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EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 906 - STERLING FINANCIAL CORP /WA/dex321.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 - STERLING FINANCIAL CORP /WA/dex312.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended MARCH 31, 2011

OR

 

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

For the transition period from              to              .

Commission File Number. 001-34696

 

 

STERLING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Washington   91-1572822

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

111 North Wall Street, Spokane, Washington 99201

(Address of principal executive offices) (Zip Code)

(509) 458-3711

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

 

Class

 

Outstanding as of April 29, 2011

Common Stock   61,943,190

 

 

 


Table of Contents

TABLE OF CONTENTS

March 31, 2011

 

               Page  

PART I - Financial Information

     1   
   Item 1    Financial Statements (Unaudited)      1   
      Consolidated Balance Sheets      1   
      Consolidated Income Statements      2   
      Consolidated Statements of Comprehensive Income      3   
      Consolidated Statements of Cash Flows      4   
      Notes to Consolidated Financial Statements      6   
   Item 2    Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   
   Item 3    Quantitative and Qualitative Disclosures About Market Risk      41   
   Item 4    Controls and Procedures      41   
PART II - Other Information      43   
   Item 1    Legal Proceedings      43   
   Item 1A    Risk Factors      44   
   Item 2    Unregistered Sales of Equity Securities and Use of Proceeds      44   
   Item 3    Defaults Upon Senior Securities      44   
   Item 4    (Removed And Reserved)      44   
   Item 5    Other Information      44   
   Item 6    Exhibits      44   
Signatures      45   


Table of Contents

STERLING FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands)

 

      March 31,
2011
    December 31,
2010
 

ASSETS:

    

Cash and cash equivalents:

    

Interest bearing

   $ 348,596      $ 341,425   

Non-interest bearing

     73,112        70,158   
                

Total cash and cash equivalents

     421,708        411,583   
                

Restricted cash

     14,669        15,681   

Investment securities and mortgage-backed securities ("MBS"):

    

Available for sale

     2,808,030        2,825,010   

Held to maturity

     12,742        13,464   

Loans held for sale

     136,447        222,216   

Loans receivable, net

     5,320,884        5,379,081   

Accrued interest receivable

     35,044        34,087   

Other real estate owned, net ("OREO")

     151,774        161,653   

Properties and equipment, net

     85,542        81,094   

Bank-owned life insurance ("BOLI")

     171,093        169,288   

Core deposit intangible assets, net

     15,704        16,929   

Mortgage servicing rights, net

     22,944        20,604   

Prepaid expenses and other assets, net

     155,888        142,479   
                

Total assets

   $ 9,352,469      $ 9,493,169   
                

LIABILITIES:

    

Deposits:

    

Noninterest bearing

   $ 1,007,684      $ 992,368   

Interest bearing

     5,716,743        5,918,639   
                

Total deposits

     6,724,427        6,911,007   

Advances from Federal Home Loan Bank ("FHLB")

     407,142        407,211   

Securities sold subject to repurchase agreements and funds purchased

     1,051,995        1,032,512   

Junior subordinated debentures

     245,286        245,285   

Accrued interest payable

     18,019        17,259   

Accrued expenses and other liabilities

     131,140        109,128   
                

Total liabilities

     8,578,009        8,722,402   
                

SHAREHOLDERS’ EQUITY:

    

Preferred stock, 10,000,000 shares authorized; no shares outstanding

     0        0   

Common stock, 151,515,151 shares authorized; 61,937,273 and 61,926,187 shares outstanding

     1,961,763        1,960,871   

Accumulated other comprehensive (loss)

     (6,795     (4,179

Accumulated deficit

     (1,180,508     (1,185,925
                

Total shareholders’ equity

     774,460        770,767   
                

Total liabilities and shareholders’ equity

   $ 9,352,469      $ 9,493,169   
                

See notes to consolidated financial statements.

 

1


Table of Contents

STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)

(in thousands, except per share amounts)

 

     Three Months Ended
March 31,
 
     2011     2010  

Interest income:

    

Loans

   $ 80,387      $ 96,976   

MBS

     20,034        19,826   

Investments and cash equivalents

     2,816        2,690   
                

Total interest income

     103,237        119,492   
                

Interest expense:

    

Deposits

     17,294        27,451   

Short-term borrowings

     80        2,111   

Long-term borrowings

     12,120        15,040   
                

Total interest expense

     29,494        44,602   
                

Net interest income

     73,743        74,890   

Provision for credit losses

     10,000        88,556   
                

Net interest income (expense) after provision for credit losses

     63,743        (13,666
                

Noninterest income:

    

Fees and service charges

     12,561        13,035   

Mortgage banking operations

     10,327        11,232   

Loan servicing fees

     1,101        1,146   

BOLI

     1,732        2,295   

Gains on sales of securities

     6,001        1,911   

Other

     (1,740     (4,322
                

Total noninterest income

     29,982        25,297   
                

Noninterest expense

     88,308        95,977   
                

Loss before income taxes

     5,417        (84,346

Income tax expense

     0        0   
                

Net income (loss)

     5,417        (84,346

Preferred stock dividend

     0        (4,412
                

Net income (loss) available to common shareholders

   $ 5,417      $ (88,758
                

Earnings (loss) per share - basic

   $ 0.09      $ (112.70
                

Earnings (loss) per share - diluted

   $ 0.09      $ (112.70
                

Weighted average shares outstanding - basic

     61,930,783        787,576   

Weighted average shares outstanding - diluted

     62,335,212        787,576   

See notes to consolidated financial statements.

 

2


Table of Contents

STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(in thousands)

 

     Three Months Ended
March 31,
 
     2011     2010  

Net income (loss)

   $ 5,417      $ (84,346
                

Other comprehensive income (loss):

    

Change in unrealized gains (losses) on investments and MBS available-for-sale

     (4,152     16,127   

Less deferred income tax benefit (provision)

     1,536        (5,986
                

Net other comprehensive (loss) income

     (2,616     10,141   
                

Comprehensive income (loss)

   $ 2,801      $ (74,205
                

See notes to consolidated financial statements.

 

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Table of Contents

STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

     Three Months Ended March 31,  
     2011     2010  

Cash flows from operating activities:

    

Net income (loss)

   $ 5,417      $ (84,346

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Provision for credit losses and OREO

     14,209        95,219   

Accretion of deferred gain on sale of buildings

     (201     (67

Net gain on sales of loans, investments and MBS

     (16,618     (13,487

Stock based compensation

     927        294   

Loss at foreclosure and on sale of OREO

     13,155        13,152   

Other losses

     416        415   

Increase in cash surrender value of BOLI

     (1,732     (2,295

Depreciation and amortization

     10,851        8,744   

Change in:

    

Accrued interest receivable

     (957     4,785   

Prepaid expenses and other assets

     (11,956     9   

Accrued interest payable

     760        (3,556

Accrued expenses and other liabilities

     22,173        (1,375

Proceeds from sales of loans originated for sale

     469,392        695,258   

Loans originated for sale

     (363,453     (676,879
                

Net cash provided by operating activities

     142,383        35,871   
                

Cash flows from investing activities:

    

Change in restricted cash

     1,012        (5,827

Loans funded

     (315,873     (51,248

Loans purchased

     (104,656     0   

Loan principal received

     365,446        515,780   

Proceeds from sales of loans

     10,483        6,425   

Purchase of investment securities

     (2,000     (1,750

Proceeds from maturities of investment securities

     94        2,972   

Proceeds from sale of investment securities

     5,377        7,728   

Purchase of MBS

     (233,538     (18,047

Principal payments received on MBS

     130,111        170,041   

Proceeds from sales of MBS

     113,402        44,579   

Office properties and equipment, net

     (7,489     (848

Improvements and other changes to OREO

     (5,404     (1,235

Proceeds from sales of OREO

     77,922        30,302   
                

Net cash provided by investing activities

     34,887        698,872   
                

See notes to consolidated financial statements.

 

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Table of Contents

STERLING FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - cont.

(in thousands)

 

     Three Months Ended March 31,  
     2011     2010  

Cash flows from financing activities:

    

Net change in transaction and savings deposits

   $ (186,580   $ (150,051

Advances from FHLB

     0        275,000   

Repayment of advances from FHLB

     (48     (345,046

Net change in securities sold subject to repurchase agreements and funds purchased

     19,483        (23,761
                

Net cash used in financing activities

     (167,145     (243,858
                

Net change in cash and cash equivalents

     10,125        490,885   

Cash and cash equivalents, beginning of period

     411,583        564,783   
                

Cash and cash equivalents, end of period

   $ 421,708      $ 1,055,668   
                

Supplemental disclosures:

    

Cash paid on interest during the period

   $ 28,734      $ 48,158   

Cash received on income taxes during the period

     (56     (1,618

Noncash financing and investing activities:

    

Loans converted into OREO

     79,820        69,583   

Preferred stock cash dividend accrued

     0        3,882   

See notes to consolidated financial statements.

