.41 0.55 0.55 0.56 0.68
Operating Cash Performance
Ratios: /(2)/
Operating cash earnings.... $ 13,929 $ 11,618 $ 9,442 $ 4,371 $ 4,889 $ 9,820 $ 12,182 $ 10,989
Operating cash earnings per
common share-diluted...... $ 1.70 $ 1.31 $ 0.94 $ 0.42 $ 0.50 $ 0.99 $ 1.32 $ 1.82
Operating cash return on
average common
shareholders' equity...... 12.13% 12.72% 10.68% 9.89% 10.83% 10.93% 16.44% 18.72%
Operating cash return on
average assets............ 0.66 0.66 0.60 0.55 0.61 0.62 0.77 0.91
Operating efficiency....... 65.0 63.2 66.5 69.3 62.9 63.1 59.4 57.5
31
Item 6. Selected Financial Data (continued)
December 31, June 30,
--------------------------------- -------------------------------
1998 1997 1996 1996 1995 1994
-------- ------- ------- ------- ------- -------
(Dollars in thousands, except per share amounts)
Financial Position Data:
Total assets................ $2,314,587 $1,938,353 $1,594,430 $1,537,813 $1,600,849 $1,437,442
Loans receivable............ 1,468,534 1,105,739 970,196 923,494 1,094,468 885,138
Mortgage-backed securities.. 405,725 477,513 379,965 403,109 284,424 364,664
Investments................. 180,680 213,426 118,005 86,775 87,146 90,634
Deposits.................... 1,545,425 1,084,445 952,379 950,317 942,118 866,733
FHLB Seattle advances....... 319,540 460,085 259,626 259,410 352,073 364,985
Other borrowings............ 97,240 72,240 32,240 17,240 17,240 17,250
Shareholders' equity........ 119,017 110,617 96,269 92,686 95,798 82,991
Statistical Data:
Number of:
Employees (full-time
equivalents).............. 746 525 512 507 517 517
Offices:
Full service........... 77 44 44 44 44 44
Loan production........ 10 8 10 10 11 20
Real estate loans.......... 6,877 8,338 10,233 12,306 15,825 14,131
Deposit accounts........... 156,362 88,969 89,350 91,053 90,623 86,063
/(1)/ Prior periods have been restated to reflect the acquisition of Big Sky on
November 13, 1998, which was accounted for as a pooling of interests.
/(2)/ Amounts and ratios exclude intangible amortization and other non-recurring
items, including acquisition-related costs and adjustments and one-time
SAIF assessments, net of related income taxes. Intangible amortization,
net of income tax effect, was $2,512, $1,399, $2,367, $1,011, $1,043,
$2,079, $2,309 and $1,475 for the years ended December 31, 1998, 1997 and
1996, six months ended December 31, 1996 and 1995 and for the fiscal years
ended June 30, 1996, 1995 and 1994, respectively. Acquisition-related
costs and other adjustments, net of income tax effect, were $5.2 million
for the year ended December 31, 1998. One-time SAIF assessments, net of
income tax effect, were $4,205 and $4,385 for the year and six months
ended December 31, 1996, respectively.
For the operating efficiency ratios, intangible amortization excluded from
operating expenses was $3,971, $2,242, $3,254, $1,590, $1,669, $3,332,
$3,487 and $2,263 for the years ended December 31, 1998, 1997 and 1996,
six months ended December 31, 1996 and 1995 and for the fiscal years ended
June 30, 1996, 1995 and 1994, respectively. Acquisition-related costs
excluded from operating expenses were $5,464 for the year ended December
31, 1998. One-time SAIF assessments, excluded from operating expenses were
$6,145 for the year and six months ended December 31, 1996.
/(3)/ Sterling changed its fiscal year end from June 30 to December 31,
effective December 31, 1996. The selected financial data (except the
ratios and statistical data) of Sterling for each of the periods has been
derived from Sterling's consolidated financial statements. Such
consolidated financial statements for the years ended December 31, 1998
and 1997, the six months ended December 31, 1996 and the fiscal year ended
June 30, 1996 have been audited by PricewaterhouseCoopers LLP. The
selected financial data as of and for all other periods presented are
unaudited and reflect the adjustments, all of which are of a normal and
recurring nature, which in the opinion of management are considered
necessary for a fair presentation of the financial position and results of
operations for such periods.
32
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
Sterling is a unitary savings and loan holding company, the
significant operating subsidiary of which is Sterling Savings Bank. The
significant operating subsidiaries of Sterling Savings Bank are Action Mortgage,
INTERVEST and Harbor Financial. Sterling Savings Bank commenced operations in
1983 as a State of Washington-chartered, federally insured stock savings and
loan association headquartered in Spokane, Washington.
Sterling, with $2.31 billion in total assets at December 31, 1998,
attracts FDIC-insured deposits from the general public through 77 retail
branches located primarily in rural and suburban communities in Washington,
Oregon, Idaho and Montana. Sterling originates loans through its branch offices
as well as ten Action Mortgage residential loan production offices in the
metropolitan areas of Spokane and Seattle, Washington; Portland, Oregon; and
Boise, Idaho; and four INTERVEST commercial real estate lending offices located
in the metropolitan areas of Spokane and Seattle, Washington; and Portland,
Oregon. Sterling also markets tax-deferred annuities, mutual funds and other
financial products through Harbor Financial.
Recently, Sterling has focused its efforts on becoming more like a
community bank by increasing its construction, business banking and consumer
lending while increasing its retail deposits. Sterling's revenues are derived
primarily from interest earned on loans and MBS, from fees and service charges
and from mortgage banking operations. The operations of Sterling Savings Bank,
and savings institutions generally, are influenced significantly by general
economic conditions and by policies of its primary regulatory authorities, the
OTS, the FDIC and the Washington Supervisor. See "Regulation."
To further enhance its presence in the Pacific Northwest market,
Sterling has been working to expand its community bank delivery system, focusing
primarily on deposit gathering and lending. Sterling completed the acquisition
of Big Sky and its subsidiary, First Federal, on November 13, 1998. On that
date First Federal had approximately $66 million in total assets and deposits of
approximately $50 million. The merger with Big Sky was accounted for as a
pooling of interests; and accordingly, all historical amounts have been restated
to include the results of Big Sky.
On June 15, 1998, Sterling acquired 33 branch offices in Washington,
Idaho and Oregon from KeyBank. The purchase included $518 million of deposit
balances and $125 million of loan balances. Upon acquisition, the weighted
average interest rate on deposits assumed was approximately 3.42%. Sterling
incurred an approximate $57 million intangible asset associated with the
acquisition. Sterling is amortizing the intangible asset over a period of 15
years using the straight-line method. With the net cash received from the
branch acquisition, Sterling repaid approximately $322 million of certain
reverse repurchase borrowings and FHLB Seattle advances.
Sterling changed its fiscal year-end from June 30 to December 31,
effective December 31, 1996. Accordingly, results of operations included herein
have been presented for the years ended December 31, 1998 and 1997, six months
ended December 31, 1996 and 1995 and the fiscal year ended June 30, 1996. See
Note 1 of "Notes to Consolidated Financial Statements."
Net Interest Income
The most significant component of earnings for a financial institution
typically is net interest income ("NII"), which is the difference between
interest income, primarily from loan, MBS and investment portfolios, and
interest expense, primarily on deposits and borrowings. Changes in NII result
from changes in volume, net interest spread and net interest margin. Volume
refers to the dollar level of interest-earning assets and interest-bearing
liabilities. 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 NII divided by total interest-earning assets and is
influenced by the level and relative mix of interest-earning assets and
interest-bearing liabilities. During the years ended December 31, 1998 and 1997
and the six months ended December 31, 1996, the increase in NII was due
primarily to an increase in the interest earned on all interest-earning assets
coupled with a decrease in the cost of deposits and FHLB Seattle advances.
During the fiscal year ended June 30, 1996, the increase in NII was due to a mix
change in the volume of interest-earning assets towards higher yielding assets,
which helped increase the net interest margin.
33
The following table sets forth, for the periods indicated, information
with regard to the average balances of interest-earning assets and interest-
bearing liabilities, the total dollar amounts of interest income from interest-
earning assets and interest expense on interest-bearing liabilities, resultant
yields or costs, NII, net interest spread, net interest margin and the ratio of
average interest-earning assets to average interest-bearing liabilities.
Years Ended December 31,
---------------------------------------------------------------------------
1998 1997
---------------------------------- -------------------------------------
Interest Average Interest Average
Earned Yield Earned Yield
Average or or Average or or
Balance(1) Paid Cost(2) Balance(1) Paid Cost(2)
--------- -------- -------- ---------- -------- --------
(Dollars in thousands)
Interest-earning assets:
Loans...................... $1,282,668 $113,813 8.87% $1,039,167 $ 94,963 9.14%
Mortgage-backed securities. 428,220 26,938 6.29 444,110 29,031 6.54
Investments and cash
equivalents............... 233,264 15,012 6.44 200,350 11,891 5.94
--------- -------- ---- ---------- -------- ----
Total interest-earning
assets.................... $1,944,152 $155,763 8.01% $1,683,627 $135,885 8.07%
========= ======== ==== ========== ======== ====
Interest-bearing
liabilities:
Certificates of deposit.... $ 791,311 $ 43,188 5.46% $ 655,121 $ 37,316 5.70%
Regular savings accounts
and money market
accounts.................. 351,759 12,745 3.62 246,218 9,578 3.89
Interest-bearing demand
accounts.................. 145,335 1,662 1.14 81,985 1,133 1.38
--------- -------- ---- ---------- -------- ----
Total deposits and checking 1,288,405 57,595 4.47 983,324 48,027 4.88
FHLB Seattle advances...... 336,809 20,837 6.19 341,836 22,179 6.49
All other borrowings....... 196,484 10,844 5.52 243,757 13,985 5.74
Trust Preferred Securities. 40,000 3,800 9.50 21,128 2,220 10.51
Subordinated Notes......... 17,240 1,509 8.75 17,242 1,666 9.66
Advances under line
of credit................. 21,667 1,973 9.11 0 0 0.00
--------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities............... $1,900,605 $ 96,558 5.08% $1,607,287 $ 88,077 5.48%
========= ======== ==== ========== ======== ====
Net interest income........ $ 59,205 $ 47,808
======== ========
Net interest spread........ 2.93% 2.59%
==== ====
Net interest margin........ 3.05% 2.84%
Ratio of average interest-
earning assets to average
interest-bearing
liabilities............... 102.3% 104.7%
Six Months Ended December 31,
------------------------------------------------------------------------
1996 1995
---------------------------------- ----------------------------------
Interest Average Interest Average
Earned Yield Earned Yield
Average or or Average or or
Balance(1) Paid Cost(2) Balance(1) Paid Cost(2)
--------- -------- -------- ---------- -------- --------
(Dollars in thousands)
Interest-earning assets:
Loans...................... $ 962,927 $43,366 8.93% $1,109,816 $48,370 8.65%
Mortgage-backed securities. 389,094 12,687 6.47 300,270 8,561 5.66
Investments and cash
equivalents............... 140,341 3,863 5.46 114,196 2,943 5.11
---------- ------- ---- ---------- ------- ----
Total interest-earning
assets.................... $1,492,362 $59,916 7.96% $1,524,282 $59,874 7.79%
========== ======= ==== ========== ======= ====
Interest-bearing
liabilities:
Certificates of deposit.... $ 614,734 $17,330 5.59% $ 666,821 $19,980 5.94%
Regular savings accounts
and money market
accounts.................. 233,144 4,411 3.75 187,235 3,427 3.63
Interest-bearing demand
accounts.................. 74,726 545 1.45 70,561 546 1.53
---------- ------- ---- ---------- ------- ----
Total deposits and checking 922,604 22,286 4.79 924,617 23,953 5.14
FHLB Seattle advances...... 258,089 8,849 6.80 348,959 11,589 6.59
All other borrowings....... 229,593 6,659 5.75 164,573 5,411 6.52
Trust Preferred Securities. 0 0 0.00 0 0 0.00
Subordinated Notes......... 17,240 832 9.57 17,242 832 9.57
Advances under line
of credit................. 0 0 0.00 0 0 0.00
---------- ------- ---- ---------- ------- ----
Total interest-bearing
liabilities............... $1,427,526 $38,626 5.37% $1,455,391 $41,785 5.70%
========== ======= ==== ========== ======= ====
Net interest income........ $21,290 $18,089
======= =======
Net interest spread........ 2.59% 2.09%
==== ====
Net interest margin........ 2.83% 2.35%
Ratio of average interest-
earning assets to average
interest-bearing
liabilities............... 104.5% 104.7%
Fiscal Years Ended June 30,
---------------------------------------------------------------------------
1996 1995
---------------------------------- -------------------------------------
Interest Average Interest Average
Earned Yield Earned Yield
Average or or Average or or
Balance(1) Paid Cost(2) Balance(1) Paid Cost(2)
--------- -------- -------- ---------- -------- --------
(Dollars in thousands)
Interest-earning assets:
Loans...................... $1,027,268 $ 89,751 8.74% $1,045,279 $ 83,385 7.98%
Mortgage-backed securities. 357,996 22,291 6.23 351,570 22,640 6.44
Investments and cash
equivalents............... 114,748 5,757 5.02 114,769 5,790 5.04
--------- -------- ---- ---------- -------- ----
Total interest-earning
assets.................... $1,500,012 $117,799 7.85% $1,511,618 $111,815 7.40%
========= ======== ==== ========== ======== ====
Interest-bearing
liabilities:
Certificates of deposit.... $ 647,555 $ 38,091 5.88% $ 661,822 $ 34,622 5.23%
Regular savings accounts
and money market
accounts.................. 205,698 7,595 3.69 167,847 6,121 3.65
Interest-bearing demand
accounts.................. 71,628 1,121 1.57 79,208 1,279 1.61
--------- -------- ---- ---------- -------- ----
Total deposits and checking 924,881 46,807 5.06 908,877 42,022 4.62
FHLB Seattle advances...... 326,232 21,691 6.65 397,642 22,546 5.67
All other borrowings....... 167,087 9,994 5.98 133,075 7,866 5.91
Trust Preferred Securities. 0 0 0.00 0 0 0.00
Subordinated Notes......... 17,240 1,680 9.74 17,246 1,674 9.71
Advances under line
of credit................. 0 0 0.00 0 0 0.00
--------- -------- ---- ---------- -------- ----
Total interest-bearing
liabilities............... $1,435,440 $ 80,172 5.59% $1,456,840 $ 74,108 5.09%
========= ======== ==== ========== ======== ====
Net interest income........ $ 37,627 $ 37,707
======== ========
Net interest spread........ 2.26% 2.31%
==== ====
Net interest margin........ 2.51% 2.49%
Ratio of average interest-
earning assets to average
interest-bearing
liabilities............... 104.5% 103.8%
- ------------------
(1) Average balances are computed on a monthly basis.
(2) The yield information for the available-for-sale portfolio does not give
effect to changes in fair value that are reflected as a component of
shareholders' equity.
34
The following table illustrates the changes in Sterling's NII due to
changes in volume (change in volume multiplied by initial rate), changes in
interest rate (change in rate multiplied by initial volume) and changes in
rate/volume (change in rate multiplied by change in average volume) for the
periods indicated.
Year Ended
December 31, 1998
versus
Year Ended
December 31, 1997
Increase (Decrease) Due to:
------------------------------------------------
Rate/
Volume Rate Volume Total
------- ------- ------- -------
(Dollars in thousands)
Interest income on:
Loans...................... $22,252 $(2,756) $ (646) $18,850
Mortgage-backed securities. (1,039) (1,093) 39 (2,093)
Investments and cash
equivalents............... 1,953 1,003 165 3,121
------- ------- ------- -------
Total interest income...... 23,166 (2,846) (442) 19,878
------- ------- ------- -------
Deposits and checking
accounts:
Certificates of deposit.... 7,757 (1,561) (324) 5,872
Regular savings accounts
and money market accounts. 4,106 (657) (282) 3,167
Interest-bearing demand
accounts.................. 875 (195) (151) 529
------- ------- ------- -------
Total deposits and checking
accounts:................. 12,738 (2,413) (757) 9,568
FHLB Seattle advances...... (326) (1,031) 15 (1,342)
All other borrowings....... (2,712) (532) 103 (3,141)
Trust Preferred Securities. 1,983 (213) (190) 1,580
Subordinated Notes......... 0 (157) 0 (157)
Advances under line of
credit.................... 0 0 1,973 1,973
------- ------- ------- -------
Total interest expense..... 11,683 (4,346) 1,144 8,481
------- ------- ------- -------
Net interest income........ $11,483 $ 1,500 $(1,586) $11,397
======= ======= ======= =======
Six Months Ended
December 31, 1996
versus
Six Months Ended
December 31, 1995
Increase (Decrease) Due to:
------------------------------------------------
Rate/
Volume Rate Volume Total
------- ------- ------- -------
(Dollars in thousands)
Interest income on:
Loans...................... $(6,402) $ 1,611 $(213) $(5,004)
Mortgage-backed securities. 2,532 1,230 364 4,126
Investments and cash
equivalents............... 674 200 46 920
------- ------- ----- -------
Total interest income...... (3,196) 3,041 197 42
------- ------- ----- -------
Deposits and checking
accounts:
Certificates of deposit.... (1,561) (1,182) 93 (2,650)
Regular savings accounts
and money market accounts. 840 115 29 984
Interest-bearing demand
accounts.................. 32 (31) (2) (1)
------- ------- ----- -------
Total deposits and checking
accounts:................. (689) (1,098) 120 (1,667)
FHLB Seattle advances...... (3,018) 376 (98) (2,740)
All other borrowings....... 2,138 (638) (252) 1,248
Trust Preferred Securities. 0 0 0 0
Subordinated Notes......... 0 0 0 0
Advances under line of
credit.................... 0 0 0 0
------- ------- ----- -------
Total interest expense..... (1,569) (1,360) (230) (3,159)
------- ------- ----- -------
Net interest income........ $(1,627) $ 4,401 $ 427 $ 3,201
======= ======= ===== =======
Fiscal Year Ended
June 30, 1996
versus
Fiscal Year Ended
June 30, 1995
Increase (Decrease) Due to:
------------------------------------------------
Rate/
Volume Rate Volume Total
------- ------- ------- -------
(Dollars in thousands)
Interest income on:
Loans...................... $(1,437) $ 7,940 $(137) $6,366
Mortgage-backed securities. 414 (749) (14) (349)
Investments and cash
equivalents............... (1) (32) 0 (33)
------- ------- ----- ------
Total interest income...... (1,024) 7,159 (151) 5,984
------- ------- ----- ------
Deposits and checking
accounts:
Certificates of deposit.... (746) 4,308 (93) 3,469
Regular savings accounts
and money market accounts. 1,380 76 18 1,474
Interest-bearing demand
accounts.................. (122) (39) 3 (158)
------- ------- ----- ------
Total deposits and checking
accounts:................. 512 4,345 (72) 4,785
FHLB Seattle advances...... (4,049) 3,893 (699) (855)
All other borrowings....... 2,010 94 24 2,128
Trust Preferred Securities. 0 0 0 0
Subordinated Notes......... (1) 7 0 6
Advances under line of
credit.................... 0 0 0 0
------- ------- ----- ------
Total interest expense..... (1,528) 8,339 (747) 6,064
------- ------- ----- ------
Net interest income........ $ 504 $(1,180) $ 596 $ (80)
======= ======= ===== ======
35
Asset and Liability Management
The results of operations for savings institutions may be materially
and adversely affected by changes in prevailing economic conditions, including
rapid changes in interest rates, declines in real estate market values and the
monetary and fiscal policies of the federal government. Like all financial
institutions, Sterling's NII and the NPV, or estimated fair value, are subject
to fluctuations in interest rates. For example, some of Sterling's ARMs are
indexed to the weekly average yield on one-year U.S. Treasury securities. When
interest-earning assets such as loans are funded by interest-bearing liabilities
such as deposits, FHLB Seattle advances and other borrowings, a changing
interest rate environment may have a dramatic effect on Sterling's results of
operations. Currently, Sterling's interest-bearing liabilities, consisting
primarily of savings deposits, FHLB Seattle advances and other borrowings,
mature or reprice more rapidly, or on different terms, than do its interest-
earning assets. The fact that liabilities mature or reprice more frequently on
average than assets may be beneficial in times of declining interest rates;
however, such an asset/liability structure may result in declining NII during
periods of rising interest rates. See "Business - Lending Activities."
Additionally, the extent to which borrowers prepay loans is affected
by prevailing interest rates. When interest rates increase, borrowers are less
likely to prepay loans; whereas when interest rates decrease, borrowers are more
likely to prepay loans. Prepayments may affect the levels of loans retained in
an institution's portfolio as well as its NII.
Sterling maintains an asset and liability management program intended
to manage NII through interest rate cycles and to protect its NPV by controlling
its exposure to changing interest rates. Sterling uses a simulation model
designed to measure the sensitivity of NII and NPV to changes in interest rates.
This simulation model is designed to enable Sterling to generate a forecast of
NII and NPV given various interest rate forecasts and alternative strategies.
The model is also designed to measure the anticipated impact that prepayment
risk, basis risk, customer maturity preferences, volumes of new business and
changes in the relationship between long- and short-term interest rates have on
the performance of Sterling. The model calculates the present value of assets,
liabilities, off-balance sheet financial instruments, and equity at current
interest rates and at hypothetical higher and lower interest rates at various
intervals. The present value of each major category of financial instruments is
calculated using estimated cash flows based on weighted-average contractual
rates and terms, then discounted at the estimated current market interest rate
for similar financial instruments. The present value of longer term fixed-rate
financial instruments is more difficult to estimate because such instruments are
susceptible to changes in market interest rates. Present value estimates of
adjustable-rate financial instruments are more reliable since they represent the
difference between the contractual and discounted rates until the next interest
rate repricing date.
The calculations of present value have certain shortcomings. The
discount rates utilized for loans, investments and MBS are based on estimated
nationwide market interest rate levels for similar loans and securities, with
prepayment assumptions based on historical experience and market forecasts. The
unique characteristics of Sterling's loans and MBS may not necessarily parallel
those in the model. The discount rates utilized for deposits and borrowings are
based upon available alternative types and sources of funds which are not
necessarily indicative of the market value of deposits and FHLB Seattle advances
since such deposits and advances are unique to and have certain price and
customer relationship advantages for depository institutions. The present
values are determined based on the discounted cash flows over the remaining
estimated lives of the financial instruments on the assumption that the
resulting cash flows are reinvested in financial instruments with virtually
identical terms.
The total measurement of Sterling's exposure to IRR as presented in
the following table may not be representative of the actual values which might
result from a higher or lower interest rate environment. A higher or lower
interest rate environment will most likely result in different investment and
borrowing strategies by Sterling designed to further mitigate the effect on the
value of and the net earnings generated from Sterling's net assets from any
change in interest rates.
36
With the acquisition of the KeyBank branches, Sterling's NPV
decreased, primarily reflecting the increase in intangible assets and IRR.
Sterling is continuing to pursue strategies to manage the level of its IRR while
increasing its NII and NPV through the origination and retention of variable-
rate consumer, business banking, construction and commercial real estate loans,
which generally have higher yields than residential permanent loans, and by
increasing the level of its core deposits, which are generally a lower-cost
funding source than borrowings. There can be no assurance that Sterling will be
successful implementing any of these strategies or that, if these strategies are
implemented, they will have the intended effect of reducing IRR or increasing
NII.
The following table presents Sterling's estimates of changes in NPV
for the periods indicated. The results indicate the potential effects of
instantaneous, parallel shifts in the market yield curve. These calculations
are highly subjective and technical and are relative measurements of IRR which
do not necessarily reflect any expected rate movement.
At December 31, 1998 At December 31, 1997
----------------------------- ---------------------------------
Change in Ratio of NPV Ratio of NPV
Interest Rate to the Present % to the Present %
in Basis Points Value of Change Value of Change
(Rate Shock) NPV Total Assets in NPV NPV Total Assets in NPV
- ---------------------- --- -------------- ------ --- -------------- ------
(Dollars in thousands)
+300 $11,384 0.53% (86.5) $ 63,304 3.40% (46.5)
+200 37,950 1.72 (55.1) 89,253 4.69 (26.1)
+100 59,814 2.66 (29.3) 113,909 5.87 (7.6)
Static 84,568 3.70 N/A 124,835 6.35 N/A
-100 71,197 3.10 (15.8) 117,947 5.93 (5.9)
-200 50,677 2.20 (40.1) 101,295 5.13 (19.2)
-300 40,966 1.77 (51.6) 80,720 4.11 (35.4)
At December 31, 1998, Sterling calculated that its NPV was $84.6
million, and that its NPV would decrease by 55.1% and 86.5% if interest rate
levels generally were to increase by 2% and 3%, respectively. This compares
with an NPV of $124.8 million at December 31, 1997, where its NPV would decrease
by 26.1% and 46.5% if interest rate levels generally were to increase by 2% and
3%, respectively. See "Business - Regulation - Regulatory Capital Requirements
- - Risk-based Capital."
Sterling also uses gap analysis, a traditional analytical tool
designed to measure the difference between the amount of interest-earning assets
and the amount of interest-bearing liabilities expected to mature or reprice in
a given period. Sterling calculated its one-year cumulative gap position to be
a negative 5.7% and a negative 13.6% at December 31, 1998 and 1997,
respectively. Sterling calculated its three-year gap position to be a negative
9.8% and a negative 6.9% at December 31, 1998 and 1997, respectively. The
reduction in the negative one-year gap position at December 31, 1998 was due
primarily to increases in rate sensitive loans and retail deposits. The
increase in the three-year gap position was due primarily to an increase in cash
and other noninterest-bearing assets and an increase in fixed-rate mortgage
loans. The increase in fixed-rate mortgage loans reflected borrower preferences
to prepay ARM and balloon loans and "lock-in" long-term financing in the current
low-rate environment. Management attempts to maintain Sterling's gap position
between positive 5% and negative 20%. At December 31, 1998, Sterling's gap
positions were within limits established by its Board of Directors. Management
is pursuing strategies to increase its NII without significantly increasing its
cumulative gap positions in future periods. See "Results of Operations - Net
Interest Income" and "Capital Resources."
37
The following table sets forth the estimated maturity/repricing and
the resulting gap between Sterling's interest-earning assets and interest-
bearing liabilities at December 31, 1998. Other than loans which are in the
available-for-sale portfolio, all of the financial instruments of Sterling are
intended to be held to maturity. The estimated maturity/repricing amounts
reflect contractual maturities and amortizations, assumed loan prepayments based
upon Sterling's historical experience, estimates from secondary market sources
such as FHLMC and estimated passbook deposit decay rates (the rate of
withdrawals or transfers to higher-yielding CDs). Management believes these
assumptions and estimates are reasonable, but there can be no assurance in this
regard. The classification of mortgage loans, investments and MBS is based upon
regulatory reporting formats and, therefore, may not be consistent with the
financial information reported in accordance with GAAP and contained elsewhere
in this Report on Form 10-K.
Maturity or Repricing
--------------------------------------------------------------------
Over Over Over
0 to 3 3 Months 1 Year 3 Years Over
Months to 1 Year to 3 Years to 5 Years 5 Years Total
--------- --------- ---------- ---------- -------- -----------
(Dollars in thousands)
Interest-earning assets:
Mortgage loans, investments and MBS:
ARM and balloon mortgage loans......... $348,523 $ 138,660 $ 65,252 $ 3,876 $ 63 $ 556,374
Fixed-rate mortgage loans.............. 34,213 97,190 156,249 106,406 323,962 718,020
Loans held for sale.................... 15,881 0 0 0 0 15,881
-------- --------- --------- --------- -------- ----------
Total mortgage loans, investments
and MBS.............................. 398,617 235,850 221,501 110,282 324,025 1,290,275
Nonmortgage loans:
Consumer............................... 58,634 67,864 95,292 37,188 27,965 286,943
Commercial............................. 157,503 60,626 40,131 27,733 26,928 312,921
-------- --------- --------- --------- -------- ----------
Total loans, investments and MBS....... 614,754 364,340 356,924 175,203 378,918 1,890,139
Cash, investments and MBS.............. 104,419 18,204 3,980 72,759 8,296 207,658
-------- --------- --------- --------- -------- ----------
Total rate-sensitive assets............ 719,173 382,544 360,904 247,962 387,214 2,097,797
Cash on hand and in banks.............. 70,129 70,129
Other noninterest-earning assets....... 146,661 146,661
-------- --------- --------- --------- -------- ----------
Total assets........................... $719,173 $ 382,544 $ 360,904 $ 247,962 $604,004 $2,314,587
======== ========= ========= ========= ======== ==========
Interest-bearing liabilities:
Deposits:
Certificates of deposit................ $273,751 $ 385,111 $ 107,231 $ 33,658 $ 15,206 $ 814,957
Checking accounts...................... 6,042 18,092 48,247 48,247 176,662 297,290
Money market accounts.................. 330,251 0 0 0 0 330,251
Passbook accounts...................... 4,117 12,351 32,937 32,937 20,585 102,927
-------- --------- --------- --------- -------- ----------
Total deposits......................... 614,161 415,554 188,415 114,842 212,453 1,545,425
FHLB Seattle advances.................. 60,000 55,000 103,342 86,342 14,856 319,540
Repurchase agreements.................. 36,194 13,080 145,800 0 0 195,074
Other borrowings....................... 40,000 0 17,240 0 40,000 97,240
-------- --------- --------- --------- -------- ----------
Total interest-bearing liabilities..... $750,355 $ 483,634 $ 454,797 $ 201,184 $267,309 $2,157,279
======== ========= ========= ========= ======== ==========
Other noninterest-bearing liabilities.. 38,291 38,291
Shareholders' equity................... 119,017 119,017
-------- ----------
Total liabilities and shareholders'
equity............................... $424,617 $2,314,587
======== ==========
Net gap................................ $(31,182) $(101,090) $ (93,893) $ 46,778 $179,387 $ 0
======== ========= ========= ========= ======== ==========
Cumulative gap......................... $(31,182) $(132,272) $(226,165) $(179,387) $ 0 $ 0
======== ========= ========= ========= ======== ==========
Cumulative gap to total assets......... (1.35)% (5.71)% (9.77)% (7.20)% 0.0% 0.0%
38
Financial Position
Assets. At December 31, 1998, Sterling's assets were $2.31 billion,
up 19.4% from $1.94 billion at December 31, 1997. The increase was due primarily
to increases associated with the KeyBank branch acquisition as well as internal
generation of loans.
Investments and MBS. Sterling's investment and MBS portfolio at
December 31, 1998 was $586.4 million, down $104.5 million from the December 31,
1997 balance of $690.9 million. The decrease was due primarily to net sales of
MBS during the period.
Loans Receivable. At December 31, 1998, net loans receivable were
$1.47 billion, up $362.8 million from $1.11 billion at December 31, 1997. A
portion of the increase was due to the acquisition of $123.7 million of KeyBank
loans, net of allowances for loan losses, on June 15, 1998. These loans were
comprised of consumer and business banking portfolios of $79.9 million and
$43.8 million, respectively. Loan originations increased $196.8 million from
December 31, 1997. The most significant area of increase in loan originations
for the year ended December 31, 1998 was in consumer lending. See the loan
origination table below.
The following table sets forth the composition of Sterling's loan
portfolio at the dates indicated. Loan balances do not include undisbursed loan
proceeds, unearned discounts, deferred loan origination costs and fees or
allowances for loan losses.
December 31, 1998 December 31, 1997
----------------- -----------------
Amount % Amount %
-------- -- -------- --
(Dollars in thousands)
Residential............. $ 342,757 21.3 $ 313,792 26.0
Multifamily............. 124,656 7.7 68,697 5.7
Commercial real estate.. 177,912 11.1 120,502 10.0
Construction............ 358,714 22.3 302,940 25.1
Consumer - direct....... 224,651 14.0 139,666 11.6
Consumer - indirect..... 64,764 4.0 19,016 1.6
Business banking........ 315,614 19.6 241,808 20.0
---------- ----- ---------- -----
Total loans receivable.. $1,609,068 100.0 $1,206,421 100.0
========== ===== ========== =====
The following table sets forth Sterling's loan originations for the
periods indicated.
Years Ended December 31,
------------------------
1998 1997 % Change
---- ------ --------
(Dollars in thousands)
Residential............. $ 241,725 $179,297 34.8
Multifamily............. 83,904 29,015 189.2
Commercial real estate.. 34,735 36,410 (4.6)
Construction............ 316,135 291,154 8.6
Consumer - direct....... 99,449 79,448 25.2
Consumer - indirect..... 51,958 20,955 148.0
Business banking........ 178,209 173,014 3.0
---------- --------
Total loans originated.. $1,006,115 $809,293 24.3
========== ========
39
Deposits. Total deposits increased $461.0 million to $1.55 billion at
December 31, 1998 from $1.08 billion at December 31, 1997. Sterling assumed
$517.5 million in deposits associated with the KeyBank branch acquisition in
June 1998.
The following table sets forth the composition of Sterling's deposits
at the dates indicated.
December 31, 1998 December 31, 1997
----------------- -----------------
Amount % Amount %
-------- -- -------- --
(Dollars in thousands)
Certificates of deposit... $ 814,957 52.7 $ 704,655 65.0
Checking.................. 297,290 19.2 123,511 11.4
Savings and money market.. 433,178 28.1 256,279 23.6
---------- ----- ---------- -----
Total deposits............ $1,545,425 100.0 $1,084,445 100.0
========== ===== ========== =====
Borrowings. Sterling's primary sources of borrowing are the FHLB
Seattle advances, securities sold under agreements to repurchase and other
borrowings. At December 31, 1998, total borrowings were $611.9 million,
compared with $712.4 million at December 31, 1997, a decrease of $100.5 million.
The decrease reflects the repayment of certain borrowings with the net cash
acquired with the KeyBank branch acquisition, thereby replacing wholesale funds
with lower cost deposit funding sources. FHLB Seattle advances outstanding have
decreased by $140.5 million since December 31, 1997. See "Liquidity and Sources
of Funds."
Results of Operations for the Years Ended December 31, 1998 and 1997
Overview. Core earnings, which are defined as total earnings before
acquisition and conversion costs, associated with two acquisitions and certain
other charges (collectively, "non-core charges"), for the year ended December
31, 1998 were $11.4 million, or $1.39 per diluted share. After the non-core
charges, Sterling recorded net income of $6.2 million, or $0.76 per diluted
share for the year ended December 31, 1998. This compares to net income of
$10.2 million, or $1.25 per diluted share, for the year ended December 31, 1997.
The increases in core earnings for the twelve-month period reflected an increase
in net interest income and other income.
Sterling completed its merger with Big Sky on November 13, 1998. This
transaction was accounted for as a pooling of interests; and accordingly, all
historical amounts have been restated to include the results of Big Sky. The
after-tax non-core charges associated with the Big Sky acquisition were
approximately $1.5 million. During the second quarter of 1998, Sterling
completed the acquisition of 33 Northwest KeyBank branches. After-tax non-core
charges associated with the KeyBank branch acquisition were approximately $2.0
million. See "Operating Expenses."
During the second quarter of 1998, Sterling added approximately $2.9
million for loan losses to its reserves. In addition, to improve asset and
liability management associated with the effects of the acquisition of the
KeyBank branches, a loss of approximately $581,000 was incurred on the sale of
MBS during the second quarter of 1998. See "Provision for Loan Losses."
The returns on average common shareholders' equity and average assets
were negatively impacted by the non-core charges during 1998. The returns on
average assets were 0.30% and 0.58% for the years ended December 31, 1998 and
1997, respectively. The returns on average common shareholders' equity were
5.4% and 11.1% for the years ended December 31, 1998 and 1997, respectively.
These decreases were due primarily to non-core charges and higher operating
expenses.
Net Interest Income. Net interest income for the years ended December
31, 1998 and 1997 was $59.2 million and $47.8 million, respectively. During
these same periods, the net interest margins were 3.05% and 2.84%, respectively,
and the volumes of interest-earning assets were $1.94 billion and $1.68 billion,
respectively. The increase in NII was due primarily to an increase in the volume
of average interest-earning assets which were primarily loans and an increase in
the net interest margin. The increase in the net interest margin was due
primarily to a decrease in the cost of deposits.
40
Provision for Loan Losses. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding provisions
against income. The evaluation of the adequacy of specific and general
valuation allowances is an ongoing process. Sterling recorded provisions for
loan losses of $5.3 million and $2.5 million for the years ended December 31,
1998 and 1997, respectively. Sterling increased its provision for loan losses
in anticipation of potentially higher levels of loss from its expanded
construction, business banking and consumer lending activities. Additionally,
during the quarter ended June 30, 1998, Sterling provided approximately $2.9
million for loan losses, reflecting a more conservative view of the factors used
to determine such reserves, including impacts on Pacific Northwest economy
resulting from a slowdown of trade with Asia. Management anticipates that its
provisions for loan losses will increase in the future as Sterling continues to
expand into higher-yielding, higher-risk loans.
At December 31, 1998, Sterling's loan delinquency rate as a percentage
of total loans was 0.43%, compared with 0.69% at December 31, 1997. Total
nonperforming loans were $3.1 million at December 31, 1998, compared with $4.9
million at December 31, 1997. As a percentage of total loans, nonperforming
loans were 0.19% at December 31, 1998, compared with 0.41% at December 31, 1997.
Management believes the loan loss provisions represent appropriate allowances
for loan losses based upon its evaluation of factors affecting the adequacy of
valuation allowances, although there can be no assurance in this regard. Such
factors include concentrations of the types of loans and associated risks within
the loan portfolio and economic factors affecting the Pacific Northwest economy.
Other Income. The following table summarizes the components of other
income for the periods indicated:
Years Ended
December 31,
------------------------
1998 1997
------------ ----------
(Dollars in thousands)
Fees and service charges.................. $ 7,858 $5,140
Mortgage banking operations............... 1,848 1,922
Loan servicing fees....................... 791 1,299
Net gain on sales of securities........... 2,038 1,197
Net loss on sales and operations of real
estate owned ("REO")................... (222) (84)
------- ------
$12,313 $9,474
======= ======
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on sales of
credit life insurance, commissions on sales of mutual funds and annuity products
and late charges on loans. The increase for the year ended December 31, 1998,
compared with the year ended December 31, 1997, was due primarily to an increase
in service charges on deposit accounts, fees for certain customer services and
commissions on sales of credit life insurance. The increase in service charges
on deposit accounts and fees for certain customer services was due primarily to
an increase in the number of accounts associated with the KeyBank branch
acquisition.
The following table summarizes loan originations and sales of loans
for the periods indicated:
Years Ended
December 31,
---------------------
1998 1997
---------- ---------
(Dollars in millions)
Originations of one- to four-family permanent
mortgage loans............................... $241.7 $179.3
Sales of residential loans..................... 110.2 108.0
Principal balances at end of period of
mortgage loans serviced for others........... 211.0 454.3
41
The decrease in loan servicing fees for the year ended December 31,
1998, compared with the year ended December 31, 1997, was due primarily to a
decrease in the balance of loans serviced. During the year ended December 31,
1998, Sterling sold in bulk rights to service conventional loans for others with
principal balances of $117.6 million. There were no such sales in the year
ended December 31, 1997. Sterling's average loan servicing portfolios for the
years ended December 31, 1998 and 1997 were approximately $283.3 million and
$506.8 million, respectively.
During the year ended December 31, 1998, Sterling sold approximately
$394.8 million of investments and MBS, resulting in a net gain of $2.0 million.
In the same period in 1997, Sterling sold $263.3 million in investments and MBS,
resulting in a net gain of $1.2 million.
Operating Expenses. Operating expenses before non-core charges were
$50.8 million for the year ended December 31, 1998. Including non-core charges,
total operating expenses were $56.3 million, compared with $38.4 million for the
year ended December 31, 1997. Non-core charges included acquisition and
conversion costs, the buyout of certain management contracts and the costs
associated with mailing customer notices, issuing new checks and ATM cards,
training new employees, related travel expenses, equipping branches with office
supplies, implementing a targeted marketing campaign and converting computer
systems.
Employee compensation and benefits were $22.4 million and $16.6
million for the years ended December 31, 1998 and 1997, respectively. The
increase was due primarily to an increase in staffing for the new branches and
in lending staff related to Sterling's efforts to increase its commercial real
estate, business banking and consumer lending areas. Amortization of
intangibles amounted to $4.0 million and $2.2 million for the years ended
December 31, 1998 and 1997, respectively. The increase was due primarily to the
KeyBank branch acquisition. Occupancy and equipment expenses were $7.5 million
and $6.2 million for the years ended December 31, 1998 and 1997, respectively.
This increase resulted from increased branches. Insurance expenses were $1.1
million and $1.2 million for the years ended December 31, 1998 and 1997,
respectively. The decrease was due primarily to a reduction in property and
casualty insurance premiums. Legal and accounting expenses were $1.6 million
and $1.5 million during the years ended December 31, 1998 and 1997,
respectively. The increase was due primarily to an increase in accounting
expenses. Other expenses were $3.7 million and $2.3 million for the years ended
December 31, 1998 and 1997, respectively. The increase in other expenses was
due primarily to a reduction in the deferral of loan origination costs, as well
as an increase in loan processing expense. See "General," "Capital Resources,"
"Year 2000 Issues" and Note 19 of "Notes to Consolidated Financial Statements."
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total revenues, which
includes NII and total other income but excludes intangible amortization
expense). Sterling's operating efficiency ratios were 73.2% and 63.2% for the
years ended December 31, 1998 and 1997, respectively. Management is striving to
reduce its operating efficiency ratio below 65%, but there can be no assurance
that it will be able to achieve this goal. Sterling also measures the
efficiency of its operations by its cash operating efficiency ratio (the ratio
of total operating expenses to total revenues, which includes NII and total
other income but excludes non-core charges and intangible amortization expense).
Sterling's cash operating efficiency ratios were 65.0% and 63.2% for the years
ended December 31, 1998 and 1997, respectively.