 

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Table of Contents

STERLING FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

1. Basis of Presentation:

The foregoing unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements as disclosed in the annual report on Form 10-K for the year ended December 31, 2010. In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of a normal recurring nature, necessary for a fair statement of the results for the interim periods presented.

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

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

In July 2010, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2010-20,”Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” This update amends codification topic 310 on receivables to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. This guidance was phased in, with the new disclosure requirements for period end balances effective as of December 31, 2010, and the new disclosure requirements for activity during the reporting period effective March 31, 2011. The troubled debt restructuring disclosures in this ASU have been delayed by ASU 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” which was issued in January 2011. See Note 3.

In April 2011, the FASB issued ASU 2011-2, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This update to codification topic 310 provides guidance for what constitutes a concession, as well as clarity for determining whether a debtor is experiencing financial difficulties. The amendments in this update are effective for Sterling on July 1, 2011, with retrospective application from January 1, 2011. This update is not expected to have a material effect on Sterling’s consolidated financial statements.

 

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2. Investments and MBS:

The carrying and fair values of investments and MBS are summarized as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (in thousands)  

March 31, 2011

          

Available for sale

          

MBS

   $ 2,588,434       $ 25,008       $ (29,140   $ 2,584,302   

Municipal bonds

     205,383         2,401         (6,925     200,859   

Other

     24,848         0         (1,979     22,869   
                                  

Total

   $ 2,818,665       $ 27,409       $ (38,044   $ 2,808,030   
                                  

Held to maturity

          

Tax credits

   $ 12,742       $ 0       $ 0      $ 12,742   
                                  

Total

   $ 12,742       $ 0       $ 0      $ 12,742   
                                  

December 31, 2010

          

Available for sale

          

MBS

   $ 2,598,086       $ 30,017       $ (25,493   $ 2,602,610   

Municipal bonds

     208,588         949         (8,394     201,143   

Other

     24,821         2         (3,566     21,257   
                                  

Total

   $ 2,831,495       $ 30,968       $ (37,453   $ 2,825,010   
                                  

Held to maturity

          

Tax credits

   $ 13,464       $ 0       $ 0      $ 13,464   
                                  

Total

   $ 13,464       $ 0       $ 0      $ 13,464   
                                  

Sterling’s tax credit investments are in low income housing partnerships. Subsequent to March 31, 2011, Sterling was presented with an opportunity to sell $10.5 million of its tax credit investments. Prior to this opportunity, there was not a liquid market to sell these types of investments. If this sale is executed, it would likely close during the second quarter of 2011 and result in a loss of approximately $2.1 million. Other available for sale securities primarily consisted of a trust preferred security at both March 31, 2011 and December 31, 2010. During the periods ended March 31, 2011 and 2010, Sterling sold available-for-sale investments and MBS and recorded the following results:

 

     Proceeds from
Sales
     Gross Realized
Gains
     Gross Realized
(Losses)
 
     (in thousands)  

Three months ended:

        

March 31, 2011

   $ 118,779       $ 6,004       $ 3   

March 31, 2010

     52,307         1,971         60   

Reclassification adjustments from other comprehensive income, representing realized net gains on available-for-sale securities, net of related deferred income taxes, were as follows for the periods presented:

 

     Three Months Ended
March 31,
 
     2011      2010  
     (in thousands)  

Realized net gains reclassified from other comprehensive income

   $ 4,899       $ 1,223   

 

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The following table summarizes Sterling’s investments and MBS that had a market value below their amortized cost as of March 31, 2011 and December 31, 2010, segregated by those investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer:

 

     Less than 12 months     12 months or longer     Total  
     Market Value      Unrealized
Losses
    Market Value      Unrealized
Losses
    Market Value      Unrealized
Losses
 
     (in thousands)  

March 31, 2011

  

Municipal bonds

   $ 46,730       $ (1,857   $ 51,486       $ (5,068   $ 98,216       $ (6,925

MBS

     1,337,676         (29,057     10,205         (83     1,347,881         (29,140

Other

     0         0        22,862         (1,979     22,862         (1,979
                                                   

Total

   $ 1,384,406       $ (30,914   $ 84,553       $ (7,130   $ 1,468,959       $ (38,044
                                                   

December 31, 2010

               

Municipal bonds

   $ 89,364       $ (3,193   $ 47,101       $ (5,201   $ 136,465       $ (8,394

MBS

     1,460,173         (25,493     0         0        1,460,173         (25,493

Other

     0         0        21,250         (3,566     21,250         (3,566
                                                   

Total

   $ 1,549,537       $ (28,686   $ 68,351       $ (8,767   $ 1,617,888       $ (37,453
                                                   

The following table presents the amortized cost and fair value of available-for-sale and held-to-maturity securities as of March 31, 2011, grouped by contractual maturity. Actual maturities for MBS will differ from contractual maturities as a result of the level of prepayments experienced on the underlying mortgages. As of March 31, 2011, the weighted average life of the MBS portfolio was 5.1 years, and its effective duration was 4.0%. This compares with a weighted average life of 5.0 years, and an effective duration of 3.6% at December 31, 2010.

 

     Held-to-maturity      Available-for-sale  
     Amortized
Cost
     Estimated Fair
Value
     Amortized
Cost
     Estimated Fair
Value
 
     (in thousands)  

Due within one year

   $ 0       $ 0       $ 25       $ 25   

Due after one year through five years

     0         0         457         457   

Due after five years through ten years

     0         0         231,934         231,297   

Due after ten years

     12,742         12,742         2,586,249         2,576,251   
                                   

Total

   $ 12,742       $ 12,742       $ 2,818,665       $ 2,808,030   
                                   

Management evaluates investment securities for other than temporary declines in fair value on a quarterly basis. If the fair value of investment securities falls below their amortized cost and the decline is deemed to be other than temporary, the securities are written down to current market value, resulting in a loss. There were no investment securities that management identified to be other than-temporarily impaired at March 31, 2011, because Sterling expects the return of all principal and interest on all securities within its investment and MBS portfolio pursuant to the contractual terms, has the ability and intent to hold these investments, has no intent to sell securities that are deemed to have a market value impairment, and believes it is unlikely that Sterling would be required to sell these investments before a recovery in market price occurs, or until maturity. As of March 31, 2011, Sterling held nonagency collateralized mortgage obligations with an amortized book value of $35.3 million, and a net unrealized gain of $456,000. All nonagency collateralized mortgage obligations are internally monitored monthly and independently stress-tested quarterly for both credit quality and collateral strength, and are AAA rated according to at least one major rating agency. The vintage, or year of issuance, for these nonagency securities ranges from 2003 to 2005. Additionally as of March 31, 2011, Sterling held municipal bonds with an amortized book value of $205.4 million, and a net unrealized loss of $4.5 million. Sterling reviews its municipal bonds for impairment at least quarterly. Approximately 90% of Sterling’s municipal bonds are general obligation bonds.

 

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3. Loans Receivable and Allowance for Credit Losses:

The following table presents the composition of Sterling’s loan portfolio as of the balance sheet dates:

 

     March 31,
2011
    December 31,
2010
 
     (in thousands)  

Residential real estate

   $ 719,458      $ 758,410   

Multifamily real estate

     638,250        517,022   

Commercial real estate (1)

     1,400,867        1,314,657   

Construction:

    

Residential

     106,051        156,853   

Multifamily

     72,885        90,518   

Commercial

     217,364        278,297   
                

Total construction

     396,300        525,668   

Consumer

     715,206        744,068   

Commercial banking (2)

     1,686,573        1,770,426   
                

Gross loans receivable

     5,556,654        5,630,251   

Deferred loan fees, net

     (2,826     (4,114

Allowance for losses on loans

     (232,944     (247,056
                

Net loans receivable

   $ 5,320,884      $ 5,379,081   
                

 

(1) 

Comprised of non owner-occupied commercial real estate ("CRE").

(2) 

Comprised of commercial and industrial ("C&I"), and owner-occupied CRE.

Gross loans pledged as collateral for borrowings from the FHLB and the Federal Reserve totaled $1.34 billion and $1.52 billion as of March 31, 2011 and December 31, 2010, respectively. As of March 31, 2011 and December 31, 2010, the unamortized portion of discounts on acquired loans was $5.1 million and $5.3 million, respectively.

 

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The following table sets forth details by segment for Sterling’s loan portfolio and related allowance as of the balance sheet dates:

 

     Real Estate           Commercial              
     Residential     Multifamily     Commercial     Construction     Consumer     Banking     Unallocated     Total  
     (in thousands)  

March 31, 2011

                

Loans receivable, gross:

                

Individually evaluated for impairment

   $ 62,734      $ 21,034      $ 64,423      $ 237,955      $ 6,532      $ 84,389      $ 0      $ 477,067   

Collectively evaluated for impairment

     656,724        617,216        1,336,444        158,345        708,674        1,602,184        0        5,079,587   
                                                                

Total loans receivable, gross

     719,458        638,250        1,400,867        396,300        715,206        1,686,573        0        5,556,654   

Deferred loan fees

     0        0        0        0        0        0        (2,826     (2,826

Allowance for loan losses:

                

Individually evaluated for impairment

     (532     (133     (4,295     (12,732     (51     (3,741     0        (21,484

Collectively evaluated for impairment

     (17,980     (9,421     (44,269     (42,177     (13,005     (53,643     (30,965     (211,460
                                                                

Total allowance for loan losses

     (18,512     (9,554     (48,564     (54,909     (13,056     (57,384     (30,965     (232,944
                                                                

Net loans receivable

   $ 700,946      $ 628,696      $ 1,352,303      $ 341,391      $ 702,150      $ 1,629,189      $ (33,791   $ 5,320,884   
                                                                

December 31, 2010

                

Loans receivable, gross:

                

Individually evaluated for impairment

   $ 91,411      $ 23,541      $ 106,085      $ 335,656      $ 7,973      $ 89,973      $ 0      $ 654,639   

Collectively evaluated for impairment

     666,999        493,481        1,208,572        190,012        736,095        1,680,453        0        4,975,612   
                                                                

Total loans receivable, gross

     758,410        517,022        1,314,657        525,668        744,068        1,770,426        0        5,630,251   

Deferred loan fees

     0        0        0        0        0        0        (4,114     (4,114

Allowance for loan losses:

                

Individually evaluated for impairment

     (1,239     (362     (4,670     (12,368     (33     (2,564     0        (21,236

Collectively evaluated for impairment

     (16,068     (9,306     (44,692     (53,509     (14,612     (54,387     (33,246     (225,820
                                                                

Total allowance for loan losses

     (17,307     (9,668     (49,362     (65,877     (14,645     (56,951     (33,246     (247,056
                                                                

Net loans receivable

   $ 741,103      $ 507,354      $ 1,265,295      $ 459,791      $ 729,423      $ 1,713,475      $ (37,360   $ 5,379,081   
                                                                

 

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The following table presents a roll-forward by segment of the allowance for credit losses for the three months ended March 31, 2011 and 2010:

 

     Real Estate           Commercial              
     Residential     Multifamily     Commercial     Construction     Consumer     Banking     Unallocated     Total  
     (in thousands)  

2011

                

Allowance for loan losses:

                

Beginning balance, January 1

   $ 17,307      $ 9,668      $ 49,362      $ 65,877      $ 14,645      $ 56,951      $ 33,246      $ 247,056   

Chargeoffs

     (6,816     (211     (1,648     (9,339     (2,146     (9,584     0        (29,744

Recoveries

     250        1        578        3,687        621        495        0        5,632   

Provisions

     7,771        96        272        (5,316     (64     9,522        (2,281     10,000   
                                                                

Ending balance, March 31

     18,512        9,554        48,564        54,909        13,056        57,384        30,965        232,944   
                                                                

Allowance for unfunded commitments:

                

Beginning balance, January 1

     3,103        0        31        4,126        1,113        1,306        1,028        10,707   

Chargeoffs

     (66     0        0        0        0        0        0        (66

Recoveries

     0        0        0        0        0        0        0        0   

Provisions

     248        0        (31     (736     (12     80        451        0   
                                                                

Ending balance, March 31

     3,285        0        0        3,390        1,101        1,386        1,479        10,641   
                                                                

Total credit allowance

   $ 21,797      $ 9,554      $ 48,564      $ 58,299      $ 14,157      $ 58,770      $ 32,444      $ 243,585   
                                                                

2010

                

Allowance for loan losses:

                

Beginning balance, January 1

   $ 28,319      $ 8,984      $ 42,296      $ 185,222      $ 19,198      $ 59,135      $ 289      $ 343,443   

Chargeoffs

     (4,721     (10,380     (7,489     (104,508     (3,721     (13,040     0        (143,859

Recoveries

     120        0        16        6,291        503        394        0        7,324   

Provisions

     1,421        10,465        13,176        38,747        1,635        20,399        2,047        87,890   
                                                                

Ending balance, March 31

     25,139        9,069        47,999        125,752        17,615        66,888        2,336        294,798   
                                                                

Allowance for unfunded commitments:

                

Beginning balance, January 1

     712        0        0        9,228        1,481        1,665        (1,119     11,967   

Chargeoffs

     (310     0        0        0        0        0        0        (310

Recoveries

     0        0        0        0        0        0        0        0   

Provisions

     678        0        189        (2,082     (208     151        1,938        666   
                                                                

Ending balance, March 31

     1,080        0        189        7,146        1,273        1,816        819        12,323   
                                                                

Total credit allowance

   $ 26,219      $ 9,069      $ 48,188      $ 132,898      $ 18,888      $ 68,704      $ 3,155      $ 307,121   
                                                                

 

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

Sterling assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

 

   

Pass – asset is considered of sufficient quality to preclude a Special Mention or an adverse rating. Pass assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral.

 

   

Special Mention – asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in Sterling’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

   

Substandard – asset is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified have well-defined weaknesses. They are characterized by the distinct possibility that Sterling will sustain some loss if the deficiencies are not corrected.

 

   

Doubtful – asset has the weaknesses of those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

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Credit quality indicators for Sterling’s loan portfolio as of March 31, 2011 and December 31, 2010 grouped according to internally assigned risk ratings and payment activity:

 

     Real Estate             Commercial             % of
total
 
     Residential      Multifamily      Commercial      Construction      Consumer      Banking      Total     
     (in thousands)         

March 31, 2011

                       

Pass

   $ 616,140       $ 573,313       $ 1,179,218       $ 59,367       $ 693,310       $ 1,411,070       $ 4,532,418         81

Special mention

     44,384         29,272         116,861         91,094         12,687         84,244         378,542         7

Substandard

     58,934         35,665         104,788         245,839         9,209         190,179         644,614         12

Doubtful

     0         0         0         0         0         1,080         1,080         0
                                                                       

Total

   $ 719,458       $ 638,250       $ 1,400,867       $ 396,300       $ 715,206       $ 1,686,573       $ 5,556,654         100
                                                                       

Restructured

   $ 19,302       $ 0       $ 11,439       $ 50,725       $ 118       $ 15,095       $ 96,679      

Nonaccrual

     43,431         21,034         52,985         187,231         6,413         69,294         380,388      
                                                                 

Nonperforming

     62,733         21,034         64,424         237,956         6,531         84,389         477,067      

Performing

     656,725         617,216         1,336,443         158,344         708,675         1,602,184         5,079,587      
                                                                 

Total

   $ 719,458       $ 638,250       $ 1,400,867       $ 396,300       $ 715,206       $ 1,686,573       $ 5,556,654      
                                                                 

December 31, 2010

                       

Pass

   $ 638,273       $ 446,363       $ 1,047,239       $ 68,099       $ 718,831       $ 1,474,312       $ 4,393,117         78

Special mention

     15,670         29,566         91,870         89,524         7,074         89,680         323,384         6

Substandard

     104,467         41,093         175,548         368,045         18,163         205,354         912,670         16

Doubtful

     0         0         0         0         0         1,080         1,080         0
                                                                       

Total

   $ 758,410       $ 517,022       $ 1,314,657       $ 525,668       $ 744,068       $ 1,770,426       $ 5,630,251         100
                                                                       

Restructured

   $ 20,569       $ 0       $ 10,856       $ 57,662       $ 119       $ 19,298       $ 108,504      

Nonaccrual

     70,842         23,541         95,229         277,992         7,854         70,675         546,133      
                                                                 

Nonperforming

     91,411         23,541         106,085         335,654         7,973         89,973         654,637      

Performing

     666,999         493,481         1,208,572         190,014         736,095         1,680,453         4,975,614      
                                                                 

Total

   $ 758,410       $ 517,022       $ 1,314,657       $ 525,668       $ 744,068       $ 1,770,426       $ 5,630,251      
                                                                 

Upgrades in loan risk ratings from substandard to special mention and pass during the first quarter of 2011 were primarily related to loans that have performed in accordance with their original terms, but were previously classified due to a decline in the value of their underlying collateral.