Income Tax Provision. For the year ended December 31, 1998,
Sterling's federal and state income tax provision of $3.7 million represented
37.2% of income before income taxes. The effective income tax rates are higher
than the statutory federal rate due to higher sources of income being derived
from states with income taxes. For the year ended December 31, 1997, Sterling's
income tax provision of $6.2 million consisted of the provision on the operating
income which approximates the statutory tax rates plus a provision related to a
change in the estimate of prior period income taxes.
Results of Operations for the Six Months Ended December 31, 1996 and 1995
Overview. Sterling's SAIF assessment resulted in a pre-tax charge to
earnings of $6.1 million during the six months ended December 31, 1996.
Primarily as a result of this charge and an increase in other operating
expenses, Sterling reported a net loss of $1.0 million, or $0.33 per diluted
share, for the six months ended December 31, 1996, compared with net income of
$3.8 million, or $0.48 per diluted share, for the six months ended December 31,
1995.
42
The annualized return on average assets was (0.13)% and 0.48% for the
six months ended December 31, 1996 and 1995, respectively. The return on
average common shareholders' equity was (5.7)% and 8.0% for the six months ended
December 31, 1996 and 1995, respectively. This decrease was due primarily to
the SAIF assessment and the increase in other operating expenses.
Net Interest Income. Net interest income for the six months ended
December 31, 1996 was $21.3 million, compared to $18.1 million for the six
months ended December 31, 1995. During these same periods, the net interest
margins were 2.83% and 2.35%, respectively, and the volumes of interest-earning
assets were $1.49 billion and $1.52 billion, respectively. The increase in NII
was due primarily to an increase in the rates earned on interest-earning assets
coupled with a decrease in the cost of deposits and other borrowings. See "Net
Interest Income."
Provision for Loan Losses. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding provisions
against income. The evaluation of the adequacy of specific and general
valuation allowances is an ongoing process. Sterling recorded provisions for
loan losses of $1.1 million and $822,000 for the six months ended December 31,
1996 and 1995, respectively.
At December 31, 1996, Sterling's loan delinquency rate as a percentage
of total loans was 0.51%, compared with 0.56% at December 31, 1995. Total
nonperforming loans were $2.5 million at December 31, 1996, compared with $4.5
million at December 31, 1995. As a percentage of total loans, nonperforming
loans were 0.24% at December 31, 1996, compared with 0.47% at December 31, 1995.
Management believes the loan loss provisions represent appropriate allowances
for loan losses based upon its evaluation of factors affecting the adequacy of
valuation allowances, although there can be no assurance in this regard. Such
factors include concentrations of the types of loans and associated risks within
the loan portfolio and economic factors affecting the Pacific Northwest economy.
Other Income. The following table summarizes the components of other
income for the periods indicated:
Six Months Ended
December 31,
------------------------
1996 1995
----------- -----------
(Dollars in thousands)
Fees and service charges................. $2,506 $1,882
Mortgage banking operations.............. 1,686 1,761
Loan servicing fees...................... 639 466
Net gain on sales of securities.......... 46 451
Net gain on sale of building............. 0 616
Net loss on sales and operations of REO.. (102) (114)
------ ------
$4,775 $5,062
====== ======
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on sales of
credit life insurance and late charges on loans, as well as escrow fees,
commissions on sales of mutual funds and annuity products. The increase for the
six months ended December 31, 1996, compared with the six months ended December
31, 1995, was due primarily to an increase in service charges on deposit
accounts, fees for certain customer services and commissions on sales of credit
life insurance. This increase in service charges on deposit accounts and fees
for certain customer services was due primarily to the change in the mix of
Sterling's deposit accounts.
The decrease in income from mortgage banking operations for the six
months ended December 31, 1996, compared with the six months ended December 31,
1995, primarily resulted from a decrease in the volume of loans sold during the
six months ended December 31, 1996, as compared with the six months ended
December 31, 1995.
43
The following table summarizes loan originations and sales of loans
for the periods indicated:
Six Months Ended
December 31,
---------------------
1996 1995
---------- ---------
(Dollars in millions)
Originations of one- to four-family permanent
mortgage loans.............................. $ 75.0 $126.1
Sales of residential loans..................... 77.9 122.8
Principal balances at end of period of
mortgage loans serviced for others.......... 542.2 837.1
The increase in loan servicing fees for the six months ended December
31, 1996, compared with the six months ended December 31, 1995, was due
primarily to a decrease in the balance of loans serviced that have amortization
of a related acquisition premium, offsetting the loan servicing income.
Sterling's average loan servicing portfolios for the six months ended
December 31, 1996 and 1995 were approximately $562.3 million and $625.2 million,
respectively.
During the six months ended December 31, 1995, Sterling sold
approximately $55.6 million of investments and MBS. Sterling used the majority
of the proceeds from the 1995 sales to invest in one- to four-family loans and
intermediate-term MBS.
Operating Expenses. Operating expenses were $25.8 million and $16.2
million for the six months ended December 31, 1996 and 1995, respectively. The
significant increase is due primarily to the one-time SAIF assessment and
increases in employee compensation and benefits, legal and accounting costs and
other expenses.
Employee compensation and benefits were $7.3 million and $6.4 million
for the six months ended December 31, 1996 and 1995, respectively. The increase
was due primarily to an increase in the number of employees. Occupancy and
equipment expenses were $2.9 million and $2.7 million for the six months ended
December 31, 1996 and 1995, respectively. Depreciation expense was $1.6 million
and $1.4 million for the six months ended December 31, 1996 and 1995,
respectively. The increases in occupancy and equipment and depreciation expenses
were due primarily to higher computer and data processing costs following a
conversion to a new data processing system in October 1995. Insurance expenses
were $1.3 million and $1.2 million for the six months ended December 31, 1996
and 1995, respectively. The increase was due primarily to the initiation of
liability coverage for directors and officers and to increased premiums on
property and casualty policies. Legal and accounting expenses were $1.3 million
and $548,000 during the six months ended December 31, 1996 and 1995,
respectively. The increase was due primarily to costs incurred to pursue
Sterling's breach of contract claim against the U.S. government and higher
levels of accounting and regulatory examination costs. Other expenses were $1.0
million and $465,000 for the six months ended December 31, 1996 and 1995,
respectively. The increase in other expenses was due primarily to a reduction in
the deferral of loan origination costs, increased business and occupation taxes
and increased provisions for various other expense items. See "General,"
"Capital Resources" and Note 19 of "Notes to Consolidated Financial Statements."
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total revenues, which
includes NII and total other income but excludes intangible amortization
expense). Sterling's operating efficiency ratios were 92.9% and 62.9% for the
six months ended December 31, 1996 and 1995, respectively. The increase was due
primarily to the significant increase in operating expenses described above.
Sterling also measures the efficiency of its operations by its cash operating
efficiency ratio (the ratio of total operating expenses to total revenues, which
includes NII and total other income but excludes intangible amortization and the
one-time SAIF assessment). Sterling's cash operating efficiency ratios were
69.3% and 62.9% for the six months ended December 31, 1996 and 1995,
respectively.
44
Income Tax Provision. For the six months ended December 31, 1996,
Sterling's federal and state income tax provision of $162,000 resulted from a
change in the estimated prior period income taxes which exceeded the benefit
from the current operating loss related to a change in the estimate of prior
period income taxes. For the six months ended December 31, 1995, Sterling's
income tax provision was $2.3 million, a 36.9% effective tax rate. The
effective income tax rates are higher than the statutory federal rate due to
higher sources of income being derived from states with income taxes.
Results of Operations for Fiscal Years Ended June 30, 1996 and 1995
Overview. Sterling reported net income of $7.7 million, or $0.97 per
diluted share, for the fiscal year ended June 30, 1996, compared with the fiscal
year ended June 30, 1995, when net income was $9.9 million or $1.27 per diluted
share. In the fiscal year ended June 30, 1996, the decrease in net income was
due primarily to a decrease in income from mortgage banking operations. All per
share amounts have been adjusted for all Common Stock dividends declared and/or
paid. See "- Other Income" and "- Operating Expenses."
For the fiscal year ended June 30, 1996, the annualized return on
average assets was 0.49%, compared with 0.62% for the fiscal year ended June 30,
1995. The decrease was due primarily to the decrease in net income. The return
on common shareholders' equity was 8.1% for the fiscal year ended June 30, 1996,
compared with 12.8% for the fiscal year ended June 30, 1995. This decrease was
due primarily to a decline in income from mortgage banking operations.
Net Interest Income. NII was $37.6 million for the fiscal year ended
June 30, 1996, compared with NII of $37.7 million for the fiscal year ended June
30, 1995. During this same period, the net interest margins were 2.51% and
2.49%, respectively, and the volumes of interest-earning assets were $1.50
billion and $1.51 billion, respectively. The decrease in NII was due primarily
to an increase in the cost of funds. The increase in net interest margin was
due primarily to the increase in the yield on average interest-earning assets.
See "Net Interest Income."
Provision for Loan Losses. Management's policy is to establish
valuation allowances for estimated losses by charging corresponding provisions
against income. The evaluation of the adequacy of specific and general
valuation allowances is an ongoing process. Sterling recorded provisions for
loan losses of $1.6 million for the fiscal years ended June 30, 1996 and 1995.
At June 30, 1996, Sterling's loan delinquency rate was 0.35%, compared
with 0.33% at June 30, 1995. Total nonperforming loans were $3.6 million at
June 30, 1996 and 1995, respectively. As a percentage of total loans,
nonperforming loans were 0.34% at June 30, 1996 compared with 0.31% at June 30,
1995. Management believes the loan loss provisions represent appropriate
allowances for loan losses based upon its evaluation of the factors affecting
the adequacy of valuation allowances, although there can be no assurance in this
regard. Such factors include concentrations of the types of loans and
associated risks within the loan portfolio and economic factors affecting the
Pacific Northwest economy.
Other Income. The following table summarizes the components of other
income for the periods indicated.
Fiscal Years Ended June 30,
---------------------------
1996 1995
-------- ------
(Dollars in thousands)
Fees and service charges................. $4,643 $ 4,176
Mortgage banking operations.............. 3,054 6,416
Loan servicing fees...................... 933 1,286
Net gain on sales of securities.......... 458 253
Net gain on sale of building............. 616 0
Net loss on sales and operations of REO.. (171) (491)
------ -------
$9,533 $11,640
====== =======
45
Fees and service charges consist primarily of service charges on
deposit accounts, fees for certain customer services, commissions on sales of
credit life insurance and late charges on loans, as well as escrow fees,
commissions on sales of mutual funds and annuity products. The increase for the
fiscal year ended June 30, 1996 was due primarily to an increase in service
charges on deposit accounts, fees for certain customer services and commissions
on sales of credit life insurance.
The decrease in income from mortgage banking operations for the fiscal
year ended June 30, 1996 was due primarily to lower levels of bulk sales of
servicing rights. During the fiscal year ended June 30, 1996 there were no gains
on bulk sales of loan servicing rights compared with a gain of $5.6 million for
the fiscal year ended June 30, 1995. Sterling sold bulk servicing during the
fiscal year ended June 30, 1995 primarily to offset the reduction in residential
loan originations and related gains on sales of loans. Residential loan
originations declined in response to a reduction in refinance activities and
increases in short-term interest rates. See "Asset and Liability Management."
The following table summarizes loan originations and sales of loans
and bulk servicing rights for the periods indicated:
Fiscal Years Ended June 30,
----------------------------
1996 1995
------- ------
(Dollars in millions)
Originations of one- to
four-family permanent mortgage loans................... $221.1 $288.8
Sales of residential loans............................... 232.1 98.2
Principal balances of servicing portfolios sold in bulk
during the period...................................... 172.2 437.8
Principal balances of servicing portfolios acquired...... 0.0 451.4
Principal balances at end of period of mortgage loans
serviced for others.................................... 587.8 647.0
The decrease in loan servicing fees for the fiscal year ended June 30,
1996, compared with the fiscal year ended June 30, 1995, was due primarily to a
decrease in the average size of the loan servicing portfolios. During the fiscal
years ended June 30, 1996 and 1995, Sterling sold in bulk rights to service
conventional loans for others with principal balances of $172.2 million and
$437.8 million, respectively. Gains on these sales were included in income from
mortgage banking operations. Sterling's average loan servicing portfolios for
the fiscal years ended June 30, 1996 and 1995 were approximately $677.4 million
and $671.4 million, respectively.
During the fiscal year ended June 30, 1996, Sterling sold
approximately $55.6 million of investments and MBS. In the fiscal year ended
June 30, 1996, Sterling used the majority of the sales proceeds to repay
maturing borrowings and jumbo deposits. See "Asset and Liability Management."
The decrease in net losses from sales and operation of REO was due
primarily to a higher level of income from the operations of REO.
Operating Expenses. Operating expenses were $33.1 million for the
fiscal year ended June 30, 1996, compared with $32.8 million for fiscal year
ended June 30, 1995. The increase in operating expenses of 1.0% was due
primarily to increases in depreciation, employee compensation and benefits,
insurance, and occupancy and equipment, offset by decreases in advertising, data
processing and amortization of intangibles. See Note 19 of "Notes to
Consolidated Financial Statements."
Sterling measures the efficiency of its operations by its operating
efficiency ratio (the ratio of total operating expenses to total revenues, which
includes NII and total other income but excludes intangible amortization
expense). Sterling's operating efficiency ratios were 63.1% and 59.4% for the
fiscal years ended June 30, 1996 and 1995, respectively. The increase was due
primarily to lower levels of NII and income from mortgage banking operations.
In addition, the operating efficiency ratio reflected a decrease in cost
efficiency of the residential lending operations due primarily to a decrease in
loan originations. Management is striving to reduce its operating efficiency
ratio below 65%, but there can be no assurance that it will be able to achieve
this goal.
46
Sterling also measures the efficiency of its operations by its cash operating
efficiency ratio (the ratio of total operating expenses to total revenues, which
includes NII and total other income but excludes non-core charges and intangible
amortization expense). Sterling's cash operating efficiency ratios were 63.1%
and 59.4% for the fiscal years ended June 30, 1996 and 1995, respectively.
Income Tax Provision. Income tax provisions were $4.7 million and $5.0
million for the fiscal years ended June 30, 1996 and 1995, respectively. For the
fiscal years ended June 30, 1996 and 1995, the effective tax rates on income
before income taxes were 37.6% and 33.8%, respectively. The effective tax rate
for the fiscal year ended June 30, 1996 was influenced by higher sources of
income being derived from states with state income taxes.
Liquidity and Sources of Funds
As a financial institution, Sterling's primary sources of funds are
operating, investing and financing activities, including the collection of loan
principal and interest payments. Financing activities consist primarily of
customer deposits, advances from the FHLB Seattle and other borrowings. Deposits
increased to $1.55 billion at December 31, 1998, from $1.08 billion at December
31, 1997. Retail deposits, which exclude public funds, increased to $1.45
billion at December 31, 1998, from $990.0 million at December 31, 1997. At
December 31, 1998, approximately $98.2 million of deposits consisted of public
funds that generally had maturities of 60 days or less. Advances from the FHLB
Seattle decreased to $319.5 million at December 31, 1998 from $460.1 million at
December 31, 1997. See "Business - Sources of Funds - Borrowings."
Sterling also borrows funds under reverse repurchase agreements
pursuant to which it sells investments (generally U.S. agency and MBS) 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. Sterling uses these borrowings to supplement deposit
gathering for funding the origination of loans. Sterling had $195.1 million and
$180.1 million in reverse repurchase agreements outstanding at December 31, 1998
and 1997, respectively. Sterling enters into short-term repurchase agreements
with selected retail customers. The balance of such short-term repurchase
agreements was $6.8 million at December 31, 1998. The use of reverse repurchase
agreements may expose Sterling to certain risks not associated with other
borrowings, including IRR and the possibility that additional collateral may
have to be provided if the market value of the pledged collateral declines. For
additional information regarding reverse repurchase agreements, see
"Asset and Liability Management" and Note 10 of "Notes to Consolidated Financial
Statements."
During the year ended December 31, 1998, Sterling received net cash
from the KeyBank branch acquisition of approximately $327.2 million. Other cash
was provided by investing activities consisting of principal and interest
payments on loans and MBS and sales of MBS. The levels of these payments and
sales increase or decrease depending on the size of the loan and MBS portfolios
and the general trend and level of interest rates, which influences the level of
refinancing and mortgage prepayments. During the year ended December 31, 1998,
net cash was used in investing activities primarily to purchase $752 million in
investments and MBS and to fund loans.
Cash provided or used by operating activities is determined largely by
changes in the level of loan sales. Proceeds from sales of loans increased in
the year ended December 31, 1998 due primarily to an increase in residential
loan sales. The level of loans held for sale depends on the level of loan
originations and the time within which investors fund the purchase of loans from
Sterling. A majority of conventional loans held for sale are sold within 10
days of the closing while the sale of FHA- and VA- insured loans may take up to
60 days. Sterling typically offsets fluctuations in the level of loans held for
sale by changing the level of advances from the FHLB Seattle, using reverse
repurchase agreements or cash. Management believes that proceeds from loans
sold, advances from the FHLB Seattle and reverse repurchase agreements will be
sufficient to fund loan commitments in the future.
47
Sterling Savings Bank's credit line with the FHLB Seattle provides for
borrowings up to 35% of its total assets. At December 31, 1998, this credit line
represented a total borrowing capacity of $815.2 million, of which $495.7
million was available. Sterling Savings Bank also borrows on a secured basis
from major broker/dealers and financial entities by selling securities subject
to repurchase agreements. At December 31, 1998, Sterling Savings Bank had $195.1
million in outstanding borrowings under reverse repurchase agreements and
investments and MBS available for additional secured borrowings of $246.2
million. Sterling Savings Bank also had a secured line-of-credit agreement from
a commercial bank of $10.0 million as of December 31, 1998. At December 31,
1998, Sterling Savings Bank had no funds drawn on this line of credit.
Excluding its subsidiaries, Sterling had cash and other resources of
approximately $1.6 million and a line of credit from a commercial bank of $5.0
million at December 31, 1998 but had no funds drawn on this line of credit. At
December 31, 1998, Sterling had drawn all the funds on a $40.0 million twelve-
month line of credit from a commercial bank which matures in June 1999 but may
be renewed at Sterling's option for an additional six months. All of the
proceeds of this loan were contributed to Sterling Savings Bank to enhance its
regulatory capital ratios and to substantially offset the intangible asset
incurred in connection with the KeyBank branch acquisition. The line of credit
is secured by all of the stock of Sterling Savings Bank. At December 31, 1998,
Sterling had an investment of $88.6 million in the Preferred Stock of Sterling
Savings Bank, compared with $66.1 million at December 31, 1997. Sterling
received cash dividends on Sterling Savings Bank Preferred Stock of $8.0 million
during the year ended December 31, 1998. These resources were sufficient to meet
the operating needs of Sterling, including interest expense on its 8.75%
Subordinated Notes Due 2000 and other borrowings. Sterling Savings Bank's
ability to pay dividends is limited by its earnings, financial condition and
capital requirements, as well as rules and regulations imposed by the OTS.
OTS regulations require savings institutions such as Sterling Savings
Bank to maintain an average daily balance of liquid assets equal to or greater
than a specific percentage (currently 4%) of the average daily balance of net
withdrawable accounts and borrowings payable on demand in one year or less
during the preceding calendar month. At December 31, 1998 and 1997, Sterling
Savings Bank's liquidity ratio was 11.5% and 14.3%, respectively. The lower
level of liquidity at December 31, 1998 was due primarily to an increase in the
balance of net withdrawable deposits. Sterling Savings Bank's strategy
generally is to maintain its liquidity ratio at or near the level necessary to
support expected and potential loan fundings and deposit withdrawals. Sterling
Savings Bank tries to minimize liquidity levels in order to maximize its yield
on alternative investments. The regulatory liquidity ratio does not take into
account certain other sources of liquidity, such as funds invested through
Sterling Savings Bank subsidiaries, potential borrowings against investments and
MBS and other potential financing alternatives. The required minimum liquidity
ratio may vary from time to time, depending on economic conditions, savings
flows and loan funding needs. See "Business - Regulation."
Capital Resources
Sterling's total shareholders' equity was $119.0 million at December
31, 1998, compared with $110.6 million at December 31, 1997. At December 31,
1998 and 1997, shareholders' equity was 5.1% and 5.7% of total assets,
respectively. The increase in total shareholders' equity was due primarily to
the increase in retained earnings and to an increase in the value of available-
for-sale investments and MBS. See "General." Sterling's shares outstanding
increased by 448,030 shares on November 13, 1998 as a result of the Big Sky
merger.
At December 31, 1998, Sterling had an unrealized gain of $788,000, net
of related income taxes, on investments and MBS classified as available for
sale. The improvement from December 31, 1997, which reflected an unrealized
loss of $706,000, was due primarily to an increase in the market valuation of
investments, MBS and U.S. Treasury securities due to the decline in long-term
interest rates over the past 12 months. Fluctuations in prevailing interest
rates could continue to cause volatility in this component of shareholders'
equity in future periods. See "Business - Investments and Mortgage-Backed
Securities."
Sterling has issued and outstanding $40.0 million of Trust Preferred
Securities. The indenture governing the Trust Preferred Securities limits the
ability of Sterling under certain circumstances to pay dividends or make other
capital distributions. The Trust Preferred Securities are treated as debt of
Sterling. The Trust Preferred Securities mature on June 30, 2027 and are
redeemable at the option of Sterling on June 30, 2002, or earlier in the event
the deduction of related interest for federal income taxes is prohibited,
treatment as Tier 1 capital is no longer permitted or certain other
contingencies arise.
48
Sterling has issued and outstanding $17.2 million of 8.75%
Subordinated Notes due on January 31, 2000. These notes are unsecured general
obligations of Sterling and are subordinated to certain other existing and
future indebtedness. The indenture governing the Subordinated Notes limits the
ability of Sterling under certain circumstances to incur additional
indebtedness, to pay cash dividends or to make other capital distributions. See
Note 11 of "Notes to Consolidated Financial Statements."
Sterling anticipates total capital expenditures of approximately $4.8
million for the year ended December 31, 1999. Sterling also anticipates
spending approximately $430,000 during 1999 in connection with the Year 2000
("Year 2000") issues. Sterling anticipates continuing to fund these
expenditures from various sources, including retained earnings and borrowings
with various maturities. Sterling is exploring opportunities to sell certain
developed properties and enter into lease arrangements. There can be no
assurance that Sterling's estimates of capital and Year 2000 expenditures or the
funding thereof are accurate. See "Year 2000 Issues."
Sterling Savings Bank is required by applicable regulations to
maintain certain minimum capital levels with respect to tangible capital, core
leverage capital and risk-based capital. Sterling Savings Bank anticipates that
it will continue to enhance its capital resources and the regulatory capital
ratios of Sterling Savings Bank through the retention of earnings, the
amortization of intangible assets and the management of the level and mix of
assets, although there can be no assurance in this regard. At December 31,
1998, Sterling Savings Bank exceeded all such regulatory capital requirements.
See Note 16 of "Notes to Consolidated Financial Statements."
Sterling continues to proactively manage its claim against the U.S.
government for breach of contract on three supervisory goodwill acquisition
contracts. In July 1996, the U.S. Supreme Court ruled in three similar cases
that the U.S. government was liable for having breached its acquisition
contracts with certain savings associations. Sterling is encouraged by the
Supreme Court's decision, although it is uncertain when a trial to determine
Sterling's damages will be held or when a judgment, if any, will be paid.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting
for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999; however,
earlier application of all of the provisions of this Statement is encouraged as
of the beginning of any fiscal quarter. Sterling has not yet determined the
effect, if any, of implementing SFAS No. 133 on its consolidated financial
statements.
In June 1997, FASB issued SFAS No. 131, Disclosures about Segments for
an Enterprise and Related Information. This Statement changes the way public
companies report information about segments of their business in their annual
financial statements and requires them to report selected segment information in
their quarterly reports issued to shareholders. It also requires entity-wide
disclosures about the products and services an entity provides and its major
customers. Sterling provided business segment disclosures in its consolidated
financial statements for the year ended December 31, 1998, in accordance with
this statement.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. This Statement requires that comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This Statement does not require a specific format for the
financial statement, but requires that an enterprise display net income as a
component of comprehensive income in the financial statement. Comprehensive
income is defined as the change in equity of a business enterprise arising from
non-owner sources. The classifications of comprehensive income under current
accounting standards include foreign currency items, minimum pension liability
adjustments and unrealized gains and losses on certain investments in debt and
equity securities. Sterling presented separate statements of comprehensive
income in its consolidated financial statements for the year ended December 31,
1998. Comparative statements were presented for all years included in the
consolidated financial statements in accordance with this statement.
49
Year 2000 Issues
The Year 2000 issue concerns the inability of information systems to
recognize properly and process date-sensitive information beginning on January
1, 2000. Systems that do not properly recognize such information could generate
erroneous data or fail. The potential failure on January 1, 2000 of computer
systems that use two-digit calendar notations has developed into a major concern
for financial institutions and other entities.
To address this concern, Sterling has created a Year 2000 Action Plan
that focuses on identifying, testing and implementing solutions for Year 2000
processing. At December 31, 1998, Sterling had completed the awareness and
assessment phases and a substantial portion of the testing phase of its Year
2000 Action Plan. The awareness phase included gaining understanding and
support, committing resources to the plan, establishing a project team
consisting of senior managers and department heads and developing a strategy to
address all internal and external systems.
The assessment phase involved attempting to identify all critical
business processes and determining the impact of the Year 2000 issues on all
computer systems throughout the organization. This assessment included critical
functions and systems not generally included in the information systems
category, such as fax machines, telephone switches, elevators, vaults, ATMs and
security systems. Certain vendors were contacted and asked to submit
certification letters stating that they are adequately addressing Year 2000
conversion issues. An assessment of Sterling's data service provider, The BISYS
Group, Inc. ("BISYS"), was conducted by federal regulatory agencies.
Sterling has completed an evaluation of its deposit base and
identified potential problems due to concentrations. Management will assess
whether those concentrations are at risk due to Year 2000 problems. All
financial institutions are considering the possibility of some level of
reduction in deposits during the month of December 1999. Sterling has
determined that alternative sources of funds should be available so that
adequate funding will not be a problem.
In conjunction with its review of Year 2000 issues, Sterling has
endeavored to assess the impact of the Year 2000 event on significant borrowers
and their ability to repay loans. Sterling is continually evaluating and
monitoring its allowances for loan losses with its review of Year 2000 concerns
in relation to its borrowers.
Sterling's Year 2000 testing, renovation and/or replacement of
hardware, proprietary programs, security systems, facility systems and non-BISYS
software was largely completed by December 31, 1998. Testing of BISYS-supported
software and systems is scheduled to be completed in the first half of 1999.
It is currently estimated that the aggregate cost of Sterling's Year
2000 readiness efforts will be approximately $870,000, of which approximately
$440,000 has been spent. The costs associated with the replacement of computer
hardware or equipment, currently estimated to be approximately $305,000, are
included in the estimate. Computer hardware and equipment expenses will be
capitalized, and all other costs are being expensed as they are incurred and are
being funded through operating cash flow. The aggregate Year 2000 cost
estimates do not include any costs associated with the implementation of
contingency plans, which are in the process of being developed.
Sterling is currently developing contingency plans to be implemented
as part of its efforts to identify and correct Year 2000 problems affecting its
internal operations. Year 2000 contingency plans are designed to supplement
Sterling's existing disaster recovery plan. Depending on the systems affected,
these plans could include short- to medium-term use of backup equipment and
software, increased work hours for Sterling personnel, implementation of manual
workarounds for information systems or department functions or similar
approaches. Testing of the Year 2000 Contingency Plan is scheduled to be
completed by June 30, 1999. Final implementation is scheduled for September 30,
1999.
The discussion of Sterling's efforts and management's expectations
relating to Year 2000 readiness include forward-looking statements. Although
Sterling expects to identify and resolve all Year 2000 issues that could
materially adversely affect its business operations, it is not possible to
determine with complete certainty that all Year 2000 issues affecting the
company will be identified or corrected. The number of devices that could be
affected and the interactions among these devices are simply too numerous. In
addition, no one can
50
accurately predict how many Year 2000-related failures will occur generally or
specifically with respect to Sterling and its customers and suppliers. Nor can
anyone accurately predict the severity, duration or financial consequences of
these perhaps inevitable failures.
Sterling's Year 2000 Action Plan is expected to significantly reduce
Sterling's level of uncertainty about the Year 2000 event and, in particular,
about the Year 2000 compliance and readiness of its external vendors and major
customers. Sterling believes that, with the implementation of its Action Plan as
scheduled, the possibility of significant interruptions of normal operations
should be reduced. There can, however, be no assurances in this regard.
Effects of Inflation and Changing Prices
A savings institution has an asset and liability structure that is
interest-rate sensitive. As a holder of monetary assets and liabilities, a
savings institution's performance may be significantly influenced by changes in
interest rates. Although changes in the prices of goods and services do not
necessarily move in the same direction as interest rates, increases in inflation
generally have resulted in increased interest rates, which may have an adverse
effect on Sterling's business.
Item 7.A. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of Sterling's market risk, see "Management's
Discussion and Analysis - Asset and Liability Management."
Item 8. Financial Statements and Supplementary Data
The required information is contained on pages F-1 through F-41 of
this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During the year ended December 31, 1998, Sterling neither changed nor
had any disagreements with its independent accountants on accounting and
financial disclosures.
PART III
Item 10. Directors and Executive Officers of the Registrant
The required information is contained under the captions "Board of
Directors of Sterling Financial Corporation" and "Executive Officers" in
Sterling's Proxy Statement dated March 26, 1999, for the annual meeting of
Shareholders on April 27, 1999, and is incorporated herein by reference.
Item 11. Executive Compensation
The required information is contained under the captions "Personnel
Committee Report on Executive Compensation" and "Executive Compensation" in
Sterling's Proxy Statement dated March 26, 1999, for the annual meeting of
Shareholders on April 27, 1999, and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The required information is contained under the caption "Security
Ownership of Certain Beneficial Owners and Management" in Sterling's Proxy
Statement dated March 26, 1999, for the annual meeting of Shareholders on April
27, 1999, and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The required information is contained under the caption "Interest of
Directors, Officers and Others in Certain Transactions" in Sterling's Proxy
Statement dated March 26, 1999, for the annual meeting of Shareholders on April
27, 1999, and is incorporated herein by reference.
51
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents which are filed as a part of this report:
1. Financial Statements: The required financial statements are
contained in pages F-1 through F-41 of this Form 10-K.
2. Financial Statement Schedules: Financial statement schedules
have been omitted as they are not applicable or the information
is included in the Consolidated Financial Statements.
3. Exhibits:
Exhibit No. Exhibit
3.1 Restated Articles of Incorporation of Sterling. Filed as
Exhibit 3.1 to Sterling's Form S-4 dated November 7, 1994
and incorporated by reference herein.
3.2 Articles of Amendment of Restated Articles of
Incorporation of Sterling. Filed as Exhibit 3.2 to
Sterling's Form S-4 dated November 7, 1994 and
incorporated by reference herein.
3.3 Copy of Amended and Restated Bylaws of Sterling. Filed as
Exhibit 3.3 to Sterling's Form 10-Q dated March 31, 1997
and incorporated by reference herein.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2 Sterling has outstanding certain long-term debt. None of
such debt exceeds ten percent of Sterling's total assets;
therefore, copies of the constituent instruments defining
the rights of the holders of such debt are not included as
exhibits. Copies of instruments with respect to such
long-term debt will be furnished to the Securities and
Exchange Commission upon request.
10.1 Copy of Sterling Financial Corporation 1998 Long-term
Incentive Plan, filed as Exhibit A to Sterling's Proxy
Statement in connection with the Annual Meeting of
Shareholders held on April 28, 1998 and incorporated by
reference herein.
10.2 First Federal Savings and Loan Association of Montana 1992
Stock Option and Incentive Plan, incorporated by reference
from the Registration Statement on Form 10 filed by the
Association with the Office of Thrift Supervision on May
15, 1992.
10.3 Copy of Sterling Savings Bank Incentive Stock Option Plan
dated July 25, 1984, including a copy of Form of Incentive
Stock Option Plan Letter Agreement. Filed as Exhibit 10.1
to Sterling's Form S-4 dated August 28, 1992 and
incorporated by reference herein.
10.4 Copy of Sterling Savings Bank 1992 Incentive Stock Option
Plan. Filed as Exhibit 10.2 to Sterling's Form S-4 dated
August 28, 1992 and incorporated by reference herein.
52
Exhibit No. Exhibit
10.5 Copy of Sterling Savings Bank Deferred Compensation Plan,
effective July 1, 1984. Filed as Exhibit 10.3 to
Sterling's Form S-4 dated August 28, 1992 and
incorporated by reference herein.
10.6 Copy of Sterling Savings Bank Employment Savings and
Incentive Plan and Trust dated September 21, 1990. Filed
as Exhibit 10.4 to Sterling's Form S-4 dated August 28,
1992 and incorporated by reference herein.
10.7 Copy of Employment Agreement, dated July 1, 1995, between
Sterling and Harold B. Gilkey. Filed as Exhibit 10.1 to
Sterling's Form 10-Q dated March 30, 1996 and incorporated
by reference herein.
10.8 Copy of Amendment to Employment Agreement, dated June 30,
1996, between Sterling and Harold B. Gilkey. Filed as
Exhibit 10.6 to Sterling's Form 10-Q dated March 31, 1997
and incorporated by reference herein.
10.9 Copy of Employment Agreement, dated July 1, 1995, between
Sterling and William W. Zuppe. Filed as Exhibit 10.2 to
Sterling's Form 10-Q dated March 30, 1996 and
incorporated by reference herein.
10.10 Copy of Amendment to Employment Agreement, dated June 30,
1996, between Sterling and William W. Zuppe. Filed as
Exhibit 10.8 to Sterling's Form 10-Q dated March 31, 1997
and incorporated by reference herein.
12.1 Statement regarding Computation of Return on Average
Common Shareholders' Equity. Filed herewith.
12.2 Statement regarding Computation of Return on Average
Assets. Filed herewith.
12.3 Statement regarding Computation of Operating Cash
Performance Ratios. Filed herewith.
21.1 List of Subsidiaries of Sterling. Filed herewith.
23.1 Consent of PricewaterhouseCoopers LLP. Filed herewith.
27.1 Financial Data Schedule. Filed herewith.
(b) Reports on Form 8-K. One report on Form 8-K was filed during the
last quarter of the period covered by this report.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
STERLING FINANCIAL CORPORATION
March 23, 1999 By /s/ Harold B. Gilkey
-------------------------------------
Harold B. Gilkey,
Chairman of the Board, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
March 23, 1999 /s/ Harold B. Gilkey
-------------------------------------
Harold B. Gilkey
Chairman of the Board, Chief Executive Officer,
Principal Executive Officer
March 23, 1999 /s/ William W. Zuppe
-------------------------------------
William W. Zuppe
President, Chief Operating Officer, Director
March 23, 1999 /s/ Daniel G. Byrne
-------------------------------------
Daniel G. Byrne
Senior Vice President, Chief Financial Officer,
Principal Financial Officer, Principal Accounting
Officer
March 23, 1999 /s/ Ned M. Barnes
-------------------------------------
Ned M. Barnes, Secretary, Director
March 23, 1999 /s/ Rodney W. Barnett
-------------------------------------
Rodney W. Barnett, Director
March 23, 1999 /s/ James P. Fugate
-------------------------------------
James P. Fugate, Director
March 23, 1999 /s/ Robert D. Larrabee
-------------------------------------
Robert D. Larrabee, Director
March 23, 1999 /s/ Robert E. Meyers
-------------------------------------
Robert E. Meyers, Director
March 23, 1999 /s/ David O. Wallace
-------------------------------------
David O. Wallace, Director
54
Report of Independent Accountants
The Board of Directors and Shareholders
Sterling Financial Corporation
Spokane, Washington
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, comprehensive income (loss), changes in
shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of Sterling Financial Corporation and its subsidiaries
("Sterling") as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the years ended December 31, 1998 and 1997,
the six months ended December 31, 1996 and the year ended June 30, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of Sterling's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
January 26, 1999
F-1
Sterling Financial Corporation
Consolidated Balance Sheets
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31,
-----------------------
1998 1997
---------- ----------
Assets:
Cash and cash equivalents:
Interest bearing $ 26,977 $ 16,483
Non-interest bearing and vault 61,354 35,110
Restricted 8,775 2,988
Loans receivable, net 1,468,534 1,105,739
Loans held for sale 15,881 5,225
Investments and mortgage-backed securities:
Available for sale 566,372 666,476
Held to maturity 20,033 24,463
Accrued interest receivable 14,938 14,058
Real estate owned, net 6,232 8,817
Office properties and equipment, net 51,771 39,231
Other intangibles, net 61,180 7,789
Purchased mortgage servicing rights, net 18 1,170
Prepaid expenses and other assets 12,522 10,804
---------- ----------
Total assets $2,314,587 $1,938,353
========== ==========
Liabilities:
Deposits $1,545,425 $1,084,445
Advances from Federal Home Loan Bank (FHLB)
Seattle 319,540 460,085
Securities sold subject to repurchase agreements 195,074 180,077
Other borrowings (Note 11) 97,240 72,240
Cashiers checks issued and payable 17,512 11,260
Borrowers' reserves for taxes and insurance 1,826 1,522
Accrued interest payable 5,639 5,879
Accrued expenses and other liabilities 13,314 12,228
---------- ----------
Total liabilities 2,195,570 1,827,736
---------- ----------
Commitments and contingencies (Note 17)
Shareholders' equity:
Preferred stock, $1 par value; 10,000,000
shares authorized;
0 shares issued and outstanding -- --
Common stock, $1 par value; 20,000,000 shares
authorized;
8,056,072 and 8,017,821 shares issued and
outstanding 8,056 8,018
Additional paid-in capital 70,229 69,889
Accumulated other comprehensive income (loss):
Unrealized gains (losses) on investments and
mortgage-backed securities available for sale,
net of deferred income tax provision
(benefit) of $424 and $(351) 788 (706)
Unearned stock compensation -- (305)
Retained earnings 39,944 33,721
---------- ----------
Total shareholders' equity 119,017 110,617
---------- ----------
Total liabilities and shareholders' equity $2,314,587 $1,938,353
========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
Sterling Financial Corporation
Consolidated Statements of Operations
(DOLLAR AMOUNTS IN THOUSANDS)
Year Ended Six Months Ended Year
December 31, December 31, Ended
---------------------------- ------------------------ June 30,
1998 1997 1996 1995 1996
----------- ---------- ---------- ---------- ----------
(Unaudited)
Interest income:
Loans $ 113,813 $ 94,963 $ 43,366 $ 48,370 $ 89,751
Mortgage-backed securities 26,938 29,031 12,687 8,561 22,291
Investments and cash equivalents 15,012 11,891 3,863 2,943 5,757
---------- ---------- ---------- ---------- ----------
Total interest income 155,763 135,885 59,916 59,874 117,799
---------- ---------- ---------- ---------- ----------
Interest expense:
Deposits 57,595 48,027 22,286 23,953 46,807
Short-term borrowings 26,005 26,976 8,903 10,714 19,473
Long-term borrowings 12,958 13,074 7,437 7,118 13,892
---------- ---------- ---------- ---------- ----------
Total interest expense 96,558 88,077 38,626 41,785 80,172
---------- ---------- ---------- ---------- ----------
Net interest income 59,205 47,808 21,290 18,089 37,627
Provision for losses on loans (5,325) (2,482) (1,121) (822) (1,643)
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for losses on loans 53,880 45,326 20,169 17,267 35,984
---------- ---------- ---------- ---------- ----------
Other income (expense):
Fees and service charges 7,858 5,140 2,506 1,882 4,643
Mortgage banking operations 1,848 1,922 1,686 1,761 3,054
Loan servicing fees 791 1,299 639 466 933
Net gains on sales of securities
and property 2,038 1,197 46 1,067 1,074
Real estate owned operations (222) (84) (102) (114) (171)
---------- ---------- ---------- ---------- ----------
Total other income 12,313 9,474 4,775 5,062 9,533
---------- ---------- ---------- ---------- ----------
Operating expenses (Note 19) 56,291 38,429 25,807 16,231 33,109
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes 9,902 16,371 (863) 6,098 12,408
---------- ---------- ---------- ---------- ----------
Income tax (provision) benefit:
Current (7,392) (6,150) (173) (1,330) (4,998)
Deferred 3,713 (2) 11 (922) 331
---------- ---------- ---------- ---------- ----------
Total income tax provision (3,679) (6,152) (162) (2,252) (4,667)
---------- ---------- ---------- ---------- ----------
Net income (loss) 6,223 10,219 (1,025) 3,846 7,741
Less preferred stock dividends declared -- (940) (942) (942) (1,885)
---------- ---------- ---------- ---------- ----------
Income (loss) available to common shares $ 6,223 $ 9,279 $ (1,967) $ 2,904 $ 5,856
========== ========== ========== ========== ==========
Income (loss) per common share - basic $0.78 $1.40 $(0.33) $0.50 $1.00
========== ========== ========== ========== ==========
Income (loss) per common share - diluted $0.76 $1.25 $(0.33) $0.48 $0.97
========== ========== ========== ========== ==========
Weighted average common shares outstanding
- basic 8,027,537 6,634,599 5,955,387 5,830,804 5,840,359
========== ========== ========== ========== ==========
Weighted average common shares
outstanding - diluted 8,217,067 8,170,675 8,074,600 7,974,257 8,000,454
========== ========== ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
Sterling Financial Corporation