 

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Aging by class for Sterling’s loan portfolio as of March 31, 2011 and December 31, 2010 was as follows:

 

     Real Estate             Commercial             % of
total
 
     Residential      Multifamily      Commercial      Construction      Consumer      Banking      Total     
     (in thousands)         

March 31, 2011

                       

30 - 59 days past due

   $ 9,979       $ 1,744       $ 6,328       $ 21,588       $ 4,067       $ 23,280       $ 66,986         1

60 - 89 days past due

     3,107         3,167         2,947         14,590         1,350         5,208         30,369         1

> 90 days past due

     30,273         6,178         33,825         203,220         4,902         43,299         321,697         6
                                                                       

Total past due

     43,359         11,089         43,100         239,398         10,319         71,787         419,052         8

Current

     676,099         627,161         1,357,767         156,902         704,887         1,614,786         5,137,602         92
                                                                       

Total Loans

   $ 719,458       $ 638,250       $ 1,400,867       $ 396,300       $ 715,206       $ 1,686,573       $ 5,556,654         100
                                                                       

> 90 days and accruing

   $ 0       $ 0       $ 0       $ 0       $ 0       $ 0       $ 0      
                                                                 

December 31, 2010

                       

30 - 59 days past due

   $ 10,273       $ 3,235       $ 4,251       $ 27,251       $ 5,650       $ 12,994       $ 63,654         1

60 - 89 days past due

     4,179         6,146         7,089         15,419         1,837         4,099         38,769         1

> 90 days past due

     35,544         6,428         34,517         232,140         4,834         52,497         365,960         6
                                                                       

Total past due

     49,996         15,809         45,857         274,810         12,321         69,590         468,383         8

Current

     708,414         501,213         1,268,800         250,858         731,747         1,700,836         5,161,868         92
                                                                       

Total Loans

   $ 758,410       $ 517,022       $ 1,314,657       $ 525,668       $ 744,068       $ 1,770,426       $ 5,630,251         100
                                                                       

> 90 days and accruing

   $ 0       $ 0       $ 0       $ 0       $ 0       $ 0       $ 0      
                                                                 

 

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Sterling considers its nonperforming loans to be impaired loans. Impaired loans by class were as follows at March 31, 2011 and December 31, 2010:

 

     Unpaid
principal
balance
            Book balance                       
        Charge-offs      without
specific
reserve
     with specific
reserve
     Specific
reserve
     Average
book
balance
     Interest
income
recognized
 
     (in thousands)  

March 31, 2011

  

Residential real estate

   $ 81,524       $ 18,790       $ 26,176       $ 36,558       $ 532       $ 77,072       $ 0   

Multifamily real estate

     25,656         4,622         10,311         10,723         133         22,288         528   

Commercial real estate

     78,310         13,887         21,385         43,038         4,295         85,254         320   

Construction

     389,141         151,185         44,623         193,333         12,731         286,806         30   

Consumer

     10,244         3,713         3,968         2,563         51         7,252         0   

Commercial banking

     136,932         52,543         42,845         41,544         3,741         87,181         722   
                                                              

Total

   $ 721,807       $ 244,740       $ 149,308       $ 327,759       $ 21,483       $ 565,853       $ 1,600   
                                                              

December 31, 2010

                    

Residential real estate

   $ 114,401       $ 22,990       $ 11,539       $ 79,872       $ 1,239         

Multifamily real estate

     30,464         6,923         3,201         20,340         362         

Commercial real estate

     135,366         29,281         13,993         92,092         4,670         

Construction

     539,330         203,674         39,015         296,641         12,369         

Consumer

     12,740         4,767         1,232         6,741         33         

Commercial banking

     142,111         52,138         14,839         75,134         2,564         
                                                  

Total

   $ 974,412       $ 319,773       $ 83,819       $ 570,820       $ 21,237         
                                                  

At the applicable foreclosure date, OREO is recorded at the fair value of the real estate, less the costs to sell. The carrying value of OREO is periodically evaluated and, if necessary, an allowance is established to reduce the carrying value to net realizable value. Changes in this allowance are as follows for the periods presented:

 

     Three Months Ended March 31,  
     2011     2010  
     (in thousands)  

Balance, January 1

   $ 21,799      $ 8,204   

Provision

     4,209        6,663   

Charge-offs

     (11,341     (2,831
                

Balance, March 31

   $ 14,667      $ 12,036   
                

The increase in charge-offs during the first quarter of 2011 was due to the increase in OREO sales, as OREO sales were $78.0 million for the first quarter of 2011 compared to $30.3 million during the same period in 2010.

 

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Table of Contents

4. Junior Subordinated Debentures:

Sterling has raised capital through the formation of trust subsidiaries. The trusts are business trusts in which Sterling owns all of the common equity. The proceeds from the sale of the securities were used to purchase junior subordinated debentures issued by Sterling. Sterling’s obligations under the junior subordinated debentures and related documents, taken together, constitute a full and unconditional guarantee by Sterling of the trusts’ obligations. The junior subordinated debentures are treated as debt of Sterling. The junior subordinated debentures generally mature 30 years after issuance and are redeemable at the option of Sterling under certain conditions, including, with respect to certain of the trusts, payment of call premiums. During the third quarter of 2009, Sterling elected to defer regularly scheduled interest payments on these securities, and has continued to defer these payments through March 31, 2011. As of March 31, 2011 and December 31, 2010, the accrued deferred interest was $10.9 million and $9.4 million, respectively. Sterling is allowed to defer payments of interest on the junior subordinated debentures for up to 20 consecutive quarterly periods without triggering an event of default. Details of the junior subordinated debentures are as follows:

 

Subsidiary Issuer

  

Issue Date

  

Maturity
Date

  

Next Call
Date

  

Rate at March 31,
2011

    Amount  
               (in thousands)             

Sterling Capital Trust IX

   July 2007    Oct 2037    Oct 2012    Floating      1.70   $ 46,392   

Sterling Capital Trust VIII

   Sept 2006    Sept 2036    Dec 2011    Floating      1.94     51,547   

Sterling Capital Trust VII

   June 2006    June 2036    June 2011    Floating      1.83     56,702   

Lynnwood Capital Trust II

   June 2005    June 2035    June 2011    Floating      2.11     10,310   

Sterling Capital Trust VI

   June 2003    Sept 2033    June 2011    Floating      3.51     10,310   

Sterling Capital Statutory Trust V

   May 2003    May 2033    May 2011    Floating      3.56     20,619   

Sterling Capital Trust IV

   May 2003    May 2033    May 2011    Floating      3.46     10,310   

Sterling Capital Trust III

   April 2003    April 2033    April 2011    Floating      3.55     14,433   

Lynnwood Capital Trust I

   Mar 2003    Mar 2033    June 2011    Floating      3.46     9,451   

Klamath First Capital Trust I

   July 2001    July 2031    July 2011    Floating      4.20     15,212   
                      
                 2.44 %*    $ 245,286   
                      

 

* Weighted average rate

 

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Table of Contents

5. Earnings (Loss) Per Share:

The following table presents the basic and diluted earnings per common share computations:

 

     Three Months Ended March 31,  
     2011      2010  
     (in thousands, except shares and per share amounts)  

Numerator:

     

Net income (loss) available to common shareholders

   $ 5,417       $ (88,758

Denominator:

     

Weighted average shares outstanding - basic

     61,930,783         787,576   

Dilutive securities outstanding

     404,429         0   
                 

Weighted average shares outstanding - diluted

     62,335,212         787,576   
                 

Earnings (loss) per share - basic

   $ 0.09       $ (112.70
                 

Earnings (loss) per share - diluted

   $ 0.09       $ (112.70
                 

Antidilutive securities outstanding (weighted average):

     

Stock options

     17,701         23,140   

Warrants

     0         97,541   

Restricted shares

     31,847         2,805   
                 

Total antidilutive securities outstanding

     49,548         123,486   
                 

Prior period share and per share amounts disclosed in this footnote, as well as all other prior period share and per share amounts disclosed in these financial statements, have been restated to reflect the 1-for-66 reverse stock split that was effected in November 2010.