Consolidated Statements of Comprehensive Income (Loss)
(DOLLAR AMOUNTS IN THOUSANDS)
Year Ended Six Months Ended Year
December 31, December 31, Ended
---------------- ----------------- June 30,
1998 1997 1996 1995 1996
------ ------- ------ ------- ---------
(Unaudited)
Net income (loss) $6,223 $10,219 $(1,025) $3,846 $ 7,741
------ ------- ------- ------ --------
Other comprehensive income (loss):
Change in unrealized gains or losses on investments and
mortgage-backed securities available for sale 2,269 7,892 6,611 (334) (14,146)
Less deferred income tax provision (benefit) 775 2,760 2,316 (118) (4,953)
------ ------- ------- ------ --------
Net other comprehensive income (loss) 1,494 5,132 4,295 (216) (9,193)
------ ------- ------- ------ --------
Comprehensive income (loss) $7,717 $15,351 $ 3,270 $3,630 $ (1,452)
====== ======= ======= ====== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
Sterling Financial Corporation
Consolidated Statements of Changes in Shareholders' Equity
FOR THE YEARS ENDED DECEMBER 31, 1998 and 1997, FOR THE SIX MONTHS ENDED
DECEMBER 31, 1996 AND FOR THE YEAR ENDED JUNE 30, 1996
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Accum-
ulated Un-
Other earned Total
Preferred Stock Common Stock Compre- Stock Share-
--------------------- -------------------- Paid-In hensive Compen- Retained holders'
Shares Amount Shares Amount Capital Income sation Earnings Equity
--------- --------- --------- -------- -------- -------- -------- -------- -------
Balance, June 30, 1995 1,040,000 $ 1,040 5,821,530 $ 5,822 $69,305 $ (940) $ -- $20,571 $95,798
Shares issued upon exercise
of stock options 31,419 31 171 202
Shares acquired and retired
upon exercise of stock
options (3,006) (3) (40) (43)
Shares issued upon exercise
of warrants, net of
related costs 1,949 2 20 22
Adjustment of estimated
common stock dividend paid
to reflect final price and
cash paid for fractional shares 424 52 (8) 44
Dividends declared and paid
on preferred stock
($1.81 per share) (1,885) (1,885)
Change in unrealized loss on
investments and MBS available
for sale, net of income taxes (9,193) (9,193)
Net income 7,741 7,741
--------- --------- --------- -------- -------- -------- -------- -------- -------
Balance, June 30, 1996 1,040,000 1,040 5,852,316 5,852 69,508 (10,133) -- 26,419 92,686
Shares issued upon exercise of
stock options 20,972 21 148 169
Shares acquired and retired
upon exercise of stock options (4,876) (5) (68) (73)
Shares issued upon exercise
of warrants, net of
related costs 98,036 98 1,061 1,159
Dividends declared and paid on
preferred stock ($0.91 per
share) (942) (942)
Change in unrealized loss on
investments and MBS available
for sale, net of income taxes 4,295 4,295
Net loss (1,025) (1,025)
--------- --------- --------- -------- -------- -------- -------- -------- -------
Balance, December 31, 1996 1,040,000 1,040 5,966,448 5,966 70,649 (5,838) -- 24,452 96,269
--------- --------- --------- -------- -------- -------- -------- -------- -------
F-5
Sterling Financial Corporation
Consolidated Statements of Changes in Shareholders' Equity
FOR THE YEARS ENDED DECEMBER 31, 1998 and 1997, FOR THE SIX MONTHS ENDED
DECEMBER 31, 1996 AND FOR THE YEAR ENDED JUNE 30, 1996
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Accum-
ulated Un-
Other earned Total
Preferred Stock Common Stock Compre- Stock Share-
--------------------- -------------------- Paid-In hensive Compen- Retained holders'
Shares Amount Shares Amount Capital Income sation Earnings Equity
--------- --------- --------- -------- -------- -------- ------- -------- --------
Balance, December 31, 1996 1,040,000 $ 1,040 5,966,448 $ 5,966 $ 70,649 $(5,838) $ -- $24,452 $ 96,269
Shares issued upon exercise of
stock options 14,632 15 130 145
Shares acquired and retired
upon exercise of stock options (5,209) (5) (84) (89)
Preferred shares converted
to common stock (1,035,700) (1,036) 2,021,190 2,021 (998) (13)
Preferred shares redeemed (4,300) (4) (99) (10) (113)
Dividends declared and paid
on preferred stock
($0.45 per share) (940) (940)
Change in unrealized loss on
investments and MBS
available for sale,
net of income taxes 5,132 5,132
Shares issued under stock
compensation plan 20,760 21 291 312
Unearned stock compensation (305) (305)
Net income 10,219 10,219
--------- --------- --------- -------- -------- -------- -------- -------- -------
Balance, December 31, 1997 -- -- 8,017,821 8,018 69,889 (706) (305) 33,721 110,617
Shares issued upon exercise of
stock options 39,301 39 428 467
Shares acquired and retired
upon exercise of stock options (969) (1) (84) (85)
Cash paid for fractional
shares (81) (4) (4)
Change in unrealized loss on
investments and MBS available
for sale, net of income taxes 1,494 1,494
Vesting of unearned stock
compensation 305 305
Net income 6,223 6,223
--------- --------- --------- -------- -------- -------- -------- -------- -------
Balance, December 31, 1998 -- $ -- 8,056,072 $ 8,056 $ 70,229 $ 788 $ -- $39,944 $119,017
========= ========= ========= ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
Sterling Financial Corporation
Consolidated Statements of Cash Flows
(DOLLAR AMOUNTS IN THOUSANDS)
Year
Year Ended Six Months Ended Ended
December 31, December 31, June 30,
1998 1997 1996 1995 1996
------------- ------------- ---------- --------- -----------
(Unaudited)
Cash flows from operating activities:
Net income (loss) $ 6,223 $ 10,219 $ (1,025) $ 3,846 $ 7,741
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Provisions for loan and real estate owned losses 5,396 2,655 1,152 861 1,710
Stock dividends on FHLB Seattle stock (2,370) (2,197) (1,083) (898) (1,884)
Net gain on sales of loans, securities and
mortgage servicing rights (3,578) (2,690) (1,504) (1,958) (3,512)
Net (gain) loss on sales of office properties and
equipment -- 6 -- (616) (616)
Net loss on sales of real estate owned (133) (218) (110) -- (28)
Depreciation and amortization 8,820 7,791 4,267 4,345 9,058
Deferred income tax provision (benefit) 3,713 (2) 11 (922) 331
Compensation expense associated with stock grants 305 -- -- -- --
Change in:
Accrued interest receivable 246 (3,370) (1,588) (199) (111)
Prepaid expenses and other assets (2,467) (862) 415 401 1,893
Cashiers checks issued and payable 6,252 5,537 (1,028) 1,108 (938)
Accrued interest payable (976) 760 1,517 (3,295) (4,478)
Accrued expenses and other liabilities (2,627) 200 1,826 1,285 (2,882)
Proceeds from sales of loans 111,591 109,497 79,314 124,304 235,115
Loans originated for sale (110,162) (107,113) (76,516) (117,361) (212,153)
----------- --------- --------- --------- ---------
Net cash provided by operating activities 20,233 20,213 5,648 10,901 29,246
----------- --------- --------- --------- ---------
Cash flows from investing activities:
Change in restricted cash (5,787) 242 (1,005) -- (2,225)
Loans disbursed (1,211,678) (952,453) (383,006) (273,386) (568,608)
Loan principal received 952,479 807,808 334,496 222,785 492,694
Purchase of investments (350,111) (182,228) (41,718) (3,003) (7,847)
Proceeds from maturities of investments 374,648 85,594 10,000 5,225 6,420
Proceeds from sales of available-for-sale investments 10,825 -- 101 -- --
Purchase of mortgage-backed securities ("MBS") (401,897) (421,900) -- -- --
Principal payments on MBS 90,828 67,206 28,541 20,185 53,854
Proceeds from sales of MBS 385,979 264,543 -- 56,338 56,345
Principal payments on held-to-maturity MBS 137 108 50 57 136
Proceeds from maturity of investments -- 5,645 2,000 750 3,750
Purchase of office properties and equipment (4,896) (1,222) (963) (1,606) (7,926)
Proceeds from sales of office properties and
equipment -- 12 -- 1,438 1,566
Improvements and other changes to real estate owned 126 (294) -- (78) (70)
Proceeds from sales and liquidation of real estate
owned 4,525 2,011 1,627 1,332 1,755
Proceeds from sales of mortgage servicing rights 1,123 -- -- -- 741
Net cash received from branch acquisition 327,183 -- -- -- --
----------- --------- --------- --------- ---------
Net cash provided by (used in) investing
activities 173,484 (324,928) (49,877) 30,037 30,585
----------- --------- --------- --------- ---------
F-7
Sterling Financial Corporation
Consolidated Statements of Cash Flows, Continued
(DOLLAR AMOUNTS IN THOUSANDS)
Year
Year Ended Six Months Ended Ended
December 31, December 31, June 30,
1998 1997 1996 1995 1996
---------- --------- --------- --------- ----------
(Unaudited)
Cash flows from financing activities:
Net change in checking, passbook and money market deposits $ 52,054 $ 46,840 $ 914 $ 25,322 $ 67,496
Proceeds from issuance of certificates of deposit 725,755 444,026 202,582 256,697 467,830
Payments for maturing certificates of deposit (892,557) (406,969) (224,012) (299,865) (564,511)
Interest credited to deposits 58,228 48,169 22,578 18,457 37,411
Advances from FHLB Seattle 238,192 605,000 100,000 50,713 50,713
Repayment of FHLB Seattle advances (379,084) (405,081) (100,040) (58,031) (144,067)
Net change in securities sold subject to repurchase
agreements and funds purchased 14,997 (49,720) 34,012 (22,552) 35,905
Proceeds from other borrowings 40,000 40,000 15,000 -- --
Repayment of other borrowings (15,000) -- -- -- --
Payments to redeem preferred stock and fractional shares (4) (126) -- -- --
Proceeds from exercise of stock options and warrants, net
of repurchases 382 56 1,250 58 163
Cash dividends on preferred stock -- (940) (942) (942) (1,885)
Shareholders' redemption -- -- -- (831) (820)
Other 58 160 (592) (3,000) (2,864)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities (156,979) 321,415 50,750 (33,974) (54,629)
--------- --------- --------- --------- ---------
Net change in cash and cash equivalents 36,738 16,700 6,521 6,964 5,202
Cash and cash equivalents, beginning of period 51,593 34,893 28,372 23,170 23,170
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 88,331 $ 51,593 $ 34,893 $ 30,134 $ 28,372
========= ========= ========= ========= =========
Supplemental disclosures:
Cash paid during the period for:
Interest $ 96,798 $ 84,729 $ 35,894 $ 43,781 $ 82,089
Income taxes 5,873 6,708 1,278 2,468 5,369
Noncash financing and investing activities (see Note 1):
Loans converted into real estate owned $ 2,004 $ 6,515 $ 649 $ 393 $ 1,287
Preferred stock converted to common stock -- 24,523 -- -- --
Loans exchanged for mortgage-backed securities -- -- -- 243,030 244,146
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies:
Business
Sterling Financial Corporation ("Sterling") is a savings and loan holding
company for Sterling Savings Bank. Sterling Savings Bank is a Washington
State-chartered savings association headquartered in Spokane, Washington,
that conducts business from 77 offices located throughout Washington,
Oregon, Idaho and Montana. Sterling Savings Bank provides full-service
banking, including attracting FDIC-insured deposits and originating
consumer, business banking, commercial real estate and residential
construction loans. Action Mortgage Company ("Action Mortgage"), a wholly
owned subsidiary of Sterling Savings Bank, operates ten residential loan
production offices. Sterling Savings Bank also owns Harbor Financial
Services, Inc. ("Harbor Financial"), which markets investment products to
clients through regional representatives in Spokane, Auburn, Centralia,
Chehalis, Clarkston and Kennewick, Washington and Portland, Oregon.
INTERVEST-Mortgage Investment Company ("INTERVEST"), also a wholly owned
subsidiary of Sterling Savings Bank, provides commercial real estate
lending through its offices in the metropolitan areas of Portland, Oregon,
Spokane, Washington and the Puget Sound region.
Effective December 31, 1996, Sterling changed its fiscal year end from June
30 to December 31. Therefore, the consolidated financial statements
presented herein are audited for the six months ended December 31, 1996
with comparable unaudited consolidated financial statements for the six
months ended December 31, 1995.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Sterling and its wholly owned subsidiaries. Results of operations of
purchased companies are consolidated for all periods after the date of
acquisition. All significant intercompany accounts and transactions have
been eliminated in consolidation.
On June 15, 1998, Sterling assumed approximately $518 million in deposit
liabilities and acquired certain branch assets from 33 branch offices of
KeyBank National Association ("KeyBank"). The following shows the
allocation of the purchase price for the KeyBank branch transaction (in
thousands):
Liabilities assumed:
Certificates of deposit $233,864
NOW accounts 79,887
Non-interest bearing demand accounts 76,419
Savings and money market accounts 127,330
--------
517,500
Accrued interest payable 736
--------
Total liabilities assumed 518,236
--------
Less assets acquired:
Loans receivable, net 121,569
Office properties and equipment 10,996
Accrued interest on loans 1,126
Intangible asset 57,362
--------
Total assets acquired 191,053
--------
Net cash received from branch acquisition $327,183
========
The intangible asset includes both the identifiable value of existing
depositor relationships and the remaining unidentified intangible asset. As
it was not practical to separately value the existing depositor
relationships, Sterling is amortizing the entire intangible asset over 15
years using the straight-line method.
F-9
Sterling Ffinancial Ccorporation
Notes To Consolidated Financial Statements
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies, Continued:
Principles of Consolidation, Continued
On November 13, 1998, Sterling completed a business combination with Big
Sky Bancorp, Inc. ("Big Sky") whereby Big Sky was merged with Sterling. In
connection with the merger, Sterling issued 448,030 shares of its common
stock for all of the outstanding common shares of Big Sky based on an
exchange ratio of 1.384 Sterling shares for each Big Sky share. The merger
has been accounted for as a pooling of interests. Accordingly, Sterling's
consolidated financial statements have been restated to present the
combination of Sterling and Big Sky as if the merger had occurred at the
beginning of the earliest period presented.
The following table presents a reconciliation of interest income and net
income (loss) previously reported by Sterling and Big Sky individually,
prior to the merger, to the combined amounts included in the consolidated
statements of operations (in thousands).
Nine Six Months Ended Year
Months Ended Year Ended December 31, Ended
September 30, December 31, ------------------ June 30,
1998 1997 1996 1995 1996
-------- -------- ------- ------- --------
Interest income:
Sterling $110,537 $131,149 $57,614 $57,518 $113,081
Big Sky 3,554 4,736 2,302 2,356 4,718
-------- -------- ------- ------- --------
$114,091 $135,885 $59,916 $59,874 $117,799
======== ======== ======= ======= ========
Net income (loss):
Sterling $ 4,466 $ 9,636 $(1,103) $ 3,206 $ 6,792
Big Sky 333 583 78 640 949
-------- -------- ------- ------- --------
$ 4,799 $ 10,219 $(1,025) $ 3,846 $ 7,741
======== ======== ======= ======= ========
Cash and Cash Equivalents
Cash equivalents are any highly liquid instrument with a remaining
maturity of three months or less at the date of purchase. At December 31,
1998 and 1997, Sterling had approximately $48.9 million and $29.0 million,
respectively, of uninsured non-interest bearing deposits. Restricted cash
consists of non-interest bearing deposits maintained as a reserve at the
Federal Reserve Bank.
Loans Receivable
Loans receivable that management of Sterling has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are reported
at their outstanding principal balance less any origination and commitment
fees, net of direct loan origination costs and an associated allowance for
loan losses.
F-10
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies, Continued:
Loans Receivable, Continued
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to make payments as they
become due. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only to
the extent cash payments are received.
Allowance for Loan Losses
Management of Sterling provides an allowance for loan losses based upon
estimates of the cash flows to be received from the loans or the fair value
of the underlying collateral, net of selling costs. These estimates are
affected by factors including changes in the economic environment in the
Pacific Northwest region and the resultant effect on collateral values. As
a result of changing economic conditions, it is reasonably possible that
the amount of the allowance for loan losses could change in the near term.
A provision for loan losses is charged to income based on management's
evaluation of the probable losses that may occur in the loan portfolio.
Loans Held for Sale
Loans held for sale are reported at the lower of amortized cost or market
value as determined on an aggregate basis. Any loan that management
determines will not be held to maturity is classified as held for sale.
Market value is determined for loan pools of common interest rates using
published quotes as of the close of business. Unrealized losses on loans
held for sale are included in the consolidated statements of operations in
the period that the unrealized loss is identified.
Loan Origination and Commitment Fees
Loan origination fees, net of direct origination costs, are deferred and
recognized as interest income using the level interest yield method over
the contractual term of each loan adjusted for actual loan prepayment
experience. If the related loan is sold, the remaining net amount deferred,
which is part of the basis of the loan, is considered in determining the
gain or loss on sale.
Loan commitment fees are deferred until the expiration of the commitment
period unless management believes there is a remote likelihood that the
underlying commitment will be exercised, in which case the fees are
amortized to fee income using the straight-line method over the commitment
period. If a loan commitment is exercised, the deferred commitment fee is
accounted for in the same manner as a loan origination fee. Deferred
commitment fees associated with expired commitments are recognized as fee
income.
Investments and Mortgage-Backed Securities
Sterling classifies debt and equity securities as follows:
. Available-for-Sale. Except for FHLB Seattle stock, debt and equity
securities that will be held for indefinite periods of time are
classified as available for sale and are carried at market value. Market
value is determined using published quotes or other indicators of value
as of the close of business on December 31, 1998 and 1997. Unrealized
gains and losses are reported, net of deferred income taxes, as a
separate component of accumulated other comprehensive income or loss
until realized. FHLB Seattle stock may only be sold to FHLB Seattle or
to another member institution at par. Therefore, this investment is
restricted and is carried at cost.
F-11
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies, Continued:
Investments and Mortgage-Backed Securities, Continued
. Held-to-Maturity. Debt securities that management has the intent and
ability to hold until maturity are classified as held to maturity and
are carried at their remaining unpaid principal balance, net of
unamortized premiums or unaccreted discounts. Premiums are amortized and
discounts are accreted using the level interest yield method over the
estimated remaining term of the underlying security.
Realized gains and losses on sales of investments and mortgage-backed
securities are recognized in the statement of operations in the period sold
using the specific identification method.
Office Properties and Equipment
Office properties and equipment are carried at cost less accumulated
depreciation and amortization. Depreciation and amortization are computed
using the straight-line method over the lesser of the estimated useful
lives or lease terms of the assets. Expenditures for new properties and
equipment and major renewals or betterments are capitalized. Expenditures
for repairs and maintenance are charged to expense as incurred. Upon sale
or retirement, the cost and related accumulated depreciation are removed
from the respective property or equipment accounts, and the resulting gains
or losses are reflected in operations.
Real Estate Owned
Property acquired in settlement of loans is carried at the lower of cost or
fair value less estimated costs to sell. Development and improvement costs
relating to the property are capitalized to the extent they are deemed to
be recoverable.
An allowance for losses on real estate owned is established to include
amounts for estimated losses as a result of an impairment in value of the
real property. Sterling reviews its real estate owned for impairment in
value whenever events or circumstances indicate that the carrying value of
the property may not be recoverable. In performing the review, if expected
future undiscounted cash flow from the use of the property or the fair
value, less selling costs, from the disposition of the property is less
than its carrying value, an impairment loss is recognized. As a result of
changes in the real estate markets in which these properties are located,
it is reasonably possible that the carrying values could be reduced in the
near term.
Intangible Assets
Net assets of organizations acquired in purchase transactions are recorded
at fair value at the date of acquisition. Where separately identifiable,
the value of depositor relationships that existed at the date of an
acquisition are amortized over the estimated life of the depositor
relationships acquired (generally 8 to 10 years). Unidentified intangible
assets are amortized on a straight-line basis over periods ranging from 8
to 20 years.
In March 1995, SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of " was issued. This
standard requires a review for impairment of long-lived assets and
identifiable intangibles to be held and used by an entity whenever events
or changes in circumstances indicate that the carrying amount of the assets
may not be recoverable.
F-12
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies, Continued:
Mortgage Banking Operations
Sterling, through Action Mortgage, originates and sells loans and
participating interests in loans to provide additional funds for general
corporate purposes. Loans and participating interests therein are held for
sale and are carried at the lower of cost or market value. Sterling
recognizes a gain or loss on these loan sale transactions which includes a
component reflecting the differential between the contractual interest rate
of the loan and the interest rate which will be received by the investor.
The present value of the estimated future profit for servicing the loans,
together with the normal servicing fee rate, is taken into account in
determining the amount of gain or loss on the sale of loans.
On January 1, 1997, Sterling adopted SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities," which applies to transactions involving sales or
securitizations of financial assets, such as mortgage loans, and the
liquidation of financial liabilities. SFAS No. 125 provides accounting and
reporting standards based on a consistent application of a financial-
components approach that focuses on control. Under this approach, after a
transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered and
derecognizes liabilities when extinguished. This statement provides
consistent standards for distinguishing transfers of financial assets that
are sales from transfers that are secured borrowings. This statement also
requires that servicing assets and liabilities be measured by (a)
amortization in proportion to and over the period of estimated net
servicing income or loss, and (b) assessment for asset impairment or
increased obligation based on their fair values. The application of the
provisions of SFAS No. 125 did not have a material effect on Sterling's
financial condition, results of operations or cash flows.
At December 31, 1998 and 1997, purchased mortgage servicing rights were
$18,000 and $1.2 million, respectively, net of accumulated amortization of
$357,000 and $1.1 million, respectively. The cost of mortgage servicing
rights is amortized in proportion to, and over the period of, estimated net
servicing revenues. Impairment of mortgage servicing rights is assessed
based on the fair value of those rights. Fair values are estimated using
discounted cash flows based on a current market interest rate. For purposes
of measuring impairment, the rights are stratified based primarily on
prepayment and interest rate risks. The amount of impairment recognized is
the amount by which the capitalized mortgage servicing rights for a stratum
exceed their fair value.
Income Taxes
Sterling accounts for income taxes using the liability method, which
requires that deferred tax assets and liabilities be determined based on
the temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities and tax attributes using enacted
tax rates in effect in the years in which the temporary differences are
expected to reverse.
Sterling files a consolidated federal income tax return with its
subsidiaries.
Income (Loss) Per Share
Income (loss) per share - basic is computed by dividing income (loss)
available to common shares by the weighted-average number of common shares
outstanding during the period. Income (loss) per share - diluted is
computed by dividing net income (loss) by the weighted-average number of
common shares outstanding increased by the additional common shares that
would have been outstanding if the dilutive potential common shares had
been issued.
F-13
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
1. Business and Significant Accounting Policies, Continued:
Comprehensive Income
During the year ended December 31, 1998, Sterling adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS No. 130). SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses,
gains and losses) in a full set of general-purpose financial statements.
This Statement requires that all items required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 requires the change in unrealized gains
or losses on marketable securities to be included in comprehensive income.
Prior periods' financial statements have been reclassified to conform to
this Statement.
Reclassification adjustments, representing the net gains (losses) on
available-for-sale securities that were realized during the period, net of
related deferred income taxes, were as follows (in thousands):
AMOUNT
-------
Year ended December 31, 1998 $ 25
Year ended December 31, 1997 133
Six months ended December 31, 1996 (29)
Six months ended December 31, 1995 360
Year ended June 30, 1996 361
These gains (losses) had previously been included in other comprehensive
income as unrealized gains (losses) on investments and mortgage-backed
securities available for sale.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the
financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
F-14
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information for the six months ended December 31, 1995 is unaudited)
2. Investments and Mortgage-Backed Securities:
A summary of carrying and fair values of investments and mortgage-backed
securities follows (in thousands):
Held to Maturity Available for Sale
---------------------------------------------- ----------------------------------------------------
Amortized
Cost/ Gross Gross Gross Gross Carrying/
Carrying Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Value Gains Losses Value Cost Gains Losses Value
--------- ---------- ----------- ------- --------- ---------- --------------- ---------
December 31, 1998
U.S. government and
agency obligations $ 6,345 $ 10 $ -- $ 6,355 $105,661 $ 900 $ -- $106,561
FHLB Seattle stock
(restricted) -- -- -- 32,318 -- -- 32,318
Municipal bonds 13,047 293 -- 13,340 -- -- -- --
Mortgage-backed
securities 355 15 -- 370 404,927 1,420 (977) 405,370
Other 286 4 -- 290 22,254 608 (739) 22,123
------- ---- ---------- ------- -------- ------ -------------- ---------
$20,033 $322 $ -- $20,355 $565,160 $2,928 $ (1,716) $566,372
======= ==== ========== ======= ======== ====== ============== =========
December 31, 1997
U.S. government and
agency obligations $10,741 $165 $ -- $10,906 $158,707 $ 301 $ -- $159,008
FHLB Seattle stock
(restricted) -- -- -- -- 29,949 -- -- 29,949
Municipal bonds 13,033 166 (8) 13,191 -- -- -- --
Mortgage-backed
securities 492 30 -- 522 478,737 1,570 (3,286) 477,021
Other 197 1 -- 198 140 363 (5) 498
------- ---- ---------- ------- -------- ------ -------------- ---------
$24,463 $362 $ (8) $24,817 $667,533 $2,234 $ (3,291) $666,476
======= ==== ========== ======= ======== ====== ============== =========
At December 31, 1998 and 1997, accrued interest on investments and mortgage-
backed securities was $4,954 and $6,313 respectively.
In accordance with a Special Report issued by the Financial Accounting
Standards Board in 1995, during the year ended June 30, 1996, Sterling
reassessed and reclassified held-to-maturity debt securities with a carrying
value of approximately $214.1 million to the available-for-sale
classification. At the date of the transfer, the fair value of such debt
securities was approximately $211.4 million. The difference between the
carrying value and fair value of the reclassified debt securities at the
date of transfer of $2.7 million has been included in the unrealized loss on
investment securities component of accumulated comprehensive income (loss).
F-15
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
2. Investments and Mortgage-Backed Securities, Continued:
During the years ended December 31, 1998 and 1997, the six months ended
December 31, 1996 and 1995 and the year ended June 30, 1996, Sterling sold
available-for-sale investments and mortgage-backed securities which resulted
in the following (in thousands):
Proceeds Gross Gross
from Realized Realized
Sales Gains Losses
-------- -------- --------
Year ended December 31, 1998 $396,804 $2,669 $631
Year ended December 31, 1997 264,543 1,325 128
Six months ended December 31, 1996 101 46 --
Six months ended December 31, 1995 56,338 569 118
Year ended June 30, 1996 56,345 576 118
At December 31, 1998, the amortized cost and fair value of available-for-sale
and held-to-maturity debt securities, by contractual maturity (in thousands),
are shown below. Expected maturities may differ from contractual maturities
because issuers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Amortized Fair
Cost Value
--------- -----
Available-for-sale mortgage-backed securities:
Under one year $ 824 $ 836
After one year through five years 8,255 8,311
After five years through ten years 52,916 52,915
After ten years 342,932 343,308
-------- --------
$404,927 $405,370
======== ========
Held-to-maturity mortgage-backed securities:
Ater ten years $ 355 $ 370
======== ========
Available-for-sale U.S. government and agency obligations:
Under one year $ 10,119 $ 10,157
After one year through five years 95,542 96,404
-------- --------
$105,661 $106,561
======== ========
Held-to-maturity U.S. government and agency obligations:
After one year through five years $ 5,750 $ 5,757
After five years through ten years 345 348
After ten years 250 250
-------- --------
$ 6,345 $ 6,355
======== ========
Held-to-maturity municipal bonds:
Under one year $ 2,538 $ 2,559
After one year through five years 8,517 8,715
After five years through ten years 1,992 2,066
-------- --------
$ 13,047 $ 13,340
======== ========
F-16
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
2. Investments and Mortgage-Backed Securities, Continued:
At December 31, 1998 and 1997, U.S. government and agency obligations and
mortgage-backed securities with an aggregate fair value of $31.8 million
and $30.2 million, respectively, were pledged as collateral for the
treasury tax and loan account in accordance with Federal Reserve Board
regulations or for wholesale public funds deposits in accordance with
Washington and Oregon Public Deposit Protection Commission regulations.
Additionally, Sterling periodically utilizes mortgage-backed securities as
collateral for other borrowing transactions (see Notes 10 and 11).
3. Loans Receivable:
The components of loans receivable are as follows (in thousands):
December 31,
------------------------
1998 1997
----------- -----------
Real estate loans:
Variable-rate:
1-4 unit residential $ 56,299 $ 123,259
5 or more unit residential 75,866 59,939
Commercial 157,551 114,542
Land and other 1,001 174
Fixed-rate:
Conventional 1-4 unit residential 242,801 141,420
5 and 7 year balloon or reset 1-4 unit residential 18,210 42,127
1-4 unit residential, insured by FHA/VA 25,324 6,986
5 or more unit residential 50,998 8,758
Commercial 17,101 5,526
Land and other 174 260
Construction:
1-4 unit residential 206,139 179,495
5 or more unit residential 98,934 97,059
Commercial 53,641 26,386
---------- ----------
1,004,039 805,931
---------- ----------
Other loans:
Commercial loans 243,410 196,278
Commercial and personal lines of credit 102,374 65,469
Consumer loans 253,987 133,618
Loans secured by deposits 5,258 5,125
---------- ----------
605,029 400,490
---------- ----------
Total loans receivable 1,609,068 1,206,421
Undisbursed portion of loans in process (125,147) (91,048)
(Deferred loan fees, net of direct origination costs) deferred direct
origination costs, net of deferred loan fees (2,309) 232
Premium (discount) on loans acquired pursuant to purchase transactions 1,545 (380)
Allowance for losses (14,623) (9,486)
---------- ----------
Loans receivable, net $1,468,534 $1,105,739
========== ==========
Weighted average interest rate 8.29% 8.57%
========== ==========
F-17
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
3. Loans Receivable, Continued:
Sterling originates residential, commercial real estate, consumer and
commercial loans throughout the Pacific Northwest region. Loans originated
outside this area are primarily for immediate sale into the secondary
market. At December 31, 1998, approximately 54.7%, 6.4%, 3.0% and 35.8% of
real estate loans are collateralized by property in Washington, Idaho,
Montana and Oregon, respectively. The value of real estate properties in
these geographic regions will be affected by changes in the economic
environment of that region. It is reasonably possible that these values
could change in the near term, which would affect Sterling's estimate of
its allowance for loan losses associated with these loans receivable.
The principal amount of outstanding loans receivable at December 31, 1998
is due as follows (in thousands):
Year Ending
-----------
1999 $ 477,750
2000 144,414
2001 78,774
2002 78,998
2003 60,480
Thereafter 768,652
----------
$1,609,068
==========
4. Loan Servicing:
Loans serviced for others are not included in the consolidated balance
sheets. The unpaid principal balances of these loans as of the dates
indicated are summarized as follows (in thousands):
December 31,
------------------
1998 1997
-------- --------
Loan portfolios serviced for:
FHLMC $167,541 $317,679
FNMA 25,682 61,702
Others 17,767 74,932
-------- --------
$210,990 $454,313
======== ========
Custodial escrow balances maintained in connection with the foregoing loan
servicing were approximately $1.1 million and $1.8 million at December 31,
1998 and 1997, respectively.
F-18
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
4. Loan Servicing, Continued:
Following is an analysis of the changes in purchased mortgage servicing
rights (in thousands):
Purchased Excess
Servicing Servicing
---------- ----------
Balance, June 30, 1995 $ 3,147 $ 50
Sale of servicing portfolio (889) --
Amortization (616) (50)
------- ---------
Balance, June 30, 1996 1,642 --
Amortization (168) --
------- ---------
Balance, December 31, 1996 1,474 --
Amortization (304) --
------- ---------
Balance, December 31, 1997 1,170 --
Sale of servicing portfolio (1,023) --
Amortization (129) --
------- ---------
Balance, December 31, 1998 $ 18 $ --
======= =========
During the year ended December 31, 1998, Sterling sold, in bulk, the rights
to service conventional loans for others with an oustanding balance of
approximately $117.6 million and recognized a gain of approximately
$100,000 on the sale.
5. Real Estate Owned:
The components of real estate owned are as follows (in thousands):
December 31,
----------------
1998 1997
------- -------
Commercial real estate $4,537 $6,174
Construction 34 283
Residential 301 616
Other 2,311 2,628
------ ------
7,183 9,701
Allowance for losses (951) (884)
------ ------
Real estate owned, net $6,232 $8,817
====== ======
F-19
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
6. Allowances for Loan and Real Estate Owned Losses:
The following is an analysis of the changes in the allowances for loan and
real estate owned losses (in thousands):
Real
Estate
Loan Owned Total
------- ----- -------
Balance, June 30, 1995 $ 7,796 $ 714 $ 8,510
Provision 1,643 68 1,711
Amounts written off (1,169) (407) (1,576)
Recoveries 96 79 175
------- ----- -------
Balance, June 30, 1996 8,366 454 8,820
Provision 1,121 31 1,152
Amounts written off (1,177) (61) (1,238)
Recoveries 79 364 443
------- ----- -------
Balance, December 31, 1996 8,389 788 9,177
Provision 2,482 173 2,655
Amounts written off (1,568) (77) (1,645)
Recoveries 183 -- 183
------- ----- -------
Balance, December 31, 1997 9,486 884 10,370
Provision 5,325 71 5,396
Amounts written off (2,391) (4) (2,395)
Recoveries 203 -- 203
Loss allowances acquired 2,000 -- 2,000
------- ----- -------
Balance, December 31, 1998 $14,623 $ 951 $15,574
======= ===== =======
The following is a summary of loans that are not performing in accordance
with their original contractual terms (in thousands):
December 31,
--------------
1998 1997
------ ------
Nonaccrual loans (A) $3,050 $4,755
Restructured loans (B) 87 150
------ ------
Total nonperforming loans $3,137 $4,905
====== ======
(A) The total allowance for loan losses related to these loans was $63,000
and $35,000 at December 31, 1998 and 1997, respectively. For loans on
nonaccrual status at period end, additional gross interest income of
$159,000, $258,000, $86,000, $151,000 and $224,000 would have been
recorded during the years ended December 31, 1998 and 1997, the six
months ended December 31, 1996 and 1995 and the year ended June 30,
1996, respectively, if nonaccrual and restructured loans had been
current in accordance with their original contractual terms. Interest
income of $194,000, $311,000, $8,000, $21,000 and $62,000 was recorded
during the years ended December 31, 1998 and 1997, the six months ended
December 31, 1996 and 1995 and the year ended June 30, 1996,
respectively, in connection with such loans.
The average recorded investment in impaired loans during the years
ended December 31, 1998 and 1997, the six months ended December 31,
1996 and 1995 and the year ended June 30, 1996 was $4.5 million, $4.2
million, $3.0 million, $4.8 million and $4.5 million, respectively.
F-20
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
6. Allowances for Loan and Real Estate Owned Losses, Continued:
(B) Restructured loans occur when Sterling has agreed to compromise the
contractual loan terms to provide a reduction in the rate of interest
and, in most instances, an extension of payments of principal or
interest, or both, because of a deterioration in the financial position
of the borrower. Restructured loans performing in accordance with their
new terms are not included in nonaccrual loans unless there is
uncertainty as to the ultimate collection of principal or interest.
7. Office Properties and Equipment:
The components of office properties and equipment are as follows (in
thousands):
December 31, Estimated
1998 1997 Useful Life
------------- ---------- -----------
Buildings and improvements $ 39,523 $ 30,976 20-40 years
Furniture, fixtures, equipment and computer software 20,101 16,920 3-10 years
Automobiles 62 62 3-5 years
Leasehold improvements 3,202 2,599 5-20 years
-------- --------
62,888 50,557
Less accumulated depreciation and amortization (18,791) (17,132)
-------- --------
44,097 33,425
Land 7,674 5,806
-------- --------
$ 51,771 $ 39,231
======== ========
8. Deposits:
The components of deposits are as follows (in thousands):
December 31,
1998 1997
---------- ----------
Commercial checking accounts (non-interest bearing) $ 104,176 $ 31,230
Checking accounts, 1.50% 193,114 92,281
Passbook accounts, 2.55% 102,927 71,484
Money market demand accounts, 1.50% to 4.17% 330,251 184,795
---------- ----------
730,468 379,790
---------- ----------
Certificate accounts:
Up to 3.99% 8,548 1,633
4.00 to 4.99% 267,080 4,338
5.00 to 5.99% 473,287 566,810
6.00 to 6.99% 43,592 108,239
7.00 to 7.99% 13,741 12,984
8.00 to 8.99% 6,738 8,911
9.00 to 9.99% 1,355 1,177
10.00% and over 616 563
---------- ----------
814,957 704,655
---------- ----------
$1,545,425 $1,084,445
========== ==========
F-21
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
8. Deposits, Continued:
The weighted average interest rate paid on deposit accounts was 3.85% and
4.80% at December 31, 1998 and 1997, respectively. At December 31, 1998, the
scheduled maturities of certificate accounts are as follows (in thousands):
Year Ending Weighted-Average
December 31, Interest Rate Amount
------------ ---------------- --------
1999 5.12% $655,560
2000 5.29 90,053
2001 5.89 20,329
2002 6.64 19,439
2003 5.98 14,377
Thereafter 6.41 15,199
--------
5.21% $814,957
===== ========
At December 31, 1998, the remaining maturities of certificate accounts with
a minimum balance of $100,000 were as follows (in thousands):
Less than three months $117,660
Three to six months 40,700
Six to twelve months 47,767
Over twelve months 22,364
--------
$228,491
========
The components of interest expense associated with deposits are as
follows (in thousands):
Six Months
Year Ended Ended Year
December 31, December 31, Ended
------------------ --------------- June 30,
1998 1997 1996 1995 1996
------- ------- ------ ------- --------
Checking accounts $ 1,662 $ 1,133 $ 545 $ 546 $ 1,121
Passbook accounts 1,552 1,987 1,106 1,390 2,568
Money market demand accounts 11,193 7,591 3,305 2,037 5,027
Certificate accounts 43,188 37,316 17,330 19,980 38,091
------- ------- ------- ------- -------
$57,595 $48,027 $22,286 $23,953 $46,807
======= ======= ======= ======= =======
F-22
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
9. Federal Home Loan Bank Advances and Available Lines of Credit:
Advances from FHLB are collateralized by qualifying loans with a carrying
value of approximately $450.8 million at December 31, 1998. Sterling Savings
Bank's credit line with FHLB Seattle is limited to 35% of total assets. At
December 31, 1998, Sterling Savings Bank had the ability to borrow an
additional $495.7 million from FHLB Seattle.
The advances from FHLB Seattle at December 31, 1998 are repayable as follows
(in thousands):
Year Ending Weighted-Average
December 31, Interest Rate Amount
------------ ---------------- --------
1999 5.97% $ 95,000
2000 6.15 38,691
2001 0.00 --
2002 4.54 125,683
2003 4.85 45,000
Thereafter 8.04 15,166
--------
$319,540
========
Sterling has a $5.0 million term line-of-credit agreement with a bank. The
term line of credit matures in June 1999. These borrowings are
collateralized by all shares of Sterling Savings Bank 10.75% and 10.25%
Preferred and Common Stock. At December 31, 1998 and 1997, no amounts were
outstanding under this line-of-credit agreement.
Sterling Savings Bank has an unsecured $10.0 million line-of-credit
agreement with a bank that bears interest at the Federal Funds rate plus an
incremental negotiated rate and matures in June 1999. At December 31, 1998
and 1997, no amounts were outstanding under this line-of-credit agreement.
10. Securities Sold Subject to Repurchase Agreements:
Sterling enters into sales of securities under agreements to repurchase
(reverse repurchase agreements). Fixed-coupon reverse repurchase agreements
are treated as financings, and the obligations to repurchase securities sold
are reflected as a liability in the consolidated balance sheet. The dollar
amount of securities underlying the agreements remains in the applicable
asset accounts. These agreements had a weighted-average interest rate of
5.0% at December 31, 1998. The reverse repurchase agreements mature at
various dates through October 2003. Substantially all of Sterling's reverse
repurchase agreements are transacted with Donaldson, Lufkin and Jenerette
(DLJ), Morgan Stanley (MS), Merrill Lynch (ML) and Salomon (SAL). The
mortgage-backed securities underlying these agreements were held by DLJ, MS,
ML and SAL. The risk of default under such agreements is limited by the
financial strength of these broker-dealers and the level of borrowings
relative to the market value of pledged securities. At December 31, 1998,
under the repurchase agreements, Sterling has pledged as collateral
investments and mortgage-backed securities with aggregate amortized costs
and market/carrying values of $219.4 million and $220.5 million,
respectively.
F-23
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
10. Securities Sold Subject to Repurchase Agreements, Continued:
The average balances of securities sold subject to repurchase agreements
were $123.7 million, $185.7 million, $213.6 million, $164.6 million and
$156.6 million during the years ended December 31, 1998 and 1997, the six
months ended December 31, 1996 and 1995 and the year ended June 30, 1996,
respectively. The maximum amount outstanding at any month end during these
same periods was $366.7 million, $273.6 million, $232.9 million, $184.5
million and $195.8 million, respectively.
The securities sold subject to repurchase agreements are repayable as
follows (in thousands):
Year Ending Weighted-Average
December 31, Interest Rate Amount
-------------- ----------------- --------
1999 5.36% $ 49,274
2001 5.75 30,000
2003 4.48 115,800
--------
$195,074
========
11. Other Borrowings:
The components of other borrowings are as follows (in thousands):
December 31,
----------------
1998 1997
------- -------
Advances on line of credit(1) $40,000 $ --
8.75% Subordinated Notes Due 2000(2) 17,240 17,240
Sterling obligated mandatorily redeemable preferred capital securities
of subsidiary trust holding solely junior subordinated deferrable
interest debentures of Sterling(3) 40,000 40,000
Term note payable(4) -- 15,000
------- -------
$97,240 $72,240
======= =======
(1) In June 1998, Sterling entered into a one-year variable rate line-of-
credit agreement with KeyBank National Association. Interest accrues
at the London Interbank Offering Rate Index plus 2.0% ( 7.6875% at
December 31, 1998) and is payable monthly. This line of credit is for
twelve months and may be renewed for an additional six months.