6. Noninterest Expense:

The following table details the components of Sterling’s noninterest expense:

 

     Three Months Ended March 31,  
             2011                      2010              % change  
     (in thousands)         

Employee compensation and benefits

   $ 43,850       $ 40,059         9

OREO operations

     11,400         10,923         4

Occupancy and equipment

     9,822         9,946         -1

Data processing

     6,080         5,105         19

Insurance

     4,504         12,685         -64

Professional fees

     3,058         6,380         -52

Depreciation

     3,012         3,568         -16

Advertising

     1,960         2,583         -24

Travel and entertainment

     1,236         716         73

Amortization of core deposit intangibles

     1,225         1,225         0

Other

     2,161         2,787         -22
                          

Total noninterest expense

   $ 88,308       $ 95,977         -8
                          

The decrease in noninterest expense was primarily due to a lower level of FDIC deposit insurance premiums and professional fees. Insurance, which is primarily comprised of FDIC deposit insurance premiums, was down over the 2010 amount due to the higher assessment rates last year applicable to Sterling Savings Bank prior to its returning to a well-capitalized status. Professional fees decreased over the same period a year earlier, because the 2010 period included advisory costs related to Sterling’s recapitalization.

 

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7. Income Taxes:

Sterling uses an estimate of future earnings and an evaluation of its loss carryback ability and tax planning strategies to determine whether it is more likely than not that it will realize the benefit of its net deferred tax asset. Sterling has determined that it does not at this time meet the required threshold, and accordingly, has a valuation allowance against its deferred tax asset. As of March 31, 2011, the reserved deferred tax asset was approximately $358 million, including approximately $271 million of net operating loss carry-forwards. This is compared with a reserved deferred tax asset of approximately $359 million, including approximately $263 million of net operating loss carry-forwards, as of December 31, 2010.

With regard to the deferred tax asset, the benefits of Sterling’s accumulated tax losses would be reduced in the event of an “ownership change,” as determined under Section 382 of the Internal Revenue Code. During 2010, in order to preserve the benefits of these tax losses, Sterling’s shareholders approved a protective amendment to Sterling’s restated articles of incorporation and Sterling’s board has adopted a shareholder rights plan, both of which restrict certain transfers of stock that would result in investors acquiring more than 4.95% of Sterling’s total outstanding common stock.

8. Segment Information:

For 2011, Sterling changed its reporting segments to reflect the integration of Golf Savings Bank into Sterling Savings Bank and leadership realignments. The segments for 2011 are as follows:

 

 

Community Banking – a division within Sterling Savings Bank providing traditional banking and wealth management services through the retail banking, private banking and commercial banking groups.

 

 

Home Loan Division – originating residential real estate loans primarily through the mortgage banking operations of Sterling Savings Bank on both a servicing-retained and servicing-released basis.

 

 

Commercial Real Estate – a division within Sterling Savings Bank focused on the origination and servicing of multifamily real estate, commercial real estate, and construction loans.

The Other and Eliminations caption represents intercompany eliminations of revenue and expenses. Segment results for the comparable period presented are grouped according to the original classifications, due to the impracticability of reclassification to current period presentation.

 

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     As of and for the Three Months Ended March 31, 2011  
     Community
Banking
    Home
Loan
Division
    Commercial
Real Estate
    Other and
Eliminations
    Total  
     (in thousands)  

Interest income

   $ 91,744      $ 1,295      $ 10,600      $ (402   $ 103,237   

Interest expense

     26,434        503        2,604        (47     29,494   
                                        

Net interest income (expense)

     65,310        792        7,996        (355     73,743   

Provision for credit losses

     10,678        (89     (589     0        10,000   

Noninterest income

     18,301        9,932        1,422        327        29,982   

Noninterest expense

     73,120        10,282        4,906        0        88,308   
                                        

Income (loss) before income taxes

   $ (187   $ 531      $ 5,101      $ (28   $ 5,417   
                                        

Total assets

   $ 9,438,037      $ 144,143      $ 834,019      $ (1,063,730   $ 9,352,469   
                                        

 

     As of and for the Three Months Ended March 31, 2010  
     Community
Banking
    Residential
Construction
Lending
    Residential
Mortgage
Banking
     Commercial
Mortgage
Banking
     Other and
Eliminations
    Total  
     (in thousands)  

Interest income

   $ 108,955      $ 2,714      $ 6,134       $ 1,619       $ 70      $ 119,492   

Interest expense

     33,737        6,329        3,063         0         1,473        44,602   
                                                  

Net interest income (expense)

     75,218        (3,615     3,071         1,619         (1,403     74,890   

Provision for credit losses

     48,933        36,067        3,556         0         0        88,556   

Noninterest income

     12,681        11        12,593         663         (651     25,297   

Noninterest expense

     76,636        1,615        12,070         1,408         4,248        95,977   
                                                  

Income (loss) before income taxes

   $ (37,670   $ (41,286   $ 38       $ 874       $ (6,302   $ (84,346
                                                  

Total assets

   $ 9,171,631      $ 812,115      $ 555,481       $ 17,085       $ (1,745   $ 10,554,567   
                                                  

 

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9. Stock-Based Compensation:

The following table presents a summary of stock option and restricted stock activity during the three months ended March 31, 2011:

 

     Stock Options      Restricted Stock  
     Number     Weighted
Average
Exercise
Price
     Number     Weighted
Average
Grant Price
 

Balance, January 1, 2011

     18,920      $ 1,357.97         368,805      $ 18.24   

Granted

     0        0.00         55,610        18.15   

Exercised/vested

     0        0.00         (11,741     49.14   

Cancelled/expired

     (2,221     1,167.12         0        0.00   
                                 

Outstanding, March 31, 2011

     16,699      $ 1,383.36         412,674      $ 17.35   
                                 

Exercisable, March 31, 2011

     14,581      $ 1,501.21        
                     

At March 31, 2011, the weighted average remaining contractual life and the aggregate intrinsic value of stock options outstanding was 2.9 years and $0, respectively, and of stock options exercisable was 2.8 years and $0, respectively, and at December 31, 2010, were 2.8 years and $0, respectively, and 2.6 years and $0, respectively. As of March 31, 2011, a total of 5,549,089 shares remained available for grant under Sterling’s 2003, 2007 and 2010 Long-Term Incentive Plans. The stock options granted under these plans have terms of four, six, eight and ten years. Restricted shares granted during 2011 have vesting schedules that vary, ranging from vesting immediately upon grant to vesting up to three years after the grant date.

Stock-based compensation expense recognized during the periods presented was as follows:

 

     Three Months Ended March 31,  
     2011      2010  
     (in thousands)  

Stock based compensation expense:

     

Stock options

   $ 96       $ 146   

Restricted stock

     831         147   
                 

Total

   $ 927       $ 293   
                 

As of March 31, 2011, unrecognized equity compensation expense totaled $6.7 million, as the underlying outstanding awards had not yet been earned. This amount will be recognized over a weighted average period of 2.0 years. During the three months ended March 31, 2011, 83 stock options were forfeited, and no shares of restricted stock were forfeited.

10. Derivatives and Hedging:

As part of its mortgage banking activities, commitments to prospective borrowers on residential mortgage loan applications may have the interest rates fixed for a period of 10 to 60 days (interest rate lock commitments). To offset the exposure to interest rate risk, the pricing for the sale of these loans is fixed with various qualified investors under both non-binding (“best-efforts”) and binding (“mandatory”) delivery programs. For mandatory delivery programs, Sterling hedges interest rate risk by entering into offsetting forward sale agreements on MBS with third parties. Risks inherent in mandatory delivery programs include the risk that if Sterling does not close the loans subject to interest rate lock commitments, it is nevertheless obligated to deliver MBS to the counterparty under the forward sale agreement. Sterling could incur significant costs in acquiring replacement loans or MBS and such costs could have a material adverse effect on mortgage banking operations in future periods.

 

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Interest rate lock commitments and loan delivery commitments are off-balance sheet commitments that are considered to be derivatives. As of March 31, 2011, Sterling had $152.9 million of interest rate lock commitments, $80.0 million of residential mortgage loans held for sale that were not committed to investors and offsetting forward sale agreements on MBS valued at $242.5 million. As of December 31, 2010, Sterling had $118.6 million of interest rate lock commitments, $207.0 million of residential mortgage loans held for sale that were not committed to investors and offsetting forward sale agreements on MBS valued at $285.3 million. In addition, Sterling had mandatory delivery commitments to sell mortgage loans to investors valued at $32.5 million as of March 31, 2011, compared with $800,000 as of December 31, 2010. As of March 31, 2011 and December 31, 2010, Sterling had entered into best efforts forward commitments to sell $14.4 million and $18.5 million of mortgage loans, respectively.