(2) Sterling's 8.75% Subordinated Notes are due on January 31, 2000. These
notes are unsecured general obligations of Sterling and are
subordinated to certain other existing and future indebtedness. Under
the terms of the notes, Sterling is limited in the amount of certain
long-term debt that it may incur and the notes restrict Sterling,
under certain circumstances, as to the amount of cash dividends on its
preferred or common stock and capital distributions which can be made.
At December 31, 1998, Sterling could incur approximately $78.0 million
of additional long-term debt and Sterling would have been limited to
the payment of up to approximately $55.3 million in additional
dividends. Interest on these notes is due the first day of each month.
Sterling may, at its option, redeem the notes, in whole or in part, at
par plus accrued interest.
F-24
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
11. Other Borrowings, Continued:
/(3)/ On June 4, 1997, Sterling issued $41.2 million of 9.50% junior
subordinated deferrable interest debentures (the "Junior
Subordinated Debentures") to Sterling Capital Trust I (the "Trust"),
a Delaware business trust, in which Sterling owns all of the common
equity. The sole asset of the Trust is the Junior Subordinated
Debentures. The Trust issued $40.0 million of 9.50% Cumulative
Capital Securities (the "Trust Preferred Securities") to investors.
Sterling's obligations under the Junior Subordinated Debentures and
related documents, taken together, constitute a full and
unconditional guarantee by Sterling of the Trust's obligations under
the Trust Preferred Securities. The Trust Preferred Securities are
treated as debt of Sterling. Although Sterling, as a savings and
loan holding company, is not subject to the Federal Reserve capital
requirements for bank holding companies, the Trust Preferred
Securities have been structured to qualify as Tier 1 capital,
subject to certain limitations, if Sterling were to become regulated
as a bank holding company. The Junior Subordinated Debentures and
related Trust Preferred Securities mature on June 30, 2027 and are
redeemable at the option of Sterling in the event the deduction of
related interest for federal income taxes is prohibited, treatment
as Tier 1 capital is no longer permitted, or certain other
contingencies arise. The Trust Preferred Securities must be redeemed
upon maturity of the Junior Subordinated Debentures in 2027.
/(4)/ Sterling had a five-year term variable rate loan from a commercial
bank. Interest was payable quarterly on this loan. The interest rate
at December 31, 1997 was 7.325%. This loan was repaid in June 1998.
12. Income Taxes:
The tax effects of the principal temporary differences giving rise to
deferred tax assets and liabilities were as follows (in thousands):
December 31,
----------------------------------------
1998 1997
------------------- -------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Allowance for loan losses $5,390 $ -- $3,311 $ 163
Office properties and equipment -- 415 -- 754
Equity in losses of partnerships -- 502 -- 473
FHLB dividends -- 4,863 -- 4,424
Purchase accounting discount or premium 1,220 464 1,399 495
Deferred loan fees -- 2,434 115 3,330
Unrealized losses on available-for-sale
securities -- 424 540 189
Acquired mortgage servicing rights -- -- -- 576
Net operating loss carryforward 105 -- 144 --
Other 764 -- 368 34
------ ------ ------ -------
Total deferred income taxes $7,479 $9,102 $5,877 $10,438
====== ====== ====== =======
A valuation allowance against deferred tax assets has not been established
as it is more likely than not that these assets will be realized through the
reversal of taxable temporary differences.
F-25
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
12. Income Taxes, Continued:
A reconciliation of the income tax provision and the amount of income taxes
computed by applying the statutory federal corporate income tax rate to
income (loss) before income taxes follows (dollars in thousands):
Year Ended December 31,
------------------------------------
1998 1997
-------------------- --------------
Amount % Amount %
------- ----------- ------- -----
Income tax provision at federal statutory rate $3,466 35.0% $5,720 35.0%
Tax effect of:
State taxes, net of federal benefit (20) (0.2) 277 1.7
Amortization of goodwill 217 2.2 255 1.6
Tax-exempt interest (160) (1.6) (157) (1.0)
Other, net 176 1.8 57 0.2
------ ------- ------ ----
$3,679 37.2% $6,152 37.5%
====== ======= ====== ====
Six Months Ended December 31,
------------------------------------
1996 1995
-------------------- --------------
Amount % Amount %
------- ----------- ------- -----
Income tax provision (benefit) at federal statutory rate $ (303) (35.0)% $2,124 35.0%
Tax effect of:
State taxes, net of federal benefit 6 0.7 51 0.8
Amortization of goodwill 138 16.0 185 3.0
Tax-exempt interest (74) (8.6) (75) (1.2)
Change in tax estimates of prior periods 340 39.4 -- --
Other, net 55 6.3 (33) (0.7)
------ ------- ------ ----
$ 162 18.8% $2,252 36.9%
====== ======= ====== ====
Year Ended
June 30, 1996
--------------------
Amount %
------- -----------
Income tax provision at federal statutory rate $4,328 35.0%
Tax effect of:
State taxes, net of federal benefit 255 2.0
Amortization of goodwill 343 2.8
Tax-exempt interest (152) (1.2)
Other, net (107) (1.0)
------ -------
$4,667 37.6%
====== =======
At December 31, 1998, Sterling had acquired net operating loss carryforwards
of approximately $425,000, which expire beginning in 2002. Sterling's
utilization of tax net operating loss carryforwards is currently limited to
approximately $123,000 annually.
F-26
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
13. Stock Options and Warrants:
Sterling has granted options to purchase shares of its common stock at
exercise prices equal to the fair market value of the stock at the date of
grant. The options vest over 1 to 4 years and are exercisable from 4 to 10
years from the date of grant. Sterling is authorized to grant 1,100,000
options under the plans. At December 31, 1998, 358,995 options are available
to be granted.
Sterling has chosen not to record compensation expense using fair value
measurement provisions in the statement of operations. Had compensation cost
for Sterling's plans been determined based on the fair value at the grant
dates for awards under the plans, Sterling's reported net income (loss) and
income (loss) per common share would have been changed to the pro forma
amounts indicated below:
Year Ended December 31,
---------------------------------------------------
1998 1997
-------------------------- -----------------------
As Pro As Pro
Reported Forma Reported Forma
------------ ------------ ----------- ----------
Net income $ 6,223,000 $ 5,779,000 $10,219,000 $9,802,000
=========== =========== =========== ==========
Income per common share - basic $ 0.78 $ 0.69 $ 1.40 $ 1.34
=========== =========== =========== ==========
Income per common share - diluted $ 0.76 $ 0.68 $ 1.25 $ 1.20
=========== =========== =========== ==========
Six Months Ended Year Ended
December 31, 1996 June 30, 1996
------------------------- -----------------------
As Pro As Pro
Reported Forma Reported Forma
----------- ----------- ----------- ----------
Net income (loss) $(1,025,000) $(1,261,000) $ 7,741,000 $7,337,000
=========== =========== =========== ==========
Income (loss) per common share - basic $ (0.33) $ (0.37) $ 1.00 $ 0.93
=========== =========== =========== ==========
Income (loss) per common share - diluted $ (0.33) $ (.037) $ 0.97 $ 0.92
=========== =========== =========== ==========
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the periods above: dividend yield of 0% in
each period, expected stock price volatility of 80%-85% each period, risk-
free interest rates of 4.46% to 6.97% and expected lives of 2 to 10 years,
respectively.
F-27
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
13. Stock Options and Warrants, Continued:
Stock option transactions are summarized as follows:
Exercise
Number of Weighted-Average Price Expiration
Shares Exercise Price Per Share Date
---------- ---------------- ------------- ----------
Balance, June 30, 1995 238,842 $ 7.92 $ 3.61-$11.85 1995-2004
Options granted 222,750 13.26 $11.93-$14.13 1999-2006
Options exercised (31,419) 6.21 $ 3.61-$10.33 1995-2002
Options canceled (500) 11.93 $ 11.93 1999
-------
Balance, June 30, 1996 429,673 10.81 $ 3.65-$14.13 1996-2006
Options granted 64,233 13.20 $ 10.83-14.00 2001-2007
Options exercised (20,972) 7.93 $ 3.61-$11.85 1996-2004
Options canceled (1,000) 14.13 $ 14.13 2001
-------
Balance, December 31, 1996 471,933 11.25 $ 3.65-$14.13 2002-2007
Options granted 75,352 21.08 $14.18-$21.31 1998-2007
Options exercised (14,632) 9.37 $ 3.61-$14.13 1997-2006
Options canceled (2,352) 14.13 $ 14.13 2006
------- ------
Balance, December 31, 1997 530,301 13.37 $ 3.61-$21.31 1998-2007
Options granted 110,744 16.47 $16.38-$21.13 1999-2008
Options exercised (39,301) 11.89 $ 7.22-$14.13 1998-2007
Options canceled (7,250) 8.77 $14.00-$21.13 2002-2007
------- ------
Balance, December 31, 1998 594,495 $13.39
======= ======
Exercisable, December 31, 1998 417,494 $11.74
======= ======
The weighted-average fair value of options granted during the years ended
December 31, 1998 and 1997, the six months ended December 31, 1996 and the
year ended June 30, 1996 was $16.47, $21.25, $13.20 and $10.15 per share,
respectively.
All share and dollar amounts have been restated to reflect the conversion of
each Big Sky stock option into a Sterling stock option at the exchange
ratio.
The following table summarizes information about the Plan's outstanding and
exercisable stock options at December 31, 1998:
Options Outstanding Options Exercisable
-------------------------------------------------- -------------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- -------------------- ----------- ---------------- ------------------- ------------------- ----------------
$3.61-$3.65 33,926 3.4 years $ 3.62 33,926 $ 3.62
$6.00-$6.99 5,250 2.3 years 6.26 5,250 6.26
$7.00-$8.00 30,000 3.8 years 7.38 30,000 7.38
$9.00-$11.84 95,912 3.7 years 10.03 95,912 10.03
$11.85-$14.18 249,406 4.9 years 13.33 227,406 13.26
$16.38-$19.62 110,500 7.5 years 16.42 2,000 18.93
$21.13-$21.31 69,500 6.8 years 21.31 23,000 21.31
F-28
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
13. Stock Options and Warrants, Continued:
Big Sky had adopted a Management Recognition and Development Plan (the
"Plan") whereby stock was granted to the board of directors and management.
In accordance with the vesting provisions of the Plan, all participants
became fully vested upon consummation of the merger. Accordingly, the
compensation expense associated with this Plan was recorded in Sterling's
operations during the year ended December 31, 1998.
In connection with an acquisition in 1994, Sterling issued warrants to
purchase 99,985 shares of Sterling's Common Stock at $11.82 per share. All
such warrants were exercised in 1996, thereby increasing Sterling's
shareholders' equity by approximately $1.2 million.
14. Preferred Stock:
During the year ended December 31, 1997, the $1.8125 Series A Cumulative
Convertible Preferred Stock (the "Preferred Stock") was called for
redemption at $26.07 per share plus accrued but unpaid dividends. As a
result of the call for redemption, the holders of 1,035,700 shares of
Preferred Stock elected to convert their interests into 2,021,190 shares of
Sterling Common Stock. The remaining 4,300 shares of Preferred Stock were
redeemed for $113,000 during the year ended December 31, 1997.
15. Earnings Per Share:
The following table presents a reconciliation of the numerators and
denominators used in the basic and diluted income per share computations,
which includes the number of antidilutive securities (if any) that were not
included in the dilutive income per share computation. These antidilutive
securities occur when options outstanding held an option price greater than
the average market price for the period. Also shown is the effect that has
been given to preferred dividends in computing basic income per share .
For the Year Ended December 31,
-------------------------------------------------------------------------------
1998 1997
--------------------------------------- --------------------------------------
Weighted- Weighted-
Net Average Net Average
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ----------- ------------ ------------- ---------
Net income $6,223,000 $10,219,000
Less preferred stock dividends -- (940,000)
---------- -----------
Income per common share - basic 6,223,000 8,027,537 $ 0.78 9,279,000 6,634,599 $1.40
Effect of dilutive securities:
Convertible preferred stock -- -- 940,000 1,363,935
Common stock options -- 189,530 -- 172,141
---------- --------- ----------- -----------
Income per common share - diluted $6,223,000 8,217,067 $ 0.76 $10,219,000 8,170,675 $1.25
========== ========= =========== ===========
Antidilutive options not included
in diluted income per share 71,500 74,000
F-29
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
15. Earnings Per Share, Continued:
For the Six Months Ended December 31,
1996 1995
---------------------------------------- -------------------------------------
Weighted- Weighted-
Net Average Net Average
Income (Loss) Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (A) (Numerator) (Denominator) Amount
------------- ------------- ----------- ----------- ------------- ---------
Net income (loss) $(1,025,000) $3,846,000
Less preferred stock dividends (942,000) (942,000)
---------- ---------
Income (loss) per common share -
basic (1,967,000) 5,955,387 $ (0.33) 2,904,000 5,830,804 $0.50
Effect of dilutive securities:
Convertible preferred stock 942,000 2,029,664 942,000 2,029,664
Common stock options -- 89,549 -- 113,789
---------- ---------- --------- ---------
Income (loss) per common share -
diluted $(1,025,000) 8,074,600 $ (0.33) $3,846,000 7,974,257 $0.48
=========== ========== ========== ==========
Antidilutive options not included
in diluted income per share 130,500
For the Year Ended June 30, 1996
------------------------------------
Weighted-
Net Average
Income (Loss Shares Per Share
(Numerator) (Denominator) Amount
------------ ------------ ----------
Net income $ 7,741,000
Less preferred stock dividends (1,885,000)
----------
Income per common share - basic 5,856,000 5,840,359 $ 1.00
Effect of dilutive securities:
Convertible preferred stock 1,885,000 2,029,664
Common stock options -- 130,431
---------- ----------
Income per common share - diluted $7,741,000 8,000,454 $ 0.97
========== ==========
(A) During the six months ended December 31, 1996, the effect of
convertible preferred stock of 2,029,664 shares was antidilutive.
Thus, the presentation of basic and diluted income (loss) per common
share is identical.
16. Regulatory Matters:
In connection with the insurance of its deposits by the Federal Deposit
Insurance Corporation ("FDIC") and general regulatory oversight by the
Office of Thrift Supervision ("OTS"), Sterling Savings Bank is required to
maintain minimum levels of regulatory capital, including core Tier 1 risk-
based and total risk-based capital. At December 31, 1998, Sterling Savings
Bank was in compliance with all regulatory capital requirements. The OTS is
empowered to take "prompt, corrective action" to resolve problems of insured
depository institutions. The extent of these powers depends on whether an
institution is classified as "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly under capitalized," or "critically
undercapitalized." At December 31, 1998, Sterling Savings Bank was
considered "well capitalized."
F-30
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
16. Regulatory Matters, Continued:
The following table sets forth the amounts and ratios regarding actual and
minimum core Tier 1 risk-based and total risk-based capital requirements,
together with the amounts and ratios required in order to meet the
definition of a "well capitalized" institution, without giving effect to
forbearance or capital provisions contained in certain acquisition
agreements.
Minimum
Capital Well Capitalized
Requirements Requirements Actual
---------------- ---------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- ------ ----- ------ ------
As of December 31, 1998:
Total Capital
(to Risk-Weighted Assets) $122,254 8.00% $152,818 10.00% $157,373 10.30%
Core (Tier I) Capital
(to Risk-Weighted Assets) 61,127 4.00 91,691 6.00 143,669 9.40
Core (Tier I) Capital
(to Adjusted Assets) 89,900 4.00 112,375 5.00 143,669 6.39
As of December 31, 1997:
Total Capital
(to Risk-Weighted Assets) $ 89,398 8.00% $111,748 10.00% $156,650 14.03%
Core (Tier I) Capital
(to Risk-Weighted Assets) N/A -- 67,049 6.00 148,228 13.60
Core (Tier I) Capital
(to Adjusted Assets) 57,751 3.00 96,252 5.00 148,228 7.70
Tangible Capital
(to Tangible Assets) 28,876 1.50 N/A -- 148,228 7.70
On September 30, 1996, federal legislation was enacted which included
provisions regarding the recapitalization of the Savings Association
Insurance Fund ("SAIF"), which is operated by the FDIC and provides deposit
insurance for thrift institutions. The new legislation required SAIF-insured
savings institutions, like Sterling Savings Bank, to pay a one-time special
assessment. Sterling's SAIF assessment resulted in a pre-tax charge to
earnings of $6.1 million during the six months ended December 31, 1996.
Sterling Savings Bank may be required to convert its charter to either a
national bank charter, a state depository institution charter or a newly
designed charter. Sterling also may become regulated at the holding company
level by the Board of Governors of the Federal Reserve System ("Federal
Reserve") rather than by the OTS. Regulation by the Federal Reserve could
subject Sterling to capital requirements that are not currently applicable
to Sterling as a holding company under OTS regulations and may result in
statutory limitations on the type of business activities in which Sterling
may engage at the holding company level, which are not currently restricted.
At this time, Sterling Savings Bank is unable to predict whether a charter
change will be required and, if so, whether the charter change would
significantly impact Sterling Savings Bank's operations.
F-31
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
17. Commitments and Contingent Liabilities:
At December 31, 1998, Sterling had loan commitments to borrowers and brokers
totaling $296.7 million, including $78.2 million for fixed-rate loans and
$218.5 million for variable-rate loans. At December 31, 1998, commitments to
secondary market institutions to sell fixed-rate loans totaled $23.4
million. Commitments, which are disbursed subject to certain limitations,
extend over various periods of time, with the majority of funds being
disbursed within a twelve-month period. Substantially all of the commitments
are for loans that have credit risk similar to Sterling's existing
portfolio.
At December 31, 1998, Sterling had made available various secured and
unsecured commercial and personal lines of credit totaling approximately
$166.0 million, of which the undisbursed portion is approximately $86.5
million. These lines of credit provide for periodic adjustment to market
rates of interest and have credit risk similar to Sterling's existing
portfolio. Sterling historically has not realized credit losses due to these
off-balance sheet credits. Based on this fact and Sterling's analysis of the
undisbursed portion of these lines of credit, no specific valuation
allowances were recorded for these off-balance sheet credits at December 31,
1998 and 1997.
Rent expense for office properties under operating leases was $1.3 million,
$1.1 million, $500,000, $431,000 and $1.1 million for the years ended
December 31, 1998 and 1997, the six months ended December 31, 1996 and 1995
and the year ended June 30, 1996, respectively.
Future minimum rental commitments as of December 31, 1998, under
noncancelable operating leases with initial or remaining terms of more than
one year, are as follows (in thousands):
Year Ending
December 31, Amount
------------- ------
1999 $ 1,422
2000 1,116
2001 861
2002 702
2003 677
Thereafter 5,264
-------
$10,042
=======
18. Employee Savings Plan:
Sterling maintains an employee savings plan under Section 401(k) of the
Internal Revenue Code. Substantially all employees are eligible to
participate in the plan subject to certain requirements. Under the plan,
employees may elect to contribute up to 8% of their salary, and Sterling
will make a matching contribution equal to 35% of the employee's
contribution. All matching contributions are made exclusively in the form of
Sterling Common Stock. Each employee may make a supplemental contribution of
an additional 7% of their salary. All contributions vest immediately.
Employees have the option of investing their contributions among four
selected mutual funds, Sterling Savings Bank's certificates of deposit and
Sterling Common Stock. During the years ended December 31, 1998 and 1997,
Sterling contributed $373,000 and $210,000, respectively, to the employee
savings plan. During the six months ended December 31, 1996 and 1995,
Sterling contributed $129,500 and $48,000, respectively. During the year
ended June 30, 1996, Sterling contributed $156,000.
F-32
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
19. Operating Expenses:
The components of total operating expenses are as follows (in thousands):
Six Months
Year Ended Ended Year
December 31, December 31, Ended
----------------- ------------------ June 30,
1998 1997 1996 1995 1996
------- ------- ------- ------- -------
Employee compensation and benefits $22,430 $16,571 $ 7,285 $ 6,433 $12,787
Occupancy and equipment 7,499 6,179 2,931 2,650 5,410
Depreciation 3,352 3,171 1,553 1,350 2,867
Amortization of intangibles 3,971 2,242 1,590 1,669 3,332
Advertising 2,076 1,707 631 499 1,373
Data processing 3,777 2,457 1,401 950 1,846
Insurance 1,116 1,217 1,335 1,210 2,450
SAIF one-time assessment (see Note 16) -- -- 6,145 -- --
Legal and accounting 1,597 1,494 1,260 548 1,246
Travel and entertainment 1,318 1,102 636 457 934
Acquisition and conversion costs 5,464 -- -- -- --
Other 3,691 2,289 1,040 465 864
------- ------- ------- ------- -------
$56,291 $38,429 $25,807 $16,231 $33,109
======= ======= ======= ======= =======
20. Mortgage Banking Operations:
Sterling operates ten residential loan production offices primarily in the
Spokane and Seattle, Washington; Portland, Oregon; and Boise, Idaho
metropolitan areas through its subsidiary Action Mortgage. Mortgage banking
operations include revenues from servicing released and servicing retained
sales of originated residential loans, bulk sales of loan servicing rights
and other fees.
The following table summarizes information related to Sterling's mortgage
banking operations (in thousands):
Six Months
Year Ended Ended Year
December 31, December 31, Ended
---------------- ---------------- June 30,
1998 1997 1996 1995 1996
------ ------ ------ ------ ------
Revenues:
Gains on sales of originated residential loans $1,440 $1,494 $1,087 $1,506 $3,054
Other fees and income 4,628 2,524 1,156 255 2,032
------ ------ ------ ------ ------
Total revenues 6,068 4,018 2,243 1,761 5,086
Identifiable expenses 2,414 2,932 801 1,167 2,491
------ ------ ------ ------ ------
Income before adjustments, eliminations and income taxes 3,654 1,086 1,442 594 2,595
Adjustments and eliminations 1 836 244 1,167 459
------ ------ ------ ------ ------
Income before income taxes $3,655 $1,922 $1,686 $1,761 $3,054
====== ====== ====== ====== ======
Identifiable assets $9,094 $5,153 $3,643 $2,404 $3,220
====== ====== ====== ====== ======
Depreciation and amortization expense $ 141 $ 177 $ 108 $ 186 $ 327
====== ====== ====== ====== ======
Capital expenditures for office properties and equipment $ 232 $ 15 $ 15 $ 57 $ 93
====== ====== ====== ====== ======
F-33
20. Mortgage Banking Operations, Continued:
The following is a reconcilation of certain mortgage banking operations to
the amounts reported in the consolidated financial statements (in
thousands):
Mortgage
Banking Banking
Operations Operations Total
----------- ---------- -----------
As of and for the year ended December 31, 1998:
Other income $ 6,245 $6,068 $ 12,313
Income before income taxes 6,248 3,654 9,902
Total assets 2,305,493 9,094 2,314,587
As of and for the year ended December 31, 1997:
Other income $ 5,456 $4,018 $ 9,474
Income before income taxes 14,449 1,922 16,371
Total assets 1,933,200 5,153 1,938,353
As of and for the six months ended December 31, 1996:
Other income $ 2,532 $2,243 $ 4,775
Income (loss) before income taxes (2,549) 1,686 (863)
Total assets 1,590,787 3,643 1,594,430
As of and for the six months ended December 31, 1995:
Other income $ 3,301 $1,761 $ 5,062
Income before income taxes 4,337 1,761 6,098
Total assets 1,599,987 2,404 1,602,391
As of and for the year ended June 30, 1996:
Other income $ 4,447 $5,086 $ 9,533
Income before income taxes 9,354 3,054 12,408
Total assets 1,534,593 3,220 1,537,813
21. Interest Rate Risk:
The results of operations for savings institutions may be materially and
adversely affected by changes in prevailing economic conditions, including
rapid changes in interest rates, declines in real estate market values and
the monetary and fiscal policies of the federal government. Like all
financial institutions, Sterling's net interest income and its NPV (the net
present value of financial assets, liabilities and off-balance sheet
contracts) are subject to fluctuations in interest rates. Currently,
Sterling's interest-bearing liabilities, consisting primarily of savings
deposits, FHLB Seattle advances and other borrowings, mature or reprice more
rapidly, or on different terms, than do its interest-earning assets. The
fact that liabilities mature or reprice more frequently on average than
assets may be beneficial in times of declining interest rates; however, such
an asset/liability structure may result in declining net interest income
during periods of rising interest rates.
F-34
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
21. Interest Rate Risk, Continued:
Additionally, the extent to which borrowers prepay loans is affected by
prevailing interest rates. When interest rates increase, borrowers are less
likely to prepay loans; whereas when interest rates decrease, borrowers are
more likely to prepay loans. Prepayments may affect the levels of loans
retained in an institution's portfolio, as well as its net interest income.
Sterling maintains an asset and liability management program intended to
manage net interest income through interest rate cycles and to protect its
NPV by controlling its exposure to changing interest rates.
Sterling uses a simulation model designed to measure the sensitivity of net
interest income and NPV to changes in interest rates. This simulation model
is designed to enable Sterling to generate a forecast of net interest income
and NPV given various interest rate forecasts and alternative strategies.
The model also is designed to measure the anticipated impact that prepayment
risk, basis risk, customer maturity preferences, volumes of new business and
changes in the relationship between long- and short-term interest rates have
on the performance of Sterling. Another monitoring tool used by Sterling to
assess interest rate risk is "gap analysis." The matching of repricing
characteristics of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest sensitive" and by
monitoring Sterling's interest sensitivity "gap." Management is aware of the
sources of interest rate risk and endeavors to actively monitor and manage
its interest rate risk although there can be no assurance regarding the
management of interest rate risk in future periods.
22. Quarterly Financial Data (Unaudited):
Year Ended December 31, 1998
------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
(Dollars in thousands, except per share amounts)
Interest income $ 35,955 $ 38,042 $ 40,094 $ 41,672
Interest expense (23,543) (24,462) (24,156) (24,397)
Provision for loan losses (808) (2,907) (807) (803)
-------- -------- -------- --------
Net interest income after provision for
loan losses 11,604 10,673 15,131 16,472
Net gain (loss) on sales of securities 711 (133) 655 805
Other income 2,255 2,180 2,914 2,926
Merger and acquisition costs -- (3,210) -- (2,254)
Other operating expenses (10,164) (10,942) (14,182) (15,539)
-------- -------- -------- --------
Income (loss) before income taxes 4,406 (1,432) 4,518 2,410
Income tax (provision) benefit (1,580) 559 (1,672) (986)
-------- -------- -------- --------
Net income (loss) $ 2,826 $ (873) $ 2,846 $ 1,424
======== ======== ======== ========
F-35
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
22. Quarterly Financial Data (Unaudited), Continued:
Year Ended December 31, 1998
----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ----------- -----------
(Dollars in thousands, except per share amounts)
Income (loss) per common share - basic $ 0.35 $ (0.11) $ 0.35 $ 0.18
========== ========== ========== ==========
Income (loss) per common share - diluted $ 0.34 $ (0.11) $ 0.35 $ 0.17
========== ========== ========== ==========
Weighted average common shares
outstanding - basic 8,004,135 8,029,425 8,032,882 8,043,217
========== ========== ========== ==========
Weighted average common shares
outstanding - diluted 8,207,691 8,261,690 8,188,326 8,168,718
========== ========== ========== ==========
Year Ended December 31, 1997
----------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------ ------------ ----------- -----------
(Dollars in thousands, except per share amounts)
Interest income $ 30,784 $ 31,981 $ 35,998 $ 37,122
Interest expense (19,198) (20,381) (23,900) (24,598)
Provision for loan losses (560) (558) (682) (682)
---------- ---------- ---------- ----------
Net interest income after provision for
loan losses 11,026 11,042 11,416 11,842
Net gain on sales of securities 85 487 582 43
Other income 2,005 2,232 2,092 1,948
Operating expenses (9,190) (9,822) (9,758) (9,659)
---------- ---------- ---------- ----------
Income before income taxes 3,926 3,939 4,332 4,174
Income tax provision (1,494) (1,504) (1,656) (1,498)
---------- ---------- ---------- ----------
Net income 2,432 2,435 2,676 2,676
Less preferred stock dividends declared (471) (469) -- --
---------- ---------- ---------- ----------
Income available to common shares $ 1,961 $ 1,966 $ 2,676 $ 2,676
========== ========== ========== ==========
Income per common share - basic $ 0.33 $ 0.33 $ 0.41 $ 0.33
========== ========== ========== ==========
Income per common share - diluted $ 0.30 $ 0.30 $ 0.33 $ 0.33
========== ========== ========== ==========
Weighted average common shares
outstanding - basic 5,968,035 5,977,414 6,576,190 7,995,125
========== ========== ========== ==========
Weighted average common shares
outstanding - diluted 8,158,171 8,171,003 8,169,749 8,198,053
========== ========== ========== ==========
F-36
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
23. Fair Values of Financial Instruments:
Fair value estimates are determined as of a specific date in time utilizing
quoted market prices, where available, or various assumptions and estimates.
As the assumptions underlying these estimates change, the fair value of the
financial instruments will change. The use of assumptions and various
valuation techniques, as well as the absence of secondary markets for
certain financial instruments, will likely reduce the comparability of fair
value disclosures between financial institutions. Additionally, Sterling has
not disclosed highly subjective values of core deposit intangibles or other
non-financial instruments. Accordingly, the aggregate fair value amounts
presented do not represent and should not be construed to represent the full
underlying value of Sterling.
The methods and assumptions used to estimate the fair values of each class
of financial instruments are as follows:
Cash and Cash Equivalents
The carrying value of cash and cash equivalents approximates fair value due
to the relatively short-term nature of these instruments.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities is based on
quoted market prices. If quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments.
Loans Held for Sale
The fair values are based on the estimated value at which the loans could
be sold in the secondary market considering the fair value of options and
commitments to sell or issue mortgage loans.
Loans Receivable
The fair values of performing residential mortgage loans and home equity
loans are estimated using current market comparable information for
securitizable mortgages, adjusting for credit and other relevant
characteristics. The fair value of performing commercial real estate
construction, permanent financing, consumer and commerical loans is
estimated by discounting the cash flows using interest rates that consider
the current credit and interest rate risk inherent in the loans and current
economic and lending conditions.
The fair value of nonperforming loans is estimated by discounting
management's current estimate of future cash flows using a rate estimated
to be commensurate with the risks involved.
Deposits
The fair values for deposits subject to immediate withdrawal such as
interest and non-interest bearing checking, passbook savings, and money
market deposit accounts, are equal to the amounts payable on demand at the
reporting date (i.e., their carrying amount on the balance sheet). The
carrying amounts for variable-rate certificates of deposit and other time
deposits approximate their fair value at the reporting date. Fair values
for fixed-rate certificates of deposit are estimated by discounting future
cash flows using interest rates currently offered on time deposits with
similar remaining maturities.
F-37
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
23. Fair Values of Financial Instruments, Continued:
Borrowings
The carrying amounts of short-term borrowings under repurchase agreements,
FHLB Seattle advances, and other short-term borrowings approximate their
fair values due to the relatively short period of time between the
origination of the instruments and their expected payment. The fair value
of long-term debt is estimated using discounted cash flow analyses based on
Sterling's current incremental borrowing rates for similar types of
borrowing arrangements with similar remaining terms.
December 31,
----------------------------------------------
1998 1997
---------------------- ----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
Financial assets:
Cash and cash equivalents $ 97,106 $ 97,106 $ 54,581 $ 54,581
Investments and mortgage-backed securities:
Available for sale 566,372 566,372 666,476 666,476
Held to maturity 20,033 20,355 24,463 24,817
Loans held for sale 15,581 15,581 5,225 5,225
Loans receivable, net 1,468,534 1,465,298 1,105,739 1,116,411
Accrued interest receivable 14,938 14,938 14,058 14,058
Financial liabilities:
Non-maturity deposits 730,468 730,468 379,790 379,790
Deposits with stated maturities 814,957 822,950 704,655 709,396
Borrowings 611,854 619,882 712,402 720,161
Accrued interest payable 5,639 5,639 5,879 5,879
The fair value estimates above do not include the value of residential
mortgage loan servicing rights on Sterling's residential loan servicing
portfolio which totaled approximately $211.0 million and $454.3 million at
December 31, 1998 and 1997, respectively. The gross fair value of these
rights is estimated to be approximately $2.5 million and $5.3 million at
December 31, 1998 and 1997, respectively.
24. Related-Party Transactions:
One of Sterling's directors is a principal in the law firm that provides
legal services to Sterling. During the years ended December 31, 1998 and
1997, the six months ended December 31, 1996 and 1995 and the year ended
June 30, 1996, Sterling incurred approximately $766,000, $794,000, $389,000,
$207,000 and $552,000, respectively, for legal services provided by this
firm.
F-38
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
25. Parent Company Only Financial Information:
Sterling Financial Corporation became the holding company for Sterling
Savings Bank on November 1, 1992. The following Sterling Financial
Corporation (parent company only) financial information should be read in
conjunction with the other notes to consolidated financial statements. The
accounting policies for the parent company only financial statements are the
same as those used in the presentation of the consolidated financial
statements other than the parent company only financial statements account
for the parent company's investments in its subsidiaries under the equity
method.
December 31,
------------------
Balance Sheets 1998 1997
-------- --------
(Dollars in thousands)
ASSETS
Cash and cash equivalents $ 1,626 $ 21,570
Investments in subsidiaries:
Big Sky -- 7,502
Sterling Savings Bank 206,008 148,403
Tri-Cities Mortgage Company 1,246 1,033
Sterling Capital Trust I 1,237 1,237
Income taxes receivable from subsidiaries 1,598 816
Other assets 3,123 2,980
Federal income taxes receivable 2,772 591
-------- --------
Total assets $217,610 $184,132
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued expenses payable $ 23 $ 16
Term note payable -- 15,000
Advances under line of credit 40,000 --
8.75% Subordinated Notes due 2000 17,240 17,240
Junior Subordinated Debentures of Sterling 41,237 41,237
Federal income taxes payable/other liabilities 93 22
Shareholders' equity 119,017 110,617
-------- --------
Total liabilities and shareholders' equity $217,610 $184,132
======== ========
F-39
Sterling Financial Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Information for the six months ended December 31, 1995 is unaudited)
25. Parent Company Only Financial Information, Continued:
Six Months
Year Ended Ended Year
December 31, December 31, Ended
---------------------- ------------------ June 30,
1998 1997 1996 1995 1996
--------- --------- ------- -------- --------
(Dollars in thousands)
Statements of Operations
Interest income $ 219 $ 975 $ 5 $ 17 $ 22
Interest expense (7,281) (4,682) (1,217) (859) (1,692)
-------- -------- ------- ------- -------
Net interest expense (7,062) (3,707) (1,212) (842) (1,670)
Other income - equity in net earnings (loss)
of subsidiaries 11,583 12,987 (135) 4,724 9,596
Miscellaneous income, net 57 -- 219 46 107
Operating expenses (1,319) (822) (211) (172) (351)
-------- -------- ------- ------- -------
Income (loss) before income taxes 3,259 8,458 (1,339) 3,756 7,682
Deferred income tax benefit 2,964 1,761 314 90 59
-------- -------- ------- ------- -------
Net income (loss) $ 6,223 $ 10,219 $(1,025) $ 3,846 $ 7,741
======== ======== ======= ======= =======
Statements of Cash Flows
Cash flows from operating activities:
Net income (loss) $ 6,223 $ 10,219 $(1,025) $ 3,846 $ 7,741
Adjustments to reconcile net income (loss) to net
cash used in operating activities (14,413) (16,878) 606 (3,898) (8,212)
-------- -------- ------- ------- -------
Net cash used in operating activities (8,190) (6,659) (419) (52) (471)
-------- -------- ------- ------- -------
Cash flows from investing activities:
Investment in subsidiaries, net (45,278) (30,076) (9,494) (82) (392)
Dividends from subsidiary 8,088 6,078 2,487 2,317 4,633
-------- -------- ------- ------- -------
Net cash provided by (used in) investing activities (37,190) (23,998) (7,007) 2,235 4,241
-------- -------- ------- ------- -------
Cash flows from financing activities:
Repayment of note payable (15,000) -- -- -- --
Proceeds from line of credit and other borrowings 40,000 40,000 15,000 -- --
Proceeds from exercise of stock options and warrants,
net of repurchases 382 56 1,250 58 163
Payments to redeem preferred stock and fractional
shares (4) (126) -- -- --
Cash dividends on preferred stock -- (940) (942) (942) (1,885)
Shareholders' redemption -- -- -- (831) (820)
Other, net 58 -- 4 -- --
-------- -------- ------- ------- -------
Net cash provided by (used in) financing activities 25,436 38,990 15,312 (1,715) (2,542)
-------- -------- ------- ------- -------
Net change in cash and cash equivalents (19,944) 8,333 7,886 468 1,228
Cash and cash equivalents, beginning of period 21,570 13,237 5,351 4,124 4,124
-------- -------- ------- ------- -------
Cash and cash equivalents, end of period $ 1,626 $ 21,570 $13,237 $ 4,592 $ 5,351
======== ======== ======= ======= =======
F-40
25. Parent Company Only Financial Information, Continued:
Federal law prohibits Sterling Financial Corporation from borrowing from its
subsidiary savings association unless the loans are collateralized by
specified assets and are generally limited to 10% of the subsidiary savings
association's capital and surplus.
During the year ended December 31, 1998, Sterling purchased $45.0 million of
Sterling Savings Bank common and preferred stock.
Current income taxes are allocated to Sterling and its subsidiaries as if
they were separate taxpayers.
The payment of dividends to Sterling Financial Corporation by its subsidiary
savings association is subject to various federal and state regulatory
limitations. Under current regulations, at December 31, 1998, the subsidiary
savings association could have declared approximately $55.3 million of
aggregate dividends, in addition to amounts previously paid. Sterling
Financial Corporation's non-regulated subsidiaries are not subject to the
dividend payment limitations applicable to savings associations.
F-41
EXECUTIVE OFFICERS
Harold B. Gilkey, Chairman of the Board and Chief Executive Officer
William W. Zuppe, President and Chief Operating Officer
Ned M. Barnes, Corporate Secretary
David P. Bobbitt, Executive Vice President-Community Banking Services
Heidi B. Stanley, Executive Vice President-Corporate Administration
Daniel G. Byrne, Senior Vice President-Corporate Finance; Chief Financial
Officer; Treasurer, Assistant Secretary
Stephen L. Page, Senior Vice President-Credit Management; Chief Credit Officer
John M. Harlow, Vice President; President, INTERVEST-Mortgage Investment Company
Stanton C. Parrish, Vice President; President, Harbor Financial Services, Inc.
John B. Richardson, Vice President; President, Action Mortgage Company
THE BOARD OF DIRECTORS
Harold B. Gilkey, Chairman of the Board and Chief Executive Officer
William W. Zuppe, President and Chief Operating Officer
Ned M. Barnes, Secretary; Principal in the law firm of Witherspoon, Kelley,
Davenport & Toole, P.S. of Spokane, Washington
Rodney W. Barnett, Principal an General Manager of Carr Sales Company, an
electrical supply firm in Spokane, Washington
James P Fugate, Retired Superintendent of Auburn School District No. 408 in
Auburn, Washington
Robert D. Larrabee, Former Owener of Merchant Funeral Home in Clarkston,
Washington
Robert E. Meyers, Retired Dentist in Clarkston, Washington
David O. Wallace, Owner of Startup Business Planning, Spokane, Washington
THE CORPORATION
Sterling Financial Corporation is a Washington State-chartered corporation
headquartered in Spokane, Washington. Sterling Financial Corporation is a
holding company for Sterling Savings Bank, Sterling Capital Trust I and Tri-
Cities Mortgage Corporation. Sterling Savings Bank is a Washington State-
chartered savings and loan association headquartered in Spokane, Washington. Its
subsidiaries are Action Mortgage Company; Harbor Financial Services, Inc.;
INTERVEST-Mortgage Investment Company; Evergreen Environmental Development
Corporation; Evergreen First Service Corporation; Fidelity Service Corporation;
and Tri-West Mortgage Company.
THE ANNUAL MEETING
The Annual Meeting of Shareholders of Sterling Financial Corporation will be
held on Tuesday, April 27, 1999. The Meeting will begin at 10:00 a.m. in the
Conference Theater of the Agricultural Trade Center, 334 West Spokane Falls
Boulevard, Spokane, Washington.
FORM 10-K
To obtain a copy of Sterling Financial Corporation's Annual Report on Form 10-K,
as filed with the Securities and Exchange Commission, please contact Daniel G.
Byrne, Sr. Vice President and Chief Financial Officer, Sterling Financial
Corporation, 111 North Wall Street, Spokane, Washington 99201.
TRANSFER AGENT, REGISTRAR AND DIVIDEND DISBURSING AGENT
ChaseMellon Shareholder Services, L.L.C.
Shareholder Relations
85 Challenger Road
Ridgefield Park, NJ 07660
(800) 522-6645
www.chasemellon.com
SHAREHOLDER INFORMATION
For further information, contact:
Shareholder Relations
Sterling Financial Corporation
111 North Wall Street
Spokane, Washington 99201
509-458-2711
INVESTOR RELATIONS CONTACT
Heidi B. Stanley, Executive Vice President - Corporate Administration
509-358-6160
SUBSIDIARIES
Subsidiaries of Sterling Financial Corporation: Sterling Savings Bank, Sterling
Capital Trust I and Tri-Cities Mortgage Corporation.
Subsidiaries of Sterling Savings Bank: Action Mortgage Company;
INTERVEST-Mortgage Investment Company; Harbor Financial Services, Inc.;
Evergreen Environmental Development Corporation; Evergreen First Service
Corporation; Fidelity Service Corporation; Tri-West Mortgage Company