From time to time, Sterling may enter into interest rate swap transactions with loan customers. The interest rate risk on these swap transactions is managed by entering into offsetting interest rate swap agreements with various counterparties (“broker-dealers”). Both customer and broker-dealer related interest rate derivatives are carried at fair value by Sterling.

11. Fair Value:

Fair value estimates are determined as of a specific date using 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. Accordingly, the aggregate fair value amounts presented do not represent and should not be construed to represent the full underlying value of Sterling.

 

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The carrying amounts and fair values of financial instruments as of the periods indicated were as follows. Other assets are comprised of FHLB stock and derivatives, while other liabilities are comprised of derivatives:

 

     March 31, 2011      December 31, 2010  
     Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  
     (in thousands)  

Financial assets:

           

Cash and cash equivalents

   $ 436,377       $ 436,377       $ 427,264       $ 427,264   

Investments and MBS:

           

Available for sale

     2,808,030         2,808,030         2,825,010         2,825,010   

Held to maturity

     12,742         12,742         13,464         13,464   

Loans held for sale

     136,447         136,447         222,216         222,216   

Loans receivable, net

     5,320,884         5,031,617         5,379,081         5,078,157   

Accrued interest receivable

     35,044         35,044         34,087         34,087   

Other assets

     106,734         106,734         106,717         106,717   

Financial liabilities:

           

Non-maturity deposits

     3,480,270         3,211,558         3,376,188         3,123,840   

Deposits with stated maturities

     3,244,157         3,271,905         3,534,819         3,588,051   

Borrowings

     1,704,423         1,663,799         1,685,008         1,660,387   

Accrued interest payable

     18,019         18,019         17,259         17,259   

Other liabilities

     5,402         5,402         6,176         6,176   

Companies have the option of carrying financial assets and liabilities at fair value, which can be implemented on all or individually selected financial instruments. The framework for defining and measuring fair value requires that one of three valuation methods be used to determine fair market value: the market approach, the income approach or the cost approach. To increase consistency and comparability in fair value measurements and related disclosures, the standard also creates a fair value hierarchy to prioritize the inputs to these valuation methods into the following three levels:

 

 

Level 1 inputs are a select class of observable inputs, based upon the quoted prices for identical instruments in active markets that are accessible as of the measurement date, and are to be used whenever available.

 

 

Level 2 inputs are other types of observable inputs, such as quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are inactive; or other inputs that are observable or can be derived from or supported by observable market data. Level 2 inputs are to be used whenever Level 1 inputs are not available.

 

 

Level 3 inputs are significantly unobservable, reflecting the reporting entity’s own assumptions regarding what market participants would assume when pricing a financial instrument. Level 3 inputs are to be used only when Level 1 and Level 2 inputs are unavailable.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis. The following table presents Sterling’s financial instruments that are measured at fair value on a recurring basis:

 

     Total      Level 1      Level 2      Level 3  
     (in thousands)  

Balance, March 31, 2011:

           

Investment securities available-for-sale:

           

MBS

   $ 2,584,302       $ 0       $ 2,584,302       $ 0   

Municipal bonds

     200,859         0         200,859         0   

Other

     22,869         0         22,869         0   
                                   

Total investment securities available-for-sale

     2,808,030         0         2,808,030         0   

Loans held for sale

     136,447         0         136,447         0   

Other assets - derivatives

     6,989         0         2,686         4,303   
                                   

Total assets

   $ 2,951,466       $ 0       $ 2,947,163       $ 4,303   
                                   

Other liabilities - derivatives

   $ 5,402       $ 0       $ 1,493       $ 3,909   
                                   

Balance, December 31, 2010:

           

Investment securities available-for-sale:

           

MBS

   $ 2,602,610       $ 0       $ 2,602,610       $ 0   

Municipal bonds

     201,143         0         201,143         0   

Other

     21,257         0         21,257         0   
                                   

Total investment securities available-for-sale

     2,825,010         0         2,825,010         0   

Loans held for sale

     222,216         0         222,216         0   

Other assets - derivatives

     6,746         0         1,869         4,877   
                                   

Total assets

   $ 3,053,972       $ 0       $ 3,049,095       $ 4,877   
                                   

Other liabilities - derivatives

   $ 6,176       $ 0       $ 1,750       $ 4,426   
                                   

Level 2 derivatives represent mortgage banking interest rate lock and loan delivery commitments, as well as a common stock warrant carried as a derivative liability. Level 3 derivatives represent interest rate swaps, with market values for these instruments being equal to the present value differential between the fixed interest rate payments, as established in the swap agreement, and the floating interest rate payments, as projected by the forward interest rate curve, over the agreed to term of the swap. See Note 10 for a further discussion of these derivatives. The following table provides a reconciliation of interest rate swaps measured at fair value using significant unobservable or Level 3 inputs on a recurring basis during the three months ended March 31, 2011 and the year ended December 31, 2010. Gains and losses on these interest rate swaps are included in earnings as interest income or expense.

 

     Beginning
Balance
     Change included
in earnings
    Ending
Balance
 
     (in thousands)  

Three Months Ended March 31, 2011

  

Other assets - derivatives

   $ 4,877       $ (574   $ 4,303   

Other liabilities - derivatives

     4,426         (517     3,909   

Year Ended December 31, 2010

       

Other assets - derivatives

     4,547         330        4,877   

Other liabilities - derivatives

     4,319         107        4,426   

Changes in the fair value of available-for-sale securities are recorded on the balance sheet under accumulated-other-comprehensive income, while gains and losses from sales are recognized as income. The difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale that are carried at fair value were included in earnings as follows:

 

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     Three Months Ended March 31,  
     2011      2010  
     (in thousands)  

Mortgage banking operations

   $ 3,348       $ 2,771   

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis. Sterling may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis from application of lower of cost or market (“LOCOM”) accounting or write-downs of individual assets. The following table presents the carrying value for these financial assets as of the dates indicated:

 

     March 31, 2011  
     Total Carrying
Value
     Level 1      Level 2      Level 3  
     (in thousands)  

Loans

   $ 345,840       $ 0       $ 0       $ 345,840   

OREO

     136,916         0         0         136,916   

Mortgage servicing rights

     22,944         0         0         22,944   
     December 31, 2010  
     Total Carrying
Value
     Level 1      Level 2      Level 3  

Loans

   $ 539,032       $ 0       $ 0       $ 539,032   

OREO

     145,155         0         0         145,155   

Mortgage servicing rights

     20,604         0         0         20,604   

The loans disclosed above represent the carrying value of impaired loans at period end. OREO represents the carrying value after write-downs taken at foreclosure that were charged to the loan loss allowance, as well as specific reserves established subsequent to foreclosure due to updated appraisals. Fair value adjustments to the mortgage servicing rights were mainly due to market derived assumptions associated with mortgage prepayment speeds. Sterling carries its mortgage servicing rights at LOCOM, and they are accordingly measured at fair value on a non-recurring basis.

The methods and assumptions used to estimate the fair value 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 MBS

The fair value of investments and MBS has been valued using a matrix pricing technique based on quoted prices for similar instruments, which Sterling validates with non-binding broker quotes, in depth collateral analysis and cash flow stress testing.

Loans Held for Sale

Sterling has elected to carry loans held for sale at fair value. The fair values are based on investor quotes in the secondary market based upon the fair value of options and commitments to sell or issue mortgage loans. The fair value election was made to match changes in the value of these loans with the value of their economic hedges. Loan origination fees, costs and servicing rights, which were previously deferred on these loans, are now recognized as part of the loan value at origination.

Loans Receivable

 

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The fair value of performing 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. The fair value of nonperforming collateral dependent loans is estimated based upon the value of the underlying collateral. In addition, a liquidity discount has been applied against the portfolio to reflect the uncertainty surrounding the timing of when a sale may occur.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated using a discounted cash flow methodology to arrive at the present value of future expected earnings from the servicing of the loans. Model inputs include prepayment speeds, market interest rates, contractual interest rates on the loans being serviced, and the amount of other fee income generated over the servicing contract.

OREO

The fair value of OREO is estimated using third party appraisals, subject to updates to reflect comparable market transactions, with appraisals ordered for “as is” or “disposal value.”

Deposits

The fair values of deposits subject to immediate withdrawal such as interest and noninterest bearing checking, regular savings, and money market deposit accounts, are equal to the amounts payable on demand at the reporting date, net of a core deposit intangible. Fair values for time deposits are estimated by discounting future cash flows using interest rates currently offered on time deposits with similar remaining maturities.

Borrowings

The carrying amounts of short-term borrowings under repurchase agreements, federal funds purchased, short-term FHLB 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 the expected payment dates on the instruments. The fair value of advances under lines of credit approximates their carrying value because such advances bear variable rates of interest. The fair value of long-term FHLB advances and other long-term borrowings 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.

12. Regulatory Matters and Capital Position:

On September 27, 2010, Sterling announced the cease and desist order put in place in October 2009 with Sterling Savings Bank was terminated, reflecting a strengthened balance sheet and capital position. Although the cease and desist is no longer applicable, Sterling Savings Bank will continue to be subject to enhanced supervisory review by the FDIC and WDFI under a memorandum of understanding (“MOU”), pursuant to which Sterling Savings Bank must maintain Tier 1 capital in an amount that ensures that its leverage ratio is at least 8%. Sterling Savings Bank is also required to meet certain asset quality targets, develop a written capital plan, develop a three-year strategic plan and comply with other requirements. As of March 31, 2011, Sterling Savings Bank’s capital position exceeded the level prescribed under the MOU.

As of the date of this filing, Sterling continues to be subject to a regulatory agreement with the Federal Reserve Bank of San Francisco (the “Reserve Bank Agreement”). Under the terms of the Reserve Bank Agreement, Sterling is subject to restrictions on its ability to pay dividends and distributions, incur debt, purchase or redeem its stock and appoint new board members or senior executive officers. Under the Reserve Bank Agreement, Sterling is also required to act as a source of strength to Sterling Savings Bank and to report quarterly to the Reserve Bank on steps taken to improve its capital ratios and risk, liquidity and fund management and on other matters.

 

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The following table sets forth the respective capital positions for Sterling and Sterling Savings Bank as of March 31, 2011:

 

     Actual            Adequately
Capitalized
           Well-
Capitalized
        
     Amount      Ratio     Amount      Ratio     Amount      Ratio  
                  (in thousands)  

Tier 1 leverage ratio

               

Sterling

   $ 1,008,883         10.6   $ 379,868         4.0   $ 474,835         5.0

Sterling Savings Bank

     976,027         10.3     379,832         4.0     474,790         5.0

Tier 1 risk-based capital ratio

               

Sterling

     1,008,883         16.5     243,938         4.0     365,907         6.0

Sterling Savings Bank

     976,027         16.0     243,821         4.0     365,731         6.0

Total risk-based capital ratio

               

Sterling

     1,087,461         17.8     487,876         8.0     609,845         10.0

Sterling Savings Bank

     1,054,288         17.3     487,642         8.0     609,552         10.0

 

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Table of Contents

PART I – Financial Information (continued)

 

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

STERLING FINANCIAL CORPORATION

March 31, 2011

This report contains forward-looking statements. For a discussion about such statements, including the risks and uncertainties inherent therein, see “Forward-Looking Statements.” Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes presented elsewhere in this report and in Sterling’s 2010 annual report on Form 10-K.

General

Sterling Financial Corporation, with headquarters in Spokane, Washington, is the bank holding company for Sterling Savings Bank, which commenced operations in 1983. References to “Sterling,” “the Company,” “we,” “our,” or “us” in this report refer to Sterling Financial Corporation, a Washington corporation, and its consolidated subsidiaries on a combined basis, unless otherwise specified or the context otherwise requires. References to “Sterling Savings Bank” refer to our subsidiary Sterling Savings Bank, a Washington state-chartered commercial bank. References to “our subsidiary bank” or “our banking subsidiary” refer to Sterling Savings Bank. Sterling Savings Bank offers retail and commercial banking products and services, mortgage lending, construction financing and investment products to individuals, small businesses, commercial organizations and corporations. As of March 31, 2011, Sterling had assets of $9.35 billion and operated 178 depository branches throughout Washington, Oregon, Idaho, Montana, and California.

Executive Summary and Highlights

Net income available to common shareholders was $5.4 million or $0.09 per share for the first quarter of 2011, versus a net loss attributable to common shareholders of $88.8 million or $112.70 per common share for the same period in 2010. Comparability in per share results over the periods presented reflects the increase in the amount of shares outstanding subsequent to Sterling’s Recapitalization in August 2010.

The following are selected financial metrics from the first quarter of 2011:

 

 

Net interest margin expanded to 3.22%, improving 37 basis points from the first quarter of 2010.

 

 

Total funding costs were reduced by 38 basis points from the same period last year.

 

 

Nonperforming assets decreased $187.4 million, or 23%, to $628.8 million during the first quarter of 2011, and are down 41% from the same period in 2010.

 

 

The provision for credit losses declined by $78.6 million as compared with the same period in 2010.

 

 

The loan loss allowance at March 31, 2011 was $232.9 million, or 4.19% of total loans, compared to $294.8 million, or 4.19% of total loans at March 31, 2010.

 

 

Tier 1 leverage ratio increased to 10.6% at March 31, 2011, from 2.6% a year ago, and tangible common equity to tangible assets increased to 8.1% at March 31, 2011. As of March 31, 2011, Sterling’s regulatory capital ratios exceed the requirements to be deemed well-capitalized.

Critical Accounting Policies

The accounting and reporting policies of Sterling conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry. The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

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Allowance for Credit Losses. The allowance for credit losses is comprised of the allowance for loan losses and the reserve for unfunded credit commitments. In general, determining the amount of the allowance requires significant judgment and the use of estimates by management. Sterling maintains an allowance for credit losses to absorb probable losses in the loan portfolio based on a quarterly analysis of the portfolio and expected future losses. This analysis is designed to determine an appropriate level and allocation of the allowance for losses among loan types by considering factors affecting loan losses, including specific and confirmed losses, levels and trends in classified and nonperforming loans, historical loan loss experience, loan migration analysis, current national and local economic conditions, volume, growth and composition of the portfolio, regulatory guidance and other relevant factors. The reserve for unfunded credit commitments includes loss coverage for loan repurchases arising from mortgage banking activities. Management monitors the loan portfolio to evaluate the adequacy of the allowance. The allowance can increase or decrease each quarter based upon the results of management’s analysis.

The portfolio is grouped into standard industry categories for homogeneous loans based on characteristics such as loan type, borrower and collateral. Annual and quarterly loan migration to loss data is used to determine the probability of default. Currently, Sterling is establishing the expected loss rate on loans using losses from the most recent 12 months to estimate the amount that would be lost if a default were to occur, which is termed the “loss given default.” The probability of default is multiplied by the loss given default to calculate the expected losses for each loan category.

Sterling may also maintain an unallocated allowance to provide for other credit losses that may exist in the loan portfolio that are not taken into consideration in establishing the probability of default and loss given default. The unallocated amount may generally be maintained at higher levels during times of economic uncertainty. The unallocated amount is reviewed at least quarterly based on credit and economic trends. As of March 31, 2011, the unallocated allowance was 13% of the allowance for loan losses, unchanged from December 31, 2010.

Individual loan reviews are based upon specific quantitative and qualitative criteria, including the size of the loan, loan quality ratings, value of collateral, repayment ability of borrowers and guarantors, as applicable, and historical experience factors. The historical experience factors utilized and allowances for homogeneous loans (such as residential mortgage loans and consumer loans) are collectively evaluated based upon historical loss experience, loan migration analysis, trends in losses and delinquencies, growth of loans in particular markets, and known changes in economic conditions in each particular lending market.

A loan is considered impaired when, based on current information and events, it is probable Sterling will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reasons for the delay, the borrower’s prior payment record, the ability and willingness of guarantors to make payments, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent.

The fair value of the underlying collateral for real estate loans, which may or may not be collateral dependent, is determined by using appraisals from qualified external sources. For commercial properties and residential development loans, the external appraisals are reviewed by qualified internal appraisal staff to ensure compliance with appropriate standards and technical accuracy. Appraisals are updated according to regulatory provisions for extensions or restructurings of commercial or residential real estate construction and permanent loans that have not performed within the terms of the original loan. Updated appraisals are also ordered for loans that have not been restructured, but that have stale valuation information, generally defined in the current market as information older than one year, and deteriorating credit quality that warrants classification as substandard.

The timing of obtaining appraisals may vary, depending on the nature and complexity of the property being evaluated and the general breadth of appraisal activity in the marketplace, but generally it is within 30 to 90 days of recognition of substandard status, following determination of collateral dependency, or in connection with a loan’s maturity or a negotiation that may result in the restructuring or extension of a real estate secured loan. Delays in timing may occur to comply with actions such as a bankruptcy filing or provisions of an SBA guarantee.

 

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Estimates of fair value may be used for substandard collateral dependent loans at quarter end if external appraisals are not expected to be completed in time for determining quarter end results or to update values between appraisal dates to reflect recent sales activity of comparable inventory or pending property sales of the subject collateral. Sterling records a specific reserve for impaired loans for which an updated valuation analysis has not been completed within the last quarter. The specific reserve is calculated by applying an estimated fair value adjustment to each loan based on market and property type. Estimates of value are not used to raise a value; however, estimates may be used to recognize deterioration of market values in quarters between appraisal updates. The judgment with respect to recognition of any provision or related charge-off for a confirmed loss also takes into consideration whether the loan is collateral dependent or whether it is supported by sources of repayment or cash flow beyond the collateral that is being valued. For loans that are deemed to be collateral dependent, the amount of charge-offs is determined in relation to the collateral’s appraised value. For loans that are not deemed to be collateral dependent, the amount of charge-offs may differ from the collateral’s appraised value because there is additional support for the loan, such as cash flow from other sources.

While management uses available information to provide for loan losses, the ultimate collectability of a substantial portion of the loan portfolio and the need for future additions to the allowance will be influenced by changes in economic conditions and other relevant factors. There can be no assurance that the allowance for credit losses will be adequate to cover all losses, but management believes the allowance for credit losses was adequate at March 31, 2011.

Income Taxes. Sterling estimates income taxes payable based on the amount it expects to owe various taxing authorities. Accrued income taxes represent the net estimated amount due to, or to be received from, taxing authorities. In estimating accrued income taxes, Sterling assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account the applicable statutory, judicial and regulatory guidance in the context of Sterling’s tax position. Sterling also considers recent audits and examinations, as well as its historical experience in making such estimates. Although Sterling uses available information to record income taxes, underlying estimates and assumptions can change over time as a result of unanticipated events or circumstances. Penalties and interest associated with any potential estimate variances would be included in income tax expense on the Consolidated Statement of Income.

Sterling uses an estimate of future earnings and an evaluation of its loss carryback ability and tax planning strategies to determine whether it is more likely than not that it will realize the benefit of its net deferred tax asset. Sterling has determined that it does not at this time meet the required threshold, and accordingly, has a valuation allowance against its deferred tax asset. During the three months ended March 31, 2011, Sterling did not recognized any income tax expense, as the income tax for the quarter was offset by a reduction in the deferred tax asset valuation allowance.

 

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Results of Operations

The most significant component of earnings for a financial institution typically is net interest income, which is the difference between interest income, primarily from loans, MBS and investment securities, and interest expense, primarily on deposits and borrowings. Net interest spread refers to the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin refers to net interest income divided by total average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. The following table sets forth, on a tax equivalent basis, information with regard to Sterling’s net interest income, net interest spread and net interest margin:

 

     Three Months Ended  
     March 31, 2011     March 31, 2010  
     Average
Balance
     Interest
Income/
Expense
     Yields/
Rates
    Average
Balance
    Interest
Income/
Expense
     Yields/
Rates
 
     (in thousands)  

ASSETS:

  

Loans:

               

Mortgage

   $ 3,428,296       $ 43,111         5.04   $ 4,704,576      $ 49,897         4.25

Commercial and consumer

     2,520,610         37,393         6.02     3,285,954        47,242         5.83
                                                   

Total loans (1)

     5,948,906         80,504         5.45     7,990,530        97,139         4.90

MBS (2)

     2,590,546         20,034         3.09     1,792,460        19,826         4.42

Investments and cash (2)

     792,959         3,900         1.99     962,400        3,887         1.64

FHLB stock

     99,953         0         0.00     100,682        0         0.00
                                                   

Total interest-earning assets

     9,432,364         104,438         4.46     10,846,072        120,852         4.49
                                       

Noninterest-earning assets (3)

     68,518              (152,171     
                           

Total average assets

   $ 9,500,882            $ 10,693,901        
                           

LIABILITIES and EQUITY:

               

Deposits:

               

Interest-bearing transaction

   $ 493,651         146         0.12   $ 1,040,020        863         0.34

Savings and MMDA

     1,959,561         1,970         0.41     1,557,907        2,949         0.77

Time deposits

     3,453,419         15,178         1.78     4,070,961        23,639         2.35
                                                   

Total interest-bearing deposits

     5,906,631         17,294         1.19     6,668,888        27,451         1.67

Borrowings

     1,694,391         12,200         2.92     2,564,223        17,155         2.71
                                                   

Total interest-bearing liabilities

     7,601,022         29,494         1.57     9,233,111        44,606         1.96

Noninterest-bearing transaction

     1,005,290         0         0.00     991,447        0         0.00
                                                   

Total funding liabilities

     8,606,312         29,494         1.39     10,224,558        44,606         1.77
                                       

Other noninterest-bearing liabilities

     125,026              175,939        
                           

Total average liabilities

     8,731,338              10,400,497        

Total average equity

     769,544              293,404        
                           

Total average liabilities and equity

   $ 9,500,882            $ 10,693,901        
                           

Net interest income and spread (4)

      $ 74,944         2.89     $ 76,246         2.53
                                       

Net interest margin (4)

           3.22          2.85
                           

Deposits:

               

Total interest-bearing deposits

   $ 5,906,631       $ 17,294         1.19   $ 6,668,888      $ 27,451         1.67

Noninterest-bearing transaction

     1,005,290         0         0.00     991,447        0         0.00
                                                   

Total deposits

   $ 6,911,921       $ 17,294         1.01   $ 7,660,335      $ 27,451         1.45
                                                   

 

(1) Includes gross nonperforming loans.
(2) Does not include market value adjustments on available for sale securities.
(3) Includes charge-offs on nonperforming loans (“confirmed losses”) and the allowance for credit losses.
(4) Interest income on certain loans and securities are presented gross of their applicable tax savings using a 37% effective tax rate.

 

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The following table sets forth the return on average assets and return on average common equity for the periods presented:

 

     Three Months Ended March 31,  
     2011     2010  

Return on average assets

     0.23     -3.20

Return on average common equity

     2.85     NM  (1) 

 

(1)

NM stands for "not meaningful," as the balance of common equity reflected a deficiency as of the date indicated.

Net Interest Income. Sterling reported net interest income of $73.7 million for the three months ended March 31, 2011, representing a decline of 2% compared with $74.9 million for the three months ended March 31, 2010. The decline in net interest income over the periods presented mainly reflects a decline in average loan balances. The effect of the decline in average loan balances was mostly offset by expansion in the net interest margin, which was 3.22% during the first quarter of 2011 versus 2.85% in the same period a year earlier. The net interest margin expanded primarily due to the decline in nonperforming loans and the reduced cost of deposits. The reversal of interest income from nonperforming loans reduced the net interest margin by 53 basis points for the first quarter of 2011, compared with 87 basis points for the first quarter of 2010.

Provision for Credit 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. This process includes information derived from many factors, including historical loss trends, trends in classified assets, trends in delinquent and nonaccrual loans, trends in portfolio volume, diversification as to type of loan, size of individual credit exposure, current and anticipated economic conditions, loan policies, collection policies and effectiveness, quality of credit evaluation, effectiveness of policies, procedures and practices, and recent loss experience of peer banking institutions.

Sterling recorded provisions for credit losses of $10.0 million and $88.6 million for the three months ended March 31, 2011 and 2010, respectively. The reduced level of credit loss provisioning reflects improvement in asset quality as evidenced by the decline in nonperforming loans and charge-offs.

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

 

     Three Months Ended March 31,  
     2011     2010     % change  
     (in thousands)        

Fees and service charges

   $ 12,561      $ 13,035        -4

Mortgage banking operations

     10,327        11,232        -8

Loan servicing fees

     1,101        1,146        -4

BOLI

     1,732        2,295        -25

Gains on sales of securities

     6,001        1,911        214

Other

     (1,740     (4,322     -60
                        

Total noninterest income

   $ 29,982      $ 25,297        19
                        

Increases in gains on sales of securities, combined with lower losses on portfolio loan sales (which are included in other), were the primary causes of variances in noninterest income. Securities sales were driven both from the realization of certain valuations, and rebalancing of the portfolio to reduce duration levels. Other noninterest income for the three months ended March 31, 2010 included $3.7 million of losse